EX-99.(A)(1)(B) 3 ex991a1b.htm EXHIBIT 99.(A)(1)(B) Exhibit

Exhibit (a)(1)(B)
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THE TRANSACTION CONTEMPLATED HEREIN; PASSED UPON THE MERITS OR FAIRNESS OF THE TRANSACTION; OR PASSED UPON THE ADEQUACY OR ACCURACY OF THE DISCLOSURE IN THIS DOCUMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
 
OFFER TO AMEND AND EXERCISE

WARRANTS TO PURCHASE COMMON STOCK


INNOVATE BIOPHARMACEUTICALS, INC.

FEBRUARY 12, 2020
 
THE OFFER TO AMEND AND EXERCISE (AND ASSOCIATED WITHDRAWAL RIGHTS)
WILL EXPIRE AT 5:00 P.M. (Eastern time) ON MARCH 20, 2020 UNLESS
THIS OFFER PERIOD IS EXTENDED.
 
Innovate Biopharmaceuticals, Inc., a Delaware corporation, is referred to in this Offer to Amend and Exercise as “we,” “us,” ”Innovate” or the “Company,” and a holder of record of certain outstanding warrants as of February 12, 2020 is referred to as “Eligible Holder” or “you.”
 
The Company is offering to amend, upon the terms and subject to the conditions set forth herein, outstanding warrants to purchase an aggregate of 12,346,631 shares of common stock held by Eligible Holders (the “Offer to Amend and Exercise”), consisting of the following outstanding warrants

Issue Date
Number of Warrants
Exercise Price
Expiration Date
1/29/2018
1,410,364

$3.18

 
1/29/2023
1/29/2018
349,555

$2.54

 
1/29/2023
3/18/2019
2,508,634

$2.56

 
3/18/2024
3/18/2019
4,181,068

$4.00

 
3/18/2020
5/17/2019
3,897,010

$2.13

 
5/17/2024


The above warrants are collectively referred to as the “Original Warrants”. The shares of common stock underlying the Original Warrants are known together as the “Warrant Shares”.
 
Pursuant to the Offer to Amend and Exercise, the Original Warrants of Eligible Holders who elect to participate in the Offer to Amend and Exercise will be amended (the “Amended Warrants) to: (i) shorten the exercise period so that they expire concurrently with the expiration of the Warrant Offer at 5:00 p.m. (Eastern Time) on March 20, 2020, as may be extended by the Company in its sole discretion (the “Expiration Date”) and (ii) reduce the exercise price to $0.15 (the “Revised Exercise Price”).
 
As further described in the Proxy Statement, the Company’s stockholders are being asked to approve Proposal No. 2 at the Special Meeting which is to approve the potential issuance of more than 20% of the Company’s issued and outstanding common stock pursuant to this Offer to Amend and Exercise which has the effect of a reduction in the exercise price of outstanding Original Warrants. 
 

 
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Reasons for Requesting Stockholder ApprovalBecause the Company’s common stock is traded on the Nasdaq Capital Market (“NasdaqCM”), the Company is subject to the NASDAQ Listing Rules, including Listing Rule 5635(d). Pursuant to Listing Rule 5635(d), stockholder approval is required prior to the issuance of securities in connection with a transaction (or a series of related transactions) other than a public offering involving the sale, issuance or potential issuance of common stock (or securities convertible into or exercisable for common stock) equal to 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance for less than the greater of book or market value of the stock. Since the Revised Exercise Price is below ‘‘market’’, any securities issued for greater than the book or market value of the Company’s Common Stock at the time of the exercise of the Original Warrants will be included in the calculation of the 20% beneficial ownership limitation cap set forth in Listing Rule 5635(d). If the Company’s stockholders approve Proposal No. 2, the Company will not be subject to the issuance of beneficial ownership limitation cap set forth in Listing Rule 5635(d) and the Company would be able to adjust the exercise price of the Original Warrants to the Revised Exercise Price and issue the shares further to the Offer to Amend and Exercise. The Company is seeking stockholder approval to permit adjustments to the exercise price of the Original Warrants and to allow the Company to make such issuances of its common stock described above in accordance with NASDAQ Listing Rule 5635(d).
 
Vote Required. The affirmative votes from the holders of a majority of the votes cast at the Special Meeting is necessary under Rule 5635(e)(4) of the NASDAQ Listing Rules to approve Proposal 2. If stockholder approval of Proposal No. 2 is not obtained, no shares will be issued and terms of the Original Warrants will be unaffected.
 
The exercise of the Original Warrants pursuant to this Offer to Amend and Exercise is expressly contingent on (i) the approval of Proposal No. 2 by Company stockholders at the Special Meeting and (ii) the satisfaction or waiver of the obligations of each party to the Merger Agreement (the “Expiration Conditions”).
 
The purpose of the Offer to Amend and Exercise is to encourage the amendment and exercise of the Original Warrants at a significantly reduced exercise price in order to provide funds to support the Company’s operations. Please see Section 2 “Purposes of the Offer to Amend and Exercise and Use of Proceeds; Plans or Proposals” below for a description of the purposes of the Offer to Amend and Exercise.
 
Eligible Holders may elect to participate in the Offer to Amend and Exercise with respect to some, all or none of their Original Warrants. If you choose not to participate in the Offer to Amend and Exercise or the Expiration Conditions are not met, your Original Warrants will remain in full force and effect, as originally issued with the original exercise price per share.
 
The period during which Original Warrants may be amended and exercised in the Offer to Amend and Exercise will commence on February 13, 2020 (the date the materials relating to the Offer to Amend and Exercise are first sent to Eligible Holders) through the Expiration Date.
 
The Company will agree to amend all Original Warrants held by Eligible Holders who elect to participate in the Offer to Amend and Exercise, upon the terms and subject to the conditions of the Offer to Amend and Exercise and the attached Election to Consent, Participate and Exercise Warrant. IT IS THE COMPANY’S CURRENT INTENTION NOT TO CONDUCT ANOTHER OFFER DESIGNED TO INDUCE THE EARLY EXERCISE OF THE ORIGINAL WARRANTS.
 
IMPORTANT PROCEDURES
 
This Offer to Amend and Exercise together with the Election to Consent, Participate and Exercise Warrant, Notice of Withdrawal, and Forms of Amended Warrants constitute the “Offering Materials.” These Offering Materials provide information regarding the Offer to Amend and Exercise and instructions as to how you can amend your Original Warrants and exercise an Amended Warrant. You should read all of the materials carefully before you decide whether to participate in the Offer to Amend and Exercise and exercise an Amended Warrant.
 
To participate in the Offer to Amend and Exercise and exercise an Amended Warrant and receive the number of shares of Company’s common stock issuable therefor, you must deliver to the Company before the Expiration Date all

 
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of the following: (i) a signed copy of the Election to Consent, Participate and Exercise Warrant, (ii) a signed copy of an Accredited Investor Questionnaire, (iii) the original copy of your Original Warrant (or an Affidavit of Loss and Indemnification Agreement), for cancellation, and (iv) cash in the amount equal to $0.15 per share multiplied by the number of shares of common stock the Eligible Holder elects to purchase (collectively, the “Acceptance and Exercise Documents”). The cash must be tendered in the form of a check payable to “Corporate Stock Transfer as Escrow Agent for Innovate Biopharmaceuticals, Inc.”, or by wire transfer to the Company’s escrow account at Corporate Stock Transfer, Inc. which is acting as the Escrow Agent for the Company (the “Escrow Agent”), as set forth in the Election to Consent, Participate and Exercise Warrant, and the cash must be received before the Expiration Date. Each of the Acceptance and Exercise Documents must be properly delivered, before the Expiration Date to: Innovate Biopharmaceuticals, Inc., 8480 Honeycutt Road, Suite 120, Raleigh, NC 27615 (or in the case of the cash exercise price, pursuant to the wire or check delivery instructions set forth in the Election to Consent, Participate and Exercise Warrant).
 
If you properly tender (and do not validly withdraw) your Original Warrants and the other Acceptance and Exercise Documents on or prior to the Expiration Date and the Company’s stockholders approve Proposal No. 2 at the Special Meeting, promptly following the date of the Special Meeting, we intend to notify our Escrow Agent and our transfer agent of our acceptance of your payment of the exercise price and your other Acceptance and Exercise Documents and issue and deliver to you the number of shares of Company common stock issuable under the Amended Warrant. See Section 8 “Procedure for Participating in Offer to Amend and Exercise and Exercising Amended Warrants” below.
 
If you change your mind and do not want to participate in the Offer to Amend and Exercise, you may submit a Notice of Withdrawal to the Company at any time prior to the Expiration Date by delivery to: Innovate Biopharmaceuticals, Inc., 8480 Honeycutt Road, Suite 120, Raleigh, NC 27615, Attn: Chief Financial Officer. The Notice of Withdrawal must be properly completed and must be returned to the Company on or prior to the Expiration Date. If you properly withdraw prior to the Expiration Date, we will promptly: (i) cancel your signed copy of the Election to Consent, Participate and Exercise Warrant, (ii) return the original copy of your Original Warrant or issue you a new Original Warrant if you submitted an Affidavit of Loss and Indemnification Agreement, and (iii) provide you with a check equal to the amount of cash you paid to exercise the Amended Warrant, without interest thereon or deduction therefrom.
 
If you have any question or need assistance, you should contact the Company; the Company may be reached at:
 
Innovate Biopharmaceuticals, Inc.
8480 Honeycutt Road, Suite 120
Raleigh, NC 27615
Tel: 919-275-1933
Attn: Chief Financial Officer
 
You may request additional copies of this document and any of the Offering Materials from the Company. The Company may be reached at:
 
8480 Honeycutt Road, Suite 120
Raleigh, NC 27615
Attention: Chief Financial Officer
(919) 275-1933
 
OUR BOARD OF DIRECTORS MAKES NO RECOMMENDATION AS TO WHETHER OR NOT YOU SHOULD PARTICIPATE IN THE OFFER TO AMEND AND EXERCISE. YOU MUST MAKE YOUR OWN DECISION WITH RESPECT TO THE OFFER TO AMEND AND EXERCISE. FOR QUESTIONS REGARDING TAX IMPLICATIONS OR OTHER INVESTMENT-RELATED QUESTIONS, YOU SHOULD TALK TO YOUR OWN ATTORNEY, ACCOUNTANT AND/OR FINANCIAL PLANNER.
 
WE HAVE NOT AUTHORIZED ANY PERSON TO MAKE ANY RECOMMENDATION ON OUR BEHALF AS TO WHETHER OR NOT YOU SHOULD PARTICIPATE IN THE OFFER TO AMEND AND

 
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EXERCISE. YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS DOCUMENT.
 
THIS OFFER TO AMEND AND EXERCISE HAS BEEN PREPARED SOLELY FOR THE BENEFIT OF ELIGIBLE HOLDERS OF ORIGINAL WARRANTS. DISTRIBUTION OF THIS OFFER TO AMEND AND EXERCISE TO ANY PERSON OTHER THAN SUCH HOLDERS AND THOSE PERSONS RETAINED TO ADVISE SUCH HOLDERS IS UNAUTHORIZED AND ANY REPRODUCTION OF THIS OFFER TO AMEND AND EXERCISE OR RELATED DOCUMENTS, IN WHOLE OR IN PART, IS PROHIBITED.

THE SECURITIES BEING OFFERED PURSUANT TO THIS OFFER TO AMEND AND EXERCISE ARE BEING OFFERED PURSUANT TO EXEMPTIONS PROVIDED BY SECTION 4(a)(2) OF THE SECURITIES ACT OF 1933, AS AMENDED, REGULATION D THEREUNDER, CERTAIN STATE SECURITIES LAWS AND CERTAIN RULES AND REGULATIONS PROMULGATED THEREUNDER.
 
THE DATE OF THIS OFFER TO AMEND AND EXERCISE IS FEBRUARY 12, 2020
 

 
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TABLE OF CONTENTS
 
 
Page
 
 
SUMMARY OF PROPOSED MERGER
7

 
 
SUMMARY OF TERMS
10

 
 
RISK FACTORS
16

 
 
SECTION 1.
FORWARD LOOKING STATEMENTS
27

 
 
 
SECTION 2.
PURPOSES OF THE OFFER TO AMEND AND EXERCISE AND USE OF PROCEEDS; PLANS OR PROPOSALS
28

 
 
 
SECTION 3.
ELIGIBLE WARRANTS
28

 
 
 
SECTION 4.
EXPIRATION DATE
29

 
 
 
SECTION 5.
TERMS OF AMENDED WARRANTS
29

 
 
 
SECTION 6.
CONDITIONS TO THE OFFER TO AMEND AND EXERCISE
29

 
 
 
SECTION 7.
EXTENSION OF OFFER TO AMEND AND EXERCISE PERIOD; TERMINATION; AMENDMENTS
30

 
 
 
SECTION 8.
PROCEDURE FOR PARTICIPATING IN OFFER TO AMEND AND EXERCISE AND EXERCISING AMENDED WARRANTS
31

 
 
 
SECTION 9.
MANNER OF ACCEPTANCE OF PAYMENT AND ISSUANCE OF SHARES
31

 
 
 
SECTION 10.
WITHDRAWAL RIGHTS
31

 
 
 
SECTION 11.
REGISTRATION OF WARRANT SHARES
31

 
 
 
SECTION 12.
TRADING MARKET AND PRICE RANGE OF COMMON STOCK
32

 
 
 
SECTION 13.
SOURCE AND AMOUNT OF FUNDS
32

 
 
 
SECTION 14.
TRANSACTIONS AND AGREEMENTS CONCERNING ORIGINAL WARRANTS
32

 
 
 

 
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SECTION 15.
INFORMATION REGARDING THE COMPANY AND RDD
32

 
 
 
SECTION 16.
HISTORICAL AND PRO FORMA FINANCIAL INFORMATION AND OTHER FINANCIAL INFORMATION REGARDING THE COMPANY AND RDD
34

 
 
 
SECTION 17.
INTERESTS OF DIRECTORS AND EXECUTIVE OFFICERS IN THE OFFER TO AMEND AND EXERCISE
34

 
 
 
SECTION 18.
LEGAL MATTERS AND REGULATORY APPROVALS
34

 
 
 
SECTION 19.
MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES
34

 
 
 
SECTION 20.
FEES AND EXPENSES
36

 
 
 
SECTION 21.
TRANSFERS
36

 
 
 
SECTION 22.
ADDITIONAL INFORMATION
36

 
 
 
SECTION 23.
INFORMATION REQUESTS
37

 
 
 
EXHIBIT A
RDD PHARMA LTD FINANCIAL STATEMENTS
INNOVATE BIOPHARMACEUTICALS, INC. FINANCIAL STATEMENTS
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
F-A-1

 

 
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SUMMARY OF PROPOSED MERGER
 
On October 6, 2019, we entered into an Agreement and Plan of Merger and Reorganization (as amended on December 17, 2019, the “Merger Agreement”) with INNT Merger Sub 1 Ltd., a company organized under the laws of Israel and a direct, wholly-owned subsidiary of the Company (“Merger Sub”), RDD Pharma Ltd., a company organized under the laws of Israel (“RDD”) and Orbimed Israel Partners, Limited Partnership, as the Shareholder Representative.
 
