rsls_Current_Folio_10K

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

(Mark one)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 

For the fiscal year ended December 31, 2018

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to

 

Commission file number: 1-33818


RESHAPE LIFESCIENCES INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware

48-1293684

(State or other jurisdiction of incorporation)

(IRS Employer Identification No.)

 

1001 Calle Amanecer, San Clemente, California 92673

(Address of principal executive offices, including zip code)

 

(949) 429-6680

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

Title of Class

    Trading Symbol

Name of Exchange on which Registered

Common stock, $0.01 par value per share

RSLS

OTCQB Market

 

Securities registered pursuant to Section 12(g) of the Act: None


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ◻    No   

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ◻    No   

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  ◻ 

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  ◻ 

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

Large accelerated filer   ◻

Accelerated filer  ◻

Non-accelerated filer   

Smaller reporting company 

 

Emerging growth company  ◻

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ◻

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ◻    No    

 

At June 30, 2018, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant, based upon the closing price of a share of the registrant’s common stock as reported by the NASDAQ Capital Market on that date was $7,608,535.  

 

As of April 22, 2019, 8,895,233 shares of the registrant’s Common Stock were outstanding.

 

Documents Incorporated by Reference

Portions of the registrant's proxy statement for the 2019 Annual Meeting of Stockholders (to be filed within 120 days of December 31, 2018) are incorporated by reference into Part III, as indicated herein.  


 

Table of Contents

 

 

 


 

Table of Contents

RESHAPE LIFESCIENCES INC.

FORM 10-K

TABLE OF CONTENTS

 

 

 

 

PART I

 

 

 

Item 1. 

Business

1

Item 1A. 

Risk Factors

12

Item 1B. 

Unresolved Staff Comments

29

Item 2. 

Properties

29

Item 3. 

Legal Proceedings

29

Item 4. 

Mine Safety Disclosures

31

 

 

 

PART II 

 

 

 

Item 5. 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

32

Item 6. 

Selected Financial Data

32

Item 7. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

33

Item 8. 

Financial Statements and Supplementary Data

39

Item 9. 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

71

Item 9A. 

Controls and Procedures

71

Item 9B. 

Other Information

73

 

 

 

PART III 

 

 

 

Item 10. 

Directors, Executive Officers and Corporate Governance

74

Item 11. 

Executive Compensation

74

Item 12. 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

74

Item 13. 

Certain Relationships and Related Transactions, and Director Independence

75

Item 14. 

Principal Accountant Fees and Services

75

 

 

 

PART IV 

 

 

 

Item 15. 

Exhibits, Financial Statements and Financial Statement Schedules

75

Item 16. 

Form 10-K Summary

75

 

 

EXHIBITS 

76

 

 

SIGNATURES 

80

 

Registered Trademarks and Trademark Applications: In the United States we have registered trademarks for LAP-BAND®, LAP-BAND AP®, LAP BAND SYSTEM®, RAPIDPORT®, RESHAPE® and RESHAPE MEDICAL®, each registered with the United States Patent and Trademark Office, and trademark applications for RESHAPE VEST, and RESHAPE LIFESCIENCES.  In addition, some or all of the marks LAP-BAND, LAP-BAND AP, LAP BAND SYSTEM, RAPIDPORT, RESHAPE, RESHAPE MEDICAL, RESHAPE VEST, and RESHAPE LIFESCIENCES are the subject of either a trademark registration or an application for registration in Australia, Canada, the European Community, Mexico, Saudi Arabia, South Korea, and the United Arab Emirates.  We believe that we have common law trademark rights to RESHAPE VEST.  This Annual Report on Form 10-K contains other trade names and trademarks and service marks of ReShape Lifesciences and of other companies.

 

 


 

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ITEM 1. BUSINESS

Our Company

The Company is a developer of minimally invasive medical devices that advance bariatric surgery to treat obesity and metabolic diseases. The Company’s current portfolio includes the LAP-BAND® Adjustable Gastric Banding System and the ReShape VestTM, an investigational device, to help treat more patients with obesity. Our vision is to be recognized as a leading medical technology company focused on the design, development and commercialization of transformative technology to treat obesity and metabolic diseases.

Our Product Portfolio

Lap-Band System

The Lap-Band System, which we acquired from Apollo Endosurgery, Inc. (“Apollo”), in December 2018, is designed to provide minimally invasive long-term treatment of severe obesity and is an alternative to more invasive surgical stapling procedures such as the gastric bypass or sleeve gastrectomy. The Lap-Band System is an adjustable saline-filled silicone band that is laparoscopically placed around the upper part of the stomach through a small incision, creating a small pouch at the top of the stomach, which slows the passage of food and creates a sensation of fullness. The procedure can normally be performed as an outpatient procedure, where the patient is able to go home the day of the procedure without the need for an overnight hospital stay.

The Lap-Band System has been in use in Europe since 1993 and received the CE mark in 1997. FDA approval for the Lap-Band System in the U.S. was obtained in 2001 and the Lap-Band System has been approved in many countries around the world. More than 860,000 Lap-Band Systems have been distributed worldwide.

The Lap-Band System was approved for use in the U.S. for patients with Body Mass Index (“BMI”) greater than or equal to 40 or a BMI greater than or equal to 35 with one or more severe comorbid conditions. In 2011, the U.S. FDA granted approval for an expanded indication for the Lap-Band System to include patients with a BMI in the range of 30 to 35 and with one or more comorbid conditions.

The Lap-Band System has been subject to more than 400 peer-reviewed publications and extensive real-world experience. Adjustable gastric banding using the Lap-Band System has been reported to be significantly safer than gastric bypass while statistically producing the same weight loss five years after surgery when accompanied by an appropriate post-operative follow-up and adjustment protocol. Studies have reported sustained resolution or improvement in type 2 diabetes, gastroesophageal reflux, obstructive sleep apnea, asthma, arthritis, hypertension and other pre-existing obesity related comorbidities following gastric banding. The gastric banding surgical procedure is generally reimbursed by most payors and insurance programs that cover bariatric surgery.

Benefits.  Lap-Band System offers the following benefits:

·

Minimally Invasive.  The Lap-Band System does not change anatomy and is removable or reversible.

·

Lifestyle Enhancing.  The Lap-Band System helps patients lose weight and live a more comfortable life and potentially reduces co-morbidities from excess weight.

·

Durable Weight Loss.  The Lap-Band System offers a sustainable solution that helps patients achieve long-term success.

ReShape Vest

The ReShape Vest is an investigational, minimally invasive, laparoscopically implanted medical device being studied for weight loss in morbidly obese adults with a BMI of at least 35. The device wraps around the stomach, emulating the effect of conventional weight loss surgery, and is intended to enable gastric volume reduction. This device is designed to restrict the intake of food and provide the feeling of fullness without cutting or permanently removing portions of the stomach, or bypassing, any portion of the gastrointestinal tract. The implantation of the device mimics a traditional weight‑loss surgery without permanently altering the anatomy and may not require vitamin supplementation.

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In a small pilot study conducted outside the United States, at 12 months, ReShape Vest patients demonstrated a mean percent excess weight loss (“%EWL”) of 85% and a mean percent total body weight loss of 30.2%, an average drop in HbA1c (Hemoglobin A1c) of 2.1 points, an average decrease of systolic blood pressure of 13mmHg, an average waist circumference reduction of 38 centimeters, or approximately 15 inches, and an average increase in HDL “good cholesterol” of 29 mg/dl.

Benefits.  The ReShape Vest, if approved for sale, would allow us to offer an additional weight loss solution that emulates the effect of conventional weight loss surgery through a procedure that is minimally invasive. The ReShape Vest potentially offers the following benefits:

·

Minimizes Changes to Normal Anatomy.  The ReShape Vest emulates the effects of conventional weight‑loss surgery without stapling, cutting or removing any portion of the stomach.

·

Minimally Invasive Procedure.  Unlike conventional weight loss surgery, which typically is performed in a hospital setting under general anesthesia and requires a hospital stay of up to four days, the ReShape Vest may result in shorter hospital stays.

·

Removable/Reversible.  The ReShape Vest is designed to be removed laparoscopically, permitting the removal of the device at a later time, if that is desired.

·

Allows Continued Ingestion and Digestion of Foods Found in a Typical, Healthy Diet.  Because the ReShape Vest also leaves the digestive anatomy largely unaltered, patients are able to maintain a more consistent nutritional balance compared to conventional surgical approaches, thus allowing them to effect positive changes in their eating behavior in a non‑forced and potentially more consistent way.

The ReShape Vest will continue to be studied in upcoming trials in the US and internationally. In the U.S., we are currently planning a non-randomized trial enrolling approximately 250 patients at approximately 15-20 investigational sites with a 12-month primary endpoint (weight loss and safety) and 24 to 36-month follow-up. We intend to initiate that study in 2020 and our goal is to have FDA premarket approval (“PMA”)  in the second half of 2022. Internationally, we initiated a non-randomized trial enrolling up to 95 patients at investigational sites in five countries (Germany, Netherlands, Belgium, Spain and Czech Republic) with a 12-month primary endpoint (weight loss and safety) and 24-month follow-up. We expect to obtain the CE mark by the third quarter of 2021.

ReShape vBloc

ReShape vBloc uses vBloc Therapy to block the gastrointestinal effects of the vagus nerve using high‑frequency, low‑energy electrical impulses to intermittently interrupt naturally occurring neural impulses on the vagus nerve between the brain and the digestive system. We are not currently actively marketing ReShape vBloc, although we continue to support existing patients and their physicians. We are also currently investigating a proprietary technique that would utilize our vBloc technology to stimulate nerves feeding into the pancreas while simultaneously blocking nerves feeding into the liver. The goal of the procedure is to increase release of the body’s natural insulin and to prevent glucose release from the liver into the blood stream.

Our Strategic Focus

Develop and Commercialize a Differentiated Portfolio of Products/Therapies

An overarching strategy for our company is to develop and commercialize a product portfolio that is differentiated from our competition by offering transformative technologies to bariatric surgeons that consists of a selection of patient friendly, non-anatomy changing, lifestyle enhancing alternatives to traditional bariatric surgery that help patients achieve durable weight loss. With the Lap-Band System and the ReShape Vest (if approved for commercial use), we believe we have two compelling and differentiated medical devices. We believe that we are well positioned for the existing market

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and can serve more of the overweight and obese population with our solutions and thereby help expand the addressable market for obesity.

Picture 1

Drive the Adoption of Our Portfolio through Obesity Therapy Experts and Patient Ambassadors

Our clinical development strategy is to collaborate closely with regulatory bodies, healthcare providers, obesity therapy experts and others involved in the obesity management process, patients and their advocates and scientific experts. We have established relationships with obesity therapy experts and healthcare providers, including physicians and hospitals, and have identified Lap-Band patient ambassadors and we believe these individuals will be important in promoting patient awareness and gaining widespread adoption of the Lap-Band and the ReShape Vest.

Expand and Protect Our Intellectual Property Position

We believe that our issued patents and our patent applications encompass a broad platform of therapies focused on obesity, diabetes, hypertension and other gastrointestinal disorders. We intend to continue to pursue further intellectual property protection through U.S. and foreign patent applications.

Leverage our vBloc Technology for Other Disease States

We intend to continue to conduct research and development for other potential applications for our vBloc Therapy and believe we have a broad technology platform that will support the development of additional clinical applications and therapies for other metabolic and gastrointestinal disorders in addition to obesity.

Alternative Weight Loss Solutions

If we are able to commercialize the ReShape Vest, we believe that we will be able to offer two distinct weight loss treatment solutions that may be selected by the physician depending on the severity of the patient’s BMI or condition. Together, the Lap-Band and ReShape Vest provide a minimally-invasive continuum of care for bariatric patients and their care providers.

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Our Market

The Obesity and Metabolic Disease Epidemic

Obesity is a disease that has been increasing at an alarming rate with significant medical repercussions and associated economic costs. The World Health Organization (“WHO”) currently estimates that more than 2.1 billion adults, approximately 30% of the global population, are overweight. The global economic impact of obesity is approximately $2 trillion, or approximately 2.8% of global GDP. Healthcare costs for severely or morbidly obese adults are 81% higher than for healthy weight adults and obesity is responsible for 5% of deaths worldwide. We believe our products and product candidates could address a $1.64 billion per year global surgical device market.

We believe that this epidemic will continue to grow worldwide given dietary trends in developed nations that favor highly processed sugars, larger meals and fattier foods, as well as increasingly sedentary lifestyles. Despite the growing obesity rate, increasing public interest in the obesity epidemic and significant medical repercussions and economic costs associated with obesity, there continues to be a significant unmet need for effective treatments.

The United States Market

Obesity has been identified by the U.S. Surgeon General as the fastest growing cause of disease and death in the United States, and according to a 2014 McKinsey Report is the leading cause of preventable death in the U.S. Currently, it is estimated that approximately 160 million American adults are overweight or obese, 74 million American adults are overweight, 78 million American adults are obese or severely obese, and 24 million American adults are morbidly obese. It is estimated that if obesity rates stay consistent, 51% of the U.S. population will be obese by 2030. According to data from the U.S. Department of Health and Human Services, almost 80% of adults with a BMI above 30 have comorbidity, and almost 40% have two or more of these comorbidities. According to The Obesity Society and the CDC, obesity is associated with many significant weight‑related comorbidities including Type 2 diabetes, high blood‑pressure, sleep apnea, certain cancers, high cholesterol, coronary artery disease, osteoarthritis and stroke. According to the American Cancer Society, 572,000 Americans die of cancer each year, over one‑third of which are linked to excess body weight, poor nutrition and/or physical inactivity. Over 75% of hypertension cases are directly linked to obesity, and more than 90% of the approximately 28 million U.S. adults with Type 2 diabetes are overweight or have obesity.

Currently, medical costs associated with obesity in the U.S. are estimated to be up to $210 billion per year and nearly 21% of medical costs in the U.S. can be attributed to obesity. An estimated approximately $1.5 billion was spent in 2015 alone in the U.S. on approximately 200,000 bariatric surgical procedures to treat obesity. By 2025, it is estimated that up to $3.8 billion will be spent in the U.S. on approximately 800,000 bariatric surgical procedures to treat obesity. Researchers estimate that if obesity trends continue, obesity related medical costs could rise by another $44‑$66 billion each year in the U.S. by 2030. The medical costs paid by third‑party payers for people who are obese were $2,741 per year, or 42% higher than those of people who are normal weight and the average cost to employers is $6,627 to $8,067 per year per obese employee (BMI of 35 to 40 and higher).

Current Treatment Options and Their Limitations

We believe existing bariatric surgery and endoscopic procedural options for the treatment of obesity have seen limited adoption to date, with approximately 1% of the obese population qualifying for treatment actually seeking treatment, due to patient concerns and potential side effects including permanently altered anatomy and morbidity.

The principal treatment alternatives available today for obesity include:

·

Behavioral modification.  Behavioral modification, which includes diet and exercise, is an important component in the treatment of obesity; however, most obese patients find it difficult to achieve and maintain significant weight loss with a regimen of diet and exercise alone.

·

Pharmaceutical therapy.  Pharmaceutical therapies often represent a first option in the treatment of obese patients but carry significant safety risks and may present troublesome side effects and compliance issues.

·

Bariatric Surgery and Endoscopic Procedures.  In more severe cases of obesity, patients may pursue more aggressive surgical treatment options such as sleeve gastrectomy and gastric bypass. These procedures

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promote weight loss by surgically restricting the stomach’s capacity and outlet size. While largely effective, these procedures generally result in major lifestyle changes, including dietary restrictions and food intolerances, and they may present substantial side effects and carry short‑ and long‑term safety and side effect risks that have limited their adoption.

Our Research and Development

Current R&D Focus

We have an experienced research and development team, including clinical, regulatory affairs and quality assurance, comprised of scientists and mechanical engineers with significant clinical knowledge and expertise. Our research and development efforts are focused in the following major areas:

 

·

supporting the current Lap-Band System;

 

·

testing and developing the ReShape Vest; and

 

·

investigating ReShape vBloc for the treatment of type 2 diabetes, which, if marketed, would require additional FDA approval through the PMA process.

 

We have spent a significant portion of our capital resources on research and development. Our research and development expenses from continuing operations were $5.7 million in 2018 and $5.4 million in 2017.

