---

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-Q

(Mark One)
☒		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended March 31, 2017
		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:  000-54785

 

(Exact name of registrant as specified in its charter)

Delaware		98-0668934
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
19 Ha'Yahalomim Street P.O. Box 12163 Ashdod, Israel		L3 7760049
(Address of principal executive offices)		(Zip Code)

972 (8) 675-7878

---

(Registrant’s telephone number, including area code)

N/A

---

(Former name, former address and former fiscal year, if changed since last report)

 

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). 

 

Yes ☒          No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth 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 ☐ (Do not check if a smaller reporting company)	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 ☒

 

As of May 15, 2017, 6,199,940 shares of the Company’s common stock, par value $0.001 per share, were outstanding.

 

INTEGRITY APPLICATIONS, INC.

 

TABLE OF CONTENTS

 

			Page
PART I - FINANCIAL INFORMATION			3
	Item 1.	Financial Statements.	3
		Condensed Consolidated Balance Sheets	3
		Condensed Consolidated Statements of Operations and Comprehensive Loss	4
		Condensed Consolidated Statement of Changes in Stockholders’ Deficit	5
		Condensed Consolidated Statements of Cash Flows	6
		Notes to Condensed Consolidated Financial Statements	8
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	23
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	34
	Item 4.	Controls and Procedures.	35
PART II - OTHER INFORMATION			36
	Item 6.	Exhibits.	37
SIGNATURES			38
EXHIBIT INDEX			39

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		US dollars (except share data)
		March 31,				December 31,
		2017				2016
		(unaudited)
A S S E T S
Current Assets
Cash and cash equivalents			1,639,003				148,836
Accounts receivable, net			95,172				92,061
Inventories			1,423,261				1,419,604
Other current assets			183,863				356,994
Total current assets			3,341,299				2,017,495
Property and Equipment, Net			239,426				240,452
Long-Term Restricted Cash			37,765				35,673
Funds in Respect of Employee Rights Upon Retirement			177,139				167,326
Total assets			3,795,629				2,460,946
LIABILITIES, TEMPORARY EQUITY AND STOCKHOLDERS’ DEFICIT
Current Liabilities
Accounts payable			1,585,387				1,634,642
Other current liabilities			1,692,137				713,549
Total current liabilities			3,277,524				2,348,191
Long-Term Liabilities
Long-Term Loans from Stockholders			170,150				162,034
Liability for Employee Rights Upon Retirement			187,083				176,719
Warrants with down-round protection			754,603				681,970
Total long-term liabilities			1,111,836				1,020,723
Total liabilities			4,389,360				3,368,914
Temporary Equity
Convertible Preferred Stock of $ 0.001 par value ("Preferred Stock"):
10,000,000 shares of Preferred Stock authorized as of March 31, 2017 and December 31, 2016
376 shares of Series A Preferred Stock issued and outstanding as of March 31, 2017 and December 31, 2016			221,152				221,152
15,031 shares of Series B Preferred Stock issued and outstanding as of March 31, 2017 and December 31, 2016			6,715,844				6,715,844
8,793 and 5,829 shares of Series C Preferred Stock issued and outstanding as of March 31, 2017 and December 31, 2016, respectively			4,737,903				3,104,466
Total temporary equity			11,674,899				10,041,462
Stockholders' Deficit
Common Stock of $ 0.001 par value ("Common Stock"):
40,000,000 shares authorized as of March 31, 2017 and December 31, 2016; 6,199,940 and 6,026,527 shares issued and outstanding as of March 31, 2017 and December 31, 2016, respectively			6,203				6,028
Additional paid in capital			26,131,070				24,586,142
Accumulated other comprehensive income			95,315				62,576
Accumulated deficit			(38,501,218	)			(35,604,176	)
Total stockholders' deficit			(12,268,630	)			(10,949,430	)
Total liabilities, temporary equity and stockholders’ deficit			3,795,629				2,460,946