The Merger Agreement provides that, upon the terms and subject to the satisfaction or waiver of the conditions set forth therein, Merger Sub will be merged with and into RDD (the “Merger”), with RDD continuing as the surviving corporation and a direct wholly-owned subsidiary of the Company.

At the effective time of the Merger (the “Effective Time”), and if the Merger Consideration Proposal is approved, all outstanding ordinary and preferred shares of RDD, nominal value of NIS 0.01 each, will be converted into the right to receive such number of validly issued, fully paid and non-assessable shares of common stock of the Company (“Company Common Shares”) as defined in the Merger Agreement (the “Consideration Allocation”).

Additionally, each outstanding RDD stock option will be converted into and become an option exercisable for Company Shares with the number and exercise price adjusted in a manner consistent with the Consideration Allocation. Each outstanding RDD warrant will be exercised or cancelled prior to the Effective Time. Following completion of the Merger and on an as-converted basis, the Innovate stockholders will own up to approximately 62.0% of the combined company’s capital stock and the former RDD stockholders will own approximately 38.0% of the combined company’s capital stock, each on a fully diluted basis (the “RDD Ownership Ratio”). The Merger Agreement also includes, as a closing condition, a minimum funding requirement of $10,000,000 (the “Financing”), which will dilute the Innovate stockholders and former RDD shareholders pro rata.
 
The combined company, led by RDD’s management team, is expected to be named “9 Meters Biopharma, Inc.” The combined company is expected to trade on the Nasdaq Capital Market under a new ticker symbol. At the closing, the combined company’s board of directors is expected to consist of six (6) directors and will be comprised of three (3) members designated by RDD and three (3) members designated by the Company. The Merger has been unanimously approved by the Board of Directors of each company.
 
The parties to the Merger Agreement have made representations and warranties to each other as of specific dates for the purpose of allocating risks and not for the purpose of establishing facts. In addition, the representations and warranties are qualified by information in confidential disclosure schedules exchanged by the parties together with the Merger Agreement. While the Company does not believe that these schedules contain material information that the securities laws require it to publicly disclose, the disclosure schedules do contain information that modifies, qualifies and creates exceptions to the representations and warranties set forth in the Merger Agreement. Accordingly, the representations and warranties should not be relied on as characterizations of the actual state of facts.
 
Special Meeting/Proxy Statement
 
On January 22, 2020, we filed a proxy statement pursuant to Section 14(a) of the Securities Exchange Act of 1934 (the “Proxy Statement”) with respect to a special meeting of stockholders to take place on February 14, 2020 (the “Special Meeting”).
 
Further to the Proxy Statement, stockholders of Innovate will be solicited to vote at the Special Meeting to approve a number of matters. The following summarizes the proposals to be voted upon at the Special Meeting:
 
1.
To authorize, for purposes of complying with Nasdaq Listing Rule 5635, the issuance of shares of our common stock, pursuant to the terms of that certain Agreement and Plan of Merger and Reorganization,

 
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dated October 6, 2019, by and among the Company, RDD Pharma Ltd (“RDD”) and the other parties thereto, as amended by Amendment No. 1, dated December 17, 2019 (the “Merger Agreement”), in an amount in excess of 20% of our common stock outstanding before the issuance of such common stock (the “Merger Consideration Proposal”).
    
2.
To approve the potential issuance of 20% or more of the Company’s issued and outstanding common stock pursuant to a proposed reduction in the exercise price of outstanding warrants (including an exchange of warrants for shares of common stock) (the “Warrants Proposal”).
    
3.
To approve an amendment to the amended and restated certificate of incorporation to effect a reverse stock split of the Company’s common stock (the “Reverse Stock Split Proposal”).
 
As further described in the Proxy Statement, the Company’s stockholders are being asked to approve Proposal No. 2 at the Special Meeting which is to approve the potential issuance of more than 20% of the Company’s issued and outstanding common stock pursuant to this Offer to Amend and Exercise which has the effect of a reduction in the exercise price of outstanding Original Warrants. 
 
Reasons for Requesting Stockholder ApprovalBecause the Company’s common stock is traded on the Nasdaq Capital Market (“NasdaqCM”), the Company is subject to the NASDAQ Listing Rules, including Listing Rule 5635(d). Pursuant to Listing Rule 5635(d), stockholder approval is required prior to the issuance of securities in connection with a transaction (or a series of related transactions) other than a public offering involving the sale, issuance or potential issuance of common stock (or securities convertible into or exercisable for common stock) equal to 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance for less than the greater of book or market value of the stock. Since the Revised Exercise Price is below ‘‘market’’, any securities issued for greater than the book or market value of the Company’s Common Stock at the time of the exercise of the Original Warrants will be included in the calculation of the 20% beneficial ownership limitation cap set forth in Listing Rule 5635(d). If the Company’s stockholders approve Proposal No. 2, the Company will not be subject to the issuance of beneficial ownership limitation cap set forth in Listing Rule 5635(d) and the Company would be able to adjust the exercise price of the Original Warrants to the Revised Exercise Price and issue the shares further to the Offer to Amend and Exercise. The Company is seeking stockholder approval to permit adjustments to the exercise price of the Original Warrants and to allow the Company to make such issuances of its common stock described above in accordance with NASDAQ Listing Rule 5635(d).
 
Vote Required. The affirmative votes from the holders of a majority of the votes cast at the Special Meeting is necessary under Rule 5635(e)(4) of the NASDAQ Listing Rules to approve Proposal 2. If stockholder approval of Proposal No. 2 is not obtained, no shares will be issued and terms of the Original Warrants will be unaffected.

The exercise of the Original Warrants pursuant to this Offer to Amend and Exercise is expressly contingent on (i) the approval of Proposal No. 2 by Company stockholders at the Special Meeting and (ii) the satisfaction or waiver of the obligations of each party to the Merger Agreement (the “Expiration Conditions”).
  
If the Merger is not completed for any reason, no shares will be issued and terms of the Original Warrants will be unaffected and Innovate will remain an independent public company, its common stock will continue to be listed and traded on NASDAQ (assuming the Company can meet all of NASDAQ’s continued listing standards) and registered under the Exchange Act and Innovate will continue to file periodic reports with the Securities and Exchange Commission (the “SEC”).
 
If the Merger is not completed, there can be no assurance as to the effect of these risks and opportunities on the future value of your shares of Innovate’s common stock. If the Merger is not completed, Innovate’s board of directors will continue to evaluate and review the Company’s business operations, properties, dividend policy and capitalization, among other things, make such changes as are deemed appropriate and continue to seek to identify strategic alternatives to enhance stockholder value. If the Merger is not completed for any other reason, there can be no assurance that any other transaction acceptable to Innovate will be offered or that Innovate’s business, prospects or results of operations will not be adversely impacted.

 
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Furthermore, if the Merger is not completed, and depending on the circumstances that would have caused the Merger not to be completed, the price of Innovate’s common stock may decline significantly. If that were to occur, it is uncertain when, if ever, the price of Innovate’s common stock would return to the price at which it trades as of the date of this Offer to Amend and Exercise.
 

 
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SUMMARY OF TERMS

Company:
Innovate Biopharmaceuticals, Inc., a Delaware corporation, with principal executive offices at 8480 Honeycutt Road, Suite 120, Raleigh, NC 27615. Innovate Biopharmaceuticals, Inc., is referred to in this Offer to Amend and Exercise as “we,” “us,” “Innovate” or the “Company.” The Company’s telephone number is (919) 275-1933.
 
 
Eligible Warrants:
The Company is offering to amend, upon the terms and subject to the conditions set forth herein, warrants held by Eligible Holders to purchase an aggregate of 12,346,631 shares of common stock (the “Offer to Amend and Exercise”), consisting of the following outstanding warrants:

Issue Date
Number of Warrants
Exercise Price
Expiration Date
1/29/2018
1,410,364
$3.18
1/29/2023
1/29/2018
349,555
$2.54
1/29/2023
3/18/2019
2,508,634
$2.56
3/18/2024
3/18/2019
4,181,068
$4.00
3/18/2020
5/17/2019
3,897,010
$2.13
5/17/2024

The above warrants are collectively referred to as the “Original Warrants”. The shares of common stock underlying the Original Warrants are known together as the “Warrant Shares”.

Expiration Date:
5:00 p.m., Eastern Time on March 20, 2020, as may be extended by the Company in its sole discretion (the “Expiration Date”).

Eligible Holders:
Holders of record of Original Warrants as of February 12, 2020.
 
 
Terms of Amended Warrants:
Pursuant to the Offer to Amend and Exercise, the Original Warrants of Eligible Holders who elect to participate in the Offer to Amend and Exercise will be amended (the “Amended Warrants”) as described below:

 
New Exercise Price: The exercise price will be reduced to $0.15 per share (the “Revised Exercise Price”).
 
 
 
New Termination Date:  The termination date will be shortened to run concurrently with the Expiration Date.
 
 
 
No Cashless Exercise:  The Amended Warrants must be exercised for cash, and any cashless exercise provisions in the Original Warrants will be inapplicable to the Amended Warrants.
 
 

 
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Other Terms:  Except as set forth above all other terms of the Amended Warrants will be the same as the terms of the Original Warrants. See the applicable form of amendment of your Original Warrants attached as an Exhibit to the Election to Consent, Participate and Amend Warrant.
 
 
Partial Participation Permitted:
Eligible Holders may elect to participate in the Offer to Amend and Exercise with respect to some, all or none of their Original Warrants. If an Eligible Holder of Original Warrants elects to participate in the Offer to Amend and Exercise with respect to less than all of such Eligible Holder’s Original Warrants, then the Company will issue a new Original Warrant with the original exercise price of such Original Warrants per share exercisable for that number of shares of common stock that such Eligible Holder elects to exclude from the Offer to Amend and Exercise and with the original terms of such Original Warrants.
 
 
Conditions
The Offer to Amend and Exercise is subject to certain conditions, as described herein:
 
(i) As further described in the Proxy Statement, the Company’s stockholders are being asked to approve Proposal No. 2 at the Special Meeting which is to approve the potential issuance of more than 20% of the Company’s issued and outstanding common stock pursuant to this Offer to Amend and Exercise which has the effect of a reduction in the exercise price of outstanding Original Warrants. 
 
Reasons for Requesting Stockholder ApprovalBecause the Company’s common stock is traded on the Nasdaq Capital Market (“NasdaqCM”), the Company is subject to the NASDAQ Listing Rules, including Listing Rule 5635(d). Pursuant to Listing Rule 5635(d), stockholder approval is required prior to the issuance of securities in connection with a transaction (or a series of related transactions) other than a public offering involving the sale, issuance or potential issuance of common stock (or securities convertible into or exercisable for common stock) equal to 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance for less than the greater of book or market value of the stock. Since the Revised Exercise Price is below ‘‘market’’, any securities issued for greater than the book or market value of the Company’s Common Stock at the time of the exercise of the Original Warrants will be included in the calculation of the 20% beneficial ownership limitation cap set forth in Listing Rule 5635(d). If the Company’s stockholders approve Proposal No. 2, the Company will not be subject to the issuance of beneficial ownership limitation cap set forth in Listing Rule 5635(d) and the Company would be able to adjust the exercise price of the Original Warrants to the Revised Exercise Price and issue the shares further to the Offer to Amend and Exercise. The Company is seeking stockholder approval to permit adjustments to the exercise price of the Original Warrants and to allow the Company to make such issuances of its common stock described above in accordance with NASDAQ Listing Rule 5635(d).

Vote Required. The affirmative votes from the holders of a majority of the votes cast at the Special Meeting is necessary under Rule 5635(e)(4) of the NASDAQ listing Rules to approve Proposal 6. If stockholder approval of Proposal No. 2 is not obtained, no shares will be issued and terms of the Original Warrants will be unaffected.

(ii) This Offer to Amend and Exercise is subject to the satisfaction or waiver of the obligations of each party to the Merger Agreement. We anticipate that the Expiration Date will occur immediately prior to or concurrently with the Effective Time of the Merger.