Our Competition

The market for obesity treatments is competitive, subject to technological change and significantly affected by new product development. Our primary competition in the obesity treatment market is currently from bariatric surgical procedures and from endoscopic procedures.

Our Lap-Band System competes, and we expect that our ReShape Vest System will compete, with surgical obesity procedures, including gastric bypass, gastric balloons, sleeve gastrectomy and the endoscopic sleeve.  These current surgical procedures are performed in less than 1% of all eligible obese patients today. Current manufacturers of gastric balloon and suturing products that are approved in the United States include Apollo (ORBERA Intragastric Balloon System and OverStitch Endoscopic Suturing System) and Obalon Therapeutics, Inc. (Obalon Balloon System).

In June 2016, Aspire Bariatrics, Inc. received FDA approval for the Aspire Assist® System, an endoscopic alternative to weight loss surgery for people with moderate to severe obesity. We are also aware that GI Dynamics, Inc. has received approvals in various international countries to sell its EndoBarrier Gastrointestinal Liner.

We also compete against the manufacturers of pharmaceuticals that are directed at treating obesity and the 99% of obese patients eligible for surgery that are not willing to pursue a surgical option. We are aware of a number of drugs that are approved for long-term treatment of obesity in the United States: Orlistat, marketed by Roche as Xenical and GlaxoSmithKline as Alli, Belviq marketed by Arena Pharmaceuticals, Inc., Qsymia, marketed by VIVUS, Inc. and Contrave, marketed by Orexigen Therapeutics, Inc.  In addition, we are aware of a pivotal trial for GELESIS100 that is being conducted by Gelesis, Inc.

In addition to competition from surgical obesity procedures, we compete with several private early-stage companies developing neurostimulation devices for application to the gastric region and related nerves for the treatment of obesity. Further, we know of two intragastric balloon companies either in clinical trials or working toward clinical trials in the US:  Spatz3 Adjustable Balloon and Allurion Technology’s Elipse Balloon. These companies may prove to be significant competitors, particularly through collaborative arrangements with large and established companies. They also compete with us in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and subject registration for clinical trials, as well as in acquiring technologies and technology licenses complementary to our programs or advantageous to our business.

In addition, there are many larger potential competitors experimenting in the field of neurostimulation to treat various diseases and disorders. For example, Medtronic plc, which develops deep brain stimulators and spinal cord

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stimulators, acquired TransNeuronix, which sought to treat obesity by stimulating the smooth muscle of the stomach wall and nearby tissue. St. Jude Medical, Inc., through its acquisition of Advanced Neuromodulation Systems, is developing spinal cord stimulators. LivaNova PLC is developing vagus nerve stimulators to modulate epileptic seizures and other neurological disorders. Boston Scientific Corporation, through its Advanced Bionics division, is developing neurostimulation devices such as spinal cord stimulators and cochlear implants. Ethicon-Endo Surgery acquired LivaNova PLC’s patents and patent applications pertaining to vagus nerve stimulation for the treatment of obesity and two related comorbidities, diabetes and hypertension, in overweight patients.

We believe that the principal competitive factors in our market include:

·

acceptance by healthcare professionals, patients and payers;

 

·

published rates of safety and efficacy;

 

·

reliability and high quality performance;

 

·

effectiveness at controlling comorbidities such as diabetes and hypertension;

 

·

invasiveness and the inherent reversibility of the procedure or device;

 

·

cost and average selling price of products and relative rates of reimbursement;

 

·

effective marketing, education, sales and distribution;

 

·

regulatory and reimbursement expertise;

 

·

technological leadership and superiority; and

 

·

speed of product innovation and time to market.

 

Many of our competitors are larger than we are and are either publicly-traded or are divisions of publicly-traded companies, and they enjoy several competitive advantages over us, including:

 

·

significantly greater name recognition;

 

·

established relations with healthcare professionals, customers and third-party payers;

 

·

established distribution networks;

 

·

greater experience in research and development, manufacturing, preclinical testing, clinical trials, obtaining regulatory approvals, obtaining reimbursement and marketing approved products; and

 

·

greater financial and human resources.

As a result, we cannot assure you that we will be able to compete effectively against these companies or their products.

Market Opportunity

Given the limitations of behavioral modification, pharmaceutical therapy and traditional bariatric surgical approaches, we believe there is a substantial need for patient-friendly, safer, effective and durable solutions that:

·

preserves normal anatomy;

 

·

are “non-punitive” in that they support continued ingestion and digestion of foods and micronutrients such as vitamins and minerals found in a typical, healthy diet while allowing the user to modify his or her eating

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behavior appropriately without inducing punitive physical restrictions that physically force a limitation of food intake; 

 

·

minimize undesirable side-effects; 

 

·

minimize the risks of re-operations, malnutrition and mortality; and 

 

·

reduce the natural hunger drive of patients.

 

Our Intellectual Property

In order to remain competitive, we must develop and maintain protection of the proprietary aspects of our technologies. We rely on a combination of patents, trademarks, trade secret laws and confidentiality and invention assignment agreements to protect our intellectual property rights. Our patent applications may not result in issued patents and our patents may not be sufficiently broad to protect our technology. Any patents issued to us may be challenged by third parties as being invalid or unenforceable, or third parties may independently develop similar or competing technology that does not infringe our patents. The laws of certain foreign countries do not protect our intellectual property rights to the same extent as do the laws of the United States.

Lap-Band

As of December 31, 2018, we had 101 total U.S. and foreign patents and patent applications related to our Lap-Band System. The international patents and patent applications are in regions including the United States, Germany, France, Spain, the UK, Mexico, Canada, Italy, the Netherlands, Portugal, Ireland, Belgium, Poland, Australia, and South Korea. The issued patents expire between the years 2020 and 2031. 

We also have 226 total U.S. and international trademarks for the LAP-BAND brand name.

ReShape Vest

As of December 31, 2018, we had four granted U.S. patents and four granted foreign patents in China, Israel, Canada and Australia related to our ReShape Vest. The patents expire between the years 2029 and 2032.

We also have U.S. and international trademark applications for the RESHAPE VEST brand name.

Sales and Distribution

We market directly to patients but sell the Lap-Band System to select surgical centers throughout the United States and internationally that have patients that would like to treat obesity and its comorbidities. The surgical centers then sell our product to the patients and implant. Our sales representatives are supported by field clinical experts who are responsible for training, technical support, and other support services at various implant centers. Our sales representatives implement consumer marketing programs and provide surgical centers and implanting surgeons with educational patient materials.

In connection with our acquisition of the Lap-Band System in December 2018, we entered into a transition services agreement, supply agreement and distribution agreement with Apollo pursuant to which, among other things, Apollo will manufacture the Lap-Band product for us for up two years and Apollo will serve as our distributor of the Lap-Band product outside of the United States for up to one year.

In order to support our Lap-Band sales efforts, we have increased the size of our dedicated U.S. sales team from two to six. We have also launched co-op marketing campaigns that allow us to partner with clinics in marketing efforts and use digital marketing to drive qualified leads to physicians. During the first half of 2019, our international sales efforts will be through a combination of distributor and direct sales channels, with a focus on top Lap-Band customers in Australia and Europe.

On July 25, 2017, we entered into a Collaboration Agreement with Galvani Bioelectronics Limited (“Galvani”). Under the Collaboration Agreement, we agreed to modify our ReShape vBloc for use in pre-clinical research by Galvani

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in exchange for payment for our development work and supply under this agreement. We retained all rights, title, and ownership in the intellectual property for the new device. Galvani was granted a right of first negotiation for the potential exclusive or non-exclusive supply by us of the developed device, exercisable at Galvani’s election. We have not collaborated with Galvani since late in 2017 and we do not have any further plans to re-engage any further research activities with them at this time.

Our Manufacturers and Suppliers

We are party to a supply agreement with Apollo pursuant to which, among other things, Apollo will manufacture the Lap-Band product for us for up two years after our acquisition of the Lap-Band product, which was completed in December 2018.

To date, all of the materials and components of our products, as well as any related outside services, are procured from qualified suppliers and contract manufacturers in accordance with our proprietary specifications. All of our key manufacturers and suppliers have experience working with commercial implantable device systems, are ISO certified and are regularly audited by various regulatory agencies including the FDA. Our key manufacturers and suppliers have a demonstrated record of compliance with international regulatory requirements.

Given that we rely on third-party manufacturers and suppliers for the production of our products, our ability to increase production going forward will depend upon the experience, certification levels and large scale production capabilities of our suppliers and manufacturers. Qualified suppliers and contract manufacturers have been and will continue to be selected to supply products on a commercial scale according to our proprietary specifications. Our FDA approval process required us to name and obtain approval for the suppliers of key components of the Lap-Band System.

Many of our parts are custom designed and require custom tooling and, as a result, we may not be able to quickly qualify and establish additional or replacement suppliers for the components of our products. Any new approvals of vendors required by the FDA or other regulatory agencies in other international markets for our products as a result of the need to qualify or obtain alternate vendors for any of our components would delay our ability to sell and market our products and could have a material adverse effect on our business.

We believe that our current manufacturing and supply arrangements will be adequate to continue our ongoing commercial sales and our ongoing and planned clinical trials. In order to produce our products in the quantities we anticipate to meet future market demand, we will need our manufacturers and suppliers to increase, or scale up, manufacturing production and supply arrangements by a significant factor over the current level of production. There are technical challenges to scaling up manufacturing capacity and developing commercial-scale manufacturing facilities that may require the investment of substantial additional funds by our manufacturers and suppliers and hiring and retaining additional management and technical personnel who have the necessary experience. If our manufacturers or suppliers are unable to do so, we may not be able to meet the requirements to expand the launch of the product in the United States or launch the product internationally or to meet future demand, if at all. We may also represent only a small portion of our suppliers’ or manufacturers’ business and if they become capacity constrained, they may choose to allocate their available resources to other customers that represent a larger portion of their business. If we are unable to obtain a sufficient supply of our product, our revenue, business and financial prospects would be adversely affected.

Government Regulations

Device Classification and Regulations

United States

Our products and products under development are regulated by the FDA as medical devices under the Federal Food, Drug, and Cosmetic Act (“FFDCA”) and the regulations promulgated under the FFDCA. Pursuant to the FFDCA, the FDA regulates the research, design, testing, manufacture, safety, labeling, storage, record keeping, advertising, sales and distribution, post-market adverse event reporting, production and advertising and promotion of medical devices in the United States. Noncompliance with applicable requirements can result in warning letters, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant premarket approval for devices and criminal prosecution.

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Medical devices in the United States are classified into one of three classes, Class I, II or III, on the basis of the amount of risk and the controls deemed by the FDA to be necessary to reasonably ensure their safety and effectiveness. Class I, low risk, devices are subject to general controls (e.g., labeling and adherence to good manufacturing practices). Class II, intermediate risk, devices are subject to general controls and to special controls (e.g., performance standards, and premarket notification). Generally, Class III devices are those which must receive premarket approval by the FDA to ensure their safety and effectiveness (e.g., life-sustaining, life-supporting and implantable devices, or new devices which have not been found substantially equivalent to legally marketed devices), and require clinical testing to ensure safety and effectiveness and FDA approval prior to marketing and distribution. The FDA also has the authority to require clinical testing of Class II devices. In both the United States and certain international markets, there have been a number of legislative and regulatory initiatives and changes, such as the Modernization Act and the EU-Medical Device Regulations, which could and have altered the healthcare system in ways that could impact our ability to sell our medical devices profitably.

The FFDCA provides two basic review procedures for medical devices. Certain products may qualify for a submission authorized by Section 510(k) of the FFDCA, where the manufacturer submits to the FDA a premarket notification of the manufacturer’s intention to commence marketing the product. The manufacturer must, among other things, establish that the product to be marketed is substantially equivalent to another legally marketed product. Marketing may commence when the FDA issues a letter finding substantial equivalence. If a medical device does not qualify for the 510(k) procedure, the manufacturer must file a PMA application with the FDA. This procedure requires more extensive pre-filing clinical and preclinical testing than the 510(k) procedure and involves a significantly longer FDA review process. A PMA is required to establish the safety and effectiveness of the device and a key component of a PMA submission is the pivotal clinical trial data, as discussed in more detail below. 

Premarket Approval

Our ReShape vBloc and our Lap-Band System are medical devices that required PMAs from the FDA to market in the United States. The FDA approved ReShape vBloc in January of 2015 and the Lap-Band System in 2001 with post-approval conditions intended to ensure the safety and effectiveness of the devices. Failure to comply with the conditions of approval can result in material adverse enforcement action, including the loss or withdrawal of the approvals. Even after approval of the PMAs, new PMAs or supplemental PMAs will be required for significant modifications to the manufacturing process, labeling, use and design of a device that is approved through the premarket approval process. Premarket approval supplements often require submission of the same type of information as a PMA except that the supplement is limited to information needed to support any changes from the device covered by the original PMA. In addition, holders of an approved PMA are required to submit annual reports to the FDA that include relevant information on the continued use of the device.

The ReShape Vest will be considered a Class III Long Term Implantable (“LTI”) product by the FDA requiring the PMA path.  A pivotal trial for the ReShape Vest will likely include approximately 250 implanted patients monitored up to three years.  Other implantable devices for the treatment of obesity relied on twelve-month endpoints for the PMA submission with annual follow-up visits up to five years and we expect the pivotal trial for the ReShape Vest to be similar.  A US pivotal trial requires FDA Investigational Device Exemption (“IDE”) submission and approval. 

Clinical Trials

A clinical trial is almost always required to support a PMA. Clinical trials for a “significant risk” device such as ours require submission to the FDA of an application for an IDE for clinical studies to be conducted within the United States. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. Clinical trials for a significant risk device in the United States may begin once the IDE application is approved by the FDA and by the Institutional Review Boards (“IRBs”) overseeing the clinical trial at the various investigational sites.

Clinical trials require extensive recordkeeping and detailed reporting requirements. Our clinical trials must be conducted under the oversight of an IRB for each participating clinical trial site and in accordance with applicable regulations and policies including, but not limited to, the FDA’s good clinical practice IDE requirements. We, the trial Data Safety Monitoring Board, the FDA or the IRB for each site at which a clinical trial is being performed may suspend a clinical trial at any time for various reasons, including a belief that the risks to study subjects outweigh the anticipated benefits.

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Pervasive and Continuing U.S. Regulation

Numerous regulatory requirements apply. These include:

·

Quality System Regulation, which requires manufacturers to follow design, testing, control, documentation, complaint handling and other quality assurance procedures during the design and manufacturing processes;

 

·

regulations which govern product labels and labeling, prohibit the promotion of products for unapproved or “off-label” uses and impose other restrictions on labeling and promotional activities;

 

·

medical device reporting regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur;

 

·

notices of correction or removal and recall regulations;

 

·

periodic reporting of progress related to clinical trials, post approval studies required as conditions of PMA approval and relevant changes to information contained within the PMA approval; and

 

·

reporting of transfers of value and payments to physicians and teaching hospitals.

 

Advertising and promotion of medical devices are also regulated by the Federal Trade Commission and by state regulatory and enforcement authorities. Recently, some promotional activities for FDA-regulated products have resulted in enforcement actions brought under healthcare reimbursement laws and consumer protection statutes. In addition, under the federal Lanham Act, competitors and others can initiate litigation relating to advertising claims.

 

Compliance with regulatory requirements is enforced through periodic facility inspections by the FDA, which may be unannounced. Because we rely on contract manufacturing sites and service providers, these additional sites are also subject to these FDA inspections. Failure to comply with applicable regulatory requirements can result in enforcement action, which may include any of the following sanctions:

 

·

warning letters or untitled letters;

 

·

fines, injunction and civil penalties;

 

·

recall or seizure of our products;

 

·

customer notification, or orders for repair, replacement or refund;

 

·

operating restrictions, partial suspension or total shutdown of production or clinical trials;

 

·

refusing our request for premarket approval of new products;

 

·

withdrawing premarket approvals that are already granted; and

 

·

criminal prosecution.