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

 

		US dollars (except share data)
		Three month period ended March 31,
		2017				2016
		(unaudited)
Revenues			96,237				89,147
Research and development expenses			581,539				579,495
Selling and marketing expenses			236,939				313,395
General and administrative expenses			1,877,359				460,654
Total operating expenses			2,695,837				1,353,544
Operating loss			2,599,600				1,264,397
Financing income, net			69,275				37,633
Loss for the period			2,530,325				1,226,764
Other comprehensive (income) loss:
Foreign currency translation loss (income)			(32,739	)			21,976
Comprehensive loss for the period			2,497,586				1,248,740
Loss per share (Basic and Diluted)			0.48				0.24
Common shares used in computing loss per share (Basic and Diluted)			6,029,342				5,690,097

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ DEFICIT

		US dollars (except share data)
		(unaudited)
		Common Stock								Additional				Accumulated other								Total
		Number of shares				Amount				paid in capital				comprehensive income				Accumulated deficit				Stockholders’ deficit
Balance as of January 1, 2017			6,026,527				6,028				24,586,142				62,576				(35,604,176	)			(10,949,430	)
Loss for the period of three months																			(2,530,325	)			(2,530,325	)
Other comprehensive income															32,739								32,739
Amounts allocated to Series C-1 and Series C-2 Warrants, net											808,906												808,906
Stock dividend on Series C Preferred Stock			48,795				49				115,937								(115,986	)
Stock dividend on Series B Preferred Stock			103,505				104				245,927								(246,031	)
Cash dividend on Series A Preferred Stock																			(4,700	)			(4,700	)
Stock-based compensation			21,113				22				374,158												374,180
Balance as of March 31, 2017			6,199,940				6,203				26,131,070				95,315				(38,501,218	)			(12,268,630	)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

		US dollars
		Three month period ended March 31,
		2017				2016
		(unaudited)
Cash flows from operating activities:
Loss for the period			(2,530,325	)			(1,226,764	)
Adjustments to reconcile loss for the period to net cash used in operating activities:
Depreciation			16,380				11,704
Stock-based compensation			374,180				950
Change in the fair value of Warrants with down-round protection			(84,099	)			(43,510	)
Linkage difference on principal of loans from stockholders			(1,367	)			(1,464	)
Changes in assets and liabilities:
(Increase) decrease in accounts receivable			2,255				(17,294	)
Decrease in inventory			78,416				44,101
Decrease in other current assets			190,590				152,969
(Decrease) increase in accounts payable			(129,419	)			269,474
Increase in other current liabilities			937,276				323,453
Net cash used in operating activities			(1,146,113	)			(486,381	)
Cash flows from investing activities:
Purchase of property and equipment			(1,477	)			(23,955	)
Net cash used in investing activities			(1,477	)			(23,955	)
Cash flows from financing activities
Credit from banking institutes			-				27,388
Proceeds allocated to Series C Preferred Stock, net of cash issuance expenses			1,738,259				-
Proceeds allocated to Series C Warrants, net of cash issuance expenses			860,812				-
Net cash provided by financing activities			2,599,071				27,388
Effect of exchange rate changes on cash and cash equivalents			38,686				5,648
Increase (decrease) in cash and cash equivalents			1,490,167				(477,300	)
Cash and cash equivalents at beginning of the period			148,836				608,701
Cash and cash equivalents at end of the period			1,639,003				131,401

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

INTEGRITY APPLICATIONS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (cont.)