 
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The exercise of the Original Warrants pursuant to this Offer to Amend and Exercise is expressly contingent on (i) the approval of Proposal No. 2 by Company stockholders at the Special Meeting and (ii) the satisfaction or waiver of the obligations of each party to the Merger Agreement (the “Expiration Conditions”).
 
(iii) As part of the Election to Participate and Exercise Warrant, the holders of the Original Warrants must complete an Accredited Investor Questionnaire. In addition, as part of the Election to Participate and Exercise Warrant, the holders of the Original Warrants are asked to make certain representations and warranties upon which the Company will rely in establishing that the transactions contemplated by the Offer to Amend and Exercise are exempt from the registration requirements of the Securities Act. The holders of the Original Warrants, previously made substantially the same representations and warranties to the Company, including a representation that they were “accredited investors”, in connection with the private placement transactions in which such holders acquired the Original Warrants.

(iii) As part of the Election to Participate and Exercise Warrant, the holders of the Original Warrants must complete an Accredited Investor Questionnaire. In addition, as part of the Election to Participate and Exercise Warrant, the holders of the Original Warrants are asked to make certain representations and warranties upon which the Company will rely in establishing that the transactions contemplated by the Offer to Amend and Exercise are exempt from the registration requirements of the Securities Act. The holders of the Original Warrants, previously made substantially the same representations and warranties to the Company, including a representation that they were “accredited investors”, in connection with the private placement transactions in which such holders acquired the Original Warrants.

You may not elect to exercise your Original Warrants pursuant to this Offer to Amend and Exercise unless you both consent to (a) the amendment of your Original Warrants in the form of amendment of your Original Warrants attached as an Exhibit to the Election to Consent, Participate and Amend and (b) the exercise of your Amended Warrant, which will happen automatically on the Expiration Date should you choose to participate in the Offer to Amend and Exercise and should the Expiration Conditions be met.
 
Original Warrants of Eligible Holders that elect not to participate and exercise will remain outstanding pursuant to their original terms.



Future Amendments to the Offer to
Amend and Exercise:
If we materially change the terms of the Offer to Amend and Exercise, we will extend the Expiration Date to the extent required under the rules of the Exchange Act.
 
 
How to Participate in the Offer to
Amend and Exercise:
To participate in the Offer to Amend and Exercise and exercise an Amended Warrant and receive the number of shares of Company common stock issuable therefor, you must deliver to the Company before the Expiration Date all of the following: (i) a signed copy of the Election to Consent, Participate and Exercise Warrant, (ii) a signed copy of an Accredited Investor Questionnaire, (iii) the original copy of your Original Warrant (or an Affidavit of Loss and Indemnification Agreement), for cancellation, and (iv) cash in the amount equal to $0.15 per share multiplied by the number of shares of common stock the Eligible Holder elects to purchase (collectively, the “Acceptance and Exercise Documents”). The cash must be tendered in the form of a check payable to “Corporate Stock Transfer as Escrow Agent for Innovate Biopharmaceuticals, Inc.”, or by wire transfer to the Company’s escrow account at Corporate Stock Transfer, Inc. which is acting as the Escrow Agent for the Company (the “Escrow Agent”), as set forth in the Election to Consent, Participate and Exercise Warrant, and the cash must be received before the Expiration Date. Each of the Acceptance and Exercise documents must be properly delivered before the Expiration Date to: Innovate Biopharmaceuticals, Inc., 8480 Honeycutt Road, Suite 120, Raleigh, NC 27615 (or in the case of the cash exercise price, pursuant to the wire or check delivery instructions set forth in the Election to Consent, Participate and Exercise Warrant).

 
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If you execute and deliver an Affidavit of Loss and Indemnification Agreement in lieu of delivering the original copy of your Original Warrant, your Original Warrant will be cancelled by the Company, and the Company will promptly following the Expiration Date issue to you a new Original Warrant with the original exercise price of such Original Warrant exercisable for that number of shares of common stock that such Eligible Holder elects to exclude from the Offer to Amend and Exercise.
 
 
Manner of Acceptance of 
Payment:
If you properly tender (and do not validly withdraw) your Original Warrants and the other Acceptance and Exercise Documents on or prior to the Expiration Date and the Company’s stockholders approve Proposal No. 2 at the Special Meeting, promptly following the Expiration Date, we intend to notify our Escrow Agent and our transfer agent of our acceptance of your payment of the exercise price and your other Acceptance and Exercise Documents and issue and deliver to you the number of shares of Company common stock issuable under the Amended Warrant. See Section 8 “Procedure for Participating in Offer to Amend and Exercise and Exercising Amended Warrants” below.
 
 
Withdrawal Rights:
If you change your mind and do not want to participate in the Offer to Amend and Exercise, you may submit the Notice of Withdrawal to us. However, to be effective, the Notice of Withdrawal must be properly completed and must be returned, prior to the Expiration Date, to: Innovate Biopharmaceuticals, Inc., 8480 Honeycutt Road, Suite 120, Raleigh, NC 27615, Attention: Chief Financial Officer. Following the Expiration Date, you cannot withdraw your Election to Consent, Participate and Exercise Warrant.

If you properly withdraw prior to the Expiration Date, we will promptly: (i) cancel your signed copy of the Election to Consent, Participate and Exercise Warrant, (ii) return the original copy of your Original Warrant or issue you a new Original Warrant if you submitted an Affidavit of Loss and Indemnification Agreement, and (iii) provide you with a check equal to the amount of cash you paid upon exercise of the Amended Warrant without interest thereon or deduction therefrom.

 
 
Purpose of the Offer to Amend and
Exercise and Use of Proceeds:
The purpose of this Offer to Amend and Exercise is to encourage the amendment and exercise of the Original Warrants at a significantly reduced exercise price and the proceeds will be used to provide operating capital to fund Company operations.
 
 
Plans or Proposals:
The Company intends to cancel the Original Warrants that are amended and exercised by the Eligible Holders thereof pursuant to the Offer to Amend and Exercise. Original Warrants that are not so amended and exercised will remain outstanding pursuant to their original terms.

No plans or proposals described in this Offer to Amend and Exercise or in any materials sent to Eligible Holders of Original Warrants in connection with this Offer to Amend and Exercise relate to or would result in the conditions or transactions described in Regulation M-A, Item 1006(c)(1) through (10), except as follows:

Any Eligible Holder of Original Warrants who elects to exercise such Holder’s Original Warrants will acquire additional shares of common stock of the Company as a result of such exercise. As of February 3, 2020, the Company had 41,324,976 shares of common stock outstanding. The Original Warrants are exercisable for an aggregate of 12,346,631 shares of common stock. Assuming all Original Warrants are exercised at the Revised Exercise Price, the Company’s outstanding shares of common stock would increase to 53,671,607 shares, with the shares issued upon exercise of the Original Warrants representing 23% of the then outstanding shares of common stock.




 
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Taxes:
We recommend that you consult with your own tax advisor with regard to the possibility of any federal, state, local or other tax consequences of the Offer to Amend and Exercise. See Section 19 “Material U.S. Federal Income Tax Consequences” below for a discussion of the material U.S. Federal Income Tax Consequences of participating in the Offer to Amend and Exercise.
 
 
Interests of Directors and Executive
Officers:
No directors or executive officers beneficially hold Original Warrants. Please see Section 17 “Interests of Directors and Officers in the Offer to Amend and Exercise” below.
 
 
Historical and Pro Forma Financial
Information and Other Financial
Information:
Historical financial information of RDD, as well as pro forma financial information of the combined company, are attached to this Offer to Amend and Exercise.
 
 
Additional Information:
The Company has filed with the SEC a Tender Offer Statement on Schedule TO of which this Offer to Amend and Exercise is a part. This Offer to Amend and Exercise does not contain all of the information contained in the Schedule TO and the exhibits to the Schedule TO. We recommend that Eligible Holders of the Original Warrants review the Schedule TO, including the exhibits, and the Company’s other materials that have been filed with the SEC before making a decision on whether to participate in the Offer to Amend and Exercise.
 
 
 
The Board of Directors of the Company recognizes that the decision to participate in the Offer to Amend and Exercise is an individual one that should be based on a variety of factors. Eligible Holders of Original Warrants should consult with their respective professional advisors if they have questions about their financial or tax situation. The information about this Offer to Amend and Exercise from the Company is limited to the Offering Materials.

The Company is subject to the information requirements of Section 15(d) of the Exchange Act, and in accordance therewith files and furnishes reports and other information with the SEC. All reports and other documents the Company has filed with the SEC, including the Schedule TO relating to the Offer to Amend and Exercise, or will file with the SEC in the future, can be accessed electronically on the SEC’s website at www.sec.gov.
 

 
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Information Requests:
Please direct questions or requests for assistance regarding this Offer to Amend and Exercise, Election to Consent Participate and Exercise Warrant, and Notice of Withdrawal or other materials, in writing, to the Company at the following address:
 
Innovate Biopharmaceuticals, Inc.
8480 Honeycutt Road, Suite 120
Raleigh, NC 27615
Tel: 919-275-1933
Attn: Chief Financial Officer
 
 
 
Please direct requests for additional copies of this Offer to Amend and Exercise, Election to Consent, Participate and Exercise Warrant, and Notice of Withdrawal or other materials, in writing, to the Company — Innovate Biopharmaceuticals, Inc., 8480 Honeycutt Road, Suite 120, Raleigh, NC 27615, Attn: Chief Financial Officer, telephone number (919) 275-1933.
 
 
ABOUT THIS OFFER TO AMEND AND EXERCISE
 
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS OFFER TO AMEND AND EXERCISE. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE INFORMATION DIFFERENT FROM THAT CONTAINED OR INCORPORATED BY REFERENCE IN THIS OFFER TO AMEND AND EXERCISE AND, IF PROVIDED, SUCH INFORMATION MUST NOT BE RELIED UPON.
 
ALTHOUGH OUR BOARD OF DIRECTORS HAS APPROVED THE OFFER TO AMEND AND EXERCISE, NEITHER THE COMPANY, NOR ITS DIRECTORS, OFFICERS, ADVISORS OR AGENTS, INCLUDING THE WARRANT AGENT, MAKES ANY RECOMMENDATION AS TO WHETHER YOU SHOULD ACCEPT THE OFFER TO AMEND AND EXERCISE. YOU SHOULD NOT CONSIDER THE BOARD’S APPROVAL TO BE A RECOMMENDATION AS TO WHETHER YOU SHOULD PARTICIPATE IN THE OFFER TO AMEND AND EXERCISE WARRANTS. YOU MUST MAKE YOUR OWN DECISION WHETHER TO ACCEPT THE OFFER TO AMEND AND EXERCISE.
 

 
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RISK FACTORS
 
AN INVESTMENT IN OUR SECURITIES IS HIGHLY SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. WE FACE A VARIETY OF RISKS THAT MAY AFFECT OUR OPERATIONS OR FINANCIAL RESULTS AND MANY OF THOSE RISKS ARE DRIVEN BY FACTORS THAT WE CANNOT CONTROL OR PREDICT. BEFORE YOU ELECT TO PARTICIPATE IN THE OFFER TO AMEND AND EXERCISE, YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISKS, TOGETHER WITH THE FINANCIAL AND OTHER INFORMATION CONTAINED IN THIS OFFER TO AMEND AND EXERCISE. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCURS, OUR BUSINESS, PROSPECTS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY ADVERSELY AFFECTED. IN THAT CASE, THE TRADING PRICE OF OUR COMMON STOCK WOULD LIKELY DECLINE AND YOU MAY LOSE ALL OR A PART OF YOUR INVESTMENT. ONLY THOSE INVESTORS WHO CAN BEAR THE RISK OF LOSS OF THEIR ENTIRE INVESTMENT SHOULD CONSIDER AN INVESTMENT IN OUR SECURITIES.
 
THIS OFFER TO AMEND AND EXERCISE CONTAINS CERTAIN STATEMENTS RELATING TO FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF OUR COMPANY. PROSPECTIVE INVESTORS ARE CAUTIONED THAT SUCH STATEMENTS ARE ONLY PREDICTIONS AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY. IN EVALUATING SUCH STATEMENTS, PROSPECTIVE INVESTORS SHOULD SPECIFICALLY CONSIDER THE VARIOUS FACTORS IDENTIFIED IN THIS OFFER TO AMEND AND EXERCISE, INCLUDING THE MATTERS SET FORTH BELOW, WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS.
 
Prospective investors should consider carefully whether an investment in the Company is suitable for them in light of the information contained in this Offer to Amend and Exercise and the financial resources available to them. The risks described below do not purport to be all of the risks to which the Company could be exposed. This section is a summary of certain risks and is not set out in any particular order of priority. They are the risks that we presently believe are material to the operations of the Company. Additional risks of which we are not presently aware or which we presently deem immaterial may also impair the Company’s business, financial condition or results of operations.
 
If the Merger is not completed for any other reason, Innovate will remain an independent public company, its common stock will continue to be listed and traded on NASDAQ (assuming the Company can meet all of NASDAQ’s continued listing standards) and registered under the Exchange Act and Innovate will continue to file periodic reports with the SEC. Please see the heading “Risk Factors” in Innovate’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018 and subsequent Quarterly Reports on Form 10-Q for a review of risk factors applicable to the historical Innovate business.
 
RISKS RELATED TO THE MERGER
 
 
The Merger is subject to conditions to closing that could result in the Merger being delayed or not consummated and can be terminated in certain circumstances, each of which could negatively impact the Company’s stock price and future business and operations.

