20-F 1 v462577_20f.htm 20-F

As filed with the Securities and Exchange Commission on March 30, 2017

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

(Mark One)

 

¨       REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

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

 

For the fiscal year ended December 31, 2016

 

OR

 

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

 

OR

 

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

 

Date of event requiring this shell company report . . . . . . . . . . . . . . . .

 

Commission file number: 001-33042

 

 

 

 

ROSETTA GENOMICS LTD.

(Exact name of Registrant as specified in its charter)

 

Not Applicable

(Translation of Registrant’s Name into English)

 

Israel

(Jurisdiction of incorporation or organization)

 

10 Plaut Street, Science Park

Rehovot 76706, Israel

(Address of principal executive offices)

 

Kenneth A. Berlin, CEO and President

3711 Market Street, Suite 740

Philadelphia, Pennsylvania 19104

Tel: (215) 382-9000

Fax: (215) 382-0815

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

 

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

Title of each class Name of each exchange on which registered
Ordinary shares, par value NIS 7.2 per share The NASDAQ Stock Market LLC

 

Securities registered or to be registered pursuant to Section 12(g) of the Act. None

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act. None

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the Annual Report: As of December 31, 2016, the issuer had 1,843,537 ordinary shares outstanding and no preferred shares outstanding.

 

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

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes ¨ No x

 

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 periods that the registrant was required to file such reports), and (2) has been subject to such reporting requirements for the past 90 days.

Yes x 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 x No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer ¨ Accelerated Filer ¨ Non-Accelerated Filer x

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

x U.S. GAAP

 

¨ International Financial Reporting Standards as issued by the International Accounting Standards Board

 

¨ Other

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. Item 17 ¨ Item 18 ¨

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

  

 

 

 

TABLE OF CONTENTS 

 

INTRODUCTION ii
FORWARD-LOOKING STATEMENTS ii
PART I   1
ITEM 1 IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 1
ITEM 2 OFFER STATISTICS AND EXPECTED TIMETABLE 1
ITEM 3 KEY INFORMATION 1
ITEM 4 INFORMATION ON THE COMPANY 24
ITEM 4A UNRESOLVED STAFF COMMENTS 44
ITEM 5 OPERATING AND FINANCIAL REVIEW AND PROSPECTS 44
ITEM 6 DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 53
ITEM 7 MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 65
ITEM 8 FINANCIAL INFORMATION 67
ITEM 9 THE OFFER AND LISTING 67
ITEM 10 ADDITIONAL INFORMATION 68
ITEM 11 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 86
ITEM 12 DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 87
PART II   87
ITEM 13 DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 87
ITEM 14 MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 87
ITEM 15 CONTROLS AND PROCEDURES 87
ITEM 16 RESERVED 88
ITEM 16A AUDIT COMMITTEE FINANCIAL EXPERT 88
ITEM 16B CODE OF ETHICS 88
ITEM 16C PRINCIPAL ACCOUNTANT FEES AND SERVICES 88
ITEM 16D EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES 89
ITEM 16E PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS 89
ITEM 16F CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT 89
ITEM 16G CORPORATE GOVERNANCE 89
ITEM 16H MINE SAFETY DISCLOSURE 90
PART III   90
ITEM 17 FINANCIAL STATEMENTS 90
ITEM 18 FINANCIAL STATEMENTS 90
ITEM 19 EXHIBITS 90
SIGNATURE 93
INDEX TO FINANCIAL STATEMENTS F-1

 

 i 

 

 

INTRODUCTION

 

As used in this Annual Report on Form 20-F (hereinafter referred to as this “Annual Report”), unless the context requires otherwise, references to “we”, “our”, “us”, “Rosetta” or the “Company” are references to Rosetta Genomics Ltd., a company organized under the laws of the State of Israel, and its subsidiaries.

 

Our consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles, or U.S. GAAP. Except as otherwise specified, financial information is presented in U.S. dollars. All references in this Annual Report to “U.S. dollars,” “dollars” or “$” are to United States dollars and all references in this Annual Report to “NIS” or “shekels” are to New Israeli Shekels.

 

All information in this Annual Report on Form 20-F relating to shares or price per share reflect (i) the 1-for-4 reverse stock split effected by Rosetta on July 6, 2011 and (ii) the 1-for-15 reverse stock split effected by Rosetta on May 14, 2012, and (iii) the 1-for-12 reverse stock split effected by Rosetta on March 16, 2017.

 

FORWARD-LOOKING STATEMENTS

 

This Annual Report contains forward-looking statements. These forward-looking statements include, in particular, statements about our plans, strategies and prospects and may be identified by terminology such as “may,” “will,” “should,” “expect,” “scheduled,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “aim,” “potential,” or “continue” or the negative of those terms or other comparable terminology. These forward-looking statements are subject to risks, uncertainties and assumptions about us. Although we believe that our plans, intentions and expectations are reasonable, we may not achieve our plans, intentions or expectations.

 

Important factors that could cause actual results to differ materially from the forward-looking statements we make in this Annual Report are set forth in “Item 3. Key Information - D. Risk Factors.” All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements in “Risk Factors,” in which we have disclosed the material risks related to our business. These forward-looking statements involve risks and uncertainties, and the cautionary statements identify important factors that could cause actual results to differ materially from those predicted in any forward-looking statements. We undertake no obligation to update any of the forward-looking statements after the date of this Annual Report to conform those statements to reflect the occurrence of unanticipated events, except as required by applicable law.

 

You should read this Annual Report and the documents that we reference in this Annual Report and have filed as exhibits to this Annual Report, that we have filed with the Securities and Exchange Commission (the “SEC”), completely and with the understanding that our actual future results, levels of activity, performance and achievements may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

 

 ii 

 

 

PART I

 

ITEM 1.IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not Applicable.

 

ITEM 2.OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not Applicable.

 

ITEM 3.KEY INFORMATION

 

A.SELECTED CONSOLIDATED FINANCIAL DATA

 

We have prepared our historical consolidated financial statements in accordance with generally accepted accounting principles in the United States (U.S. GAAP). The following financial data for the years ended December 31, 2014, 2015 and 2016, and as of December 31, 2015 and 2016 have been derived from our audited financial statements which are included elsewhere in this Annual Report. The following financial data for the years ended December 31, 2012 and 2013 and as of December 31, 2012, 2013 and 2014 have been derived from our audited financial statements which are not included in this Annual Report. In July 2008, through our wholly owned subsidiary Rosetta Genomics Inc., we purchased Parkway Clinical Laboratories, Inc., a privately held Pennsylvania corporation owning a CLIA-certified laboratory. Parkway remained an indirect wholly owned subsidiary until we sold it in May 2009. On April 18, 2013, we signed a settlement agreement with Sanra Laboratories (“Sanra”) in connection with our sale of Parkway to Sanra. Under the terms of the agreement, on April 20, 2013 and on May 10, 2013, Sanra and Parkway paid us a total of $625,000. Operating results for Parkway have been classified as discontinued operations for all presented periods.

 

 

 1 

 

 

   Year Ended December 31, 
   2016   2015   2014   2013   2012 
   (In thousands, except share and per share data) 
Consolidated Statement of Comprehensive Loss:                    
Clinical testing revenues   $9,234   $6,668   $1,099   $405   $201 
Licensing revenues   -    1,600    228    -    - 
     Total revenues   9,234   $8,268   $1,327   $405   $201 
                          
Cost of clinical testing revenues    7,439    6,192    1,310    709    258 
Cost of  licensing revenues    -    80    -    -    - 
     Total cost of revenues   7,439    6,272    1,310    709    258 
                          
Gross profit (loss)   1,795    1,996    (17)   304    57 
                          
Consolidated Statements of Operations:                         
Operating expenses:                         
 Research and development, net   3,156    2,956    1,927    1,744    1,247 
Marketing and business development    6,806    7,350    6,848    7,002    3,938 
General and administrative    7,497    7,566    5,494    4,297    3,025 
Gain from bargain purchase related to acquisition of CynoGen, Inc.   -    (155)   -    -    - 
Total operating expenses    17,459    17,717    14,269    13,043    8,210 
                          
Operating loss    15,664    15,721    14,252    13,347    8,267 
Financial expenses (income), net    603    1,605    259    (177)   2,429 
Loss before taxes   16,267    17,326    14,511    13,170    10,696 
Tax expense   (34)   19    15    -    - 
                          
Loss from continuing operations    16,233    17,345    14,526    13,170    10,696 
Net loss (income) from discontinued operations    -    -    -    (273)   (239)
Net loss after discontinued operations    16,233    17,345    14,526    12,897    10,457 
                          
                          
Net loss attributable to Rosetta   $16,233   $17,345   $14,526   $12,897   $10,457 
Basic and diluted net loss per ordinary share from continuing operations   $9.31   $13.80   $15.51   $16.47   $28.85 
Basic and diluted net loss (income) per ordinary share from discontinued operations attributable to Rosetta  $-   $-   $-   $(0.336)  $(0.648)
Basic and diluted net loss per ordinary share attributable to Rosetta  $9.31   $13.79   $15.51   $16.13   $28.21 
Weighted average number of ordinary shares used to compute basic and diluted net loss per ordinary share attributable to Rosetta    1,743,067    1,257,724    936,658    799,496    370,705 

 

   As of December 31, 
   2016   2015   2014   2013   2012 
   (In thousands) 
Consolidated Balance Sheet Data:                         
Cash and cash equivalents  $6,163   $12,447   $7,929   $16,744   $30,978 
Short-term bank deposits and restricted cash   130    1,098    7,702    7,702    164 
Trade receivable   2,851    3,633    338    224    88 
Working capital   5,709    16,567    14,241    23,060    30,487 
Total assets   11,961    22,423    17,278    25,880    32,530 
Long-term liabilities   3,740    -    2    309    364 
Total shareholders’ equity   4,417    19,620    15,065    23,633    30,900 
Capital stock   160,920    159,890    137,990    132,032    126,402 
                          

 

 2 

 

 

B.CAPITALIZATION AND INDEBTEDNESS

 

Not applicable.

 

C.REASONS FOR THE OFFER AND USE OF PROCEEDS

 

Not applicable.

 

D.RISK FACTORS

 

If any of the following risks occur, our business, business prospects, financial condition, results of operations, or cash flows could be materially harmed.

 

Risks Related to Our Business, Our Financial Results and Need for Financing

 

We will require substantial additional funds to continue our operations and, if additional funds are not available, we may need to significantly scale back or cease our operations.

 

We anticipate that our principal sources of liquidity will only be sufficient to fund our activities into the third quarter of 2017. As of December 31, 2016, we had cash, cash equivalents, short-term bank deposits and restricted cash of $6.3 million, compared to $13.5 million as of December 31, 2015. We need to raise additional equity or debt capital by the third quarter of 2017 in order to continue to fund our operations, and we cannot provide any assurance that we will be successful in doing so. Our independent registered public accounting firm, Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, has included an explanatory paragraph in their opinion that accompanies our audited consolidated financial statements as of and for the year ended December 31, 2016, indicating that our current liquidity position raises substantial doubt about our ability to continue as a going concern.

 

We may seek additional funding through collaborative arrangements and public or private equity offerings and debt financings. Additional funds may not be available to us when needed on acceptable terms, or at all. In addition, the terms of any financing may adversely affect the holdings or the rights of our existing shareholders. For example, if we raise additional funds by issuing equity securities, further dilution to our then-existing shareholders may result. Debt financing, if available, may involve restrictive covenants that could limit our flexibility in conducting future business activities. We also could be required to seek funds through arrangements with collaborators or others.

 

If adequate funds are needed and not available, we may be required to:

 

delay, reduce the scope of or eliminate certain research and development programs;

 

obtain funds through arrangements with collaborators or others on terms unfavorable to us or that may require us to relinquish rights to certain technologies or products that we might otherwise seek to develop or commercialize independently;

 

monetize certain of our assets;

 

pursue merger or acquisition strategies; or

 

seek protection under the bankruptcy laws of Israel and the United States.

 

Although our financial statements have been prepared on a going concern basis, we must raise additional capital before the third quarter of 2017 to fund our operations in order to continue as a going concern.

 

Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, our independent registered public accounting firm for the fiscal year ended December 31, 2016, has included an explanatory paragraph in their opinion that accompanies our audited consolidated financial statements as of and for the year ended December 31, 2016, indicating that our current liquidity position raises substantial doubt about our ability to continue as a going concern. If we are unable to improve our liquidity position we may not be able to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result if we are unable to continue as a going concern and, therefore, be required to realize our assets and discharge our liabilities other than in the normal course of business which could cause investors to suffer the loss of all or a substantial portion of their investment.

 

 3 

 

 

We anticipate that our principal sources of liquidity will only be sufficient to fund our activities into the third quarter of 2017. In order to have sufficient cash to fund our operations through the end of the third quarter and beyond, we will need to raise additional equity or debt capital, and we cannot provide any assurance that we will be successful in doing so.

 

The approach we are taking to discover and develop novel microRNA-based diagnostics and therapeutics is new and may never lead to commercially accepted products.

 

We have concentrated our research and development efforts on diagnostics and therapeutics in the relatively new field of microRNAs. We are currently marketing and selling the following four diagnostic tests based on our proprietary microRNA technologies: RosettaGX Cancer Origin, mi-KIDNEY and RosettaGx Reveal. To date, these tests have achieved very limited commercial success. The scientific discoveries that form the basis for our efforts to develop diagnostics and therapeutics are relatively new, and the scientific evidence to support the feasibility of developing products based on these discoveries is limited. Further, our focus on developing microRNA-based diagnostics and therapeutics as opposed to multiple or more proven technologies for the development of diagnostics and therapeutics increases the risks associated with the ownership of our ordinary shares. If we or a collaborative partner are not successful in commercializing our existing diagnostic tests or developing and commercializing additional microRNA-based tests or products, our business may fail.

 

Successful integration of PersonalizeDx with us and successful operation of the combined company are not assured. Also, integrating our business with that of PersonalizeDx may divert the attention of management away from operations.

 

In April 2015, we acquired CynoGen, Inc., which does business as PersonalizeDx (“CynoGen” or “PersonalizeDx”). There can be no assurance that we will be able to maintain and grow the acquired business and operations of PersonalizeDx. In addition, the market segments in which PersonalizeDx operates may experience declines in demand and/or new competitors. Integrating and coordinating certain aspects of the operations, portfolio of products and personnel of PersonalizeDx with ours have involved and will continue to involve complex operational, technological and personnel-related challenges. This process will be time-consuming and expensive, may disrupt the businesses of either or both of the companies and may not result in the full benefits expected by us and PersonalizeDx, including cost synergies expected to arise from supply chain efficiencies and overlapping general and administrative functions. The potential difficulties, and resulting costs and delays, include:

 

·managing a larger combined company;

 

·consolidating corporate and administrative infrastructures;

 

·issues in integrating research and development, commercial and sales forces;

 

·difficulties attracting and retaining key personnel;

 

·loss of customers and suppliers and inability to attract new customers and suppliers;

 

·unanticipated issues in integrating information technology, communications and other systems;

 

·incompatibility of purchasing, logistics, marketing, administration and other systems and processes;

 

·unforeseen and unexpected liabilities related to the acquisition or PersonalizeDx’s business; and

 

·potential costs of relocating employees to PersonalizeDx’s facilities or our other facilities.

 

 4 

 

 

Additionally, the integration of our and PersonalizeDx’s operations, products and personnel may place a significant burden on management and other internal resources. The diversion of management’s attention, and any difficulties encountered in the transition and integration process, could harm the combined company’s business, financial condition and operating results.

 

Because we have a short operating history, there is a limited amount of information about us upon which our business and prospects can be evaluated.

 

Our operations began in 2000, and we have only a limited operating history upon which our business and prospects can be evaluated. In addition, as a company providing relatively new diagnostic services, we have limited experience and have not yet demonstrated an ability to successfully overcome many of the risks and uncertainties frequently encountered by companies in new and rapidly evolving fields, particularly in the biotechnology area. For example, to execute our business plan, we will need to successfully:

 

maintain and further build our intellectual property portfolio;

 

execute development activities using an unproven technology;

 

execute sales, marketing and distribution activities;

 

continue to develop and maintain successful strategic relationships;

 

manage our spending while costs and expenses increase as we expand our efforts to discover, develop and commercialize diagnostics and therapeutics based on microRNAs; and

 

gain commercial and, if applicable, regulatory acceptance of our tests and products.

 

If we are unsuccessful in accomplishing these objectives, we may not be able to raise capital, develop additional tests or products, successfully commercialize our existing tests, expand our business or continue our operations.

 

We have a history of losses and may never be profitable.

 

We have experienced significant operating losses since our inception in 2000, and as of December 31, 2016, we had an accumulated deficit of approximately $157 million. We had net loss of $16.2 million for the year ended December 31, 2016. We anticipate that the majority of any revenues we generate over the next several years will be from sales of our currently marketed products in the United States and from existing and future collaborations and licensing arrangements and the sale of future products we develop or acquire. We cannot be certain, however, that our sales efforts will be successful or that we will be able to secure any collaborations or achieve any milestones that may be required to receive payments or that diagnostic tests based on our technologies, including our currently marketed tests, will be successfully commercialized. If we are unable to secure significant revenues from our current selling efforts or through collaborations and the sale of tests or products, we may be unable to continue our efforts to discover, develop and commercialize microRNA-based diagnostics and therapeutics without raising additional funds from other sources.

 

Fluctuations in currency exchange rates of the New Israeli Shekel vs. the U.S. dollar may have a significant impact on our reported results of operations.

 

Fluctuations in currency exchange rates may have a significant impact on our reported results of operations. Although our reporting currency is the U.S. dollar, significant portions of our expenses are denominated in New Israeli Shekels, or NIS. In periods when the U.S. dollar is devalued against the NIS, our reported results of operations may be adversely affected. In addition, fluctuations in currencies may result in valuation adjustments in our assets and liabilities which could affect our reported results of operations. We enter from time to time into foreign currency hedge transactions in order to mitigate some of this risk; however, we are unlikely to offset the entire currency exchange risk.

 

Fluctuations in our share price may have a significant impact on our reported liabilities and reported results of financial income or expenses.

 

Fluctuations in our share price may have a significant impact on our reported liabilities because certain outstanding warrants and debentures are classified as liabilities measured at fair value each reporting period until they are exercised or expire, with changes in the fair values being recognized in our statement of operations as financial income or expense. In periods when share price is ascending, the reported liability and the reported results of financial expense are adversely affected.

 

 5 

 

 

Risks Related to Our Intellectual Property

 

If we are not able to obtain and enforce patent protection for our discoveries, our ability to develop and commercialize microRNA-based diagnostics and therapeutics could be harmed.

 

Our success depends, in large part, on our ability to protect proprietary methods and technologies that we develop under the patent and other intellectual property laws of the United States, Israel and other countries, so that we can prevent others from unlawfully using our inventions and proprietary information. As of March 1, 2017, our patent portfolio included a total of 49 issued U.S. patents, two issued Australian patents, three issued European Union patents, all validated in UK, Germany and France, and one validated also in Denmark, four issued Israeli patents, one issued Japanese patent, one issued Korean patent, 41 pending patent applications worldwide, consisting of 20 U.S. patent applications, four of which received notice of allowance, six applications that are pending in Europe, two of which received a notice of allowance, two applications pending in Israel, one application pending in Japan, two applications pending in Canada, three applications pending in China, three applications pending in Brazil, and two PCT applications. There can be no assurance, however, that any of these pending patent applications will result in issued patents. The patent position of pharmaceutical or biotechnology companies, including ours, is generally uncertain and involves complex legal and factual considerations, and, therefore, validity and enforceability cannot be predicted with certainty. Patents may be challenged, deemed unenforceable, invalidated, or circumvented.

 

Furthermore, the standards that the U.S. Patent and Trademark Office, or USPTO, and its foreign counterparts use to grant patents are not always applied predictably or uniformly and may change. There is also no uniform, worldwide policy regarding the subject matter and scope of claims granted or allowable in pharmaceutical or biotechnology patents. Furthermore, the field of microRNAs is new and developing. Accordingly, there is significant uncertainty about what patents will be issued, and what their claims may cover. It is likely that there will be significant litigation and other proceedings, such as interference proceedings and opposition proceedings, in certain patent offices, relating to patent rights in the microRNA field. Others may attempt to invalidate our intellectual property rights. Currently, there is an opposition proceeding pending against one of our patents in Europe. This opposition relates to a patent granted by the European Patent Office that claims the use of miR-34a for the preparation of a pharmaceutical composition for treating cancer where the cancer is p53 negative. Even if this opposition is successful, we do not anticipate that the result will have a materially adverse effect on our business.

 

Even if our other rights are not directly challenged, disputes among third parties could lead to the weakening or invalidation of our intellectual property rights. Accordingly, we do not know the degree of future protection for our proprietary rights or the breadth of claims that will be allowed in any patents issued to us or to others. Additionally, the mere issuance of a patent does not guarantee that it is valid or enforceable, so even issued patents may not be valid or enforceable against third parties.

 

In addition, we cannot be certain that we hold the rights to the technology covered by our pending patent applications or to other proprietary technology required for us to commercialize our proposed tests and products. Because certain U.S. patent applications are confidential until patents issue, and because certain applications will not be filed in foreign countries, third parties may have filed patent applications for technology covered by our pending patent applications without our being aware of those applications, and our patent applications may not have priority over those applications. For this and other reasons, we may be unable to secure desired patent rights, thereby losing desired exclusivity. Thus, it is possible that one or more organizations will hold patent rights to which we will need a license. If those organizations refuse to grant us a license to such patent rights on reasonable terms, we will not be able to market our tests and products.

 

 6 

 

 

From time to time, the U.S. Supreme Court, other federal courts, the U.S. Congress or the USPTO may change the standards of patentability and any such changes could have a negative impact on our business. There have been several cases involving “gene patents” and diagnostic claims that have been considered by the U.S. Supreme Court. On June 13, 2013, in Association for Molecular Pathology v. Myriad Genetics, Inc., the Court held that claims to isolated genomic DNA were not patentable subject matter, but claims to complementary DNA (cDNA) molecules were patentable subject matter. The effect of the decision on patents for other isolated natural products is uncertain, and this uncertainty includes microRNAs, which have a different chemical composition, differ in size, and have a more complicated discovery process than DNA. On March 20, 2012, in Mayo Collaborative Services, DBA Mayo Medical Laboratories, et al. v. Prometheus Laboratories, Inc., the Court held that several claims drawn to measuring drug metabolite levels from patient samples and correlating them to drug doses were not patentable subject matter. Although the decision relates to biomarker method patents, relating to simple methods, for affecting treatment decisions, the decision has created uncertainty around the ability to patent certain biomarker-related method patents. On June 12, 2015, the United States Court of Appeals for the Federal Circuit (CAFC) issued a decision in Ariosa Diagnostics, Inc. v. Sequenom, Inc. The decision dealt with the subject matter eligibility of a non-invasive method for detecting paternally inherited cell-free fetal DNA from a blood sample of the pregnant woman carrying a fetus. The district court ruled that the method claims were patent ineligible and the Federal Circuit agreed. In December 2015, the CAFC denied an en banc hearing of this case. These decisions have increased the uncertainty with regard to our ability to obtain patents in the future as well as the value of current and future patents, once obtained. Depending on decisions by the U.S. federal courts and the Patent Office, the interpretation of laws and regulations governing patents could change in unpredictable ways that would weaken our ability to obtain new patents or to enforce our existing patents, all of which could have a material adverse effect on our business

 

On March 4, 2014, the USPTO issued a memorandum to patent examiners titled 2014 Procedure For Subject Matter Eligibility Of Claims Reciting Or Involving Laws Of Nature/Natural Principles, Natural Phenomena, And/Or Natural Products. These guidelines instruct USPTO examiners on the ramifications of the Prometheus and Myriad rulings. In addition, these guidelines reflect the USPTO’s interpretation of Supreme Court case law addressing patent subject matter eligibility. As such, the guidelines are subject to challenge in a court proceeding and are subject to modification by future court or USPTO decisions.

 

On December 15, 2014, the USPTO released the revised subject matter eligibility examination guidance to patent examiners entitled "2014 Interim Guidance on Patent Subject Matter Eligibility" (the "Interim Guidance"). The Interim Guidance intends to assist USPTO patent examiners to evaluate inventions that may be related to law of nature, natural phenomena, and/or an abstract idea. The Interim Guidance addresses the concerns raised by the public against the guidance issued in March of 2014 – namely that the USPTO applied with too broad a brush the recent Supreme Court decisions regarding the judicial exceptions (law of nature, natural phenomena, and/or an abstract idea). The USPTO’s new analysis, focusing on the claims as a whole and an analysis of the “markedly different” properties of the claimed subject matter (as compared to the natural counterpart product) is a balanced approach. The Interim Guidance also appears to indicate that a claim that recites a natural phenomenon, such as a diagnostic process or method, will satisfy Section 101 if the claim sufficiently limits the practical application of the natural phenomenon. The USPTO issued another update in July 2015 to provide additional information for subject matter eligibility. While we believe our patents and pending patent applications include claims that are patentable under current US law, as well as in foreign jurisdictions, no assurances can be given that a federal district court of the USPTO would agree.

 

In addition, Congress has directed the USPTO to study effective ways to provide independent, confirming genetic diagnostic test activity where gene patents and exclusive licensing for primary genetic diagnostic tests exist. This study will examine the impact that independent second opinion testing has on providing medical care to patients; the effect that providing independent second opinion genetic diagnostic testing would have on the existing patent and license holders of an exclusive genetic test; the impact of current practices on testing results and performance; and the role of insurance coverage on the provision of genetic diagnostic tests. The USPTO was directed to report the findings of the study to Congress and provide recommendations for establishing the availability of independent confirming genetic diagnostic test activity by June 16, 2012. On August 28, 2012, the Department of Commerce sent a letter to the House and Senate Judiciary Committee leadership updating them on the status of the genetic testing report. The letter stated in part: “Given the complexity and diversity of the opinions, comments, and suggestions provided by interested parties, and the important policy considerations involved, we believe that further review, discussion, and analysis are required before a final report can be submitted to Congress.” The USPTO issued a Request for Comments and Notice of Public Hearing on Genetic Diagnostic Testing on January 25, 2012, and held additional public hearings in February and March 2013. In September 2015, the USPTO submitted a report to Congress pursuant to Section 27 of the Leahy Smith America Invents Act. The report stated that in view of the altered legal landscape, the USPTO’s recommendations to Congress are limited in scope. The report provided three recommendations. The first recommendation was to proceed cautiously, monitoring changes in the actual availability of gene-based diagnostic tests from multiple providers. The second recommendation was to consider creating mechanisms to facilitate sharing data on diagnostic correlations in order to build robust databases of the relationships between genetic mutations and the presence, absence, or likelihood of acquiring the relevant medical condition. The third recommendation was to consider the role of cost and insurance. It is unclear whether the recommendations of this study will be acted upon by Congress to change the law or process in a manner that could negatively impact our patent portfolio or our future research and development efforts.

 

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It may be more difficult to adequately protect or enforce the intellectual property rights of our company as a result of the acquisition of PersonalizeDx, which could harm our competitive position.

 

Our success and future revenue growth depends in part, on our ability to protect our intellectual property. We primarily rely on patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods, to protect our proprietary technologies and processes. It is possible that competitors or other unauthorized third parties may obtain, copy, use or disclose proprietary technologies and processes, despite efforts by us to protect our proprietary technologies and processes. While we hold and have access to a significant number of patents, there can be no assurances that any additional patents will be issued. Even if new patents are issued, the claims allowed may not be sufficiently broad to protect our technology. In addition, any of our existing patents, and any future patents issued to us, may be challenged, invalidated or circumvented. As such, any rights granted under these patents may not provide us with meaningful protection. We may not have foreign patents or pending applications corresponding to its U.S. patents and applications. Even if foreign patents are granted, effective enforcement in foreign countries may not be available. If our patents do not adequately protect our technology, competitors may be able to offer products similar to our products. Our competitors may also be able to develop similar technology independently or design around our patents.

 

If we become involved in patent litigation or other proceedings related to a determination of rights, we could incur substantial costs and expenses, substantial liability for damages or be required to stop our development and commercialization efforts.

 

A third party may sue us for infringing its patent rights. Likewise, we may need to resort to litigation to enforce a patent issued or licensed to us or to determine the scope and validity of third-party proprietary rights. In addition, a third party may claim that we have improperly obtained or used its confidential or proprietary information. The cost to us of any litigation or other proceeding relating to intellectual property rights, even if resolved in our favor, could be substantial, and the litigation would divert our management’s efforts. Some of our competitors may be able to sustain the costs of complex patent litigation more effectively than we can because they have substantially greater resources, and we may not have sufficient resources to adequately enforce our intellectual property rights. Uncertainties resulting from the initiation and continuation of any litigation could limit our ability to continue our operations.

 

If we are found to infringe upon intellectual property rights of third parties, we could be forced to pay damages, potentially including treble damages, if we are found to have willfully infringed on such parties’ patent rights. In addition to any damages we might have to pay, a court could require us to stop the infringing activity or obtain a license. If we fail to obtain a required license and are unable to design around a patent, we may be unable to effectively market some of our technology, tests and products, which could limit our ability to generate revenues or achieve profitability and possibly prevent us from generating revenues sufficient to sustain our operations. Moreover, we expect that a number of our collaborations will provide that royalties payable to us for licenses to our intellectual property may be offset by amounts paid by our collaborators to third parties who have competing or superior intellectual property positions in the relevant fields, which could result in significant reductions in our revenues from tests or products developed through collaborations.

 

We license patent rights from third-party owners. If such owners do not properly maintain or enforce the patents underlying such licenses, our competitive position and business prospects will be harmed.

 

We are a party to license agreements that give us rights to third-party intellectual property that we believe may be necessary or useful for our business, such as our agreements with The Rockefeller University, Max Planck Innovation GmbH, or Max Planck, and Johns Hopkins University. We expect to enter into additional licenses of intellectual property with third parties in the future. Our success will depend in part on the ability of our licensors to obtain, maintain and enforce patent protection for our licensed intellectual property, in particular, those patents to which we have secured exclusive or co-exclusive rights. Our licensors may not successfully prosecute the patent applications which we have licensed. Even if patents are issued in respect of these patent applications, our licensors may fail to maintain these patents, may determine not to pursue litigation against other companies that are infringing these patents, or may pursue such litigation less aggressively than we would. Without protection for the intellectual property we license, other companies might be able to offer substantially identical tests or products for sale, which could adversely affect our competitive business position and harm our business prospects.

 

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In addition, as a result of the acquisition of PersonalizeDx, after twelve months from the date of the acquisition, we will be required to renegotiate the terms of certain agreements under which PersonalizeDx had in-licensed proprietary markers from Abbott Molecular, Inc. We cannot be sure that we will be able to renegotiate these license agreements on acceptable terms or at all. If we are unable to do so, we may lose the ability to commercialize the products that rely on these licenses.

 

If we fail to comply with our obligations under any licenses or related agreements, we could lose license rights that may be necessary for developing microRNA-based diagnostics and therapeutics.

 

Our current licenses impose, and any future licenses we enter into are likely to impose, various obligations on us. Such obligations may include:

 

royalty payments;

annual maintenance fees;

payment of fees relating to patent prosecution, maintenance and enforcement;

maintaining insurance coverage; and

using commercially reasonable efforts to develop and commercialize tests and products using the licensed technology.

 

If we breach any of our obligations under our licenses, the licensor may have the right to terminate the license, which could result in our being unable to develop, manufacture and sell tests or products that are covered by the licensed technology or a competitor gaining access to the licensed technology.

 

Confidentiality agreements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information.

 

We rely on trade secrets, know-how and technology, which are not protected by patents, to maintain our competitive position. In order to protect our proprietary technology and processes, we rely in part on confidentiality agreements with our collaborators, employees, consultants, outside scientific collaborators and sponsored researchers and other advisors. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, others may independently discover trade secrets and proprietary information, and in such cases we could not assert any trade secret rights against such party. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

 

Risks Related to Development, Clinical Testing and Regulatory Approval of Diagnostics

 

If we fail to comply with the complex federal, state, local and foreign laws and regulations that apply to our business, we could suffer severe consequences that could materially and adversely affect our operating results and financial condition.

 

Our operations are subject to extensive federal, state, local and foreign laws and regulations, all of which are subject to change. These laws and regulations currently include, among other things:

 

·CLIA, which requires that laboratories obtain certification from the federal government;
·Some state laws that require laboratories that test specimens from residents of the state to obtain licenses;
·Food Drug and Cosmetics Act and Food and Drug Administration (FDA) regulations;

 

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·Health Insurance Portability and Accountability Act of 1996 (HIPAA), which established comprehensive federal standards with respect to the privacy and security of protected health information and requirements for the use of certain standardized electronic transactions; amendments to HIPAA under the Health Information Technology for Economic and Clinical Health Act, or HITECH, which strengthen and expand HIPAA privacy and security compliance requirements, increase penalties for violators, extend enforcement authority to state attorneys general and impose requirements for breach notification;
·state laws regulating genetic testing and protecting the privacy of genetic test results, as well as state laws protecting the privacy and security of health information and personal data and mandating reporting of breaches to affected individuals and state regulators;
·the federal anti-kickback law, or the Anti-Kickback Statute, which prohibits knowingly and willfully offering, paying, soliciting, receiving, or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing, arranging for, or recommending of an item or service that is reimbursable, in whole or in part, by a federal health care program;
·the federal False Claims Act, which imposes liability on any person or entity that, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment to the federal government;
·the federal Civil Monetary Penalties Law, which prohibits, among other things, the offering or transfer of remuneration to a Medicare or state health care program beneficiary if the person knows or should know it is likely to influence the beneficiary’s selection of a particular provider, practitioner, or supplier of services reimbursable by Medicare or a state health care program, unless an exception applies;
·other federal and state fraud and abuse laws, such as anti-kickback laws, prohibitions on self-referral, and false claims acts, which may extend to services reimbursable by any third-party payor, including private insurers; and
·similar foreign laws and regulations that apply to us in the countries in which we operate.

 

These laws and regulations are complex and are subject to interpretation by the courts and by government agencies. Our failure to comply could lead to civil or criminal penalties, exclusion from participation in government health care programs, or prohibitions or restrictions on our laboratories’ ability to provide services. We believe that we are in material compliance with all statutory and regulatory requirements, but there is a risk that one or more government agencies could take a contrary position, or that a private party could file suit under the qui tam provisions of the federal False Claims Act or a similar state law. Such occurrences, regardless of their outcome, could damage our reputation and adversely affect important business relationships with third parties, including managed care organizations, and other private third-party payors.

 

If we do not comply with governmental regulations applicable to our CLIA-certified laboratories, we may not be able to continue our operations.

 

The operations of our laboratories in Philadelphia, Pennsylvania and Lake Forest, California are subject to regulation by numerous federal, state and local governmental authorities in the United States. Both laboratories are CLIA-certified and are accredited by the College of American Pathologists, or CAP. The CAP Laboratory Accreditation Program is an internationally recognized program that utilizes teams of practicing laboratory professionals as inspectors, and accreditation by CAP can also be used to meet CLIA and state certification requirements. In addition, our laboratories have obtained certain state licenses as required, including from California, Florida, Maryland, New York, Pennsylvania, and Rhode Island, and we plan to obtain licenses from other states if and as required.

 

CLIA is a federal law that regulates clinical laboratories that perform testing on human specimens for the purpose of providing information for the diagnosis, prevention or treatment of disease. CLIA imposes quality standards for laboratory testing to ensure the accuracy, reliability and timeliness of reporting patient test results. CLIA-certified laboratories are subject to survey and inspection every two years. Moreover, CLIA inspectors may make random inspections of these laboratories. If we were to lose our CLIA certification or our state licenses, or if they were limited in scope, we would no longer be able to continue our testing operations, which would have a material adverse effect on our business.

 

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From time to time, we may become aware of states other than California, Florida, Maryland, New York, Pennsylvania, and Rhode Island that require out-of-state laboratories to obtain a license in order to accept specimens from the state, and it is possible that other states already have such requirements or will have such requirements in the future. If we identify any other state with such requirements or if we are contacted by any other state advising us of such requirements, we intend to follow instructions from the state regulators as to how we should comply with such requirements. If we learn that we were accepting specimens from a state that requires licensure, we may be required to cease accepting specimens from that state while obtaining licensure, and we may be subject to monetary and other penalties for accepting specimens without a license.

 

Any diagnostic tests that may be developed by us or others using our microRNA technology may be subject to regulatory approval, which can be lengthy, costly and burdensome.

 

Although the FDA has consistently stated that it has the authority to regulate clinical laboratory tests as medical devices, it generally exercised enforcement discretion in not otherwise regulating most tests such as ours that are designed, manufactured and used within the same high complexity CLIA-certified laboratory at which the test was performed. These tests are known as laboratory developed tests, or LDTs. In 2014, the FDA issued a draft guidance on the regulation of LDTs entitled, “Framework for Regulatory Oversight of Laboratory Developed Tests (LDTs)” and an accompanying draft guidance document, or Draft Guidance, entitled, “FDA Notification and Medical Device Reporting for Laboratory Developed Tests (LDTs)”. However, in November 2016, the FDA announced that it would not release a final version of the Draft Guidance, and in January 2017, it published a discussion paper with its thoughts about elements of a possible future LDT regulatory framework. We cannot predict when or whether the FDA will issue a final guidance, but FDA could still try to regulate LDTs in the absence of additional guidance. Although we intend to continue to launch new clinical tests as LDTs in our CLIA-certified laboratory, we cannot provide any assurance that FDA regulations, including pre-market clearance or approval, will not be required in the future for LDTs applying our microRNA technology. If pre-market clearance or approval, or additional legal requirements such as implementing additional quality controls, are required, our business could be negatively impacted because we would have to obtain the data required to support the requirements of new FDA regulations and because our CLIA-certified laboratory may be required to stop offering our tests until they are cleared or approved by the FDA.

 

Diagnostic tests based on our microRNA technology may require the performance of clinical trials, which can be lengthy, costly and burdensome.

 

If the FDA decides to require pre-market clearance or approval of our current tests or the tests that we are developing, it may require us to perform clinical trials prior to submitting a marketing application. If we are required to conduct clinical trials, whether using prospectively acquired samples or archival samples, delays in the commencement or completion of clinical testing could significantly increase development costs and delay commercialization. The commencement of clinical trials also may be delayed if we are unable to obtain a sufficient number of patient samples, which is a function of many factors, including the size of the relevant patient population and the nature of the disease or condition being studied. We also might need to engage contract research organizations, or CROs, to perform data collection and analysis and other aspects of these clinical trials, which might increase the cost and increase the time to completion.

 

Failure to comply with government laws and regulations related to submission of claims for our services could result in significant monetary damages and penalties and exclusion from the Medicare and Medicaid programs and corresponding foreign reimbursement programs.

 

We are subject to laws and regulations governing the submission of claims for payment for our services, such as those relating to: coverage of our services under Medicare, Medicaid and other state, federal and foreign health care programs; the amounts that we may bill for our services; and the party to which we must submit claims. Our failure to comply with applicable laws and regulations could result in our inability to receive payment for our services or in attempts by government healthcare programs, such as Medicare and Medicaid, to recover payments already made. Submission of claims in violation of these laws and regulations can result in recoupment of payments already received, substantial civil monetary penalties, and exclusion from government health care programs, and can subject us to liability under the federal False Claims Act and similar laws. The failure to report and return an overpayment to the Medicare or Medicaid program within 60 days of identifying its existence can give rise to liability under the False Claims Act. Further, a government agency could attempt to hold us liable for causing the improper submission of claims by another entity for services that we performed if we were found to have knowingly participated in the arrangement at issue.