Supplementary information on financing activities not involving cash flows:

 

During the three-month period ended March 31, 2017, $246,031 and $115,986, 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, were accounted for as stock dividends in the statement of changes in stockholders’ deficit and was charged to accumulated deficit against additional paid in capital and Common Stock therein.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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 significant revenues from operations, and therefore they are dependent upon external sources for financing their operations. As of March 31, 2017, the Group has incurred an accumulated deficit of $38,501,218, a stockholder's deficit of $12,268,630 and negative operating cash flows. Management considered the significance of such conditions in relation to the Group’s ability to meet its current and future obligations and determined that these conditions 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. The Company has raised funds through the issuance of (a) Series A 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”) and (b) Series B units (the “Series B Units”), each consisting of (i) one share of the Company’s 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, (ii) 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 (iii) 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”). Additionally, during the period between April 2016 and March 2017, the Company raised funds in an aggregate amount of approximately $7.56 million (net of related cash expenses) through the issuance of 8,792.8 units (the “Series C Units”). Each of the Series C Units consists 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. See also Note 8 regarding issuance of additional Series C Units subsequent to the balance sheet date.

 

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 1

–

GENERAL (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 (cont.)

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, 2016. 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 three months ended March 31, 2017 are not necessarily indicative of the results to be expected for the year ending December 31, 2017 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. Significant intercompany balances and transactions have been eliminated in consolidation.

 

INTEGRITY APPLICATIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

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):

		Warrants with down-round Protection
		March 31,
		2017				2016
		(unaudited)
Balance, Beginning of the period			681,970				321,695
Warrants issued as consideration for placement services			156,732				-
Change in fair value Warrants with Down-Round Protection			(84,099	)			(43,510	)
Balance, End of period			754,603				278,185

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

		March 31,
		2017				2016
Dividend yield (%)			-				-
Expected volatility (%) (*)			56.59				62.16
Risk free interest rate (%)			0.92-1.21				1.08
Expected term of options (years) (**)			0.95-5.00				3.20
Exercise price (US dollars)			4.50, 7.75				5.80
Share price (US dollars) (***)			2.38				2.38
Fair value (US dollars)			0.11-0.74				0.71

(*)

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 March 31, 2017 and 2016. 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 B Units and the Series C Units as applicable to each reporting period (See Note 3).

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 2

–

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)

 

C.

Recently issued accounting pronouncements

1.

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

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards 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 Standards Updates (“ASUs”) that focus on certain implementation issues of the new revenue recognition guidance including Narrow-Scope Improvements, Practical Expedients and technical corrections.

 

In accordance with an amendment to ASU 2014-09, introduced by Accounting Standard 2015-14, “Revenue from contracts with Customers – Deferral of the Effective Date”, for a public entity, the amendments in ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period (the first quarter of fiscal year 2018 for the Company). Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.

 

The Company intends to adopt ASU 2014-09 as of January 1, 2018.

 

The Company is in the process of evaluating the impact of ASU 2014-09 on its revenue streams and selling contracts, if any, and on its financial reporting and disclosures. Management is expecting to complete the evaluation of the impact of the accounting and disclosure changes on the business processes, controls and systems during 2017.

 

Since the company did not report significant revenues, management believes that the adoption of ASU 2014-09 will not have a significant impact on its consolidated financial statements.

 

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

 

Effective January 1, 2017, the Group adopted 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).

 

The adoption of ASU 2015-11 did not have a significant effect on the consolidated financial statements.

 

Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications did not have material effect on the reported results of operations, shareholder’s deficit or cash flows.

NOTE 3

–

RECENT EVENTS

 

Between April 2016 and December 31, 2016, and during the first quarter of 2017, we received aggregate net proceeds of approximately $4.9 million and $2.6 million, respectively (net of related cash expenses), from the issuance and sale in a private placement transaction, at a price of $1,000 per unit, of 8,792.80 Series C Units. As of March 31, 2017, the shares of Series C Preferred Stock comprising the Series C Units are convertible into an aggregate of 1,953,956 shares of Common Stock, and the Series C Warrants comprising the Series C Units are exercisable for an aggregate of 3,907,911 shares of Common Stock, in each case subject to adjustment in certain circumstances.