The Merger is subject to conditions to closing as set forth in the Merger Agreement. In addition, each of the Company and RDD has the right, in certain circumstances, to terminate the Merger Agreement. If the Merger Agreement is terminated or any of the conditions to the Merger are not satisfied and, where permissible, not waived, the Merger will not be consummated. Failure to consummate the Merger or any delay in the consummation of the Merger or any uncertainty about the consummation of the Merger may adversely affect the Company’s stock price or have an adverse impact on the Company’s future business operations.

 
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If the Merger is not completed, the Company’s ongoing business may be adversely affected and, without realizing any of the benefits of having completed the Merger, it would be subject to a number of risks, including the following:

 
negative reactions from the financial markets and from persons who have or may be considering business dealings with the Company;

 
financial difficulties that the Company may experience;

 
the Company will be required to pay certain costs relating to the Merger, whether or not the Merger is completed; and

 
the Company has agreed to pay a break-up fee if the Merger Agreement is terminated in certain circumstances.

In addition, the Company could be subject to litigation related to any failure to complete the Merger or related to any proceeding commenced against the Company seeking to require the Company to perform its obligations under the Merger Agreement.

The Merger will present challenges associated with integrating operations, personnel, and other aspects of the companies and assumption of liabilities that may exist at RDD and which may be known or unknown by the Company.

The results of the combined company following the Merger will depend in part upon the Company’s ability to integrate RDD’s business with the Company’s business in an efficient and effective manner. The Company’s attempt to integrate two companies that have previously operated independently may result in significant challenges, and the Company may be unable to accomplish the integration smoothly or successfully. In particular, the necessity of coordinating geographically dispersed organizations and addressing possible differences in corporate cultures and management philosophies may increase the difficulties of integration. The integration may require the dedication of significant management resources, which may temporarily distract management’s attention from the day-to-day operations of the businesses of the combined company. In addition, the combined company may adjust the way in which RDD or the Company has conducted its operations and utilized its assets, which may require retraining and development of new procedures and methodologies. The process of integrating operations and making such adjustments after the Merger could cause an interruption of, or loss of momentum in, the activities of one or more of the combined company’s businesses and the loss of key personnel. Employee uncertainty, lack of focus, or turnover during the integration process may also disrupt the businesses of the combined company. Any inability of management to integrate the operations of the Company and RDD successfully could have a material adverse effect on the business and financial condition of the combined company.

In addition, the Merger will subject the Company to contractual or other obligations and liabilities of RDD, some of which may be unknown. Although the Company and its legal and financial advisors have conducted due diligence on RDD and its business, there can be no assurance that the Company is aware of all obligations and liabilities of RDD.

 
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These liabilities, and any additional risks and uncertainties related to RDD’s business and to the Merger not currently known to the Company or that the Company may currently be aware of, but that prove to be more significant than assessed or estimated by the Company, could negatively impact the business, financial condition, and results of operations of the combined company following consummation of the Merger.

The pro forma financial statements are presented for illustrative purposes only and might not be an indication of the combined company’s financial condition or results of operations following the Merger.
The pro forma financial statements are presented for illustrative purposes only and might not be an indication of the combined company’s financial condition or results of operations following the Merger for several reasons. For example, the pro forma financial statements have been derived from the historical financial statements of the Company and RDD and certain adjustments and assumptions have been made regarding the combined company after giving effect to the Merger. The information upon which these adjustments and assumptions have been made is preliminary, and these kinds of adjustments and assumptions are difficult to make with complete accuracy. Moreover, the pro forma financial statements do not reflect all costs that are expected to be incurred by the combined company in connection with the Merger. For example, the impact of any incremental costs incurred in integrating the Company and RDD is not reflected in the pro forma financial statements. In addition, the assumptions used in preparing the pro forma financial information might not prove to be accurate, and other factors may affect the combined company’s financial condition or results of operations following the Merger. The Company’s stock price may be adversely affected if the actual results of the combined company fall short of the pro forma financial statements contained in this proxy statement. See the Unaudited Pro Forma Condensed Combined Financial Statements attached as Annex A hereto.

Completion of the Merger would result in the issuance of a significant number of additional shares of the Company’s common stock, which would reduce the voting power of the Company’s current stockholders and may depress the trading price of the Company’s common stock.

Completion of the Merger would result in the issuance of a significant number of shares of the Company’s common stock. As a result, the Company’s existing stockholders will not exert the same degree of voting power with respect to the combined company that they did before the consummation of the Merger. Further, the issuance of such a significant amount of common stock, and its potential sale in the public market from time to time, could depress the trading price of the Company’s common stock and you may lose all or a part of your investment.

The Company has incurred and will continue to incur significant transaction, combination-related and restructuring costs in connection with the Merger.

The Company has incurred and will continue to incur transaction fees and other expenses related to the Merger, including filing fees, legal and accounting fees, soliciting fees, regulatory fees, and printing and mailing costs. The Company also expects to incur significant costs associated with combining the operations of the two companies. It is difficult to predict the amount of these costs before we begin the integration process. The combined company may incur additional unanticipated costs as a consequence of difficulties arising from efforts to integrate the operations of the two companies. Although we expect that the elimination of duplicative costs, as well as the realization of other efficiencies related to the integration of the businesses, can offset incremental transaction, combination-related, and restructuring costs over time, we may not be able to achieve this net benefit in the near term, or at all. If the Merger is not completed, the Company would have to recognize these expenses without realizing the expected benefits of the Merger.


 
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RISKS RELATED TO RDD’S BUSINESS

The combined company might not be able to successfully or timely complete its proposed acquisition of NAIA, which could materially impact the market price of the combined company’s common stock, financial condition, results of operations and cash flows.

On November 12, 2019, RDD entered into a nonbinding letter of intent with NAIA Rare Diseases (“NAIA”) to acquire all of the outstanding capital stock of privately-held NAIA in exchange for a combination of cash and shares of the combined company, as well as certain earn-out payments (the “NAIA Acquisition”). The terms of the NAIA Acquisition are subject to further negotiation and the transaction is currently expected to close following the Merger. The NAIA Acquisition might not be completed, or might not be completed in the timeframe, on the terms or in the manner currently anticipated. The completion of the NAIA Acquisition is subject to further negotiation of a binding agreement. There can be no assurance that the combined company will negotiate the NAIA Acquisition on satisfactory terms and enter into a binding agreement, or that other events will not intervene to delay or result in the failure to close the NAIA Acquisition. The non-binding letter of intent might be terminated by the parties for any reason prior to the execution of a definitive and binding agreement. If there are delays in negotiating a definitive and binding agreement or delays in closing the transaction, or a failure to close the transaction, the combined company’s ongoing business could be materially adversely affected, including without limitation, as follows:

the combined company might incur significant additional costs in connection with such delay or termination;
the combined company might experience negative reactions from financial markets and the stock price could decline;
the combined company might experience negative reactions from employees, suppliers or other third parties; and
the combined company’s management’s focus would have been diverted from pursuing other valuable opportunities.

Additionally, if the combined company is unable to consummate the transaction with NAIA, the combined company will have incurred significant due diligence, legal, accounting and other transaction costs in connection with the transaction without realizing the anticipated benefits.

If the Merger closes, and we are unable to successfully integrate the RDD and NAIA portfolio of products into our existing business operations, or if we do not realize the anticipated benefits of the Merger with RDD or NAIA, our business could be adversely affected.

We will need to successfully integrate RDD and NAIA’s pipeline of products (if the NAIA Acquisition is completed), which includes drug candidates for fecal incontinence (RDD-0315), pruritis ani (RDD-1609), radiation colitis (RDD-2007), pediatric short bowel syndrome (NB1001) and short bowel syndrome (NB1002), with our other business operations. Integrating the RDD products and NAIA products with our existing business will be a complex and time-consuming process. There might be substantial difficulties, costs and delays involved in any integration of these products. These might include:

distracting management and key functional areas from day-to-day operations;

 
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difficulties with respect to the timing and results of ongoing and future clinical trials in the RDD or NAIA products; and
diversion of financial resources that would otherwise be available for the ongoing development or commercialization of our existing programs.

Any one or all of these factors might increase our operating costs and capital needs or lower our anticipated financial performance. Certain of these factors are outside of our control. Achieving the potential benefits underlying our reasons for the merger with RDD will depend on a successful, timely and efficient integration of RDD and NAIA’s pipeline of products.

Even if the integration of RDD and NAIA’s portfolio is successful, the Merger might fail to further our business strategy as anticipated or to achieve anticipated benefits and success. We have made assumptions relating to the impact of the RDD and NAIA pipelines on our financial results relating to numerous matters, including:

transaction and integration costs;
the cost of development and commercialization of RDD or NAIA products; and
the other financial and strategic risks related to the Merger.

Further, we might incur higher than expected operating, transaction and integration costs, and we might encounter general economic and business conditions that adversely affect us following the completion of the Merger. If one or more of our assumptions are incorrect, it could have an adverse effect on our business and operating results, and the benefits from the Merger might not be realized or be of the magnitude expected.

RDD does not have any products that are approved for commercial sale and therefore the combined company will remain subject to many of the same risks regarding the clinical, regulatory and commercial success of these product candidates as the Company was subject to prior to the closing of the Merger.

RDD currently does not have any therapeutic products approved for commercial sale. Provided that the anticipated Merger closes, the combined company would have ten product candidates at various phases of clinical drug development and will therefore remain subject to the same risks regarding the clinical, regulatory and commercial success of the combined company’s product candidates as the Company was subject to prior to the closing of the Merger. In addition, the combined company will have to determine how best to allocate limited financial resources between the ten therapeutic products, none of which currently generate revenue. The combined company will incur significant costs related to the clinical trials and regulatory approval of our existing therapeutic products, as well as the therapeutic products in RDD and NAIA’s pipelines. The combined company might not receive within the next several years, if at all, any revenues from the commercialization of any of our product candidates, even if a product candidate is approved. Additionally, in the event one or more of our product candidates is approved for commercial sale, the combined company will incur significant costs in connection with commercializing any approved product candidate and the combined company might not generate significant revenue from sales of such products, which would impact our ability to become profitable and maintain profitability.

Many of RDD’s products rely on patent and/or regulatory exclusivity and the combined company’s success will depend in part on obtaining and maintaining effective patent and other intellectual property protection for the product candidates and proprietary technology.


 
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As with the Company’s current pipeline of products, the products in the RDD product portfolio rely on patent and regulatory exclusivity. The intellectual property rights protecting the RDD products might not afford the combined company with meaningful protection from third parties infringing on the proprietary rights of RDD. Competitors could also design around any of RDD’s intellectual property or otherwise design competitive products that do not infringe RDD’s intellectual property. If a product is approved for commercial sale and competitors are successful in such designs, it could have an adverse impact on the combined company’s revenue or results of operations.

If RDD or the combined company fails to comply with obligations under any license, collaboration or other agreements, the combined company could lose intellectual property rights that are necessary for developing and commercializing product candidates.

RDD’s intellectual property relating to the nifedipine capository for anal fissure program is licensed from Mor Research Applications Ltd. RDD’s intellectual property relating to the pregabalin for pruritus Ani program is licensed from Dr. Eli D. Ehrenpreis. RDD’s license agreements with Mor Research Applications Ltd. and Dr. Eli D. Ehrenpreis impose, and any future licenses or collaboration agreements the combined company might enter into are likely to impose, various development, commercialization, funding, milestone, royalty, diligence, sublicensing, patent prosecution and enforcement and other obligations. These type of agreements and related obligations are complex and subject to contractual disputes. If RDD (and the combined company following the closing of the Merger) breach any of these imposed obligations, or use the intellectual property licensed to RDD in an unauthorized manner, RDD (and the combined company following the closing of the Merger) might be required to pay damages or the licensor might have the right to terminate the license, which could result in the loss of the intellectual property rights and RDD (and the combined company following the closing of the Merger) being unable to develop, manufacture and sell drugs that are covered by the licensed technology.

Intense competition might render RDD’s GI products noncompetitive or obsolete.

Competition in the GI business is intense and characterized by extensive research efforts and rapid technological progress. Technological developments by competitors, regulatory approval for marketing competitive products, including potential generic or Over The Counter products, or superior marketing resources possessed by competitors could adversely affect the commercial potential of the combined company’s GI products and could have a material adverse effect on the combined company’s future revenue and results of operations. We believe that there are numerous pharmaceutical and biotechnology companies, as well as academic research groups throughout the world, engaged in research and development efforts with respect to pharmaceutical products targeted at GI diseases and conditions addressed by RDD’s product pipeline. In particular, we are aware of products in research or development by competitors that address the diseases being targeted by RDD’s products. Developments by others might render RDD’s product pipeline obsolete or noncompetitive. Competitors might be able to complete the development and regulatory approval process sooner and, therefore, market their GI products earlier than the combined company can.