 

 

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If we are found to have violated laws protecting the privacy or security of patient health information, we could be subject to civil or criminal penalties, which could increase our liabilities and harm our reputation or our business.

 

We are subject to a number of U.S. federal and state laws and foreign laws protecting the privacy and security of identifiable health information, or “protected health information” as defined under HIPAA, and restricting the use and disclosure of that protected health information. In the United States, the U.S. Department of Health and Human Services promulgated health information privacy and security rules under the Health Insurance Portability and Accountability Act of 1996 (HIPAA) and then significantly strengthened and broadened the applicability of HIPAA under the Health Information Technology for Economic and Clinical Health Act (HITECH). HIPAA and HITECH and their implementing regulations and guidance will be collectively referred to herein as “HIPAA”. HIPAA applies to health care providers engaging in certain standard transactions electronically; health plans and health care clearing houses. These entities are referred to as “covered entities.” Certain HIPAA provisions also apply to “business associates” of covered entities, or third party providers of services to covered entities that involve the use or disclosure of protected health information. HIPAA’s privacy rules protect medical records and protected health information in all forms by limiting its use and disclosure, giving individuals the right to access, amend and seek accounting of their own health information and limiting, in some circumstances, the use and disclosure of protected health information to the minimum amount reasonably necessary to accomplish the intended purpose of the use or disclosure. HIPAA’s security standards require both covered entities and business associates to implement administrative, physical and technical security measures to maintain the security of protected health information in electronic form. Covered entities and business associates must conduct initial and ongoing risk assessments to ensure the ongoing effectiveness of security measures and maintain a written information security plan. HITECH amended HIPAA to require the reporting of breaches of protected health information to affected individuals, the federal government and in some cases, to the media. We are a covered entity, and as such, we must comply with HIPAA and ensure that all aspects of our operations comply with relevant HIPAA standards. For example, we must take steps to ensure that our sales team does not inappropriately access or use protected health information in providing services and support to customers. We are subject to random audit by federal authorities, and enforcement by both state and federal regulators. We are also subject to investigation in response to complaints. If we are found to be in violation of the privacy rules security standards, breach notification rules or other HIPAA requirements, we could be subject to civil or criminal penalties as well as fines, which could increase our liabilities and harm our reputation or our business. Large breaches of protected health information could lead to class action lawsuits and other litigation. Any publicly reported breach could cause significant reputational harm to our business and significant expense for reporting, mitigation of harm and implementation of corrective actions mandated by regulators. HITECH expanded HIPAA enforcement authority to state attorneys general, so we are subject to additional enforcement and penalties from each state where individuals affected by a HIPAA violation may reside. Allegations that we have violated individuals’ privacy or security rights, even if we are not found liable, could be expensive and time-consuming to defend and could result in adverse publicity that could harm our business.

 

Beyond HIPAA, most states have adopted data security laws protecting the personal data of state residents. Personal data subject to protection typically includes name coupled with social security number, state-issued identification number, or financial account number. Most states require specific, technical security measures for the protection of all personal data, including employee data, and impose their own breach notification requirements in the event of a loss of personal data. Many states also have adopted genetic testing and privacy laws. These laws typically require a specific, written consent for genetic testing, as well as consent for the disclosure of genetic test results, and otherwise limit uses and disclosures of genetic testing results. A few states have adopted laws that give their residents property rights in their genetic information. State privacy and data security laws generally overlap and apply simultaneously with HIPAA. In the event of a data breach affecting individuals from more than one state, we must comply with all relevant state notification requirements as well as HIPAA and are subject to enforcement by all relevant state and federal authorities as well as fines and penalties imposed by each state.

 

Non-U.S. privacy protection requirements such as the European Union’s Data Protection Directive governing the processing of personal data, may be stricter than U.S. law, and violations could result in claims for damages, fines or orders to stop or change the processing of the personal data. The European Union’s final draft General Data Protection Regulation, which is likely to be formally adopted, imposes extensive new legal obligations and substantially increases the risk of fines, with upper limits based on a corporate group’s global turnover. Privacy and data security laws, including those relating to health information, are complex, overlapping and rapidly evolving. All of these laws impact our business either directly or indirectly. Our failure to comply with applicable privacy or security laws, or significant changes in these laws, could significantly impact our business and future business plans.

 

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If we do not comply with laws regulating the protection of the environment and health and human safety, our business could be adversely affected.

 

Our research and development activities involve the use of hazardous and chemical materials, and we maintain quantities of various flammable and toxic chemicals in our facilities in Israel and the United States. We believe our procedures for storing, handling and disposing these materials in our Israel and U.S. facilities comply with the relevant guidelines of the State of Israel and the United States. Although we believe that our safety procedures for handling and disposing of these materials comply with the standards mandated by applicable regulations, the risk of accidental contamination or injury from these materials cannot be eliminated. If an accident occurs, we could be held liable for resulting damages, which could be substantial. We are also subject to numerous environmental, health and workplace safety laws and regulations, including those governing laboratory procedures, exposure to blood-borne pathogens and the handling of biohazardous materials. We may incur substantial costs to comply with, and substantial fines or penalties if we violate, any of these laws or regulations.

 

If we do not comply with laws regulating the use of human tissues, our business could be adversely affected.

 

We use human tissue samples for the purpose of development and validation of our tests. Our access and use of these samples is subjected to government regulation in the United States, Israel and elsewhere and may become subject to further regulation. For example, the Israeli Ministry of Health requires compliance with the principles of the Helsinki Declaration, the Public Health Regulations (Clinical Trials in Human Subjects) 1980, the provisions of the Guidelines for Clinical Trials in Human Subjects and the provisions of the current Harmonized Tripartite Guideline for Good Clinical Practice. Our failure to comply with these or similar regulations could impact our business and results of operations. In the United States, we must comply with 45 C.F.R. 46, Federal Policy for the Protected of Human Subjects, or the Common Rule, as well as HIPAA with respect to the use of clinical data associated with tissue samples. Failure to comply with these laws may result in federal or state enforcement, fines and/or civil penalties, reputational harm and inability to use data for test validation, research or other purposes.

 

Risks Related to Competition and Commercialization

 

If we are unable to expand sales of our diagnostic tests in the United States, it would have a material adverse effect on our business and financial condition.

 

In November 2010, we reacquired the U.S. commercial rights to our microRNA-based diagnostic tests, and in May 2011, we established our own internal sales team consisting of four sales specialists, which has since been increased and as of the date of this report stands at 10 sales specialists, two Regional Managers and an Executive Vice President. To date, this team has had moderate success in commercializing our diagnostic tests. In addition, in July 2012 (as amended in October 2012), we entered into a co-marketing agreement with Precision Therapeutics, pursuant to which we granted Precision Therapeutics the co-exclusive right, along with us, to market the RosettaGX Cancer Origin TestTM in the United States. Precision Therapeutics launched its marketing effort in October 2012, but had limited success and this agreement terminated on February 28, 2014. If we are unable to establish adequate sales, marketing and distribution capabilities to successfully commercialize our tests in the United States, whether independently or with third parties, it will have a material adverse effect on our business and financial condition.

 

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The intensely competitive biotechnology market could diminish demand for our tests and products.

 

The biopharmaceutical market is intensely competitive and rapidly changing. Many diagnostic, pharmaceutical and biotechnology companies, academic institutions, governmental agencies and other public and private research organizations are pursuing the research of technologies and development of novel diagnostic tests and therapeutic products for the same diseases that we and others who may develop products based on our technologies are targeting or may target. We and they will face intense competition from tests and products that have already been approved and accepted by the medical community for the diseases for which we or they may develop tests or products. We and others who may develop products based on our technologies may also face competition from new tests or products that enter the market. We believe a significant number of tests and products are currently under development, and may become commercially available in the future, for the diseases for which we, our collaborators, or third-party licensees may try to develop tests and products. In addition to the competition we face from existing tests and products in development, we will also face competition from other companies working to develop novel tests and products using technology that competes more directly with our technologies. We are aware of several other companies that are working to develop microRNA diagnostics and therapeutics, including Alnylam Pharmaceuticals, Inc., Asuragen Inc., HTG Molecular Diagnostics Inc., Interpace Diagnostics, Inc., QIAGEN N.V., Life Technologies Corporation, Ionis Pharmaceuticals, Inc. (formerly Isis Pharmaceuticals), Mirna Therapeutics Group, Inc. Merck & Co., Inc., Santaris Pharma A/S, Regulus Therapeutics Inc. and others. In addition, we face competition from companies that have developed or are developing diagnostic tests based on other non-microRNA technologies such as Cancer Genetics, Inc., NeoGenomics Inc., Biotheranostics, Inc., Foundation Medicine, and Veracyte Inc. We are also aware of several other companies that provide tests and services that are competitive with those provided by our recently acquired PersonalizeDx business, including Cancer Genetics, Inc., NeoGenomics, Inc., Miraca Life Sciences, Inc., Bostwick Laboratories, Inc. and Healthtronics Inc. If we are unable to compete effectively with existing tests and products, new treatment methods and new technologies, we and others who may develop products based on our technologies may be unable to commercialize any diagnostic tests or therapeutic products that we or they develop.

 

Many of our competitors have:

 

much greater financial, technical and human resources than we have at every stage of the discovery, development, manufacture and commercialization process;

more extensive experience in preclinical testing, conducting clinical trials, obtaining regulatory approvals, and in manufacturing and marketing diagnostics and therapeutics;

tests or products that have been approved or are in late stages of development; and

collaborative arrangements in our target markets with leading companies and research institutions.

 

Our competitors may develop or commercialize tests or products with significant advantages over any diagnostic tests or therapeutic products we, our collaborators or third-party licensees may develop. Our competitors may therefore be more successful in commercializing their tests and products than we, our collaborators, or third party licensees are, which could adversely affect our competitive position and business.

 

Health insurers and other third-party payors may decide not to cover our diagnostic products or may provide inadequate reimbursement, which could jeopardize our commercial prospects.

 

In the United States, private and government payors decide whether to cover a new diagnostic test, the amount that they will pay for a covered test and the specific conditions for reimbursement. In May 2012, we announced that the designated Medicare Administrative Contractor, or MAC, with jurisdiction for the RosettaGX Cancer Origin TestTM had informed us that it plans to cover this test for Medicare beneficiaries, and in June 2012, we announced that the MAC had established a reimbursement rate for the test. We then announced that this MAC had formalized its coverage decision in a Local Coverage Determination (LCD) effective August 1, 2013. Each third-party payor, however, makes its own decision about which tests it will cover and how much it will pay. While many third-party payors will follow the lead of Medicare, we cannot provide any assurance that other payors will cover this test or any of our other tests. The coverage determination process is often a time-consuming and costly process that will require us to provide scientific and clinical support for the use of each of our tests to each payor separately, with no assurance that approval will be obtained. Furthermore, reimbursement from third-party payors depends upon whether a service is covered under the patient’s policy and if payment practices for the service have been established. If third-party payors decide not to cover our diagnostic tests or if Medicare or other payors offer inadequate payment amounts, our ability to generate revenue from our diagnostic tests could be limited. Third-party payors that decide to reimburse for our tests may stop or lower payment at any time, which would reduce revenue. We cannot predict whether third-party payors will cover our tests or offer adequate payments. We also cannot predict the timing of such decisions. In addition, physicians or patients may decide not to order our tests if third-party payments are inadequate, especially if ordering the test could result in financial liability for the patient.

 

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In the United States, the American Medical Association, or AMA, assigns specific Current Procedural Terminology, or CPT, codes, which are a medical nomenclature used to report medical procedures and services under public and private health insurance plans. Once the CPT code is established, the Centers for Medicare and Medicaid Services, or CMS, establishes reimbursement payment levels and coverage rules for Medicare, and private payors establish rates and coverage rules independently. While we have been assigned a CPT code for the Rosetta Cancer Origin TestTM, we cannot guarantee that any of our other tests will be assigned a CPT code and will be approved for reimbursement by Medicare or other third-party payors. Additionally, any or all of our diagnostic tests developed in the future may not be approved for reimbursement or may be approved at a level that limits our commercial success.

 

In addition, payment for diagnostic tests furnished to Medicare beneficiaries in most instances is made based on a fee schedule set by CMS. In recent years, payments under these fee schedules have decreased and may decrease more, which could jeopardize our commercial prospects. Reimbursement decisions in the European Union and in other jurisdictions outside of the United States vary by country and regions and there can be no assurance that we will be successful obtaining adequate reimbursement.

 

Recent and future changes to policies and pricing from the MolDx molecular diagnostics program utilized by Noridian Healthcare Solutions, our Medicare Administrative Carrier, could have positive or negative effects on our Medicare billing. This relates primarily to our high complexity laboratory in Lake Forest, California which is under Noridian and MolDx jurisdiction. MolDx changes to coding and reimbursement over the past three years for Fluorescence In Situ Hybridization, or FISH, is indicative of the MolDx impact. In 2013, MolDx reduced FISH reimbursement in an attempt to reduce overutilization causing substantive losses for many laboratories. In 2016, MolDx revised pricing for FISH upward after implementing better utilization controls in the form of revised code and billing guidance.

 

Because of Medicare billing rules, we may not receive reimbursement for all tests provided to Medicare patients.

 

Under current Medicare billing rules, the bundled payment for inpatient services includes clinical laboratory testing performed for a Medicare beneficiary who was a hospital inpatient at the time the tumor tissue sample was obtained and whose testing was ordered less than 14 days after discharge. Medicare billing rules also require hospitals to bill for our testing if it is ordered for a hospital outpatient under the same circumstances. Accordingly, we must bill hospitals for such testing. Because we generally do not have written agreements in place obligating these hospitals to pay for our testing, we may not be paid or may have to pursue payment from the hospital on a case-by-case basis. We cannot ensure that hospitals will pay us for tests performed on patients falling under these rules.

 

Failure to comply with federal and state anti-kickbackand fraud and abuse laws could result in severe penalties.

 

Healthcare providers, physicians and third-party payors play a primary role in the recommendation and prescription of drug products that are granted marketing approval. Arrangements with third-party payors and customers are subject to broadly applicable fraud and abuse and other healthcare laws and regulations. Such restrictions under applicable federal and state healthcare laws and regulations, include the following:

 

·the federal Anti-Kickback Statute prohibits, among other things, persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in cash or in kind, to induce or reward either the referral of an individual for, or the purchase, order or recommendation of, any good or service, for which payment may be made, in whole or in part, under a federal healthcare program such as Medicare and Medicaid;

  

·the federal False Claims Act imposes civil penalties, and provides for civil whistleblower or qui tam actions, against individuals or entities for knowingly presenting, or causing to be presented, to the federal government, claims for payment that are false or fraudulent or making a false statement to avoid, decrease or conceal an obligation to pay money to the federal government;

 

·the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, imposes criminal and civil liability for executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters;

 

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·HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act and its implementing regulations, also imposes obligations, including mandatory contractual terms, with respect to safeguarding the privacy, security and transmission of individually identifiable health information;

 

·the federal false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false statement in connection with the delivery of or payment for healthcare benefits, items or services;

 

·the federal transparency requirements under the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, or collectively the ACA will require applicable manufacturers of covered drugs, devices, drugs and medical supplies to report to the Department of Health and Human Services information related to payments and other transfers of value to physicians and teaching hospitals and physician ownership and investment interests; and

 

·analogous state and foreign laws and regulations, such as state anti-kickback and false claims laws, may apply to sales or marketing arrangements and claims involving healthcare items or services reimbursed by non-governmental third-party payors, including private insurers.

 

Changes in healthcare policy, including legislation reforming the U.S. healthcare system, may have a material adverse effect on our financial condition and operations.

 

The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act, collectively the ACA, enacted in March 2010, makes changes that are expected to significantly affect the pharmaceutical and medical device industries and clinical laboratories. Effective January 1, 2013, the ACA includes a 2.3% excise tax on the sale of certain medical devices sold outside of the retail setting. Although a moratorium has been imposed on this excise tax for 2016 and 2017, the excise tax is scheduled to be restored in 2018.

 

Other significant measures contained in the ACA include, for example, coordination and promotion of research on comparative clinical effectiveness of different technologies and procedures, initiatives to revise Medicare payment methodologies, such as bundling of payments across the continuum of care by providers and physicians, and initiatives to promote quality indicators in payment methodologies. The ACA also includes significant new fraud and abuse measures, including required disclosures of financial arrangements with physician customers, lower thresholds for violations and increasing potential penalties for such violations. In addition, the ACA establishes an Independent Payment Advisory Board, or IPAB, to reduce the per capita rate of growth in Medicare spending. The IPAB has broad discretion to propose policies to reduce expenditures, which may have a negative effect on payment rates for services. The IPAB proposals may affect payments for clinical laboratory services beginning in 2016 and for hospital services beginning in 2020. We are monitoring the effect of the ACA to determine the trends and changes that may be necessitated by the legislation, any of which may potentially affect our business.

 

President Trump and some members of the U.S. Congress have repeatedly expressed their intentions to repeal or repeal and replace the ACA. We cannot predict whether they will be successful in repealing the ACA in its entirety or in part or whether they will be successful in replacing it with a new law, nor can we predict what the effect of either of these actions would have on our business.

 

In addition to the ACA, various healthcare reform proposals have also emerged from federal and state governments. For example, in February 2012, Congress passed the Middle Class Tax Relief and Job Creation Act of 2012, which in part reset the clinical laboratory payment rates on the Medicare Clinical Laboratory Fee Schedule, or CLFS, by 2% in 2013. In addition, under the Budget Control Act of 2011, which is effective for dates of service on or after April 1, 2013, Medicare payments, including payments to clinical laboratories, are subject to a reduction of 2% due to the automatic expense reductions (sequester) until fiscal year 2024. Reductions resulting from the Congressional sequester are applied to total claims payment made; however, they do not currently result in a rebasing of the negotiated or established Medicare reimbursement rates.

 

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State legislation on reimbursement applies to Medicaid reimbursement and managed Medicaid reimbursement rates within that state. Some states have passed or proposed legislation that would revise reimbursement methodology for clinical laboratory payment rates under those Medicaid programs. We cannot predict whether future healthcare initiatives will be implemented at the federal or state level or in countries outside of the United States in which we may do business, or the effect any future legislation or regulation will have on us. The taxes imposed by the new federal legislation, cost reduction measures and the expansion in the role of the U.S. government in the healthcare industry may result in decreased revenue, lower reimbursement by payers for our tests or reduced medical procedure volumes, all of which may adversely affect our business, financial condition and results of operations. In addition, sales of our tests outside the United States subject our business to foreign regulatory requirements and cost-reduction measures, which may also change over time.

 

Ongoing calls for deficit reduction at the federal government level and reforms to programs such as the Medicare program to pay for such reductions may affect the pharmaceutical, medical device and clinical laboratory industries. Currently, clinical laboratory services are excluded from the Medicare Part B co-insurance and co-payment as preventative services. Any requirement for clinical laboratories to collect co-payments from patients may increase our costs and reduce the amount ultimately collected.

 

The Protecting Access to Medicare Act of 2014, or PAMA, includes a substantial new payment system for clinical laboratory tests under the CLFS. Under PAMA, laboratories that receive the majority of their Medicare revenues from payments made under the CLFS would report initially and then on a subsequent three-year basis thereafter (or annually for advanced diagnostic laboratory tests, or ADLTs), private payer payment rates and volumes for their tests. The final PAMA ruling was issued June 17, 2016, indicating that data for reporting for the new PAMA process will begin in 2017 and the new market based rates will take effect January 1, 2018. The private payer rate will be calculated based on claims whose adjudication is final and will include patient deductible and co-insurance amounts.  Additionally, we believe our Reveal test, once covered, would be considered ADLTs and that we can determine when to seek ADLT status. We cannot assure you that reimbursement rates under the final regulations for tests like ours will not be adversely affected.

 

The market may not be receptive to any diagnostic tests or therapeutic products using our microRNA technology upon their commercial introduction.

 

Any diagnostic tests or therapeutic products using our microRNA technology that we, our collaborators or third-party licensees have developed or are developing are based upon new technologies or diagnostic or therapeutic approaches. Key participants in pharmaceutical marketplaces, such as physicians, third-party payors and consumers, may not accept a microRNA-based approach. As a result, it may be more difficult for us, our collaborators or third-party licensees to convince the medical community and third-party payors to accept and use such tests and products. Other factors that we believe will materially affect market acceptance of diagnostic tests or therapeutic products using our microRNA technology include:

 

the timing of any marketing approvals, the terms of any approvals and the countries in which approvals are obtained;

the success of physician education programs;

the availability of alternative diagnostics and therapeutics; and

the pricing of such tests or products, particularly as compared to alternatives.

 

Risks Related to Our Dependence on Third Parties

 

We are largely dependent upon our distributors for the success of commercialization of our current diagnostic tests.

 

We currently have distribution agreements with respect to some of our tests covering Australia, Greece, India, Israel, New Zealand, and Turkey. All of these distribution agreements call for samples to be sent to our CLIA-certified laboratory in Philadelphia for analysis, but we are largely dependent upon these distributors for the commercial success of our tests outside of the United States. The potential revenues from these agreements are based on the sale of our products by these distributors and will depend upon our distributors’ ability to devote the necessary resources to successfully commercialize these tests. In addition, if any of our current or potential future distributors were to breach or terminate its agreement with us, the commercialization of these tests could be adversely affected because we may not have sufficient financial resources or capabilities to successfully commercialize these tests on our own or find other partners. If any of our distributors or co-marketers does not devote sufficient time and resources to the collaboration or if a collaboration is breached or terminated, we may not realize the potential commercial benefits of the arrangement, and our results of operations may be adversely affected.

 

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We contract with a single manufacturer for the purchase of microarray chips for certain tests, including the RosettaGX Cancer Origin Test and miKIDNEY. The failure of this manufacturer to supply sufficient quantities on a timely basis could have a material adverse effect on our business.

 

We use a single manufacturer for the supply of microarray chips for certain tests, including the RosettaGX Cancer Origin Test and miKIDNEY. While we believe that there are a number of manufacturers from whom we could obtain such chips, we have not screened or approved any such manufacturers as potential back-up manufacturers for these chips, and it could take a significant amount of time and would be costly to do so. Accordingly, if this manufacturer is unable or unwilling to supply sufficient quantities of chips on a timely basis, it could have a material adverse effect on our business.

 

We may not be able to execute our business strategy if we are unable to enter into additional collaborations with other companies that can provide capabilities and funds for the development and commercialization of our microRNA-based diagnostics and therapeutics.

 

We have limited capabilities for sales, marketing, distribution and product development, including obtaining regulatory approval of therapeutic products. Accordingly, we may enter into additional collaborations with pharmaceutical, biotechnology or diagnostic companies to jointly develop specific tests or products and to jointly commercialize them. In such collaborations, we would expect our collaborators to provide substantial capabilities in clinical development, regulatory affairs, marketing and sales. While such agreements could provide us with an opportunity to develop and commercialize tests and products, they may necessitate a reliance on our collaboration partner in numerous aspects of the research and development, regulation, manufacturing, marketing and sales of these tests and products. We may not be successful in entering into any additional collaborations on favorable terms or maintaining any such collaborations into which we enter. In addition, while such agreements would provide us with opportunities, they would also require us to share the down-stream profits with our collaborators, thereby reducing our ability to fully capitalize on sales.

 

If any collaborator terminates or fails to perform its obligations under agreements with us, the development and commercialization of our tests and products could be delayed or terminated.

 

Our expected dependence on collaborators for certain capabilities and funding means that our business would be adversely affected if any collaborator terminates its collaboration agreement with us or fails to perform its obligations under that agreement. Our current or future collaborations, if any, may not be scientifically or commercially successful. Disputes may arise in the future with respect to the ownership of rights to tests or products developed with collaborators, which could have an adverse effect on our ability to develop and commercialize any affected test or product. If a collaborator terminates its collaboration with us, for breach or otherwise, it could be difficult for us to attract new collaborators and it could adversely affect how we are perceived in the business and financial communities. In addition, a collaborator could determine that it is in its financial interest to:

 

pursue alternative technologies or develop alternative tests or products, either on its own or jointly with others, that may be competitive with the tests or products on which it is collaborating with us or which could affect its commitment to the collaboration with us;

pursue higher priority programs or change the focus of their development programs, which could affect the collaborator’s commitment to us; or

if it has marketing rights and obligations, choose to devote fewer resources to the marketing of our tests or products, than they do for tests or products of their own development, or of their co-development with third parties.

 

 

 

 

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If any of these occur, we may not have sufficient financial resources or capabilities to continue the development and commercialization of such test or product on our own.

 

We rely on third parties for tissue samples and other materials required for our research and development activities, and if we are unable to reach agreements with these third parties our research and development activities would be delayed.

 

We rely on third parties, primarily hospitals, health clinics and academic institutions, for the provision of tissue samples and other materials required in our research and development activities. Obtaining these materials requires various approvals as well as reaching a commercial agreement on acceptable terms with the hospital or other provider of the materials. We may not be able to reach agreements with a sufficient number of suppliers or do so on terms acceptable to us. If we are unable to reach acceptable agreements with a sufficient number of suppliers of research materials, our research and development activities will be delayed and our ability to implement our business plan will be compromised.

 

We currently have limited sales, marketing or distribution experience and may in the future depend significantly on third parties to commercialize microRNA-based diagnostic tests or therapeutic products we may develop.

 

We currently have a U.S. sales and marketing team that covers the markets for our current product offerings; however, we may need to expand our sales team as we introduce diagnostic tests to new markets. In the future, we may rely on collaborators or other third parties to commercialize certain future tests we may develop in the United States in the event such tests don’t align with current call points. We have limited control over the sales, marketing and distribution activities of our collaborators, and our future revenues will depend on the success of the efforts of our collaborators. To expand our internal sales, distribution and marketing capabilities, we will have to invest financial and management resources, and we will face a number of additional risks, including:

 

our inability to develop and launch new tests that focus on larger potential markets;

we may not be able to attract and grow a marketing or sales force;

the cost of establishing a marketing or sales force may not be justifiable in light of the revenues generated by any particular test or product; and

our direct sales and marketing efforts may not be successful.

 

Risks Related to Our Operations

 

If we are unable to attract and retain qualified key management and scientists, staff consultants and advisors, our ability to implement our business plan may be adversely affected.

 

We are highly dependent upon certain of our senior management and scientific staff. The loss of the service of these persons may significantly delay or prevent our achievement of product development and other business objectives. Our employment agreements with our key personnel are terminable by the employee at any time with notice. Additionally, we face intense competition for qualified individuals from numerous pharmaceutical and biotechnology companies, universities, governmental entities and other research institutions. We may be unable to attract and retain suitably qualified individuals, and our failure to do so could have an adverse effect on our ability to implement our business plan.

 

There is a substantial risk of product liability claims in our business. If we are unable to obtain sufficient insurance, a product liability claim against us could adversely affect our business.

 

Our business exposes us to significant potential product liability risks that are inherent in the development, manufacturing and marketing of diagnostics and therapeutics. Product liability claims could delay or prevent completion of our clinical development programs. We currently have product liability insurance covering our current commercial tests, and clinical trial insurance for certain trials and cancer programs requiring insurance in an amount up to $5 million in the aggregate. We plan to obtain insurance for all research programs at appropriate levels prior to initiating any required clinical trials and at higher levels prior to marketing approved therapeutic products. Any insurance we obtain may not provide sufficient coverage against potential liabilities. Furthermore, clinical trial and product liability insurance is becoming increasingly expensive. As a result, we may be unable to obtain sufficient insurance at a reasonable cost to protect us against losses caused by product liability claims that could have a material adverse effect on our business.

 

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If we are unable to manage the challenges associated with our international operations, the growth of our business could be limited.

 

We are subject to a number of risks and challenges that specifically relate to international operations. Our international operations may not be successful if we are unable to meet and overcome these challenges, which could limit the growth of our business and may have an adverse effect on our business and operating results. These risks include:

 

fluctuations in foreign currency exchange rates that may increase the U.S. dollar cost of our international operations;

difficulty managing operations in multiple locations, which could adversely affect the progress of our development programs and business prospects;

local regulations that may restrict or impair our ability to conduct pharmaceutical and biotechnology-based research and development;

foreign protectionist laws and business practices that favor local competition;

failure of local laws to provide the same degree of protection against infringement of our intellectual property, which could adversely affect our ability to develop tests or products or reduce future product or royalty revenues, if any, from tests or products we may develop;

laws and regulations governing U.S. immigration and entry into the United States that may restrict free movement of our employees between Israel and the United States; and

laws and regulations governing U.S. immigration and entry into the United States that could limit the number of foreign employees in our U.S. facilities.

 

We are exposed to risks relating to evaluations of controls required by Section 404 of the Sarbanes-Oxley Act of 2002.

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. We cannot guarantee that we will not identify material weaknesses or significant control deficiencies in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in significant deficiencies or material weaknesses and cause us to fail to meet our periodic reporting obligations or result in material misstatements in our financial statements, which in turn could lead to a decline in our stock price. Any such failure could also adversely affect the results of periodic management evaluations regarding the effectiveness of our internal control over financial reporting.

 

Risks Related to Israeli Law and Our Operations in Israel

 

For certain calendar years, we were a passive foreign investment company, or PFIC, for U.S. federal income tax purposes. There may be negative tax consequences for holders of our ordinary shares who are U.S. residents and do not make certain timely tax elections.

 

We believe we may be a PFIC for the year ended December 31, 2016. The determination of whether or not we are a PFIC is made on an annual basis and will depend on the composition of our income and assets from time to time. Specifically, for U.S. federal income tax purposes, we will generally be classified as a PFIC for any taxable year in which either: (i) 75% or more of our gross income is passive income or (ii) at least 50% of the average value (determined on a quarterly basis) of our total assets for the taxable year (including cash) produce or are held for the production of passive income. The calculation of the value of our assets will be based, in part, on the quarterly market value of our ordinary shares. It is difficult to make accurate predictions of our future income, assets, activities and market capitalization, all of which are relevant to the PFIC determination. For years in which we are determined to be a PFIC for U.S. federal income tax purposes, U.S. holders of our ordinary shares may become subject to increased tax liabilities under U.S. tax laws and regulations and will become subject to burdensome reporting requirements. Accordingly, our treatment as a PFIC could therefore result in a reduction in the after-tax return of U.S. holders of our ordinary shares and may cause a reduction in the value of our shares. For more information please see “Item 10. Additional Information – E. Taxation - Certain Material U.S. Federal Income Tax Considerations – Passive Foreign Investment Company.”

 

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We are headquartered in Israel and therefore our results may be adversely affected by political, economic and military instability in Israel.

 

Our principal executive offices and research and development facilities are located in Israel. Accordingly, political, economic and military conditions in Israel may directly affect our business. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors, as well as incidents of civil unrest. Although Israel has entered in the past into various agreements with the Palestinian Authority, Israel has been and is subject to related civil unrest and Palestinian terrorist activity, with varying levels of severity. In addition, tension among the different Palestinian factions may create additional unrest and uncertainty. In recent years, Israel was engaged in several rounds of armed conflicts with Hamas in the Gaza Strip. These conflicts involved missile strikes against civilian targets in parts of Israel that resulted in economic losses.

 

We can give no assurance that security and political conditions will have no impact on our business in the future. Hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could adversely affect our operations and could make it more difficult for us to raise capital. Ongoing and revived hostilities or other adverse political or economic developments in Israel or the region could harm our operations and product development and cause sales of any approved products to decrease. In addition, Israel and companies doing business with Israel have, in the past, been subject to economic boycotts. Several countries, principally those in the Middle East, still restrict business with Israel and Israeli companies. These restrictions may seriously limit our ability to sell any approved products in these countries.

 

Our business insurance does not cover losses that may occur as a result of events associated with the security situation in the Middle East. Although the Israeli government commonly covers the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, there can be no assurance that this government coverage will be maintained. Any losses or damages incurred by us could have a material adverse effect on our business. Any armed conflicts or political instability in the region would likely negatively affect business conditions and could harm our results of operations.

 

Our operations could be disrupted as a result of the obligation of management or key personnel to perform military service in Israel.

 

Many of our male employees in Israel are obligated to perform military reserve duty annually for extended periods of time through the age of 40 (or older for citizens with certain occupations) and, in the event of a military conflict, could be called to active duty. In response to increases in terrorist activity, there have been periods of significant call-ups of military reservists. It is possible that there will be additional call-ups in the future. Our operations could be disrupted by the absence of a significant number of our employees related to military service or the absence for extended periods of military service of one or more of our key employees.

 

The government tax benefits that we are currently eligible to receive require us to meet several conditions and may be terminated or reduced in the future, which would increase our costs.

 

Some of our operations in Israel have been granted “approved enterprise” status by the Investment Center in the Israeli Ministry of Economy, which resulted in our being eligible for tax benefits under the Israeli Law for Encouragement of Capital Investments, 1959, as amended. These benefits will commence in the first year in which we produce taxable income. Pursuant to these benefits, undistributed income that we generate from our “approved enterprise” will be tax exempt for two years and, thereafter, will be subject to a corporate tax at a rate of 25% for an additional five to eight years, depending on the extent of foreign investment in us. The availability of these tax benefits, however, is subject to certain requirements, including, among other things, making specified investments in fixed assets and equipment, financing a percentage of those investments with our capital contributions, compliance with our marketing program which was submitted to the Investment Center, filing of certain reports with the Investment Center and compliance with Israeli intellectual property laws. If we do not meet these requirements in the future, these tax benefits may be cancelled and we may be required to refund the amount of the benefits already received, in whole or in part, with the addition of linkage differentials to the Israeli consumer price index and interest, or other monetary penalty. The tax benefits that we anticipate receiving under our current “approved enterprise” program may not be continued in the future at their current levels or at all.

 

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We participated in programs supported by the Israeli Chief Scientist, which may restrict the transfer of know-how that we develop.

 

Until December 2016 we participated in the consortium “Rimonim,” which was supported by the Israel Innovation Authority (formerly known as the Office of the Chief Scientist, "IIA" or "OCS") of the Ministry of Economy and Industry of the State of Israel. The aim of this consortium was to develop novel technologies for the use of short interfering RNA, or siRNA, and microRNA mimetics or anti-microRNAs for therapeutics. In addition, in the past we participated in a two year Magneton project with Tel Aviv University that was jointly funded by the IIA, the aim of which was to develop a delivery system for microRNA mimetics for the treatment of cancer. The transfer of know-how developed in the framework of these programs or rights to manufacture based on and/or incorporating such know-how to third parties which are not members of the programs requires the consent of the IIA.

 

The IIA, under special circumstances, may approve the transfer of the know-how developed in these supported projects outside of Israel, provided that the grant recipient pays to the IIA a portion of the sale price paid in consideration for such know-how, which portion will not exceed six times the amount of the grants received plus interest (or three times the amount of the grant received plus interest, in the event that the recipient of the know-how has committed to retain the R&D activities of the grant recipient in Israel after the transfer). As of December 31, 2016, we had received from the IIA total grants of $932,299 for our development under the Rimonim Consortium and $282,141 for our development under the Magneton project.

 

According to an amendment to the Israeli Encouragement of Industrial Research and Development Law, 5744-1984 (R&D law), a new National Technological Innovation Authority, or NTIA, was established and will replace the IIA in the implementation of the governmental policy in connection with the R&D Law (and has been given discretion in the implementation of the R&D Law for such purpose). Until otherwise determined by NTIA, the provisions of the R&D Law and regulations that applied to existing IIA programs (including those provisions described above) will continue to apply.

 

Provisions of Israeli law may delay, prevent or impede an acquisition of us, which could prevent a change of control.

 

Israeli corporate law regulates mergers, requires tender offers for acquisitions of shares above specified thresholds, requires special approvals for transactions involving directors, officers or significant shareholders and regulates other matters that may be relevant to these types of transactions. For example, a merger may not be completed unless at least 50 days have passed from the date that a merger proposal was filed by each merging company with the Israel Registrar of Companies and at least 30 days from the date that the shareholders of both merging companies approved the merger. In addition, if the target company's shares are divided into classes, the approval of a majority of each class of shares of the target company is required to approve a merger.

 

Furthermore, Israeli tax considerations may make potential transactions unappealing to us or to our shareholders whose country of residence does not have a tax treaty with Israel exempting such shareholders from Israeli tax. For example, Israeli tax law does not recognize tax free share exchanges to the same extent as U.S. tax law. With respect to mergers, Israeli tax law allows for tax deferral in certain circumstances but makes the deferral contingent on the fulfillment of numerous conditions, including a holding period of two years from the date of the transaction during which sales and dispositions of shares of the participating companies are restricted. Moreover, with respect to certain share swap transactions, the tax deferral is limited in time, and when the time expires, tax then becomes payable even if no actual disposition of the shares has occurred.

 

These provisions could delay, prevent or impede an acquisition of us, even if such an acquisition would be considered beneficial by some of our shareholders.

 

 

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It may be difficult to enforce a U.S. judgment against us, our officers and directors or to assert U.S. securities law claims in Israel.

 

We are incorporated in Israel. Most of our executive officers and directors are not residents of the United States, and a majority of our assets and the assets of these persons are located outside of the United States. Therefore, it may be difficult to enforce a judgment obtained in the United States against us or any of these persons in U.S. or Israeli courts based on the civil liability provisions of the U.S. federal securities laws. Additionally, it may be difficult to enforce civil liabilities under U.S. federal securities laws in original actions instituted in Israel.

 

Being a foreign private issuer exempts us from certain SEC and NASDAQ requirements

 

We are a “foreign private issuer” within the meaning of rules promulgated by the SEC. As such, we are exempt from certain provisions applicable to U.S. public companies including:

 

the rules under the Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q and current reports on Form 8-K;

the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations in respect of a security registered under the Exchange Act;

the provisions of Regulation FD aimed at preventing issuers from making selective disclosures of material information; and

the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and establishing insider liability for profits realized from any “short-swing” trading transaction (a purchase and sale, or sale and purchase, of the issuer’s equity securities within less than six months).

 

In addition, under the rules and regulations of The NASDAQ Stock Market, a foreign private issuer may follow its home country practice in lieu of certain NASDAQ listing requirements. For example, under NASDAQ’s rules, each of (1) the private placement completed in December 2010, (2) the concurrent private placement and registered direct offering completed in February 2011, (3) the private placement completed in October 2011, (4) the Debenture transaction completed in January 2012, (5) the registered direct offering completed in April 2012, (6) the registered direct offerings completed in May 2012, (7) the private placement completed in October 2015 and (8) the concurrent private placement and registered direct offering completed in November 2016, would have required shareholder approval because these offerings represented the issuance (or potential issuance) of more than 20% of our outstanding ordinary shares at a price per share below the greater of book value per share or market value per share. However, we chose to follow our home country practice, which did not require shareholder approval of these offerings. Because of these SEC and NASDAQ exemptions, investors are not afforded the same protections or information generally available to investors holding shares in public companies organized in the United States. See also “Item 16G Corporate Governance.”

 

Risks Related to our Ordinary Shares

 

Our stock price has been and is likely to continue to be volatile and the market price of our ordinary shares may drop.

 

Prior to our February 2007 initial public offering, there was not a public market for our ordinary shares. Since our ordinary shares began trading on NASDAQ on February 27, 2007, through March 24, 2017, our stock price has fluctuated from a low of $3.22 to a high of $7,086.22 (after giving effect to the reverse stock splits effected in July 2011, May 2012, and March 2017). Furthermore, the stock market has recently experienced significant volatility, particularly with respect to pharmaceutical, biotechnology, and other life sciences company stocks. The volatility of pharmaceutical, biotechnology, and other life sciences company stocks often does not relate to the operating performance of the companies represented by the stock. Some of the factors that may cause the market price of our ordinary shares to fluctuate include:

 

failure of any of our diagnostic tests to achieve commercial success;

failure to successfully maintain and grow the acquired business and operations of PersonalizeDx;

 

 

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introduction of technological innovations or new commercial products by us or our competitors;

our entry into new, or termination or other developments relating to our existing, collaboration, distribution and licensing agreements;

developments relating to our efforts to commercialize our tests in the United States;

regulatory developments in the United States and foreign countries;

developments or disputes concerning patents or other proprietary rights;

failure to secure adequate capital to fund our operations, or the issuance of equity securities at prices below fair market volume;

changes in estimates or recommendations by securities analysts, if any cover our securities;

litigation;

future sales of our ordinary shares;

general market conditions;

changes in the structure of healthcare payment systems;

economic and other external factors or other disasters or crises;

period-to-period fluctuations in our financial results; and

overall fluctuations in U.S. equity markets.