International Regulations

International sales of medical devices are subject to foreign government regulations, which vary substantially from country to country. The time required to obtain approval by a foreign country may be longer or shorter than that required for FDA approval, and the requirements may differ. The primary regulatory environment in Europe is that of the European Economic Community (“EEC”), which consists of 28 European Union (“EU”) member states encompassing nearly all the major countries in Europe. Additional countries that are not part of the EU, but are part of the European Economic Area (“EEA”), and other countries, such as Switzerland, have voluntarily adopted laws and regulations that mirror those of the EEC with respect to medical devices. The EEC has adopted Directive 90/385/EEC as amended by

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2007/47/EC for active implantable medical devices and numerous standards that govern and harmonize the national laws and standards regulating the design, manufacture, clinical trials, labeling and adverse event reporting for medical devices that are marketed in member states. Medical devices that comply with the requirements of the national law of the member state in which their Notified Body is located will be entitled to bear CE marking, indicating that the device conforms to applicable regulatory requirements, and, accordingly, can be commercially marketed within the EEA and other countries that recognize this mark for regulatory purposes.

The Lap-Band System was CE marked in 1997. The method of assessing conformity with applicable regulatory requirements varies depending on the class of the device, but for our Lap-Band System, the method involved a combination of self-assessment and issuance of declaration of conformity by the manufacturer of the safety and performance of the device, and a third-party assessment by a Notified Body of the design of the device and of our quality system. A Notified Body is a private commercial entity that is designated by the national government of a member state as being competent to make independent judgments about whether a product complies with applicable regulatory requirements. The assessment included, among other things, a clinical evaluation of the conformity of the device with applicable regulatory requirements. We use BSI as the Notified Body for our CE marking approval process.

Continued compliance with CE marking requirements is enforced through periodic facility inspections by the Notified Body, which may be unannounced. Because we rely on contract manufacturing sites and service providers, these additional sites may also be subject to these Notified Body inspections.

Patient Privacy Laws

United States and various international laws have been evolving to protect the confidentiality of certain patient health information, including patient medical records. These laws restrict the use and disclosure of certain patient health information. Enforcement actions, including financial penalties, related to patient privacy issues are globally increasing. The management of patient data may have an impact on certain clinical research activities and product design considerations.

Employees

As of December 31, 2018, we had 43 employees. All of these employees are located in the United States.

From time to time we also employ independent contractors, consultants and temporary employees to support our operations. None of our employees are subject to collective bargaining agreements. We have never experienced a work stoppage and believe that our relations with our employees are good.

Executive Officers

The following table sets forth information regarding our executive officers as of April 1, 2019:

 

The following table sets forth information regarding our executive officers, including their ages, as of December 31, 2018:

Name

 

Age

 

Position

Barton P. Bandy

 

58

 

President and Chief Executive Officer

Scott P. Youngstrom

 

59

 

Chief Financial Officer and Senior Vice President, Finance

 

Barton P. Bandy has served as our President and Chief Executive Officer since April 1, 2019.  Mr. Bandy has extensive leadership experience in health care and specifically in the obesity and bariatric space. Most recently, Mr. Bandy was President and Chief Executive Officer of BroadSpot Imaging Corporation, a developer of medical devices for eye care, since April 2017. From April 2013 to August 2016, Mr. Bandy was President of Wellness at Alphaeon Corporation, where he was responsible for business development, commercial activities, strategy and acquisition integration. He previously spent 10 years at Inamed, including during its acquisition by Allergan.

Scott P. Youngstrom is our Senior Vice President, Finance and has served as our Chief Financial Officer since October 3, 2016. Mr. Youngstrom has over 25 years of strategic financial and operational experience in a variety of medical device companies, most recently having served as Chief Financial Officer and Vice President, Finance at Galil Medical, a leading developer of cryotherapy technology. Prior to Galil Medical, from 2009-2014, Mr. Youngstrom served as Vice President, Chief Operating Officer, and Chief Financial Officer at DGIMED Ortho, Inc., a developer of

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orthopedic medical devices. Mr. Youngstrom has previously served as Chief Financial Officer and Vice President, Finance with Anulex Technologies, Enpath Medical, Compex Technologies, Acist Medical Systems, and Cardiotronics.

Our Corporate Information

We were incorporated in Minnesota in December 2002 and then reincorporated in the state of Delaware in July 2004. On October 23, 2017 we changed the company name from EnteroMedics Inc. to ReShape Lifesciences Inc. Our shares of common stock were traded on the Nasdaq Capital Market under the symbol RSLS until December 31, 2018. Effective as of December 31, 2018, our shares were delisted from the Nasdaq Capital Market and now trade on the OTCQB Market under the symbol RSLS.

We file reports and other information with the Securities and Exchange Commission (“SEC”) including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy or information statements. Those reports and statements as well as all amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (1) are available at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549, (2) may be obtained by sending an electronic message to the SEC at publicinfo@sec.gov or by sending a fax to the SEC at 1-202-777-1027, (3) are available at the SEC’s internet site (http://www.sec.gov), which contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC and (4) are available free of charge through our website as soon as reasonably practicable after electronic filing with, or furnishing to, the SEC. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

Our principal executive offices are located at 1001 Calle Amanecer, San Clemente, California  92673, and our telephone number is (949) 429-6680. Our website address is www.reshapelifesciences.com. The information on, or that may be accessed through, our website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered a part of this Annual Report on Form 10-K.

 

ITEM 1A. RISK FACTORS 

RISK FACTORS 

 

Risks Related to Our Business and Industry

Our acquisition of the assets related to the Lap-Band System from Apollo Endosurgery, Inc. in December 2018 could adversely affect our operations, financial results and financial condition.

In December 2018, we acquired substantially all of the assets exclusively related to Apollo Endosurgery, Inc.’s Lap-Band product line and Apollo acquired from us substantially all of the assets exclusively related to our ReShape Balloon product line. In addition, we agreed to pay Apollo $17 million in cash, of which $10 million was paid at the closing of the transaction, $2 million is payable on the first anniversary of the closing date, $2 million is payable on the second anniversary of the closing date, and $3 million is payable on the third anniversary of the closing date.

A successful acquisition depends on our ability to identify, negotiate, complete and integrate such acquisition and to obtain any necessary financing. With respect to our acquisition of the Lap-Band product line and any future acquisitions, we may experience:

·

difficulties in integrating the acquired businesses and their respective personnel and products into our existing business;

·

difficulties in integrating commercial organizations;

·

delays in transferring regulatory approvals from Apollo to ReShape Lifesciences

·

difficulties or delays in realizing the anticipated benefits of the acquisition;

·

diversion of our management’s time and attention from other business concerns;

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·

challenges due to limited or no direct prior experience in new markets or countries we may enter;

·

inability to successfully develop new products and services on a timely basis that address our new market opportunities post-acquisition;

·

inability to compete effectively against companies already serving the broader market opportunities expected to be available to us post-acquisition;

·

unanticipated costs and other contingent liabilities; and

·

any unforeseen compliance risks and accompanying financial and reputational exposure or loss not uncovered in the due diligence process and which are imputed to our company, such as compliance with federal laws and regulations, the advertising and promotion regulations under the federal Food, Drug and Cosmetic Act, the Anti-kickback Statute, the False Claims Act, the Physician Sunshine Payments Act and other applicable laws.

We have invested, and expect to continue to invest, significant cash and other resources in connection with our acquisition of the Lap-Band product line, including our obligation to pay the remaining $7 million of the purchase price. Our efforts to successfully integrate and continue the commercialization of the Lap-Band product line will require significant cash expenditures. There can be no assurance that we will be successful in our efforts. Should we be unable to obtain adequate financing or generate sufficient revenue in the future, our business, results of operations, liquidity and financial condition could be materially and adversely harmed.

We face a risk of default under our security agreement with Apollo that we entered into in connection with our acquisition of the Lap-Band product line and under our subordinated secured debentures that we issued in March 2019.

In connection with our acquisition of the Lap-Band product line, we entered into a security agreement with Apollo pursuant to which we granted to Apollo a security interest in substantially all of our assets as security for our obligations under the asset purchase agreement entered into in connection with the transaction, including our obligation to pay the cash purchase price. The security interest will be terminated upon the earlier of the date we pay the cash purchase price to Apollo in full or complete an equity financing raising gross proceeds of at least $15 million. In March 2019, we issued $2.2 million in aggregate principal amount subordinated secured debentures and a related security agreement to secure our payment obligations under the debentures, which obligations and security interest are subordinated to our obligations to and security interest of Apollo. If we default on our payment obligations, Apollo and our other secured lenders have the right to enforce their rights under the security agreements, including by enforcing their security interest and taking control of substantially all of our assets and declaring the entire remaining portion of our outstanding obligations to be immediately due and payable. In addition, the security agreements contain certain restrictions that may adversely affect our ability to engage in certain business activities or finance our future operations or capital needs. Transactions that we may view as important opportunities, such as acquisitions, may be subject to the consent of Apollo or our other secured lenders, which consent may be withheld or granted subject to conditions specified at the time that may affect the attractiveness or viability of the transaction.

If we do not achieve the contemplated benefits of our acquisition of the Lap-Band product line, our business and financial condition may be materially impaired.

We may not achieve the desired benefits from our acquisition of the Lap-Band product line. For any of the reasons described above and elsewhere in this report and even if we are able to successfully integrate the Lap-Band product line within our company, we may not be able to realize the revenue and other growth that we anticipate from the acquisition in the time frame that we currently expect, and the costs of achieving these benefits may be higher than what we currently expect, because of a number of risks, including, but not limited to:

·

the possibility that the acquisition may not further our business strategy as we expected; and

·

the possibility that the revenue from the Lap-Band product line may be lower than we expected.

As a result of these risks, we may not achieve the anticipated strategic and financial benefits of the Lap-Band acquisition.

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If we are unable to either substantially improve our operating results or obtain additional financing in the future, we will be unable to continue as a going concern.

Our independent registered public accounting firm’s report on our December 31, 2018 audited financial statements includes an explanatory paragraph referring to our ability to continue as a going concern. The proceeds from any future financings that we may be able to obtain, if any, together with our other available cash, may not be sufficient to fund our operating expenses, capital expenditures and other cash requirements. Should we be unable to obtain adequate financing or generate sufficient revenue in the future, our business, result of operations, liquidity and financial condition would be materially and adversely harmed, and we would be unable to continue as a going concern. These events and circumstances could have a material adverse effect on our ability to raise additional capital and on the market value of our common stock and the warrants offered hereby. Moreover, should we experience a cash shortage that requires us to curtail or cease our operations, or should we be unable to continue as a going concern, you could lose all or part of your investments in our securities.

We currently are not generating revenue from operations that is significant relative to our level of operating expenses, and we do not anticipate generating revenue sufficient to offset operating costs in the short-term to mid-term. We have financed our operations to date principally through the sale of equity securities. Our history of operating losses, limited cash resources and lack of certainty regarding obtaining significant third-party reimbursement for our products or timing thereof, raise substantial doubt about our ability to continue as a going concern. As of December 31, 2018, we had $5.5 million of cash and cash equivalents.  We expect our current cash and cash equivalents to fund our operations through early 2019.

Our anticipated operations include plans to (i) integrate the sales and operations of the Lap-Band product line as well as to obtain cost savings synergies (ii) continue development of the ReShape Vest, (iii) seek opportunities to leverage our intellectual property portfolio and custom development services to provide third party sales and licensing opportunities, and (iv) explore and capitalize on synergistic opportunities to expand our portfolio and offer future minimally invasive treatments and therapies in the obesity continuum of care. We believe that we have the flexibility to manage the growth of our expenditures and operations depending on the amount of available cash flows, which could include reducing expenditures for marketing, clinical and product development activities. However, we will ultimately need to achieve sufficient revenues from product sales and obtain additional debt or equity financing in addition to the proceeds from this offering to support our operations.

Our ReShape Vest product is in the early stages of clinical evaluation. If the clinical trial is not successfully completed or any required regulatory approvals are not obtained, the ReShape Vest may not be commercialized and our business prospects may suffer.

Our ReShape Vest product is in the early stages of development and is currently in the early stages of clinical evaluation. Our ability to market the ReShape Vest in the United States and abroad depends upon our ability to demonstrate the safety and effectiveness of the product with clinical data to support our requests for regulatory approval. The ReShape Vest may not be found to be safe and, where required, effective in clinical trials and may not ultimately be approved for marketing by U.S. or foreign regulatory authorities, which would have a negative impact on our net sales.

There is no assurance that we will be successful in achieving the desired results in our anticipated clinical trials for the ReShape Vest or, if we do, that the FDA or other regulatory agencies will approve the product for sale without the need for additional clinical trial data to demonstrate safety and efficacy. We continually evaluate the potential financial benefits and costs of clinical trials and the products being evaluated in them. If we determine that the costs associated with obtaining regulatory approval of a product exceed the potential financial benefits of that product or if the projected development timeline is inconsistent with our investment horizon, we may choose to stop a clinical trial and/or the development of a product.

The shares of series C convertible preferred stock issued in connection with our acquisition of ReShape Medical have certain rights and preferences senior to our common stock, including a liquidation preference that is senior to our common stock.

There are currently 95,388 shares of our series C convertible preferred stock outstanding, which are convertible into 4,543 shares of our common stock. We issued the shares of our series C convertible preferred stock in connection with our acquisition of ReShape Medical. The series C convertible preferred stock has a liquidation preference of

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$274.8774 per share, or $5,772.4254 per underlying share of common stock, or approximately $26.2 million in the aggregate. Holders of the series C convertible preferred stock have the right to convert their shares into shares of common stock instead of receiving the liquidation preference. In general, the series C convertible preferred stock is entitled to receive dividends (on an as-if-converted-to-common stock basis) actually paid on shares of common stock when, as and if such dividends are paid on shares of common stock. No other dividends will be paid on shares of series C convertible preferred stock. While the series C convertible preferred stock generally does not have voting rights, as long as any shares of series C convertible preferred stock remain outstanding, we cannot, without the affirmative vote of holders of a majority of the then-outstanding shares of series C convertible preferred stock, (a) alter or change adversely the powers, preferences or rights given to the series C convertible preferred stock (including by the designation, authorization, or issuance of any shares of preferred stock that purports to have equal rights with, or be senior in rights or preferences to, the series C convertible preferred stock), (b) alter or amend the series C convertible preferred stock certificate of designation, (c) amend our certificate of incorporation or other charter documents in any manner that adversely affects any rights of the holders of series C convertible preferred stock, (d) increase the number of authorized shares of series C convertible preferred stock or (e) enter into any agreement with respect to any of the foregoing.

We are a medical device company with a limited history of operations and sales, and we cannot assure you that we will ever generate substantial revenue or be profitable.

We are a medical device company with a limited operating history upon which you can evaluate our business.  We have been engaged in research and development and clinical trials since our inception in 2002 and have invested substantially all of our time and resources in developing our products and product candidates. The success of our business will depend on our ability to establish a sales force, make sales and control costs, as well as our ability to obtain additional regulatory approvals needed to market new versions of our Lap-Band system or regulatory approvals needed to market our ReShape Vest and any other products we may develop in the future, all of which we may be unable to do. If we are unable to successfully market our Lap-Band system for its indicated use or develop and commercialize the ReShape Vest, we may never become profitable and may have to cease operations as a result. Our lack of a significant operating history also limits your ability to make a comparative evaluation of us, our products and our prospects.

We have incurred losses since inception and we anticipate that we will continue to incur losses for the foreseeable future.  

We have incurred losses in each year since our formation in 2002. For the years ended December 31, 2018 and 2017, our loss from continuing operations was $35.3 million and $30.5 million, respectively, and our net loss attributable to common stockholders was $84.2 million and $33.8 million, respectively. We have funded our operations to date principally from the sale of securities and the issuance of indebtedness. Development of a new medical device, including conducting clinical trials and seeking regulatory approvals, is a long, expensive and uncertain process. We expect to incur significant sales and marketing expenses prior to recording sufficient revenue to offset these expenses. We expect our general and administrative expenses to increase as we continue to add the infrastructure necessary to support our initial commercial sales, market the Lap-Band system, develop the ReShape Vest, operate as a public company and develop our intellectual property portfolio. For these reasons, we expect to continue to incur significant operating losses for the next several years. These losses, among other things, have had and will continue to have an adverse effect on our stockholders’ equity and working capital. Because of the numerous risks and uncertainties associated with developing new medical devices, we are unable to predict the extent of any future losses or when we will become profitable, if ever.

During the second quarter of 2018 we were required to record a non-cash goodwill impairment loss, which significantly impacted our results of operations, and we may be exposed to additional impairment losses that could be material.