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, fourth, fifth, sixth, seventh, eighth and ninth 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 390,798 shares of Common Stock at an exercise price of $4.50 per share and (b) 5 year warrants to purchase up to 195,398 shares of Common Stock at an exercise price of $7.75 per share. The terms of such warrants are substantially similar to the Series C Warrants except that the warrants issued to AGI are exercisable on a cashless basis and include full ratchet anti-dilution protection.

 

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 3

–

RECENT EVENTS (cont.)

Subject to certain ownership limitations described below, the Series C Preferred Stock are 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, 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 remaining 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 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

–

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.

As of March 31, 2017, none of the Series A or B Unit holders asked the company to amend the terms of their units.

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 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.

INTEGRITY APPLICATIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 4

–

INVENTORIES

 

		US dollars
		March 31,				December 31,
		2017				2016
		(unaudited)
Raw materials			673,991				735,201
Work in process			742,226				633,132
Finished products			7,044				51,271
			1,423,261				1,419,604

NOTE 5

–

OTHER CURRENT LIABILITIES

 

		US dollars
		March 31, 2017				December 31, 2016
		(unaudited)
Employees and related institutions			508,085				363,738
Accrued expenses			1,058,494				261,651
Other current liabilities			125,558				88,160
			1,692,137				713,549

 

NOTE 6

–

FINANCING INCOME, NET

		US dollars
		Three month period ended March 31,
		2017				2016
		(unaudited)
Israeli CPI linkage difference on principal of loans from stockholders			1,367				1,464
Exchange rate differences			(10,474	)			(4,915	)
Change in fair value of Warrants with down round protection			84,099				43,510
Interest expenses on credit from banks and other			(5,717	)			(2,426	)
			69,275				37,633

INTEGRITY APPLICATIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 7

–

LOSS PER SHARE

 

In periods of net loss, basic loss per share is computed by dividing net loss for the period after consideration of the effect of dividends on preferred stock by the weighted average number of shares outstanding during the period.

 

The loss and the weighted average number of shares used in computing basic and diluted loss per share for the three-month periods ended March 31, 2017 and 2016 are as follows:

 

		US dollars
		Three month period ended March 31,
		2017				2016
		(unaudited)
Loss for the period			2,530,325				1,226,764
Cash dividend on Series A Preferred Stock			4,700				4,700
Stock dividend on Series B Preferred Stock			246,031				122,820
Stock dividend on Series C Preferred Stock			115,986				-
Loss for the period attributable to common stockholders			2,897,042				1,354,284

 

		Number of shares
		Three month period ended March 31,
		2017				2016
		(unaudited)
Number of shares:
Weighted average number of shares used in the computation of basic and diluted earnings per share			6,029,342				5,690,097
Total weighted average number of common shares related to outstanding convertible preferred stock, options and warrants excluded from the calculations of diluted loss per share (*)			16,056,013				9,462,671

 

(*)

All outstanding convertible Preferred Stock, stock options and warrants have been excluded from the calculation of the diluted net loss per share for all the reported periods, because the effect of the common shares issuable as a result of the exercise or conversion of these instruments was determined to be anti-dilutive.

INTEGRITY APPLICATIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 8

–

SUBSEQUENT EVENTS

 

On April 28, 2017, the Company, entered into a Securities Purchase Agreement (the “Purchase Agreement”) with certain accredited investors (the “Purchasers”) pursuant to which, the Company issued to the Purchasers an aggregate of 1,551, units of the Company’s Series C Preferred Stock, as described in Note 3 above. The shares of Preferred Stock comprising the Series C Units are convertible into an aggregate of 344,682 shares of Common Stock, and the Series C Warrants comprising the Series C Units are exercisable for an aggregate of 689,364 shares of Common Stock, in each case subject to certain adjustments. The Company received aggregate gross proceeds of $1,551,000 from the sale of the Series C Units pursuant to the Purchase Agreement.