 

These and other external factors may cause the market price and demand for our ordinary shares to fluctuate substantially, which may limit or prevent investors from readily selling their shares and may otherwise negatively affect the liquidity of our ordinary shares. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have instituted securities class action litigation against the company that issued the stock. If any of our stockholders brought a lawsuit against us, we could incur substantial costs defending the lawsuit. Such a lawsuit could also divert the time and attention of our management.

 

We do not intend to pay any cash dividends in the foreseeable future and, therefore, any return on an investment in our ordinary shares must come from increases in the fair market value and trading price of our ordinary shares.

 

We do not intend to pay any cash dividends in the foreseeable future and, therefore, any return on an investment in our ordinary shares must come from increases in the fair market value and trading price of our ordinary shares.

 

 

ITEM 4.INFORMATION ON THE COMPANY

 

A.HISTORY AND DEVELOPMENT OF THE COMPANY

 

History

 

We were incorporated under the laws of the State of Israel on March 9, 2000 as Rosetta Genomics Ltd., an Israeli company. The principal legislation under which we operate is the Israeli Companies Law, 5759-1999, as amended, or the Companies Law. Our principal executive office is located at 10 Plaut Street, Science Park, Rehovot 76706 Israel, and our telephone number is + 972-73-222-0700. Our wholly owned subsidiary, Rosetta Genomics Inc., which was incorporated in Delaware on April 21, 2005, is located at 3711 Market Street, Suite 740, Philadelphia, Pennsylvania 19104, and its telephone number is (215) 382-9000. Rosetta Genomics Inc. serves as our agent for service of process in the United States. In April 2015, we acquired CynoGen Inc. (d/b/a PersonalizeDx), a Delaware corporation with principal offices located at 25901 Commercentre Drive, Lake Forest, CA 92630. Our web site address is www.rosettagx.com. The information on our web site is not incorporated by reference into this prospectus and should not be considered to be a part of this annual report.

 

Principal Capital Expenditures

 

We had net capital expenditures and repayment of capital lease of $251,000 in 2016, $273,000 in 2015, and $247,000 in 2014. Our capital expenditures during 2016, 2015, and 2014 consisted primarily of laboratory equipment, computer equipment and leasehold improvements. We have financed our capital expenditures with cash generated from financing activities.

 

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B.BUSINESS OVERVIEW

 

Overview

 

We are seeking to develop and commercialize new diagnostic tests based on various genomics markers, including DNA, microRNA and protein biomarkers and using various technologies, including, qPCR, microarrays, Next Generation Sequencing (NGS) and Fluorescence In Situ Hybridization (FISH). We have two CLIA-certified, CAP-accredited, laboratories in Philadelphia, PA and Lake Forest, CA which enable us to commercialize our own diagnostic tests applying our microRNA technology.

 

We believe that we were the first commercial enterprise to focus on the emerging microRNA field, and that as a result, we have developed an early and strong intellectual property position related to the development and commercialization of microRNA-based diagnostics. Using our intellectual property, collaborative relationships with leading commercial enterprises and academic and medical institutions, and expertise in the field of microRNAs, we have initiated microRNA-based diagnostic programs for various cancers and other diseases. We are currently marketing and selling the following four diagnostic tests based on our proprietary microRNA technologies:

 

·RosettaGX Cancer Origin (formerly “miRview® mets2”) – This test is our second-generation microRNA-based diagnostic for the identification of the primary site of metastatic cancer, specifically metastatic cancer of unknown or uncertain primary (CUP). RosettaGX Cancer Origin has replaced miRview® mets as our primary CUP assay.

 

·mi-KIDNEY(formerly “Rosetta Kidney Cancer Test”) – This test is a microRNA-based kidney tumor classification test for pathology samples. This test was designed to classify primary kidney tumors into one of the four most common types: the malignant renal cell carcinomas clear cell (conventional), papillary and chromophobe as well as the benign oncocytoma.

 

·RosettaGX Reveal This is a microRNA-based assay for the diagnosis of indeterminate thyroid fine-needle aspirate, or FNA, samples. The test utilizes routinely prepared FNA smears to diagnose a cytologically indeterminate thyroid nodule as “benign” or “suspicious for malignancy by microRNA”. The test also measures a microRNA biomarker for medullary carcinoma.

 

We currently have distribution agreements with respect to some of our tests covering Australia, Greece, India, Israel, New Zealand, and Turkey. All of these distribution agreements call for samples to be sent to our CLIA-certified laboratory in Philadelphia for analysis.

 

In general, we are generating demand for our testing services, primarily RosettaGX Cancer Origin and RosettaGX Reveal through our direct selling effort in the United States and are successfully fulfilling that demand in our lab in Philadelphia, Pennsylvania. We are working with our Director of Reimbursement and Managed Care to gain more consistent payment from commercial payors, as well as to secure reimbursement coverage from Medicare. We are increasing our activity to establish policy-level reimbursement, which could improve our ability to receive prompt payment from commercial payors. We announced in May 2012 that the designated Medicare Administrative Contractor, or MAC, for RosettaGX Cancer Origin is covering this test for all Medicare beneficiaries, and we are receiving approved payments for claims submitted.

 

On April 13, 2015, we acquired CynoGen, Inc., which does business as PersonalizeDx (“CynoGen” or “PersonalizeDx”). PersonalizeDx is a molecular diagnostics and services company serving community-based pathologists, urologists, oncologists and other reference laboratories across the United States. PersonalizeDx is focused on the detection of genomic changes through Fluorescence In Situ Hybridization, or FISH, technology, which helps to detect cancer, measure the potential aggressiveness of the disease and identify patients most likely to respond to targeted therapies.

 

PersonalizeDx offers its clients a virtual “tech only” platform in which such clients can collaborate with the company to perform and bill for the “professional component” of FISH molecular testing services for lung, breast, bladder, prostate and hematologic cancers. PersonalizeDx also performs IHC and histology testing services for its clients in its 30,000 square foot laboratory facility located in Lake Forest, CA. PersonalizeDx was initially founded by Abbott Laboratories, and PersonalizeDx performed several clinical trial studies for Abbott and Abbott’s research partners. PersonalizeDx is currently performing testing for one clinical trial for Abbott in bladder cancer. There is no guarantee that PersonalizeDx will be granted additional clinical trial business from Abbott moving forward.

 

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Rosetta has entered into an agreement to sell and market products for Admera Health, offering products to oncology physicians that are key call points for the Rosetta sales force. By entering into this agreement, Rosetta believes it could gain additional opportunities to meet with oncologists and discuss new products that may improve the patients’ diagnostic experience.

 

In addition, we have a number of projects in our diagnostics pipelines including the research and development of product line extensions to, and next generation versions of, our thyroid assay.

 

We are seeking to develop a second version of RosettaGX Reveal, a microRNA-based assay for the differential diagnosis of indeterminate thyroid FNAs that utilizes routinely prepared FNA smears. This second version will combine RosettaGX Reveal’s current microRNA biomarkers with a panel of additional biomarkers. We anticipate that we will launch this assay by the end of 2018.

 

MicroRNAs also represent potential targets for the development of novel drugs. Until December 2016 we participated in the Rimonim Consortium, which was supported by the IIA. The aim of this consortium was to develop novel technologies for the use of short interfering RNA, or siRNA, and microRNA mimetics or anti-microRNAs for therapeutics. In this consortium we attempted to: (1) develop novel RNA molecules that contain chemical modifications or conjugations for therapeutic purposes; and (2) develop novel delivery systems for microRNAs that will enable targeted delivery to desired cells. The transfer of know-how developed in the framework of the consortium or rights to manufacture based on and/or incorporating such know-how to third parties which are not members of the consortium requires the consent of the IIA.

 

In addition, in the past we participated in a two-year Magneton Project. This two-year project was also supported by the IIA and was conducted in collaboration with Prof. Ronit Satchi-Fainaro (Department of Physiology and Pharmacology, Sackler School of Medicine, Tel Aviv University). It was aimed at developing a nano-carrier delivery system for microRNA mimetics for the treatment of cancer. In December 2015, we completed this project. Project activity included in vivo studies, pre-clinical toxicity studies and in vivo efficacy studies in an animal model of glioblastoma. The results have shown limited efficacy. The transfer of knowledge discovered in this project is subject to limitations specified in the Israeli R&D law.

 

The IIA, under special circumstances, may approve the transfer of the know-how developed in these supported projects outside of Israel, provided that the grant recipient pays to the IIA a portion of the sale price paid in consideration for such know-how, which portion will not exceed six times the amount of the grants received plus interest (or three times the amount of the grant received plus interest, in the event that the recipient of the know-how has committed to retain the R&D activities of the grant recipient in Israel after the transfer).

 

As of December 31, 2016, we had received from the IIA total grants of $932,299 for our development under the Rimonim Consortium and $282,141 for our development under the Magneton project.

 

The R&D law was amended effective as of January 1, 2016. Pursuant to the amendment, a new National Technological Innovation Authority, or NTIA, was established and will replace the IIA in the implementation of the governmental policy in connection with the R&D Law (and has been given discretion in the implementation of the R&D Law for such purpose). Pursuant to the amendment, the current restrictions under the R&D Law will be replaced by new arrangements to be determined by the National Authority for Technological Innovation; however, until the NTIA determines otherwise, the provisions of the R&D Law and regulations that applied to existing IIA programs (including those provisions described above) will continue to apply.

 

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Background

 

Rosetta Genomics was founded in 2000 with the belief that what was known as “junk DNA” actually contains hundreds, possibly thousands, of tiny RNA genes that encode small RNA molecules, later termed microRNAs, which play an important role in the regulation of protein production, and hence the onset and progression of disease. In the cell, genes are expressed through information carried from our DNA by messenger RNAs, or mRNAs, which is in turn translated into proteins. Proteins are the building blocks of all living cells. The type of cell, its function, and the timing of its death are determined by which proteins are produced in the cell, and at what quantities and time they are produced. However, the proteins are the end product of a complex process, which begins with the genetic code present in DNA. Before a protein is expressed, or produced, relevant parts of the DNA are copied into a mRNA. Each mRNA holds a code with instructions on how to build a specific protein using a process called translation. Although one messenger RNA molecule is capable of translating hundreds of thousands of protein molecules, the number it actually produces is regulated by microRNAs. MicroRNAs have been found to regulate the expression of other genes by binding to the mRNA.

 

MicroRNAs have been shown to have varying expression levels across various pathological conditions, and thus have significant potential as a class of highly sensitive and tissue specific biomarkers. We have developed a microRNA discovery process and have demonstrated, in a work published by us in Nature Genetic, that the number of human microRNAs is significantly higher than what was previously believed. We have discovered hundreds of biologically validated human microRNAs and dozens of validated viral microRNAs and filed extensive patent applications with claims potentially covering these microRNAs, some of which have been issued.

 

To leverage the potential of microRNAs as a novel diagnostic platform, we have developed proprietary methods to extract microRNAs from a wide range of tissue and body fluid samples and to quantify specific microRNA expression signatures, which may be used as diagnostic panels to potentially diagnose cancers, their subtypes, as well as the origin of metastases. We have already developed and launched a number of diagnostic tests based on our platforms and have published several papers demonstrating how our methods can be used to develop such diagnostics (e.g., Rosenwald et al., Modern Pathology, 2010; Benjamin et al., Journal of Molecular Diagnostics, 2010). Moreover, we were able to demonstrate the utility of our developed tests in post-market studies with collaborators from leading medical centers in the United States and Europe (Bishop et al. Clinical Cancer Research, 2010; Muller et al., The Oncologist, 2010).

 

We believe that microRNAs are stable, sensitive and specific markers, and we are advancing diagnostic development programs in cancer and other areas, to potentially enable accurate diagnosis and improve patient care management worldwide.

 

Our Strategy

 

Rosetta’s goal is to become a leader in the development and commercialization of microRNA-based and other genomics-based, diagnostic tests. Our key business strategies to achieve this goal are as follows:

 

Leverage our knowledge and experience. We plan to leverage our extensive microRNA and Fluorescence in situ Hybridization, or FISH, knowhow and experience to potentially develop additional tissue-based as well as body fluid-based diagnostic tests.

Maximize sales of our current commercial tests through geographic partners and our own commercial efforts. We plan to maximize revenues from our current commercial tests via corporate relationships and through our own targeted commercial efforts. We have distribution agreements with three distributors, pursuant to which these distributors have the right to commercialize these tests in their territories.

Build and maintain a strong intellectual property position. We believe that we were the first commercial enterprise to focus on the emerging field of microRNAs. We also believe we have an early and strong intellectual property position (both patents we own and those we have exclusively, co-exclusively, or non-exclusively licensed) in the area of developing and commercializing microRNA-based diagnostic tests. Our patent strategy is to seek broad coverage on all of our identified microRNA sequences. We have also filed, and intend to continue to file, patent applications that claim our technical platforms and method-of-use for specific diagnostic and therapeutic applications.

Leverage our intellectual property position and microRNA expertise to continue to establish strategic collaborations. We intend to continue to establish strategic collaborations with leading clinical diagnostic and pharmaceutical companies to further develop and commercialize microRNA-based diagnostics. We believe that our strong intellectual property position and expertise in the field of microRNAs will be very attractive to additional collaboration partners.

 

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Our MicroRNA-Based Diagnostic Tests

 

The Role of MicroRNAs in Diagnostic Products

 

Diagnostic tests are designed to provide physicians and their patients with information relating to one or more of the following:

 

the existence or the probability of developing disease;

the exact type of the disease;

the severity of the disease;

the potential efficacy of specific therapies, such as different drugs or therapeutic procedures;

the monitoring of success of a chosen therapy; or

the likelihood of disease recurrence.

 

We believe that using microRNAs as diagnostic biomarkers enables the development of diagnostic products that can provide more accurate and comprehensive information to doctors and patients. Currently, many diagnostic tests are designed to detect abnormal levels of messenger RNAs or proteins. We believe microRNA-based tests have the potential to be superior to these tests because it is believed that microRNAs are closer to the biological origin of disease, and many studies have shown their involvement in disease processes, including the demonstration that microRNAs are both diagnostic and prognostic markers. A change in the expression level of a single microRNA may affect the activity of dozens of messenger RNA genes, which in turn may affect the level of hundreds of proteins. In addition, microRNAs are very tissue specific and very stable in body fluids and tissue samples. Thus, we expect that by focusing our efforts on microRNAs, we can develop a less complex biomarker panel. Furthermore, extracting microRNAs from tissue and body fluid samples is more reliable than extracting messenger RNAs because of the greater stability of microRNAs. In addition, amplification technologies, such as PCR, can potentially increase the sensitivity of a microRNA-based diagnostic test by generating millions of copies of a particular microRNA and thereby making it easier for the test to detect the presence of the microRNA. Since amplification technologies cannot be used with proteins, we believe microRNA-based diagnostic tests have the potential to be more sensitive than protein-based diagnostic tests.

 

Our Diagnostic Product Development Process

 

Our development process for diagnostic products consists of the following important steps:

 

Access to samples. As a prerequisite for the development and clinical validation of diagnostic products, evaluation of clinical samples is critical. Accordingly, we have entered into collaborations with several institutions in Israel, Europe and the United States that provide us high quality clinical samples. These relationships provide us the opportunity to study thousands of well-characterized samples relevant to different disease areas such as cancer, cardiovascular indications, women’s health, and neurodegenerative diseases. The sample collections include solid tumor samples and various body fluids, as well as high quality tissue samples from archival pathology banks. Where relevant, samples are accompanied by a database of medical history and clinical information, such as diagnosis, treatment and response to treatment, recurrence and survival, which for the samples from the archival pathology banks can be as long as 20 years.

RNA extraction. We utilize both commercial and our proprietary technologies to extract microRNAs from both tissue and body fluid samples.

Expression profiling. The identification of microRNA biomarkers requires sensitive and specific measurements of the levels of the microRNAs extracted from the tissue or body fluid samples. We have developed proprietary methods to rapidly, robustly and accurately perform these measurements. Our methods allow us to perform simultaneous profiling of multiple samples, and we believe result in more accurate measurements of expression levels for each of the analyzed samples.

 

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Analysis. We analyze expression profiles to identify microRNA signatures, which detect the existence of disease and provide information on certain disease parameters, such as tumor subtype, tumor origin, tumor aggressiveness, response to treatment, and risk of recurrence. Identifying microRNA signatures is a complex task, and we believe our analytical expertise is one of our key advantages.

 

Current MicroRNA-Based Commercial Tests

 

We are currently marketing and selling the following diagnostic tests based on our proprietary microRNA technologies:

 

RosettaGX Cancer Origin (formerly “miRview® mets2”) This test is our second-generation microRNA-based diagnostic for the identification of the primary site of metastatic cancer, specifically metastatic cancer of unknown primary (CUP). CUP is a heterogeneous group of cancers that constitutes approximately 3-5% of all cancers with a poor median survival of six to ten months. It is estimated that over 50,000 patients in the United States are diagnosed with CUP each year. A patient is typically diagnosed with CUP only after undergoing a wide range of tests, including various imaging tests such as x-ray, CT, MRI, and PET, which have failed to identify the origin of the cancer. Presently, the choice of treatment for metastatic cancer is largely dependent on the nature of the primary tumor. Patients with CUP pose a therapeutic dilemma and treatment is often empiric with a “one treatment fits all” approach. In the era of rapidly growing effective cytotoxic and targeted therapies for known cancers, quicker and more accurate methods to identify the tissue of origin of CUP cancers would permit the use of these therapies, thereby improving the chances of achieving a response and possibly extending the patient’s survival. RosettaGX Cancer Origintm is able to identify 49 tumor types that include carcinomas, soft tissue tumors, lymphoma and other malignancies with very high accuracy.

  

RosettaGX Reveal – This is a microRNA-based assay for the diagnosis of indeterminate thyroid fine-needle aspirate, or FNA, samples. The test utilizes routinely prepared FNA smears to diagnose a cytologically indeterminate thyroid nodule as “benign” or “suspicious for malignancy by microRNA”. The test also measures a microRNA biomarker for medullary carcinoma. The test targets patients with a cytologically indeterminate FNA biopsy result, estimated to be up to 150,000 people annually in the United States alone. FNA biopsy is the most widely used method for diagnosis of thyroid nodules. FNA biopsy allows a definitive benign or malignant diagnosis of the majority of tumors; however, 10-30% of FNAs are classified as cytologically indeterminate. Most patients with cytologically indeterminate nodules are referred for partial or complete thyroidectomy, though up to 70% of these nodules prove to be benign on final surgical pathology.

  

mi-KIDNEY (formerly “Rosetta Kidney Cancer Test”) - In May 2012 we launched this microRNA-based kidney tumor classification test for pathology samples. This test targets newly diagnosed kidney tumor patients, estimated to be 61,560 people in the United States in 2015. Renal cancers account for more than 3% of adult malignancies and cause more than 14,000 deaths per year in the United States. The test was designed to classify primary kidney tumors into one of the four most common types: the malignant renal cell carcinomas clear cell (conventional), papillary and chromophobe as well as the benign oncocytoma. These histological subtypes vary in their clinical course and their prognosis, and different clinical strategies have been developed for their management. In some of the kidney tumor cases it is difficult for the pathologist to distinguish between tumor types on the basis of morphology. The microRNA-based assay that we have developed is performed by measuring microRNA biomarkers in a sample from the tumor. The assay uses the expression of 24 microRNAs to accurately identify the kidney tumor subtype.

 

We currently have distribution agreements with respect to some of our tests covering Australia, Greece, India, Israel, New Zealand, and Turkey. All of these distribution agreements call for samples to be sent to our CLIA-certified, CAP-accredited laboratory in Philadelphia, Pennsylvania for analysis.

 

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Our Long-Term MicroRNA-Based Diagnostic Test Pipeline

 

We are seeking to develop a second version of RosettaGX Reveal, a microRNA-based assay for the differential diagnosis of indeterminate thyroid FNAs that utilizes routinely prepared FNA smears. This second version will combine RosettaGx Reveal’s current microRNA biomarkers with a panel of DNA-based biomarkers providing prognostic information (e.g. BRAF and TERT mutations). Four to seven percent of the general population develops nodules in the thyroid that can be felt on examination but fewer than 10% are malignant. An FNA to obtain tissue for analysis is the standard technique for detecting cancer. Interpretation of FNA samples is not always straightforward, leading to an indeterminate result in up to 30% of the samples. Currently, many patients with indeterminate results are sent to surgery as a precaution, even though the majority are benign, exposing patients to unnecessary surgical risk and costing hundreds of millions of dollars.

 

Our PersonalizeDx Business

 

PersonalizeDx is a CAP-accredited, CLIA-certified commercial laboratory that performs testing services on two primary platforms: FISH and IHC. FISH molecular tests query specific chromosome regions and genes in order to provide diagnostic, prognostic and predictive information to clients in order to assist with patient treatment decisions. The majority of the company’s test volume and revenues are derived from the following tests in bladder, prostate and lung cancers:

 

·UroVysion® - UroVysion is a urine-based FISH assay intended for use in conjunction with and not in lieu of current standard diagnostic procedures, as an aid for initial diagnosis of bladder carcinoma in patients with hematuria and subsequent monitoring for tumor recurrence in patients previously diagnosed with bladder cancer. UroVysion was the first test launched by CynoGen/PersonalizeDx in 2009 and remains a top volume and revenue producer for the company. UroVysion is currently a covered service by Medicare and the majority of private third party payers for the FDA approved clinical indications. PersonalizeDx provides a ‘tech only’ service option for UroVysion that allows Pathologists throughout the United States to partner with the lab through its ‘virtual’ portal.

 

·ERG/PTEN - ERG and PTEN are FISH-based prognostic tests in prostate cancer that help urologists with the important decision point of whether or not to initiate surgery with their lower risk prostate cancer patients. ERG and PTEN have both been proven to be key biomarkers in the progression of prostate cancer, and abnormal results specific to these genes may indicate the need for more aggressive treatment. ERG and PTEN testing is performed on the same tumor tissue that is taken from the patient’s initial core needle biopsy procedure. PersonalizeDx also offers a ‘tech only, virtual’ service for ERG and PTEN testing.

 

·ALK/ROS1 - ALK and ROS1 are FISH-based predictive tests indicated for patients that are diagnosed with late stage lung cancer. Patients that test positive for either ALK or ROS1 rearrangements are considered candidates for ALK-inhibitor therapy such as XALKORI® (crizotinib). Both ALK and ROS1 are listed in the FDA label for such therapy, and these tests have been recommended for routine testing by the National Comprehensive Cancer Institute’s (NCCN) guidelines. Again, PersonalizeDx offers its ‘tech only’ platform for ALK/ROS1 testing to its clients.

 

·PCR Gene Mutation Analysis - PersonalizeDx has launched several PCR-based tests for bladder, lung, colon and melanoma patients since 2014. FGFR3, EGFR, KRAS, BRAF and NRAS are additional assays that support the core test offerings in urological disease and solid tumor analysis, and allow for an expanded breadth of testing services which may attract new customers that demand a more complete offering and is currently being outsourced to third parties.

 

 

Our Intellectual Property Strategy and Position

 

Our success will depend significantly on our ability to:

 

obtain and maintain patent and other proprietary protection for the technology, inventions and improvements we consider important to our business;

navigate the changing legal patent landscape;

defend our patents;

 

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preserve the confidentiality of our trade secrets; and

operate without infringing the patents and proprietary rights of third parties.

 

We believe that we were the first commercial enterprise to focus on the emerging microRNA field, and as a result, we have developed an early and strong intellectual property position related to the development and commercialization of research, diagnostic and therapeutic products and other applications based on microRNAs. Our patent strategy is to seek broad coverage on all of our identified microRNA sequences. We have filed, and will continue to file, patent applications that claim method-of-use for specific diagnostic and therapeutic applications as we or our collaborators develop them. We believe this approach will provide strong and broad patent protection for a large number of microRNAs that we have discovered and may provide us with a competitive advantage over new entrants to the field.

 

As of March 1, 2017, our patent portfolio included a total of 49 issued U.S. patents, two issued Australian patents, three issued European patents, all validated in UK, Germany and France, and one validated also in Denmark, four issued Israeli patents, one issued Japanese patent, one issued Korean patent, 41 pending patent applications worldwide, consisting of 20 U.S. patent applications, four of which received notice of allowance, six applications that are pending in Europe, two of which received a notice of allowance, two applications pending in Israel, one of which received a notice of allowance, three applications pending in Japan, three applications pending in Canada, three applications pending in China, three applications pending in Brazil, and one PCT application. All 41 pending patent applications relate to human microRNAs and their uses. Thirty applications contain claims directed to microRNA-based diagnostics in Heart Failure, Alzheimer’s disease, Cancer of Unknown Origin (CUP), thyroid, lung, gastric and other cancers; and six contain claims directed to microRNA-based therapeutics. The issued patents expire between 2022 and 2031.

 

To date, patent protection related to numerous human genes has been obtained in the United States and elsewhere. Although recent rulings from the U.S. Supreme Court, as well as guidelines recently issued by the USPTO expanding these, have caused uncertainty relating to the patentability of naturally occurring nucleic acid sequences, our patents and pending applications include claims to non-naturally occurring derivatives of microRNAs, which we believe are patentable under U.S. and foreign patent laws. For additional information, see “Item 3. Key Information—D. Risk Factors— If we are not able to obtain and enforce patent protection for our discoveries, our ability to develop and commercialize microRNA-based diagnostics and therapeutics will be harmed.” for a description of recent U.S. case law that could affect the patentability of genes and genetic material.

 

In order to obtain maximum patent protection for composition of matter of microRNAs in the U.S. and foreign jurisdictions, our patent applications:

 

provide for utility, function and disease targets for each microRNA sequence; and

claim specific microRNA sequences, having modified nucleotides.

We believe this approach avoids common mistakes made by others in the past with respect to attempts to patent genes and, if patents are issued, will make it more difficult for competitors to design around our patents.

 

Our intellectual property strategy is closely coordinated with our research and development plan and we have an ongoing three-tier approach to obtaining patent protection, which is illustrated and described below:

 

First Tier: Composition-of-Matter Patent applications on Biologically Validated MicroRNAs

 

We have filed a first tier of patent applications claiming patent coverage for the composition-of-matter of microRNAs that we have either detected by microarray or biologically validated by sequencing or qRT-PCR. In addition to the function and utility based on informatically calculated targets, the microRNAs claimed in these patent applications are further described as potential markers of a disease, as supported by differential expression of these microRNAs in healthy versus diseased tissue. Our patent portfolio includes 34 issued patents and five patent applications with composition-of-matter claims.

 

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Second Tier: Technologies to detect MicroRNAs

 

We have filed a second tier of patent applications claiming patent coverage for our proprietary discovery process technologies for microRNA detection, including qRT-PCR methods, microarray, in-situ hybridization and extraction methods from all body fluids. Our patent portfolio includes two issued patents, one in the U.S. and one in Europe which has been validated in the UK, Germany, France and Denmark related to discovery process technologies.

 

Third Tier: Method-of-Use Patents

 

We have filed a third tier of patent applications claiming patent coverage for the method-of-use of microRNAs, including diagnostic and therapeutic uses for specific diseases. This tier of patent applications includes applications which we have filed ourselves and those that we have filed jointly with academic, medical and commercial partners with whom we collaborate. Our patent portfolio includes 36 (22 of which are solely owned by Rosetta and 14 that are co-owned) patent applications with method of use claims related to diagnostic and therapeutic uses of microRNAs and we expect to file additional third tier applications in the future.

 

Individual patents extend for varying periods depending on the effective date of filing of the patent application or the date of patent issuance, and the legal term of the patents in the countries in which they are obtained. Generally, patents issued in the United States are effective for:

 

the longer of 17 years from the issue date or 20 years from the earliest effective filing date, if the patent application was filed prior to June 8, 1995; and

20 years from the earliest effective filing date, if the patent application was filed on or after June 8, 1995.

 

All of our current patent applications were filed after June 8, 1995.

 

The term of foreign patents varies in accordance with provisions of applicable local law, but typically is 20 years from the earliest effective filing date.

 

In some instances, a patent term in the United States and outside of the United States can be extended to recapture a portion of the term effectively lost as a result of the health authority regulatory review period. These extensions, which may be as long as five years, are directed to the approved product and its approved indications. We intend to seek such extensions as appropriate. Because of the extensive time required for development, testing and regulatory review of a potential product, it is possible that a patent may remain in force for a short period following commercialization, thereby reducing the advantage of the patent to our business and products.

 

The patent positions of companies like ours are generally uncertain and involve complex legal and factual questions. Our ability to maintain and solidify our proprietary position for our technology will depend on our success in obtaining effective claims and enforcing those claims once granted. We do not know whether any of our patent applications will result in the issuance of any patents or if issued will assist our business. Any patents that may issue in the future may be challenged, invalidated or circumvented. This could limit our ability to stop competitors from marketing related products and reduce the length of term of patent protection that we may have for any products. In addition, the rights granted under any patents which may issue may not provide us with proprietary protection or competitive advantages against competitors with similar technology. Our competitors may develop similar technologies, duplicate any technology developed by us, or use their patent rights to block us from taking full advantage of the market.

 

In addition to patents, we may rely, in some circumstances, on trade secrets to protect our technology. However, trade secrets are difficult to protect. We seek to protect the trade secrets in our proprietary technology and processes, in part, by entering into confidentiality agreements with commercial partners, collaborators, employees, consultants, scientific advisors and other contractors and into invention assignment agreements with our employees and some of our commercial partners and consultants. These agreements are designed to protect our proprietary information and, in the case of the invention assignment agreements, to grant us ownership of the technologies that are developed. These agreements may be breached, and we may not have adequate remedies for any breach. In addition, our trade secrets may otherwise become known or be independently discovered by competitors.

 

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In-Licensed Intellectual Property

 

License Agreement with The Rockefeller University (Diagnostics)

 

In May 2006, we signed a royalty-bearing, co-exclusive, worldwide license agreement with The Rockefeller University. Under this agreement, we were granted the right to make, use and sell Rockefeller’s proprietary microRNAs for diagnostic purposes including a limited right to sublicense. Our right to sublicense is limited to sublicenses we grant as part of a license that includes other technology or patent rights of ours. The agreement covers microRNAs and microRNA candidates, including approximately 80 biologically validated human microRNAs and approximately 30 biologically validated viral microRNAs discovered by researchers at The Rockefeller University and for which it has filed patent applications. These microRNAs can be licensed by Rockefeller in the diagnostics field to three additional parties. In consideration for this license, we paid an initiation fee and will pay a fixed annual license maintenance fee, royalties based on net sales and a percentage of our revenues from any sublicenses. Rockefeller is obligated to notify us of any license it grants to a third party at a lower royalty rate and we will have the right to modify the terms of our license to adopt all of the material terms and conditions of that license.

 

Rockefeller controls prosecution, maintenance and enforcement of all the licensed patent rights; however, we are responsible for a pro rata share of associated costs. Also, if Rockefeller elects not to take action against a claim of infringement of the licensed patent rights, we may undertake such action at our own expense. We are obligated to indemnify Rockefeller against any liabilities arising from our development and use of the licensed microRNAs and any actions brought by third parties or related to clinical trials or studies. We are also required to maintain comprehensive insurance coverage.

 

The agreement will terminate upon the later of the expiration or abandonment of the last patent to expire or become abandoned. If no patent ever issues, the agreement will terminate ten years after the first commercial sale of the first licensed product. Based on an estimate of the date of expiration of the last patent to expire, we estimate that we will pay a minimum of approximately $960,000 in aggregate annual license maintenance fees over the term of this agreement. Rockefeller has the right to terminate the agreement if we are more than 30 days late in meeting our payment obligations and do not pay in full within ten days of Rockefeller’s written demand; or upon our uncured material breach. We can terminate the agreement by providing sixty days written notice to Rockefeller, ceasing all use of the licensed products, terminating any sublicenses granted under the agreement and paying all amounts owed to Rockefeller through the date of termination.

 

License Agreement with The Rockefeller University (Therapeutics)

 

In May 2007, we signed a royalty-bearing, co-exclusive, worldwide license agreement with The Rockefeller University. Under this agreement, we were granted the right to make, use and sell Rockefeller’s proprietary microRNAs for therapeutic purposes, including a limited right to sublicense. Our right to sublicense is limited to sublicenses that are for research and development of products and that are granted as part of a license that includes other technology or patent rights of ours. The agreement covers microRNAs and microRNA candidates, including approximately 80 biologically validated human microRNAs and approximately 30 biologically validated viral microRNAs discovered by researchers at The Rockefeller University for which it has filed patent applications. These microRNAs can be licensed by Rockefeller in the therapeutics field to three additional parties. In consideration for this license, we paid an initiation fee and are required to pay a fixed annual license maintenance fee, milestone payments and royalties based on net sales and a percentage of our revenues from any sublicenses. Rockefeller is obligated to notify us of any license it grants to a third party at a lower royalty rate, and we will have the right to modify the terms of our license to adopt all of the material terms and conditions of that license.

 

Rockefeller controls prosecution, maintenance and enforcement of all the licensed patent rights; however, we are responsible for a pro rata share of associated costs. Also, if Rockefeller elects not to take action against a claim of infringement of the licensed patent rights, we may undertake such action at our own expense. We are obligated to indemnify Rockefeller against any liabilities arising from our development and use of the licensed microRNAs and any actions brought by third parties or related to clinical trials or studies. We are also required to maintain comprehensive insurance coverage.

 

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The agreement will terminate upon the later of the expiration or abandonment of the last patent to expire or become abandoned. If no patent ever issues, the agreement will terminate ten years after the first commercial sale of the first licensed product. Based on an estimate of the date of expiration of the last patent to expire, we estimate that we will pay a minimum of approximately $690,000 in aggregate annual license maintenance fees over the term of this agreement. Rockefeller has the right to terminate the agreement if we are more than 30 days late in meeting our payment obligations and do not pay in full within ten days of Rockefeller’s written demand; or upon our uncured material breach. We can terminate the agreement by providing 60 days written notice to Rockefeller, ceasing all use of the licensed products, terminating any sublicenses granted under the agreement and paying all amounts owed to Rockefeller through the date of termination.

 

License Agreement with The Rockefeller University (Research)

 

In January 2008, we signed a royalty-bearing, nonexclusive, worldwide license agreement with The Rockefeller University. Under this agreement, we were granted the right to make, use, import, sell and offer for sale Rockefeller’s proprietary microRNAs for research purposes including a limited right to sublicense. Our right to sublicense is limited to sublicenses we grant as part of a license that includes other technology or patent rights of ours. The agreement covers microRNAs and microRNA candidates, including approximately 80 biologically validated human microRNAs and approximately 30 biologically validated viral microRNAs discovered by researchers at The Rockefeller University and for which it has filed patent applications. In consideration for this license, we paid an initiation fee and will pay a minimum annual royalty, based on net sales and a percentage of our revenues from any sublicenses. Rockefeller is obligated to notify us of any license it grants to a third party at a lower royalty rate and we will have the right to modify the terms of our license to adopt all of the material terms and conditions of that license.

 

Rockefeller controls preparation, prosecution and maintenance of the licensed patent rights and the selection of patent council with our input; however, we are responsible for a pro rata share of associated costs. Also, if Rockefeller elects not to take action against a claim of infringement of the licensed patent rights, we may undertake such action at our own expense. We are obligated to indemnify Rockefeller against any liabilities arising from our development, testing, use, manufacture, promotion, sale of other disposition of the licensed microRNAs and any actions brought by third parties. We are also required to maintain comprehensive insurance coverage.

 

The agreement will terminate upon the later of the expiration or abandonment of the last patent to expire or become abandoned. If no patent ever issues, the agreement will terminate ten years after the first commercial sale of the first licensed product. Based on an estimate of the date of expiration of the last patent to expire, we estimate that we will pay a minimum of approximately $440,000 in aggregate minimum annual royalty over the term of this agreement. Rockefeller has the right to terminate the agreement if we are more than 30 days late in meeting our payment obligations and do not pay in full within ten days of Rockefeller’s written demand; or upon our uncured material breach. We can terminate the agreement by providing 60 days written notice to Rockefeller, ceasing all use of the licensed products, terminating any sublicenses granted under the agreement and paying all amounts owed to Rockefeller through the date of termination.

 

License Agreement with Max Planck Innovation GmbH (Diagnostics)

 

In June 2006, we entered into a royalty-bearing, co-exclusive, worldwide license agreement with Max Planck Innovation GmbH, or Max Planck, the technology transfer agency of the Max Planck Society. This agreement was amended and restated in March 2009. Under this agreement, we licensed from Max Planck the rights to its proprietary microRNAs for diagnostics purposes. The agreement covers microRNAs and microRNA candidates, including approximately 110 biologically validated human microRNAs, discovered by the researchers of the Max-Planck-Institute for Biophysical Chemistry in Goettingen. In consideration for this license, we paid an initiation fee, and are required to pay a fixed annual license maintenance fee, royalties based on net sales and a percentage of our revenues from any sublicenses.

 

These microRNAs can be licensed by Max Planck for diagnostics purposes to three other parties. Max Planck is obligated to notify us of any more favorable license in the diagnostics field it grants for these microRNAs, in which event we shall have the right to adopt all material terms of such license. We have the right to enter into sublicense agreements, provided that the granted sublicense includes a license to intellectual property rights owned or co-owned by us as well, is reasonably necessary for sublicensee in order to further develop and/or commercialize or manufacture products and permits no more than one tier of sublicensing.

 

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Max Planck is responsible, in its sole discretion, to apply for, seek issuance of, maintain and prosecute the licensed patent rights, and we have the right to comment on the documents to be filed by the patent office. We are required, however, to pay a pro rata share of associated costs. We are obligated to indemnify Max Planck against any liabilities arising from any use by us, our affiliates, sublicensees and sales partners of the patent rights, the development and use of any product, process or service under the agreement, and the use by third parties of any products, processes or services sold by us. We are also required to maintain comprehensive insurance coverage.

 

The agreement terminates upon the expiration or abandonment of all issued and filed licensed patents. Based on an estimate of the date of expiration of the last patent to expire, we estimate that we will pay a minimum of approximately $410,164 in aggregate annual license maintenance fees over the term of this agreement. We have the right to terminate the agreement with three months’ prior written notice. We have the obligation to use commercially reasonable efforts to develop and commercialize the products and services based on the licensed patents in the field of diagnostics. In the event we cease carrying out our business related to the agreement we must notify Max Planck and then both parties have the right to terminate the agreement with three months’ prior notice. Max Planck also has the right to terminate the agreement if we challenge one of the licensed patents; if we fail to cure a breach within 60 days of receiving notice of such breach; or if we fail to pay within 30 days of a notice requiring a payment. The agreement will terminate automatically upon filing of bankruptcy or insolvency proceedings by or against us, or upon the assignment of all or a substantial portion of our assets for the benefit of creditors.