We conduct our annual goodwill impairment analysis for our businesses during the fourth quarter of each year or when circumstances suggest that an indicator for impairment may be present.  Subsequent to our registered direct securities offering on April 3, 2018, the price of our common stock declined significantly and, given the decline which indicated a potential impairment of some or all of our goodwill, requiring us to perform an impairment analysis that included valuing all the tangible and intangible assets of the business. We performed an impairment analysis during the second quarter of 2018 resulting in a write-off of goodwill from continuing operations of $14.0 million and a write-off of goodwill from discontinued operations of $13.2 million. These goodwill write-offs had a material adverse effect on our results of operations. In the future, we may have additional indicators of potential impairment requiring us to record an

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impairment loss related to our remaining indefinite-lived and finite-lived intangible assets, which could also have a material adverse effect on our results of operations.

We will need substantial additional funding and may be unable to raise capital when needed, which would force us to delay, reduce or eliminate our product development programs or liquidate some or all of our assets.

Our operations have consumed substantial amounts of cash since inception. We expect to continue to spend substantial amounts on the development and commercialization of our products and on research and development, including conducting current and future clinical trials for our Lap-Band system, ReShape Vest (if approved for sale) and subsequent versions of our products. For the years ended December 31, 2018 and 2017, net cash used in operating activities from continuing operations was $20.1 million and $22.1 million, respectively, and net cash used in operating activities (including discontinued operations) was $27.5 million and $24.6 million, respectively. We expect that our cash used in operations will continue to be significant in the upcoming years, and that we will need to raise additional capital to commercialize our Lap-Band system, to develop the ReShape Vest, to continue our research and development programs, and to fund our ongoing operations.

Our future funding requirements will depend on many factors, including:

·

the cost and timing of establishing sales, marketing and distribution capabilities;

·

the cost of establishing clinical and commercial supplies of our Lap-Band system, ReShape Vest and any products that we may develop; the rate of market acceptance of our Lap-Band system, ReShape Vest and any other product candidates;

·

the rate of market acceptance of our Lap-Band system, ReShape Vest and any other product candidates;

·

the cost of filing and prosecuting patent applications and defending and enforcing our patent and other intellectual property rights;

·

the cost of defending, in litigation or otherwise, any claims that we infringe third-party patent or other intellectual property rights;

·

the effect of competing products and market developments;

·

the cost of explanting clinical devices;

·

the terms and timing of any collaborative, licensing or other arrangements that we may establish;

·

any revenue generated by sales of our Lap-Band system, ReShape Vest or our future products;

·

the scope, rate of progress, results and cost of any clinical trials and other research and development activities;

·

the cost and timing of obtaining any further required regulatory approvals; and

·

the extent to which we invest in products and technologies, although we currently have no commitments or agreements relating to these types of transactions.

Until the time, if ever, when we can generate a sufficient amount of product revenue, we expect to finance our future cash needs through public or private equity offerings, debt financings or corporate collaboration, licensing arrangements and grants, as well as through interest income earned on cash balances.

Additional capital may not be available on terms favorable to us, or at all. If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Debt financing, if available, may involve restrictive covenants or additional security interests in our assets. Any additional debt or equity financing that we complete may contain terms that are not favorable to us or our stockholders. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish some rights to our technologies or products, or grant licenses on terms that are not favorable to us. If we are unable to raise adequate funds, we may have to delay, reduce the scope of, or eliminate some or all of, our development programs or liquidate some or all of our assets.

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We may be subject to fines, restrictions or prohibitions on sales, or other penalties for failure to maintain licenses in certain states.

Certain of our licenses in states in which we currently conduct our business are expired, and we may not maintain required licenses in every state in which we conduct business. As a result, we could be subject to fines, restrictions or prohibitions on its sales, or other penalties under applicable state laws, which could adversely affect our business and results of operations.

We incur significant costs as a result of operating as a public company, and our management is required to devote substantial time to compliance initiatives.

As a public company, we incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), as well as rules subsequently implemented by the SEC have imposed various requirements on public companies, including establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Our management and other personnel devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations result in increased legal and financial compliance costs and will make some activities more time-consuming and costly.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and disclosure. In particular, we are required to perform system and process evaluation and testing of our internal controls over financial reporting to allow management to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. There have been material weaknesses identified in the past and we have identified a material weakness as of December 31, 2018 related to our ability to maintain adequate accounting resources with a sufficient understanding of accounting principles generally accepted in the United States of America (“GAAP”) to allow the Company to identify and properly account for new complex transactions. Specifically, we did not design and implement internal controls around research and development expenses paid to a  CRO. This material weakness resulted in our not identifying that certain research and development expenses paid to the CRO in connection with the clinical trial of the ReShape Vest are required to be capitalized under GAAP, and recognized into expense as the value of the capitalized asset is realized.  

We have incurred and continue to expect to incur significant expense and devote substantial management effort toward ensuring compliance with Section 404 and remediating material weaknesses in our internal controls over financial reporting. Moreover, if we do not comply with the requirements of Section 404, or if we identify additional deficiencies in our internal controls that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by the SEC or other regulatory authorities, which would entail expenditure of additional financial and management resources.

We face significant uncertainty in the industry due to government healthcare reform.

In the United States, there have been and continue to be a number of legislative initiatives to contain healthcare costs. The Patient Protection and Affordable Care Act, as amended, (the “Affordable Care Act”) as well as any future healthcare reform legislation, may have a significant impact on our business. The impact of the Affordable Care Act on the health care industry is extensive and includes, among other things, the federal government assuming a larger role in the health care system, expanding healthcare coverage of United States citizens and mandating basic healthcare benefits. The Affordable Care Act contains many provisions designed to generate the revenues necessary to fund the coverage expansions and to reduce costs of Medicare and Medicaid, including imposing a 2.3% excise tax on domestic sales of many medical devices by manufacturers that began in 2013. Although a moratorium was placed on the medical device excise tax through 2019, if Congress does not pass legislation further extending or otherwise eliminating the excise tax, our sales and selling, general and administrative expenses may be adversely affected in the future.

Congress is considering legislation to replace or repeal elements or all of the Affordable Care Act. In addition, there have been recent public announcements by members of Congress and the current presidential administration regarding their plans to repeal and replace the Affordable Care Act. Further, President Trump signed an Executive Order directing federal agencies with authorities and responsibilities under the Affordable Care Act to waive, defer, grant exemptions from, or delay the implementation of any provision of the Affordable Care Act that would impose a fiscal or regulatory burden on states, individuals, healthcare providers, health insurers, or manufacturers of pharmaceuticals or

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medical devices. At this time, it is not clear whether the Affordable Care Act will be repealed in whole or in part, and, if it is repealed, whether it will be replaced in whole or in part by another plan and what impact those changes will have on coverage and reimbursement for healthcare items and services covered by plans that were authorized by the Affordable Care Act. We expect that additional state and federal healthcare reform measures will be adopted in the future, any of which could limit the amounts that federal and state governments will pay for healthcare products and services, and also indirectly affect the amounts that private payers are willing to pay. In addition, any healthcare reforms enacted in the future may, like the Affordable Care Act, be phased in over a number of years but, if enacted, could reduce our revenue, increase our costs, or require us to revise the ways in which we conduct business or put us at risk for loss of business. In addition, our results of operations, financial position and cash flows could be materially adversely affected by changes under the Affordable Care Act and changes under any federal or state legislation adopted in the future.

We are subject, directly or indirectly, to United States federal and state healthcare fraud and abuse and false claims laws and regulations. Prosecutions under such laws have increased in recent years and we may become subject to such litigation. If we are unable to, or have not fully complied with such laws, we could face substantial penalties.

Our operations are directly, or indirectly through customers, subject to various state and federal fraud and abuse laws, including, without limitation, the federal Anti-Kickback Statute and federal False Claims Act. These laws may impact, among other things, our sales, marketing and education programs.

The federal Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing or arranging for a good or service, for which payment may be made under a federal healthcare program such as the Medicare and Medicaid programs. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered business, the statute has been violated. The Anti-Kickback Statute is broad and, despite a series of narrow safe harbors, prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. Penalties for violations of the federal Anti-Kickback Statute include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcare programs. Many states have also adopted laws similar to the federal Anti-Kickback Statute, some of which apply to the referral of patients for healthcare items or services reimbursed by any source, not only the Medicare and Medicaid programs.

The federal False Claims Act prohibits persons from knowingly filing, or causing to be filed, a false claim to, or the knowing use of false statements to obtain payment from the federal government. Suits filed under the False Claims Act, known as “qui tam” actions, can be brought by any individual on behalf of the government and such individuals, commonly known as “whistleblowers,” may share in any amounts paid by the entity to the government in fines or settlement. The frequency of filing qui tam actions has increased significantly in recent years, causing greater numbers of medical device, pharmaceutical and healthcare companies to have to defend a False Claim Act action. When an entity is determined to have violated the federal False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties for each separate false claim. Various states have also enacted laws modeled after the federal False Claims Act.

We are unable to predict whether we could be subject to actions under any of these laws, or the impact of such actions. If we are found to be in violation of any of the laws described above or other applicable state and federal fraud and abuse laws, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from government healthcare reimbursement programs and the curtailment or restructuring of our operations.

We operate in a highly competitive industry that is subject to rapid change. If our competitors are able to develop and market products that are safer or more effective than our products, our commercial opportunities will be reduced or eliminated.  

The health care industry is highly competitive, subject to rapid change and significantly affected by new product introductions and other market activities of industry participants. The obesity treatment market in which we operate has grown significantly in recent years and is expected to continue to expand as technology continues to evolve and awareness of the need to treat the obesity epidemic grows. Although we are not aware of any competitors in the neuroblocking market, we face potential competition from pharmaceutical and surgical obesity treatments. Many of our competitors in the obesity treatment field have significantly greater financial resources and expertise in research and development, manufacturing, preclinical testing, clinical trials, obtaining regulatory approvals and marketing approved

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products than we do. Smaller or early-stage companies may also prove to be significant competitors, particularly if they pursue competing solutions through collaborative arrangements with large and established companies, such as Allergan, Apollo Endosurgery, Boston Scientific, LivaNova PLC, Johnson & Johnson, Medtronic or St. Jude Medical. Our competitors may develop and patent processes or products earlier than us, obtain regulatory approvals for competing products more rapidly than we are able to and develop more effective, safer and less expensive products or technologies that would render our products non-competitive or obsolete.

Failure to protect our information technology infrastructure against cyber-based attacks, network security breaches, service interruptions, or data corruption could significantly disrupt our operations and adversely affect our business and operating results.

We currently rely on information technology and telephone networks and systems, including the Internet, to process and transmit sensitive electronic information and will rely on such systems to manage or support a variety of business processes and activities, including sales, billing, customer service, procurement and supply chain, manufacturing, and distribution. We use enterprise information technology systems to record, process, and summarize financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting, legal, and tax requirements.

Our information technology systems, some of which are managed by third-parties, may be susceptible to damage, disruptions or shutdowns due to computer viruses, attacks by computer hackers, failures during the process of upgrading or replacing software, databases or components thereof, power outages, hardware failures, telecommunication failures, user errors or catastrophic events. We are not aware of any breaches of our information technology infrastructure. Despite the precautionary measures we have taken to prevent breakdowns in our information technology and telephone systems, if our systems suffer severe damage, disruption or shutdown and we are unable to effectively resolve the issues in a timely manner, our business and operating results may suffer.

Risks Associated with Development and Commercialization of the Lap-Band system and ReShape Vest

Our efforts to increase revenue from our Lap-Band system and commercialize the ReShape Vest may not succeed or may encounter delays which could significantly harm our ability to generate revenue.

Our ability to generate revenue will depend upon the sales of our Lap-Band system and successful commercialization of our ReShape Vest (if approved for sale). Our efforts to commercialize these products may not succeed for a number of reasons, including:

·

we may not be able to obtain the regulatory approvals required for our ReShape Vest;

·

our products may not be accepted in the marketplace by physicians, patients and third-party payers;

·

the price of our products, associated costs of the surgical procedure and treatment and the availability of sufficient third-party reimbursement for the system implantation and follow-up procedures;

·

appropriate reimbursement and/or coding options may not exist to enable billing for the system implantation and follow-up procedures for our ReShape Vest;  

·

coverage policies for bariatric surgeries, including Lap-Band may be restricted in the future;

·

we may not be able to sell our products at a price that allows us to meet the revenue targets necessary to generate enough revenue for profitability;

·

the frequency and severity of any side effects of our products;

·

physicians and potential patients may not be aware of the perceived effectiveness and sustainability of the results of our products;

·

we, or the investigators of our products, may not be able to have information on the outcome of the trials published in medical journals;

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·

the availability and perceived advantages and disadvantages of alternative treatments;

·

any rapid technological change may make our products obsolete;

·

we may not be able to have our products manufactured in commercial quantities or at an acceptable cost;

·

we may not have adequate financial or other resources to complete the development and commercialization of our products or to develop sales and marketing capabilities for our products; and

·

we may be sued for infringement of intellectual property rights and could be enjoined from manufacturing or selling our products.

Besides requiring physician adoption, market acceptance of our products will depend on successfully communicating the benefits of our products to three additional constituencies involved in deciding whether to treat a particular patient using our products: (1) the potential patients themselves; (2) institutions such as hospitals, where the procedure would be performed and opinion leaders in these institutions; and (3) third-party payers, such as private healthcare insurers and governmental payers, such as Medicare and Medicaid in the United States, which would ultimately bear most of the costs of the various providers and equipment involved in our Lap-Band system and ReShape Vest (if approved for sale). Marketing to each of these constituencies requires a different marketing approach, and we must convince each of these groups of the efficacy and utility of our products to be successful.

If our products, or any other therapy or products for other gastrointestinal diseases and disorders that we may develop, do not achieve an adequate level of acceptance by the relevant constituencies, we may not generate significant product revenue and may not become profitable.

We may not be able to obtain required regulatory approvals for our ReShape Vest in a cost-effective manner or at all, which could adversely affect our business and operating results.

The production and marketing of our ReShape Vest and our ongoing research and development, preclinical testing and clinical trial activities are subject to extensive regulation and review by numerous governmental authorities both in the United States and abroad. U.S. and foreign regulations applicable to medical devices are wide-ranging and govern, among other things, the development, testing, marketing and premarket review of new medical devices, in addition to regulating manufacturing practices, reporting, advertising, exporting, labeling and record keeping procedures. We are required to obtain regulatory approval before we can market our ReShape Vest in the United States and certain foreign countries. The regulatory process will require significant time, effort and expenditures to bring products to market, and it is possible that our ReShape Vest will not be approved for sale. Even if regulatory approval of our ReShape Vest is granted, it may not be granted within the timeframe that we expect, which could have an adverse effect on our operating results and financial condition. Even after our ReShape Vest is approved by the FDA, we may have ongoing responsibilities under FDA regulations, non-compliance of which could result in the subsequent withdrawal of such approvals, or such approvals could be withdrawn due to the occurrence of unforeseen problems following initial approval. We also are subject to medical device reporting regulations that require us to report to the FDA if any of our products causes or contributes to a death or serious injury or if a malfunction were it to occur might cause or contribute to a death or serious injury. Any failure to obtain regulatory approvals on a timely basis or the subsequent withdrawal of such approvals could prevent us from successfully marketing our products, which could adversely affect our business and operating results.

We depend on clinical investigators and clinical sites to enroll patients in our clinical trials, and on other third parties to manage the trials and to perform related data collection and analysis, and, as a result, we may face costs and delays that are outside of our control.

We rely on clinical investigators and clinical sites to enroll patients in our clinical trials and other third parties to manage the trials and to perform related data collection and analysis. However, we may not be able to control the amount and timing of resources that clinical sites may devote to our clinical trials. If these clinical investigators and clinical sites fail to enroll a sufficient number of patients in our clinical trials, ensure compliance by patients with clinical protocols or comply with regulatory requirements, we will be unable to complete these trials, which could prevent us from obtaining or maintaining regulatory approvals for our product. Our agreements with clinical investigators and clinical trial sites for clinical testing place substantial responsibilities on these parties and, if these parties fail to perform

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as expected, our trials could be delayed or terminated. If these clinical investigators, clinical sites or other third parties do not carry out their contractual duties or obligations or fail to meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to their failure to adhere to our clinical protocols, regulatory requirements or for other reasons, our clinical trials may be extended, delayed or terminated, or the clinical data may be rejected by the FDA, adversely affecting our ability to successfully commercialize our product.