Pursuant to the Placement Agent Agreement (as further described in Note 3 above), at the closing 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, plus a non-accountable expense allowance equal to 3% of the aggregate sales price of the Series C Units. In addition, pursuant to the Placement Agent Agreement, the Company is required to issue to the Placement Agent: (a) 5 year warrants to purchase up to 68,934 shares of Common Stock at an exercise price of $4.50 per share and (b) 5 year warrants to purchase up to 34,467 shares of Common Stock at an exercise price of $7.75 per share. The terms of the Placement Agent warrants will be substantially similar to the Series C Warrants except that the Placement Agent warrants will also be exercisable on a cashless basis and will include full ratchet anti-dilution protection.

Effective April 7, 2017 (the “Gal Effective Date”), the Company and Integrity Israel entered into a letter agreement with Avner Gal whereby Mr. Gal separated from his employment and directorship at the Company and act as a part time consultant to the Company (the “Gal Agreement”).  Pursuant to the terms of the Gal Agreement, and as consideration for Mr. Gal’s separation from employment and services as a consultant, the Company agreed, among other things, to (a) pay Mr. Gal an amount equal to his Salary (as defined in the Gal Employment Agreement) and other financial benefits Mr. Gal is entitled to receive under the Employment Agreement entered into by and between Integrity Israel and Mr. Gal in October 2010 (the “Gal Employment Agreement”), that would have been paid to Mr. Gal during the Notice Period (as defined in the Gal Employment Agreement), in lieu of such prior notice; (b) modify the Adjustment Period, pursuant to section 19 of the Gal Employment Agreement, to 24 Salaries (as defined in the Gal Employment Agreement), including all the benefits mentioned in the Gal Employment Agreement, provided Mr. Gal does not work or provide services to a company in direct competition with the Company; (c) accelerate the vesting of 88,259 outstanding unvested options to purchase Common Stock, at an exercise price per share equal to $6.25, held by Mr. Gal as of the Gal Effective Date; (d) extend the term of all outstanding options (vested and unvested) held by Mr. Gal to be exercisable for five years from the Gal Effective Date; and (e) grant Mr. Gal an option to purchase up to 300,000 shares of Common Stock of the Company having an exercise price per share equal to $4.50 and an option to purchase up to an additional 50,000 shares of common stock of the Company having an exercise price per share equal to $7.75 (collectively, the “Options”). The Options vest monthly over a 24 months period following the date of grant.

Effective April 7, 2017, the Company entered into an amendment to the employment agreement (the “Graham Employment Amendment”) with John Graham, whom the Company appointed as Chief Executive Officer on March 20, 2017, to modify the base compensation provision and the equity compensation provision under that certain Employment Agreement, dated March 20, 2017 (the “Graham Effective Date”), by and between the Company and Mr. Graham.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

NOTE 8

–

SUBSEQUENT EVENTS (cont.)

 

Pursuant to the terms of the Graham Employment Amendment, (a) Mr. Graham’s base compensation was modified such that he receives a base salary of $500,000 per year, as well as a one-time payment of $375,000 paid to Mr. Graham upon commencement of Mr. Graham’s employment with the Company, and (b) the vesting periods of Mr. Graham’s options to purchase Common Stock were modified whereby (1) 307,754 shares of Common Stock underlying Mr. Graham’s option to purchase Common Stock at an exercise price of $4.50 per share (the “$4.50 Options”) vested immediately, (2) 923,262 of the $4.50 Options shall vest on the six month anniversary of the Graham Effective Date, and (3) the remaining 442,980 of the $4.50 Options as well as Mr. Graham’s remaining unvested options granted pursuant to the Graham Employment Amendment shall vest on the two (2) year anniversary of the Graham Effective Date.