 

License Agreement with Max Planck Innovation GmbH (Research)

 

In December 2006, we entered into a royalty-bearing, non-exclusive, worldwide license agreement with Max Planck. Under this agreement, we licensed from Max Planck the rights to its proprietary microRNAs for research purposes. The agreement covers microRNAs and microRNA candidates, including approximately 110 biologically validated human microRNAs, discovered by the researchers of the Max-Planck-Institute for Biophysical Chemistry in Goettingen. In consideration for this license, we have paid an initiation fee, and are required to pay a fixed annual license maintenance fee, royalties based on net sales and a percentage of our revenues from any sublicenses.

 

Max Planck is obligated to notify us of any more favorable license in the research field it grants for these microRNAs, in which event we shall have the right to adopt all material terms of such license. We have the right to enter into sublicense agreement, but only if the granted sublicense includes a license to microRNAs owned by us as well.

 

Max Planck is responsible, in its sole discretion, to apply for, seek issuance of, maintain and prosecute the licensed patent rights, and we have the right to comment on the documents to be filed with the patent office. We are obligated to indemnify Max Planck against any liabilities arising from any use by us, our affiliates, sublicensees and sales partners of the patent rights, the development and use of any product, process or service under the agreement, and the use by third parties of any products, processes or services sold by us. We are also required to maintain comprehensive insurance coverage.

 

The agreement terminates upon the later of the expiration or abandonment of the last patent to expire or become abandoned of the patent rights contemplated under the agreement, or, if no patent ever issues from the patent rights, ten years after the first commercial sale of the first licensed product, as contemplated under the agreement. Based on an estimate of the date of expiration of the last patent to expire, we estimate that we will pay a minimum of approximately $252,409 in aggregate annual license maintenance fees over the term of this agreement. We have the right to terminate the agreement with 60 days prior written notice. Max Planck also has the right to terminate the agreement if we fail to cure a breach within 60 days of receiving notice of such breach; or if we fail to pay within 30 days of a notice requiring a payment.

 

License Agreement with Johns Hopkins University

 

In August 2006, we signed a royalty-bearing, exclusive, worldwide license agreement with Johns Hopkins University. This agreement was amended and restated in August 2011. Under the restated agreement, we have licensed from Johns Hopkins the rights to its proprietary microRNAs for all fields and applications on a non-exclusive basis. The agreement covers approximately 130 biologically validated microRNAs. We also have the right to further sublicense these rights, provided that such sublicense includes a license to substantial intellectual property rights owned or co-owned by us and is consistent with the terms of our license agreement. In consideration for the restated license we paid an amendment fee, and are required to pay minimum annual royalties, royalties based on net sales and a percentage of our revenues from any sublicense. We are obligated to perform commercially reasonable diligent efforts in the development of products, including or using the licensed microRNAs.

 

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Johns Hopkins is responsible for filing, prosecuting and maintaining the licensed patent rights, and we have the right to comment on and advise Johns Hopkins with respect to such matters. We are required to pay all expenses related to filing, prosecution and maintenance of the licensed patent rights; unless we provide Johns Hopkins notice that we elect not to do so. If we so elect, Johns Hopkins may file, prosecute or maintain such patent rights at its own expense and any license we have with respect to such patent rights shall terminate. We have the right but not the obligation to enforce the patent rights against infringement.

 

We are obligated to indemnify Johns Hopkins against any liabilities arising out of use by us, our affiliates or sublicensees of the licensed microRNAs. We are also obligated to establish and maintain product liability or other appropriate insurance prior to initial human testing or first commercial sale of any product incorporating the licensed microRNAs.

 

The agreement terminates with respect to each country in which a patent has issued upon the expiration of the last to expire patent covered by the terms of the agreement in such country. If no patents ever issue in a country but patent applications are filed in such country, the agreement will expire with respect to such country upon the cancellation, abandonment, withdrawal or disallowance of all claims under all patent applications in that country or at such time as there is no claim that has been pending in such country for less than six years from the date such claim was filed in a non-provisional patent application in that country. Based on an estimate of the date of expiration of the last patent to expire, we estimate that we will pay a minimum of approximately $320,000 in aggregate annual royalties over the term of the agreement. In addition, either party may terminate the agreement (1) upon the filing of bankruptcy or insolvency proceedings with respect to the other party or (2) if the other party is in material breach of the agreement and such breach is not cured within 30 days of notice. We also have the right to terminate the agreement for any reason upon 90-day notice.

 

Competition

 

Our industry is highly competitive and subject to rapid and significant technological change. All of the tests and products we are developing or may develop in the future, if approved, will compete against existing non-microRNA-based diagnostic tests and therapies. In addition, we believe a significant number of non-microRNA-based diagnostic tests and drug candidates are currently under development and may become available for the diseases we are targeting or may target. We face competition for our micro-RNA-based test and products from non-microRNA-based competing tests and products from companies such as Cancer Genetics, Inc., Biotheranostics, Inc., Foundation Medicine and Veracyte, Inc. that have developed or are developing diagnostic tests based on other non-microRNA technologies. We also face competition from other companies working to develop novel tests and products using technology that competes more directly with our microRNAs. We are aware of several other companies that are working to develop microRNA diagnostics and therapeutics, including Alnylam Pharmaceuticals, Inc., Asuragen Inc., HTG Molecular Diagnostics Inc., Interpace Diagnostics, Inc., QIAGEN N.V., Life Technologies Corporation, Ionis Pharmaceuticals, Inc. (formerly Isis Pharmaceuticals), Mirna Therapeutics Group, Inc. Merck & Co., Inc., Santaris Pharma A/S, Regulus Therapeutics Inc. and others. We are also aware of several other companies that provide tests and services that are competitive with those provided by our recently acquired PersonalizeDx business, including Cancer Genetics, Inc., NeoGenomics, Inc., Miraca Life Sciences, Inc., Bostwick Laboratories, Inc. and Healthtronics Inc.

 

We believe the key competitive factors affecting the commercial success of our potential tests and products will be:

 

the safety and effectiveness of our products;

the timing and scope of regulatory approvals, if required, for these tests and products;

the availability and cost of manufacturing, marketing and sales capabilities;

providing economic healthcare benefits, by either possibly directing better clinical treatment, or potentially reducing unnecessary surgical procedures;

reimbursement coverage; and

patent position.

 

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Many of our potential competitors, either alone or with their collaborative partners, have substantially greater financial, technical and human resources than we do and significantly greater experience in the discovery and development of diagnostics and therapeutics, obtaining FDA and other regulatory approvals of tests and products and the commercialization of those tests and products. Accordingly, our competitors may be more successful than we may be in obtaining FDA approval and achieving widespread market acceptance. Our competitors’ tests or products may be more effective, or more effectively marketed and sold, than any test or product we may commercialize and may render our tests and products obsolete or non-competitive before we can recover the expenses of developing and commercializing them. We anticipate that we will face intense and increasing competition as advanced technologies become available.

 

Manufacturing

 

We currently intend to rely on contract manufacturers or our collaborative partners to produce materials for diagnostic tests and drug substances and drug products required for preclinical studies and clinical trials. We plan to continue to rely upon contract manufacturers and collaboration partners to manufacture commercial quantities of these materials for any marketed diagnostic or therapeutic.

 

Regulatory

 

Diagnostics

 

CLIA and Other Laboratory Licensure

 

Laboratories that perform testing on human specimens for the purpose of providing information for diagnosis, prevention or treatment of disease or assessment of health are subject to the Clinical Laboratory Improvement Amendments of 1988, or CLIA. This law imposes quality standards for laboratory testing to ensure the accuracy, reliability and timeliness of patient test results. The FDA is responsible for the categorization of commercially marketed IVD tests under CLIA into one of three categories based upon the potential risk to public health in reporting erroneous results. The categories were devised on the basis of the complexity of the test and include waived tests, tests of moderate complexity, and tests of high complexity. Laboratories performing moderate or high-complexity testing must meet the CLIA requirements for proficiency testing, patient test management, quality control, quality assurance and personnel.

 

Under CLIA, certified laboratories are required to hold a certificate applicable to the categories of testing they perform and to comply with standards covering, among other things, personnel, facilities administration, quality systems and proficiency testing. CLIA-certified laboratories are typically subject to survey and inspection every two years to assess compliance with program standards.

 

In addition to CLIA certification, laboratories offering clinical testing services are required to hold certain other federal, state and local licenses, certifications and permits. A clinical laboratory may be licensed by the state in which it is located, but not all states require licensure. California and Pennsylvania require state licensure, and our laboratories located in those states each hold the appropriate state license. In addition, some states (California, Florida, Maryland, New York, Pennsylvania, and Rhode Island) require any clinical laboratory that analyzes samples taken from residents of or physicians located in that state to also be licensed by it. Many CLIA-certified laboratories also seek accreditation by the College of American Pathologists, or CAP, and licensure by states that require that state specific licensure for a laboratory that intends to test clinical samples from residents of that state. The CAP Laboratory Accreditation Program is an internationally recognized program that utilizes teams of practicing laboratory professionals as inspectors, and accreditation by CAP can be used to meet the CLIA requirements.

 

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Food and Drug Administration

 

Laboratory Developed Tests

 

Although the FDA has consistently stated that it has the authority to regulate clinical laboratory tests as medical devices, it generally exercised enforcement discretion in not otherwise regulating most tests such as ours that are designed, manufactured and used within the same high complexity CLIA-certified laboratory at which the test was performed. These tests are known as laboratory developed tests, or LDTs. In 2014, the FDA issued a draft guidance on the regulation of LDTs entitled, “Framework for Regulatory Oversight of Laboratory Developed Tests (LDTs)” and an accompanying draft guidance document, or Draft Guidance, entitled, “FDA Notification and Medical Device Reporting for Laboratory Developed Tests (LDTs).” However, in November 2016, the FDA announced that it would not release a final version of the Draft Guidance, and in January 2017, it published a discussion paper with its thoughts about elements of a possible future LDT regulatory framework. We cannot predict when or whether the FDA will issue a final guidance, but the FDA could still try to regulate LDTs in the absence of additional guidance.

If the FDA were to regulate LDTs as it does other types of in vitro diagnostic tests, the LDTs could be subject to premarket review which could necessitate obtaining (i) clearance of a 510(k); or (ii) approval a premarket approval application, or PMA.

 

Non-U.S. Regulations

 

In addition to regulations in the United States, we are subject to a variety of foreign regulations governing clinical trials and commercial sales and distribution of our tests and products outside the United States. Whether or not we obtain FDA approval for a product, we must obtain the necessary approvals by the comparable regulatory authorities of foreign countries before we can commence clinical trials or marketing of the product in those countries. The approval process varies from country to country and the time may be longer or shorter than that required for FDA approval. The requirements governing the conduct of clinical trials, the approval process, product licensing, pricing and reimbursement vary greatly from country to country.

 

HIPAA and Other Privacy and Security Laws

 

The Health Insurance Portability and Accountability Act of 1996, or HIPAA, established for the first time comprehensive United States protection for the privacy and security of health information. The HIPAA standards apply to three types of organizations, or “Covered Entities”: health plans, healthcare clearing houses, and healthcare providers which conduct certain healthcare transactions electronically. Covered Entities must have in place administrative, physical, and technical safeguards to guard against the misuse of protected health information. Specifically, Title II of HIPAA, the administrative Simplification Act, contains four provisions that address the privacy of health data, the security of health data, the standardization of identifying numbers used in the healthcare system and the standardization of data content, codes and formats used in healthcare transactions. The privacy regulations protect identifiable health information or “protected health information” by limiting its use and release and giving patients the right to access and amend their protected health information. The HIPAA security standards require the adoption of administrative, physical and technical safeguards and the adoption of written security policies and procedures. Additionally, some state laws impose privacy protections more stringent than HIPAA and many impose security standards and breach notification requirements that apply in addition to HIPAA. Most of the institutions and physicians from which we obtain biological specimens that we use in our research and validation work are Covered Entities that must comply with HIPAA standards, such as obtaining proper authorization and consent from their patients for the subsequent use of those samples and associated clinical information. We are a Covered Entity to the extent that our U.S. operations involve standard transactions conducted electronically (such as billing) in connection with clinical testing. Accordingly, we have implemented privacy and security policies and procedures consistent with HIPAA standards and taken other steps to comply.

 

In 2009, Congress enacted Subtitle D of the Health Information Technology for Economic and Clinical Health Act, or HITECH, provisions of the American Recovery and Reinvestment Act of 2009. Final HITECH regulations were published in January, 2013. HITECH amends HIPAA and, among other things, creates significant new regulatory compliance obligations for “business associates” or organizations that provide services to Covered Entities involving the use or disclosure of protected health information and downstream entities providing services to business associates. Additionally, HITECH expands and strengthens HIPAA enforcement, imposes new penalties for noncompliance and establishes new breach notification requirements for Covered Entities and business associates. Under HITECH’s new breach notification requirements, Covered Entities must, as soon as possible but not later than 60 days following discovery, notify each individual whose information has been or is reasonably believed to have been, accessed, acquired or disclosed as a result of a breach. Covered Entities must also report breaches to the U.S. Department of Health and Human Services, or HHS, and in some cases, publish information about the breach in local or prominent media outlets. Consequently, it is important that breaches of PHI are promptly detected and reported within the company, so that we can make all required notifications. Most states have adopted data security laws protecting the personal data of state residents. Personal data subject to protection typically includes an individual’s name coupled with social security number, state-issued identification number, or financial account number. Most states require specific, technical security measures for the protection of all personal data, including employee data, and impose their own breach notification requirements in the event of a loss of personal data. Many states have also adopted genetic testing and privacy laws. These laws typically require a specific, written consent for genetic testing as well as consent for the disclosure of genetic test results, and otherwise limit uses and disclosures of genetic testing results. A few states have adopted laws that give their residents property rights in their genetic information. State privacy and data security laws generally overlap and apply simultaneously with HIPAA. In the event of a data breach affecting individuals from more than one state, we must comply with all relevant state notification requirements as well as HIPAA and are subject to enforcement by all relevant state and federal authorities as well as fines and penalties imposed by each state.

 

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We are currently subject to the HIPAA regulations and maintain an active program designed to address regulatory compliance issues. Regulations and guidance in this area are evolving so we must regularly evaluate and update our regulatory compliance measures to remain in compliance with the law. We are subject to audit by federal authorities and subject to prosecution or administrative enforcement and increased civil and criminal penalties for non-compliance, including monetary penalties. We are also subject to enforcement by state attorneys general who were given authority to enforce HIPAA under HITECH and who also enforce state data security laws.

 

Our activities must also comply with other applicable privacy laws. For example, there are international privacy laws that impose restrictions on the access, use, and disclosure of health and other personal information. Non-U.S. privacy protection requirements, such as the European Union’s Data Protection Directive governing the processing of personal data, may be stricter than U.S. law and violations could result in claims for damages, fines, or orders to stop or change the processing of the personal data. The European Union’s final draft General Data Protection Regulation, which is likely to be formally adopted, imposes extensive new legal obligations and substantially increases the risk of fines, with upper limits based on a corporate group’s global turnover. Privacy and data security laws, including those relating to health information, are complex, overlapping and rapidly evolving. All of these laws may impact our business. Our failure to comply with these privacy laws or significant changes in the laws restricting our ability to obtain tissue samples and associated patient information or to conduct clinical testing could significantly impact our business and our future business plans.

 

Compliance with Fraud and Abuse Laws

 

We have to comply with various U.S. federal and state laws, rules and regulations pertaining to healthcare fraud and abuse, including anti-kickback and physician self-referral laws, rules and regulations. Violations of the fraud and abuse laws are punishable by criminal and civil sanctions, including, in some instances, exclusion from participation in federal and state healthcare programs, including Medicare and Medicaid.

 

Anti-Kickback Statute

 

The federal Anti-Kickback Statute prohibits persons from knowingly or willfully soliciting, receiving, offering or paying remuneration, directly or indirectly, in exchange for or to induce:

 

the referral of an individual for a service or product for which payment may be made by Medicare, Medicaid or other federal healthcare program; or

purchasing, ordering, arranging for, or recommending the ordering of, any service or product for which payment may be made by a federal healthcare program.

 

The definition of “remuneration” has been broadly interpreted to include anything of value, including such items as gifts, certain discounts, waiver of payments, and providing anything at less than its fair market value. In addition, several courts have interpreted the law to mean that if “one purpose” of an arrangement is intended to induce referrals, the statute is violated.

 

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The Anti-Kickback Statute is broad and prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. Recognizing that the Anti-Kickback Statute is broad and may technically prohibit many innocuous or beneficial arrangements, the Office of Inspector General for the Department of Health and Human Services, or OIG, has issued regulations, commonly known as “safe harbors.” These safe harbors set forth certain requirements that, if fully met, will assure healthcare providers, including clinical laboratories, that they will not be prosecuted under the Anti-Kickback Statute. Although full compliance with these safe harbor provisions ensures against prosecution under the Anti-Kickback Statute, full compliance is often difficult and the failure of a transaction or arrangement to fit within a specific safe harbor does not necessarily mean that the transaction or arrangement is illegal or that prosecution under the Anti-Kickback Statute will be pursued. However, conduct and business arrangements that do not fully satisfy each applicable safe harbor may result in increased scrutiny by government enforcement authorities such as the OIG.

 

The statutory penalties for violating the Anti-Kickback Statute include imprisonment for up to five years and criminal fines of up to $25,000 per violation. In addition, through application of other laws, conduct that violates the Anti-Kickback Statute can also give rise to False Claims Act lawsuits, civil monetary penalties and possible exclusion from Medicare and Medicaid and other federal healthcare programs.

 

Although the federal Anti-Kickback Statute applies only to federal health care programs, a number of states in which we operate have their own kickback laws. Often, these laws closely follow the language of the federal law, although they do not always have the same scope, exceptions, safe harbors or sanctions. In some states, these anti-kickback laws apply not only to payment made by a state or federal health care program but also by other payors, including commercial insurance companies.

 

Physician Self-Referral Laws

 

The federal ban on physician self-referrals, commonly known as the “Stark Law,” prohibits, subject to certain exceptions, a physician from referring Medicare and Medicaid patients to an entity providing certain “designated health services” for which payment would otherwise be made by Medicare if the physician or an immediate family member of the physician has any financial relationship with the entity. The Stark Law also prohibits the entity receiving the referral from billing Medicare for any good or service furnished pursuant to an unlawful referral, and any person collecting any amounts in connection with an unlawful referral is obligated to refund such amounts. A person who engages in a scheme to circumvent the Stark Law’s referral prohibition may be fined up to $100,000 for each such arrangement or scheme. The penalties for violating the Stark Law also include civil monetary penalties of up to $15,000 per service and possible exclusion from federal healthcare programs. In addition, through application of other laws, conduct that violates the Stark Law can also give rise to False Claims Act lawsuits.

 

Many states have their own self-referral laws. Often, these laws closely follow the language of the federal law, although they do not always have the same scope, exceptions, safe harbors or sanctions. In some states these anti-referral laws apply not only to payment made by a federal health care program but also with respect to other payors, including commercial insurance companies. In addition, some state laws require physicians to disclose any financial interest they may have with a healthcare provider to their patients when referring patients to that provider even if the referral itself is not prohibited.

 

The False Claims Act and Other Fraud and Abuse Laws

 

The federal False Claims Act, or FCA, prohibits any person from knowingly presenting, or causing to be presented, a false claim or knowingly making, or causing to be made, a false statement to obtain payment from the federal government. Those found in violation of the FCA can be subject to fines and penalties of three times the damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim. Actions filed under the FCA can be brought by any individual with the requisite level of knowledge on behalf of the government, a “qui tam” action, and such individual, known as a “relator” or, more commonly, as a “whistleblower,” may share in any amounts paid by the entity to the government in damages and penalties or by way of settlement. In addition, certain states have enacted laws modeled after the FCA, and this legislative activity is expected to increase. Qui tam actions have increased significantly in recent years, causing greater numbers of healthcare companies, including clinical laboratories, to defend false claim actions, pay damages and penalties or be excluded from Medicare, Medicaid or other federal or state healthcare programs as a result of investigations arising out of such actions.

 

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The OIG also has authority to bring administrative actions to impose civil monetary penalties or exclusion from the Medicare, Medicaid and other federal health care programs. The federal Civil Monetary Penalties Law, or the CMP Law, prohibits, among other things (1) the offering or transfer of remuneration to a Medicare or state health care program beneficiary if the person knows or should know it is likely to influence the beneficiary’s selection of a particular provider, practitioner, or supplier of services reimbursable by Medicare or a state health care program, unless an exception applies; (2) employing or contracting with an individual or entity that the provider knows or should know is excluded from participation in a federal health care program; (3) billing for services requested by an unlicensed physician or an excluded provider; and (4) billing for medically unnecessary services. The penalties for violating the CMP Law include exclusion, substantial fines, and payment of up to three times the amount billed, depending on the nature of the offense.

 

Federal Prohibitions on Health Care Fraud and False Statements Related to Health Care Matters

 

The administrative simplification provisions of the Health Insurance Portability and Accountability Act, or HIPAA, created new federal crimes: health care fraud, false statements relating to health care matters, theft or embezzlement in connection with a health benefit program and obstruction of criminal investigation of health care offenses. The health care fraud statute prohibits knowingly and willfully executing a scheme to defraud any health care benefit program, including a private insurer. The false statements statute prohibits knowingly and willfully falsifying, concealing, or covering up a material fact or making any materially false, fictitious, or fraudulent statement in connection with the delivery of or payment for health care benefits, items, or services. The theft or embezzlement statute prohibits knowingly and willfully embezzling, stealing or otherwise converting or misapplying the money or property of a health care benefit program. The obstruction of criminal investigations of health care offenses statute prohibits willfully preventing, obstructing, misleading or delaying the communication of information and records relating to a violation of a federal health care offense to a criminal investigator. A violation of any of these laws is a felony and may result in fines, imprisonment, or exclusion from the federal health care programs.

 

Reimbursement

 

United States

 

Recent and future changes to policies and pricing from the MolDx molecular diagnostics program utilized by Noridian Healthcare Solutions, our Medicare Administrative Carrier, could have positive or negative effects on our Medicare billing. This relates primarily to our high complexity laboratory in Lake Forest, California which is under Noridian and MolDx jurisdiction. MolDx changes to FISH coding and reimbursement over the past three years is indicative of the MolDx impact. In 2013, MolDx reduced FISH reimbursement in an attempt to reduce overutilization causing substantial losses for many laboratories. In 2016, MolDx revised pricing for FISH upward after implementing better utilization controls in the form of revised code and billing guidance.

 

In the United States, payments for diagnostic tests come from several sources, including third-party payors such as insurance companies and health maintenance organizations; government health programs such as Medicare and Medicaid; patients; and, in certain circumstances, hospitals or referring laboratories (who then bill health third-party payors for testing).

 

Reimbursement of our tests by third-party payors is essential to our commercial success. Where there is a payor coverage policy, contract, or agreement in place, we bill the third party payor, the hospital, or referring laboratory as well as the patient (for deductibles and coinsurance or copayments, where applicable) in accordance with established policy, contract, or agreement terms. Where there is no payor policy in place, we pursue third party reimbursement on behalf of each patient on a case-by-case basis. Our efforts on behalf of these patients take a substantial amount of time and expense, and bills may not be paid for many months, if at all. Furthermore, if a third-party payor denies coverage after final appeal, it may take a substantial amount of time to collect from the patient, if we are able to collect at all.

 

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Code Assignment. In the United States, a third-party payor’s decisions regarding coverage and payment are driven, in large part, by the specific Current Procedural Terminology, or CPT, code used to identify a test. The American Medical Association, or AMA, publishes the CPT, which is a listing of descriptive terms and identifying codes for reporting medical services and procedures. The purpose of the CPT is to provide a uniform language that accurately describes medical, surgical, and diagnostic services and therefore to ensure reliable nationwide communication among healthcare providers, patients, and third-party payors.

 

A manufacturer of in vitro diagnostic kits or a provider of laboratory services may request establishment of a Category I CPT code for a new product. Assignment of a specific CPT code ensures routine processing and payment for a diagnostic test by both private and government third-party payors.

 

The AMA has specific procedures for establishing a new CPT code and, if appropriate, for modifying existing nomenclature to incorporate a new test into an existing code. If the AMA concludes that a new code or modification of nomenclature is unnecessary, the AMA will inform the requestor how to use one or more existing codes to report the test.

 

While the AMA’s decision is pending, billing and collection may be sought under one or more existing, non-specific CPT codes. A clinical laboratory may decide not to request assignment of a CPT code and instead use an existing, non-specific code for reimbursement purposes. However, use of such codes may result in more frequent denials and/or requests for supporting clinical documentation from the third-party payor and in lower reimbursement rates, which may vary based on geographical location.

 

Coverage Decisions. When deciding whether to cover a particular diagnostic test, private and government third-party payors generally consider whether the test is a covered benefit and, if so, whether it is reasonable and necessary for the diagnosis or treatment of illness and injury. Most third-party payors do not cover experimental services. Coverage determinations often are influenced by current standards of practice and clinical data, particularly at the local level. The Centers for Medicare & Medicaid Services, or CMS, which is the government agency responsible for overseeing the Medicare program, has the authority to make coverage determinations on a national basis, but most Medicare coverage decisions are made at the local level by contractors that administer the Medicare program in specified geographic areas. Private and government third-party payors have separate processes for making coverage determinations, and private third-party payors may or may not follow Medicare’s coverage decisions. If a third-party payor has a coverage determination in place for a particular diagnostic test, billing for that test must comply with the established policy. Otherwise, the third-party payor makes reimbursement decisions on a case-by-case basis.

 

Payment. Payment for covered diagnostic tests is determined based on various methodologies, including prospective payment systems and fee schedules. In addition, private third-party payors may negotiate contractual rates with participating providers or set rates as a percentage of the billed charge. Payment for diagnostic tests furnished to Medicare Part B beneficiaries is made based on the Clinical Laboratory Fee Schedule (“CLFS”), under which a payment amount is assigned to each covered CPT code. The law technically requires fee schedule amounts to be adjusted annually by the percentage increase in the consumer price index, or CPI, for the prior year, but Congress has frozen payment rates in certain years. For clinical laboratory services furnished through December 31, 2017, the ceiling for established tests is set at 74% of the median of all contractor fee schedule amounts for a particular test for which the national limitation amount (“NLA”) was established before January 1, 2001. The NLA is 100% of the median for diagnostic tests for which no limitation amount was established prior to 2001. Medicaid programs generally pay for diagnostic tests based on a fee schedule, but reimbursement varies by state.

 

On April 1, 2014, President Obama signed into law the Protecting Access to Medicare Act (“PAMA”), which established a new method for setting rates paid pursuant to the CLFS. PAMA requires laboratories that receive the majority of their Medicare revenues from payments made under the CLFS or Medicare’s Physician Fee Schedule to report, beginning January 1, 2016, private payer payment rates and volumes for their tests. Under a proposed rule ruled published by CMS on September 25, 2015, CMS proposed to limit reporting to laboratories that receive at least $50,000 in Medicare revenues from laboratory services. CMS has yet to finalize the proposed rule. CMS will use the rates and volumes reported by laboratories to develop Medicare payment rates for the tests equal to the volume-weighted median of the private payer payment rates for the tests. Rates for “advanced diagnostic laboratory tests” will be reported annually; rates for other diagnostic tests will be reported every three years. Laboratories that fail to report the required payment information may be subject to substantial civil money penalties.  

 

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The final PAMA ruling was issued June 17, 2016, indicating that data for reporting for the new PAMA process will begin in 2017 and the new market based rates will take effect January 1, 2018. We believe that the final PAMA regulations are generally favorable for us. The private payer rate will be calculated based on claims whose adjudication is final and will include patient deductible and co-insurance amounts. Additionally, we believe our tests, once covered, would be considered ADLTs and that we can determine when to seek ADLT status. We cannot assure you that reimbursement rates under the final regulations for tests like ours will not be adversely affected.

 

For the first three years, payment rate reductions are limited to ten (10) percent per year, and to fifteen (15) percent the following three years. The phased-in payment amount limit per year for existing tests paid under the CLFS prior to January 1, 2018 will be applied using the 2017 NLA for the existing test as the baseline payment amount. To determine the application of the phased-in payment reduction limit for a test, the weighted median private payor rate calculated for calendar year 2018 will be compared to the calendar year 2017 NLA.

 

Diagnostic tests furnished to Medicare inpatients generally are included in the bundled payment made to the hospital under Medicare Part A’s Inpatient Prospective Payment System. Further, in 2014, CMS began to bundle payment for clinical laboratory tests together with other services performed during hospital outpatient visits under the Hospital Outpatient Prospective Payment System. While CMS exempted molecular diagnostic tests from this packaging provision, it is possible that CMS could propose to bundle payment for such tests in the future. Our tests are generally not paid in the hospital outpatient setting, and insofar as they are paid in that setting they likely would be considered molecular tests if billed under specific procedure codes, but it is possible that payment for our tests could be bundled if furnished in a hospital outpatient setting in the future.

 

Under current Medicare billing rules, the bundled payment for inpatient services includes clinical laboratory testing performed for a Medicare beneficiary who was a hospital inpatient at the time the tumor tissue sample was obtained and whose testing was ordered less than 14 days after discharge. Medicare billing rules also require hospitals to bill for our testing if it is ordered for a hospital outpatient under the same circumstances. Accordingly, we must bill hospitals for such testing.

 

On several occasions Congress has considered various cost reduction alternatives, including imposing a 20% co-insurance amount on clinical laboratory services (which would require beneficiaries to pay a portion of the cost of their clinical laboratory testing). Although these changes have not been enacted at this time, Congress could decide to impose these or other fee reductions or taxes at some point in the future. If so, these additional coinsurance payments for our tests could be difficult to collect and any new fee reductions or taxes would impact our revenues.

 

Finally, state Medicaid agencies may assign a reimbursement rate equal to or less than the prevailing Medicare rate, often times determined by state law (e.g., a percentage of the Medicare reimbursement rate).

 

European Union

 

In the European Union the reimbursement mechanisms used by third party payors vary by country. For the public systems reimbursement is determined by guidelines established by the legislator or responsible national authority. As elsewhere, inclusion in reimbursement catalogues focuses on the medical usefulness, need, quality and economic benefits to patients and the healthcare system. Acceptance for reimbursement comes with cost, use and often volume restrictions, which again can vary by country.

 

C.ORGANIZATIONAL STRUCTURE

 

Rosetta Genomics Ltd. is organized under the laws of the State of Israel and has a direct wholly owned subsidiary, Rosetta Genomics Inc., which is a Delaware corporation. Rosetta Genomics Ltd. also has two indirect wholly owned subsidiaries, Minuet Diagnostics, Inc., a Delaware corporation (which is wholly owned by Rosetta Genomics Inc.), and CynoGen, Inc., a Delaware corporation (which is wholly owned by Minuet Diagnostics, Inc.).

 

D.PROPERTY, PLANTS AND EQUIPMENT

 

We currently rent approximately 6,437 square feet of office and laboratory space in Rehovot, Israel, under a lease that expires in October 2017. Our wholly-owned subsidiary, Rosetta Genomics Inc., rents approximately 3,651 square feet of office space in Princeton, New Jersey under a lease that expires in September 30, 2018. The Princeton, New Jersey premises have been sub-leased under an agreement that expires on September 29, 2018. In addition, Rosetta Genomics, Inc., rents approximately 7,349 square feet of laboratory space in Philadelphia, Pennsylvania under a lease that expires in December 2018. Rosetta Genomics, Inc.’s wholly-owned subsidiary, Cynogen, Inc., rents approximately 28,700 square feet of laboratory and office space in Lake Forest, California under a lease that expires in November 2018. If our business grows we may need additional space, but expect that alternate facilities will be available on reasonable terms as and when needed.

 

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ITEM 4A.UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 5.OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Item 3. Key Information — A. Selected Consolidated Financial Data” and our consolidated financial statements and the related notes to those statements included elsewhere in this Annual Report. In addition to historical consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under “Forward-Looking Statements,” “Item 3. Key Information — D. Risk Factors” and elsewhere in this Annual Report.

 

Overview

 

We are seeking to develop and commercialize new diagnostic products based on a recently discovered group of genes known as microRNAs. MicroRNAs are naturally expressed, or produced, using instructions encoded in DNA and are believed to play an important role in regulating protein production. Proteins control most biological processes and thus we believe that microRNAs as their regulators have the potential to form the basis of a novel class of diagnostic tests and therapies for many serious illnesses.

 

We anticipate that our principal sources of liquidity will only be sufficient to fund our activities into the third quarter of 2017. As of December 31, 2016, we had cash, cash equivalents, short-term bank deposits and restricted cash of $6.3 million, compared to $13.5 million as of December 31, 2015. We need to raise additional equity or debt capital by the third quarter of 2017 in order to continue to fund our operations, and we cannot provide any assurance that we will be successful in doing so. Our independent registered public accounting firm, Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, has included an explanatory paragraph in their opinion that accompanies our audited consolidated financial statements as of and for the year ended December 31, 2016, indicating that our current liquidity position raises substantial doubt about our ability to continue as a going concern.

 

We have used substantial funds to discover, develop, commercialize and protect our microRNA tests and technologies and will require substantial additional funds to continue our operations. Following our acquisition of PersonalizeDx in 2015, we have incurred and, assuming the availability of sufficient cash resources, expect to continue to incur increased costs that may adversely affect our operations and liquidity in 2017 and beyond. Our current operating plan includes various assumptions concerning the level and timing of cash receipts from sales and cash outlays for operating expenses and capital expenditures. Our ability to successfully carry out our business plan is primarily dependent upon our ability to (1) obtain sufficient additional capital, (2) attract and retain knowledgeable employees, (3) increase our cash collections and (4) generate significant additional revenues.

 

We may seek additional funding through collaborative arrangements and public or private equity offerings and debt financings. Additional funds may not be available to us when needed on acceptable terms, or at all. In addition, the terms of any financing may adversely affect the holdings or the rights of our existing shareholders. For example, if we raise additional funds by issuing equity securities, further dilution to our then-existing shareholders may result. Debt financing, if available, may involve restrictive covenants that could limit our flexibility in conducting future business activities. We also could be required to seek funds through arrangements with collaborators or others.

 

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If adequate funds are needed and not available, we may be required to:

 

delay, reduce the scope of or eliminate certain research and development programs;

 

obtain funds through arrangements with collaborators or others on terms unfavorable to us or that may require us to relinquish rights to certain technologies or products that we might otherwise seek to develop or commercialize independently;

 

monetize certain of our assets;

 

pursue merger or acquisition strategies; or

 

seek protection under the bankruptcy laws of Israel and the United States.

 

Since our inception in March 2000, we have generated significant losses. As of December 31, 2016, we had an accumulated deficit of approximately $157 million. We funded our operations through December 31, 2016 primarily through proceeds received from the sale of equity securities to investors:

 

We have focused our efforts since inception primarily on research and development, building and maintaining our intellectual property, business planning and commercializing our products. We have not achieved profitability and, assuming the availability of sufficient cash resources, we expect to incur significant additional losses over the next several years. We expect our net losses to continue primarily due to research and development activities relating to our internal product development, collaborations, business development, commercialization, and other general corporate activities. We anticipate that our operating results will fluctuate for the foreseeable future. Therefore, period-to-period comparisons should not be relied upon as predictive of the results in future periods. Potential source of funding include our existing cash and cash equivalents, as well as product revenues, additional equity and/or debt financings, funded research and development payments, and license fees and/or milestone payments under potential future collaborative arrangements.

 

Research and development expenses represented 18%, 17%, and 14% of our total operating expenses for the years ended December 31, 2016, 2015, and 2014, respectively. We have not tracked our historical research and development costs on a project-by-project basis because the majority of our efforts have been focused on the development of capabilities associated with our microRNA discovery process rather than on specific projects. Major components of the $3.2 million in research and development expenses for the year ended December 31, 2016 included payroll and related expenses, research materials and related expenses, and sample acquisition costs.

 

On April 13, 2015, we acquired CynoGen, Inc. (“CynoGen” or “PersonalizeDx”) from Prelude Corporation, a Fjord Ventures portfolio company. The purchase price included $2.1 million in cash, 41,667 of our ordinary shares and the provision of certain assets and services to Prelude Corporation. On July 22, 2015, we issued an additional 10,000 of our ordinary shares in lieu of services that were to be provided to an affiliate of PersonalizeDx. PersonalizeDx is a molecular diagnostics and services company serving community-based pathologists, urologists, oncologists and other reference laboratories across the United States. PersonalizeDx is focused on the detection of genomic changes through Fluorescence In Situ Hybridization, or FISH, technology, which helps to detect cancer, measure the potential aggressiveness of the disease and identify patients most likely to respond to targeted therapies.

 

 

Financial Operations Overview

 

Revenues

 

Revenues from continuing operations consist of revenues from sales of our diagnostic tests processed in either our laboratory in Philadelphia, Pennsylvania or in our laboratory in Lake Forest, California. Our first diagnostic products applying our microRNA technology that were launched in late 2008 began generating revenues in 2009. We have generated revenues from continuing operations for the years ended December 31, 2016, 2015, and 2014, in the amounts of $9.2 million, $8.3 million, and $1.3 million, respectively.

 

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Cost of Revenues

 

Cost of revenues related to our products consist primarily of salaries and employee benefits of our lab personnel as well as material costs and costs related to rent and maintenance of our labs in Philadelphia and Lake Forest.

 

 

Research and Development Expenses, net

 

We expense research and development costs as incurred. Our research and development expenses currently include costs of salaries and related expenses, activities related to intellectual property and licensing, tissue samples and other research materials, supplies, equipment depreciation, outsourced clinical and other research activities, consultants, utilities expenses and an allocation of corporate administrative costs.

 

 

We are currently conducting a number of studies analyzing microRNA expression profiles in healthy and diseased samples. As a result, assuming the availability of sufficient cash resources, we expect that our expenses related to the purchase of tissue and body fluid samples, as well as other research consumables, will increase in the future. We have entered into several license agreements for rights to utilize certain technologies. The terms of the licenses provide for up-front payments, annual maintenance payments and royalties on product sales. Costs to acquire and maintain licensed technology are expensed as incurred.

 

Marketing and Business Development Expenses

 

Marketing and business development expenses consist primarily of salaries and related expenses as well as expenses related to advertising, marketing campaigns, and our commercialization. As we continue to market our own products as well as explore new collaborations to develop and commercialize diagnostic and therapeutic products, we anticipate that these expenses will increase, assuming the availability of sufficient cash resources.

 

General and Administrative Expenses

 

General and administrative expenses consist primarily of salaries and related expenses, patent expenses, professional fees and expenses related to general corporate activities. Assuming the availability of sufficient cash resources, we anticipate that general and administrative expenses will continue to grow in 2017 due to the continued growth and activities of our business.

 

Financial Expenses (Income)

 

Financial expenses for the year ended December 31, 2016, consisted primarily of expenses associated with issuance of warrants and debentures pursuant to share purchase agreements, partially offset by interest from bank deposits and foreign currency adjustment gains.

 


Critical Accounting Estimates

 

Our discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in conformity with U.S. generally accepted accounting principles, or U.S. GAAP. The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our estimates and judgments. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and could have a material impact on our reported results.

 

While our significant accounting policies are more fully described in the notes to our consolidated financial statements included in this annual report, we believe the following accounting estimates to be the most critical in understanding our consolidated financial statements and the assumptions management used.

 

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Accounting for Stock-Based Compensation

 

We account for stock-based compensation in accordance with ASC 718 “Compensation- Stock Compensation”. ASC 718 requires companies to estimate the fair value of equity-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in our consolidated income statements.

 

We recognize compensation expenses for the value of awards granted based on the straight line method over the requisite service period of each of the awards, net of estimated forfeitures. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Estimated forfeitures are based on actual historical pre-vesting forfeitures. The term “forfeitures” is distinct from “cancellations” or “expirations” and represents only the unvested portion of the surrendered option. We currently expect, based on future expected forfeitures, that approximately 90% of our options will actually vest, and therefore have applied an annual forfeiture rate of 10% to all options that are not vested as of December 31, 2016. Ultimately, the actual expenses recognized over the vesting period will only be for those shares that vest.

