GlucoTrack, Inc. - Quarter Report: 2016 June (Form 10-Q)

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

 

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ DEFICIT

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (cont.)

 

Supplementary information on financing activities not involving cash flows:

 

$234,008, representing the fair value of warrants issued as consideration for placement agent services, was accounted for as Warrants with Down-Round Protection within long-term liabilities. Of these direct  issuance expenses, $77,503 was allocated to the Series C-1 and Series C-2 Warrants and was recorded as a reduction of additional paid in capital, and $156,505 was allocated to the Series C Preferred Stock and recorded as a reduction of temporary equity.

$341,662, representing the amount classified out of stockholders deficit and presented as Warrants with Down-Round Protection within long-term liabilities (See Note 2B and Note 3).

 

$254,101 and  $20,355 representing the fair value of the shares of Common Stock issued to owners of Series B Preferred Stock and owners of Series C Preferred Stock, respectively, was accounted for as a stock dividend in the statement of changes in stockholders’ deficit and was charged to accumulated deficit against additional paid in capital and Common Stock therein.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1

–

GENERAL

A.

Integrity Applications, Inc. (the "Company") was incorporated on May 18, 2010 under the laws of the State of Delaware.  On July 15, 2010, Integrity Acquisition Corp. Ltd. (hereinafter: "Integrity Acquisition"), a wholly owned Israeli subsidiary of the Company, which was established on May 23, 2010, completed a merger with A.D. Integrity Applications Ltd. (hereinafter: "Integrity Israel"), an Israeli corporation that was previously held by the stockholders of the Company.  Pursuant to the merger, all equity holders of Integrity Israel received the same proportional ownership in the Company as they had in Integrity Israel prior to the merger. Following the merger, Integrity Israel remained a wholly-owned subsidiary of the Company.  As the merger transaction constituted a structural reorganization, the merger has been accounted for at historical cost in a manner similar to a pooling of interests.  Integrity Israel was incorporated in 2001 and commenced its operations in 2002.  Integrity Israel, a medical device company, focuses on the design, development and commercialization of non-invasive glucose monitoring devices for use by people with diabetes.

 

B.

Going concern uncertainty

 

Since its incorporation, the Company did not conduct any material operations other than those carried out by Integrity Israel.  The development and commercialization of Integrity Israel's product is expected to require substantial expenditures.  Integrity Israel and the Company (collectively, the "Group") have not yet generated any material revenues from operations, and therefore they are dependent upon external sources for financing their operations. As of June 30, 2016, the Group has incurred an accumulated deficit of $32,476,186, stockholders’ deficit of $8,757,799 and negative operating cash flows.  These factors raise substantial doubt about the Group’s ability to continue as a going concern.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.  During 2012, the Company raised a total amount of approximately $1.0 million (net of related expenses) from the issuance of Common Stock. During 2013, the Company raised funds in an approximate amount of $5.3 million (net of related cash expenses) from the issuance of units (the “Series A Units”) consisting of shares of the Company’s Series A Convertible Preferred Stock (the “Series A Preferred Stock”) and detachable warrants to purchase shares of the Company’s Common Stock (the “Series A Warrants” or “Warrants with down round protection”).  During the period between August and December 2014, the Company raised funds in an aggregate amount of approximately $7.3 million (net of related cash expenses) from the issuance of units (the “Series B Units”), each consisting of (a) one share of the Company’s newly designated Series B 5.5% Convertible Preferred Stock, par value $0.001 per share (the “Series B Preferred Stock”), convertible into Common Stock at an initial conversion price of $5.80 per share, (b) a five year warrant to purchase, at an exercise price of $5.80 per share, up to such number of shares of Common Stock issuable upon conversion of such share of Series B Preferred Stock (each a “Series B-1 Warrant”) and (c) a five year warrant to purchase, at an exercise price of $10.00 per share, up to such number of shares of Common Stock issuable upon conversion of such share of Series B Preferred Stock (each a “Series B-2 Warrant” and, together with the Series B-1 Warrants, collectively, the “Series B Warrants”).  During the three month period ended June 30, 2016, the Company raised funds in an aggregate amount of approximately $3.75 million (net of related cash expenses) through the issuance of 4,425 units (the “Series C Units”), each consisting of (a) one share of the Company’s newly designated Series C 5.5% Convertible Preferred Stock, par value $0.001 per share (the “Series C Preferred Stock”), convertible into Common Stock at an initial conversion price of $4.50 per share, (b) a five year warrant to purchase, at an exercise price of $4.50 per share, up to such number of shares of Common Stock issuable upon conversion of such share of Series C Preferred Stock (each a “Series C-1 Warrant”) and (c) a five year warrant to purchase, at an exercise price of $7.75 per share, up to such number of shares of Common Stock issuable upon conversion of such share of Series C Preferred Stock (each a “Series C-2 Warrant” and, together with the Series C-1 Warrants, collectively, the “Series C Warrants”), as described in further detail in Note 3.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1

–

GENERAL

B.

Going concern uncertainty (cont.)