Many of RDD’s current competitors have significant financial, marketing and personnel resources and development capabilities. For example, many large, well-capitalized companies already offer GI products in the United States and Europe that target the indications for: fecal incontinence including over-the-counter bulking agents such as psyllium or methylcellulose; antidiarrheals such as loperamide, diphenoxylate plus atropine, bismuth subsalicylate or bile acid binders such as cholestyramine; biofeedback involving cognitively retraining pelvic floor and abdominal wall musculature; injectable anal bulking agents such as dextranomer-hyaluronic acid (Solesta®); sacral nerve stimulation and anal sphincteroplasty surgery. For pruritis ani including barrier cream such as those containing zinc oxide in

 
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conjunction with or without hydrocortisone cream; antihistamines such as diphenhydramine; topical capsaicin; anal tattooing with intradermal injection of methylene blue; topical formulations containing tacrolimus or other agents involving mechanisms believed to target pruritic mechanisms. For radiation colitis including short chain fatty acid enemas; sucralfate enemas; oral sulfasalazine with or without prednisolone enemas or other mesalamine enemas with or without glucocorticoids; argon plasma coagulation; cryoablation; bipolar electrocoagulation and heater probe; radiofrequency ablation; usage of formalin particularly in colitis with significant bleeding; band ligation; hyperbaric oxygen; hormonal therapy including estrogen with or without progesterone; antioxidants including vitamin E and C; vitamin A or retinoid formulations; stool softeners; metronidazole; pentosan polysulfate; aloe vera; and mesenchymal stem cell therapy. For short bowel syndrome including acid suppressive therapies such as H2 blockers or proton pump inhibitors; antidiarrheals such as loperamide; antibiotics to prevent small intestinal bacterial overgrowth; octrotide for patient with IV fluid requirements greater than 3 L per day; clonidine; GLP-1 analogues including exenatide with or without GLP-2 analogues such as teduglutide (Gattex®); human growth hormone or somatropin analogues (Zorptive®); bile acid binders such as cholestyramine or pancreatic enzymes to aid in digestion of nutrients. In addition, other GI products are in research or development by competitors that address the diseases and diagnostic procedures being targeted by RDD’s product pipeline.
 
RISKS RELATED TO THE OFFER TO AMEND AND EXERCISE.
 
Our Board of Directors makes no recommendation with regard to whether you should accept the Offer to Amend and Exercise.
 
Although our Board of Directors has approved the Offer to Amend and Exercise, it makes no recommendation as to whether Eligible Holders of Original Warrants should accept the Offer to Amend and Exercise. We have not retained and do not intend to retain any unaffiliated representative to act solely on behalf of Eligible Holders of Original Warrants for purposes of negotiating the terms of the Offer to Amend and Exercise. We cannot assure you that the value of the shares issued upon exercise of the Amended Warrants will in the future equal or exceed the exercise price per share of the Amended Warrants. We do not take a position as to whether you ought to participate in the Offer to Amend and Exercise.
 
If you choose to participate in the Offer to Amend and Exercise, you will be required to exercise your Amended Warrants for common stock, and will be subject to all of the risks associated with being a stockholder of the Company and give up the time value attributable to your Original Warrant.
 
If you choose to participate in the Offer to Amend and Exercise, you will be required to exercise your Amended Warrants prior to the effective date of the Merger. As a result, you will be subject to all the risks and uncertainties set forth in these risk factors as a holder of the Company’s common stock. In addition, you will be giving up the time value attributable to your Original Warrants by exercising the Original Warrants, as amended, prior to the original expiration date of your Original Warrant.
 
 
Income tax consequences of participation in the Offer to Amend and Exercise.
 
We have not obtained and do not intend to obtain a ruling from the Internal Revenue Service regarding the U.S. federal income tax consequences of amending the Original Warrants and immediately exercising the Amended Warrants. You should consult with your own tax advisor with regard to the possibility of any federal, state, local or other tax consequences of the Offer to Amend and Exercise. See Section 20 “Material U.S. Federal Income Tax Consequences” under “Description of the Offer to Amend and Exercise.”
 

 
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We will have substantial discretion over the use of proceeds we receive from the exercise of Amended Warrants.
 
Our management will retain broad discretion over the use of proceeds from the Offer to Amend and Exercise. See Section 2 “Purposes of the Offer to Amend and Exercise and Use of Proceeds; Plans or Proposals” for a description of our present intentions with respect to the allocation of the proceeds resulting from exercise of the Amended Warrants. The amounts and timing of the expenditures may vary significantly depending on numerous factors. The occurrence of certain unforeseen events or changed business conditions, however, could result in the application of the proceeds resulting from the exercise of the Amended Warrants in a manner other than as described in this Offer to Amend and Exercise.
 
***

The risks above do not necessarily comprise all of those associated with an investment in the Company. This Offer to Amend and Exercise contains forward looking statements that involve unknown risks, uncertainties and other factors that may cause the actual results, financial condition, performance or achievements of the combined company and Innovate to be materially different from any future results, performance or achievements expressed or implied by such forward looking statements. Factors that might cause such a difference include, but are not limited to, those set out above.
 

 
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DESCRIPTION OF THE OFFER TO AMEND AND EXERCISE
 
Overview

Innovate Biopharmaceuticals, Inc., a Delaware corporation, is referred to in this Offer to Amend and Exercise as “we,” “us,” ”Innovate” or the “Company,” and a holder of record of certain outstanding warrants as of February 12, 2020 is referred to as “Eligible Holder” or “you.”
 
The Company is offering to amend, upon the terms and subject to the conditions set forth herein, outstanding warrants to purchase an aggregate of 12,346,631 shares of common stock held by Eligible Holders (the “Offer to Amend and Exercise”), consisting of the following outstanding warrants:

Issue Date
Number of Warrants
Exercise Price
Expiration Date
1/29/2018
1,410,364

$3.18

 
1/29/2023
1/29/2018
349,555

$2.54

 
1/29/2023
3/18/2019
2,508,634

$2.56

 
3/18/2024
3/18/2019
4,181,068

$4.00

 
3/18/2020
5/17/2019
3,897,010

$2.13

 
5/17/2024


The above warrants are collectively referred to as the “Original Warrants”. The shares of common stock underlying the Original Warrants are known together as the “Warrant Shares”.
 
Pursuant to the Offer to Amend and Exercise, the Original Warrants of Eligible Holders who elect to participate in the Offer to Amend and Exercise will be amended (the “Amended Warrants) to: (i) shorten the exercise period so that they expire concurrently with the expiration of the Warrant Offer at 5:00 p.m. (Eastern Time) on March 20, 2020, as may be extended by the Company in its sole discretion (the “Expiration Date”) and (ii) reduce the exercise price to $0.15 (the “Revised Exercise Price”).
 
As further described in the Proxy Statement, the Company’s stockholders are being asked to approve Proposal No. 2 at the Special Meeting which is to approve the potential issuance of more than 20% of the Company’s issued and outstanding common stock pursuant to this Offer to Amend and Exercise which has the effect of a reduction in the exercise price of outstanding Original Warrants. 
 
Reasons for Requesting Stockholder Approval. Because the Company’s common stock is traded on the Nasdaq Capital Market (“NasdaqCM”), the Company is subject to the NASDAQ Listing Rules, including Listing Rule 5635(d). Pursuant to Listing Rule 5635(d), stockholder approval is required prior to the issuance of securities in connection with a transaction (or a series of related transactions) other than a public offering involving the sale, issuance or potential issuance of common stock (or securities convertible into or exercisable for common stock) equal to 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance for less than the greater of book or market value of the stock. Since the Revised Exercise Price is below ‘‘market’’, any securities issued for greater than the book or market value of the Company’s Common Stock at the time of the exercise of the Original Warrants will be included in the calculation of the 20% beneficial ownership limitation cap set forth in Listing Rule 5635(d). If the Company’s stockholders approve Proposal No. 2, the Company will not be subject to the issuance of beneficial ownership limitation cap set forth in Listing Rule 5635(d) and the Company would be able to adjust the exercise price of the Original Warrants to the Revised Exercise Price and issue the shares further to the Offer to Amend and Exercise. The Company is seeking stockholder approval to permit adjustments to the exercise price of the Original Warrants and to allow the Company to make such issuances of its common stock described above in accordance with NASDAQ Listing Rule 5635(d).

 
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Vote Required. The affirmative votes from the holders of a majority of the votes cast at the Special Meeting is necessary under Rule 5635(e)(4) of the NASDAQ Listing Rules to approve Proposal 2. If stockholder approval of Proposal No. 2 is not obtained, no shares will be issued and terms of the Original Warrants will be unaffected.
 
The exercise of the Original Warrants pursuant to this Offer to Amend and Exercise is expressly contingent on (i) the approval of Proposal No. 2 by Company stockholders at the Special Meeting and (ii) the satisfaction or waiver of the obligations of each party to the Merger Agreement (the “Expiration Conditions”).

We anticipate that the Expiration Date will occur immediately prior to or concurrently with the Effective Time of the Merger.

The purpose of the Offer to Amend and Exercise is to encourage the amendment and exercise of the Original Warrants at a significantly reduced exercise price in order to provide funds to support the Company’s operations. Please see Section 2 “Purposes of the Offer to Amend and Exercise and Use of Proceeds; Plans or Proposals” below for a description of the purposes of the Offer to Amend and Exercise.
 
Eligible Holders may elect to participate in the Offer to Amend and Exercise with respect to some, all or none of their Original Warrants. If you choose not to participate in the Offer to Amend and Exercise or the Expiration Conditions are not met, your Original Warrants will remain in full force and effect, as originally issued with the original exercise price per share.
 
The period during which Original Warrants may be amended and exercised in the Offer to Amend and Exercise will commence on February 13, 2020 (the date the materials relating to the Offer to Amend and Exercise are first sent to Eligible Holders) through the Expiration Date.

Proposed Merger
 
On October 6, 2019, we entered into an Agreement and Plan of Merger and Reorganization (as amended on December 17, 2019, the “Merger Agreement”) with INNT Merger Sub 1 Ltd., a company organized under the laws of Israel and a direct, wholly-owned subsidiary of the Company (“Merger Sub”), RDD Pharma Ltd., a company organized under the laws of Israel (“RDD”) and Orbimed Israel Partners, Limited Partnership, as the Shareholder Representative.
 
The Merger Agreement provides that, upon the terms and subject to the satisfaction or waiver of the conditions set forth therein, Merger Sub will be merged with and into RDD (the “Merger”), with RDD continuing as the surviving corporation and a direct wholly-owned subsidiary of the Company.

At the effective time of the Merger (the “Effective Time”), and if the Merger Consideration Proposal is approved, all outstanding ordinary and preferred shares of RDD, nominal value of NIS 0.01 each, will be converted into the right to receive such number of validly issued, fully paid and non-assessable shares of common stock of the Company (“Company Common Shares”) as defined in the Merger Agreement (the “Consideration Allocation”).

Additionally, each outstanding RDD stock option will be converted into and become an option exercisable for Company Shares with the number and exercise price adjusted in a manner consistent with the Consideration Allocation. Each outstanding RDD warrant will be exercised or cancelled prior to the Effective Time. Following completion of the Merger and on an as-converted basis, the Innovate stockholders will own up to approximately 62.0% of the combined company’s capital stock and the former RDD stockholders will own approximately 38.0% of the combined company’s capital stock, each on a fully diluted basis (the “RDD Ownership Ratio”). The Merger Agreement also includes, as a closing condition, a minimum funding requirement of $10,000,000 (the “Financing”), which will dilute the Innovate stockholders and former RDD shareholders pro rata.
 
The combined company, led by RDD’s management team, is expected to be named “9 Meters Biopharma, Inc.” The combined company is expected to trade on the Nasdaq Capital Market under a new ticker symbol. At the closing,

 
25
 
 
 
 




the combined company’s board of directors is expected to consist of six (6) directors and will be comprised of three (3) members designated by RDD and three (3) members designated by the Company. The Merger has been unanimously approved by the Board of Directors of each company.
 
The parties to the Merger Agreement have made representations and warranties to each other as of specific dates for the purpose of allocating risks and not for the purpose of establishing facts. In addition, the representations and warranties are qualified by information in confidential disclosure schedules exchanged by the parties together with the Merger Agreement. While the Company does not believe that these schedules contain material information that the securities laws require it to publicly disclose, the disclosure schedules do contain information that modifies, qualifies and creates exceptions to the representations and warranties set forth in the Merger Agreement. Accordingly, the representations and warranties should not be relied on as characterizations of the actual state of facts.
 

 
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SECTION 1.       FORWARD LOOKING STATEMENTS
 
This Offer to Amend and Exercise contains forward-looking statements regarding, among other things, Innovate’s and RDD’s plans, strategies and prospects, both business and financial. Although Innovate and RDD believe that their plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, neither Innovate nor RDD can assure you that either will achieve or realize these plans, intentions or expectations. Forward-looking statements are inherently subject to risks, uncertainties and assumptions including, without limitation, the factors described under “Risk Factors” from time to time in Innovate’s filings with the SEC. All statements other than statements of historical fact are statements that could be deemed forward-looking statements. Many of the forward-looking statements contained in this presentation may be identified by the use of forward-looking words such as “believe”, “expect”, “anticipate”, “should”, “planned”, “will”, “may”, “intend”, “estimated”, “aim”, “on track”, “target”, “opportunity”, “tentative”, “positioning”, “designed”, “create”, “predict”, “project”, “seek”, “would”, “could”, “continue”, “ongoing”, “upside”, “increases” and “potential”, among others. Important factors that could cause actual results to differ materially from the forward-looking statements we make in this presentation are set forth in other reports or documents that we file from time to time with the SEC, and include, but are not limited to:
 
 
the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger Agreement;
 
 
the ability to obtain and/or maintain the listing of the combined company’s common stock on the NasdaqCM following the Merger;
 
 
changes adversely affecting the business in which Innovate is engaged;
 
 
management of growth;
 
 
general economic conditions;
 
 
RDD’s business strategy and plans;
 
 
the result of future financing efforts; and
 
 
the other factors summarized under the section entitled “Risk Factors”.
 
You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Offer to Amend and Exercise. All forward-looking statements included herein attributable to any of Innovate, RDD or any person acting on either party’s behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.
 
For a discussion of the factors that may cause Innovate’s or RDD’s actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied in such forward-looking statements, see “Risk Factors” beginning on page 16.
 

 
27
 
 
 
 




If any of these risks or uncertainties materializes or any of these assumptions proves incorrect, the actual results of Innovate or RDD could differ materially from the forward-looking statements. All forward-looking statements in this Offer to Amend and Exercise are current only as of the date on which the statements were made. Innovate and RDD do not undertake any obligation to publicly update any forward-looking statement to reflect events or circumstances after the date on which any statement is made or to reflect the occurrence of unanticipated events.
 
