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For most companies, generating revenue is crucial to their survival because it is one of the most important indicators of their financial performance, and it is also a key metric for investors to evaluate their management, business operations, and overall health. Because of the importance of revenue generation, many young companies are usually tempted to adopt dubious revenue recognition methods. However, companies using such methods may run the risk of a total collapse as they create a mirage of greater revenue with money that does not really exist. Such is the story of Hansen Medical, which was accused by a whistleblower of using dubious revenue recognition methods since its beginnings as a public company.
Revenue Recognition at a glance
The accounting principle of recognizing revenue under generally accepted accounting principles (GAAP) states that "Revenue should be recognized on the basis of increases in an entity's net position in a contract with a customer. When an entity becomes a party to a contract with a customer, the combination of the rights and the obligations in that contract gives rise to a net contract position. Whether that net contract position is a contract asset, a contract liability, or a net nil position depends on the measurement of the remaining rights and obligations in the contract. In the proposed model, revenue is recognized when a contract asset increases or a contract liability decreases (or some combination of the two). That occurs when an entity performs by satisfying an obligation in the contract."  Generally speaking, income is recognized as revenue whenever the company delivers or performs its product or service and receives payment for it. However, there are several situations in business transactions where, the method and timing of recognizing income as revenue is unclear to say the least. Too often, It is in these unclear business transactions that many companies may manipulate revenue figures to improve the results of its financial reporting.
Hansen Medical was caught through a whistleblower manipulating its financial reports by using a quite "flexible" method of revenue recognition. Through this method, income from sold units was fully recognized as revenue before they were actually paid while no deferred revenue was ever booked on any of the company's transactions. Hansen Medical's unethical accounting method may have been used to satisfy strategic and operational goals, and also encourage a favorable valuation report for a much needed capital raise. It has also contributed to a tremendous depreciation of its publicly traded stock, strong criticism about its business model by investment professionals and a uncertain financial future.
To properly understand how Hansen Medical got into the turmoil that faces today, I will give the following Framework:
The use of Robotics in healthcare, especially in surgery, has been a sector of high risk and reward among professional investors. Regardless of the limited ability the investors have to understand the relevance of robotics applied to medicine and healthcare, many of them believe that the upside potential in this sector of healthcare outweighs any risks they may face
In Heart Disease, Atrial fibrillation (AFib) is the most common and complicated form of arrhythmia. AFib happens when the atria, usually the left atrium, is filled with random electrical signals that can cause the atrium to contract over 200 times per minute. There is an ongoing debate over the origin of the electrical signals, but it is accepted that signals often come from the pulmonary veins and perhaps a few other places. Other arrhythmias have patterns, but AFib is completely irregular, and determining proper treatment is difficult.
Over the last 20 years, AFib treatment has evolved significantly. The pioneer in AFib surgery was Dr. Cox, who invented the Maze procedure in the 1980's. Because electrical signals do not pass through scar tissue, Dr. Cox would cut the heart muscle and sew it back together, creating scar lines along the cuts when the muscle healed. By strategically placing the incisions in the heart muscle, he could "guide" the electrical signals to the correct areas. Over time, different variations of the procedure were developed and more sophisticated mapping techniques allowed surgeons to see where the electrical problems were and cut the appropriate part of the heart muscle. The procedure is considered high-risk and highly invasive because it requires a heart/lung machine to keep the patient alive during surgery. The Maze procedure is also very effective, curing AF in about 90% of cases  , and reducing the chances of stroke post-operatively  . To date, no other procedure has as high an efficacy rate as the Cox Maze cut-and-sew procedures. However, technological advancements in healthcare during the last fifteen years, especially the use of robotics in surgery, may highly decrease the severity of this high-risk and invasive procedure.
The company is the brainchild of Famous Neuro-Surgeon turned Entrepreneur, Frederick Moll. Hansen Medical is Moll's the third venture into the world of surgical-robotics, and his two prior companies, SRI International, and Intuitive Surgical have been a rotund success in a business and technological advancement sense.