 

Until such time as the Group generates sufficient revenue to fund its operations (if ever), the Group plans to finance its operations through the sale of equity or equity-linked securities and/or debt securities and, to the extent available, short term and long term loans. There can be no assurance that the Group will succeed in obtaining the necessary financing to continue its operations as a going concern.

 

C.

Risk factors

 

As described in Note 1A and Note 1B above, the Group has a limited operating history and faces a number of risks and uncertainties, including risks and uncertainties regarding continuation of the development process, demand and market acceptance of the Group's products, the effects of technological changes, competition and the development of products by competitors.  Additionally, other risk factors also exist, such as the ability to manage growth and the effect of planned expansion of operations on the Group's future results and the availability of necessary financing. In addition, the Group expects to continue incurring significant operating costs and losses in connection with the development of its products and marketing efforts. The Group has not yet generated material revenues from its operations to fund its activities and therefore is dependent on the receipt of additional funding from its stockholders and/ or new investors in order to continue its operations.

D.

Use of estimates in the preparation of financial statements

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. As applicable to these consolidated financial statements, the most significant estimates and assumptions relate to (i) the fair value estimate of the Warrants with down-round protection, (ii) the allocation of the proceeds and the related issuance costs of the Series C Units, and (iii) the going concern assumptions.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2

–

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A.

Basis of presentation

 

Accounting Principles

 

The accompanying unaudited condensed consolidated financial statements and related notes should be read in conjunction with our consolidated financial statements and related notes contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015. The unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) related to interim financial statements. As permitted under those rules, certain information and footnote disclosures normally required or included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. The financial information contained herein is unaudited; however, management believes all adjustments have been made that are considered necessary to present fairly the results of the Company’s financial position and operating results for the interim periods. All such adjustments are of a normal recurring nature.

 

The results for the six months ended June 30, 2016 are not necessarily indicative of the results to be expected for the year ending December 31, 2016 or for any other interim period or for any future period.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its subsidiary. All intercompany balances and transactions have been eliminated in consolidation.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2

–

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)

 

B.

Warrants with down-round protection

 

The Company has determined its derivative warrant liability with respect to the Series A Warrants and warrants issued to Andrew Garrett, Inc., (“AGI”) as part of the Series A Unit offering, the Series B Unit offering and the Series C Unit offering to be a Level 3 fair value measurement and has used the Binomial pricing model to calculate its fair value. Because the warrants contain a down round protection feature, the probability that the exercise price of the warrants would decrease as the stock price decreased was incorporated into the valuation calculations.  The key inputs used in the fair value calculations were as follows:

 

The changes in the fair value of the Level 3 liability are as follows (in US dollars):

		Series A Warrants
		June 30,
		2016				2015
Balance, Beginning of the period			321,695				2,057,618
Warrants issued as consideration for placement services			234,008				-
Amount classified out of stockholders deficit and presented as Warrants with Down-Round Protection			341,662				-
Exchange of Series A Warrants pursuant to the “most favored nation” provision			-				(1,573,435	)
Change in fair value Warrants with Down-Round Protection			(64,212	)			(91,309	)
Balance, End of period			833,153				392,874

The key inputs used in the fair value calculations were as follows:

		June 30,
		2016				2015
Dividend yield (%)			-				-
Expected volatility (%) (*)			62.16				105.14
Risk free interest rate (%)			0.72-1.11				1.01
Expected term of options (years) (**)			1.70-5.00				2.70
Exercise price (US dollars)			4.50-7.75				5.80
Share price (US dollars) (***)			2.38				2.31
Fair value (US dollars)			0.61				1.00

(*)

Due to the low trading volume of the Company’s Common Stock, the expected volatility was based on the historical volatility of the share price of other public companies that operate in the same industry sector as the Company.

 

(**)

Due to the fact that the Company does not have sufficient historical exercise data, the expected term was determined based on the "simplified method" in accordance with Staff Accounting Bulletin No. 110.

 

(***)

The Common Stock price, per share reflects the Company’s management’s estimation of the fair value per share of Common Stock as of June 30, 2016 and 2015. In reaching its estimation for such periods, management considered, among other things, a valuation prepared by a third-party valuation firm following the issuance of the Series C Units and the Series B Units (See Note 3).

INTEGRITY APPLICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

 

NOTE 2

–

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)

 

C.

Recently issued accounting pronouncements

 

1.

Accounting Standard Update 2014-16, “Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity”

Effective January 1, 2016, the Group adopted Accounting Standard Update 2014-16, Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity ("ASU 2014-16").

The amendments in ASU 2014-16 clarify how U.S. GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the amendments clarify that an entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, in evaluating the nature of the host contract. Furthermore, the amendments clarify that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial instrument. The amendments also clarify that, in evaluating the nature of a host contract, an entity should assess the substance of the relevant terms and features (i.e., the relative strength of the debt-like or equity-like terms and features given the facts and circumstances) when considering how to weigh those terms and features. The assessment of the substance of the relevant terms and features should incorporate a consideration of the characteristics of the terms and features themselves; the circumstances under which the hybrid financial instrument was issued or acquired; and the potential outcomes of the hybrid financial instrument, as well as the likelihood of those potential outcomes.