 

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Cautionary Note Regarding Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains forward-looking statements. These forward looking statements include statements about our expectations, beliefs or intentions regarding our product development efforts, business, financial condition, results of operations, strategies and prospects. All statements other than statements of historical fact included in this Quarterly Report on Form 10-Q, including statements regarding our future activities, events or developments, including such things as future revenues, capital raising and financing, product development, clinical trials, regulatory approval, market acceptance, responses from competitors, capital expenditures (including the amount and nature thereof), business strategy and measures to implement strategy, competitive strengths, goals, expansion and growth of our business and operations, plans, references to future success, projected performance and trends, and other such matters, are forward-looking statements. The words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “plan,” “may,” “will,” “could,” “would,” “should” and other similar words and phrases, are intended to identify forward-looking statements. The forward-looking statements made in this Quarterly Report on Form 10-Q are based on certain historical trends, current conditions and expected future developments as well as other factors we believe are appropriate in the circumstances. These statements relate only to events as of the date on which the statements are made and we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. All of the forward-looking statements made in this Quarterly Report on Form 10-Q are qualified by these cautionary statements and there can be no assurance that the actual results anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to or effects on us or our business or operations. Whether actual results will conform to our expectations and predictions is subject to a number of risks and uncertainties that may cause actual results to differ materially. Risks and uncertainties, the occurrence of which could adversely affect our business, include the risks identified under the caption “Risk Factors” included in our annual report on Form 10-K for the year ended December 31, 2016. The following discussion should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q.

 

Overview

 

	INTEGRITY APPLICATIONS, INC.
	By:	/s/ John Graham
	Name:	John Graham
	Title	Chairman of the Board and Chief Executive Officer (Principal Executive Officer)

	By:	/s/ Sami Sassoun
	Name:	Sami Sassoun
	Title	Chief Financial Officer (Principal Accounting Officer)

Exhibit No.		Description
3.1		Certificate of Incorporation of Integrity Applications, Inc. (1)
3.2		Certificate of Amendment to Certificate of Incorporation of Integrity Applications, Inc. (1)
3.3		Bylaws of Integrity Applications, Inc. (1)
3.4		Certificate of Designation of Preferences and Rights of Series A 5% Convertible Preferred Stock (2)
3.5		Certificate of Designation of Preferences and Rights of Series B 5.5% Convertible Preferred Stock (3)
3.6		Certificate of Designation of Preferences and Rights of Series C 5.5% Convertible Preferred Stock (4)
4.1		Form of Securities Purchase Agreement (4)
4.2		Form of Series C-1 Common Stock Purchase Warrant (4)
4.3		Form of Series C-2 Common Stock Purchase Warrant (4)
4.4		Form of Registration Rights Agreement (4)
10.1		Amended and Restated Consulting Agreement, dated as of February 6, 2017, between Integrity Applications, Inc. and Strand Strategy (5)
10.2 *		Personal Employment Agreement, dated as of February 1, 2017, between A.D. Integrity Applications Ltd. and Sami Sassoun (5)
10.3 *		Personal Employment Agreement, dated as of March 20, 2017, between Integrity Applications, Inc. and John Graham (5)
10.4 *		Letter Agreement, effective as of April 7, 2017, among Integrity Applications, Inc., A.D. Integrity Applications Ltd., and Avner Gal (6)
10.5 *		First Amendment to Employment Agreement, effective as of April 7, 2017, between Integrity Applications, Inc. and John Graham (6)
10.6 *		Amended and Restated Personal Employment Agreement, effective as of April 7, 2017, between A.D. Integrity Applications Ltd. and David Malka (6)
10.7 *		Amendment No. 2 to Integrity Applications, Inc. 2010 Incentive Compensation Plan (6)
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS		XBRL Instance Document (7)
101.SCH		XBRL Schema Document (7)
101.CAL		XBRL Calculation Linkbase Document (7)
101.LAB		XBRL Label Linkbase Document (7)
101.PRE		XBRL Presentation Linkbase Document (7)
101.DEF		XBRL Definition Linkbase Document (7)

39

---