Modifications to the Lap-Band system may require additional approval from regulatory authorities, which may not be obtained or may delay our commercialization efforts.

The FDA and our European Notified Body require medical device companies to initially make and document a determination of whether or not a modification requires a new approval, supplement or clearance; however, some of these regulatory authorities can review a company’s decision. Any modifications to an approved device that could significantly affect its safety or efficacy, or that would constitute a major change in its intended use could require additional clinical studies and separate regulatory applications. Product changes or revisions will require all the regulatory steps and associated risks discussed above possibly including testing, regulatory filings and clinical study. We may not be able to obtain approval of supplemental regulatory approvals for product modifications, new indications for our product or new products. Delays in obtaining future clearances would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our commercialization efforts and future growth.

If we or our suppliers fail to comply with ongoing regulatory requirements, or if we experience unanticipated product problems, our Lap-Band system could be subject to restrictions or withdrawal from the market.

Any product for which we obtain marketing approval, along with the manufacturing processes, post-approval clinical data and promotional activities for such product, will be subject to continual review and periodic inspections by our European Notified Body and the FDA and other regulatory bodies. In particular we and our manufacturers and suppliers are required to comply with ISO requirements, Good Manufacturing Practices, which for medical devices is called the Quality System Regulation (“QSR”), and other regulations which cover the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, storage and shipping of any product for which we obtain marketing approval. The FDA enforces the QSR through inspections, which may be unannounced, and the CE system enforces its certification through inspections and audits as well. Our quality system has received certification of compliance to the requirements of ISO 13485:2016 and will have to continue to successfully complete such inspections to maintain regulatory approvals for sales outside of the United States. Failure by us or one of our manufacturers or suppliers to comply with statutes and regulations administered by the FDA, CE authorities and other regulatory bodies, or failure to adequately respond to any observations, could result in enforcement actions against us or our manufacturers or suppliers, including, restrictions on our product or manufacturing processes, withdrawal of the product from the market, voluntary or mandatory recall, fines, suspension of regulatory approvals, product seizures, injunctions or the imposition of civil or criminal penalties.

If any of these actions were to occur it would harm our reputation and cause our product sales to suffer. Furthermore, our key component suppliers may not currently be or may not continue to be in compliance with applicable regulatory requirements. If the FDA or any other regulatory body finds their compliance status to be unsatisfactory, our commercialization efforts could be delayed, which would harm our business and our results of operations.

Additionally, if the FDA determines that our promotional materials, training or other activities constitute promotion of an unapproved use, we could be subject to significant liability, the FDA could request that we cease, correct or modify our training or promotional materials or subject us to regulatory enforcement actions. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our training or other promotional materials to constitute promotion of an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement.

We are subject to medical device reporting regulations that require us to report to the FDA, Competent Authorities or other governmental authorities in other countries if our products cause or contribute to a death or serious injury or malfunction in a way that would be reasonably likely to contribute to death or serious injury if the malfunction were to recur. The FDA and similar governmental authorities in other countries have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacturing. A government mandated, or voluntary, recall by us could occur as a result of component failures, manufacturing errors or design defects, including defects in labeling. Any recall would divert managerial and financial resources and could harm our reputation with

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customers. There can be no assurance that there will not be product recalls in the future or that such recalls would not have a material adverse effect on our business. Once the product is approved and implanted in a large number of patients, infrequently occurring adverse events may appear that were not observed in the clinical trials. This could cause health authorities in countries where the product is available to take regulatory action, including marketing suspension and recall.

If we are unable to establish sales and marketing capabilities or enter into and maintain arrangements with third parties to market and sell our Lap-Band product, our business may be harmed.

We have limited experience as a company in sales, marketing and distribution of our products. We market our products in the United States through a direct sales force supported by field technical managers who provide training, technical and other support services to our customers. Apollo Endosurgery will serve as our exclusive distributor of the Lap-Band system outside of the United States and Canada for up to two years following our acquisition of the Lap-Band system. Developing a sales force is expensive and time consuming and we may be unable to develop an effective sales and marketing organization on a timely basis, if at all, or maintain our current sales and marketing capabilities, either of which would delay or prevent us from generating enough revenue to become profitable. Our sales force will be competing with the experienced and well-funded marketing and sales organizations of our more established competitors. If we are unable to establish and maintain our own sales and marketing capabilities, we will need to contract with third parties to market and sell our product. In this event, our profit margins would likely be lower than if we performed these functions ourselves. In addition, we would necessarily be relying on the skills and efforts of others for the successful marketing of our product. If we are unable to establish and maintain effective sales and marketing capabilities, independently or with others, we may not be able to generate product revenue and may not become profitable.

The commercialization of our products in countries outside the United States will expose our business to certain risks associated with international operations.

We currently sell our Lap-Band system in the United States, Canada and Australia. Conducting international operations subjects us to unique risks, including:

·

unfamiliar legal requirements with which we would need to comply;

·

fluctuations in currency exchange rates;

·

potentially adverse tax consequences, including the complexities of foreign value added tax systems and restrictions on the repatriation of earnings;

·

increased financial accounting and reporting burdens and complexities; and

·

reduced or varied protection for intellectual property rights in some countries.

The occurrence of any one of these risks could negatively affect our business and results of operations generally. Additionally, operating in international markets requires significant management attention. We cannot be certain that investments required to establish operations in other countries will produce desired levels of revenues or profitability.

We may be unable to attract and retain management and other personnel we need to succeed.

Our success depends on the services of our senior management and other key employees. The loss of the services of one or more of our officers or key employees could delay or prevent the successful completion of our clinical trials and the commercialization of our Lap-Band system and the development of our ReShape Vest. Our continued growth will require hiring a number of qualified clinical, scientific, commercial and administrative personnel. Accordingly, recruiting and retaining such personnel in the future will be critical to our success. There is intense competition from other companies and research and academic institutions for qualified personnel in the areas of our activities. If we fail to identify, attract, retain and motivate these highly skilled personnel, we may be unable to continue our development and commercialization activities.

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We may be unable to manage our growth effectively.

Our business strategy entails significant future growth. For example, we will have to expand existing operations in order to increase revenue from our Lap-Band system and develop our ReShape Vest, conduct additional clinical trials, increase our contract manufacturing capabilities, hire and train new personnel to handle the marketing and sales of our product, assist patients and healthcare providers in obtaining reimbursement for the use of our product and create and develop new applications for our technology. This growth may place significant strain on our management and financial and operational resources. Successful growth is also dependent upon our ability to implement appropriate financial and management controls, systems and procedures. Our ability to effectively manage growth depends on our success in attracting and retaining highly qualified personnel, for which the competition may be intense. If we fail to manage these challenges effectively, our business could be harmed. 

We face the risk of product liability claims that could be expensive, divert management’s attention and harm our reputation and business. We may not be able to obtain adequate product liability insurance.

Our business exposes us to a risk of product liability claims that is inherent in the testing, manufacturing and marketing of medical devices. The medical device industry has historically been subject to extensive litigation over product liability claims. We may be subject to product liability claims if our products cause, or appear to have caused, an injury. Claims may be made by consumers, healthcare providers, third-party strategic collaborators or others selling our products.

We have product liability insurance, which covers the use of our products in our clinical trials and any commercial sales, in an amount we believe is appropriate. Our current product liability insurance may not continue to be available to us on acceptable terms, if at all, and, if available, the coverage may not be adequate to protect us against any future product liability claims. If we are unable to obtain insurance at an acceptable cost and on acceptable terms for an adequate coverage amount, or otherwise to protect against potential product liability claims, we could be exposed to significant liabilities, which may harm our business. A product liability claim, recall or other claim with respect to uninsured liabilities or for amounts in excess of insured liabilities could have a material adverse effect on our business, financial condition and results of operations. These liabilities could prevent or interfere with our product commercialization efforts. Defending a suit, regardless of merit, could be costly, could divert management attention and might result in adverse publicity, which could result in the withdrawal of, or inability to recruit, clinical trial volunteers or result in reduced acceptance of our products in the market.

We may be subject to product liability claims even if it appears that the claimed injury is due to the actions of others. For example, we rely on the expertise of surgeons and other associated medical personnel to perform the medical procedure to implant and remove our products and to perform the related therapy. If these medical personnel are not properly trained or are negligent, the therapeutic effect of our products may be diminished or the patient may suffer critical injury, which may subject us to liability. In addition, an injury that is caused by the negligence of one of our suppliers in supplying us with a defective component that injures a patient could be the basis for a claim against us. A product liability claim, regardless of its merit or eventual outcome, could result in decreased demand for our products; injury to our reputation; diversion of management’s attention; withdrawal of clinical trial participants; significant costs of related litigation; substantial monetary awards to patients; product recalls or market withdrawals; loss of revenue; and the inability to commercialize our products under development.

 

Risks Related to Intellectual Property

If we are unable to obtain or maintain intellectual property rights relating to our technology and neuroblocking therapy, the commercial value of our technology and any future products will be adversely affected and our competitive position will be harmed.

Our commercial success depends in part on our ability to obtain protection in the United States and other countries for our Lap-Band system and ReShape Vest by establishing and maintaining intellectual property rights relating to or incorporated into our technology and products. We own numerous U.S. and foreign patents and have numerous patent applications pending, most of which pertain to treating gastrointestinal disorders and the treatment of obesity. We have also received or applied for additional patents outside the United States. Our pending and future patent applications may not issue as patents or, if issued, may not issue in a form that will provide us any competitive advantage. We expect to incur substantial costs in obtaining patents and, if necessary, defending our proprietary rights. The patent positions of

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medical device companies, including ours, can be highly uncertain and involve complex and evolving legal and factual questions. We do not know whether we will obtain the patent protection we seek, or that the protection we do obtain will be found valid and enforceable if challenged. If we fail to obtain adequate protection of our intellectual property, or if any protection we obtain is reduced or eliminated, others could use our intellectual property without compensating us, resulting in harm to our business. We may also determine that it is in our best interests to voluntarily challenge a third-party’s products or patents in litigation or administrative proceedings, including patent interferences, re-examinations or under more recently promulgated Inter Partes Review proceedings, depending on when the patent application was filed. In the event that we seek to enforce any of our owned or exclusively licensed patents against an infringing party, it is likely that the party defending the claim will seek to invalidate the patents we assert, which, if successful could result in the loss of the entire patent or the relevant portion of our patent, which would not be limited to any particular party. Any litigation to enforce or defend our patent rights, even if we were to prevail, could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. Even if we were to prevail in any litigation, we cannot assure you that we can obtain an injunction that prevents our competitors from practicing our patented technology. Our competitors may independently develop similar or alternative technologies or products without infringing any of our patent or other intellectual property rights, or may design around our proprietary technologies.

We cannot assure you that we will obtain any patent protection that we seek, that any protection we do obtain will be found valid and enforceable if challenged or that it will confer any significant commercial advantage. U.S. patents and patent applications may also be subject to interference proceedings and U.S. patents may be subject to re-examination proceedings in the U.S. Patent and Trademark Office (“USPTO”), or under more recently promulgated Inter Partes Review proceedings, depending on when the patent application was filed, and foreign patents may be subject to opposition or comparable proceedings in the corresponding foreign patent offices, which proceedings could result in either loss of the patent or denial of the patent application, or loss or reduction in the scope of one or more of the claims of, the patent or patent application. In addition, such interference, re-examination and opposition proceedings may be costly. Moreover, the U.S. patent laws have recently changed with the adoption of the America Invents Act (“AIA”), possibly making it easier to challenge patents. Some of our technology was, and continues to be, developed in conjunction with third parties, and thus there is a risk that such third parties may claim rights in our intellectual property. Thus, any patents that we own or license from others may provide limited or no protection against competitors. Our pending patent applications, those we may file in the future, or those we may license from third parties, may not result in patents being issued. If issued, they may not provide us with proprietary protection or competitive advantages against competitors with similar technology.

Non-payment or delay in payment of patent fees or annuities, whether intentional or unintentional, may result in loss of patents or patent rights important to our business. Many countries, including certain countries in Europe, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties. In addition, many countries limit the enforceability of patents against third parties, including government agencies or government contractors. In these countries, the patent owner may have limited remedies, which could materially diminish the value of the patent. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as do the laws of the United States, particularly in the field of medical products and procedures.

Many of our competitors have significant resources and incentives to apply for and obtain intellectual property rights that could limit or prevent our ability to commercialize our current or future products in the United States or abroad.

Many of our competitors who have significant resources and have made substantial investments in competing technologies may seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, use or sell our products either in the United States or in international markets. Our current or future U.S. or foreign patents may be challenged, circumvented by competitors or others or may be found to be invalid, unenforceable or insufficient. In most cases in the United States patent applications are published 18 months after filing the application, or corresponding applications are published in other countries, and since publication of discoveries in the scientific or patent literature often lags behind actual discoveries, we cannot be certain that we were the first to make the inventions covered by each of our pending patent applications, or that we were the first to file patent applications for such inventions.

If we are unable to protect the confidentiality of our proprietary information and know-how, the value of our technology and products could be adversely affected.

In addition to patented technology, we rely on our unpatented proprietary technology, trade secrets, processes and know-how. We generally seek to protect this information by confidentiality agreements with our employees, consultants,

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scientific advisors and third parties. These agreements may be breached, and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by competitors. To the extent that our employees, consultants or contractors use intellectual property owned by others in their work for us, disputes may arise as to the rights in related or resulting know-how and inventions.

Intellectual property litigation is a common tactic in the medical device industry to gain competitive advantage. If we become subject to a lawsuit, we may be required to expend significant financial and other resources and our management’s attention may be diverted from our business.

There has been a history of frequent and extensive litigation regarding patent and other intellectual property rights in the medical device industry, and companies in the medical device industry have employed intellectual property litigation to gain a competitive advantage. Accordingly, we may become subject to patent infringement claims or litigation in a court of law, or interference proceedings declared by the USPTO to determine the priority of inventions or an opposition to a patent grant in a foreign jurisdiction. We may also become subject to claims or litigation seeking payment of royalties based on sales of our product in connection with licensing or similar joint development arrangements with third parties or in connection with claims of patent infringement.

Specifically, on April 20, 2017, Fulfillium, Inc. filed a complaint in the United States District Court for the District of Delaware accusing ReShape Medical, our wholly owned subsidiary, of trade secret misappropriation and patent infringement of U.S. Patent Nos. 9,445,930 and 9,456,915, which we are currently in the process of defending. The defense and prosecution of intellectual property suits, USPTO interference proceedings, reexamination proceedings, or under more recently promulgated Inter Partes Review proceedings, depending on when the patent application was filed, or opposition proceedings and related legal and administrative proceedings, are both costly and time consuming and could result in substantial uncertainty to us. Litigation or regulatory proceedings may also be necessary to enforce patent or other intellectual property rights of ours or to determine the scope and validity of other parties’ proprietary rights. Any litigation, opposition or interference proceedings, with or without merit, may result in substantial expense to us, cause significant strain on our financial resources, divert the attention of our technical and management personnel and harm our reputation. We may not have the financial resources to defend our patents from infringement or claims of invalidity. An adverse determination in any litigation could subject us to significant liabilities to third parties, require us to seek licenses from or pay royalties to third parties or prevent us from manufacturing, selling or using our proposed products, any of which could have a material adverse effect on our business and prospects.

Our Lap-Band system or ReShape Vest may infringe or be claimed to infringe patents that we do not own or license, including patents that may issue in the future based on patent applications of which we are currently aware, as well as applications of which we are unaware. For example, we are aware of other companies that are investigating neurostimulation, including neuroblocking, and of patents and published patent applications held by companies in those fields. While we believe that none of such patents and patent applications are applicable to our products and technologies under development, third parties who own or control these patents and patent applications in the United States and abroad could bring claims against us that would cause us to incur substantial expenses and, if such claims are successfully asserted against us, they could cause us to pay substantial damages, could result in an injunction preventing us from selling, manufacturing or using our proposed products and would divert management’s attention. Because patent applications in many countries such as the United States are maintained under conditions of confidentiality and can take many years to issue, there may be applications now pending of which we are unaware and which may later result in issued patents that our products infringe. If a patent infringement suit were brought against us, we could be forced to stop our ongoing or planned clinical trials, or delay or abandon commercialization of the product that is subject of the suit.