 

We selected the Black-Scholes option pricing model as the most appropriate fair value method for stock-option awards and value restricted stock based on the market value of the underlying shares at the date of grant. The option-pricing model requires a number of assumptions, of which the most significant are the expected stock price volatility and the expected option term. The computation of expected volatility is based on realized historical stock price of our stock starting from the IPO date. As a result of the above-mentioned calculations, the volatility used for the twelve months ended December 31, 2016 and 2015 was 115% and 123%, respectively. The risk-free interest rate assumption is the implied yield currently available on United States treasury zero-coupon issues with a remaining term equal to the expected life term of our options. We determined the expected life of the options based on realized historical share price volatility of our share, average of vesting, and the contractual term of the options.

 

We apply ASC 718 and ASC 505-50 “Equity-Based Payments to Non-Employees”, with respect to options and warrants issued to non-employees. ASC 718 requires the use of option valuation models to measure the fair value of the options and warrants at the measurement date.

 

At the end of each financial reporting period prior to vesting, the value of these options, as calculated using the Black-Scholes option pricing model, was re-measured using the then current fair value of our ordinary shares. Since the fair market value of the ordinary shares to non-employees is subject to change in the future, the compensation expense recognized during the years ended December 31, 2016, 2015, and 2014 may not be indicative of future compensation charges.

 

 

A.OPERATING RESULTS

 

Years Ended December 31, 2016 and 2015

 

Revenues. In the years ended December 31, 2016 and December 31, 2015, we recognized $9.2 million and $8.3 million, respectively, as revenues. This increase resulted primarily from our acquisition of PersonalizeDx in April 2015.

 

Cost of revenues. Cost of revenues were $7.4 million for the year ended December 31, 2016, including $47,000 of non-cash stock-based compensation, compared to $6.3 million for the year ended December 31, 2015, which included $37,000 of non-cash stock-based compensation. This increase resulted primarily from the additional volume generated by the acquired PersonalizeDx business.

 

Research and development expense, net. Research and development expenses were $3.1 million for the year ended December 31, 2016, including $116,000 of non-cash stock-based compensation, compared to $2.9 million for the year ended December 31, 2015, including $100,000 of non-cash stock-based compensation, the increase is primarily related to post-market studies.

 

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Royalty bearing grants from the Office of the Chief Scientist at the Ministry of Industry, Trade and Labor of the State of Israel, or the IIA, for funding approved research and development projects are presented as a reduction from the research and development expenses. We recognized grants in an amount of $114,000 and $197,000, for the years ended December 31, 2016 and 2015, respectively.

 

Sales, marketing and business development. Marketing and business development expenses were $6.8 million for the year ended December 31, 2016, including $293,000 of non-cash stock-based compensation, as compared to $7.3 million for the year ended December 31, 2015, including $281,000 of non-cash stock-based compensation. The decrease is primarily attributable to lower marketing, travel and business development expenses.

 

General and administrative expenses. General and administrative expenses were $7.5 million for the year ended December 31, 2016, including $403,000 of non-cash stock-based compensation, as compared to $7.6 million for the year ended December 31, 2015, including $598,000 of non-cash stock-based compensation.

 

Financial expenses, net. Net financial expense was $603,000 for the year ended December 31, 2016, as compared to a net financial expense of $1.6 million for the year ended December 31, 2015. Financial expenses for 2016 consisted primarily of issuance expenses associated with warrants and debentures classified as liabilities, partially offset by interest from bank deposits and foreign currency adjustment gains. Financial expenses for 2015 consisted primarily of revaluation of warrants, issuance expenses of warrants classified as liabilities, interest from bank deposits and foreign currency adjustment losses.

 

Years Ended December 31, 2015 and 2014

 

Revenues. In the years ended December 31, 2015 and December 31, 2014, we recognized $8.3 million and $1.3 million, respectively. This increase resulted primarily from our acquisition of PersonalizeDx in April 2015.

 

Cost of revenues. Cost of revenues were $6.3 million for the year ended December 31, 2015, including $37,000 of non-cash stock-based compensation, compared to $1.3 million for the year ended December 31, 2014, which included $34,000 of non-cash stock-based compensation. This increase resulted primarily from the additional volume generated by the acquired PersonalizeDx business.

 

Research and development expense, net. Research and development expenses were $3 million for the year ended December 31, 2015, including $100,000 of non-cash stock-based compensation, compared to $1.9 million for the year ended December 31, 2014, including $73,000 of non-cash stock-based compensation. Research and development expenses for the year ended December 31, 2015, increased as we invested in launching our new thyroid assay, RosettaGX RevealTM, in late 2015.

 

Royalty bearing grants from the Office of the Chief Scientist at the Ministry of Industry, Trade and Labor of the State of Israel, or the IIA, for funding approved research and development projects are presented as a reduction from the research and development expenses. We recognized grants in an amount of $197,000 and $292,000, for the years ended December 31, 2015 and 2014, respectively.

 

Sales, marketing and business development. Marketing and business development expenses were $7.3 million for the year ended December 31, 2015, including $281,000 of non-cash stock-based compensation, as compared to $6.8 million for the year ended December 31, 2014, including $226,000 of non-cash stock-based compensation. This increase resulted primarily from increased commercial activities, as a result of the acquisition of the PersonalizeDx business.

 

General and administrative expenses. General and administrative expenses were $7.6 million for the year ended December 31, 2015, including $598,000 of non-cash stock-based compensation, as compared to $5.5 million for the year ended December 31, 2014, including $590,000 of non-cash stock-based compensation. This increase is a result of increased corporate activities due to the acquisition of the PersonalizeDx business.

 

Financial expenses, net. Net financial expense was $1.6 million for the year ended December 31, 2015, as compared to a net financial expense of $259,000 for the year ended December 31, 2014.  Financial expenses for 2015 consisted primarily of revaluation of warrants, interest from bank deposits and foreign currency adjustment losses. Financial expenses for 2014 primarily consisted primarily of interest from bank deposits and foreign currency adjustment losses.

 

 

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B.LIQUIDITY AND CAPITAL RESOURCES

 

Since our inception, we have generated significant losses and expect to continue to generate losses for the foreseeable future. As of December 31, 2016, we had an accumulated deficit of approximately $157 million. We have funded our operations primarily through the proceeds from the sales of ordinary shares, convertible debentures and warrants.

 

We anticipate that our principal sources of liquidity will only be sufficient to fund our activities into the third quarter of 2017. As of December 31, 2016, we had cash, cash equivalents, short-term bank deposits and restricted cash of $6.3 million, compared to $13.5 million as of December 31, 2015. We need to raise additional equity or debt capital by the third quarter of 2017 in order to continue to fund our operations, and we cannot provide any assurance that we will be successful in doing so.

 

We have completed the following financing transactions during the periods covered by this Annual Report on Form 20-F:

 

·On March 22, 2013, we entered into a Controlled Equity OfferingSM Sales Agreement (the “2013 Cantor Sales Agreement”) with Cantor Fitzgerald & Co., as sales agent (“Cantor”), pursuant to which we could offer and sell, from time to time through Cantor, our ordinary shares. We terminated the 2013 Cantor Sales Agreement on October 13, 2014. Between March 22, 2013 and October 13, 2014, we sold through the 2013 Cantor Sales Agreement an aggregate of 211,008 of our ordinary shares and received gross proceeds of $10.1 million, including 102,851 ordinary shares sold in 2014 for gross proceeds of $5.1 million.

 

·On February 18, 2015, we entered into a Controlled Equity OfferingSM Sales Agreement (the “2015 Cantor Sales Agreement” and, collectively with the 2013 Cantor Sales Agreement, the “Cantor Sales Agreements”) with Cantor and filed a prospectus supplement with the SEC relating to the sale, from time to time through Cantor, of up to $14.4 million of our ordinary shares. Between February 18, 2015, and the time of the filing of this Annual Report on Form 20-F, we sold through the 2015 Cantor Sales Agreement an aggregate of 202,030 of our ordinary shares, and received gross proceeds of $10.5 million.

 

Sales of our ordinary shares under the Cantor Sales Agreements are made in sales deemed to be “at-the-market” equity offerings as defined in Rule 415 promulgated under the Securities Act of 1933, as amended.

 

·On October 13, 2015, we entered into a Securities Purchase Agreement (the "Securities Purchase Agreement"), pursuant to which we agreed to sell securities to various accredited investors (the "Purchasers") in a private placement transaction (the "Private Placement"). The Private Placement closed on October 16, 2015 (the "Closing Date").

 

Under the terms of the Private Placement, we issued an aggregate of 277,778 units and at a purchase price of $28.80 per unit for gross proceeds of approximately $8 million, Each unit consisted of (i) one ordinary share, (ii) a Series A Warrant to purchase one-half of an ordinary share at an exercise price of $33 per ordinary share (subject to adjustment), exercisable for a period of five years from the Closing Date, and (iii) a partially pre-funded Series B Warrant (collectively and together with the Series A Warrants, the "Warrants"). The Series B Warrants had an exercise price of NIS 7.2 (which has been prepaid) plus $0.0012 per share. The Series B Warrants were intended to reset the price of the units, and became exercisable for an aggregate of 222,223 shares based on 85% of the arithmetic average of the five lowest weighted average prices calculated during the ten trading days following the effective date of the Resale Registration Statement registering the shares sold in the Private Placement. The Series A Warrant exercise price has been adjusted to $19.752 per share, and all of the Series B Warrants have been exercised on a cashless basis, resulting in the issuance of 222,208 of our ordinary shares.

 

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·On November 23, 2016, we entered into a securities purchase agreement (the “Purchase Agreement”) with a prominent institutional healthcare investor to purchase (i) an aggregate of 91,250 of our ordinary shares (the “Shares”) at a purchase price of $6 per share and an aggregate principal amount of $3.2 million of unsecured convertible debentures (the “Registered Debentures”) in a registered direct offering (the “Registered Direct Offering”) and (ii) warrants to purchase up to 833,334 ordinary shares with an initial exercise price of $10.20 per share (the “Warrants”) and an aggregate principal amount of $1.3 million unsecured convertible debentures (the “PIPE Debentures” and together with the Registered Debentures, the “Debentures”) in a concurrent private placement (the “Private Placement” and, together with the Registered Direct Offering, the “Offerings”). The initial closing of the Offerings occurred on November 29, 2016, at which time we received gross proceeds of $3.7 million for the ordinary shares, the Registered Debentures and Warrants. The closing of the second tranche of the private placement of convertible debentures occurred on February 23, 2017. The closing of this second tranche involved the sale of newly registered convertible debentures (convertible into 215,417 ordinary shares) for gross proceeds of $1.3 million. The aggregate net proceeds to the Company from the Offerings, after deducting the placement agents’ fees and expenses and our estimated offering expenses, were approximately $4.6 million.

 

The Debentures are non-interest bearing, have a term of 30 years and were convertible into ordinary shares at an initial conversion price of $6 per share. However, upon completion of 10 trading days following the 1-for-12 reverse split of our ordinary shares on March 16, 2017, the conversion price of the Debentures will be reduced to the lesser of (x) the then-applicable conversion price, as adjusted, and (y) the average of the two lowest volume weighted average prices of our ordinary shares during the 10 trading days immediately following the reverse stock split. Additionally, subject to limited exceptions, for a period of 18 months following the effective date of a resale registration statement on Form F-1 covering the resale of the ordinary shares issuable upon exercise of the Warrants and conversion of the PIPE Debentures (the “Resale Registration Statement”), if we issue ordinary shares or securities that are convertible or exercisable into ordinary shares at a price that is less than the effective conversion price, then the conversion price shall be automatically reduced to the price at which the Company issued the ordinary shares or the underlying exercise price or conversion price of the securities. However, under no circumstances will the adjusted conversion price of the Debentures be lower than $3. Our payment obligations under the Debentures are guaranteed by our subsidiaries pursuant to a subsidiary guarantee. The Debentures are not subject to voluntary prepayment prior to maturity.

 

The Warrants were immediately exercisable upon issuance and have a term of five years. The exercise price of the Warrants is subject to adjustment upon the occurrence of specific events, including stock dividends, stock splits, combinations and reclassifications of the Company’s ordinary shares and rights offerings and pro rata distributions with respect to all holders of the Company’s ordinary shares. Additionally, upon completion of 10 trading days following the 1-for-12 reverse split of our ordinary shares on March 16, 2017, the exercise price will be reduced to the lesser of (x) the then-applicable exercise price, as adjusted, and (y) the average of the two lowest volume weighted average prices of the Company’s ordinary shares during the 10 trading days immediately following the reverse stock split. Additionally, subject to limited exceptions, for a period of 12 months following the effective date of the Resale Registration Statement, if we issue ordinary shares or securities that are convertible or exercisable into ordinary shares at a price that is less than the effective exercise price, then the exercise price will be automatically reduced to the price at which the Company issued the ordinary shares or the underlying exercise price or conversion price of the securities.

 

 

Cash Flows

 

Net cash used in operating activities. Net cash used in operating activities was $10.4 million in 2016, compared to $---16.9 million in 2015 and $13.6 million in 2014. These amounts were used to fund our commercial, corporate, and R&D activities for these periods, adjusted for non-cash expenses and changes in operating assets and liabilities.

 

Net cash provided by (used in) investing activities. Net cash provided by investing activities was $823,000 in 2016, compared to $4.1 million in 2015 and $258,000 net cash used in investing activities in 2014. Net cash provided by investing activities during 2016 primarily relates to bank deposits and restricted cash. Net cash provided by investing activities during 2015 primarily relates to bank deposits and restricted cash. Net cash used in investing activities during 2014 primarily relates to the purchase of property and equipment.

 

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Net cash provided by financing activities. Net cash provided by financing activities from continuing operations was$3.2 million in 2016, compared to $17.3 million in 2015 and $5.0 million in 2014. In 2016, 2015, and 2014, net cash provided by financing activities consisted primarily of proceeds from the issuance of shares, warrants and debentures.

 

Funding Requirements

 

We expect to incur continuing and increasing losses from operations for at least the next several years. In particular, we expect to incur significant marketing and business development expenses, research and development expenses, and general and administrative expenses in the future as we expand our operations and product development efforts and continue operating as a public company.

 

We anticipate that our principal sources of liquidity will only be sufficient to fund our activities into the third quarter of 2017. As of December 31, 2016, we had cash, cash equivalents, short-term bank deposits and restricted cash of $6.3 million, compared to $13.5 million as of December 31, 2015. We need to raise additional equity or debt capital by the third quarter of 2017 in order to continue to fund our operations, and we cannot provide any assurance that we will be successful in doing so. Our independent registered public accounting firm, Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, independent registered public accountants, has included an explanatory paragraph in their opinion that accompanies our audited consolidated financial statements as of and for the year ended December 31, 2016, indicating that our current liquidity position raises substantial doubt about our ability to continue as a going concern.

 

Our funding requirements may change and will depend upon numerous factors, including but not limited to:

 

the timing, receipt and amount of sales of our products;

 

progress in our research and development programs;

 

the resources, time and costs required to initiate and complete development and any required preclinical studies and clinical trials, and obtain regulatory approvals for our products;

 

the timing, receipt, and amount of milestone, royalty and other payments from present and future collaborators, if any; and

 

costs necessary to protect our intellectual property.

 

 

If we need additional funding, there can be no assurance that we will be able to obtain adequate levels of additional funding on favorable terms, if at all. If adequate funds are needed and not available, we may be required to:

 

delay, reduce the scope of or eliminate certain research and development programs;

 

obtain funds through arrangements with collaborators or others on terms unfavorable to us or that may require us to relinquish rights to certain technologies or products that we might otherwise seek to develop or commercialize independently;

 

monetize certain of our assets;

 

pursue merger or acquisition strategies; or

 

seek protection under the bankruptcy laws of Israel and the United States.

 

 

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C.RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.

 

Our research and development expenditures were $3.1 million, $2.9 million, and $1.9 million in the years ended December 31, 2016, 2015, and 2014, respectively. See also “Item 5. Operating and Financial Review and Prospects - Financial Operations Overview - Research and Development Expenses.”

 

D.TREND INFORMATION

 

See “Item 5. Operating and Financial Review and Prospects.”

 

E.OFF-BALANCE SHEET ARRANGEMENTS

 

We are not party to any material off-balance-sheet arrangements.

 

F.TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

 

Set forth below is a description of our contractual cash obligations as of December 31, 2016. Operating and capital lease obligations consist of rent payable under our existing facility leases and lease payments for company automobiles and equipment. Other long-term obligations consist of cash obligations under various license agreements.

 

(In thousands)  Total   2017   2018   2019   2020   2021   Thereafter 
Operating and capital lease obligations  $1,377   $750   $611   $16   $-   $-   $- 
Other long-term liabilities  $1,612   $147   $147   $147   $147   $147   $877 
                                    
Total  $2,989   $897   $758   $163   $147   $147   $877 

 

Under our license agreements as of December 31, 2016, we are obligated to pay an aggregate amount of approximately $147,000 annually after 2021 and until 2022, $100,000 annually after 2022 and until 2029 and $10,000 annually after 2029 and until 2032. Each of these agreements terminates upon the expiration of all patents relating to such agreement, including patents to be filed and potentially issued at an indeterminable date in the future, and, thus, such termination dates cannot be determined at this time. Accordingly, we are also unable to determine the aggregate amount of such payments due after 2020 at this time. However, based on current facts and circumstances, we estimate that our obligations under these agreements will be through at least 2032. See “Item 4. Information on the Company” for more information on our contractual obligations.

 

 

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ITEM 6.DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

A.DIRECTORS AND SENIOR MANAGEMENT

 

The following table sets forth information regarding our corporate and executive officers and directors:

 

Name   Age   Position
Kenneth A. Berlin   51   Chief Executive Officer and President
Ron Kalfus   41   Chief Financial Officer
Dganit Bar, Ph.D. (5)   47   Chief Scientific Officer
Eti Meiri, Ph.D.   47   Vice President, Research
Sigal Russo-Gueta   38   Senior Director Of Finance
Brian Markison (3)   56   Chairman of the Board of Directors
Roy N. Davis (4)   69   Director
Joshua Rosensweig, Ph.D. (2,3)   63   Director
Dr. David Sidransky, M.D. (1,4)   55   Director
Gerald Dogon (1,2)   76   External Director
Tali Yaron-Eldar (1,2)   52   External Director

_______________

(1) Member of our Audit Committee

(2) Member of our Compensation Committee

(3) Member of our Nominating and Corporate Governance Committee

(4) Member of our Research and Development Committee

(5) Dr. Bar resigned effective as of March 14, 2017

 

Kenneth A. Berlin joined us in November 2009 as our President and Chief Executive Officer. He was later appointed by our shareholders in December 2009 as a member of our board of directors, and resigned as a director in March 2011. Prior to joining us, Mr. Berlin, served as Worldwide General Manager at cellular and molecular cancer diagnostics developer Veridex, LLC, a Johnson & Johnson company. Under his leadership the organization grew to over 100 employees, and he spearheaded the launch of three cancer diagnostic products, the acquisition of its cellular diagnostics partner, and delivered significant growth in sales as Veridex transitioned from a research and development entity to a commercial provider of oncology diagnostic products and services. During Mr. Berlin’s tenure, Veridex received numerous awards including recognition from the Cleveland Clinic and Prix Galien for the use of its innovative CellSearch® technology in the fight against cancer. Mr. Berlin joined Johnson & Johnson in 1994 and served as corporate counsel for six years. He then held positions of increasing responsibility within Johnson & Johnson and a number of its subsidiary companies. From 2001 until 2004, he served as Vice President, licensing and new business development in the pharmaceuticals group, and from 2004 until 2007 was Worldwide Vice President, franchise development, Ortho-Clinical Diagnostics. Mr. Berlin holds an A.B. degree from Princeton University and a J.D. from the University of California, Los Angeles School of Law.

 

Ron Kalfus joined us in May 2012 as our Chief Financial Officer. Prior to joining Rosetta, Mr. Kalfus served as the Chief Financial Officer and Treasurer of MabCure Inc., a publicly-traded biotechnology startup company in the field of early cancer detection using antibodies, from 2008 to 2012. From 2003 to 2007, Mr. Kalfus held various positions with Toys “R” Us, Inc., being responsible for the company’s financial reporting to the Securities and Exchange Commission and being responsible for the Toys “R” Us division’s annual budget. Prior to joining Toys “R” Us, Inc., Mr. Kalfus worked as an auditor for two large public accounting firms, specializing in audits of medium-sized enterprises as well as public companies. Mr. Kalfus holds an MSc in Accounting from Fairleigh Dickinson University and a BBA in Finance from the University of Georgia, and is a Certified Public Accountant licensed in New Jersey.

 

Dganit Bar, Ph.D. joined us in October 2012, as our Chief Scientific Officer. Dr. Bar joined Rosetta with more than 10 years of experience in drug development. Prior to joining Rosetta, from 2004 to 2012 she served in various positions, including Executive Director Science & Technology at BioLineRx, Ltd, a biopharmaceutical company, where she led the development and out-licensing of several drug candidates spanning different therapeutic areas, including oncology, cardiovascular and CNS. From 2000 to 2004 Dr. Bar was with QBI Enterprises, Ltd, where she held several positions including Head of Cancer Research working on the company’s oncology pipeline. Dr. Bar received her B.Sc. in Life Science from The Hebrew University, Jerusalem. She holds an M.Sc. in Biotechnology and a Ph.D. in Biotechnology Engineering from Ben-Gurion University of the Negev.

 

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Eti Meiri, Ph.D. has served as our Vice President, Research since May 2012. She previously served as our Senior Scientist, Molecular Biology since 2003. Her contributions included the development of our microRNA array platform as well as the development of RNA extraction protocols suitable for microRNA extraction from clinical samples. Prior to joining us, from 2001 to 2002, Dr. Meiri served as Senior Scientist in ViroGene Ltd. She is the author of 20 papers published in peer reviewed journals. Dr. Meiri earned her Ph.D. from the Department of Plant Sciences in the Weizmann Institute of Science in Rehovot, her M.Sc. from The Hebrew University of Jerusalem, and her B.Sc. from the faculty of life sciences, in Tel Aviv University.

 

Sigal Russo-Gueta joined us in September 2008 as our controller.  Prior to joining Rosetta, Ms. Russo worked as an audit manager at Ernst & Young in Israel, specializing in audits of companies from various fields, both publicly traded and privately owned American and Israeli entities, from 2004 to 2008.  Ms. Russo holds a BA in economics and accounting, from the Ruppin Academic College, and is a Certified Public Accountant licensed in Israel.

 

Brian Markison has served as a member of our board of directors since March 2011. Mr. Markison was appointed by our board of directors to fill the vacancy created by the resignation of Mr. Berlin. Mr. Markison’s appointment was approved by the general meeting dated July 6, 2011. Mr. Markison was appointed as chairman of the board on April 12, 2011. Mr. Markison has been a healthcare industry executive at Avista Capital Partners since September 2012, prior to which he served as President, Chief Executive Officer and a member of the Board of Directors of Fougera Pharmaceuticals Inc., from July 2011, until it was sold to the generics division of Novartis in July 2012. Previously, he had been with King Pharmaceuticals since 2004 and led the company through its acquisition by Pfizer for $3.6 billion in 2010. Previously Mr. Markison was with Bristol-Myers Squibb from 1982 to 2004, where he served in various commercial and executive positions rising from an oncology sales representative to become President, BMS Oncology/Virology and Oncology Therapeutics Network. Mr. Markison serves on the board of directors of Immunomedics, Inc., Lantheus Medical Imaging and Alere Inc, and is the Chairman and Chief Executive Officer of Osmotica Pharmaceuticals, Mr. Markison received a B.S. from Iona College in New Rochelle, New York and serves as a Trustee for The College of New Jersey.

 

Roy N. Davis has served as a member of our board of directors since June 2012. Mr. Davis joined Johnson & Johnson (J&J) in 1984, where he moved through leadership positions of increasing responsibility in the organization in the U.S., Europe and Asia for 27 years prior to his retirement in January 2012. Most recently, from January 2008 through January 2012 Mr. Davis was President, J&J Development Corporation, J&J’s wholly owned venture group, and Vice President of Corporate Development for all of J&J. In these roles Mr. Davis was responsible for acquisition and licensing in areas outside of current J&J business sectors, venture capital investing on behalf of J&J and management of J&J’s wholly owned ventures. These efforts focused on developing new companies for J&J that offer transformational health care solutions. From 2003 to 2007, Mr. Davis held the positions of Company Group Chairman, J&J and Worldwide Franchise Chairman, Ortho Clinical Diagnostics with responsibilities for Ortho Clinical Diagnostics, Inc., Veridex LLC and Therakos, Inc. Mr. Davis received a Bachelor of Science from the State University of New York and a Master of Science from Rensselaer Polytechnic Institute. He served as a member of the Innovations Advisory Board for the Cleveland Clinic during 2008-2014 and is currently a member of the Advisory Board for the Wake Forest Institute for Regenerative Medicine and in March 2012 was named to the Board of Directors of Innosight, an innovation consulting firm.

 

Joshua Rosensweig has served as a member of our board of directors since May 2004. Since November 2010, he has served as a member of the board of directors of Bezeq Israel Telecommunication Corp. Ltd. (Israel’s leading communications group) and of Alrov Real Estate and Hotels Ltd., a publicly-traded property development company. From September 2003 to September 2006, Dr. Rosensweig served as the Chairman of the Board of Directors of the First International Bank of Israel. From 1998 to July 2005, Dr. Rosensweig was a senior partner at Gornitzky and Co., a law firm where he specialized in international transactions and taxation. Dr. Rosensweig lectured at Bar-Ilan University, Law School from 1980 to 1995 and at Tel Aviv University, School of Business from 1983 to 1995. Dr. Rosensweig received his J.S.D. (International Taxation), and LL.M. (Taxation) from New York University Law School. Dr. Rosensweig is currently a partner at the law firm of Rosensweig & Aviram, Attorneys.

 

David Sidransky, M.D., has served as a member of our board of directors since December 22, 2009. Dr. Sidransky is a renowned oncologist and research scientist named and profiled by TIME magazine in 2001 as one of the top physicians and scientists in America, recognized for his work with early detection of cancer. He serves as the Director of the Head and Neck Cancer Research Program at the Sidney Kimmel Comprehensive Cancer Center at Johns Hopkins University. He is a Professor of Oncology, Otolaryngology, Cellular & Molecular Medicine, Urology, Genetics, and Pathology at John Hopkins University and Hospital. Dr. Sidransky has written over 500 peer-reviewed publications, and has contributed to more than 65 cancer reviews and chapters. Dr. Sidransky is a founder of a number of biotechnology companies and holds numerous biotechnology patents. He has been the recipient of many awards and honors, including the 1997 Sarstedt International prize from the German Society of Clinical Chemistry, 1998 Alton Ochsner Award Relating Smoking and Health by the American College of Chest Physicians and the 2004 Hinda Rosenthal Award presented by the American Association of Cancer Research. Dr. Sidransky has served as Vice Chairman of the Board of Directors of ImClone. He is Chairman of the Board of Champions Oncology, Advaxis, and Tamir Biotechnology and is on the Board of Directors of Galmed, Celsus, and Orgenesis. He is serving and has served on scientific advisory boards of corporations and institutions, including Amgen, MedImmune, Roche and Veridex, LLC (a Johnson & Johnson diagnostic company), among others. In Addition, Dr. Sidransky served as Director of American Association for Cancer Research from 2005 to 2008. Dr. Sidransky received his B.A. from Brandeis University and his M.D. from the Baylor College of Medicine.

 

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Gerald Dogon has served as a member of our board of directors since February 2007. From December 2004 to December 2006, Mr. Dogon served as a director and a member of the audit, investment and nomination committees of Scailex Corporation (previously Scitex Corporation). From October 2005 until it was acquired by PMC-Sierra, Inc. in May 2006, he served as a member of the board of directors of Passave, Inc., a semiconductor company. From 1999 to 2000, he served as a director and as chairman of the audit committee of Nogatech, Inc. Mr. Dogon has also served as a member of the board of directors of Fundtech Ltd. and was a member of its audit and nominating committees. From 1994 to 1998, Mr. Dogon served as Executive Vice President and Chief Financial Officer of DSPC Inc., and in addition, from November 1997 until December 1999, as a member of its board of directors. Mr. Dogon holds a B.Comm. in Economics from the University of Cape Town.

 

Tali Yaron-Eldar has served as a member of our board of directors since February 2007. From January 2013, Ms. Yaron-Eldar has served as a partner and founder of Yetax law offices. Between March 2007 and December 2012, Ms. Yaron-Eldar had been a partner with the law firm of Tadmor & Co. From January 2004 to March 2007, she was a partner at the law firm of Cohen, Yaron-Eldar & Co. From January 2004 to January 2008, Ms. Yaron-Eldar served as the Chief Executive Officer of Arazim Investment Company. She has also served in a variety of public positions, including as the Chief Legal Advisor of the Customs and V.A.T department of the Finance Ministry of the State of Israel from 1998 to 2001 and as the Commissioner of Income Tax and Real Property Tax Authority of the State of Israel from 2002 to 2004. Ms. Yaron-Eldar holds an M.B.A. specializing in finance and an LL.M. from Tel Aviv University and is a member of the Israeli Bar Association.

 

B.COMPENSATION

 

Compensation-Related Requirements of the Israeli Companies Law

 

The term “office holder,” is defined in the Israeli Companies Law, 1999 (the “Israeli Companies Law”), as a general manager, general business manager, vice general manager, deputy general manager, any other person fulfilling or assuming any of the foregoing positions even if such person’s title is different, as well as director, or a manager who is directly subordinated to the general manager. Prior to amendment 20 to the Israeli Companies Law that came into effect on December 12, 2012 (“Amendment 20”), the compensation of our office holders required the approval of our audit committee and our Board of Directors, in that order. In addition, all compensation awarded to directors also required the approval of our shareholders by a simple majority. Following Amendment 20, we were required to form a Compensation Committee, whose members needed to comply with certain criteria, as well as to adopt a compensation policy regarding the compensation terms of our Office Holders, which includes direct and indirect compensation, including equity-based awards, exemption from liability, indemnification and insurance, severance and other benefits (“Compensation Terms”).

 

The compensation policy must be approved by the company's board of directors after considering the recommendations of the compensation committee. The compensation policy also requires the approval of the general meeting of shareholders, which approval must satisfy either of the following: (i) the majority of the votes for the approval should include a majority of the votes of the voting shareholders who are non-controlling shareholders or have no personal interest in the approval of the compensation policy (the votes of abstaining shareholders not included in the number of the said total votes) or (ii) the total number of votes against the proposed compensation policy among the shareholders mentioned in paragraph (i) does not exceed 2% of the aggregate voting power in the company. Under certain circumstances and subject to certain exceptions, the board of directors may approve the compensation policy despite the objection of the shareholders, provided that the compensation committee and the board of directors determines that it is for the benefit of the company, following an additional discussion and based on detailed arguments.

 

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The compensation policy must be re-approved every three years, in the manner described above and in addition the board of directors has to review from time to time the compensation policy and whether there are any material changes to the circumstances since the approval of the compensation policy that requires an adjustment of the policy. 

 

Amendment 20 details the considerations that should be taken into account in determining the compensation policy and certain issues and provisions which should be included in the compensation policy.

 

On August 8, 2016, following the favorable recommendation of the Compensation Committee and approval by the Board of Directors, our shareholders approved our updated Compensation Policy for Executive Officers and Directors (the “Compensation Policy”) which replaced the previous compensation policy that was approved by our shareholders on August 5, 2013.

 

Our Compensation Policy is designed to encourage pay for performance and align our executive officers’ interests with those of the Company and our shareholders. Its structure allows us to provide meaningful incentives that reflect both our short and long-term goals and performance, as well as the executive officer’s individual performance and impact on shareholder value, while providing compensation that is competitive in the global marketplace in which we recruit talent and providing for measures designed to reduce incentives to take excessive risks.

 

Pursuant to Amendment 20, any arrangement between the Company and its office holders regarding Compensation Terms must be consistent with the Compensation Policy. However, under certain circumstances, the Company may approve an arrangement that is not consistent with the Compensation Policy, if such arrangement is approved by a majority of the Company’s shareholders, provided that (i) the majority voting for the approval of the arrangement includes a majority of the votes cast by shareholders who are not controlling shareholders and who do not have a personal interest in the matter, (abstentions are disregarded), or (ii) the votes cast by shareholders who are not controlling shareholders and who do not have a personal interest in the matter who voted against the arrangement do not exceed two percent of the voting power of the company.

 

In addition, pursuant to Amendment 20, in general and except for certain exceptions, the Compensation Terms of our office holders require the approval of the Compensation Committee and the Board of Directors. The Compensation Terms of directors further require the approval of the shareholders by a simple majority; with respect to a chief executive officer who is not a director, the approval of our shareholders by the special majority mentioned above is also required. Under certain circumstances, if the Compensation Terms of office holders who are not directors are not approved by the shareholders, the Compensation Committee and the Board of Directors may nonetheless approve such terms.

 

Executive Officers’ Remuneration

 

The aggregate direct compensation we paid to our corporate and executive officers as a group (5 persons) for the year ended December 31, 2016 was approximately $1.1 million of which approximately $102,000 was set aside or accrued to provide for pension, retirement, severance or similar benefits. These amounts do not include expenses we incurred for other payments, including dues for professional and business associations, business travel and other expenses, and other benefits commonly reimbursed or paid by companies in Israel.

 

In 2016, we did not pay bonuses to f our corporate and executive officers during the year.

 

During 2016, we granted to our executive officers:

 

Options to purchase an aggregate amount of 7,333 ordinary shares, at an exercise price of $10.08 per share with an expiration date of February 10, 2026, of which 0 were vested as of December 31, 2016.

 

We did not grant restricted stock units to our executive officers during 2016.

 

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Additional Disclosure Required Under Israeli Law

 

According to section 4(d) of the Companies Regulations (Notification of general assemblies and by-type assemblies in a public company and adding an item to the agenda), 2000, the following table presents information regarding compensation actually received by our five most highly paid executive officers during the year ended December 31, 2016 (in USD):

 

Name and position Salary  Employer
401K*
  Vehicle Expenses  Pension**  Employee Severance benefits  Equity***  Total 
Mr. Ken Berlin
Chief Executive Officer
$500,000  $15,000  $18,000  $-  $-  $411,089  $944,089 
Mr. Ron Kalfus
Chief Financial Officer
 235,000   7,050   -   -   -   20,735   262,785 
Ms. Dganit Bar
Chief Science Officer
 119,925   -   10,022   21,323   -   35,325   186,595 
Ms. Eti Meiri
Vice President, Research
 94,921   -   10,022   20,535   -   24,153   149,630 
Mr. Oded Biran
Chief Legal Officer
 48,116   1,443   2,308   -   55,000   6,726   113,593 

_____________

*401K — in the U.S., this is the tax-qualified, defined-contribution pension account defined in subsection 401(k) of the Internal Revenue Code.
**Pension is provided for Israel based employees only.
***Equity is calculated as the value of options awarded, at the time of grant.
++Mr. Biran ceased being our Chief Legal Officer effective March 6, 2016.

 

 

Directors’ Remuneration

 

Under the directors’ compensation package approved by our audit committee or compensation committee and by our Board and shareholders, each of the Company’s directors (except for the Chairman of the Board who receives higher remuneration as described below) is entitled to receive: (1) US$20,000 plus VAT per year, paid in equal quarterly installments, and a director who serves as a member of a Committee formed by the Board shall be entitled to an additional US$7,500 plus VAT per committee ($22,500 plus VAT per committee for the chairperson of a committee), and (2) a participation fee of US$250 plus VAT for every Board or Board committee meeting including, inter alia, meeting by means of communication (teleconferences) and unanimous written resolutions. In addition, each of the Company’s directors (except for the Chairman of the Board who receives higher remuneration as described below) is entitled to receive: (1) options to purchase 2,000 Ordinary Shares, at an exercise price per share equal to the closing price on the date of the Ordinary Shares on the date of the shareholders meeting approving the options, vesting in equal installments annually over a period of three years beginning on the date of the shareholders meeting approving the options and such options shall expire seven years after their date of grant, unless they expire earlier in accordance with the terms of the Company’s 2006 Employee Incentive Plan (Global Share Incentive Plan (2006)) (the “GSIP”), and (2) 417 Restricted Stock Units (“RSUs”) upon the commencement of each twelve months period in office as a director. In 2013, our shareholders also approved an amendment to the compensation of our directors, so that the annual fee and the participation fee paid to each of the Company’s directors, shall not be less than the minimal annual fee and participation fee applying with respect to external directors under the prevailing laws and regulations, which vary based on the company’s equity. Our directors do not receive any additional benefits upon termination.

 

Under the compensation package approved by our Board and shareholders, Mr. Brian A. Markison, the Chairman of the Board, is entitled to receive: (1) US $25,000 plus VAT per year, paid in equal quarterly installments, and if Mr. Markison shall serve as a member of a Committee formed by the Board, he shall be entitled to an additional US $10,000 plus VAT per committee, and (2) a participation fee of $250 plus VAT for every Board or Board committee meeting including, inter alia, meeting by means of communication and unanimous written resolutions. In addition, Mr. Markison is entitled to receive: (1) options to purchase 4,000 Ordinary Shares, at an exercise price per share equal to the closing price of the Ordinary Shares on the date of the shareholders meeting approving the options, vesting in equal installments annually over a period of three years beginning on the date of the Annual Meeting and such options shall expire seven years after their date of grant, unless they expire earlier in accordance with the terms of the GSIP, and (2) 833 RSUs upon the end of each twelve months period in office as a director.

 

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The options and RSUs granted to our directors and Chairman of the Board are subject to the same terms and conditions as applicable to options and RSUs granted under the GSIP, except that the exercise period of the options and RSUs upon termination shall be six months. We paid an aggregate of $348,000 in direct compensation to our directors for their services as directors for the year ended December 31, 2016, including $69,500 paid in 2017 for service during the fourth quarter of 2016.

 

During 2016, we granted to our directors options to purchase an aggregate amount of 8,000 ordinary shares, at an exercise price of $13.08 per share with an expiration date of August 8, 2023. As of December 31, 2016, there were outstanding options to purchase 98,370 ordinary shares that were granted to our 11 directors and officers, at a weighted average exercise price of $51.15 per share.

 

C.BOARD PRACTICES

 

We are incorporated in Israel, and, therefore, subject to various corporate governance practices under Israeli law relating to such matters as independent directors, the audit committee, the compensation committee, independent auditor and the internal auditor. These matters are in addition to the requirements of The NASDAQ Capital Market and other relevant provisions of U.S. securities laws. Under The NASDAQ Capital Market rules, a foreign private issuer may generally follow its home country rules of corporate governance in lieu of the comparable NASDAQ Capital Market requirements, except for certain matters such as composition and responsibilities of the audit committee and the independence of its members. For U.S. domestic companies, NASDAQ Capital Market rules specify that the board of directors must contain a majority of independent directors within 12 months of its initial public offering. We currently comply with this requirement as well as the committee composition and responsibility requirements with respect to our committees. In addition, under the Companies Law, we were required to appoint at least two external directors that meet requirements and qualifications as set forth in the Companies Law. Gerald Dogon and Tali Yaron-Eldar were appointed as our external directors, each of whom is also independent under the rules of The NASDAQ Capital Market. Mr. Dogon and Ms. Yaron-Eldar were re-elected as external directors by a general meeting on August 5, 2013 for three-year terms. According to an amendment to regulations enacted under the Companies Law that became effective on April 2016, an Israeli company whose shares are listed for trading on specified exchanges outside of Israel including the NASDAQ Capital Market, that do not have a controlling shareholder and that comply with the laws of the jurisdiction in which its shares are listed with respect to the appointment of independent directors and the composition of audit and compensation committees as such laws apply to companies incorporated in such jurisdiction, may elect not to be subject to the provisions of the Companies Law with respect to the appointment of external directors and with respect to the composition, quorum and presence at meetings of the audit and compensation committees. Following such amendment, on May 18, 2016, the Board has resolved that the Company will not be required to comply with the above provisions of the Companies Law and as of such date Gerald Dogon and Tali Yaron-Eldar continued their term in office without the status of external director.