Hansen's founders also founded Intuitive Surgical and we think they have constructed a similar business, built for long term profitable growth. Hansen will be able to achieve continued growth by first penetrating the market with installed machines, then driving procedure volume and service contracts. Each procedure uses a high margin disposable that will eventually become the key source of revenue for the firm. Service contracts will also provide a high margin source of recurring revenue.
The Product: Sensei System
Hansen Medical's robot, the Sensei, comes in two main components, the robotic arm that is affixed to the operative table (pictured right) and the workstation where the doctor can sit and control the catheter (pictured left). The list price for the Sensei is $625,000 but first systems were sold at a discount, possibly as low as $400,000. The 3-D joystick at the workstation controls the catheter in all dimensions, exactly mimicking the motions of the operator. The display screens at the workstation provide an x-ray view, 3-D anatomical mapping and electrical heart rhythm monitoring. The physician can be seated while undertaking a long procedure, such as AFib and avoid radiation exposure.
The Sensei workstation is easily rolled into the room and the robotic arm can also be moved, although it is more involved. This is an important feature as it will allow maximum usage of the system and the flexibility to get it out of the way when not needed. The robotic arm functions by pulling wires inside a disposable catheter sheath, the Artisan, that guide the sheath into the desired direction. The Artisan guide catheter is approximately 12 French (4mm) on the outer diameter and the inner lumen is slightly larger than 8 French (>2.7mm). The next generation of Artisan will be 7 French in outer lumen, and after that Hansen plans to launch products with working tools for use in the vessels. To deliver therapy, and for now the main application is ablation catheters for heart arrhythmias, any ablation catheter can be inserted into the 8 French lumen and used as normal. The Artisan system sells for $1,600 and a new disposable is used in each case.
With the investors, clinical and business model perspectives now established, we now can better understand how HNSN ended up in its current state.
The Dawn of Hansen's business nightmare.
When the company went public on November 17, 2006, Investor sentiment was that Hansen Medical was poised for greatness in the same manner as Intuitive Surgical was. In fact, many investment professionals viewed Hansen Medical through the same investment scope and expectations than Intuitive Surgical, disregarding the fact that Intuitive Surgical was a more mature company and that its product had already proved its significance in the healthcare world.
Lost perhaps in the excitement created by the Sensei's technological advancement and potential to become the gold standard in Afib, most investors seemed to overlook that Hansen Medical's business model was based on a product that was yet to prove its clinical relevance, and demonstrate that was more than just an expensive surgeon's toy. Proving the Sensei's clinical benefits over the standard Cox-Maze procedure would take significant amount of positive data derived from comparative trials, and running them would cost millions of dollars and take time to generate statistically significant data. However, despite of the Sensei's clinical benefit controversy, the Sensei was given 510 (k) clearance by the FDA, thus validating the product safety in trials.
After the Sensei FDA approval for commercialization in May of 2007, demand for the sensei accelerated (see attached revenue model) based on the request of maverick surgeons and early adopters in an intent to spearhead innovation and capture the business derived from delivering to the public such innovative procedure for the treatment of attrial fibrillation.
However after a few months of operation as a public company, The company realized that there were not enough maverick surgeons and innovating hospitals combined to sustain a sound demand for the Sensei. The sentiment among many hospitals was that it was hard to justify a $625, 000 equipment expense without the Sensei having a proven clinical benefit over the far cheaper Cox-Maze procedure and without a clear way to drive usage and a justifiable return on investment.
Recognizing Non-existing Revenue
Pressured by a slowdown in Sensei's demand due to clinical benefit doubts and the beginning of (what we now know was) a worldwide economic recession, Hansen Medical may have started as early as its fourth financial quarter in 2007 to offer Hospital payment plans for the Sensei to boost revenue. This was the moment where Hansen Medical started to engage in unethical practices of revenue recognition. To date, the company has not publicly stated how it recognized revenue for all of the Sensei's sold to date. However, many inferences can be drawn from its 8-k Statement of Material Events released on October 19, 2009:
"Through June 30, 2009, we shipped 68 Sensei Robotic Catheter Systems based on valid customer purchase orders for which revenue was recognized. We have received full payment for all but two of these systems. Of these two systems, we have not been paid for one system on which we recognized revenue in the quarter ended June 30, 2009 and to date have received partial payment of $320,000 on the sale of system to a distributor on which we recognized revenue in the quarter ended March 31, 2009. We have identified systems for which revenue should have been recognized in a later period than the period in which it was recognized and revenue on a smaller number of systems that should have been reflected as deferred revenue on our balance sheet as of June 30, 2009." 