As a result of patent infringement claims, or to avoid potential claims, we may choose or be required to seek a license from a third-party and be required to pay license fees or royalties, or both. A license may not be available at all or on commercially reasonable terms, and we may not be able to redesign our products to avoid infringement. Modification of our products or development of new products could require us to conduct additional clinical trials and to revise our filings with the FDA and other regulatory bodies, which would be time-consuming and expensive. Even if we were able to obtain a license, the rights may be nonexclusive, which could result in our competitors gaining access to the same intellectual property. Ultimately, we could be forced to cease some aspect of our business operations if, as a result of actual or threatened patent infringement claims, we are unable to enter into licenses on acceptable terms. This could harm our business significantly.

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Risks Relating to Ownership of Our Common Stock

Our common stock has been delisted from the Nasdaq Stock Market and our shares currently trade on an over-the-counter market.

On December 27, 2018, we received a written notice from the Office of General Counsel of The Nasdaq Stock Market notifying us that the Nasdaq Hearings Panel (the “Panel”) had determined to delist our securities pursuant to Nasdaq’s discretionary authority under Listing Rule 5101. The Panel also cited in its decision our failure to maintain compliance with the minimum bid price requirement under Listing Rule 5550(a)(2) and our failure to comply with Listing Rule 5250(e), which requires a company to file a Notification Form Listing of Additional Shares at least 15 days prior to the issuance or potential issuance of common stock greater than 10% of the total shares outstanding. As a result of the Panel’s decision, Nasdaq suspended trading in our common stock effective with the open of business on December 31, 2018 and our common stock has now been delisted from Nasdaq.

Our common stock currently trades on the OTCQB market and therefore may have less liquidity and may experience potentially more price volatility than experienced on Nasdaq. Stockholders may not be able to sell their shares of common stock on the OTCQB market in the quantities, at the times, or at the prices that could potentially be available on a more liquid trading market. The delisting of our common stock from Nasdaq could also adversely affect our ability to obtain financing for our operations and/or result in a loss of confidence by investors or employees.

Our common stock may be deemed to be a “penny stock” and broker-dealers who make a market in our stock may be subject to additional compliance requirements.

If our common stock is deemed to be a “penny stock” as defined in the Securities Exchange Act of 1934, broker-dealers who make a market in our stock will be subject to additional sales practice requirements for selling our common stock to persons other than established customers and accredited investors. For instance, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser's written agreement to the transaction prior to the sale. Consequently, the penny stock rules, if they were to become applicable, would affect the ability or willingness of broker-dealers to sell our securities, and accordingly would affect the ability of stockholders to sell their securities in the public market. These additional procedures could also limit our ability to raise additional capital in the future.

The trading price of our common stock has been volatile and is likely to be volatile in the future.

The trading price of our common stock has been highly volatile and may be more volatile now that it trades on the OTCQB Market and not the Nasdaq Capital Market. The market price for our common stock will be affected by a number of factors, including:

·

the denial or delay of regulatory clearances or approvals of our product or receipt of regulatory approval of competing products;

·

our ability to accomplish clinical, regulatory and other product development milestones and to do so in accordance with the timing estimates we have publicly announced;

·

changes in policies affecting third-party coverage and reimbursement in the United States and other countries;

·

changes in government regulations and standards affecting the medical device industry and our product;

·

ability of our products to achieve market success;

·

the performance of third-party contract manufacturers and component suppliers;

·

our ability to develop sales and marketing capabilities;

·

actual or anticipated variations in our results of operations or those of our competitors;

·

announcements of new products, technological innovations or product advancements by us or our competitors;

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·

developments with respect to patents and other intellectual property rights;

·

sales of common stock or other securities by us or our stockholders in the future;

·

additions or departures of key scientific or management personnel;

·

disputes or other developments relating to proprietary rights, including patents, litigation matters and our ability to obtain patent protection for our technologies;

·

the trading volume of our common stock;

·

changes in earnings estimates or recommendations by securities analysts, failure to obtain or maintain analyst coverage of our common stock or our failure to achieve analyst earnings estimates;

·

public statements by analysts or clinicians regarding their perceptions of our clinical results or the effectiveness of our products;

·

decreases in market valuations of medical device companies; and

·

general market conditions and other factors unrelated to our operating performance or the operating performance of our competitors.

The stock prices of many companies in the medical device industry have experienced wide fluctuations that have often been unrelated to the operating performance of these companies. Following periods of volatility in the market price of a company’s securities, securities class action litigation often has been initiated against a company. If class action litigation is initiated against us, we may incur substantial costs and our management’s attention may be diverted from our operations, which could significantly harm our business.

Sales of a substantial number of shares of our common stock in the public market by existing stockholders, or the perception that they may occur, could cause our stock price to decline.

Sales of substantial amounts of our common stock by us or by our stockholders, announcements of the proposed sales of substantial amounts of our common stock or the perception that substantial sales may be made, could cause the market price of our common stock to decline. We may issue additional shares of our common stock in follow-on offerings to raise additional capital, upon the exercise of options or warrants, or in connection with acquisitions or corporate alliances. We also plan to issue additional shares to our employees, directors or consultants in connection with their services to us. All of the currently outstanding shares of our common stock are freely tradable under federal and state securities laws, except for shares held by our directors, officers and certain greater than five percent stockholders, which may be subject to holding period, volume and other limitations under Rule 144. Due to these factors, sales of a substantial number of shares of our common stock in the public market could occur at any time and could reduce the market price of our common stock. 

We have a significant number of outstanding warrants, options and shares of convertible preferred stock, some of which contain full-ratchet anti-dilution protection, which may cause significant dilution to our stockholders, have a material adverse impact on the market price of our common stock and make it more difficult for us to raise funds through future equity offerings.

As of December 31, 2018, we had outstanding 8,770,433 shares of common stock. In addition, as of that date we had outstanding warrants to acquire 15,304,722 shares of common stock, options to acquire 4,225 shares of common stock and shares of convertible preferred stock convertible into an aggregate of 131,743 shares of common stock. The issuance of shares of common stock upon the exercise of warrants or options or conversion of preferred stock would dilute the percentage ownership interest of all stockholders, might dilute the book value per share of our common stock and would increase the number of our publicly traded shares, which could depress the market price of our common stock.

In addition, a substantial number of our outstanding warrants and shares of convertible preferred stock contain so-called full-ratchet anti-dilution provisions which, subject to limited exceptions, would reduce the exercise price of the warrants (but not increase the number of shares issuable) and reduce the conversion price of the convertible preferred stock (and increase the number of shares issuable) in the event that we in the future issue common stock, or securities

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convertible into or exercisable to purchase common stock, at a lower price per share, to such lower price. Of our outstanding warrants as of December 31, 2018, warrants exercisable to purchase 41,963 shares of common stock with an exercise price of $1.25 per share contained a full-ratchet anti-dilution provision, and shares of convertible preferred stock convertible into 127,200 shares of common stock at a conversion price of $1.25 per share contained a full-ratchet anti-dilution provision. These full ratchet anti-dilution provisions would be triggered by the future issuances by us of shares of our common stock or common stock equivalents at a price per share below the then-exercise price of the warrants and the then-conversion price of the convertible preferred stock, subject to limited exceptions. In the event of a liquidation, the holders of shares of series C convertible preferred stock are entitled to be paid, before any payments are to be made to the holders of common stock or any other series of preferred stock, an amount per share equal to the greater of (i) $5,772.4254 per share (on an as-converted-to-common stock basis), or an aggregate of approximately $26.2 million, plus any dividends declared but unpaid thereon, or (ii) such amount per share as would have been payable had all shares of series C convertible preferred stock been converted to common stock immediately prior to such liquidation. 

In addition to the dilutive effects described above, the perceived risk of dilution as a result of the significant number of outstanding warrants, options and shares of convertible preferred stock may cause our common stockholders to be more inclined to sell their shares, which would contribute to a downward movement in the price of our common stock. Moreover, the perceived risk of dilution and the resulting downward pressure on our common stock price could encourage investors to engage in short sales of our common stock, which could further contribute to price declines in our common stock. The fact that our stockholders, warrant holders and option holders can sell substantial amounts of our common stock in the public market, whether or not sales have occurred or are occurring, as well as the existence of full-ratchet anti-dilution provisions in a substantial number of our outstanding warrants and shares of convertible preferred stock, could make it more difficult for us to raise additional funds through the sale of equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate, or at all.

You may experience future dilution as a result of future equity offerings.

In order to raise additional capital for general corporate purposes, in the future we may offer additional shares of our common stock or other securities convertible into or exchangeable for our common stock at prices that may be lower than the current price per share of our common stock. In addition, investors purchasing shares or other securities in the future could have rights superior to existing stockholders. The price per share at which we sell additional shares of our common stock, or securities convertible or exchangeable into common stock, in future transactions may be higher or lower than the price per share paid by investors in prior offerings.

Since our securities are currently quoted on the OTCQB market, our stockholders may face significant restrictions on the resale of our securities due to state “blue sky” laws.

Each state has its own securities laws, often called “blue sky” laws, which (i) limit sales of securities to a state’s residents unless the securities are registered in that state or qualify for an exemption from registration, and (ii) govern the reporting requirements for broker-dealers doing business directly or indirectly in the state. Before a security is sold in a state, there must be a registration in place to cover the transaction, or the transaction must be exempt from registration. The applicable broker must be registered in that state. We do not know whether our common stock will be registered or exempt from registration under the laws of any state. Since our common stock is currently quoted on the OTCQB, a determination regarding registration will be made by those broker-dealers, if any, who agree to serve as the market-makers for our common stock. There may be significant state blue sky law restrictions on the ability of investors to sell, and on purchasers to buy, our common stock. Investors should therefore consider the resale market for our common stock to be limited, as they may be unable to resell your common stock without the significant expense of state registration or qualification.

Our organizational documents and Delaware law make a takeover of our company more difficult, which may prevent certain changes in control and limit the market price of our common stock.

Our certificate of incorporation and bylaws and Section 203 of the Delaware General Corporation Law contain provisions that may have the effect of deterring or delaying attempts by our stockholders to remove or replace management, engage in proxy contests and effect changes in control. These provisions include:

·

the ability of our board of directors to create and issue preferred stock without stockholder approval, which could be used to implement anti-takeover devices;

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·

the authority for our board of directors to issue without stockholder approval up to the number of shares of common stock authorized in our certificate of incorporation, that, if issued, would dilute the ownership of our stockholders;

·

the advance notice requirement for director nominations or for proposals that can be acted upon at stockholder meetings;

·

a classified and staggered board of directors, which may make it more difficult for a person who acquires control of a majority of our outstanding voting stock to replace all or a majority of our directors;

·

the prohibition on actions by written consent of our stockholders;

·

the limitation on who may call a special meeting of stockholders;

·

the prohibition on stockholders accumulating their votes for the election of directors; and

·

the ability of stockholders to amend our bylaws only upon receiving a majority of the votes entitled to be cast by holders of all outstanding shares then entitled to vote generally in the election of directors, voting together as a single class.

In addition, as a Delaware corporation, we are subject to Delaware law, including Section 203 of the Delaware General Corporation Law. In general, Section 203 prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date that the stockholder became an interested stockholder unless certain specific requirements are met as set forth in Section 203. These provisions, alone or together, could have the effect of deterring or delaying changes in incumbent management, proxy contests or changes in control.

These provisions also could discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. The existence of these provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Some provisions in our certificate of incorporation and bylaws may deter third parties from acquiring us, which may limit the market price of our common stock. 

We have not paid dividends in the past and do not expect to pay dividends in the future, and any return on investment may be limited to the value of our common stock.

We have never paid dividends on our common stock and do not anticipate paying dividends on our common stock in the foreseeable future. The payment of dividends on our common stock will depend on our earnings, financial condition and other business and economic factors affecting us at such time as our board of directors may consider relevant.  If we do not pay dividends, our common stock may be less valuable because a return on your investment will only occur if our stock price appreciates. 

 

ITEM 1B. UNRESOLVED STAFF COMMENTS 

Not applicable.

 

ITEM 2. PROPERTIES 

We lease (i) approximately 14,479 square feet of office/warehouse space in San Clemente, California under an operating lease that expires June 30, 2022 and (ii) approximately 8,000 square feet of office and manufacturing space in San Clemente, California under an operating lease that expires October 31, 2019.

 

ITEM 3. LEGAL PROCEEDINGS 

Du. On February 28, 2017, the Company received a class action and derivative complaint filed on February 24, 2017 in U. S. District Court for the District of Delaware by Vinh Du, one of the Company’s shareholders. The complaint named as defendants ReShape Lifesciences, the board of directors and four members of our senior management, namely, Scott Youngstrom, Nick Ansari, Peter DeLange and Paul Hickey, and contained a purported class action claim for breach of fiduciary duty against the board of directors and derivative claims for breach of fiduciary duty against the board of directors and unjust enrichment against our senior management. The allegations in the complaint related to the

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increase in the number of shares authorized for grant under our Second Amended and Restated 2003 Stock Incentive Plan (the “Plan”), which was approved by our shareholders at the Special Meeting of Shareholders held on December 12, 2016 (the “Special Meeting”), and to our subsequent grant of stock options on February 8, 2017, to the Company’s Directors and senior management to purchase an aggregate of 521 shares of our common stock (the “Option Grants”). In the complaint, the plaintiff contended that (i) the number of shares authorized for grant under the Plan, as adjusted by the board of directors after the Special Meeting for the subsequent recapitalization of the Company, resulted from an alleged breach of fiduciary duties by the board of directors, and (ii) our senior management was allegedly unjustly enriched by the subsequent Option Grants. The plaintiff sought relief in the form of an order rescinding the Plan as approved by the shareholders at the Special Meeting, an order cancelling the Option Grants, and an award to plaintiff for his costs, including fees and disbursements of attorneys, experts and accountants. The parties settled the matter on December 17, 2018. The terms of the settlement require us to (i) rescind and cancel the Option Grants, with the exception of options that were already rescinded when certain individuals left the company in the last fiscal quarter of 2017, (ii) amend the Plan to add a provision establishing the maximum total annual equity compensation for non-employee directors and to seek stockholder approval of this amendment at the Company’s next annual meeting of stockholders, and (iii) proportionally adjust all share reserves and limitations in the Plan (and any other equity compensation plan for the company) in connection with any future split of the company’s stock during the next five years unless otherwise brought to and approved by stockholder vote. The Company is required to pay $197,000 and this was fully accrued for in 2018.

Fulfillium. On April 20, 2017, Fulfillium, Inc. filed a complaint against ReShape Medical, Inc. (which the Company acquired in October 2017 and which is now a wholly owned subsidiary of the Company) in the U.S. District Court for the District of Delaware, which alleged misappropriation of trade secrets and infringement of two U.S. Patents (“Fulfillium I”). On July 28, 2017, ReShape Medical moved to dismiss both the trade secret claim and certain aspects of the patent infringement claim, and to transfer the litigation to the U.S. District Court for the Central District of California. On October 16, 2017, the Court granted ReShape Medical’s motion to dismiss the trade secret and willful infringement claims, and ordered the case transferred to the U.S. District Court for the Central District of California. Fulfillium twice amended its complaint, narrowing its original trade secret claim and adding further patent infringement claims and additional parties. On June 4, 2018, ReShape Medical filed a motion to dismiss the patent infringement claims for lack of standing, which the Court granted on July 5, 2018. On August 10, 2018, the Court dismissed without prejudice the trade secret claim for lack of subject matter jurisdiction and terminated the case. Fulfillium has appealed these dismissals and ReShape Medical has appealed the grant and denial of certain attorney fee awards. On July 20, 2018, Fulfillium filed a new complaint against ReShape Lifesciences, Inc. (and its wholly owned subsidiary ReShape Medical LLC) in the U.S. District Court for the Central District of California (“Fulfillium II”) reasserting the patent infringement claims asserted in Fulfillium I. On August 15, 2018, Fulfillium amended its complaint in Fulfillium II to reassert the trade secret misappropriation claim asserted in Fulfillium I against ReShape Medical LLC and others. On September 7, 2018, Fulfillium filed a complaint in California state court alleging the same trade secret misappropriation claim asserted in both Fulfillium I and Fulfillium II. On November 7, 2018, the Court dismissed the non-Company parties from Fulfillium II. On April 20, 2018, ReShape Medical filed Inter Partes Review (“IPR”) petitions with the Patent Trial and Appeal Board of the U.S. Patent and Trademark Office (the “PTAB”) to have all claims of both of the originally asserted Fulfillium patents canceled as unpatentable over various combinations of prior art. On November 6, 2018, the PTAB denied those petitions. The parties held a mediation on April 9, 2019, but were unable to resolve the matter. The Company intends to continue to vigorously defend itself against Fulfillium’s claims. We currently are unable to estimate the losses or range of losses for these two matters where there is a reasonable possibility of a loss or it is probable that a loss may have been incurred.