 

Board of Directors

 

Our board of directors currently consists of seven directors. Our directors are elected at an annual meeting or an extraordinary meeting, as stated in our Articles of Association (the “Articles”) by a vote of the holders of a majority of the voting power represented at a meeting of our shareholders and voting on the election of directors. The Articles provide that we may have no less than two and no more than seven directors. According to regulations enacted under the Companies Law, if, at the time of election of a director, all other directors are of the same gender, the director to be elected must be of the other gender.

 

In accordance with our Articles, our board of directors is divided into three classes of directors, with one class being elected each year for a term of approximately three years. At each annual general meeting of shareholders, the successors to directors whose term then expires will be elected to serve from the time of election and qualification until the third annual meeting of shareholders following election. Our directors are divided among the three classes as follows:

 

·the Class I directors are Brian A. Markison and his term expires at the annual general meeting of shareholders to be held in 2017;

 

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·the Class II directors are Dr. David Sidransky and Dr. Joshua Rosensweig, and their terms expire at the annual general meeting of shareholders to be held in 2018; and

 

·the Class III directors are Roy N. Davis, Gerald Dogon and Tali Yaron-Eldar, and their terms expire at the annual general meeting of shareholders to be held in 2019.

 

In accordance with our Articles, the approval of at least 75% of the voting rights represented at a general meeting is generally required to remove any of our directors from office, elect directors instead of directors so removed or fill any vacancy created in our board of directors. In addition, in case of vacancies on the board of directors, the continuing directors may generally continue to act in every matter and may appoint directors to temporarily fill any such vacancy.

 

Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of one-third of the directors.

 

Our Articles provide, as allowed by Israeli law, that any director may, by written notice to us, appoint another natural person to serve as an alternate director (subject to the consent of the board of directors) and may cancel such appointment. Unless the appointing director limits such appointment to a specified period of time or restricts it to a specified meeting or action of the board of directors, or otherwise restricts its scope, the appointment shall be for all purposes and for a period of time concurrent with the term of the appointing director. Currently, no alternate directors have been appointed. The Companies Law stipulates that a person not qualified to be appointed as a director, shall not be appointed and shall not serve as alternate director. In addition, a person who serves as a director shall not be appointed and shall not serve as an alternate director except under very limited circumstances, which are not relevant to our company. An alternate director has the same responsibilities as a director. Under the Companies Law, and our Articles, a director that is a member of a committee of the board of directors, may appoint as his alternate director on such committee of the board of directors another member of the board of directors, provided that such director is not already a member of such committee. In addition, an independent director cannot appoint as his alternate director a person who is not qualified to be appointed as an independent director.

 

Board Committees

 

Our board of directors has established an audit committee, a compensation committee, a nominating and governance committee and a research and development committee.

 

Audit Committee

 

Under the listing requirements of The NASDAQ Capital Market, a foreign private issuer is required to maintain an audit committee that has certain responsibilities and authority, including being directly responsible for the appointment, compensation, retention and oversight of the work of the issuer’s independent auditors. The members of the audit committee are required to meet the independence requirements established by the SEC in accordance with the requirements of the Sarbanes-Oxley Act. The rules of The NASDAQ Capital Market also require that at least one member of the audit committee be a financial expert. Our audit committee is comprised of three members and meets the listing requirements of The NASDAQ Capital Market and the SEC.

 

As noted above, following the April 2016 amendment to the Companies Law, the Board, on May 18, 2016, resolved that the Company will not be required to comply with the Companies Law (which include the provisions of the Companies Law with respect to the composition of the audit committee).

 

Our audit committee provides assistance to the board of directors in fulfilling its responsibility to our shareholders relating to our accounting, financial reporting practices, and the quality and integrity of our financial reports. The audit committee also oversees consultants and experts providing the company with consulting services concerning risk management and internal control structure, pre-approves the services performed by our independent auditors and oversees that management has established and maintains processes to assure compliance by the Company with all applicable laws, regulations and corporate policies. The audit committee also oversees and ensures the independence of our independent auditors.

 

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The responsibilities of the audit committee under the Companies Law include: (a) identifying deficiencies in the management of a company’s business, including by consulting with the internal auditor or with the independent auditor (and in case that the deficiency is a significant one – the committee shall convene), and making recommendations to the board of directors as to how to modify them; (b) decide for the purpose of the approval of actions involving fiduciary duties of the company's office holders, whether such actions are material or non-material actions and for the purpose of the approval of certain related party transactions, whether such transactions are extraordinary transactions or non-extraordinary transactions; (c) with respect to transactions with controlling shareholders, to determine the obligation to perform a competitive process that shall be supervised by the audit committee; (d) to decide whether to approve related parties transactions and actions involving fiduciary duties of the company’s office holders; (e) to determine the process in which non-negligible transactions with a controlling shareholder shall be approved and to determine the type and kind of such transactions that shall require the approval of the audit committee; (f) to review the internal auditor’s work program before it is brought for the approval of the board; (g) to examine the company’s internal control structure and processes, the performance of the internal auditor and whether the internal auditor has at his or her disposal the tools and resources required to perform his or her duties, considering, inter alia, the special needs of the company and its size; (h) to examine the independent auditor’s scope of work as well as the independent auditor’s fees and to provide the corporate organ responsible for determining the independent auditor’s fees with its recommendations; (i) be responsible for providing for arrangements as to the manner in which the Company will deal with employee complaints with respect to deficiencies in the administration of the Company’s business and the protection to be provided to such employees.

 

Gerald Dogon, Tali Yaron-Eldar and Dr. David Sidransky are the current members of our audit committee. Each of these persons is an “independent director” in accordance with the NASDAQ listing standards.

 

Compensation Committee

 

Our compensation committee reviews and provides our board of directors with recommendations relating to compensation and benefits of our officers and key employees and assists the board of directors with establishing, overseeing and/or administering incentive compensation and equity based plans. The compensation committee reviews corporate goals and objectives set by our board that are relevant to compensation of the Chief Executive Officer, evaluates the performance of the Chief Executive Officer in light of those goals and objectives, and recommends to the board of directors the Chief Executive Officer’s compensation based on such evaluations, subject to additional approvals, to the extent required pursuant to the Companies Law. The compensation committee also reviews and makes recommendations for approvals to the board of directors, subject to additional approvals, to the extent required pursuant to the Companies Law, with respect to the compensation of directors, executive officers other than the Chief Executive Officer and key employees. The members of our compensation committee are, Gerald Dogon, Tali Yaron-Eldar and Joshua Rosensweig.

 

As noted above, following the April 2016 amendment to the regulations enacted under the Companies Law, the Board, on May 18, 2016, resolved that the Company will not be required to comply with certain provisions of the Companies Law (which include the provisions of the Companies Law with respect to the composition of the compensation committee).

 

The roles of the compensation committee under the Companies Law are, to: (1) recommend to the board of directors on the Compensation Policy for office holders, and recommend to the board once every three years regarding the extension of a Compensation Policy that had been approved for a period of more than three years; (2) recommend to the board of directors on periodic updates to the Compensation Policy, from time to time, and examine its implementation; (3) decide whether to approve the terms of office and of employment of office holders that require approval of the Compensation Committee; and (4) decide, in certain circumstances, and subject to certain terms whether to exempt the approval of terms of office of a proposed CEO from the requirements of shareholders’ approval.

 

Nominating and Governance Committee

 

The nominating and governance committee is responsible for making recommendations to the board of directors regarding candidates for directorships and the composition of our board of directors and its committees as well as to evaluate and consider matters relating to the qualifications of directors. In addition, the nominating and governance committee is responsible for reviewing and reassessing our corporate governance guidelines and making recommendations to the board of directors concerning governance matters. The members of our nominating and governance committee are Brian Markison and Dr. Joshua Rosensweig. Our board of directors has determined that the members of our nominating and governance committee are independent under the applicable NASDAQ Capital Market rules.

 

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Pursuant to our Articles, nominations for the election of directors may be made by the board of directors or a committee appointed by the board of directors or by any shareholder holding at least 1% of the outstanding voting power in the Company. However, any such shareholder may nominate one or more persons for election as directors at a general meeting only if a written notice of such shareholder’s intent to make such nomination or nominations has been delivered to us as required under our Articles.

 

Research and Development Committee

 

The research and development committee is responsible for liaising between the Company’s research and development team and the board of directors. This committee is also responsible for reviewing proposed research and development projects, as well as our research and development focus and making recommendations to the board of directors regarding the research and development projects which we intend to undertake as well as recommendations relating to our pipeline. The members of our research and development committee are Roy Davis and Dr. David Sidransky.

 

Internal Auditor

 

Under the Companies Law, the board of directors must appoint an internal auditor recommended by the audit committee. On May, 7, 2007, we appointed Yardeni Gelfand as our internal auditor. The role of the internal auditor is to examine, among other things, whether a company’s actions comply with applicable law and orderly business procedure. Under the Companies Law, the internal auditor may not be an interested party or an office holder, or a relative of an interested party or an office holder, nor may the internal auditor be the company’s independent auditor or anyone on his behalf. An interested party is defined in the Companies Law as a holder of 5% or more of the Company’s outstanding shares or voting rights, any person or entity who has the right to designate one director or more or the chief executive officer of the company or any person who serves as a director or as a chief executive officer. The internal auditor’s tenure cannot be terminated without his or her consent, nor can he or she be suspended from such position unless the board of directors has so resolved after hearing the opinion of the audit committee and after giving the internal auditor the opportunity to present his or her case to the board and to the audit committee.

 

Approval of Specified Related Party Transactions Under Israeli Law

 

See “Item 10 — Additional Information — B. Memorandum and Articles of Association — Fiduciary Duties of Office Holders”, “— Disclosure of Personal Interests of an Office Holder” and “—Transactions Requiring Special Approval” for a discussion of the requirements of Israeli law regarding the fiduciary duties of the office holders of the company, including directors and executive officers, and their duties to disclose any personal interest that such person may have and all related material information known to him or her relating to any existing or proposed transaction by the company, as well as transactions that require special approval.

 

D.EMPLOYEES

 

We had 86 and 77 employees as of December 31, 2016 and 2015, respectively. Of the 86 employees as of December 31, 2016, 47 were engaged in research and development and in our CLIA lab activities and 39 were engaged in management, administration, business development, marketing and finance. 66 employees were located in the United States and 20 were located in Israel.

 

The Israeli labor laws govern the employment of employees located in Israel. These statutes cover a wide range of subjects and provide certain minimum employment standards including the length of the workday, minimum wage, hiring and dismissal procedures, determination of severance pay, annual leave, sick days and other terms of employment.

 

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We contribute monthly amounts for the benefit and on behalf of all our employees located in Israel to a Managers Insurance plan and/or a pension fund. In General, according to the Israeli Severance Pay Law, the severance pay liability of the company to its Israeli employees is based upon the number of years of employment and the latest monthly salary. Nevertheless, since our contributions to the Managers Insurance plan and/or the pension fund are made pursuant to section 14 of the Israeli Severance Pay Law, our liability for severance pay is covered by our regular contributions to the Managers Insurance plan and the pension fund.

 

We have never experienced labor-related work stoppages and believe that our relations with our employees are good.

 

E.SHARE OWNERSHIP

 

The following table sets forth, as of March 1, 2017, the number of our ordinary shares beneficially owned by (i) each of our directors and corporate and executive officers and (ii) our current directors and corporate and executive officers as a group. The information in this table is based on 1,868,121 ordinary shares outstanding as of March 1, 2017. Beneficial ownership of shares is determined in accordance with the rules of the SEC and generally includes any shares over which a person exercises sole or shared voting or investment power. Ordinary shares that are subject to convertible securities, warrants or options that are currently convertible or exercisable or convertible or exercisable within 60 days of March 1, 2017 are deemed to be outstanding and beneficially owned by the person holding the convertible securities, warrants or options for the purpose of computing the percentage ownership of that person, but are not treated as outstanding for the purpose of computing the percentage of any other person.

 

Name of Beneficial Owner  Number of Shares
Beneficially Owned
   Percentage of
Outstanding
Ordinary Shares
 
Kenneth A. Berlin (1)   37,315    1.96%
Ron Kalfus(2)   2,207    * 
Dganit Bar, Ph.D.(3)   3,556    * 
Eti Meiri (4)   2,001    * 
Sigal Russo-Gueta (5)   961    * 
Brian Markison (6)   8,752    * 
Roy N. Davis(7)   2,834    * 
Joshua Rosensweig (8)   3,028    * 
Dr. David Sidransky (9)   3,540    * 
Gerald Dogon (10)   2,417    * 
Tali Yaron-Eldar (11)   2,417    * 
Total directors and executive officers as a group (11 persons)   69,028    3.58%

________________

* Less than 1%

 

(1)Consists of (i) 91 ordinary shares, which were granted to Mr. Berlin upon the start of his employment with us, 824 shares, which were granted as RSUs and converted to shares in 2013, and 506 shares which were granted as RSUs in 2014 and converted to shares in 2015 and 2016(ii) options currently exercisable or exercisable within 60 days of March 1, 2017 to purchase 695 ordinary shares (which have an exercise price of $1,476 per share and expire in November 2019), 696 ordinary shares (which have an exercise price of $352.8 per share and expire in November 2019), 556 ordinary shares (which have an exercise price of $81 per share and expire in November 2021), 8,000 ordinary shares (which have an exercise price of $64.44 per share and expire in October 2022), 13,003 ordinary shares (which have an exercise price of $40.92 per share and expire in August 2023) , 4,688 ordinary shares (which have an exercise price of $33.48 per share and expire in November 2024) and 6,303 ordinary shares (which have an exercise price of $13.92 per share and expire in December 2022). Does not include the following options that become exercisable after April 30, 2017: (i) 1,858 ordinary shares (which have an exercise price of $40.92 per share and expire in August 2023) (ii) 3,646 ordinary shares (which have an exercise price of $33.48 per share and expire in November 2024) (iii) 12,032 ordinary shares (which have an exercise price of $13.92 per share and expire in December 2022), (iv) 834 RSUs (which will vest in equal instalments annually over a period of four years and complete convert to shares in November 2018).

 

 

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(2)Consists of (i) 250 shares, which were granted as RSUs and converted to shares in 2013, and 250 shares, which were granted as RSUs and converted to shares in 2015 and (ii) options currently exercisable or exercisable within 60 days of March 1, 2017 to purchase 834 ordinary shares (which have an exercise price of $64.44 per share and expire in October 2022), and 352 ordinary shares (which have an exercise price of $30.84 per share and expire in December 2024), and 521 ordinary shares (which have an exercise price of $10.08 and expire on February 2026). Does not include the following options that become exercisable after April 30, 2017: (i) options to purchase 274 shares (which have an exercise price of $30.84 per share and expire in December 2024), and options to purchase 1,563 shares (which have an exercise price of $10.08 per share and expire in February 2026), and options to purchase 13,125 shares (which have an exercise price of $6.72 per share and expire in December 2027).

 

(3)Consists of (i) 417 shares, which were granted as RSUs and converted to shares in 2013 and 417 shares, which were granted as RSUs and converted to shares in 2015 (ii) options currently exercisable or exercisable within 60 days of March 1, 2017 to purchase 1,667 ordinary shares (which have an exercise price of $62.52 per share and expire in October 2022), and 430 ordinary shares (which have an exercise price of $30.84 per share and expire in December 2024) and 625 ordinary shares (which have an exercise price of $10.08 and expire on February 2026). Does not include the following options that become exercisable after April 30, 2017: (i) options to purchase 335 shares (which have an exercise price of $30.84 per share and expire in December 2024) and (ii) options to purchase 1,875 shares (which have an exercise price of $10.08 per share and expire in February 2026).

 

(4)Consists of (i) 282 shares which were granted as RSUs and converted to shares in the years 2014 and 2015 (ii) 2 shares, which were granted as options and converted to shares in 2014 and (iii) options currently exercisable or exercisable within 60 days of March 1, 2017 to purchase 3 ordinary shares (which have an exercise price of $2,995.20 per share and expire in June 2018), 7 ordinary shares (which have an exercise price of $1,008 per share and expire in October 2020), 834 shares (which have an exercise price of $64.44 per share and expire in October 2022), 352 ordinary shares (which have an exercise price of $30.84 per share and expire in December 2024), and 521 ordinary shares (which have an exercise price of $10.08 per share and expire in February 2026). Does not include the following options that become exercisable after April 30, 2017: (i) options to purchase 274 shares (which have an exercise price of $30.84 per share and expire in December 2024) and (ii) 1,563 shares (which have an exercise price of $10.08 per share and expire in October 2026), and (iii) 219 RSUs (which will vest in equal installment quarterly over a period of 4 years and complete convert to shares in October 2018).

 

(5)Consists of (i) 250 shares, which were granted as RSUs and converted to shares in 2015 and (ii) options currently exercisable or exercisable within 60 days of March 1, 2017 to purchase 9 ordinary shares (which have an exercise price of $1,605.60 per share and expire in March 2019), 417 ordinary shares (which have an exercise price of $51.24 per share and expire in December 2022), and 118 ordinary shares (which have an exercise price of $30.84 per share and expire in December 2024), and 167 ordinary shares (which have an exercise price of $10.08 per share and expire in February 2026) . Does not include the following options that become exercisable after April 30, 2017: (i) options to purchase 92 shares (which have an exercise price of $30.84 per share and expire in December 2024), and (ii) options to purchase 500 shares (which have an exercise price of $10.08 per share and expire in February 2026).

  

(6)Consists of (i) 1,668 shares, which were granted as RSUs and converted to shares in the years 2013 and 2014 and (ii) options currently exercisable or exercisable within 60 days of March 1, 2017 to purchase 417 ordinary shares (which have an exercise price of $194.4 per share and expire in July 2021), 4,000 ordinary shares (which have an exercise price of $64.44 per share and expire in October 2019), and 2,667 ordinary shares (which have an exercise price of $33.24 per share and expire in November 2021). Does not include the following options that become exercisable after April 30, 2017: 1,334 ordinary shares (which have an exercise price of $33.24 per share and expire in November 2021).

  

(7)Consists of (i) 834 shares, which were granted as RSUs and converted to shares in the years 2013 and 2014 and (ii) options currently exercisable or exercisable within 60 days of March 1, 2017 to purchase 2,000 ordinary shares (which have an exercise price of $64.44 per share and expire in October 2019). Does not include the following options that become exercisable after April 30, 2017: 2,000 ordinary shares (which have an exercise price of $13.08 per share and expire in August 2023).

 

(8)Consists of (i) 194 ordinary shares held by Dr. Rosensweig, (ii) 834 shares, which were granted as RSUs and converted to shares in the years 2013 and 2015 and (iii) options currently exercisable or exercisable within 60 days of March 1, 2017 to purchase 2,000 ordinary shares (which have an exercise price of $64.44 per share and expire in October 2019). Does not include the following options that become exercisable after April 30, 2017: 2,000 ordinary shares (which have an exercise price of $13.08 per share and expire in August 2023).

 

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(9)Consists of (i) 834 shares, which were granted as RSUs and converted to shares in the years 2013 and 2014 and (ii) options currently exercisable or exercisable within 60 days of March 1, 2017 to purchase 21 ordinary shares (which have an exercise price of $4,104 per share and expire in January 2018), 18 ordinary shares (which have an exercise price of $1,188 per share and expire in December 2019), 2,000 shares (which have an exercise price of $64.44 per share and expire in October 2019), and 667 shares (which have an exercise price of $13.92 per share and expire in December 2022). Does not include the following options that become exercisable after April 30, 2017: 1,334 ordinary shares (which have an exercise price of $13.92 per share and expire in December 2022).

 

(10)Consists of (i) 417 shares, which were granted as RSUs and converted to shares in 2014 (ii) options currently exercisable or exercisable within 60 days of March 1, 2017 to purchase 2,000 ordinary shares (which have an exercise price of $40.92 per share and expire in August 2020). Does not include the following (i) options that become exercisable after April 30, 2017: options to purchase 2,000 ordinary shares (which have an exercise price of $13.08 per share and expire in August 2023).

 

(11)Consists of (i) 417 shares, which were granted as RSUs and converted to shares in 2014 (ii) options currently exercisable or exercisable within 60 days of March 1, 2017 to purchase 2,000 ordinary shares (which have an exercise price of $40.92 per share and expire in August 2020). Does not include the following (i) options that become exercisable after April 30, 2017: options to purchase 2,000 ordinary shares (which have an exercise price of $13.08 per share and expire in August 2023).

 

Employee Benefit Plans

 

2003 Israeli Share Option Plan

 

In March 2003, we adopted the Rosetta Genomics Ltd. 2003 Israeli Share Option Plan, or the 2003 Plan. The 2003 Plan provided for the grant of options to our directors, employees, consultants and service providers, and to the directors, employees, consultants and service providers of our subsidiary and affiliates. Upon shareholder approval of the 2006 Global Share Incentive Plan, or 2006 Plan, in July 2006, the 2003 Plan was terminated and the 447 ordinary shares that were available for issuance under the 2003 Plan were transferred to the 2006 Plan. However, all outstanding options granted under the 2003 Plan remain outstanding and subject to the terms of the 2003 Plan. Any options that were granted under the 2003 plan and that are canceled are transferred to the 2006 Plan. As of March 1, 2017, zero options to purchase ordinary shares have been previously granted and remain outstanding under the 2003 Plan and 576 shares have been previously issued pursuant to the exercise of options granted under the 2003 Plan.

 

2006 Global Share Incentive Plan

 

The 2006 Global Share Incentive Plan, or the 2006 Plan, was approved in July 2006. In November 2007, our board of directors approved an additional 695 shares under the 2006 Plan. In December 2009, our shareholders approved an additional 2,084 shares under the 2006 Plan. In October 2012, our shareholders approved an additional 71,148 shares under the 2006 Plan. In November 2014, our shareholders approved an additional 75,000 shares under the 2006 Plan. In December 2015, our shareholders approved an additional 41,667 shares under the 2006 Plan. As of March 1, 2017, there were 16,562 shares available for grant under the 2006 Plan, 19,648 shares have been issued pursuant to the exercise of options and vesting of RSUs granted under the 2006 Plan, and options and RSUs to purchase 175,478 ordinary shares and 2,308 ordinary shares have been granted and are outstanding under the 2006 Plan, respectively. The 2006 Plan, and its appendices for grantees subject to U.S. taxation and grantees subject to Israeli taxation, provides for the grant of options to our directors, employees, consultants and office holders and those of our subsidiary and affiliates.

 

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Administration of Our Employee Benefit Plans

 

Our employee benefit plans are administered by our compensation committee, which makes recommendations to our board of directors regarding the grant of options and the terms of the grant, including, exercise price, method of payment, vesting schedule, acceleration of vesting and the other matters necessary in the administration of these plans. Options granted under the 2003 Plan and the 2006 Plan to eligible employees and office holders who are Israeli residents may be granted under Section 102(b)(2) of the Israel Income Tax Ordinance pursuant to which the options or the ordinary shares issued upon their exercise must be allocated or issued to a trustee and be held in trust for a minimum requisite period, which is currently two years from the date of grant. Under Section 102, any tax payable by an employee from the grant or exercise of the options is deferred until the transfer of the options or ordinary shares by the trustee to the employee or upon the sale of the options or ordinary shares and gains are generally subject to a capital gains tax of 25%, provided, however, that in accordance with Section 102(b)(3) of the Israel Income Tax Ordinance, if the exercise price of the options is lower than the average closing price of the shares in the 30 trading days preceding the grant, the difference between such average closing price and the exercise is taxed as ordinary employment income rates.

 

Options to be granted under the 2006 Plan to U.S. residents may qualify as incentive stock options within the meaning of Section 422 of the Code. The exercise price for incentive stock options must not be less than the fair market value on the date the option is granted, unless otherwise approved by our board of directors and shareholders, or 110% of the fair market value if the option holder holds more than 10% of our share capital.

 

Options granted under our employee benefit plans generally vest over three or four years, and they generally expire ten years from the date of grant. If we terminate the employment or engagement of a participant under the 2006 Plan for cause, all of such participant’s vested and unvested options expire immediately upon the date of such termination for cause unless specified otherwise in the award agreement. Upon termination of employment for any other reason, including due to death or disability of the participant, vested options may be exercised within three months of the date of termination, unless otherwise determined in the award agreement. Vested options not exercised within the prescribed period and options which have expired prior to vesting are available for future grants under the 2006 plan.

 

In the event of a change of control, or merger, consolidation, reorganization or similar transaction resulting in the acquisition of at least 50% of our voting power, or the sale of all or substantially all of our shares or assets, the options will be assumed or substituted by the acquiring entity, or if the acquiring party does not provide for such assumption or substitution, then the options shall be subject to acceleration.

 

ITEM 7.MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

A.MAJOR SHAREHOLDERS

 

On March 4, 2016, entities and individuals affiliated with Dolphin Offshore Partners, L.P. (collectively, “Dolphin”) filed a Schedule 13D with the SEC disclosing beneficial ownership of 92,895 of our ordinary shares (including 17,362 shares issuable upon exercise of warrants) as of February 24, 2016. This represents approximately 5% of our outstanding ordinary shares as of December 31, 2016. Based on a review of required SEC filings, we are not aware of any other person or entity that is the beneficial owner of more than 5% of our outstanding ordinary shares.

 

Our ordinary shares are traded on the NASDAQ Capital Market in the United States. A significant portion of our shares are held in street name, therefore we generally have no way of determining who our shareholders are, their geographical location or how many shares a particular shareholder owns.

 

Control of Registrant

 

To our knowledge, we are not directly or indirectly owned or controlled by another corporation, by any foreign government, or by any other natural or legal person. As of March 1, 2017, our officers and directors as a group beneficially owned 3.58% of our outstanding ordinary shares.

 

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B.RELATED PARTY TRANSACTIONS

 

Other than transactions related to compensation of our officers and directors as described under “Item 6. Directors, Senior Management and Employees—B. Compensation,” since January 1, 2015, we have not entered into any related party transactions.

 

Exemption, Indemnification and Insurance

 

Our Articles permit us to exempt from liability, indemnify and insure our directors and officers to the fullest extent permitted by the Companies Law. An undertaking provided in advance by an Israeli company to indemnify an office holder with respect to a financial liability imposed on or incurred by him or her in favor of another person pursuant to a judgment, settlement or arbitrator’s award approved by a court must be limited to events which in the opinion of the board of directors can be foreseen based on the company’s activities when the undertaking to indemnify is given, and to an amount or criteria determined by the board of directors as reasonable under the circumstances, and such undertaking shall detail the abovementioned events and amount or criteria. In addition, a company may indemnify an office holder against the following liabilities incurred for acts performed as an office holder:

 

reasonable litigation expenses, including attorneys’ fees, incurred by the office holder as a result of an investigation or proceeding instituted against him or her by an authority authorized to conduct such investigation or proceeding, provided that (i) no indictment was filed against such office holder as a result of such investigation or proceeding; and (ii) either (A) no financial liability was imposed upon him or her as a substitute for the criminal proceeding as a result of such investigation or proceeding or, (B) if such financial liability was imposed, it was imposed with respect to an offense that does not require proof of criminal intent or with respect to monetary sanction; and

reasonable litigation expenses, including attorneys’ fees, incurred by the office holder or imposed by a court in proceedings instituted against him or her by the company, on its behalf or by a third party or in connection with criminal proceedings in which the office holder was acquitted or criminal proceedings in which the office holder was convicted in an offense that does not require proof of criminal intent.

 

An Israeli company may insure an office holder against the following liabilities incurred for acts performed as an office holder:

 

a breach of duty of loyalty to the company, to the extent that the office holder acted in good faith and had a reasonable basis to believe that the act would not prejudice the company;

a breach of duty of care to the company or to a third party; and

a financial liability imposed on the office holder in favor of a third party.

 

An Israeli company may not indemnify or insure an office holder against any of the following:

 

a breach of duty of loyalty, except to the extent that the office holder acted in good faith and had a reasonable basis to believe that the act would not prejudice the company;

a breach of duty of care committed intentionally or recklessly, excluding a breach arising out of the negligent conduct of the office holder;

an act or omission committed with intent to derive illegal personal benefit; or

a fine, monetary sanction, forfeit or penalty levied against the office holder.

 

As of the effective date of Amendment no. 20 to the Companies Law, exemption of liability, indemnification and insurance of office holders are included in the definition of “terms of office and of employment” and as such must be approved in a specific manner, as noted below under “Item 10 – Additional Information – B. Memorandum and Articles of Association - Directors’ and Officers’ Compensation.”

 

Our directors and officers are currently covered by a directors’ and officers’ liability policy and our legal department is currently covered by a legal professional liability policy as well. We have also resolved to provide directors and certain other office holders with indemnification from any liability for damages caused as a result of a breach of duty of care and to provide such directors and other office holders with an exemption, to the fullest extent permitted by law, all in accordance with and pursuant to the terms set forth in our standard indemnification undertaking.

 

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C.INTERESTS OF EXPERTS AND COUNSEL

 

Not applicable.

 

ITEM 8.FINANCIAL INFORMATION

 

A.CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

 

Consolidated Financial Statements

 

Our consolidated financial statements and related notes are included in this Annual Report beginning on page F-1. See also Item 18.

 

Legal Proceedings

 

We are currently not a party to any material legal proceedings.

 

Dividend Policy

 

To date, we have not declared or paid cash dividends on any of our shares, and we have no current intention of paying any cash dividends in the near future.

 

The Companies Law also restricts our ability to declare dividends. We can only distribute dividends from profits (as defined in the Companies Law), or, if we do not meet the profits test, with court approval provided in each case that there is no reasonable concern that the dividend distribution will prevent the company from meeting its existing and foreseeable obligations as they come due. The payment of dividends may be subject to Israeli withholding taxes.

 

B.SIGNIFICANT CHANGES

 

None

 

ITEM 9.THE OFFER AND LISTING

 

A.OFFER AND LISTING DETAILS

 

Our ordinary shares began trading on The NASDAQ Global Market on February 27, 2007 under the symbol “ROSG.” On June 30, 2010, we transferred the listing of our ordinary shares from The NASDAQ Global Market to The NASDAQ Capital Market. Prior to February 27, 2007, there was no established public trading market for our ordinary shares. The high and low sales prices per share of our ordinary shares for the periods indicated are set forth below. This information reflects the 1-for-4 reverse stock split effected on July 6, 2011, the 1-for-15 reverse stock split effected on May 14, 2012, and the 1-for-12 reverse stock split effected on March 16, 2017.

 

Year Ended  High   Low 
December 31, 2012  $281.16   $16.80 
December 31, 2013  $71.76   $28.20 
December 31, 2014  $80.28   $24.84 
December 31, 2015  $53.76    12.60 
December 31, 2016  $18.00   $5.04 
           
Quarter Ended          
March 31, 2015  $42.60   $27.48 
June 30, 2015  $53.76   $34.80 
September 30, 2015  $41.28   $26.40 
December 31, 2015  $32.16   $12.60 
March 31, 2016  $18.00   $9.24 
June 30, 2016  $16.20   $12.60 
September 30, 2016  $13.68   $9.84 
December 31, 2016  $9.84   $5.04 
           
Month Ended          
September 30, 2016  $11.88   $9.84 
October 31, 2016  $9.84   $6.60 
November 30, 2016  $9.36   $7.20 
December 31, 2017  $7.44   $5.04 
January 31, 2017  $6.84   $5.40 
February 28, 2017  $6.00   $5.40 

 

 

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B.PLAN OF DISTRIBUTION

 

Not applicable.

 

C.MARKETS

 

Our ordinary shares are traded only in the United States on The NASDAQ Capital Market.

 

D.SELLING SHAREHOLDERS

 

Not applicable.

 

E.DILUTION

 

Not applicable.

 

F.EXPENSES OF THE ISSUE

 

Not applicable.

 

ITEM 10.ADDITIONAL INFORMATION

 

A.SHARE CAPITAL

 

Not applicable.

 

B.MEMORANDUM AND ARTICLES OF ASSOCIATION

 

Objects and Purposes

 

We were first registered under Israeli law on March 9, 2000. Our registration number with the Israel Registrar of Companies is 51-292138-8. The objective stated in Section 3 of our Articles is to carry on any business and perform any act which is not prohibited by law.

 

Fiduciary Duties of Office Holders

 

An “office holder” is defined in the Companies Law as a general manager, general business manager, vice general manager, deputy general manager, or any other person fulfilling or assuming any of the foregoing positions without regard to such person’s title, as well as a director, or a manager directly subordinate to the managing director.

 

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The Companies Law imposes a duty of care and a duty of loyalty on all office holders of a company. The duty of care requires an office holder to act with the standard of skills with which a reasonable office holder in the same position would have acted under the same circumstances. The duty of care includes a duty to use reasonable means to obtain, considering the relevant circumstances:

 

·information regarding the business advisability of a given action brought for his or her approval or performed by him or her by virtue of his or her position; and

·all other information of importance pertaining to the aforesaid actions.

 

The duty of loyalty requires an office holder to act in good faith and for the benefit of the company and includes a duty to:

 

·refrain from any act involving a conflict of interest between the fulfillment of his or her role in the company and the fulfillment of any other role or his or her personal affairs;

·refrain from any activity that is competitive with the business of the company;

·refrain from exploiting any business opportunity of the company with the aim of obtaining a personal gain for himself or herself or others; and

·disclose to the company all information and provide it with all documents relating to the company’s affairs which the office holder has obtained due to his position in the company.

 

Each person listed in the table under “Item 6 - Directors, Senior Management and Employees - A. Directors and Senior Management” is an office holder.

 

Disclosure of Personal Interests of an Officer Holder

 

The Companies Law requires that an office holder disclose to the company any personal interest that he or she may have, and all related material information and documents known to him or her, in connection with any existing or proposed transaction by the company. The disclosure is required to be made promptly and in any event, no later than the board of directors meeting in which the transaction is first discussed. “Personal interest”, is defined by the Companies Law, as a personal interest of a person in an act or transaction of the company, including a personal interest of his or her relative or of a corporate body in which that person or his relative holds 5% or more of the outstanding shares or voting rights, is a director or general manager, or in which either of them has the right to appoint at least one director or the general manager. “Personal interest” does not apply to a personal interest stemming merely from the fact that the office holder is also a shareholder in the company. The term “personal interest” also includes the personal interest of a person voting under a proxy given by another person, even if such appointing person has no personal interest in the proposed act or transaction. In addition, the vote of a person voting under a proxy given by a person having a personal interest in the proposed act or transaction, even if the person voting under the proxy has no personal interest, shall be deemed as a vote made by a person having a personal interest in the proposed act or transaction. The Companies Law defines a “relative” as a person’s spouse, sibling, parent, grand parent or descendent, as well as the descendant, sibling or parent of a person’s spouse, or the spouse of any of the foregoing.

 

Notwithstanding the above, if the transaction is not an extraordinary transaction, the office holder is not required to disclose any personal interest that he or she has solely as a result of a personal interest of his or her relative in the transaction.

 

Transactions Requiring Special Approval

 

Under the Companies Law, an extraordinary transaction is a transaction:

 

·not in the ordinary course of business of the company;

·not on market terms; or

·likely to have a material impact on the company’s profitability, assets or liabilities.

 

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Under the Companies Law, certain transactions require special approvals, provided however that such transactions are for the benefit of the company. A transaction, between the company and an office holder, or between the company and a third party in which the office holder has a personal interest, must be approved by the board, subject to the provisions of the company’s articles of association. If the transaction is an extraordinary transaction, then it also must be approved by the audit committee, prior to the approval of the board of directors. Any engagement between a company and any one of its office holders with respect to terms of office and/or employment by the company, including with respect to the grant of exemption from liability, indemnification or insurance would generally require compensation committee and board of directors’ approval, and in some cases followed by approval of the general meeting, all as noted below under “Directors’ and Officers’ Compensation.” Generally, any person having a personal interest in the approval of a transaction which is considered at a meeting of the board of directors or the audit committee, may not be present at such meeting or participate in the vote on such transaction, provided however that an office holder having a personal interest in a transaction may be present in order to present such transaction, if the chairman of the audit committee or of the board of directors, as applicable, determine that the presence of such office holder is required for the presentation of the transaction. Notwithstanding the foregoing, a director may be present at such meeting and may participate in the vote on such transaction, if the majority of the board of directors or the audit committee, as applicable, has a personal interest in the transaction. If a majority of the directors have a personal interest in a transaction, shareholder approval is also required.

 

Under the Companies Law, the disclosure requirements which apply to an office holder also apply to a controlling shareholder of a public company. For these purposes, a controlling shareholder is any shareholder that has the ability to direct the activities of the company, including a shareholder holding 25% or more of the voting rights if no other shareholder owns more than 50% of the voting rights in the company, but excluding a shareholder whose power derives solely from his or her position on the board of directors or any other position with the company. If two or more shareholders are interested parties in the same transaction, their shareholdings are combined for the purposes of calculating percentages.

 

Under the Companies Law, extraordinary transactions of a public company with a controlling shareholder or in which a controlling shareholder has a personal interest, as well as any engagement between a public company and a controlling shareholder thereof or such controlling shareholder’s relative, whether directly or indirectly, including through a company controlled by such person with respect to the provision of services to the company, and if such person is also an office holder of such company - with respect to such person’s terms of service and employment as an office holder, and if such person is an employee of the company but not an office holder with respect to such person’s employment by the company (“a Controlling Shareholders Transaction”), generally requires the approval of the audit committee, (or if the transaction is with respect to terms of employment and or office – the compensation committee), the board of directors and (subject to certain exceptions determined in regulations enacted under the Companies Law) the shareholders of the company. If such shareholder approval is required, it must satisfy either of the following criteria (“Special Majority”):

 

·the majority of the votes for the approval includes a majority of the votes of voting shareholders who have no personal interest in the transaction; the votes of abstaining shareholders shall not be included in the number of the said total votes; or

·the total number of votes against the approval of the transaction, among the shareholders who have no personal interest in the transaction shall not exceed 2% of the aggregate voting rights in the company.

 

Such transactions with a controlling shareholder or in which a controlling shareholder has a personal interest, that are for a period of more than three years generally need to be brought for approval in accordance with this above procedure every three years.

 

In those circumstances in which shareholders’ approval is required, shareholders have the right to review any documents in the company’s possession related to the proposed transaction. However, the company may prohibit a shareholder from reviewing the documents if the company believes the request was made in bad faith, the documents include trade secrets or patents or their disclosure could otherwise harm the company’s interests.

 

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For information concerning the direct and indirect personal interests of certain of our office holders and principal shareholders in certain transactions with us, see “Item 7 — Major Shareholders and Related Party Transactions — B. Related Party Transactions.”

 

Directors’ and Officers’ Compensation

 

As of the effective date of Amendment no. 20 to the Companies Law, directors’ and officers’ compensation, including exemption from liability, indemnification and insurance are included in the definition of “terms of employment and of office”, and as such must be approved in the following manner:

 

·Office holder (or “Officer”) (except for director and the CEO) – generally, by the compensation committee, followed by the board of directors.