The amendments in ASU 2014-16 apply to all entities that are issuers of, or investors in, hybrid financial instruments that are issued in the form of shares.

The effects of initially adopting the amendments in ASU 2014-16 were required to be applied on a modified retrospective basis to existing hybrid financial instruments issued in the form of shares as of the beginning of the fiscal year for which the amendments are effective. However, retrospective application was permitted to all relevant prior periods.

Management analyzed the economic characteristics and risks of the Series A Preferred Stock and the Series B Preferred Stock (including the embedded conversion feature of each) in accordance with the provisions of ASU 2014-16 and determined that such instruments are considered as more akin to equity than debt. Accordingly, it was determined that the economic characteristics and the risks of the embedded conversion option to Common Stock and those of the Preferred Stock themselves (the 'host contract') are clearly and closely related and accordingly, the embedded conversion feature was not required to be bifurcated. As a result of the above determination, ASU 2014-16 did not impact the classification of the Series A Preferred Stock or the Series B Preferred Stock.

INTEGRITY APPLICATIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

 

NOTE 2

–

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)

 

C.

Recently issued accounting pronouncements (cont.)

2.

Accounting Standard Update 2014-09, “Revenue from Contracts with Customers”

In May 2014, the FASB issued Accounting Standard Update 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09").

 

ASU 2014-09 outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. ASU 2014-09 also requires entities to disclose sufficient information, both quantitative and qualitative, to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.

 

An entity should apply the amendments in ASU 2014-09 using one of the following two methods: 1. Retrospectively to each prior reporting period presented with a possibility to elect certain practical expedients, or, 2. Retrospectively with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application. If an entity elects the latter transition method, it also should provide certain additional disclosures.

 

During 2016, the FASB issued several Accounting Standard Updates (“ASUs”) that focus on certain implementation issues of the new revenue recognition guidance including Narrow-Scope Improvements and Practical Expedients, Principal versus Agent Considerations and Identifying Performance Obligations and Licensing.

For a public entity, the amendments in ASU 2014-09 (including the amendments introduced through recent ASUs) are effective for annual reporting periods beginning after December 15, 2016, including interim periods within the first annual reporting period (the first quarter of fiscal year 2017 for the Company). Early application is not permitted.

 

The Company is in the process of assessing the impact, if any, of ASU 2014-09 (including the amendments introduced through recent ASUs) on its consolidated financial statements.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 2

–

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)

 

C.

Recently issued accounting pronouncements (cont.)

3.

Accounting Standards Update 2014-15, “Presentation of Financial Statements—Going Concern”

In August 2014, the FASB issued Accounting Standards Update 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern ("ASU 2014-15").

 

ASU 2014-15 provides guidance on management’s responsibility to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, when applicable).

 

ASU 2014-15 also provides guidance related to the required disclosures as a result of management’s evaluation. 

 

The amendments in ASU 2014-15 are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted.

 

Due to the current financial condition of the Company and the existing uncertainty regarding its ability to continue as a going concern, management does not believe that the provisions of ASU 2014-15 will have a significant effect on its evaluation of the Company’s ability to continue as a going concern. However, management is currently considering if additional disclosures will be required as a result of ASU 2014-15.

4.

Accounting Standard Update 2015-11, “Simplifying the Measurement of Inventory”

In July, 2015, The FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory (Topic 330) ("ASU 2015-11").

ASU 2015-11 outlines that inventory within the scope of its guidance be measured at the lower of cost and net realizable value. Inventory measured using last-in, first-out (LIFO) and the retail inventory method (RIM) are not impacted by the new guidance. Prior to the issuance of ASU 2015-11, inventory was measured at the lower of cost or market (where market was defined as replacement cost, with a ceiling of net realizable value and floor of net realizable value less a normal profit margin).

For a public entity, the amendments in ASU 2015-11 are effective, in a prospective manner, for annual reporting periods beginning after December 15, 2016, including interim periods within the first such annual reporting period (the first quarter of fiscal year 2017 for the Company). Early adoption is permitted as of the beginning of an interim or annual reporting period.

The Company is in the process of assessing the impact, if any, of ASU 2015-11 on its consolidated financial statements.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

 

NOTE 3

–

RECENT EVENTS

A.

During February 2016, the Company entered into an Advisory Agreement with AGI, pursuant to which the Company retained AGI on a non-exclusive basis to provide certain advisory services to the Company. As consideration for such services, the Company extended through December 31, 2019, the expiration date of 422,077 warrants issued to AGI and/or its designees in connection with the Company’s common stock offering completed in 2010 and the Series A Unit offering completed in 2012. The Advisory Agreement had an initial term of six months, subject to automatic renewal for additional 30 day terms unless terminated by either party with 30 days written notice.  In April 2016, the Company and AGI amended that Advisory Agreement to extend the term of the Advisory Agreement for an additional six months.  In consideration for such extension, the Company agreed to modify the terms of the 439,674 warrants issued to AGI and/or its designees in connection with the Series B Unit offering to include full-ratchet anti-dilution protection. As a result of the two agreements the Company recorded in its statement of operations for the six month and three month periods ended June 30, 2016, a one-time charge in the amount of $211,077 representing the incremental fair market value adjustments in respect of the above modified warrants issued to the placement agent. Such incremental fair market value adjustments represent the increase in the fair value of the warrants resulting from the above modifications and were recorded against stockholders’ deficit. In addition, as a result of the inclusion of anti-dilution protection, the Company classified $341,662, representing the fair market value at April 2016 of the above 439,674 warrants issued to AGI out of stockholders deficit and presented them as Warrants with down round protection within long-term liabilities.