SECTION 2.       PURPOSES OF THE OFFER TO AMEND AND EXERCISE AND USE OF PROCEEDS; PLANS OR PROPOSALS
 
The primary purpose of the Offer to Amend and Exercise is to raise funds to support the Company’s future operations and capital requirements by encouraging the participating Eligible Holders to exercise their Original Warrants at a significantly reduced exercise price during a shortened exercise period. The Company plans to use the net proceeds from the Offer to Amend and Exercise to fund its ongoing operations.
 
Plans or Proposals
 
The Company intends to cancel the Original Warrants that are amended and exercised by the Eligible Holders thereof pursuant to the Offer to Amend and Exercise. Original Warrants that are not so amended and exercised will remain outstanding pursuant to their original terms.
 
No plans or proposals described in this Offer to Amend and Exercise or in any materials sent to Eligible Holders of the Original Warrants in connection with this Offer to Amend and Exercise relate to or would result in the conditions or transactions described in Regulation M-A, Item 1006(c)(1) through (10), except as follows:
 
Any Eligible Holder of Original Warrants who elects to exercise such Holder’s Original Warrants will acquire additional shares of common stock of the Company as a result of such exercise. As of February 10, 2020, the Company had 41,324,976 shares of common stock outstanding. The Original Warrants are exercisable for an aggregate of 12,346,631 shares of common stock. Assuming all Original Warrants are exercised at the Revised Exercise Price, the Company’s outstanding shares of common stock would increase to 53,671,607 shares, with the shares issued upon exercise of the Original Warrants representing 23% of the then outstanding shares of common stock.
 
SECTION 3.       ELIGIBLE WARRANTS
 

The Company is offering to amend, upon the terms and subject to the conditions set forth herein, warrants held by Eligible Holders to purchase an aggregate of 12,346,631 shares of common stock (the “Offer to Amend and Exercise”), consisting of the following outstanding warrants:

Issue Date
Number of Warrants
Exercise Price
Expiration Date
1/29/2018
1,410,364

$3.18

 
1/29/2023
1/29/2018
349,555

$2.54

 
1/29/2023
3/18/2019
2,508,634

$2.56

 
3/18/2024
3/18/2019
4,181,068

$4.00

 
3/18/2020
5/17/2019
3,897,010

$2.13

 
5/17/2024


The above warrants are collectively referred to as the “Original Warrants”. The shares of common stock underlying the Original Warrants are known together as the “Warrant Shares”.
 

 
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SECTION 4.       EXPIRATION DATE
 
The Offer to Amend and Exercise will be open through 5:00 p.m., Eastern Time on March 20, 2020, as may be extended by the Company in its sole discretion (the “Expiration Date”).
 
SECTION 5.       TERMS OF AMENDED WARRANTS
 
Pursuant to the Offer to Amend and Exercise, the Original Warrants of Eligible Holders who elect to participate in the Offer to Amend and Exercise will be amended as described below:
 
New Exercise Price:  The exercise price will be reduced to $0.15 per share.
 
New Termination Date:  The termination date of the Original Warrants is being shortened to run concurrently with the Expiration Date.
 
No Cashless Exercise:  The Amended Warrants must be exercised for cash, and any cashless exercise provisions in the Original Warrants will be inapplicable to the Amended Warrants.
 
Other Terms:  Except as set forth above, all other terms of the Amended Warrants will be the same as the terms of the Original Warrants. See the applicable form of amendment to Original Warrant as is applicable to the Original Warrants held by an Exercising Holder attached as Exhibit A to the Election to Consent, Participate and Amend Warrant.
 
Partial Participation Permitted: Eligible Holders may elect to participate in the Offer to Amend and Exercise with respect to some, all or none of their Original Warrants. If an Eligible Holder of Original Warrants elects to participate in the Offer to Amend and Exercise with respect to less than all of such Holder’s Original Warrants, then the Company will issue a new Original Warrant with the original exercise price exercisable for that number of shares of common stock that such Eligible Holder elects to exclude from the Offer to Amend and Exercise.
 
SECTION 6.       CONDITIONS TO THE OFFER TO AMEND AND EXERCISE
 
The Offer to Amend and Exercise is subject to certain conditions, as described herein:
 
(i) As further described in the Proxy Statement, the Company’s stockholders are being asked to approve Proposal No. 2 at the Special Meeting which is to approve the potential issuance of more than 20% of the Company’s issued and outstanding common stock pursuant to this Offer to Amend and Exercise which has the effect of a reduction in the exercise price of outstanding Original Warrants. 
 
Reasons for Requesting Stockholder ApprovalBecause the Company’s common stock is traded on the Nasdaq Capital Market (“NasdaqCM”), the Company is subject to the NASDAQ Listing Rules, including Listing Rule 5635(d). Pursuant to Listing Rule 5635(d), stockholder approval is required prior to the issuance of securities in connection with a transaction (or a series of related transactions) other than a public offering involving the sale, issuance or potential issuance of common stock (or securities convertible into or exercisable for common stock) equal to 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance for less than the greater of book or market value of the stock. Since the Revised Exercise Price is below ‘‘market’’, any securities issued for greater than the book or market value of the Company’s Common Stock at the time of the exercise of the Original Warrants will be included in the calculation of the 20% beneficial ownership limitation cap set forth in Listing Rule 5635(d). If the Company’s stockholders approve Proposal No. 2, the Company will not be subject to the issuance of beneficial ownership limitation cap set forth in Listing Rule 5635(d) and the Company would be able to adjust the exercise price of the Original Warrants to the Revised Exercise Price and issue the shares further to the Offer to Amend and Exercise. The Company is seeking stockholder approval to permit adjustments to the exercise price of the Original Warrants and to allow the Company to make such issuances of its common stock described above in accordance with NASDAQ Listing Rule 5635(d).
 

 
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Vote Required. The affirmative votes from the holders of a majority of the votes cast at the Special Meeting is necessary under Rule 5635(e)(4) of the NASDAQ Listing Rules to approve Proposal 2. If stockholder approval of Proposal No. 2 is not obtained, no shares will be issued and terms of the Original Warrants will be unaffected.
 
(ii) This Offer to Amend and Exercise is subject to the satisfaction or waiver of the obligations of each party to the Merger Agreement. We anticipate that the Expiration Date will occur immediately prior to or concurrently with the Effective Time of the Merger.
 
The exercise of the Original Warrants pursuant to this Offer to Amend and Exercise is expressly contingent on (i) the approval of Proposal No. 2 by Company stockholders at the Special Meeting and (ii) the satisfaction or waiver of the obligations of each party to the Merger Agreement (the “Expiration Conditions”).
 
(iii) As part of the Election to Participate and Exercise Warrant, the holders of the Original Warrants must complete an Accredited Investor Questionnaire. In addition, as part of the Election to Participate and Exercise Warrant, the holders of the Original Warrants are asked to make certain representations and warranties upon which the Company will rely in establishing that the transactions contemplated by the Offer to Amend and Exercise are exempt from the registration requirements of the Securities Act. The holders of the Original Warrants, previously made substantially the same representations and warranties to the Company, including a representation that they were “accredited investors”, in connection with the private placement transactions in which such holders acquired the Original Warrants.
 
Original Warrants of holders that elect not to participate and exercise will remain outstanding pursuant to their original terms.
 
You may not elect to exercise your Original Warrants pursuant to this Offer to Amend and Exercise unless you both consent to (a) the amendment of your Original Warrants in the form of amendment to Original Warrant as is applicable to the Original Warrants held by an Exercising Holder attached as Exhibit A to the Election to Consent, Participate and Amend Warrant and (b) the exercise of your Amended Warrant, which will happen automatically on the Expiration Date if the Expiration Conditions have been satisfied, should you choose to participate in the Offer to Amend and Exercise.
 
SECTION 7.       EXTENSION OF OFFER TO AMEND AND EXERCISE PERIOD; TERMINATION; AMENDMENTS
 
The Company expressly reserves the right, in its sole discretion and at any time or from time to time, to extend the Expiration Date.

We anticipate that the Expiration Date will occur immediately prior to or concurrently with the Effective Time of the Merger.
 
There can be no assurance, however, that the Company will exercise its right to extend the Offer to Amend and Exercise. Amendments to the Offer to Amend and Exercise will be made by written notice thereof to Eligible Holders of the Original Warrants. Material changes to information previously provided to Eligible Holders of the Original Warrants in this Offer to Amend and Exercise or in documents furnished subsequent thereto will be disseminated to Eligible Holders of Original Warrants. Also, should the Company, pursuant to the terms and conditions of the Offer to Amend and Exercise, materially amend the Offer to Amend and Exercise, the Company will ensure that the Offer to Amend and Exercise remains open long enough to comply with U.S. federal securities laws.
 
If the Company materially changes the terms of the Offer to Amend and Exercise or the information concerning the Offer to Amend and Exercise, or it waives a material condition of the Offer to Amend and Exercise, the Company will extend the Offer to Amend and Exercise to the extent required under applicable law. The minimum period during which an offer must remain open following any material change in the terms of the Offer to Amend and Exercise or information concerning the Offer to Amend and Exercise (other than a change in price, change in dealer’s soliciting fee or change in percentage of securities sought all of which require up to ten (10) additional business days) will depend on the facts and circumstances, including the relative materiality of such terms or information.

 
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SECTION 8.       PROCEDURE FOR PARTICIPATING IN OFFER TO AMEND AND EXERCISE AND EXERCISING AMENDED WARRANTS
 
To participate in the Offer to Amend and Exercise and exercise an Amended Warrant and receive the number of shares of Company common stock issuable therefor, you must deliver to the Company before the Expiration Date all of the following: (i) a signed copy of the Election to Consent, Participate and Exercise Warrant, (ii) a signed copy of an Accredited Investor Questionnaire, (iii) the original copy of your Original Warrant (or an Affidavit of Loss and Indemnification Agreement), for cancellation, and (iv) cash in the amount equal to $0.15 per share multiplied by the number of shares of common stock the Eligible Holder elects to purchase (collectively, the “Acceptance and Exercise Documents”). The cash must be tendered in the form of a check payable to “Corporate Stock Transfer as Escrow Agent for Innovate Biopharmaceuticals, Inc.”, or by wire transfer to the Company’s escrow account at Corporate Stock Transfer, Inc. which is acting as the Escrow Agent for the Company (the “Escrow Agent”), as set forth in the Election to Consent, Participate and Exercise Warrant, and the cash must be received before the Expiration Date. Each of the Acceptance and Exercise Documents must be properly delivered, before the Expiration Date to: Innovate Biopharmaceuticals, Inc., 8480 Honeycutt Road, Suite 120, Raleigh, NC 27615, Attn: Chief Financial Officer, telephone number (919) 275-1933 (or in the case of the cash exercise price, pursuant to the wire or check delivery instructions set forth in the Election to Consent, Participate and Exercise Warrant).
 
If you execute and deliver an Affidavit of Loss and Indemnification Agreement in lieu of delivering the original copy of your Original Warrant, your Original Warrant will be cancelled by the Company, and the Company will promptly following the Expiration Date issue to you a new Original Warrant with the original exercise price per share exercisable for that number of shares of common stock that such Eligible Holder elects to exclude from the Offer to Amend and Exercise.
 
SECTION 9.       MANNER OF ACCEPTANCE OF PAYMENT AND ISSUANCE OF SHARES
 
If you properly tender (and do not validly withdraw) your Original Warrants and the other Acceptance and Exercise Documents on or prior to the Expiration Date and if the Company stockholders approve Proposal No. 2 at the Special Meeting, promptly following the Expiration Date, we intend to notify our Escrow Agent and our transfer agent of our acceptance of your payment of the exercise price and your other Acceptance and Exercise Documents and issue and deliver to you the number of shares of Company common stock issuable under the Amended Warrant.
 
SECTION 10.    WITHDRAWAL RIGHTS
 
If you change your mind and do not want to participate in the Offer to Amend and Exercise, you may submit the Notice of Withdrawal to us. However, to be effective, the Notice of Withdrawal must be properly completed and must be returned, before the Expiration Date, to: Innovate Biopharmaceuticals, Inc., 8480 Honeycutt Road, Suite 120, Raleigh, NC 27615, Attn: Chief Financial Officer. Following the Expiration Date, you cannot withdraw your Election to Consent, Participate and Exercise Warrant.
 
If you properly withdraw prior to the Expiration Date, we will promptly: (i) cancel your signed copy of the Election to Consent, Participate and Exercise Warrant, (ii) return the original copy of your Original Warrant or issue you a new Original Warrant if you submitted an Affidavit of Loss and Indemnification Agreement, and (iii) provide you with a check equal to the amount of cash you paid upon exercise of the Amended Warrant without interest thereon or deduction therefrom.
 
SECTION 11.    REGISTRATION OF WARRANT SHARES
 
Assuming the satisfactory completion of the Acceptance and Exercise Documents, shares issued in the Offer will be freely tradable. In light of the current trading volume of our Shares, if the holders of the Original Warrants were to sell a significant portion of the Shares obtained from the Offer to Amend and Exercise, such sales could have a negative impact on the trading price of our Shares.
 

 
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SECTION 12.    TRADING MARKET AND PRICE RANGE OF COMMON STOCK
 
Our common stock is quoted on the Nasdaq Capital Market under the symbol “INNT.” There is no established market for any Original Warrants.
 
The following table sets forth the high and low last-bid prices for our common stock for the periods indicated, as reported by the Nasdaq Capital Market. The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.