"Hansen Medical, Inc. (NASDAQ: HNSN) today announced that it plans to restate its financial statements for the year ended December 31, 2008 and for the quarters ended March 31, 2008, June 30, 2008, September 30, 2008, March 31, 2009 and June 30, 2009 in order to correct certain errors, some of which arose from potential irregularities occurring outside of the accounting department, regarding the timing of revenue recognition on the sale of some of its Sensei® Robotic Catheter Systems." 
There are many inferences that can be made from the official statements:
The whistle blower
There must have been many accounting irregularities since the company started generating revenue for a whistle blower to come out with sound proof and denounce the accounting irregularities of one of the hottest stocks in healthcare.
Management selection of words is quite incriminating
In an effort to appear transparent, management stated that through June 30 2009 all of 68 but 2 have been paid in full. However, timing of events is crucial to know whether the company engaged in accounting irregularities. Management failed to mention how long it took the company to collect the payment of the other 66 Sensei units and if all of these units were fully recognized as revenue before full payment was collected for them. It could have taken the company one, two, or more reporting quarters to collect payment that was fully recognized as revenue the moment the Sensei was delivered.
The capital raise timing
Another incriminating point is the financial benefit of exaggerating revenues prior to a secondary capital raising. Even if non-existent, greater revenue in financial reporting usually leads to a better valuation multiple, which translates into a greater ability to raise capital at the time of a public offering. In April of 2009, Hansen Medical completed a secondary public offering with a much needed net proceeds of $ 35 million. Given that revenue irregularities started long before April 2009, it seems unimaginable that anybody employed at Hansen Medical would make mention of the company's revenue recognition issues before their secondary public offering.
Hansen Medical (Nasdq: HNSN) has always been considered a high risk/reward stock, but after only a few months of investor excitement that drove the stock price to $37.50 (see chart above), the high degree of risk on the stock was materialized in the fourth financial quarter of 2007 when the stock started to decline due to the Sensei's lack of convincing clinical data , fears on an economic slowdown, and investors' doubts on Hansen Medical's business model. Investors' negative sentiment was further reinforced by the news of revenue recognition irregularities, which further depressed the stock to the current level of $2.70. After taking deep financial losses, many investors have united and taken Hansen Medical to court and hold them accountable for its possible violations.
Many Lawsuits now... many more to come.
Since the revenue irregularities were first made public, there have been twelve class actions lawsuits against Hansen Medical. Most Plaintiffs, have charged the company of violating SEC rules and Federal laws by stating misleading and false financial revenue information that violated Generally Accepted Accounting Principles. The plaintiffs also argue that the overstatement of revenue made the stock trade artificially high since the company's fourth financial quarter in 2007, making investors pay an unacceptable high price for the company's share and take deep loses when the stock crashed as revenue irregularities were discovered. It is unlikely that the avalanche of lawsuits will end any time soon and defending against all of them will put Hansen Medical in a precarious financial position.
Generating revenue is crucial to a business enterprise survival because it is one of the most important indicators of its financial performance and a key metric that investors use to assess its management, operations, and overall health. Because of its importance to managerial and financial accounting, revenue recognition seems to be the Achilles Tendon of many Technologically innovating and financially promising growth companies.
For Hansen Medical, its decision to use revenue recognition improperly to artificially improve its financial condition may prove to be fatal mistake. The combination of an increasing number of lawsuits, a depressed stock price, and a highly tainted management as a result of the company's current accounting scandal may put Hansen Medical out of business and severely impair the adoption of one of the greatest technological innovations for the treatment of heart disease in the last twenty years.