 

B.

During the three month period ended June 30, 2016, the Company raised funds in an aggregate amount of approximately $3.75 million (net of related cash expenses) from the issuance in four separate closings of 4,425 Series C Units. As of June 30, 2016, the shares of Preferred Stock comprising the Series C Units are convertible into an aggregate of 983,386 shares of Common Stock, and the Series C Warrants comprising the Series C Units are exercisable for an aggregate of 1,966,772 shares of Common Stock, in each case subject to adjustment as described below.

 

Pursuant to a placement agent agreement (the “Placement Agent Agreement”) with AGI, at the initial closing of the sale of the Series C Units the Company paid AGI, as a commission, an amount equal to 6% of the aggregate sales price of the Series C Units, plus 4% of the aggregate sales price as a management fee plus a non-accountable expense allowance equal to 3% of the aggregate sales price of the Series C Units. At the end of the second, third and fourth closings of the sale of the Series C Units, the Company paid AGI, as a commission, an amount equal to 10% of the aggregate sales price of the Series C Units sold in such closing, plus a non-accountable expense allowance equal to 3% of the aggregate sales price of the Series C Units sold in such closing. In addition, pursuant to the Placement Agent Agreement, the Company is required to issue to AGI: (a) 5 year warrants to purchase up to 196,678 shares of Common Stock at an exercise price of $4.50 per share and (b) 5 year warrants to purchase up to 98,339 shares of Common Stock at an exercise price of $7.75 per share. The terms of such warrants will be substantially similar to the Series C Warrants except that the warrants issued to AGI will also be exercisable on a cashless basis and will include full ratchet anti-dilution protection.

INTEGRITY APPLICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 3

–

RECENT EVENTS (Cont.)

Subject to certain ownership limitations described below, the Series C Preferred Stock is convertible at the option of the holder at any time and from time to time into shares of Common Stock at a conversion price of $4.50 per share (calculated by dividing the stated value per share of Preferred Stock, which is initially $1,000, by the conversion price per share). The conversion price of the Series C Preferred Stock is subject to adjustment for certain issuances of Common Stock or other securities of the Company at an effective price per share that is lower than the conversion price then in effect, as well as for stock splits, stock dividends, combinations of shares, similar recapitalization transactions and certain pro-rata distributions to common stockholders. In addition, the holders of Preferred Stock will be entitled to receive any securities or rights to acquire securities or property granted or issued by the Company pro rata to the holders of Common Stock to the same extent as if such holders had converted all of their shares of Series C Preferred Stock prior to such distribution. In the event of a fundamental transaction, such as a merger, consolidation, sale of substantially all assets and similar reorganizations or recapitalizations of the Company, the holders of Series C Preferred Stock will be entitled to receive, upon conversion of their shares of Series C Preferred Stock, any securities or other consideration received by the holders of the Common Stock pursuant to the fundamental transaction.

 

Holders of Series C Preferred Stock are entitled to receive cumulative dividends at a rate of 5.5% per annum, based on the stated value per share of Series C Preferred Stock. Dividends on the Series C Preferred Stock are payable quarterly on March 31, June 30, September 30 and December 31 of each year, beginning on June 30, 2016, and on each conversion date (with respect to the shares of Preferred Stock being converted). For so long as required under the terms of the Certificate of Designations for the Company’s outstanding Series A Preferred Stock or Series B Preferred Stock, dividends will be payable only in shares of Common Stock. Thereafter, dividends on the Series C Preferred Stock will be payable, at the option of the Company, in cash and/or, if certain conditions are satisfied, shares of Common Stock or a combination of both. Shares of Common Stock issued as payment of dividends will be valued at the lower of (a) the then current conversion price of the Series C Preferred Stock or (b) the average of the volume weighted average price for the Common Stock on the principal trading market therefor for the 10 trading days immediately prior to the applicable dividend payment date. The Company will incur a late fee of 9% per annum, payable in cash, on dividends that are not paid within three trading days of the applicable dividend payment date.

Subject to any limitations under the terms of the Certificate of Designations for the Company’s outstanding Series A Preferred Stock or Series B Preferred Stock, the Company may become obligated to redeem the Series C Preferred Stock in cash upon the occurrence of certain triggering events, including, among others, a material breach by the Company of certain contractual obligations to the holders of the Series C Preferred Stock, the occurrence of a change in control of the Company, the occurrence of certain insolvency events relating to the Company, or the failure of the Common Stock to continue to be listed or quoted for trading on one or more specified United States securities exchanges or a regulated quotation service. In addition, upon the occurrence of certain triggering events, each holder of Series C Preferred Stock will have the option to require the Company to redeem such holder’s shares of Preferred Stock for a redemption price payable in shares of Common Stock or receive an increased dividend rate of 9% on all of such holder’s outstanding Series C Preferred Stock.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 3

–

RECENT EVENTS (Cont.)