 
 
High
 
 
Low
Fiscal Year 2018
 
 
 
 
 
 
 
First quarter
 
$
32.99
 
 
$
3.43
Second quarter
 
$
50.50
 
 
$
9.15
Third quarter
 
$
29.09
 
 
$
4.20
Fourth quarter
 
$
7.10
 
 
$
2.12
 
 
 
 
 
 
 
 
Fiscal year 2019
 
 
 
 
 
 
 
First quarter
 
$
4.32
 
 
$
1.61
Second quarter
 
$
2.40
 
 
$
1.07
Third quarter
 
$
1.29
 
 
$
0.73
Fourth quarter
 
$
1.14
 
 
$
0.40
 
 
 
 
 
 
 
 
Fiscal year 2020
 
 
 
 
 
 
 
First quarter (through January 28, 2020)
 
$
1.22
 
 
$
0.52

 
SECTION 13.   SOURCE AND AMOUNT OF FUNDS
 
Because this transaction is solely an offer to Eligible Holders to amend their outstanding Original Warrants, there are no funds or other consideration being paid to participants. The Company will use its existing working capital to pay the fees and expenses associated with this Offer to Amend and Exercise.
 
SECTION 14.   TRANSACTIONS AND AGREEMENTS CONCERNING ORIGINAL WARRANTS
 
None of our directors or executive officers participated in any transaction involving the Original Warrants during the past 60 days.
 
SECTION 15.   INFORMATION REGARDING THE COMPANY AND RDD

Please see the heading “Business” in Innovate’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018 for a review of the historical Innovate business.
 
The following summary highlights selected information regarding RDD. Because it is a summary, it does not contain all of the information you should consider before making a decision to participate in the Offer to Amend and Exercise or exercise your Amended Warrant. Before making an investment decision, you should read the entire Offer to Amend and Exercise carefully, including the “Risk Factors” section above.
 
RDD is a privately held specialty pharmaceutical company focused on development and commercialization of orphan and innovative therapies for gastrointestinal disorders. RDD has exclusively developed drug candidates that are new therapeutic entities based on known or approved molecules with established safety and toxicology profiles. By choosing

 
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medications that are already approved for other indications and combining them with a proprietary drug-delivery technology, RDD benefits from a short regulatory route while maintaining patent protection.

RDD has three clinical-stage products which serve significant unmet needs in the anorectal region. RDD’s pipeline includes drug candidates for fecal incontinence in patients with spinal cord injury (RDD-0315), pruritis ani (RDD-1609), and radiation colitis (RDD-2007). RDD recently completed a successful Phase 2a study in Europe of RDD-0315 in fecal incontinence, which reached the primary endpoint (lowered frequency of incontinence events). Additionally, RDD-0315 has received Orphan Drug status in the E.U. and Fast Track designation in the U.S. There are no approved therapies for this indication. RDD received IRB approval for Phase 2a clinical trials for RDD-1609 and expects the study to be complete in the second half of 2020.

In November 2019, RDD entered into a non-binding letter of intent to acquire NAIA Rare Diseases (“NAIA”), a privately held biopharmaceutical company developing drugs for Short Bowel Syndrome and other rare gastrointestinal diseases. Closing of the transaction is anticipated to occur after the consummation of the Merger. In exchange, it is anticipated that NAIA will receive a combination of cash and shares in the combined company, subject to closing of the Merger.

Through the transaction, the combined company would acquire NAIA’s investigational therapeutic, NB-1001, a long-acting glucagon-like peptide-1 (GLP-1) receptor agonist that combines exenatide with a proprietary extended half-life technology for treatment of short bowel syndrome. Long-acting NB-1001 extends the half-life of GLP-1 and allows for up to once-per-month dosing, considerably increasing administration convenience with a potentially improved safety profile versus other GLP-1 agonists secondary to lower overall exposure and dose required. The proposed acquisition includes a glucagon-like peptide 2 (GLP-2) analogue, NB-1002, with improved serum half-life compared with short-acting versions, which RDD intends to progress through a clinical and regulatory pathway in an undisclosed orphan and rare gastrointestinal indication.

NB-1001 has demonstrated efficacy and an extended half-life up to 30 days in a 70-patient clinical study and received orphan drug designation by the U.S. Food and Drug Administration. The companies, along with Cedars-Sinai Medical Center, plan to initiate a clinical program in short bowel syndrome in 2020, with the goal of developing a safer, more efficacious and convenient therapy.

RDD Pharma Ltd. was founded in Israel in 2008. RDD has two wholly-owned subsidiaries, RDD Pharma Limited, founded in England in 2015, and RDD Pharma Inc., founded in Delaware in 2013.

RDD’s executive offices are located at 31 Habarzel St., Ramat Hachayal, Tel-Aviv 69710 Israel, and its telephone number is +972-722419061. RDD’s Internet website is http://www.rddpharma.com/. The contents of RDD’s Internet site are not incorporated by reference herein and are not deemed to be part of this Offer to Amend and Exercise.
Employees

As of February 10, 2020, RDD had four (4) employees and approximately ten (10) consultants.


 
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Legal Proceedings

RDD is not currently a party to any legal proceedings. From time to time, RDD may be involved in legal proceedings or subject to claims incident to the ordinary course of business. Regardless of the outcome, such proceedings or claims can have an adverse impact on RDD because of defense and settlement costs, diversion of resources and other factors, and there can be no assurances that favorable outcomes will be obtained.

 
SECTION 16. HISTORICAL AND PRO FORMA FINANCIAL INFORMATION AND OTHER FINANCIAL INFORMATION REGARDING THE COMPANY AND RDD
 
See Exhibit A attached hereto.
 
SECTION 17. INTERESTS OF DIRECTORS AND EXECUTIVE OFFICERS IN THE OFFER TO AMEND AND EXERCISE
 
The current executive officers and directors of the Company are:
 
Directors and Executive Officers:
Jay P. Madan, M.S.
Sandeep Laumas, M.D.
Patrick Griffin, M.D., F.A.C.P.
Edward J. Sitar
Lorin K. Johnson, Ph.D.
Anthony E. Maida III, Ph.D., M.A., M.B.A.
Roy Proujansky, M.D.
Saira Ramasastry, M.S., M. Phil.

As of February 12, 2020, there were outstanding Original Warrants to purchase an aggregate of 12,346,631 shares of common stock. None of the Company’s executive officers, directors or control persons hold Original Warrants.
 
SECTION 18. LEGAL MATTERS AND REGULATORY APPROVALS
 
We are not aware of any license or regulatory permit material to our business that might be adversely affected by the Offer to Amend and Exercise and the issuance of the shares of common stock upon the exercise of the Amended Warrants. Our obligations under the Offer to Amend and Exercise are subject to the conditions described in Section 6 “Conditions of the Offer to Amend and Exercise” above.
 
  
SECTION 19. MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES
 
The following is a summary of certain material U.S. federal income tax consequences that we believe will be applicable to Eligible Holders of Original Warrants who participate in the Offer to Amend and Exercise. However, we have not requested, and will not request, a ruling from the IRS or any opinion of counsel with regard to the treatment of warrant holders participating in the exchange and there can be no assurance, as discussed below, that the IRS will not take a position inconsistent with our expectations.
 
This discussion does not address all aspects of federal income taxation that may be relevant to you in light of your particular circumstances, or to those Eligible Holders of Original Warrants who are subject to special rules, such as

 
34
 
 
 
 




financial institutions and mutual funds; banks; insurance companies; investment companies; retirement plans; tax-exempt organizations; dealers or traders in securities; any person that holds their Original Warrants as part of a straddle or hedge arrangement; partnerships or other pass-through entities; persons who are not citizens or residents of the United States or who are foreign corporations, foreign partnerships or foreign estates or trusts for U.S. federal income tax purposes or whose functional currency is not the U.S. dollar; or persons who are subject to the alternative minimum tax provisions of the Internal Revenue Code (the “Code”).
 
This discussion assumes that Eligible Holders of Original Warrants hold the Original Warrants as capital assets. In addition, the following discussion does not address the tax consequences of the participation in the Offer to Amend and Exercise under foreign, state or local tax laws. You are urged to consult your tax advisors as to the U.S. federal income tax consequences of participating in the Offer to Amend and Exercise and related reporting obligations, as well as the effects of state, local and non-U.S. tax laws and U.S. tax laws other than income tax laws.
 
Tax Treatment of Eligible Holders of Original Warrants Participating in the Offer to Amend and Exercise
 
Although not free from doubt, the Company intends to take the position that the amendment of your Original Warrants followed by an exercise of the Amended Warrants are treated as separate events for U.S. tax purposes and that the exchange of Original Warrants for Amended Warrants will therefore constitute a recapitalization within the meaning of Code Section 368(a)(1)(E) for U.S. federal income tax purposes, followed by the subsequent exercise of the Amended Warrants. Under this treatment, (i) the exchange of Original Warrants for Amended Warrants by an Eligible Holder of Original Warrants would not require recognition of gain or loss, (ii) such U.S. Holder’s tax basis in the shares of our common stock received upon exercise of the Amended Warrants would be equal to the U.S. Holder’s tax basis in the Original Warrants plus the amount of any cash paid to exercise the Amended Warrants, and (iii) the holding period of the common stock would begin on the day after the exercise of the Amended Warrants.
 
The foregoing tax discussion is based on current tax law, regulations and interpretive rulings as they exist at this time. The Internal Revenue Service has not made a determination, nor has the Company received any opinion of counsel, on the U.S. federal income tax consequences of the Offer to Amend or of an Eligible Holder’s participation in the Offer to Amend, and there is no published guidance directly on point. Because of the lack of authority dealing with transactions similar to the Offer to Amend, the U.S. federal income tax consequences of the Offer to Amend are unclear, and alternative characterizations are possible that could require you to recognize gain or loss or may impact your holding period. Therefore, we urge you to consult your tax advisor regarding the potential tax consequences of the Offer to Amend to you in your particular circumstances, including the consequences of possible alternative characterizations.
 
Distributions on Common Stock Received upon Exercise of Amended Warrants
 
After you exercise the Amended Warrant, any distributions you receive in respect of our common stock generally will be treated as a dividend, subject to tax as ordinary dividend income, to the extent payable out of our current or accumulated earnings and profits (as determined for U.S. federal income tax purposes), then as a tax-free return of capital to the extent of your tax basis in the shares of our common stock, and thereafter as gain from the sale or exchange of the stock. Dividends received by a non-corporate Eligible Holder currently qualify for taxation at a reduced 15% rate if the Eligible Holder meets certain holding period and other applicable requirements. Dividends received by a corporate Eligible Holder will be eligible for the dividends-received deduction if the Holder meets certain holding period and other applicable requirements.
  
Sale or Other Taxable Disposition of Common Stock
 
You will generally recognize gain or loss upon the sale, exchange or other taxable disposition of shares of our common stock equal to the difference between (1) the amount of cash and the fair market value of any property received and (2) your adjusted tax basis in the shares of our common stock. Any gain or loss you recognize generally will be treated as a capital gain or loss. The capital gain or loss will be long-term if your holding period in the common stock is more than one year at the time of sale, exchange or other taxable disposition and will be short-term if your holding period is one year or less. Long-term capital gains of individuals and other non-corporate taxpayers are generally eligible for reduced rates of taxation. The deductibility of capital losses is subject to certain limitations.

 
35
 
 
 
 




 
Medicare Tax
 
Certain Eligible Holders that are individuals, estates or trusts will be subject to a 3.8% Medicare tax on, among other things, dividends on and capital gains from the sale or other disposition of stock, subject to certain exceptions. You are urged to consult your tax advisors regarding the applicability of the Medicare tax to your income and gains arising from ownership and disposition of our common stock.
 
Information Reporting and Backup Withholding
 
Information reporting requirements generally will apply to certain Eligible Holders with respect to dividends paid on, or, under certain circumstances, the proceeds of a sale, exchange or other disposition of, common stock. Under the Code and applicable Treasury Regulations, an Eligible Holder of common stock may be subject to backup withholding (currently at a rate of 24%) with respect to dividends paid on common stock, or the proceeds of a sale, exchange or disposition of common stock, unless such Eligible Holder (a) is a corporation or comes within certain other exempt categories and, when required, demonstrates this fact in the manner required, or (b) within a reasonable period of time, provides a correct taxpayer identification number, certifies that it is not subject to backup withholding and otherwise complies with applicable requirements of the backup withholding rules. Backup withholding is not an additional tax. Any amounts withheld under the backup withholding rules will generally be allowed as a credit against an Eligible Holder’s U.S. federal income tax liability and may entitle such Eligible Holder to a refund, provided the required information is timely furnished to the IRS. You should consult their tax advisors regarding the application of information reporting and backup withholding rules in their particular situations, the availability of an exemption therefrom, and the procedure for obtaining such an exemption, if applicable.
 
SECTION 20. FEES AND EXPENSES
 
The Company has retained H.C. Wainwright & Co., LLC (“HCW”) to act as its financial advisor for the Offer to Amend and Exercise. HCW will receive an aggregate fee equal to $75,000. In addition, the Company has agreed to reimburse HCW for their legal fees and expenses in the aggregate amount of $20,000.

The Company may also use the services of its officers and employees to solicit Eligible Holders of the Original Warrants to participate in the Offer to Amend and Exercise without additional compensation.
 
SECTION 21. TRANSFERS
 
The terms of the Original Warrants provide that an Eligible Holder may transfer the Original Warrants to a third party if the transfer qualifies for an exemption from the registration requirements of the Securities Act to the reasonable satisfaction of the Company. Any Eligible Holder of an Original Warrant who desires to transfer an Original Warrant should contact the Company prior to such transfer to ensure that the planned transfer satisfies the transfer restrictions set forth in such Original Warrants.

