NOTE 6 - CONVERTIBLE LOANS

On April 5, 2012, the Company issued senior secured convertible debentures (the "2012 Convertible Debentures") due April 5, 2014 in the original aggregate principal amount of $11,702,128 and five-year warrants (the "2012 Warrants") to purchase an aggregate of 835,866 shares of its common stock at an exercise price of $7.20 per share in a private placement transaction in exchange for aggregate gross proceeds of approximately $11 million. The 2012 Convertible Debentures bear interest at an annual rate of 8% (payable quarterly beginning on July 1, 2012) and are convertible at any time into shares of common stock at an initial conversion price of $7.00 per share.

The relevant features of the 2012 Convertible Debentures and 2012 Warrants are summarized below:

2012 Convertible Debentures

Conversion and contingent conversion

The 2012 Convertible Debentures, including accrued interest on such 2012 Convertible Debentures, are convertible at any time, in whole or part, at the option of the holders into shares of common stock at an initial conversion price of $7.00 per share, subject to adjustment for stock splits, fundamental transactions or similar events and an additional conversion adjustment described below.

The number of conversion shares issuable upon a conversion shall be determined by the quotient obtained by dividing (x) the sum of (a) the outstanding principal amount to be converted, (b) at the option of the holder, a portion or all of any accrued and unpaid interest to be converted and (c) the conversion adjustment amount by (y) the conversion price.

The "conversion adjustment amount" is calculated by multiplying the principal amount being converted by a fraction, the numerator of which is (a) the number of days elapsed from the original issue date multiplied by (b) .021917808; and the denominator of which is 100. The maximum number of days elapsed to be used in calculating the conversion adjustment amount will not be greater than 548 days regardless of the actual number of days elapsed from the original issue date.

The Company may force conversion of the 2012 Convertible Debentures if the closing bid price of the Company's common stock equals or exceeds 165% of the conversion price for twenty consecutive trading days, the minimum daily trading volume for such period is $1,100,000, all of the shares of the common stock underlying the 2012 Convertible Debentures during such period are either registered for resale with the Securities and Exchange Commission or eligible for resale pursuant to Rule 144 and there is no existing event of default or existing event which, with the passage of time or the giving of notice, would constitute an event of default during such period.

The 2012 Convertible Debentures contain certain limitations on conversion. No conversion may be made if, after giving effect to the conversion, any holder would beneifially own in excess of 4.99% of the Company's outstanding shares of common stock. This percentage may be increased to a percentage not to exceed 9.99%, at the option of such holder, except any increase will not be effective until the holder has given 61 days' prior notice to the Company.

The 2012 Convertible Debentures impose penalties on the Company for any failure to timely deliver any shares of its common stock issuable upon conversion.

Events of default and holder's contingent redemption option

If there is an event of default as stipulated in the agreement, then by election of the holders holding at least 60% of the 2012 Convertible Debentures, the Company must redeem all of the 2012 Convertible Debentures in cash for 112% of the outstanding principal, together with all unpaid and accrued interest, all interest that would have been payable through the maturity date and any other amounts due under the 2012 Convertible Debentures (such amount, the "Mandatory Default Amount"). The Mandatory Default Amount will accrue interest at a rate of 24% per annum commencing on the fifth calendar date following the relevant event of default.

Holder's noncontingent redemption option

Commencing 18 months following the original issuance date of the 2012 Convertible Debentures, the holders may require the Company to redeem all or a portion of the 2012 Convertible Debentures, for a price equal to 112% of the amount of principal to be redeemed plus all accrued but unpaid interest and other amounts due under the 2012 Convertible Debentures.

Company's noncontingent redemption option

Commencing 6 months following the original issuance date of the 2012 Convertible Debentures, the Company may redeem all or a portion of the 2012 Convertible Debentures for a price equal to 112% of the amount of principal to be redeemed plus all accrued but unpaid interest and other amounts due under the 2012 Convertible Debentures.

Covenants

The 2012 Convertible Debentures contain certain covenants which prohibit or limit the Company's and its subsidiaries ability to, among other things:

pay cash dividends to its stockholders;

redeem, repurchase or otherwise acquire more than a de minimis number of shares of its common stock or common stock equivalents;

incur additional indebtedness;

permit liens on assets or conduct sales of assets;

effectuate stock splits until April 5, 2013, except in connection with an initial listing on a national securities exchange or to meet the continued listing requirements of such exchange;

cease making public filings under the Securities Exchange Act of 1934, as amended;

engage in transactions with affiliates; and

amend its charter documents in a way that would materially and adversely affect any holder of the 2012 Convertible Debentures.