Subject to certain conditions contained in the Certificate of Designations, Preferences and Rights relating to the Series C Preferred Stock (the “Certificate of Designations”), the Company will have the option to force the conversion of the Series C Preferred Stock (in whole or in part) if (a) the volume weighted average price for the Common Stock on its principal trading market exceeds $7.00 for each of any 20 trading days during any 30 consecutive trading day period and the average daily dollar trading value for the Common Stock during such 30 day period exceeds $50,000 or (b) the Company receives approval to list the Common Stock on a national securities exchange.

Subject to certain exceptions contained in the Certificate of Designations, if the Company fails to timely deliver certificates for shares of Common Stock issuable upon conversion of the Series C Preferred Stock (the “Conversion Shares”) and, as a result, the holder is required by its brokerage firm to purchase shares of Common Stock to deliver in satisfaction of a sale by such holder of the Conversion Shares (a “Buy-In”), the Company will be required to: (a) pay the converting holder in cash an amount equal to the amount, if any, by which such holder’s total purchase price (including any brokerage commissions) for the shares of Common Stock so purchased exceeds the product of (i) the aggregate number of Conversion Shares due to the holder, multiplied by (ii) the actual sale price at which the sell order giving rise to such purchase obligation was executed (including any brokerage commissions); and (b) at the option of such holder, either reissue (if surrendered) the shares of Series C Preferred Stock equal to the number of shares of Series C Preferred Stock submitted for conversion (in which case, such conversion will be deemed rescinded) or deliver to such holder the number of shares of Common Stock that would have been issued if the Company had timely complied with its delivery requirements. In addition, the Company will be required to pay partial liquidated damages of $10 for each $1,000 of stated value of any shares of Series C Preferred Stock which have been converted by a holder and in respect of which the Company fails to deliver Conversion Shares by the fifth trading day following the applicable conversion date and the Company will continue to pay such partial liquidated damages for each trading day after such eighth trading day until such certificates are delivered or the holder rescinds such conversion.

As long as at least 35% of the originally issued shares of Series C Preferred Stock are outstanding, without the written consent of the holders of a majority in stated value of the outstanding Series C Preferred Stock, the Company will not be permitted to, among other things, incur indebtedness or liens not permitted under the Certificate of Designations; repay, repurchase, pay dividends on or otherwise make distributions in respect of any shares of Common Stock or other securities junior to the Series C Preferred Stock; enter into certain transactions with affiliates of the Company; or enter into any agreement with respect to the foregoing.

Subject to the beneficial ownership limitation described below, holders of Series C Preferred Stock will vote together with the holders of Common Stock and Series A Preferred Stock and Series B Preferred Stock on an as-converted basis. Holders will not be permitted to convert their Series C Preferred Stock if such conversion would cause such holder to beneficially own more than 4.99% of the outstanding Common Stock (subject to increase to 9.99%, at the option of the holder, upon no less than 61 days prior written notice to the Company) (the “Beneficial Ownership Limitation”). In addition, no holder may vote any shares of Series C Preferred Stock (on an as-converted to Common Stock basis) in excess of the Beneficial Ownership Limitation.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 3

–

RECENT EVENTS (Cont.)

Subject to certain limitations, so long as any purchaser holds any shares of Series C Preferred Stock, if (a) the Company sells any shares of Common Stock or other securities convertible into, or rights to acquire, Common Stock and (b) a purchaser then holding Series C Preferred Stock, Warrants, Conversion Shares or Warrant Shares (defined below) reasonably believes that any of the terms and conditions appurtenant to such issuance or sale are more favorable to the purchaser in such subsequent sale of securities than are the terms and conditions granted to such purchaser after taking into account all of the terms and conditions of the terms granted to the purchasers under the purchase agreement and the terms granted in such subsequent issuance or sale, including all of the components of the Series C Units and of the securities or units involved in such subsequent issuance or sale, then the purchaser will be permitted to require the Company to amend the terms of this transaction (only with respect to such purchaser) so as to match the terms of the subsequent issuance (including, for the avoidance of doubt, any terms and provisions that are or may be less favorable to such purchaser).

The Series C Warrants have a five-year term commencing on their respective issuance dates. Until the end of the applicable term, each Series C Warrant will be exercisable at any time and from time to time at an exercise price of $4.50 per share (with respect to the Series C-1 Warrants) or $7.75 per share (with respect to the Series C-2 Warrants). The Series C Warrants contain adjustment provisions substantially similar to those to the adjustment provisions of the Series C Preferred Stock as described above, except that the Series C Warrants do not include dilution protection for issuances of securities at an effective price per share lower than the conversion price of such Series C Warrants. In addition, the Series C Warrants provide for protection for a Buy-In on substantially the same terms as described above with respect to the Series C Preferred Stock. No holder may exercise its Series C Warrants in excess of the Beneficial Ownership Limitation.