·CEO – generally (subject to certain exceptions determined in regulations enacted under the Companies Law), by the compensation committee, followed by the board of directors and the general meeting with a Special Majority. Notwithstanding the above, the compensation committee may exempt the employment terms of a proposed CEO from the approval of the shareholders, provided that the proposed CEO is independent based on criteria set forth in the Companies Law, the compensation committee determined that bringing the transaction to the approval of the shareholders will prevent the transaction; and the proposed employment terms are consistent with the provisions of the company's compensation policy. In addition, renewal or extension of the employment terms of a CEO do not require the approval of the shareholders if the new terms of employment are not preferable in comparison to the previous terms or if there is no real change to the terms and to the relevant circumstances, and further provided that the terms of employment are consistent with the compensation policy.

·Director – generally (subject to certain exceptions determined in regulations enacted under the Companies Law), by the compensation committee, followed by the board of directors and the general meeting; if in accordance with the Compensation Policy –with a simple majority, if not in accordance with the Compensation Policy – with a Special Majority.

·Controlling shareholder – generally (subject to certain exceptions determined in regulations enacted under the Companies Law), by the compensation committee, followed by the board of directors and the general meeting with a Special Majority.

 

Notwithstanding the above, terms of employment and of office of a CEO or a director with respect to the period until the next general meeting to be summoned by the company may be approved by the compensation committee and board of directors without an approval of the general meeting provided that such terms are consistent with the company's compensation policy and further provided that the new terms are not preferable in comparison to the terms of the previous person who filled such position or if there is no real change to the terms and to the other relevant circumstances.

 

The terms of employment and office must be consistent with the company's compensation policy, provided that the compensation committee and the board of directors may, in special circumstances, approve terms of employment and office that are not in accordance with the compensation policy, subject to specific conditions regarding the consideration to be considered by the compensation committee and the board, mandatory provisions to be included in such employment terms and subject to the approval of the shareholders with a Special Majority.

 

·Notwithstanding the above, with respect to the terms of employment of office holders or CEO who are not controlling shareholders or relatives of a controlling shareholder and do not serve as directors, the compensation committee and the board of directors may, in special circumstances and under specific terms determined in the Companies law, approve such employment terms even if the shareholders' meeting objected to their approval.

·Under the Companies Law, non-material amendments to terms of employment of office holders (including the CEO), require only the approval of the compensation committee. In addition, a non-material amendments to terms of employment of office holders who are subordinated to the CEO may be approved by the CEO provided that the company’s compensation policy determines the same and that the terms of employment are consistent with the compensation policy.

 

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Directors Borrowing Powers

 

Our board of directors may from time to time, in its discretion, cause the Company to borrow or secure the payment of any sum or sums of money for the purposes of the Company.

 

Rights Attached to Our Shares

 

Dividend Rights. Our Articles provide that our board of directors may, subject to the applicable provisions of the Companies Law, from time to time, declare such dividend as may appear to the board of directors to be justified by the profits of the Company. Subject to the rights of the holders of shares with preferential or other special rights that may be authorized in the future, dividends, to the extent declared, are distributed according to the proportion of the nominal (par) value paid up on account of the shares held at the date so appointed by the Company, without regard to the premium paid in excess of the nominal (par) value, if any. Under the Companies Law, a company may only distribute a dividend which derives from its profits, as such term is defined under the Companies Law (the profit requirement), and provided that the distribution does not create a reasonable concern that the company will be unable to meet its existing and foreseeable obligations as they become due. A court may allow a company to distribute a dividend which does not comply with the profit requirement, as long as the court is convinced that there is no reasonable concern that such distribution might prevent the company from being able to meet its existing and foreseeable obligations as they become due.

 

Voting Rights. Holders of ordinary shares have one vote for each ordinary share held on all matters submitted to a vote of shareholders. These voting rights may be affected by the grant of any special voting rights to the holders of a class of shares with preferential rights that may be authorized in the future. Holders of ordinary shares that represent more than 50% of the voting power at the general meeting of shareholders, in person or by proxy, have the power to elect all the directors whose positions are being filled at that meeting to the exclusion of the remaining shareholders. With respect to the election of external directors see Item 6. “Directors, Senior Management and Employees– C. Board Practices - External Directors.”

 

Liquidation Rights. In the event of our liquidation, subject to applicable law, after satisfaction of liabilities to creditors, our assets will be distributed to the holders of ordinary shares in proportion to their respective holdings. This liquidation right may be affected by the grant of preferential dividends or distribution rights to the holders of a class of shares with preferential rights that may be authorized in the future.

 

Redemption Provisions. We may, subject to applicable law and to our Articles, issue redeemable preference shares and redeem the same.

 

Capital Calls. Under our Articles and the Companies Law, the liability of our shareholders is limited to the nominal (par) value of the shares held by them.

 

Transfer of Shares. Fully paid ordinary shares are issued in registered form and may be transferred pursuant to our Articles, unless such transfer is restricted or prohibited by another instrument and subject to applicable securities laws.

 

Modification of Rights

 

Pursuant to our Articles, if at any time our share capital is divided into different classes of shares, the rights attached to any class, unless otherwise provided by our Articles, may be modified or abrogated by the Company, by a resolution of the shareholders, subject to the consent in writing of the holders of at least a majority of the issued shares of such class or the adoption of a resolution passed at a separate meeting of the holders of the shares of such class.

 

Shareholders’ Meetings and Resolutions

 

Pursuant to our Articles, the quorum required for an ordinary meeting of shareholders consists of at least two shareholders present in person or by proxy, who hold shares conferring in the aggregate more than 25% of the voting power of the Company. A meeting adjourned for lack of a quorum generally is adjourned to the same day in the following week at the same time and place or any time and place as the chairman of the meeting may designate. At such reconvened meeting, the required quorum consists of any two shareholders present in person or by proxy.

 

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Under the Companies Law, each shareholder of record will be provided at least 21 calendar days’ prior notice of any general shareholders meeting or 35 days prior notice to the extent required under regulations promulgated under the Companies Law.

 

Under the Companies Law and our Articles, all resolutions of our shareholders require a simple majority of the shares present, in person or by proxy or by written ballot, and voting on the matter, subject to certain exceptions provided for in our Articles namely: (a) the amendment of the provisions of our Articles relating to the election of directors, which require the approval of the greater of (i) holders of not less than seventy-five percent (75%) of the voting power represented at a meeting in person or by proxy and voting thereon, or (ii) holders of a majority of the outstanding voting power of all shares of the Company voting on such matter at a general meeting; (b) the removal of any director from office, the election of a director in place of a director so removed or the filling of any vacancy, however created, on the board of directors, which require the vote of the holders of at least 75% of the voting power represented at the meeting; and (c) the consummation of a merger (as defined in the Companies Law) which requires the approval of the holders of at least a majority of the voting power of the Company.

 

Under the Companies Law, each and every shareholder has a duty to act in good faith and in customary manner in exercising his or her rights and fulfilling his or her obligations towards the company in which he or she holds shares and other shareholders, and refrain from abusing his or her power in the company, including in voting in the general meeting of shareholders on the following matters:

 

·any amendment to the articles of association;

·an increase of our authorized share capital;

·a merger; or

·approval of interested party transactions that require shareholder approval.

 

In addition, each and every shareholder has the general duty to refrain from discriminating against other shareholders. In addition, any controlling shareholder, any shareholder who knows that it possesses the power to determine the outcome of a shareholder or class vote and any shareholder who, pursuant to the company’s articles of association has the power to appoint or prevent the appointment of an office holder in the company is under a duty to act with fairness towards the company. The Companies Law does not describe the substance of this duty of fairness.

 

Our annual general meetings are held once in every calendar year at such time (within a period of not more than fifteen months after the last preceding annual general meeting) and at such place determined by our board of directors. All general meetings other than annual general meetings are called extraordinary general meetings.

 

Our board of directors may, in its discretion, convene additional meetings as “extraordinary general meetings.” In addition, the board of directors must convene an extraordinary general meeting upon the demand of (i) two of the directors or one fourth of the directors in office, (ii) one or more shareholders having at least 5% of the outstanding share capital and at least 1% of the voting power in the company, or one or more shareholders having at least 5% of the voting power in the company. The chairperson of the board of directors shall preside at each of our general meetings, or if at any meeting the chairperson is not present within fifteen (15) minutes after the time fixed for holding the meeting or is unwilling to act as chairperson, then if there is a co-chairperson, such co-chairperson shall preside at the meeting, or in the absence of both or if both are unwilling to act as chairperson, the shareholders present shall choose someone of their number to be chairperson. The chairperson of the board of directors is not entitled to a vote at a general meeting in his capacity as chairperson.

 

 

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Limitation on Owning Securities

 

Our Articles and Israeli law do not restrict in any way the ownership or voting of ordinary shares by non-residents or persons who are not citizens of Israel, except with respect to subjects of nations which are in a state of war with Israel. Until December 2016, we were members of the Rimonim Consortium, and in the past we also participated in a “Magneton” project which were supported by the IIA. According to the R&D Law, a change of control of our company should be reported to the research committee at the Ministry of Economy (the Committee), and a change in the holding of the means of control in our company (means of control include the right to vote at a general meeting of a company or a corresponding body of another corporation or the right to appoint directors of the corporation or its general manager) which results in any person not being a citizen or resident of Israel or corporation incorporated in Israel holding 5% or more of the issued share capital or of the voting power of our company, should be reported to the committee, which (according to its internal proceedings) will notify us of its decision within seven days from the date thereof, and such person should sign an undertaking in the form published by the research committee.

 

Mergers and Acquisitions and Tender Offers under Israeli Law

 

The Companies Law includes provisions that allow a merger transaction and generally requires that each company that is a party to a merger have the transaction approved by its board of directors and shareholders (including the separate approval of each class of shares of the party to the merger which is not the surviving entity) at a shareholders’ meeting called on at least 35 days’ prior notice. In addition, under our Articles, approval of a merger transaction requires that holders of at least a majority of the voting power of the Company vote in favor of the merger transaction.

 

At a voting of the shareholders of a merging company whose shares are held by the other merging company, or by a person holding 25% or more of any means of control in the other merging company, the merger shall not be approved if the majority of the votes of the shareholders present and voting in such meeting (excluding abstains not taking into consideration the votes of the other merging company, of the person holding 25% or more of any means of control in the other merging company or anyone acting on their behalf, including their relatives or entities under their control), objected to the merger (the "Special Majority Requirement"). If the general meeting of shareholders of a merging company approved the merger proposal, the court may, at the request of holders of at least 25% of the voting rights of the company, determine that the company approved the merger, even if the merger was not approved by all the classes of shares as set forth above or even if the Special Majority Requirement was not met. The court shall not approve a merger request unless the court was convinced that the merger proposal was fair and reasonable, while taking into account the value of the parties to the merger and the consideration offered to the shareholders. Notwithstanding the foregoing, a merger that is also an extraordinary transaction with a controlling shareholder or a transaction with another person in which a controlling shareholder has a personal interest, requires approval as an extraordinary transaction with a controlling shareholder (see “Transactions Requiring Special Approval”).

 

Under the Companies Law, each merging company must inform its creditors of the proposed merger. The court may, at the request of a creditor of a merging company delay or prevent the execution of the merger, if the court has concluded that there exists a reasonable concern that as a result of the merger, the surviving company will not be able to fulfill the obligations of the merged company and may further give instructions to secure the rights of creditors. A merger may not be completed unless at least 50 days have passed from the time that a proposal for the approval of the merger has been filed with the Israeli Registrar of Companies and 30 days have passed from the time that the approval of the merging parties’ shareholders has been received.

 

The Companies Law also provides that, subject to certain exceptions, an acquisition of shares of a public company must be made by means of a special tender offer if as a result of the acquisition the purchaser would become a holder of 25% or more of the voting rights in the company if at that time no other shareholder of the company holds 25% or more of the voting rights in the company. Similarly, the Companies Law provides that, subject to certain exceptions, an acquisition of shares in a public company must be made by means of a special tender offer if as a result of the acquisition the purchaser would become a holder of more than 45% of the voting rights in the company, if at that time there is no other shareholder of the company that holds more than 45% of the voting rights in the company.

 

Under the Companies Law, a person may not acquire shares of a public company or voting rights in such company if, following the acquisition, the acquirer will hold more than 90% of the company’s shares or more than 90% of any class of shares, other than by means of a tender offer to acquire all of the outstanding shares of the company or all of the shares of the particular class.

 

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The Companies Law also provides that as long as a shareholder in a public company holds more than 90% of the company’s shares or of a class of shares, such shareholder shall be precluded from purchasing any additional shares of such company.

 

In the event that, either (i) the shareholders who did not accept the tender offer hold less than 5% of the company’s outstanding share capital or of the relevant class of shares and the majority of offerees who do not have a personal interest in accepting the tender offer, have accepted the offer, or (ii) the shareholders who did not accept the tender offer hold less than 2% of the company’s outstanding share capital or of the relevant class, then all of the shares that the acquirer offered to purchase will be transferred to the him by operation of law.

 

A shareholder that had its shares so transferred, whether he or she accepted the tender offer or not, has the right, within six months from the date of acceptance of the tender offer, to request the court to determine that the consideration for the shares under the tender offer was less than their fair value and that the fair value should be paid as shall be determined by the court. However, the acquirer may provide under the tender offer that shareholders who accepted the tender offer proposal will not be entitled to such remedy.

 

If the conditions set forth above are not met, the acquirer may not acquire additional shares of the company from shareholders who accepted the tender offer to the extent that following such acquisition the acquirer would own more than 90% of the company’s issued and outstanding share capital.

 

Any shares that were acquired in contradiction to the above conditions shall not provide any rights and shall be redeemed as long as they are held by the acquirer.

 

Notwithstanding the above, Israeli antitrust laws require that certain mergers be announced and receive approval of the Israeli Antitrust authority.

 

C.MATERIAL CONTRACTS

 

Please see “Item 4. Information on the Company — B. Business Overview — Our Intellectual Property Strategy and Position — In-Licensed Intellectual Property for a discussion of our material strategic alliances and research and license agreements.

 

D.EXCHANGE CONTROLS

 

There are currently no exchange controls in effect in Israel that restrict the repatriation by non-residents of Israel in non-Israeli currency of any dividends, if any are declared and paid, and liquidation distributions.

 

E.TAXATION

 

The following contains a description of material relevant provisions of the current Israeli income tax regime applicable to companies in Israel, with special reference to its effect on us. To the extent that the discussion is based on new tax legislation which has not been subject to judicial or administrative interpretation, we cannot assure you that the views expressed in the discussion will be accepted by the appropriate tax authorities or the courts.

 

This discussion does not address all of the tax consequences that may be relevant to purchasers of our ordinary shares in light of their particular circumstances or certain types of purchasers of our ordinary shares subject to special tax treatment. Examples of this kind of investor include residents of Israel and traders in securities who are subject to special tax regimes not covered in this discussion. Because individual circumstances may differ, you should consult your tax advisor to determine the applicability of the rules discussed below to you and the particular tax effects of the offer, including the application of Israeli or other tax laws. The discussion below is not intended, and should not be construed, as legal or professional tax advice and is not exhaustive of all possible tax considerations.

 

Taxation of Companies

 

General Corporate Tax Structure

 

Israeli companies are generally subject to corporate tax. In 2016 and 2015, the corporate tax rate was 25.0% and 26.5%, respectively. The corporate tax rate for 2017 is scheduled to be 24% and the corporate tax rate for 2018 and thereafter is scheduled to be 23%. However, the effective tax rate payable by a company that derives income from an Approved Enterprise, a Benefited Enterprise or a Preferred Enterprise (as discussed below) may be considerably less. Capital gains derived by an Israeli company are generally subject to the prevailing corporate tax rate.

 

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In December 2010, the “Knesset” (Israeli Parliament) passed the Law for Economic Policy for 2011 and 2012 (Amended Legislation), 2011, which prescribes, among others, amendments to the Law. The amendment became effective as of January 6, 2011. According to the amendment, the benefit tracks in the Law were modified and a flat tax rate applies to the Company’s entire preferred income. The Company will be able to opt to apply (the waiver is non-recourse) the amendment and from then on it will be subject to the amended tax rates that are: 2011, 2012, and 2013 - 15% (in development area A - 10%), 2014 and 2015 - 16% (in development area A - 9%).

 

We examined the possible effect of the amendment on the financial statements, if at all, and at this time do not believe it will opt to apply the amendment.

 

Tax Benefits for Research and Development

 

Israeli tax law allows, under specified conditions, a tax deduction for R&D expenditures, including capital expenditures, for the year in which they are incurred. These expenses must relate to scientific research and development projects and must be approved by the relevant Israeli government ministry, determined by the field of research. Furthermore, the research and development must be for the promotion of the company and carried out by or on behalf of the company seeking such tax deduction. However, the amount of such deductible expenses is reduced by the sum of any funds received through government grants for the finance of such scientific research and development projects. Expenditures not so approved are deductible over a three-year period.

 

Tax Benefits Under the Law for the Encouragement of Industry (Taxes), 1969

 

The Law for the Encouragement of Industry (Taxes), 1969, industrial companies, as defined under the law, are entitled to the following tax benefits, among others:

 

1.Deduction of purchases of know-how and patents over an eight-year period for tax purposes;

 

2.Right to elect, under specified conditions, to file a consolidated tax return with additional related Israeli Industrial Companies;

 

3.Deductions over a three-year period of expenses involved with the issuance and listing of shares on a stock market.

 

Under certain tax laws and regulations, an “Industrial Enterprise” may be eligible for special depreciation rates for machinery, equipment and buildings. These rates differ based on various factors, including the date the operations begin and the number of work shifts. An “Industrial Company” owning an approved enterprise may choose between these special depreciation rates and the depreciation rates available to the approved enterprise.

 

Eligibility for benefits under the Law for the Encouragement of Industry is not subject to receipt of prior approval from any governmental authority. Under the law, an “industrial company” is defined as a company resident in Israel, at least 90.0% of the income of which, in any tax year, determined in Israeli currency, exclusive of income from government loans, capital gains, interest and dividends, is derived from an “industrial enterprise” owned by it and located in Israel. An “industrial enterprise” is defined as an enterprise whose major activity in a given tax year is industrial production activity.

 

We believe that we currently qualify as an industrial company within the definition under the Law for the Encouragement of Industry. No assurance can be given that we will continue to qualify as an industrial company or that the benefits described above will be available in the future.

 

Special Provisions Relating to Taxation under Inflationary Conditions

 

According to the Income Tax law (Inflationary Adjustments), 1985, until 2007 (inclusive), the results for tax purposes were measured based on the changes in the Israeli CPI.

 

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Starting 2008, the results for tax purposes are measured in nominal values, excluding certain adjustments for changes in the Israeli CPI carried out in the period up to December 31, 2007. The amendment to the law includes, inter alia, the elimination of the inflationary additions and deductions and the additional deduction for depreciation starting 2008.

 

Tax Benefits for Income from Approved Enterprises Approved Before April 1, 2005

 

Before April 1, 2005 an Approved Enterprise was entitled to either receive investment grants and certain tax benefits from the Government of Israel or an alternative package of tax benefits (“Alternative Benefits”). We have elected to forego the entitlement to grants and have applied for the Alternative Benefits, under which undistributed income that we generate from our Approved Enterprises will be completely tax exempt (a “tax exemption”) for two years commencing from the year that we first produce taxable income and will be subject to a reduced tax rate of 10%-25% for an additional five to eight years, depending on the extent of foreign investment in the company.

 

Alternative Benefits are available until the earlier of (i) seven consecutive years, commencing in the year in which the specific Approved Enterprise first generates taxable income, (ii) 12 years from commencement of production and (iii) 14 years from the date of approval of the Approved Enterprise status.

 

Dividends paid out of income generated by an Approved Enterprise (or out of dividends received from a company whose income is generated by an Approved Enterprise) are generally subject to withholding tax at the rate of 15%. This tax is withheld at source by the Approved Enterprise. The 15% tax rate is limited to dividends and distributions out of income derived during the benefits period and actually paid at any time up to 12 years thereafter. Since we elected the Alternative Benefits track, we will be subject to pay corporate tax at the rate of 10% - 25% (as mentioned below) in respect of the gross amount of the dividend that we may distribute out of profits which were exempt from corporate tax in accordance with the provisions of the Alternative Benefits track. However, we are not obliged to attribute any part of dividends that we may distribute to exempt profits, and we may decide from which year’s profits to declare dividends. We currently intend to reinvest any income that we may in the future derive from our Approved Enterprise programs and not to distribute the income as a dividend.

 

If we qualify as a “Foreign Investors’ Company” or “FIC”, our Approved Enterprises will be entitled to additional tax benefits. Subject to certain conditions, a FIC is a company with a level of foreign investment of more than 25%. The level of foreign investment is measured as the percentage of rights in the company (in terms of shares, rights to profits, voting and appointment of directors), and of combined share and loan capital, that are owned, directly or indirectly, by persons who are not residents of Israel. Such a company will be eligible for an extension of the period during which it is entitled to tax benefits under its Approved Enterprise status (so that the benefit periods may be up to ten years) and for further tax benefits if the level of foreign investment exceeds 49%. The tax rate for the remainder of the benefits period will be 25%, unless the level of foreign investment exceeds 49%, in which case the tax rate will be 20% if the foreign investment is more than 49% and less than 74%; 15% if more than 74% and less than 90%; and 10% if 90% or more. The benefits available to an Approved Enterprise are subject to the fulfillment of conditions stipulated in the Investment Law and its regulations and the criteria in the specific certificate of approval, as described above. If a company does not meet these conditions, it would be required to refund the amount of tax benefits, together with consumer price index linkage adjustment and interest.

 

Tax Benefits under an Amendment that became effective on April 1, 2005

 

On April 1, 2005, a significant amendment to the Investment Law became effective (the “2005 Amendment”). The Investment Law provides that terms and benefits included in any certificate of approval that was granted before the 2005 Amendment came into effect will remain subject to the provisions of the Investment Law as they were on the date of such approval.

 

The 2005 Amendment changed certain provisions of the Law. As a result of the 2005 Amendment, a company is no longer obliged to acquire Approved Enterprise status in order to receive the tax benefits previously available under the Alternative Benefits provisions, and therefore generally there is no need to apply to the Investment Center for this purpose (Approved Enterprise status remained mandatory for companies seeking grants). Rather, the company may claim the tax benefits offered by the Investments Law directly in its tax returns, provided that its facilities meet the criteria for tax benefits set out by the 2005 Amendment. A company is also granted a right to approach the Israeli Tax Authority for a pre-ruling regarding their eligibility for benefits under the 2005 Amendment.

 

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Tax benefits are available under the Amendment to production facilities (or other eligible facilities), which are generally required to derive more than 25% of their business income from export (referred to as a “Benefited Enterprise”). In order to receive the tax benefits, the 2005 Amendment states that the company must make an investment which meets all the conditions set out in the 2005 Amendment for tax benefits and exceeds a minimum amount specified in the Investment Law. Such investment allows the company to receive a “Benefiting Enterprise” status, and may be made over a period of no more than three years ending at the end of the year in which the company requested to have the tax benefits apply to the Benefiting Enterprise (the “Year of Election”). Where the company requests to have the tax benefits apply to an expansion of existing facilities, only the expansion will be considered to be a Benefiting Enterprise and the company’s effective tax rate will be the weighted average of the applicable rates. In this case, the minimum investment required in order to qualify as a Benefiting Enterprise is required to exceed a certain amount or certain percentage of the value of the company’s production assets before the expansion.

 

The duration of tax benefits is subject to a limitation of the earliest of 7 (or 10 years) from the commencement year, or 12 years from the first day of the Year of Election. The tax benefits granted to a Benefiting Enterprise are determined, as applicable to its geographic location within Israel, according to one of the following new tax routes, which may be applicable to us:

 

·Similar to the previous Alternative Benefits package, exemption from corporate tax on undistributed income for a period of two to ten years, depending on the geographic location of the Benefiting Enterprise within Israel, and a reduced corporate tax rate of 10% to 25% for the remainder of the benefits period, depending on the level of foreign investment in each year. Benefits may be granted for a term of seven or ten years, depending on the level of foreign investment in the company. If the company pays a dividend out of income derived from the Benefiting Enterprise during the tax exemption period, such income will be subject to corporate tax at the applicable rate (10%-25%). The company is required to withhold tax at the source at a rate of 15% from any dividends distributed from income derived from the Benefiting Enterprise; and

·A special tax route, which enables companies owning facilities in certain geographical locations in Israel to pay corporate tax at the rate of 11.5% on income of the Benefiting Enterprise. The benefits period is ten years. Upon payment of dividends, the company is required to withhold tax at source at a rate of 15% for Israeli residents and at a rate of 4% for foreign residents.

 

Generally, a company which has a sufficiently high level of foreign investment (as defined in the Investments Law) is entitled to an extension of the benefits period by an additional five years, depending on the extent of its income that is derived from exports.

 

Dividends paid out of income derived by a Benefiting Enterprise will be treated similarly to payment of dividends by an Approved Enterprise under the Alternative Benefits track. Therefore, dividends paid out of income derived by a Benefiting Enterprise (or out of dividends received from a company whose income is derived from a Benefiting Enterprise) are generally subject to withholding tax at the reduced rate of 15% (deductible at source). The reduced rate of 15% is limited to dividends and distributions out of income derived from a Benefiting Enterprise during the benefits period. A company qualifying for tax benefits under the 2005 Amendment which pays a dividend out of income derived by its Benefiting Enterprise during the tax exemption period will be subject to tax in respect of the gross amount of the dividend at the otherwise applicable rate of 10%-25%.

 

The 2005 Amendment changed the definition of “foreign investment” in the Investment Law so that the definition now requires a minimal investment of NIS 5 million by foreign investors. Furthermore, such definition now also includes the purchase of shares of a company from another shareholder, provided that the company’s outstanding and paid-up share capital exceeds NIS 5 million. Such changes to the aforementioned definition are retroactive from 2003.

 

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As a result of the 2005 Amendment, tax-exempt income generated under the new provisions will subject us to taxes upon distribution of the tax-exempt income to shareholders or upon liquidation of the company, and we may be required to record a deferred tax liability with respect to such tax-exempt income.

 

Under the transitional provisions of the 2011 Tax Amendment, the Company may elect whether to irrevocably implement the 2011 Tax Amendment with respect to its existing Approved and Benefiting Enterprises while waiving benefits provided under the legislation prior to the 2011 Tax Amendment or keep implementing the legislation prior to the 2011 Tax Amendment during the next years.

 

We do not expect the 2011 Tax Amendment to have a material effect on the tax payable in respect of our Israeli operations.

 

As of December 31, 2016, we did not generate income under any of the above mentioned laws.

 

Israeli Transfer Pricing Regulations

 

On November 29, 2006, Income Tax Regulations (Determination of Market Terms), 2006, promulgated under Section 85A of the Tax Ordinance, came into effect (the “TP Regs”). Section 85A of the Tax Ordinance and the TP Regs generally require that all cross-border transactions carried out between related parties be conducted on an arm’s length basis and be taxed accordingly. The TP Regs are not expected to have a material effect on us.

 

Taxation of our Shareholders

 

To the extent that the following discussion is based on new or existing tax or other legislation that has not been subject to judicial or administrative interpretation, there can be no assurance that the views expressed herein will be accepted by the tax or other authorities in question. The summary below does not address all of the tax consequences that may be relevant to all purchasers of ordinary shares in light of each purchaser’s particular circumstances and specific tax treatment. For example, the summary below does not address the tax treatment of residents of Israel and traders in securities who are subject to specific tax regimes. As individual circumstances may differ, holders of ordinary shares should consult their own tax advisors as to United States, Israeli or other tax consequences of the purchase, ownership and disposition of ordinary shares. This discussion is not intended, nor should it be construed, as legal or professional tax advice and it is not exhaustive of all possible tax considerations. Each individual should consult his or her own tax or legal advisor.

 

(a) Israeli Taxation

 

(i) Taxation of Capital Gains Applicable to Non-Israeli Shareholders

 

Israeli law generally imposes a capital gains tax on the sale of securities and any other capital assets located in Israel. Pursuant to an amendment of the Tax Ordinance in 2005, effective as of January 1, 2006, the capital gains tax rate applicable to individuals upon the sale of securities acquired after that date is 20%. A 25% tax rate will apply to an individual who meets the definition of a ‘Substantial Shareholder’ on the date of the sale of the securities or at any time during the 12 months preceding such date. A ‘Substantial Shareholder’ is defined as a person who, either alone or together with any other person, holds, directly or indirectly, at least 10% of any of the means of control of a company (including, among other things, the right to receive profits of the company, voting rights, the right to receive the company’s liquidation proceeds and the right to appoint a director). Pursuant to an amendment of the Tax Ordinance in 2011, effective as of January 1, 2012, the capital gains tax rate applicable to individuals upon the sale of securities acquired after that date is 25% (instead of 20%), and a 30% tax rate will apply to an individual who meets the definition of a ‘Substantial Shareholder’ on the date of the sale of the securities or at any time during the 12 months preceding such date (instead of 25%). For sake of good order, securities acquired before January 1, 2012 and sold after that date, the profit received from such sale will be taxed as follows: from the purchase date until January 1, 2012 – 20% (or 25% - for Substantial Shareholder), and from January 1, 2012 until sales date – 25% (or 30% for Substantial Shareholder).

 

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In addition, shareholders who bought their securities before January 1, 2003, will be taxed for the profit made from the purchase date until January 1, 2003 in accordance with their marginal rate of income.

 

In addition, as of January 1, 2013, shareholders that are individuals who have taxable income that exceeds ILS 800,000 in a tax year (linked to the CPI each year - ILS 803,520 in 2016), will be subject to an additional tax, referred to as High Income Tax, at the rate of 2% on their taxable income for such tax year which is in excess of such amount. Starting from January 1, 2017, the High Income tax rate has increased to 3% and its threshold has been lowered to 640,000 ILS. For this purpose taxable income will include taxable capital gains from the sale of our shares and taxable income from dividend distributions.

 

With respect to corporate investors capital gain tax of 25% will be imposed on the sale of traded shares. This rate is subject to the provisions of any applicable bilateral double taxation treaty. The treaty concerning double taxation between the United States and Israel (the Convention between the Government of the State of Israel and the Government of the United States of America With Respect to Taxes on Income (the “Treaty”) is discussed below.

 

In addition, if the shares are traded on the Tel Aviv Stock Exchange, on an authorized stock exchange outside Israel or on a regulated market (which includes a system through which securities are traded pursuant to rules prescribed by the competent authority in the relevant jurisdiction) in or outside Israel, gains on the sale of shares held by non-Israeli tax resident investors will generally be exempt from Israeli capital gains tax. However, non-Israeli corporations will not be entitled to such exemption if Israeli residents (i) have controlling interest of 25% or more in such non-Israeli corporation, or (ii) are the beneficiaries of or are entitled to 25% or more of the revenues or profits of such non-Israeli corporation, whether directly or indirectly. Notwithstanding the foregoing, dealers in securities in Israel are taxed at regular tax rates applicable to business income. In addition, persons paying consideration for shares, including purchasers of shares, Israeli securities dealers effecting a transaction, or a financial institution through which securities being sold are held, are required, subject to any applicable exemptions and the demonstration of the selling shareholder of its non-Israeli residency, to withhold tax upon the sale of publicly traded securities at the applicable corporate tax rate (25% in 2013) for a corporation and 25% for an individual, subject to further conditions under the Israeli law.

 

Israeli law generally exempts non-resident individuals and entities from capital gains tax on the sale of securities of Israeli companies, provided that the securities were acquired on or after January 1, 2009.

 

(ii) Income Taxes on Dividend Distribution to Non-Israeli Shareholders

 

Non-Israeli residents (whether individuals or corporations) are generally subject to Israeli income tax on the receipt of dividends paid on the shares of companies that are not publicly traded at the rate of 25% (30% if the dividend recipient is a Substantial Shareholder, at the time of distribution or at any time during the preceding 12-month period), which tax is to be withheld at source, unless a different rate is provided under an applicable tax treaty. Dividends paid on the shares of companies that are publicly traded, like our ordinary shares, to non-Israeli residents, although generally subject to the same tax rates applicable to dividends paid on the shares of companies that are not publicly traded, are generally subject to Israeli withholding tax at a rate of 25% (whether or not the recipient is a Substantial Shareholder), unless a different rate is provided under an applicable tax treaty. The distribution of dividends to non-Israeli residents (either individuals or corporations) from income derived from an Approved Enterprise or a Benefiting Enterprise during the applicable benefits period or from Preferred Income is subject to withholding tax at a rate of 20% (as of January 1, 2014), unless a different tax rate is provided under an applicable tax treaty. In addition, non-Israeli residents who receive dividends may be entitled to tax refund from the Israeli Tax Authority, under certain conditions.

 

A non-resident of Israel who has dividend income derived from or accrued in Israel, from which the full amount of tax was withheld at source, is generally exempt from the duty to file tax returns in Israel in respect of such income, provided that: (i) such income was not derived from a business conducted in Israel by the taxpayer; and (ii) the taxpayer has no other taxable sources of income in Israel with respect to which a tax return is required to be filed.

 

Residents of the United States generally will have withholding tax in Israel deducted at source. Such residents may be entitled to a credit or deduction for U.S. federal income tax purposes in the amount of the taxes withheld, subject to detailed rules contained in U.S. tax legislation.

 

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(iii) U.S. - Israel Tax Treaty

 

The Treaty is generally effective as of January 1, 1995. Under the Treaty, the maximum Israeli withholding tax on dividends paid to a holder of shares who is a Treaty U.S. Resident (as defined below) is generally 25%. However, pursuant to the Investment Law, dividends distributed by an Israeli company and derived from income eligible for benefits under the Investment Law will generally be subject to a reduced 15% dividend withholding tax rate, subject to the conditions specified in the Treaty. The Treaty further provides that a 12.5% Israeli dividend withholding tax will apply to dividends paid to a U.S. corporation owning 10% or more of an Israeli company’s voting shares during, in general, the current and preceding tax year of the Israeli company. The lower 12.5% rate applies only on dividends distributed from income not derived from an Approved Enterprise or a Benefiting Enterprise in the applicable period or, presumably, from a Preferred Enterprise, and does not apply if the company has certain amounts of passive income.

 

Pursuant to the Treaty, the sale, exchange or disposition of shares in an Israeli company by a person who qualifies as a resident of the United States within the meaning of the Treaty and who is entitled to claim the benefits afforded to such residents under the Treaty (a “Treaty U.S. Resident”) generally will not be subject to the Israeli capital gains tax unless such Treaty U.S. Resident holds, directly or indirectly, shares representing 10% or more of the voting power of the company during any part of the 12-month period preceding such sale, exchange or disposition subject to certain conditions. A sale, exchange or disposition of shares in an Israeli Company by a Treaty U.S. Resident who holds, directly or indirectly, shares representing 10% or more of the voting power of the company at any time during such preceding 12-month period would not be exempt under the Treaty from such Israeli tax; however, under the Treaty, such Treaty U.S. Resident would be permitted to claim a credit for such taxes against U.S. federal income tax imposed on any gain from such sale, exchange or disposition, under the circumstances and subject to the limitations specified in the Treaty. In addition, in the event that (1) the capital gains arising from the sale of shares of an Israeli company will be attributable to a permanent establishment of the shareholder located in Israel, or (2) the shareholder, being an individual, is present in Israel for a period or periods aggregating 183 days or more during a taxable year, the aforesaid exemption shall not apply.

 

CERTAIN MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

 

General

 

The following is a summary of certain material U.S. federal income tax consequences to U.S. holders (as defined below) of purchasing, owning, and disposing of our ordinary shares. For this purpose, a U.S. holder is, in each case as defined for U.S. federal income tax purposes: (a) an individual who is a citizen or resident of the United States; (b) a corporation (or other entity taxable as a corporation for U.S. federal income tax purposes) created or organized in or under the laws of the United States, any state thereof or the District of Columbia; (c) an estate the income of which is subject to U.S. federal income tax regardless of its source; or (d) a trust that is subject to the primary supervision of a court over its administration and one or more U.S. persons control all substantial decisions, or a trust that has validly elected to be treated as a domestic trust under applicable Treasury Regulations. This summary does not address any tax consequences to persons other than U.S. holders.

 

This discussion is a general summary and does not address all aspects of U.S. federal income taxation that may be relevant to particular U.S. holders based on their particular investment or tax circumstances. Except where noted, this summary deals only with ordinary shares held as capital assets (generally, property held for investment). It does not address any tax consequences to certain types of U.S. holders that are subject to special treatment under the U.S. federal income tax laws, such as insurance companies, tax-exempt organizations, financial institutions, broker-dealers, dealers in securities or currencies, traders in securities that elect to use the mark-to-market method of accounting for their securities, partnerships or other pass-through entities for U.S. federal tax purposes, regulated investment companies, real estate investment trusts, expatriates, persons liable for alternative minimum tax, persons owning, directly or by attribution, 10% or more, by voting power or value, of our ordinary shares, persons whose “functional currency” is not the U.S. dollar, persons holding ordinary shares as part of a hedging, constructive sale or conversion, straddle, or other risk-reducing transaction, or persons acquiring an interest in our ordinary shares in exchange for services.


This summary relates only to U.S. federal income taxes. It does not address any other tax, including but not limited to, state, local, or foreign taxes, or any other U.S. federal taxes other than income taxes.

 

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If a partnership holds our ordinary shares, the tax treatment of a partner will generally depend upon the status of the partner and the activities of the partnership. A partner of a partnership holding our ordinary shares should consult its tax advisors.

 

The statements in this summary are based on the current U.S. federal income tax laws as contained in the Internal Revenue Code, Treasury Regulations, and relevant judicial decisions and administrative guidance, all as of the date hereof, and such authorities may be replaced, revoked or modified so as to result in U.S. federal income tax consequences different from those discussed below.. The U.S. federal tax laws are subject to change, and any such change may materially affect the U.S. federal income tax consequences of purchasing, owning, or disposing of our ordinary shares. We cannot assure you that new laws, interpretations of law or court decisions, any of which may take effect retroactively, will not cause any statement in this summary to be inaccurate. No ruling or opinions of counsel will be sought in connection with the matters discussed herein. There can be no assurance that the positions we take on our tax returns will be accepted by the Internal Revenue Service.

 

This summary is not a substitute for careful tax planning. Prospective investors are urged to consult their own tax advisors regarding the specific U.S. federal, state, foreign and other tax consequences to them, in light of their own particular circumstances, of the purchase, ownership and disposition of our ordinary shares and the effect of potential changes in applicable tax laws.

 

Dividends

 

Subject to the discussion under “—Passive Foreign Investment Company” below, the gross amount of any distributions with respect to our ordinary shares (including any amounts withheld to reflect Israeli withholding taxes) will be taxable as dividends, to the extent paid out of our current or accumulated earnings and profits, as determined under U.S. federal income tax principles. Such income (including any withheld taxes) will be includable in a U.S. holder’s gross income as ordinary income on the day actually or constructively received. The dividends received deduction will not be available to a U.S. holder that is taxed as a corporation.

 

With respect to non-corporate U.S. holders, certain dividends received from a qualified foreign corporation may be subject to reduced rates of taxation. A qualified foreign corporation includes a foreign corporation that is eligible for the benefits of a comprehensive income tax treaty with the United States which the United States Treasury Department determines to be satisfactory for these purposes and which includes an exchange of information provision. The United States Treasury Department has determined that the Treaty meets these requirements. A foreign corporation is also treated as a qualified foreign corporation with respect to dividends paid by that corporation on shares that are readily tradable on an established securities market in the United States. Our ordinary shares are listed and readily tradeable on NASDAQ, which United States Treasury Department guidance treats as an established securities market in the United States. There can be no assurance that our ordinary shares will be considered readily tradable on an established securities market in later years. Non-corporate holders that do not meet a minimum holding period requirement during which they are not protected from the risk of loss or that elect to treat the dividend income as “investment income’’ pursuant to Section 163(d)(4) of the Code will not be eligible for the reduced rates of taxation regardless of our status as a qualified foreign corporation. In addition, the rate reduction will not apply to dividends if the recipient of a dividend is obligated to make related payments with respect to positions in substantially similar or related property. This disallowance applies even if the minimum holding period has been met.