On July 12, 2018, Alpha Capital Anstalt (“Alpha”) filed a complaint against the Company in the U.S. District Court for the Southern District of New York. In August 2017, Alpha acquired shares of the Company’s series B convertible preferred stock and warrants to purchase shares of the Company’s common stock in an underwritten public offering. Pursuant to the terms of the series B convertible preferred stock and warrants, the conversion price of the series B convertible preferred stock and exercise price of the warrants was subject to adjustment in the case of, among other things, dilutive issuances of securities by the Company. The complaint alleges breach of contract, claiming that the Company should have adjusted the conversion price of the series B convertible preferred stock and exercise price of the warrants to not less than $420.00 per share, rather than the $1,575.00 per share to which the Company actually adjusted such conversion price and exercise price, in connection with its registered direct offering of series D convertible preferred stock and warrants to purchase common stock that it completed and announced in April 2018. Alpha seeks declaratory relief, damages of not less than approximately $3.6 million (less the proceeds of actual sales of the Company’s common stock made by Alpha) and attorneys’ fees. The Company believes the claims alleged are without merit and intends to vigorously protect and defend itself. However, we are currently unable to estimate a loss or range of loss for this matter.

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On July 26, 2018, Iroquois Capital Investment Group, LLC and Iroquois Master Fund, Ltd. filed a complaint against the Company in the U.S. District Court for the Southern District of New York, with substantially the same claims and seeking substantially the same relief as Alpha’s complaint described above, except that Iroquois claims that the conversion price of the series D convertible preferred stock and exercise price of the warrants should have been adjusted to $189.00 per share, and Iroquois is claiming damages estimated to exceed $5 million. The Company believes the claims alleged are without merit and intends to vigorously protect and defend itself. However, we are currently unable to estimate a loss or range of loss for this matter

Except as disclosed in the foregoing paragraphs, the Company is not currently a party to any litigation and the Company is not aware of any pending or threatened litigation against it that could have a material adverse effect on the Company’s business, operating results or financial condition. The medical device industry in which the Company operates is characterized by frequent claims and litigation, including claims regarding patent and other intellectual property rights as well as improper hiring practices. As a result, the Company may be involved in various legal proceedings from time to time.

 

ITEM 4. MINE SAFETY DISCLOSURES 

Not applicable.

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PART II. 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 

Market for Our Common Stock

Our common stock is traded on the OTCQB Market under the symbol RSLS. As of March 31, 2019, there were approximately 19 holders of record of our common stock.

 

The following table sets forth the high and low sales prices of our common stock as quoted on the NASDAQ Stock Market and OTC Markets for the periods indicated.

Price Range of Common Stock

 

 

 

 

 

 

 

 

 

Price Range

 

    

High

    

Low

Year Ended December 31, 2018

 

 

 

 

 

 

First Quarter

 

$

3,759.00

 

$

2,772.00

Second Quarter

 

$

1,512.00

 

$

288.40

Third Quarter

 

$

448.00

 

$

5.60

Fourth Quarter

 

$

8.40

 

$

0.17

Year Ended December 31, 2017

 

 

 

 

 

 

First Quarter

 

$

63,861.00

 

$

3,675.00

Second Quarter

 

$

13,608.00

 

$

8,400.00

Third Quarter

 

$

10,920.00

 

$

3,360.00

Fourth Quarter

 

$

5,460.00

 

$

2,583.00

 

The closing price for our common stock as reported by the OTCQB Market on March 31, 2019 was $0.24 per share.

Securities Authorized for Issuance Under Equity Compensation Plans

The information required by this Item regarding equity compensation plans is incorporated by reference to the information set forth in Part III, Item 12 of this Annual Report on Form 10-K.

Unregistered Sales of Equity Securities

During the period covered by this report, we did not sell any securities which were not registered under the Securities Act of 1933, as amended.

Uses of Proceeds from Sale of Registered Securities

None.

Dividend Policy

We have never paid cash dividends on our common stock. The board of directors presently intends to retain all earnings for use in our business and does not anticipate paying cash dividends in the foreseeable future. We do not have a dividend reinvestment plan or a direct stock purchase plan.

Issuer Purchases of Equity Securities

None.

 

ITEM 6. SELECTED FINANCIAL DATA 

Not applicable.

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ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

Except for the historical information contained herein, the matters discussed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Form 10-K are forward-looking statements that involve risks and uncertainties. The factors listed in Item 1A “Risk Factors,” as well as any cautionary language in this Form 10-K, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from those projected. Except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events after the date of this report.

Overview

We are a developer of minimally invasive medical devices that advance bariatric surgery to treat obesity and metabolic diseases. Our current portfolio includes the LAP-BAND® Adjustable Gastric Banding System and the ReShape VestTM, an investigational device, to help treat more patients with obesity. 

In December 2018, we acquired from Apollo Endosurgery, Inc. (“Apollo”) substantially all of the assets exclusively related to Apollo’s Lap-Band product line and Apollo acquired from us substantially all of the assets exclusively related to the our ReShape Balloon product line (“Asset Purchase Agreement”).  The assets and operating results of the ReShape Balloon product line prior to disposal have been reflected as discontinued operations in the Consolidated Financial Statements. As a result of our acquisition of the Lap-Band product line, we will no longer be actively marketing our ReShape vBloc product.

Financial Overview

Results of Operations – Continuing Operations

Revenue. Revenue from continuing operations totaled $0.6 million in both of the years ended December 31, 2018 and 2017. In 2018, revenue included sales of our recently acquired Lap-Band product of $0.4 million and sales of our ReShape vBloc product of $0.2 million. In 2017, revenue was comprised of $.3 million in sales of our ReShape vBloc product and $0.3 million in other revenue related to custom development services based on our intellectual property portfolio that had been requested and contracted for by a third party.

Cost of revenue. Cost of revenue from continuing operations was $0.2 million for the year ended December 31, 2018 compared to $0.3 million for the year ended December 31, 2017. For 2018, cost of revenue was comprised of $0.1 million related to Lap-Band product sales, and $0.1 million related to sales of our ReShape vBloc product. In 2017, cost of revenue was comprised of $0.2 million related to sales of our ReShape vBloc product and $0.1 million related to cost of services in connection with the custom development.

Selling, General and Administrative Expenses. Selling, general and administrative expenses from continuing operations were $19.3 million for the year ended December 31, 2018, compared to $22.8 million for the year ended December 31, 2017. The reduction was primarily due to reduced headcount in 2018 in connection with a strategic realignment of our operations.

Research and Development Expenses. Research and development expenses from continuing operations were $5.7 million for the year ended December 31, 2018 compared with $5.4 million for the year ended December 31, 2017. The increase was primarily attributable to a full year of research and development activities associated with of our ReShape Vest, acquired with our acquisition of BarioSurg in May 2018. Our ReShape Vest product is in the early stages of development and is currently in an initial clinical trial stage.

Goodwill Impairment. The goodwill impairment of $14.0 million for the year ended December 31, 2018 reflects the full write-down of the goodwill recorded in connection with our acquisition of BarioSurg, Inc. As discussed further in Note 8 to the Consolidated Financial Statements, we performed an impairment analysis due to the significant decline in our stock price following our registered direct securities offering in April 2018, which resulted in the impairment of goodwill.  

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Warrants Expense. Warrant expense of $0.1 million for the year ended December 31, 2018 is primarily related to the change in fair value of certain warrants held by an institutional investor for which the exercise price was reduced as an inducement for the investor to exercise the warrants. For the year ended December 31, 2017 in connection with our public offering of series B convertible preferred stock in August 2017, we recorded $4.4 million for the value of warrants issued to former investors as consideration for the waiver by each investor of their right to participate in future securities offerings by the Company.

Net Interest Expense. Interest expense was $12,000 for the year ended December 31, 2018 compared with $3,000 for the year ended December 31, 2017. In 2018, we recorded $14,000 of accretion of interest expense on the net present value of the asset purchase consideration payable for our acquisition of the Lap-Band product line. Interest expense in both 2018 and 2017 was recorded net of an insignificant amount of interest income. We do not hold any investment securities in 2018 or 2017.

Income tax benefit.  Income tax benefit from continuing operation was $3.4 million and $2.3 million for the years ended December 31, 2018 and 2017, respectively. The tax benefit recorded in 2018 is attributable to the losses for U.S. federal income tax purposes, which, effective with the enactment of the 2017 Tax Cuts and Jobs Act, have an unlimited carryforward period. The tax benefit in 2017 was primarily the result of the revaluation of our deferred income taxes upon enactment of the 2017 Tax Cuts and Jobs Act.

Results of Operations – Discontinued Operations

Results of operations from discontinued operations reflect the activities of our Reshape Balloon product line, which we acquired as part of our acquisition of ReShape Medical, Inc. in October 2017 and sold in December 2018 in connection with our acquisition of the Lap-Band product line assets. Loss from discontinued operations was $45.9 million and $3.4 million for the years ended December 31, 2018 and 2017, respectively. The loss in 2018 includes an impairment charge of $13.2 million for the full write-down of the goodwill recorded in connection with our acquisition of ReShape Medical.  In addition, in connection with the determination of the fair value of the Lap-Band assets acquired, no value was assigned to the ReShape Balloon product line assets sold as projections updated during the fourth quarter of 2018 indicated negative cash flows. Accordingly, the loss from discontinued operations for the year ended December 31, 2018 includes an impairment charge of $22.6 million for the full write-down of the ReShape Balloon product line assets disposed of. There was no income tax expense or benefit for discontinued operations.

Liquidity and Capital Resources

We have financed our operations to date principally through the sale of equity securities and debt financing. During the years ended December 31, 2018 and 2017, we received aggregate net proceeds of $33.2 million and $34.5, million, respectively, from equity offerings and $0.5 million and $3.3 million, respectively, from the exercise of warrants to purchase common stock. As of December 31, 2018, we had $5.5 million of cash and cash equivalents to fund operations into early 2019. 

Our anticipated operations include plans to (i) integrate the sales and operations of the Company with the newly acquired Lap-Band product line in order to expand sales domestically and internationally as well as to obtain cost savings synergies, (ii) continue development of the ReShape Vest, (iii) seek opportunities to leverage our intellectual property portfolio and custom development services to provide third party sales and licensing opportunities, and (iv) explore and capitalize on synergistic opportunities to expand our portfolio and offer future minimally invasive treatments and therapies in the obesity continuum of care. The Company believes that it has the flexibility to manage the growth of its expenditures and operations depending on the amount of available cash flows, which could include reducing expenditures for marketing, clinical and product development activities. However, the Company will ultimately need to achieve sufficient revenues from product sales and obtain additional debt or equity financing to support its operations.

Management is currently pursuing various funding options, including seeking additional equity or debt financing as well as a strategic merger or other transaction to obtain additional funding to support the expansion of Lap-Band product sales and to continue the development of, and to successfully commercialize, the ReShape Vest. While the acquisition of Lap-Band product line does provide incremental revenues to the Company, the cost to support the European clinical trial of the ReShape Vest is expected to exceed revenues for the foreseeable future.  While there can be no assurance that the Company will be successful in its efforts, the Company has a long history of raising equity financing to fund its development activities. Should the Company be unable to obtain adequate financing in the near

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term, the Company’s business, result of operations, liquidity and financial condition would be materially and negatively affected, and the Company would be unable to continue as a going concern. Additionally, there can be no assurance that, assuming the Company is able to strengthen its cash position, it will achieve sufficient revenue or profitable operations to continue as a going concern.

Net Cash Used in Operating Activities - Continuing Operations

Net cash used in operating activities from continuing operations was $20.1 million and $22.1 million for the years ended December 31, 2018 and 2017, respectively. Net cash used in operating activities from continuing operations was primarily the result of the loss from continuing operations in each year net of noncash items and changes in operating assets and liabilities.

Net Cash Used in Investing Activities - Continuing Operations

Net cash used in investing activities from continuing operations was $10.3 million for the year ended December 31, 2018, as compared with $2.0 million for the year ended December 31, 2017. Investing activities in 2018 reflect our acquisition of the Lap-Band product line, which included asset purchase consideration paid of $10 million and transaction costs paid of $0.3 million. Of the remaining $7 million of asset purchase consideration, $2 million is payable on the first anniversary of the closing date, $2 million is payable on the second anniversary of the closing date and $3 million is payable on the third anniversary of the closing date. In 2017, $1.8 million of cash, net of cash acquired, was used as part of the consideration paid to acquire BarioSurg. Cash used for purchases of property and equipment was $50,000 and $0.1 million in 2018 and 2017, respectively.

Net Cash Provided by Financing Activities from Continuing Operations

Net cash provided by financing activities from continuing operations was $33.2 million and $37.8 million for the years ended December 31, 2018 and 2017, respectively. During the years ended December 31, 2018 and 2017, we received aggregate net proceeds of $33.2 million and $34.5, million, respectively, from equity offerings and $0.5 million and $3.3 million, respectively, from the exercise of warrants to purchase common stock. In connection with these equity transactions, we paid an aggregate of $4.6 million and $4.5 million of related transaction costs in 2018 and 2017, respectively. In 2018, we used cash of $0.5 million to redeem 500 shares of our series D convertible preferred stock.

On March 29, 2019, we completed a private placement with two healthcare focused institutional investors for the sale of secured subordinated original issue discount convertible debentures for a purchase price of $2 million. The debentures are due June 28, 2019 and have a face amount of $2.2 million, reflecting a 10% original issue discount. At any time after June 28, 2019, if the debentures have not been repaid, subject to certain investor ownership limitations, the debentures will be convertible into shares of common stock at a conversion price equal to the lesser of $0.33 and 80% of the average of the lowest two volume weighted average prices of the Company’s common stock during the 20 trading days prior to conversion. As collateral for the Company’s obligations under the debentures, the Company has granted the debenture holders a subordinated security interest in all of the assets of the Company and its subsidiary.

Discontinued Operations

Net cash used in operating activities of discontinued operations of $7.4 million for the year ended December 31, 2018, reflects activities of the ReShape Balloon product line until its disposal on December 17, 2019. For the year ended December 31, 2017, net cash used in operating activities of $2.4 million reflects activities since the October 2, 2017 acquisition of ReShape Medical, Inc. There were no investing or financing activities related to discontinued operations for the year ended December 31, 2018. For the year ended December 31, 2017, net cash used in investing activities for discontinued operations related to the cash portion of the purchase price for ReShape Medical, Inc. of $5.0 million, net of $0.6 million of cash acquired.

Operating Capital and Capital Expenditure Requirements

Our anticipated operations include plans to (i) integrate the sales and operations of the Company with the newly acquired Lap-Band product line; (ii) continue development of the ReShape Vest, (iii) seek opportunities to leverage the Company’s intellectual property portfolio and custom development services to provide third party sales and licensing opportunities, and (iv) explore and capitalize on synergistic opportunities to expand our portfolio and offer future

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minimally invasive treatments and therapies in the obesity continuum of care. The Company believes that it has the flexibility to manage the growth of its expenditures and operations depending on the amount of available cash flows, which could include reducing expenditures for marketing, clinical and product development activities.  However, the Company will ultimately need to achieve sufficient revenues from product sales and obtain additional equity or debt financing to support its operations.