As a result of the initial issuance and sale of the Series C Units, pursuant to the terms of the Series A Warrants, on April 8, 2016, the exercise price per share of the Series A Warrants decreased from $5.80 per share to $4.50 per share and the number of shares of Common Stock issuable upon exercise of each of the Series A Warrants, in the aggregate, increased such that the aggregate exercise price payable thereunder, after taking into account the decrease in the exercise price, will be equal to the aggregate exercise price prior to such adjustment. Also as a result of the initial issuance and sale of the Series C Units, pursuant to the terms of the certificates of designations for the Series A Preferred Stock and Series B Preferred Stock, on April 8, 2016, the conversion price per share of Series A Preferred Stock and Series B Preferred Stock decreased to $4.50 per share.

Based on the terms of the purchase agreements relating to the issuance and sale of the Series A Units and the Series B Units, respectively, so long as any initial purchaser of Series A Units or Series B Units, as applicable (each, a “Purchaser”) holds any shares of Series A Preferred Stock or Series B Preferred Stock, as applicable, if (1) the Company sells any shares of Common Stock or other securities convertible into, or rights to acquire, Common Stock and (2) a Purchaser then holding Series A or Series B Preferred Stock or Warrants reasonably believes that any of the terms and conditions appurtenant to such issuance or sale are more favorable to the purchaser in such subsequent sale of securities than are the terms and conditions granted to such Purchaser, then the Purchaser will be permitted to require the Company to amend the terms of this transaction (only with respect to such Purchaser) so as to match the terms of the subsequent issuance (including, for the avoidance of doubt, any terms and provisions that are or may be less favorable to such Purchaser).

INTEGRITY APPLICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 3

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RECENT EVENTS (Cont.)

Pursuant to the purchase agreements relating to the issuance and sale of the Series A Units and the Series B Units, the Company was required to and did notify the holders of the Series A Preferred Stock and Series B Preferred Stock of the closing of the sale of the Series C Units, and following receipt thereof such holders of Series A Preferred Stock and Series B Preferred Stock will be entitled, pursuant to the “most favored nation” provisions contained in their respective purchase agreements (as described above), to elect to amend the terms of their purchase of Series A Units and Series B Units, respectively, to match the terms of the Series C Units. The Company is obligated to amend the terms of any of Series A Units or Series B Units who timely makes such election and tenders its Series A Units or Series B Units for exchange.

Upon initial recognition, the Series C Preferred Stock issued together with detachable Series C Warrants (classified as equity) were measured based on the relative fair value basis and were presented net of the direct issuance expenses that were allocated to them.

The Company has determined that due to the economic characteristics and risks of the Series C Preferred Stock, based on their stated or implied substantive terms and features, that such Preferred Stock, are considered as more akin to equity than debt. Accordingly, it was determined that the economic characteristics and the risks of the embedded conversion option to Common Stock and those of the Series C Preferred Stock themselves (the 'host contract') are clearly and closely related. As a result, the embedded conversion feature was not required to be bifurcated.

Since at the issuance dates of the Series C Preferred Stock, the exercise price of the conversion feature (based on the effective conversion rate of the Series C Preferred Stock into Common Stock) was higher than the estimated fair value of the Company’s Common Stock, it was determined that the conversion feature was not beneficial. Also, due to the liquidation preference and certain redemption rights for the benefit of the holders of the Series C Preferred Stock, upon the occurrence of the certain contingent events, which are not considered as solely within the Company's control management determined that the Series C Preferred Stock were to be presented as temporary equity. On each balance sheet date, the Company’s management assesses the probability of redemption of the outstanding Preferred Stock. In the event that management determines such redemption to be probable as of an applicable balance sheet date, the Company will recognize a liability in an amount equal to the aggregate redemption price of the Preferred Stock. In addition, upon such determination, the difference between the amount that was allocated to the Preferred Stock (after deduction of issuance expenses) and such redemption amount will be accreted over the period beginning on the date that it becomes probable that the instrument will become redeemable and ending on the earliest redemption date.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 4

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INVENTORIES

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Effective January 1, 2016, the Group adopted Accounting Standard Update 2014-16, Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity ("ASU 2014-16").

The amendments in ASU 2014-16 clarify how U.S. GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the amendments clarify that an entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, in evaluating the nature of the host contract. Furthermore, the amendments clarify that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial instrument. The amendments also clarify that, in evaluating the nature of a host contract, an entity should assess the substance of the relevant terms and features (i.e., the relative strength of the debt-like or equity-like terms and features given the facts and circumstances) when considering how to weigh those terms and features. The assessment of the substance of the relevant terms and features should incorporate a consideration of the characteristics of the terms and features themselves; the circumstances under which the hybrid financial instrument was issued or acquired; and the potential outcomes of the hybrid financial instrument, as well as the likelihood of those potential outcomes.

The amendments in ASU 2014-16 apply to all entities that are issuers of, or investors in, hybrid financial instruments that are issued in the form of shares.

The effects of initially adopting the amendments in ASU 2014-16 were required to be applied on a modified retrospective basis to existing hybrid financial instruments issued in the form of shares as of the beginning of the fiscal year for which the amendments are effective. However, retrospective application was permitted to all relevant prior periods.