 

Notwithstanding the above, dividends received by a non-corporate U.S. holder during a year in which the Company is a Passive Foreign Investment Company (a “PFIC Year”) or in a year following a PFIC Year generally will not be eligible for the reduced rates of taxation. Dividends will generally be from a non-U.S. source and treated as “passive income” for U.S. foreign tax credit purposes. U.S. holders should consult their own tax advisors regarding the application of these rules given their particular circumstances.

 

Although, to the extent we pay dividends in the future, we intend to pay dividends to U.S. holders in U.S. dollars, the amount of any dividend paid in Israeli currency will equal its U.S. dollar value for U.S. federal income tax purposes, calculated by reference to the exchange rate in effect on the date the dividend is received by the U.S. holder, regardless of whether the Israeli currency is converted into U.S. dollars. If the Israeli currency received as a dividend is converted into United States dollars on the date they are received, the U.S. holder generally will not be required to recognize foreign currency gain or loss in respect of the dividend income. If the Israeli currency is not converted into U.S. dollars on the date of receipt, the U.S. holder will have a basis in the Israeli currency equal to its U.S. dollar value on the date of receipt. Any subsequent gain or loss upon the conversion or other disposition of the Israeli currency will be treated as ordinary income or loss, and generally will be income or loss from U.S. sources

 

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Subject to certain conditions and limitations, Israeli withholding taxes on dividends may be treated as foreign taxes eligible for credit against a U.S. holder’s U.S. federal income tax liability. For purposes of calculating the foreign tax credit, dividends paid on our ordinary shares will be treated as income from sources outside the United States and will generally constitute passive category income. Further, in certain circumstances, if a U.S. holder has held ordinary shares for less than a specified minimum period during which the U.S. holder is not protected from risk of loss, or is obligated to make payments related to the dividends, such U.S. holder will not be allowed a foreign tax credit for foreign taxes imposed on dividends paid on our ordinary shares. The rules governing the foreign tax credit are complex. U.S. holders are urged to consult their tax advisors regarding the availability of the foreign tax credit under their particular circumstances. Instead of claiming a credit, a U.S. holder may, at its election, deduct such otherwise creditable Israeli withholding taxes in computing its taxable income, but only for a taxable year in which such holder elects to do so with respect to all foreign income taxes paid or accrued in such taxable year and subject to generally applicable limitations under U.S. law.

 

To the extent that the amount of any distribution (including amounts withheld to reflect Israeli withholding taxes) exceeds our current and accumulated earnings and profits for a taxable year, as determined under U.S. federal income tax principles, the distribution will first be treated as a tax-free return of capital, causing a reduction in the adjusted basis of the shares, and the balance in excess of adjusted basis will be treated as capital gain, long-term if the U.S. holder has held the shares for more than one year, and generally will be gain or loss from U.S. sources. See “Disposition of Ordinary Shares” below for a discussion of capital gains tax rates and limitations on deductions for losses. We do not expect to determine earnings and profits in accordance with U.S. federal income tax principles. Therefore, U.S. holders should expect that a distribution will generally be treated as a dividend (as discussed above).

 

Disposition of Ordinary Shares

 

In general, subject to the discussion under “—Passive Foreign Investment Company,”, a U.S. holder must treat any gain or loss recognized upon a taxable disposition of an ordinary share as capital gain or loss, long-term if the U.S. holder has held the share for more than one year. In general, a U.S. holder will recognize gain or loss in an amount equal to the difference between the sum of the fair market value of any property and the amount of cash received in such disposition and the U.S. holder’s adjusted tax basis in such share. A U.S. holder’s adjusted tax basis generally will equal the U.S. holder’s acquisition cost less any return of capital. Subject to certain exceptions (including but not limited to those described under “Passive Foreign Investment Company” below), long-term capital gain realized by a non-corporate U.S. holder generally will be eligible for reduced rates of tax. The deduction of capital losses is subject to limitations, as are losses upon a taxable disposition of our ordinary shares if the U.S. holder purchases, or enters into a contract or option to purchase, substantially identical stock or securities within 30 days before or after any disposition. Gain or loss from the disposition of our ordinary shares will generally be from U.S. sources, but such gain or loss may be from a non-U.S. source under some circumstances under the Treaty. If such gain or loss is treated as U.S. source gain or loss, a U.S. holder may not be able to use the foreign tax credit arising from any Israeli tax imposed on the disposition of an ordinary share unless such credit can be applied (subject to applicable limitations) against tax due on other income treated as derived from foreign sources.. U.S. holders should consult their own independent tax advisors regarding the sourcing of any gain or loss on the disposition of our ordinary shares, as well as regarding any foreign currency gain or loss in connection with such a disposition.

 

Credit for Foreign Taxes Paid or Withheld

 

Payments to U.S. holders as dividends or consideration for ordinary shares may in some circumstances be subject to Israeli withholding taxes. See “Israeli Taxation, U.S. – Israel tax Treaty” above. Generally, such withholding taxes in lieu of Israeli income taxes imposed on such transactions are creditable against the U.S. holder’s U.S. tax liability, subject to numerous U.S. foreign tax credit limitations, including additional limitations in the case of qualified dividends eligible for the maximum rate accorded to capital gains. A corporate U.S. holder may also be eligible for an “indirect” foreign tax credit on dividends to take account of certain Israeli taxes we previously paid to Israel. A U.S. holder should consult its own independent tax advisor regarding use of the U.S. foreign tax credit and its limitations. A U.S. holder (except an individual who does not itemize deductions) may elect to take a deduction rather than a credit for foreign taxes paid.

 

 

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Passive Foreign Investment Company

 

We believe we may be a PFIC for the year ended December 31, 2016. In general, we will be a PFIC for any taxable year in which:

 

·at least 75% of our gross income is passive income, or
·at least 50% of the value (determined on a quarterly basis) of our assets is attributable to assets, that produce or are held for the production of passive income.

 

For this purpose, cash is a passive asset and passive income generally includes dividends, interest, royalties and rents (other than royalties and rents derived in the active conduct of a trade or business and not derived from a related person). If we own at least 25% (by value) of the stock of another corporation, we will be treated, for purposes of the PFIC tests, as owning our proportionate share of the other corporation’s assets and receiving our proportionate share of the other corporation’s income.

 

PFIC status is determined annually and cannot be definitively determined until the close of the year in question. Accordingly, it is possible that we may become a PFIC in the current or any future taxable year due to changes in our asset or income composition. Because we have valued our goodwill based on the market value of our equity, a decrease in the price of our ordinary shares may also result in our becoming a PFIC to the extent we are not already a PFIC. If we are a PFIC for any taxable year during which a U.S. holder holds our ordinary shares, such U.S. holder will be subject to special tax rules discussed below.

 

If we qualify as a PFIC at any time during a U.S. holder’s holding period of our ordinary shares, any subsequent distributions to, or disposition of the shares by, the U.S. holder will be subject to the excess distribution rules (described below), regardless of whether we are a PFIC in the year of distribution or disposition, unless the U.S. holder: (1) made the qualified electing fund (“QEF”) election (described below); (2) made the mark-to-market election (described below); or (3) during a year in which the corporation is no longer a PFIC, elected to recognize all gain inherent in the shares on the last day of the last taxable year in which the corporation was a PFIC. If a U.S. holder holds our ordinary shares in a PFIC Year, such ordinary shares will henceforth be considered shares in a PFIC, regardless of whether we meet the PFIC tests in future years, unless the U.S. holder makes a timely QEF or mark-to-market election, or makes the deemed-gain election in a year in which the corporation is no longer a PFIC.

 

If we are a PFIC, each U.S. holder, upon certain “excess distributions” by us and upon disposition of our ordinary shares at a gain, would be liable to pay tax at the highest then-prevailing income tax rate on ordinary income plus interest on the tax, as if the distribution or gain had been recognized ratably over the holder’s holding period for the ordinary shares. Distributions received in a taxable year that are greater than 125.0% of the average annual distributions received during the shorter of the three preceding taxable years or the U.S. holder’s holding period for the shares will be treated as excess distributions. Additionally, if we are a PFIC, a U.S. holder who acquires ordinary shares from a deceased person who was a U.S. holder would not receive the step-up of the income tax basis to fair market value for such ordinary shares. Instead, such U.S. holder would have a tax basis equal to the deceased’s tax basis, if lower. Furthermore, non-corporate U.S. Holders will not be eligible for reduced rates of taxation on any dividends received from us in a PFIC Year or in the taxable year following a PFIC Year.

 

If a U.S. holder has made a QEF election covering all taxable years during which the holder holds ordinary shares and in which we are a PFIC, distributions and gains will not be taxed as described above, nor will denial of a basis step-up at death described above apply. Instead, a U.S. holder that makes a QEF election is required for each taxable year to include in income the holder’s pro rata share of the ordinary earnings of the QEF as ordinary income and a pro rata share of the net capital gain of the QEF as capital gain, regardless of whether such earnings or gain have in fact been distributed. Undistributed income is subject to a separate election to defer payment of taxes. If deferred, the taxes will be subject to an interest charge. Where earnings and profits that were included in income under this rule are later distributed, the distribution is not a dividend. The basis of a U.S. shareholder’s shares in a QEF is increased by amounts that are included in income, and decreased by amounts distributed but not taxed as dividends. In addition, if a U.S. holder makes a timely QEF election, our ordinary shares will not be considered shares in a PFIC in years in which we are not a PFIC, even if the U.S. holder had held ordinary shares in prior years in which we were a PFIC.

 

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In order to comply with the requirements of a QEF election, a U.S. holder must receive certain information from us. The QEF election is made on a shareholder-by-shareholder basis and can be revoked only with the consent of the IRS. A shareholder makes a QEF election by attaching a completed IRS Form 8621, including the information provided in the PFIC annual information statement, to a timely filed U.S. federal income tax return and by filing a copy of the form with the IRS. There is no assurance that we will provide such information as the IRS may require in order to enable U.S. holders to make the QEF election. Moreover, there is no assurance that we will have timely knowledge of our status as a PFIC in the future. Even if a shareholder in a PFIC does not make a QEF election, if such shareholder is a U.S. holder, such shareholder must annually file with the shareholder’s tax return and with the IRS a completed Form 8621.

 

If our ordinary shares are “regularly traded” on a “qualified exchange or other market,” as provided in applicable Treasury Regulations, a U.S. holder of our shares may elect to mark the shares to market annually, recognizing as ordinary income or loss each year an amount equal to the difference between the shareholder’s adjusted tax basis in such shares and their fair market value. Losses would be allowed only to the extent of net mark-to-market gain previously included by the U.S. holder under the election in previous taxable years. The adjusted tax basis of a U.S. holder’s ordinary shares is increased by the amount included in gross income under the mark-to-market regime, or is decreased by the amount of the deduction allowed under the regime. As with the QEF election, a U.S. holder who makes a mark-to-market election would not be subject to the general excess distribution rules and the denial of basis step-up at death described above. If a U.S. holder makes a mark-to-market election it will be effective for the taxable year for which the election is made and all subsequent taxable years unless the shares are no longer regularly traded on a qualified exchange or the Internal Revenue Service consents to the revocation of the election. U.S. holders are urged to consult their tax advisor about the availability of the mark-to-market election, and whether making the election would be advisable in such holder’s particular circumstances.

 

THE RULES DEALING WITH PFICS AND WITH THE QEF AND MARK-TO-MARKET ELECTIONS ARE VERY COMPLEX AND ARE AFFECTED BY VARIOUS FACTORS IN ADDITION TO THOSE DESCRIBED ABOVE, INCLUDING OUR OWNERSHIP OF ANY NON-U.S. SUBSIDIARIES. AS A RESULT, U.S. HOLDERS OF ORDINARY SHARES ARE STRONGLY ENCOURAGED TO CONSULT THEIR TAX ADVISORS ABOUT THE PFIC RULES IN CONNECTION WITH THEIR PURCHASING, HOLDING OR DISPOSING OF ORDINARY SHARES.

 

Backup Withholding and Information Reporting

 

In general, information reporting will apply to dividends in respect of our ordinary shares and the proceeds from the sale, exchange or redemption of our ordinary shares that are paid to a U.S. holder within the United States (and in certain cases, outside the United States), unless such holder is an exempt recipient. A backup withholding tax generally would apply to such payments if the U.S. holder fails to provide a taxpayer identification number or certification of other exempt status or, in the case of dividend payments, fails to report in full dividend and interest income.

Any amounts withheld under the backup withholding rules will be allowed as a refund or a credit against a U.S. holder’s U.S. federal income tax liability provided the required information is furnished to the Internal Revenue Service in a timely manner.

 

Under the Hiring Incentives to Restore Employment Act of 2010, individuals that own “specified foreign financial assets” with an aggregate value in excess of US$50,000 are required to file an information report with respect to such assets with their tax returns. “Specified foreign financial assets” include any financial accounts maintained by foreign financial institutions, as well as any of the following, but only if they are not held in accounts maintained by financial institutions: (i) stocks and securities issued by non-U.S. persons; (ii) financial instruments and contracts held for investment that have non-U.S. issuers or counterparties; and (iii) interests in foreign entities. U.S. holders that are individuals are urged to consult their tax advisors regarding the application of this legislation to their ownership of our ordinary shares.

 

 

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Tax on Net Investment Income

 

For tax years beginning after December 31, 2012, certain U.S. holders that are individuals, estates or trusts whose income exceeds certain thresholds will be required to pay an additional 3.8% tax on “net investment income”, which includes, among other things, dividends and net gain from the sale or other disposition of property (other than property held in a trade or business), which may include our ordinary shares. U.S. holders should consult their own tax advisors regarding the application of the tax on net investment income to their particular circumstances.

 

F.DIVIDENDS AND PAYING AGENTS

 

Not applicable.

 

G.STATEMENT BY EXPERTS

 

Not applicable.

 

H.DOCUMENTS ON DISPLAY

 

We file annual and special reports and other information with the SEC. You may inspect and copy such material at the public reference facilities maintained by the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may also obtain copies of such material from the SEC at prescribed rates by writing to the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. Our SEC filings also are available to the public from the SEC’s website at www.sec.gov. In addition, our annual and special reports and other information filed with the SEC is available free of charge through the Investors section of our website at www.rosettagenomics.com as soon as reasonably practicable after such materials have been electronically filed with, or furnished to, the SEC.

 

I.SUBSIDIARY INFORMATION

 

Not applicable.

 

ITEM 11.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

We are exposed to market risk related to changes in interest rates primarily from our investments in certain short-term investments. We maintain an investment portfolio consisting mainly of Israeli mutual fund and Israeli government bonds, directly or through managed funds. We do not utilize derivative financial instruments, derivative commodity instruments or other market risk-sensitive instruments to manage exposure to interest rate changes. Accordingly, we believe that, while the securities we hold are subject to changes in the financial standing of the issuer of such securities, we are not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments.

 

Exchange Rate Risk

 

We hold most of our cash, cash equivalents and short term bank deposits in U.S. dollars but incur a significant portion of our expenses, principally salaries and related personal expenses, in NIS. As a result, we are exposed to the risk that the U.S. dollar will be devalued against the NIS.

 

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The following table illustrates the effect of the changes in exchange rates on our operation loss for the periods indicated:

 

   Year ended December 31, 
   2016   2015   2014 
   Actual   At 2015
Exchange
rates (1)
   Actual   At 2013 
Exchange
rates (1)
   Actual   At 2012
Exchange
rates (1)
 
   (In thousands) 
Operating loss  $15,664   $15,616   $15,721   $16,097   $14,252   $14,221 
                               

__________________ 

(1)Based on average exchange rates during the period.

 

 

ITEM 12.DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

 

Not applicable.

 

PART II

 

ITEM 13.DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

 

None.

 

ITEM 14.MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

 

Material Modifications to the Rights of Security Holders

 

On December 3, 2015, our stockholders approved an increase to our registered (authorized) share capital by NIS 12,000,000, divided into 1,666,667 ordinary shares, nominal (par) value NIS 7.2 each, so that following such increase, the registered (authorized) share capital was NIS 36,000,000 divided into 5,000,000, ordinary shares nominal (par) value NIS 7.2 each.

 

The material provisions of our articles of association, as amended, are described under “Item 10. Additional Information — B. Memorandum and Articles of Association.”

 

Use of Proceeds

 

Not applicable.

 

ITEM 15.CONTROLS AND PROCEDURES

 

A.DISCLOSURE CONTROLS AND PROCEDURES

 

Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 20-F, have concluded that, based on such evaluation, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

B.MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. Our internal control system was designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

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Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2016. Management reviewed the results of its assessment with our Audit Committee.

 

C.ATTESTATION REPORT OF THE REGISTERED PUBLIC ACCOUNTING FIRM

 

This Annual Report on Form 20-F does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Because we are neither an accelerated filer nor a large accelerated filer, management’s report was not subject to attestation by our registered public accounting firm pursuant to the rules of the SEC.

 

D.CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

 

Based on the evaluation conducted by our management, there were no changes in our internal control over financial reporting, identified in connection with the evaluation of such internal control that occurred during the last fiscal year that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 16.RESERVED

 

ITEM 16A.AUDIT COMMITTEE FINANCIAL EXPERT

 

Our audit committee consists of Gerald Dogon (Chairman), Dr. David Sidransky and Tali Yaron-Eldar, all of whom are independent under the rules and regulations of NASDAQ. Our board of directors has determined that Mr. Dogon qualifies as an “audit committee financial expert” as defined in the instructions to Item 16A of Form 20-F.

 

ITEM 16B.CODE OF ETHICS

 

We have adopted a code of corporate conduct and ethics that applies to all of our employees, officers and directors. The text of the code of corporate conduct and ethics is posted on the “Corporate Governance” section of our website at www.rosettagenomics.com. Disclosure regarding any amendments to, or waivers from, provisions of the code of conduct and ethics that apply to our directors, principal executive and financial and accounting officers will be included in a Form 6-K within four business days following the date of the amendment or waiver, unless website posting of such amendments or waivers is then permitted by the rules of The NASDAQ Stock Market.

 

ITEM 16C.PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

Accounting Fees and Services

 

The following table presents fees for professional audit services rendered by Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, independent registered public accountants, for the audit of our consolidated financial statements and services normally provided by the independent auditor in connection with statutory and regulatory filings or engagements for the years ended December 31, 2016 and December 31, 2015 and fees billed for other services rendered by Kost Forer Gabbay & Kasierer during those periods.

 

   2016   2015 
Audit fees (1)  $195,000   $202,500 
Audit-related fees (2)   5,000    71,150 
Tax fees (3)   37,000    16,872 
Total  $237,000   $290,522 

 

(1) Audit services were comprised of services associated with the audit of our consolidated financial statements and services normally provided by the independent auditor in connection with statutory and regulatory filings or engagements and registration statements.

 

(2) Audit related fees relate to assurance and associated services that traditionally performed by the independent auditor, including: due diligence investigations and audit services provided in connection with other statutory or regulatory filings.

 

(3) Tax services were comprised of tax compliance, tax advice and tax planning services.

 

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Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors

 

Our audit committee was established effective upon the completion of our initial public offering in March 2007. Consistent with policies of the Securities and Exchange Commission regarding auditor independence, the audit committee has responsibility for appointing, setting compensation and overseeing the work of the independent auditor. The audit committee operates under a written charter which provides that the committee must approve in advance all audit services and all permitted non-audit services, except where such services are determined to be de minimis under the Exchange Act. The audit committee may delegate, to one or more designated members of the audit committee, the authority to grant such pre-approvals. The decision of any member to whom such authority is delegated is to be presented to the full audit committee at each of its scheduled meetings.

 

ITEM 16D.EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

 

Not applicable.

 

ITEM 16E.PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

 

Not applicable.

 

ITEM 16F.CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

 

Not applicable.

 

ITEM 16G.CORPORATE GOVERNANCE

 

There are no significant differences between our corporate governance practices and those required of a U.S. domestic issuer under the rules of The NASDAQ Stock Market. However, pursuant to the rules and regulations of The NASDAQ Stock Market, a foreign private issuer may follow its home country practice in lieu of certain NASDAQ listing requirements. We have in the past elected to follow home country practice in lieu of certain NASDAQ requirements as follows:

 

·NASDAQ rules require that the quorum for meetings of a company’s shareholders be not less than 33 1/3% of the outstanding voting stock of the company. We have, however, chosen to follow home country practice with respect to shareholder meeting quorum and our Articles provide that the quorum required for any meeting of our shareholders shall consist of at least two shareholders present, in person or by proxy, who hold or represent between them more than 25% of the voting power of our issued share capital.

·Under NASDAQ’s rules, (1) the private placement completed in December 2010, (2) the concurrent private placement and registered direct offering completed in February 2011, (3) the private placement completed in October 2011, (4) the convertible debt transaction completed in January 2012, (5) the registered direct offerings completed in April 2012 and May 2012, and (6) the private placement completed in October 2015 would have required shareholder approval because these offerings represented the issuance (or potential issuance) of more than 20% of our outstanding ordinary shares at a price per share below the greater of book value per share or market value per share. However, we chose to follow our home country practice, which exempts companies such as us from the requirement of shareholder approval of these offerings.

 

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·Under NASDAQ’s rules, the written charter of the Compensation Committee is required to specify certain details, including certain factors that must be considered when the Compensation Committee selects, or receives advice from, a compensation consultant, legal counsel or other advisor. However, we have chosen to follow our home country practice, which does not require such information to be specified in the Compensation Committee Charter.

 

Because of these SEC and NASDAQ exemptions, investors are not afforded the same protections or information generally available to investors holding shares in public companies organized in the United States. See also “Item 3. Key Information — D. Risk Factors — Risks Related to Israeli Law and Our Operations in Israel — Being a foreign private issuer exempts us from certain SEC and NASDAQ requirements.”

 

ITEM 16H.MINE SAFETY DISCLOSURE

 

Not applicable.

 

PART III

 

ITEM 17.FINANCIAL STATEMENTS

 

See Item 18.

 

ITEM 18.FINANCIAL STATEMENTS

 

Our consolidated financial statements and related notes are included in this Annual Report beginning on page F-1.

 

ITEM 19EXHIBITS

 

The following is a list of exhibits filed as part of this Annual Report.

 

Exhibit Number Description of Exhibit
1.1(21) Amended and Restated Articles of Association, as amended.
2.1(1) Form of Share Certificate for Ordinary Shares.
2.2(6) Registration Rights Agreement, dated November 29, 2010, by and between Rosetta Genomics Ltd. and the investors in the December 2010 private placement.
2.3(7) Registration Rights Agreement, dated February 16, 2011, by and between Rosetta Genomics Ltd. and the investors in the February 2011 private placement.
2.4(8) Form of Series A Warrant issued by Rosetta Genomics Ltd. to the investors and the placement agent in the October 2011 private placement.
2.5(8) Registration Rights Agreement, dated October 13, 2011, by and between Rosetta Genomics Ltd. and the investors in the October 2011 private placement.
2.6(15) Form of warrant issued to the placement agent in the January 2012 debt financing.
2.7(12) Form of Purchase Option Agreement issued to Aegis Capital Corp as placement agent in the April 2012 Registered Direct Offering.

 

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2.8(13) Form of Purchase Option Agreement issued to Aegis Capital Corp as placement agent in the May 2012 Registered Direct Offering.
2.9(9) Form of Purchase Option Agreement issued to Aegis Capital Corp as placement agent in the second May 2012 Registered Direct Offering.
2.10(15) Form of Purchase Option Agreement issued to the underwriter in the August 2012 underwritten public offering.
2.11(16) Form of Series A Warrant issued by Rosetta Genomics Ltd. to the investors and the placement agent in the October 2015 private placement.
2.12(16) Form of Series B Warrant issued by Rosetta Genomics Ltd. to the investors in the October 2015 private placement.
2.12.1(17) Form of Amendment to Series B Warrants issued by Rosetta Genomics Ltd. to the investors in the October 2015 private placement.
2.13(16) Registration Rights Agreement, dated October 13, 2015, by and between Rosetta Genomics Ltd. and the investors in the October 2015 private placement.
2.14(16) Controlled Equity OfferingSM Sales Agreement, dated February 18, 2015, by and between Rosetta Genomics Ltd. and Cantor Fitzgerald & Co.
2.15(19) Form of 2016 Warrant issued to investors in the 2016 Offerings.
2.16(19) Form of Registered Debenture issued to investors in the 2016 Offerings.
2.17(19) Form of PIPE Debenture issued to investors in the 2016 Offerings.
2.18(19) Subsidiary Guarantee, dated November 29, 2016, issued to investors in the 2016 Offerings.
2.19(19) Form of Placement Agent Warrant issued to the Placement Agents and affiliates in the 2016 Offerings.
2.20(19) Registration Rights Agreement, dated November 23, 2016 between the Company and investors in the 2016 Offerings.
4.1(1)@ License Agreement, dated as of May 4, 2006, by and between Rosetta Genomics Ltd. and The Rockefeller University.
4.2(2)@ License Agreement, dated effective as of May 1, 2007, by and between Rosetta Genomics Ltd. and The Rockefeller University.
4.3(1) Lease Agreement, dated August 4, 2003, by and between Rosetta Genomics Ltd., as tenant, and Rorberg Contracting and Investments (1963) Ltd. and Tazor Development Ltd., as landlords, as amended in April 2004 and as extended on April 9, 2006 (as translated from Hebrew).
4.4(10)

Air Commercial Real Estate Association Standard Industrial/Commercial Single-Tenant Lease – Net, by and between Donna June Kitts Revocable Trust dated April 10, 2006 and CynoGen Inc., dated as of December 1, 2013, as amended.

 

4.5(4) Lease Agreement from Wexford-UCSC II, L.P. to Rosetta Genomics Inc., dated July 7, 2008, and First Amendment thereto, dated August 11, 2008.
4.6(1) 2003 Israeli Share Option Plan.
4.7(11) 2006 Employee Incentive Plan (Global Share Incentive Plan).
4.8(1) Form of Director and Officer Indemnification Agreement.
4.9(5)@ Amended and Restated License Agreement, dated as of March 3, 2009, by and between Rosetta Genomics Ltd. and Max Planck Innovation GmbH.
4.10(14)@ Amended and Restated License Agreement, dated August 14, 2011, by and between The Johns Hopkins University and Rosetta Genomics Ltd.
4.11(1)@ License Agreement, dated as of December 22, 2006, by and between Rosetta Genomics Ltd. and Max Planck Innovation GmbH.
4.12(1)@ Cooperation and Project Funding Agreement, dated effective as of May 1, 2006, by and among Rosetta Genomics Ltd., the Israel-United States Binational Industrial Research and Development Foundation and Isis Pharmaceuticals, Inc.
4.13(3)@ License Agreement, dated effective as of January 8, 2008, by and between Rosetta Genomics Ltd. and The Rockefeller University.

 

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4.14(20) Stock Purchase Agreement dated April 3, 2015, by and between Prelude Corporation and Rosetta Genomics Inc. and Rosetta Genomics Ltd.
4.15(17) Securities Purchase Agreement, dated October 13, 2015, by and between Rosetta Genomics Ltd. and the investors in the October 2015 private placement.
4.16(19) Securities Purchase Agreement, dated November 23, 2016, between the Company and the investors in the 2016 Offering.
8.1* Subsidiaries.
12.1* Certification of Principal Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a).
12.2* Certification of Principal Accounting and Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b).
13.1* Certification of the Principal Executive Officer and the Principal Accounting and Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.
15.1* Consent of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global.
101* The following materials from Rosetta Genomics Ltd.’s Annual Report on Form 20-F for the year ended December 31, 2016, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Stockholders’ Equity (Deficit) and Comprehensive Income (Loss), (iv) the Consolidated Statements of Cash Flows, and (v) Notes to Consolidated Financial Statements

____________
*Filed herewith.
@Confidential portions of these documents have been filed separately with the SEC pursuant to a request for confidential treatment.
(1)Incorporated by reference from the Registrant’s Registration Statement on Form F-1 (Reg. No. 333-137095), initially filed with the SEC on September 1, 2006.
(2)Incorporated by reference from the Registrant’s Form 6-K dated August 2, 2007 (Reg. No. 001-33042), filed with the SEC on August 3, 2007.
(3)Incorporated by reference from the Registrant’s Annual Report on Form 20-F for the year ended December 31, 2007 (Reg. No. 001-33042), filed with the SEC on June 26, 2008.
(4)Incorporated by reference from the Registrant’s Annual Report on Form 20-F for the year ended December 31, 2008 (Reg. No. 001-33042), filed with the SEC on June 30, 2009.
(5)Incorporated by reference from the Registrant’s Form 6-K dated August-September 2009 (Reg. No. 001-33042), filed with the SEC on September 9, 2009.
(6)Incorporated by reference from the Registrant’s Form 6-K dated November 2010 (Reg. No. 001-33042), filed with the SEC on November 30, 2010.
(7)Incorporated by reference from the Registrant’s Form 6-K dated February 2011 (Reg. No. 001-33042), filed with the SEC on February 18, 2011.
(8)Incorporated by reference from the Registrant’s Form 6-K dated October 2011 (Reg. No. 001-33042), filed with the SEC on October 14, 2011.
(9)Incorporated by reference from the Registrant’s Form 6-K dated May 2012 (Reg. No. 001-33042), filed with the SEC on May 25, 2012.
(10)Incorporated by reference from the Registrant’s Annual Report on Form 20-F for the year ended December 31, 2013 (Reg. No. 001-33042), filed with the SEC on March 31, 2014.
(11)Incorporated by reference from the Registrant’s Annual Report on Form 20-F for the year ended December 31, 2012 (Reg. No. 001-33042), filed with the SEC on March 22, 2013.
(12)Incorporated by reference from the Registrant’s Form 6-K dated April 2012 (Reg. No. 001-33042), filed with the SEC on April 16, 2012.
(13)Incorporated by reference from the Registrant’s Form 6-K dated April 2012 (Reg. No. 001-33042), filed with the SEC on May 17, 2012.
(14)Incorporated by reference from the Registrant’s Annual Report on Form 20-F for the year ended December 31, 2011 (Reg. No. 001-33042), filed with the SEC on April 2, 2012.
(15)Incorporated by reference from the Registrant’s Registration Statement on Form F-1 (Reg. No. 333-182329), filed with the SEC on June 25, 2012, as amended on July 26, 2012 and August 2, 2012.
(16)Incorporated by reference from the Registrant’s Form 6-K/A (Reg. No. 001-33042), filed with the SEC on February 18, 2015.
(17)Incorporated by reference from the Registrant’s Form 6-K dated October 2015 (Reg. No. 001-33042), filed with the SEC on October 14, 2015.
(18)Incorporated by reference from the Registrant’s Form 6-K dated December 2015 (Reg. No. 001-33042), filed with the SEC on December 3, 2015.
(19)Incorporated by reference from the Registrant’s Form 6-K dated November 2016 (Reg. No. 001-33042), filed with the SEC on November 25, 2016.
(20)Incorporated by reference from the Registrant’s Annual Report on Form 20-F for the year ended December 31, 2015 (Reg. No. 001-33042), filed with the SEC on March 23, 2016.
(21)Incorporated by reference from the Registrant’s Form 6-K dated March 2017 (Reg. No. 001-33042), filed with the SEC on March 16, 2017.

 

 92 

 

 

SIGNATURE

 

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.

 

  ROSETTA GENOMICS LTD.
   
Dated: March 30, 2017 By: /s/ Kenneth A. Berlin  
  Kenneth A. Berlin, Chief Executive Officer and
  President

 

 

 

 

 

 

 

 93 

 

 

ROSETTA GENOMICS LTD. AND SUBSIDIARY

 

CONSOLIDATED FINANCIAL STATEMENTS

 

AS OF DECEMBER 31, 2016

 

U.S. DOLLARS IN THOUSANDS

 

INDEX

 

  Page
   
Report of Independent Registered Public Accounting Firm F-2
   
Consolidated Balance Sheets F-3 - F-4
   
Consolidated Statements of Comprehensive Loss F-5
   
Consolidated Statements of Changes in Shareholders’ Equity   F-6
   
Consolidated Statements of Cash Flows F-7 - F-8
   
Notes to Consolidated Financial Statements F-9 - F-37

 

 

 

 

- - - - - - - - - - - - - - - - - - - -

 

 

 F-1 

 

 

 

Kost Forer Gabbay & Kasierer

3 Aminadav St.

Tel-Aviv 6706703, Israel

 

 

Tel: +972-3-6232525

Fax: +972-3-5622555

ey.com

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders of Rosetta Genomics Ltd.

 

We have audited the accompanying consolidated balance sheets of Rosetta Genomics Ltd. (the “Company”) and its subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of comprehensive loss, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. We were not engaged to perform an audit of the Company’s and its subsidiaries internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Company’s and its subsidiaries internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above, present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1e to the consolidated financial statements, the Company has recurring losses from operations and has limited liquidity resources that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1e. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

Tel-Aviv, Israel /s/ KOST FORER GABBAY & KASIERER
March 30, 2017 A Member of Ernst & Young Global

  

 F-2 

 

 

ROSETTA GENOMICS LTD. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands

 

      December 31, 
   Note  2016   2015 
ASSETS             
              
CURRENT ASSETS:             
Cash and cash equivalents     $6,163   $12,447 
Short-term bank deposits and restricted cash  4   130    1,098 
Trade receivables      2,851    3,633 
Other accounts receivable and prepaid expenses  5   369    2,192 
              
Total current assets      9,513    19,370 
              
LONG TERM ASSETS:             
              
Property and equipment, net  6   2,442    2,975 
Long-term bank deposits and other long-term receivables      6    78 
              
Total long term assets      2,448    3,053 
              
Total assets     $11,961   $22,423 

 

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

 

 F-3 

 

 

ROSETTA GENOMICS LTD. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands (except share and per share data)

 

      December 31, 
   Note  2016   2015 
LIABILITIES AND SHAREHOLDERS EQUITY             
              
CURRENT LIABILITIES:             
Current maturity of long-term capital lease  7  $55   $- 
Trade payables      1,574    1,070 
Other accounts payable and accruals  8   2,175    1,733 
              
Total current liabilities      3,804    2,803 
              
LONG-TERM LIABILITIES:             
Debentures and Warrants  3, 9   3,675    - 
Long-term capital lease obligations  7   65    - 
              
Total long-term liabilities      3,740    - 
              
COMMITMENTS AND CONTINGENT LIABILITIES  10          
              
SHAREHOLDERS’ EQUITY:             
Share capital:  11          
Ordinary Shares of NIS 7.2 par value: 5,000,000 shares authorized at December 31, 2016 and 2015, respectively; 1,842,704 and 1,709,900 shares issued at December 31, 2016 and 2015, respectively; 1,842,704 and 1,709,628 shares outstanding at December 31, 2016 and 2015, respectively      3,442    3,194 
Additional paid-in capital      157,478    156,696 
Accumulated deficit      (156,503)   (140,270)
              
Total shareholders’ equity      4,417    19,620 
              
Total liabilities and shareholders’ equity     $11,961   $22,423 

 

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

 F-4 

 

 

ROSETTA GENOMICS LTD. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

U.S. dollars in thousands (except share and per share data)

 

     

Year ended

December 31,

 
   Note  2016   2015   2014 
Clinical testing revenues     $9,234   $6,668   $1,099 
Licensing revenues      -    1,600    228 
Total revenues      9,234    8,268    1,327 
                   
Cost of clinical testing revenues      7,439    6,192    1,310 
Cost of licensing revenues      -    80    - 
Total cost of revenues      7,439    6,272    1,310 
                   
Gross profit      1,795    1,996    17 
                   
Operating expenses:                  
                   
Research and development, net  2l   3,156    2,956    1,927 
Sales, marketing and business development      6,806    7,350    6,848 
General and administrative      7,497    7,566    5,494 
Gain from bargain purchase related to acquisition of  CynoGen, Inc.  1d   -    (155)   - 
                   
Total operating expenses      17,459    17,717    14,269 
                   
Operating loss      15,664    15,721    14,252 
Financial expenses, net  13   603    1,605    259 
                   
Loss before income taxes      16,267    17,326    14,511 
Income tax (benefit) expense  12   (34)   19    15 
                   
Net loss      16,233    17,345    14,526 
                   
Basic and diluted net loss per Ordinary Share     $9.31   $13.79   $15.51 
                   
Weighted average number of Ordinary Shares used to compute basic and diluted net loss per Ordinary Share      1,743,067    1,257,724    936,658 

 

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

 

 F-5 

 

 

ROSETTA GENOMICS LTD. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

U.S. dollars in thousands (except per share data)

 

   Number of
Ordinary
Shares
  

Share

capital

   Additional
paid-in
capital
   Accumulated
deficit
  

Total

equity (deficit)

 
Balance as of December 31, 2013   872,520   $1,609   $130,423   $(108,399)  $23,633 
Issuance of shares in January 2014, at $43.68 per share, net of $33 issuance expenses   21,805   $45   $876   $-   $921 
Issuance of shares in April 2014, at $61.08 per share, net of $9 issuance expenses   4,937    10    283    -    293 
Issuance of shares in May 2014, at $48.36 per share, net of $8 issuance expenses   5,533    11    247    -    258 
Issuance of shares in June 2014, at $50.76 per share, net of $45 issuance expenses   30,164    62    1,422    -    1,484 
Issuance of shares in July 2014, at $54.24 per share, net of $48 issuance expenses   29,305    62    1,481    -    1,543 
Issuance of shares in August 2014, at 45.84 per share, net of $6 issuance expenses   4,038    8    171    -    179 
Issuance of shares in September 2014, at $45.72 per share, net of $10 issuance expenses   7,071    14    300    -    314 
RSUs conversion   3,584    7    (7)   -    - 
Exercise of warrants   746    1    (1)   -    - 
Employee options exercised   4    (*)   (*)   -    - 
Issuance of shares to a former employee   500    1    22    -    23 
Share-based compensation relating to options and RSUs issued to employees and directors   -    -    943    -    943 
Net loss   -    -    -    (14,526)   (14,526)
                          
Balance as of December 31, 2014   980,202   $1,830   $136,160   $(122,925)  $15,065 
                          
Issuance of shares in February 2015, at $53.52 per share, net of $491 issuance expenses   183,731    344    8,994    -    9,338 
Issuance of shares related to acquisition (Note 1)   51,667    94    1,856    -    1,950 
Issuance of shares in July 2015, at $39.24 per share, net of $18 issuance expenses   15,457    29    560    -    589 
Issuance of shares in August 2015, at $36.48 per share, net of $3 issuance expenses   2,844    6    95    -    101 
Issuance of shares and exercise of warrants B related to the October 2015 placement, at $15.96 per share, net of $331 issuance expenses   472,209    884    1,750    -    2,634 
Reclassification of Warrants A and B to shareholders’ equity   -    -    6,272    -    6,272 
RSUs conversion   3,521    7    (7)   -    - 
Share-based compensation relating to options and RSUs issued to employees and directors   -    -    1,016    -    1,016 
Net loss   -    -    -    (17,345)   (17,345)
                          
Balance as of December 31, 2015   1,709,628   $3,194   $156,696   $(140,270)  $19,620 
                          
Issuance of shares in November 2016, at $6 per share   91,250    171    (171)   -    - 
Issuance of warrants to placement agents related to November 2016 placement   -    -    152    -    152 
Exercise of warrants B related to the October 2015 placement   27,776    51    (51)   -    - 
Conversion of debentures related to the November 2016 placement, at $6 per share   8,333    16    3    -    19 
RSUs conversion   5,445    10    (10)   -    - 
Share-based compensation relating to options and RSUs issued to employees and directors   -