Obtaining funds through the sale of additional equity and debt securities or the warrant holders’ exercise of outstanding common stock warrants may result in dilution to our stockholders. If we raise additional funds through the issuance of debt securities, these securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations. The sale of additional equity may require us to obtain approval from our stockholders to increase the number of shares of common stock we have authorized under our certificate of incorporation. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on reasonable terms, if at all. If we are unable to obtain additional financing, we may be required to reduce the scope of, delay, or eliminate some or all of, our planned research, development and commercialization activities, which could materially harm our business. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish valuable rights to products or proprietary technologies, or grant licenses on terms that are not favorable.

Our forecast of the period of time through which our financial resources will be adequate to support our operations, the costs to complete development of products and the cost to commercialize our products are forward-looking statements and involve risks and uncertainties, and actual results could vary materially and negatively as a result of a number of factors, including the factors discussed in Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect.

The Company’s acquisition of the Lap-Band product line provides incremental revenues and does not require further product development. In order to continue the development of, and to successfully commercialize the Lap-Band and provide clinical support for the ReShape Vest, the Company’s management is currently pursuing various funding options, including seeking additional equity or debt financing as well as a strategic merger or other transaction to obtain additional funding. The Company has a long history of raising equity financing to fund its development activities; however, there can be no assurance that the Company will continue to be successful in its efforts Should the Company be unable to obtain adequate financing in the near term, the Company’s business, result of operations, liquidity and financial condition would be materially and negatively affected, and the Company would be unable to continue as a going concern. Additionally, there can be no assurance that, assuming the Company is able to strengthen its cash position, it will achieve sufficient revenue or profitable operations to continue as a going concern.  The consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

Because of the numerous risks and uncertainties associated with the development of medical devices, such as our ReShape Vest, we are unable to estimate the exact amounts of capital outlays and operating expenditures necessary to complete the development of the ReShape Vest or other additional products and successfully deliver a commercial product to the market. Our future capital requirements will depend on many factors, including, but not limited to, the following:

·

the cost and timing of establishing sales, marketing and distribution capabilities;

·

the cost of establishing clinical and commercial supplies of our ReShape Vest and any products that we may develop;

·

the rate of market acceptance of our ReShape Vest and any other product candidates;

·

the cost of filing and prosecuting patent applications and defending and enforcing our patent and other intellectual property rights;

·

the cost of defending, in litigation or otherwise, any claims that we infringe third-party patent or other intellectual property rights;

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·

the effect of competing products and market developments;

·

the cost of explanting clinical devices;

·

the terms and timing of any collaborative, licensing or other arrangements that we may establish;

·

any revenue generated by sales of our Lap-Band, ReShape Vest or our future products;

·

the scope, rate of progress, results and cost of our clinical trials and other research and development activities;

·

the cost and timing of obtaining any further required regulatory approvals; and

·

the extent to which we invest in products and technologies, although we currently have no commitments or agreements relating to any of these types of transactions.

Off-balance-sheet Arrangements

Since our inception, we have not engaged in any off-balance-sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities as defined by rules enacted by the SEC and FASB, and accordingly, no such arrangements are likely to have a current or future effect on our financial position, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported expenses during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. Actual results may differ materially from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K, we believe that the following accounting policies and estimates are most critical to a full understanding and evaluation of our reported financial results.

Revenue Recognition

When we recognize revenue from the sale of our products, the amount of consideration we ultimately receive may vary depending upon the return terms and any sales rebates that we may offer, which are accounted for as variable consideration when estimating the amount of revenue to recognize. As discussed in Note 14 to the Consolidated Financial Statements, such variable consideration to date has not been material. 

Goodwill and Long-Lived Assets

We evaluate long-lived assets, including finite-lived intangible assets, for impairment by comparison of the carrying amounts to future net undiscounted cash flows expected to be generated by such assets when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset’s fair value or estimates of future discounted cash flows.

For goodwill and indefinite-lived intangible assets, in-process research and development, we review for impairment annually and upon the occurrence of certain events as required by Accounting Standards Codification (“ASC”) Topic 350, “Intangibles — Goodwill and Other.” Goodwill and indefinite-lived intangible assets are tested at least annually for impairment and more frequently if events or changes in circumstances indicate that the asset might be impaired. We review goodwill for impairment by first assessing qualitative factors to determine whether it is more likely

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than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. If we are able to determine that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, we would conclude that goodwill is not impaired. If the carrying amount of a reporting unit is zero or negative, the second step of the impairment test is performed to measure the amount of impairment loss, if any, when it is more likely than not that a goodwill impairment exists. In 2018, the Company recorded goodwill impairment of $14.0 million included in continuing operations and $13.2 million included in discontinued operations. There was no goodwill impairment recorded in 2017. In connection the Company’s sale and disposal of its ReShape Balloon product line, the Company recorded an impairment charge of $22.6 million for the full write-down of the ReShape Balloon product line assets. The Company did not identify any other impairments of indefinite-lived or finite-lived intangible assets in 2018 or 2017.

Research and Development Expenses

We record the estimated costs of research and development activities performed by third party service providers based upon the estimated services provided but not yet invoiced and includes these costs in accrued expenses and other payables in the Consolidated Balance Sheets and within research and development expense in the consolidated statements of operations. We accrue for these costs based on factors such as estimates of the work completed and in accordance with agreements established with its third party service providers. As actual costs become known, the Company adjusts its accrued liabilities.

The Company’s CRO arrangement generally requires payments in advance of services. Upon making a payment, the Company makes a determination as to the amount to record as a deferred charge and the amount of research and development expense. The amount of CRO related costs included in research and development expense each period is based upon the Company’s estimate of the time period over which services will be performed, enrollment of patients, number of sites activated and level of effort to be expended. Any amount of advances paid in excess of expense recognized is included in Prepaid expenses and other current assets on the Consolidated Balance Sheets. If the actual timing of the CRO’s performance of services or the level of effort varies from the Company’s estimate, the amount of prepaid CRO expense is adjusted accordingly.

We make significant judgments and estimates in determining the accrued balance and any deferred charges in each reporting period. Our understanding of factors such as the status and timing of services performed, the number of patients enrolled and the rate of patient enrollment may vary from our estimates and could result in us reporting amounts that are too high or too low in any particular period.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance for deferred income tax assets is recorded when it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The Company’s policy is to classify interest and penalties related to income taxes as income tax expense in the consolidated statements of operations.  

Recent Accounting Pronouncements

See Note 2 to our financial statements for a discussion of new accounting standards that have been adopted and those not yet adopted.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA    

Index to Financial Statements

 

 

 

Page

Report of Independent Registered Public Accounting Firm 

40

Financial Statements

 

Consolidated Balance Sheets 

41

Consolidated Statements of Operations 

42

Consolidated Statements of Stockholders’ Equity 

43

Consolidated Statements of Cash Flows 

44

Notes to Consolidated Financial Statements 

45

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders and the Board of Directors of ReShape Lifesciences Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of ReShape Lifesciences Inc. and subsidiaries (the "Company") as of December 31, 2018 and 2017, the related consolidated statements of operations, stockholders' equity, and cash flows, for each of the two years in the period ended December 31, 2018, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.

Going Concern

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements the Company is experiencing difficulty in generating sufficient revenues and cash flow to meet its obligations and sustain its operations, which raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are described in Note 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Basis for Opinion

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/    DELOITTE & TOUCHE LLP

Minneapolis, Minnesota

May 16, 2019

We have served as the Company's auditor since 2006.

 

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RESHAPE LIFESCIENCES INC.

Consolidated Balance Sheets 

 

 

 

 

 

 

 

 

 

December 31, 

 

    

2018

    

2017

ASSETS

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

5,547,745

 

$

10,163,208

Accounts receivable (net of allowance for bad debts of $235,567 and $155,872 at December 31, 2018 and December 31, 2017)

 

 

916,813

 

 

488,613

Inventory

 

 

984,735

 

 

1,968,546

Prepaid expenses and other current assets

 

 

1,269,741

 

 

467,783

Current assets of discontinued operations

 

 

 —

 

 

848,566

Total current assets

 

 

8,719,034

 

 

13,936,716

Property and equipment, net

 

 

63,548

 

 

341,976

Goodwill

 

 

 —

 

 

14,004,573

Other intangible assets, net

 

 

36,927,221

 

 

21,808,827

Other assets

 

 

562,863

 

 

990,015

Noncurrent assets of discontinued operations

 

 

 —

 

 

37,622,442

Total assets

 

$

46,272,666

 

$

88,704,549

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

1,626,545

 

$

1,088,271

Accrued and other liabilities

 

 

4,829,176

 

 

5,955,518

Asset purchase consideration payable, current

 

 

1,906,821

 

 

 

Total current liabilities

 

 

8,362,542

 

 

7,043,789

Asset purchase consideration payable, noncurrent

 

 

4,403,389

 

 

 

Deferred income taxes

 

 

1,844,297

 

 

5,292,291

Common stock warrant liability

 

 

 —

 

 

1,600

Total liabilities

 

 

14,610,228

 

 

12,337,680

Commitments and contingencies (Note 11)

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

Preferred stock, 5,000,000 shares authorized:

 

 

 

 

 

 

Series B convertible preferred stock, $0.01 par value; 159 and 6,055 shares issued and outstanding at December 31, 2018 and 2017, respectively

 

 

 2

 

 

61

Series C convertible preferred stock, $0.01 par value; 95,388 shares issued and outstanding at December 31, 2018 and 2017

 

 

954

 

 

954

Common stock, $0.01 par value; 275,000,000 shares authorized at December 31, 2018 and 2017; 8,770,433 and 14,742 shares issued and outstanding at December 31, 2018 and 2017, respectively

 

 

87,704

 

 

147

Additional paid-in capital

 

 

450,563,689

 

 

411,125,061

Accumulated deficit

 

 

(418,989,911)

 

 

(334,759,354)

Total stockholders’ equity

 

 

31,662,438

 

 

76,366,869

Total liabilities and stockholders’ equity

 

$

46,272,666

 

$

88,704,549

 

See accompanying notes to consolidated financial statements.

 

 

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RESHAPE LIFESCIENCES INC.

Consolidated Statements of Operations 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31, 

 

 

 

2018

    

2017

 

Revenue:

 

 

 

 

 

 

 

Product sales

 

$

606,710

 

$

319,160

 

Service and other revenue

 

 

 —

 

 

250,000

 

Total revenue

 

 

606,710

 

 

569,160

 

Cost of revenue:

 

 

 

 

 

 

 

Cost of goods sold

 

 

164,299

 

 

173,745

 

Cost of service and other revenue

 

 

 —

 

 

159,531

 

Total cost of revenue

 

 

164,299

 

 

333,276

 

Gross profit

 

 

442,411

 

 

235,884

 

Operating expenses:

 

 

 

 

 

 

 

Selling, general and administrative

 

 

19,261,680

 

 

22,848,922

 

Research and development

 

 

5,722,117

 

 

5,441,189

 

Goodwill impairment

 

 

14,004,573

 

 

 —

 

Total operating expenses

 

 

38,988,370

 

 

28,290,111

 

Operating loss

 

 

(38,545,959)

 

 

(28,054,227)

 

Other expense (income), net

 

 

 

 

 

 

 

Interest expense, net

 

 

12,378

 

 

2,808

 

Warrant expense

 

 

144,751

 

 

4,721,246

 

Other, net

 

 

10,643

 

 

652

 

Loss from continuing operations before income taxes

 

 

(38,713,731)

 

 

(32,778,933)

 

Income tax benefit

 

 

3,446,708

 

 

2,314,611

 

Loss from continuing operations

 

 

(35,267,023)

 

 

(30,464,322)

 

Loss from discontinued operations, net of tax

 

 

(45,884,552)

 

 

(3,353,650)

 

Net loss

 

 

(81,151,575)

 

 

(33,817,972)

 

Less: Down round adjustments for convertible preferred stock and warrants

 

 

(3,078,982)

 

 

 —

 

Net loss attributable to common shareholders

 

$

(84,230,557)

 

$

(33,817,972)

 

Net loss per share - basic and diluted:

 

 

 

 

 

 

 

Continuing operations

 

$

(34.28)

 

$

(5,803.84)

 

Discontinued operations

 

 

(41.03)

 

 

(638.91)

 

Net loss per share - basic and diluted

 

$

(75.31)

 

$

(6,442.75)

 

Shares used to compute basic and diluted net loss per share

 

 

1,118,439

 

 

5,249

 

 

See accompanying notes to consolidated financial statements.

 

 

 

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RESHAPE LIFESCIENCES INC.

Consolidated Statements of Stockholders’ Equity 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Series A Convertible

 

Conditional Convertible

 

Series B Convertible

 

Series C Convertible

 

Series D Convertible

 

 

 

Additional

 

 

 

 

Total

 

 

Preferred Stock

 

Preferred Stock

 

Preferred Stock

 

Preferred Stock

 

Preferred Stock

 

Common Stock

 

Paid-in

 

Accumulated

 

Stockholders’

 

    

Shares

    

Amount

    

Shares

    

Amount

    

Shares

    

Amount

    

Shares

    

Amount

    

Shares

    

Amount

    

Shares

    

Amount

     

Capital

    

Deficit

     

Equity

Balance December 31, 2016

 

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

1,304

 

$

13

 

$

303,879,935

 

$

(300,941,382)

 

$

2,938,566

Net loss

 

 

 

 —

 

 

 

 —

 

 

 

 —

 

 

 

 —

 

 

 

 —

 

 

 

 

 

 

 

(33,817,972)

 

 

(33,817,972)

Stock-based compensation expense

 

 

 

 —

 

 

 

 —

 

 

 

 —

 

 

 

 —

 

 

 

 —

 

 

 

 

 

4,436,797

 

 

 —

 

 

4,436,797

Issuance of convertible preferred stock, common stock and warrants in January 2017 public offering, net of issuance costs (Note 12)

 

12,531

 

 

125

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

581

 

 

 6

 

 

16,493,773

 

 

 

 

16,493,904

Issuance of convertible preferred stock and common stock related to BarioSurg, Inc. acquisition (Note 3)

 

 —

 

 

 —

 

1,000,181

 

 

10,002

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

658

 

 

 6

 

 

26,248,955

 

 

 

 

26,258,963

Issuance of convertible preferred stock and warrants in August 2017 public offering, net of issuance costs (Note 12)

 

 —

 

 

 —

 

 —

 

 

 —

 

20,000

 

 

200

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 

 

 

17,980,039

 

 

 

 

17,980,239

Issuance of warrants to certain investors as consideration for their waiver of future securities offering participation rights (Note 13)

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 

 

 

4,438,149

 

 

 

 

4,438,149

Issuance of convertible preferred stock and common stock related to ReShape Medical, Inc. acquisition (Note 12)

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

187,772

 

 

1,878

 

 —

 

 

 —

 

1,123

 

 

11

 

 

33,981,468

 

 

 

 

33,983,357

Conversions of convertible preferred stock into common stock

 

(12,531)

 

 

(125)

 

(1,000,181)

 

 

(10,002)

 

(13,945)

 

 

(139)

 

(92,384)

 

 

(924)

 

 —

 

 

 —

 

10,790

 

 

108

 

 

11,082

 

 

 

 

 —

Issuance of common stock upon exercise of warrants

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

286

 

 

 3

 

 

3,654,863

 

 

 

 

3,654,866

Balance December 31, 2017

 

 —

 

 

 —

 

 —

 

 

 —

 

6,055

 

 

61

 

95,388

 

 

954

 

 —

 

 

 —

 

14,742

 

 

147

 

 

411,125,061

 

 

(334,759,354)

 

 

76,366,869

Net loss

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

(81,151,575)

 

 

(81,151,575)

Stock-based compensation expense

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 

3,097,806

 

 

 —

 

 

3,097,806

Down round adjustments for convertible preferred stock and warrants

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 

3,078,982

 

 

(3,078,982)

 

 

 —

Institutional sale of convertible preferred stock and warrants in April 2018, net of issuance costs (Note 12)

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

6,000

 

 

60

 

 —

 

 

 —

 

 

5,081,128

 

 

 —

 

 

5,081,188

Institutional sales of common stock and warrants in June, July, August and November 2018, net of issuance costs (Note 12)

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

692,041

 

 

6,920

 

 

14,309,416

 

 

 —

 

 

14,316,336

Issuance of common stock and warrants in September 2018 public offering (Note 12)

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

83,493

 

 

835

 

 

445,825

 

 

 —

 

 

446,660

Issuance of common stock and warrants in an at-the-market public offering, net of issuance costs (Note 12)