Management analyzed the economic characteristics and risks of the Series A Preferred Stock and the Series B Preferred Stock (including the embedded conversion feature of each) in accordance with the provisions of ASU 2014-16 and determined that such instruments are considered as more akin to equity than debt. Accordingly, it was determined that the economic characteristics and the risks of the embedded conversion option to Common Stock and those of the Preferred Stock themselves (the 'host contract') are clearly and closely related and accordingly, the embedded conversion feature was not required to be bifurcated. As a result of the above determination, ASU 2014-16 did not impact the classification of the Series A Preferred Stock or the Series B Preferred Stock.

 

2.	Accounting Standard Update 2014-09, “Revenue from Contracts with Customers”

In May 2014, the FASB issued Accounting Standard Update 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09").

 

ASU 2014-09 outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. ASU 2014-09 also requires entities to disclose sufficient information, both quantitative and qualitative, to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.

 

An entity should apply the amendments in ASU 2014-09 using one of the following two methods: 1. Retrospectively to each prior reporting period presented with a possibility to elect certain practical expedients, or, 2. Retrospectively with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application. If an entity elects the latter transition method, it also should provide certain additional disclosures.

 

During 2016, the FASB issued several Accounting Standard Updates (“ASUs”) that focus on certain implementation issues of the new revenue recognition guidance including Narrow-Scope Improvements and Practical Expedients, Principal versus Agent Considerations and Identifying Performance Obligations and Licensing.

 

The Company is in the process of assessing the impact, if any, of ASU 2014-09 (including the amendments introduced through recent ASUs) on its consolidated financial statements.

 

3.	Accounting Standards Update 2014-15, “Presentation of Financial Statements—Going Concern”

In August 2014, the FASB issued Accounting Standards Update 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern ("ASU 2014-15").

 

ASU 2014-15 provides guidance on management’s responsibility to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable).

 

ASU 2014-15 also provides guidance related to the required disclosures as a result of management’s evaluation. 

 

The amendments in ASU 2014-15 are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted.

 

Due to the current financial condition of the Company and the existing uncertainty regarding its ability to continue as a going concern, management does not believe that the provisions of ASU 2014-15 will have a significant effect on its evaluation of the Company’s ability to continue as a going concern. However, management is currently considering if additional disclosures will be required as a result of ASU 2014-15.

4.	Accounting Standard Update 2015-11, “Simplifying the Measurement of Inventory”

In July, 2015, The FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory (Topic 330) ("ASU 2015-11").

ASU 2015-11 outlines that inventory within the scope of its guidance be measured at the lower of cost and net realizable value. Inventory measured using last-in, first-out (LIFO) and the retail inventory method (RIM) are not impacted by the new guidance. Prior to the issuance of ASU 2015-11, inventory was measured at the lower of cost or market (where market was defined as replacement cost, with a ceiling of net realizable value and floor of net realizable value less a normal profit margin).

For a public entity, the amendments in ASU 2015-11 are effective, in a prospective manner, for annual reporting periods beginning after December 15, 2016, including interim periods within the first such annual reporting period (the first quarter of fiscal year 2017 for the Company). Early adoption is permitted as of the beginning of an interim or annual reporting period.

The Company is in the process of assessing the impact, if any, of ASU 2015-11 on its consolidated financial statements.

 

Results of Operations

 

The following discussion explains material changes in our results of operations for the six and three month periods ended June 30, 2016, compared with the same periods ended June 30, 2015. This discussion should be read in conjunction with the financial statements and related notes included elsewhere in this report.

 

Six Months Ended June 30, 2016 Compared to Six Months Ended June 30, 2015

 

Revenues

 

 

 

Selling, Marketing and General and Administrative Expenses

 

Financing (income) expenses, net

 

Financing (income) expenses, net was $(32,065) for the six month period ended June 30, 2016, as compared to financing expense of 1,224,437 for the prior-year period. The change is primarily attributable to the non-cash loss on partial extinguishment of Series A Preferred Stock and Series A Warrants during the six months period ended June 30, 2015 (see Note 10C to our annual report on Form 10-K for the year ended December 31, 2015).

 

Net loss

 

Revenues

 

 

We recognize revenues from GlucoTrack® model DF-F and PEC when delivery has occurred, persuasive evidence of an agreement exists, the fee is fixed and determinable, collectability is reasonably assured and no further obligations exist.

 

Research and development expenses

 

Selling, marketing and general and administrative expenses

 

Financing expenses, net

 

Net Loss

 

Net loss was $1,588,998 for the three month period ended June 30, 2016, as compared to $1,666,806 for the prior-year period. The decrease in net loss is attributable primarily to the change in financing (income) expenses, net and increase in revenues offset partially by the increase in operating expenses, as described above.

 

Liquidity and Capital Resources

 

We have a credit line with Bank HaPoalim of NIS 150,000 (approximately $39,002 based on the exchange rate of 3.85 NIS/dollar as of June 30, 2016). Borrowings under the line of credit are secured by our funds on deposit with the bank at the time of borrowing, which generally must be sufficient to cover the principal amount of the borrowings in full. As of June 30, 2016 and August 15, 2016, we did not utilize our credit line.