Pro rata distributions

If the Company, at any time while the 2012 Convertible Debentures are outstanding, distributes to all holders of common stock evidences of its indebtedness or assets (including cash and cash dividends) or rights or warrants to subscribe for or purchase any security other than the common stock, then, upon any conversion of the 2012 Convertible Debentures, the holder shall be entitled to receive such distribution to the same extent that the holder would have if the holder had held the number of conversion shares issued upon such conversion of the 2012 Convertible Debentures immediately before the date on which a record was taken for such distribution, or, if no such record was taken, the date as of which the record holders of shares of common stock were determined for the participation in such distribution.

2012 Warrants

Exercisability

The 2012 Warrants are immediately exercisable and, in the aggregate, entitle the holders to purchase up to 835,866 shares of common stock. The 2012 Warrants have an initial exercise price of $7.20 per share payable in cash. The 2012 Warrants expire on April 5, 2017.

Similar to the 2012 Convertible Debentures, the 2012 Warrants also contain limitations on exercise that would cause the holder to beneficially own in excess of 4.99% or 9.99% of the Company's outstanding common stock.

Anti-dilution protection

The exercise price of the 2012 Warrants and the number of shares issuable upon exercise of the 2012 Warrants are subject to adjustments for stock splits, combinations or similar events.

"Most favored nation"

The 2012 Warrants are also subject to an adjustment pursuant to which, in the event that the Company issues or is deemed to have issued certain securities with terms that are superior to those of the 2012 Warrants, except with respect to exercise price and warrant coverage, the superior terms will automatically be incorporated into the 2012 Warrants (a "Most Favored Nation Adjustment").

Contingent holder redemption option

Upon the occurrence of a transaction involving a change of control that is (i) an all cash transaction, (ii) a "Rule 13e-3 transaction" as defined in Rule 13e-3 under the Securities Exchange Act of 1934, as amended, or (iii) involving a person or entity not traded on a national securities exchange, the holders of the 2012 Warrants will have the right, among others, to have the 2012 Warrants repurchased for a purchase price in cash equal to the Black-Scholes value of the then unexercised portion of the 2012 Warrants.

Pro rata distributions

Similar to the 2012 Convertible Debentures, the 2012 Warrants allow exercising holders to participate in pro rata distributions.

Public information failure

If the Company fails for any reason to satisfy the current public information requirement under Rule 144(c) then, in addition to any other remedies available to the holders, the Company must pay to the holders, in cash, partial liquidated damages as set forth in the agreement.

Transaction costs

In connection with the Transaction, the Company paid issuance costs, including placement agent and legal fees, of approximately $1,200,000, and issued five-year warrants ("2012 Placement Agents Warrants") to purchase 78,078 shares of the Company's common stock at an exercise price of $7.20 per share to the placement agent.

Accounting treatment

2012 Warrants

The Company determined, based on the provisions of ASC 480-10-25-8, that equity classification is precluded because of the redeemable option of the holders in the event of a change in control (in certain conditions), which is an event that is not within the Company's control. Accordingly, the 2012 Warrants are classified as a liability in the consolidated balance sheets and measured at fair value at each reporting period. The fair value of the 2012 Warrants is estimated using the Black-Scholes valuation model. See Note 2t.

In calculating the fair value of the 2012 Warrants (including the 2012 Placement Agents Warrants), the Company used the following assumptions: expected term of 5 and 4.76 years for the transaction date and for the June 30, 2012 respectively; expected volatility of 66.1% and 69.6% for the transaction date and for the June 30, 2012 respectively; risk-free interest rate of 1.01% and 0.72% for the transaction date and for the June 30, 2012 respectively; and dividend yield of 0%.

As of the closing day of the Exchange Agreement (see also Note 6) the Company recalculated the fair value of the 2012 Warrants by using the following assumptions: expected term of 3.79-4 years, expected volatility of 63.5%-64.7%, risk-free interest rate of 0.52%-0.78% and dividend yield of 0%.

2012 Convertible Debentures

In accordance with ASC 470-20, "Debt with Conversion and Other Options," the Company determined that a BCF existed at the issuance date of the 2012 Convertible Debentures. The BCF amounting to approximately $3,790,000 was recorded in equity.