 

Messrs. Avner Gal and Zvi Cohen collectively loaned Integrity Israel NIS 176,000 ($45,762 based on the same exchange rate) in May 15, 2002 pursuant to a board approval. Messrs. Nir Tarlovsky, Yitzhak Fisher and Asher Kugler loaned Integrity Israel NIS 336,300 ($87,441 based on the same exchange rate) on March 16, 2004. These loans are not required to be repaid until the first year in which we realize profits in our annual statement of operations (accounting profit). At such time, the loans are to be repaid on a quarterly basis in an amount equal to 10% of our total sales in the relevant quarter, beginning on the quarter following the first year in which we realize profits in our annual statement of operations. The total amount to be repaid by us to each lender shall be an amount equal to the aggregate principal amount loaned by such lender to us, plus an amount equal to the product of the amount of each payment made by us in respect of such loan multiplied by the percentage difference between the Israeli Consumer Price Index on the date on which the loan was made and the Israeli Consumer Price Index on the date of such payment. However, notwithstanding the above-mentioned mechanism, we will not be required to repay the loans during any time when such repayment would cause a deficit in our working capital. Our board of directors is entitled to modify the repayment terms of these loans, so long as such modification does not discriminate against any particular lender, and provided that all payments must be allocated among the lenders on a pro-rata basis.

 

Integrity Israel is required to pay royalties to the Office of the Chief Scientist of the Ministry of Industry, Trade and Labor of the State of Israel at a rate ranging between 3-5% of the proceeds from the sale of the Company’s products arising from the development plan up to an amount equal to $93,300, plus interest at LIBOR from the date of grant. As of June 30, 2016, the contingent liability with respect to royalty payment on future sales equals to approximately $72,993, excluding interest.

 

Net Cash Used in Operating Activities for the Six Month Periods Ended June 30, 2016 and June 30, 2015

 

Net cash used in operating activities was $2,887,167 and $1,836,282 for the six month periods ending June 30, 2016 and 2015, respectively. Net cash used in operating activities primarily reflects the net loss of $2,815,762 for the six month periods ending June 30, 2016 and 2015, respectively. Net cash used in operating activities was partially offset by the one-time charges in the amount of $211,077 representing the incremental fair market value adjustments in respect of modified warrants issued to AGI during the six month period ended June 30, 2016 and loss on extinguishment of Series A Preferred Stock and Series A Warrants during the six month period ended June 30, 2015 in the amount of $1,270,971. Changes in operating assets and liabilities during the six month period ended June 30, 2016 increased our net cash used in operating activities for the six months period ended June 30, 2016 by $279,908, which resulted primarily from payment of deferred balances to suppliers. For the six months period ended June 30, 2015 net cash used in operations was partially offset by changes in operating assets and liabilities in the amount of $156,759 resulting primarily for deferral of payments to suppliers.

 

Net Cash Used in Investing Activities for the Six Month Periods Ended June 30, 2016 and June 30, 2015

 

Net cash used in investing activities was $46,397 and $43,171 for the six month periods ended June 30, 2016, and 2015, respectively. Net cash used to purchase equipment (such as computers, R&D and office equipment) was $46,397 and $18,892, respectively and cash used to fund deposits in respect of employees rights upon retirement amounted to $0 and $24,279, for the six month periods ended June 30, 2016, and 2015, respectively.

 

Net Cash Provided by (Used in) Financing Activities for the Six Month Periods Ended June 30, 2016 and June 30, 2015

 

Net cash provided by (used in) financing activities was $3,745,726 and $(486,975) for the six month period ended June 30, 2016 and 2015, respectively. Cash provided by financing activities for the six months period ended June 30, 2016 reflects net capital raised from the issuance of Series C units in the amounts of $3,750,479, offset partially by dividends paid to the holders of our Preferred Stock in the amounts of $4,753. Cash used in financing activities  for the six month period ended June 30, 2015, reflects primarily the repayment of stockholders loan to Stockholders (see Note 9D to our annual report on Form 10-K for the year ended December 31, 2015) in the amount of $439,939 and cash dividends paid to the holders of our Series A Preferred Stock in the amounts of $47,036.

 

Off-Balance Sheet Arrangements

 

As of June 30, 2016, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.

 

 

Not required for smaller reporting companies.

 

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2016.  The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (the “SEC”). Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2016, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

(1)	Previously filed as an exhibit to the Company’s Registration Statement on Form S-1, as filed with the SEC on August 22, 2011, which exhibit is incorporated herein by reference.

 

(2)	Previously filed as an exhibit to the Company’s Current Report on Form 8-K, as filed with the SEC on March 18, 2013, which exhibit is incorporated herein by reference.

 

(3)	Previously filed as an exhibit to the Company’s Current Report on Form 8-K, as filed with the SEC on September 5, 2014, which exhibit is incorporated herein by reference.

 

(4)	Previously filed as an exhibit to the Company’s Current Report on Form 8-K, as filed with the SEC on April 14, 2016, which exhibit is incorporated herein by reference.

 

(5)

Pursuant to Rule 406T of Regulation S-T, the interactive files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated:  August 15, 2016

 

 

EXHIBIT INDEX

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