In addition, the Company analyzed the holders' contingent redemption option based on the guidance stipulated in Topic 815, and concluded that the holders' contingent redemption option is not clearly and closely related to the debt host contract. Thus, the Company bifurcated and accounted for it separately as an embedded derivative and classified it, together with the 2012 Convertible Debentures, in its statement of financial position. This embedded derivative will be measured at fair value at each reporting period. The fair value of the embedded derivative is estimated using the binominal valuation model.

In addition, the Company analyzed the holders' noncontingent redemption option and determined that the prepayment options are clearly and closely related to the debt host contract and should not be bifurcated from the 2012 Convertible Debentures.

The gross proceeds amounting to approximately $11,000,000 from the 2012 Convertible Debentures transaction were allocated as follows:

2012 Warrants at fair value - approximately $2,807,000 based on their fair value;

embedded derivative - approximately $8,000 based on its fair value; and

2012 Convertible Debentures - approximately $8,185,000 based on the residual amount after the allocation of other components as described above.

In addition, an amount of approximately $3,790,000 was recognized as a BCF against the 2012 Convertible Debentures.

The 2012 Convertible Debentures are subsequently measured at amortized cost on the basis of the effective interest method over the loan period until the maturity date.

Transaction costs

Direct transaction costs of approximately $1,394,000, which included the placement agents fees and the 2012 Placement Agents Warrants valued at approximately $262,000 as of the transaction date, as well as other issuance costs, were allocated to the various instruments associated with the 2012 Convertible Debentures pro-rata to the amount such instruments were recorded as of the transaction date. The amounts that were allocated to the 2012 Warrants at fair value and embedded derivative were recorded in "Financial expenses" and the remainder amounting to approximately $1,037,000 was recorded as "Deferred debt issuance costs" in the consolidated balance sheets and will be amortized over the loan period using the effective interest method until the maturity date.

Exchange and amendment agreement

On April 9, 2013, the Company, entered into an exchange and amendment agreement with the holders of the Company's 2012 Convertible Debentures due April 5, 2014 and as subsequently amended on April 15, 2013 (the "Exchange Agreement"). Simultaneously with the closing of the Offering (as defined in Note 9a), the Company consummated the transactions under the Exchange Agreement on April 16, 2013 (the "Closing Day"). Pursuant the Exchange Agreement and in full satisfaction of the Company's obligations under the Debentures, the Company:

repaid $8,787,234 in cash;

issued 2,159,574 shares of common stock to the holders of the Debentures, reflecting a conversion price of $2.00 per share for the remaining unpaid portion of the Debentures;

issued five year warrants to the holders of the Debentures to purchase an aggregate of 659,091 shares of common stock for $3.00 per share ("$3.00 Warrants");

In accordance with the provisions of ASC 470-20, the terms of the Exchange Agreement were considered to be an induced conversion and the retirement of the Debentures was accounted for as if the 2012 Convertible Debentures had been converted according to their original conversion price of $7 valued at $3,538,723. This value was compared to the fair value of the consideration paid to the debt holders, including the 2,159,574 shares issued (which reflected a conversion price of $2.00 per share) that were valued at $4,081,595, the $8,787,234 of cash paid to the holders of the Debentures and the $3.00 Warrants valued at $568,098. As a result, the Company incurred approximately $9.9 million of expenses in connection with the Exchange Agreement which were recorded in "Financial expenses (income), net" within the consolidated statements of operations.

In calculating the fair value of the $3.00 Warrants, the Company used the following assumptions: dividend yield of 0% and expected term of 5 years; expected volatility of 68%; and risk-free interest rate of 0.71%.

In connection with the Exchange Agreement the Company amortized the deferred debt issuance costs. The expenses amounting to approximately $641,000 were recorded in "Financial expenses (income), net" within the consolidated statements of operations.

In addition, pursuant to the Exchange Agreement, the Company:

amended the securities purchase agreement pursuant to which the Debentures were originally issued to prohibit the Company from issuing securities containing anti-dilution protective provisions; and

amended the 2012 Warrants to (i) eliminate the Most Favored Nation Adjustment and (ii) provide that upon a fundamental transaction, the holders of such warrants will now have the right to cause the Company to repurchase the unexercised portion of such warrants at their Black-Scholes value on the date of such fundamental transaction, payable in shares of common stock, rather than in cash as was previously provided.

The Company determined, based on the provisions of ASC 480-10-25-8, that following the amendment to the 2012 Warrants described above, equity classification is no longer precluded and accordingly, the 2012 Warrants valued at approximately $314,000 as of the Closing Day of the Exchange Agreement were classified from a liability to equity in the consolidated balance sheets.