  
SECTION 22. ADDITIONAL INFORMATION
 
The Company has filed with the SEC a Tender Offer Statement on Schedule TO of which this Offer to Amend and Exercise is a part. This Offer to Amend and Exercise does not contain all of the information contained in the Schedule TO and the exhibits to the Schedule TO. We recommend that Eligible Holders of the Original Warrants review the Schedule TO, including the exhibits, and the Company’s other materials that have been filed with the SEC before making a decision on whether to participate in the Offer to Amend and Exercise.
 
The Board of Directors of the Company recognizes that the decision to participate in the Offer to Amend and Exercise is an individual one that should be based on a variety of factors. Eligible Holders of the Original Warrants should consult with their respective professional advisors if they have questions about their financial or tax situation. The information about this Offer to Amend and Exercise from the Company is limited to the Offering Materials.

 
36
 
 
 
 




 
The Company is subject to the information requirements of Section 15(d) of the Exchange Act, and in accordance therewith files and furnishes reports and other information with the SEC. All reports and other documents the Company has filed with the SEC, including the Schedule TO relating to the Offer to Amend and Exercise, or will file with the SEC in the future, can be accessed electronically on the SEC’s website at www.sec.gov.
 
SECTION 23. INFORMATION REQUESTS
 
Please direct questions or requests for assistance regarding this Offer to Amend and Exercise, Election to Consent, Participate and Exercise Warrant, and Notice of Withdrawal or other materials, in writing, to the Company at the following address.
 

Innovate Biopharmaceuticals, Inc.
8480 Honeycutt Road, Suite 120
Raleigh, NC 27615
Tel: (919) 275-1933
Attn: Chief Financial Officer


You may direct requests for additional copies of this Offer to Amend and Exercise, Election to Consent, Participate and Exercise Warrant, and Notice of Withdrawal or other materials, in writing, to the Company at:
 
8480 Honeycutt Road, Suite 120
Raleigh, NC 27615
Attention: Chief Financial Officer
(919) 275-1933
 
Sincerely,
 
 
 
/s/ Sandeep Laumas, M.D.
 
Sandeep Laumas, M.D.
 
Executive Chairman and Chief Executive Officer
 
 
 

  

 

 

 
37
 
 
 
 




EXHIBIT A



RDD PHARMA, LTD.
2018 ANNUAL REPORT



TABLE OF CONTENTS


 
Page
REPORT OF INDEPENDENT AUDITORS
CONSOLIDATED FINANCIAL STATEMENTS - IN U.S. DOLLARS ($):
 
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated statements of changes in capital deficiency
Consolidated statements of cash flows
Notes to consolidated financial statements
 
 


 
F-A-1
 
 
 
 





Report of Independent Auditors

To the board of directors and shareholders of RDD Pharma Ltd.


We have audited the accompanying consolidated financial statements of RDD Pharma Ltd. and its subsidiary, which comprise the consolidated balance sheets as of December 31, 2018 and 2017, and the related consolidated statements of operations, changes in capital deficiency and cash flows for the years then ended.

Management’s Responsibility for the Consolidated Financial Statements

Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditors’ Responsibility

Our responsibility is to express an opinion on the consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Company’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of RDD Pharma Ltd. and its subsidiary as of December 31, 2018 and 2017, and the results of its operations, changes in capital deficiency and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.

Emphasis of Matter


 
F-A-2
 
 
 
 




The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1d to the consolidated financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency and cash outflows from operating activities, and has stated that substantial doubt exists about the Company’s ability to continue as a going concern. Management’s evaluation of the events and conditions and management’s plans regarding these matters are also described in Note 1d. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.

Tel-Aviv, Israel
Kesselman & Kesselman
December 19, 2019
Certified Public Accountants (Isr.)
 
A member firm of PricewaterhouseCoopers International Limited



RDD PHARMA LTD.
CONSOLIDATED BALANCE SHEETS


 
F-A-3
 
 
 
 




 
 
December 31
 
Note
2018
2017
 
 
U.S. dollars
in thousands
Assets
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
 
$
2,375

$
3,344

Prepaid expense and other receivable
9a
26

45

TOTAL CURRENT ASSETS
 
2,401

3,389

 
 
 
 
NON-CURRENT ASSETS -
 
 
 
Property and equipment, net
3
49

19

TOTAL ASSETS
 
2,450

3,408

 
 
 
 
Liabilities net of capital deficiency
 
 
CURRENT LIABILITIES -
 
 
 
Accounts payable:
 
 
 
Trade
 
$
107

$
56

Other
9b
223

725

TOTAL CURRENT LIABILITIES
 
330

781

NON-CURRENT LIABILITIES -
 
 
 
Warrants liabilities
6
653

730

Liability for employees rights upon retirement
 
36

36

 
 
689

766

COMMITMENTS AND CONTINGENCIES
5
 
 
TOTAL LIABILITIES
 
1,019

1,547

 
 
 
 
REDEEMABLE CONVERTIBLE PREFERRED SHARES
8
16,656

14,656

 
 
 
 
CAPITAL DEFICIENCY
 
 
 
Ordinary shares, par value NIS 0.01 per share, 615,241 shares authorized; 48,895 shares issued and outstanding at December 31, 2018 and 2017
 
*

*

Additional paid in capital
 
447

396

Accumulated deficit
 
(15,672)

(13,191)

TOTAL CAPITAL DEFICIENCY
 
(15,225)

(12,795)

TOTAL LIABILITIES NET OF CAPITAL DEFICIENCY
 
$
2,450

$
3,408


* Represents an amount of less than $1 thousand


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

RDD PHARMA LTD.

 
F-A-4
 
 
 
 




CONSOLIDATED STATEMENTS OF OPERATIONS



 
 
Year ended December 31
 
Note
2018
2017
 
 
U.S. dollars in thousands
REVENUES
5c
$

 
$
100

COST OF REVENUES
 

 
3

GROSS PROFIT
 

 
97

OPERATING EXPENSES:
 
 
 
Research and development expenses, net
9c
1,929
 
3,178

General and administrative expenses
9d
632
 
503

OPERATING LOSS
 
2,561
 
3,584

FINANCIAL INCOME, NET
9e
(80)
 
(160)

NET LOSS
 
$
2,481
 
$
3,424






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



RDD PHARMA LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS



 
 
Year ended December 31
 
Note
2018
2017
 
 
U.S. dollars in thousands
REVENUES
5c
$

 
$
100

COST OF REVENUES
 

 
3

GROSS PROFIT
 

 
97

OPERATING EXPENSES:
 
 
 
Research and development expenses, net
9c
1,929
 
3,178

General and administrative expenses
9d
632
 
503

OPERATING LOSS
 
2,561
 
3,584

FINANCIAL INCOME, NET
9e
(80)
 
(160)

NET LOSS
 
$
2,481
 
$
3,424




 
F-A-5
 
 
 
 







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




 
F-A-6
 
 
 
 




RDD PHARMA LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Year ended December 31
 
2018
2017
 
U.S. dollars
in thousands
CASH FLOWS FROM OPERATING ACTIVITIES -
 
 
Net loss
$
(2,481
)
$
(3,424
)
Adjustments required to reconcile net loss to net cash used in operating activities:
 
 
Share-based compensation
51

36

Fair value adjustment of warrants for preferred shares and
   convertible loans
(77)

(263)

Depreciation
5

5

 
(2,502
)
(3,646)

Changes in operating assets and liabilities:
 
 
Decrease (increase) in other receivables
19

(44)

Increase (decrease) in trade payables
51

(191)

Increase (decrease) in accounts payable – other
(502)

591

Increase in liability for employees rights upon retirement

4

 
(432)

360

Net cash used in operating activities
(2,934)

(3,286)

 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES -
 
 
Purchases of property and equipment
(35)


Net cash used in investing activities
(35)


 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES -
 
 
Issuance of Preferred B Shares
2,000

3,312

Issuance of Preferred B-1 warrants

570

Convertible loan from shareholders

500

Net cash provided by financing activities
2,000

4,382

 
 
 
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(969)

1,096

CASH AND CASH EQUIVALENTS AT THE
 
 
    BEGINNING OF THE YEAR
3,344

2,248

CASH AND CASH EQUIVALENTS AT THE END
 
 
     OF THE YEAR
$
2,375

$
3,344

 
 
 
SUPPLEMENTAL DISCLOSURES OF NON-CASH FINANCING ACTIVITIES:
 
 
Non-cash transactions - Conversion of convertible loans into Preferred B Shares and Preferred B-1 Shares

(3,315)



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


 
F-A-7
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows


NOTE 1 - NATURE OF OPERATIONS:

a.
RDD Pharma Ltd. (hereinafter- the Company) commenced operations on March 1, 2008.

b.
The Company is engaged in the medical field, developing treatments for ano-rectal diseases.

c.
In February 2013, the Company established a wholly owned subsidiary in Delaware, USA, named RDD Pharma Inc. (hereinafter- RDD Inc), which started its business activities in April 2017. In July 2015, the Company established a wholly owned subsidiary in United Kingdom, named RDD Pharma Ltd. UK (hereinafter - RDD UK). As of December 31, 2018, RDD UK has not yet started any business activities.

d.
Liquidity

The Company has suffered recurring losses from operations and has a net capital deficiency and cash outflows from operating activities. The Company expects to continue incurring losses and negative cash flows from operations until its products reach commercial profitability. As a result of these expected losses and negative cash flows from operations, along with the Company’s current cash position, the Company does not have sufficient cash to meet its liquidity requirements for the following twelve months. Consequently, there is substantial doubt about the Company’s ability to continue as a going concern. These financial statements have been prepared assuming that the Company will continue as a going concern and do not include any adjustments that might result from the outcome of this uncertainty.

Management’s plans are to raise additional funding from existing and new shareholders until profitable results are achieved, refer also to note 12. There are no assurances however, that the Company will be successful in obtaining the level of financing needed for its operations. If the Company is unsuccessful in commercializing its products and raising capital, it may need to reduce activities, curtail or cease operations.


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

The significant accounting policies applied on a consistent basis are as follows:

a.
Basis of preparation

The Company’s financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (‘U.S. GAAP’).

b.
Principles of consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. Intercompany balances and transactions have been eliminated upon consolidation.

 
F-A-8
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows


c.
Use of estimates in the preparation of financial statements

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results may differ from those estimates. As applicable to these financial statements, the most significant estimates and assumptions relate to the fair value of share-based compensation and fair value of the warrants for preferred shares.

d.
Functional and presentation currency

The U.S. dollar (“dollar”) is the currency of the primary economic environment in which the operations of the Company and the Subsidiary are conducted. Almost all of the Company’s operational expenses are in dollars and the Company’s financings have been provided in dollars. Accordingly, the functional currency of the Company is the dollar.

Transactions and balances originally denominated in dollars are presented at their original amounts. Balances in non-dollar currencies are translated into dollars using historical and current exchange rates for non-monetary and monetary balances, respectively. For non-dollar transactions and other items in the statements of operations (indicated below), the following exchange rates are used: (i) for transactions — exchange rates at transaction dates or average rates; and (ii) for other items (derived from non-monetary balance sheet items such as depreciation) — historical exchange rates. Currency transaction gains and losses are presented in financial income or expenses, as appropriate.

e.
Cash and cash equivalents

The Company considers as cash equivalents all short-term, highly liquid investments, which include short-term bank deposits with original maturities of three months or less from the date of purchase that are not restricted as to withdrawal or use and are readily convertible to known amounts of cash

f.
Property and equipment

1)
Property and equipment are stated at cost, net of accumulated depreciation.

2)
The Company’s property and equipment are depreciated by the straight-line method on the basis of their estimated useful lives.

Annual rates of depreciation are as follows:
 
%
Computer
33
Electronic equipment
10
Office furniture
6


 
F-A-9
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

Leasehold improvements are depreciated by the straight-line method over the shorter of the expected lease term and the estimated useful life of the improvements.

g.
Impairment of long-lived assets

The Company tests long-lived assets, comprised of property and equipment and other assets, for impairment whenever events or circumstances present an indication of impairment. If the sum of expected future cash flows (undiscounted and without interest charges) of the assets is less than the carrying amount of such assets, an impairment loss would be recognized. The assets would be written down to their estimated fair values, calculated based on the present value of expected future cash flows (discounted cash flows), or some other fair value measure.

As of December 31, 2018, and 2017, the Company did not recognize an impairment loss for its long-lived assets.


h.
Financial instruments

When the Company issues preferred shares, it considers the provisions of ASC 480 in order to determine whether the preferred share should be classified as a liability. If the instrument is not within the scope of ASC 480, the Company further analyses the instrument’s characteristics in order to determine whether it should be classified within temporary equity (mezzanine) or within permanent equity in accordance with the provisions of ASC 480-10-S99. The Company’s redeemable convertible preferred shares are not mandatorily or currently redeemable. However, it includes, a liquidation or deemed liquidation events that would constitute a redemption event that is outside of the Company’s control. As such, all shares of redeemable preferred shares have been presented outside of permanent equity. The Company has not adjusted the carrying values of the redeemable preferred shares to the deemed liquidation values of such shares since a liquidation event was not probable at any of the balance sheet dates. Subsequent adjustments to increase or decrease the carrying values to the ultimate liquidation values will be made only if and when it becomes probable that such a liquidation event will occur.

When the Company issues other freestanding instruments, the Company first analyses the provisions of ASC 480 in order to determine whether the instrument should be classified as a liability, with subsequent changes in fair value recognized in the Statements of Operations in each period. If the instrument is not within the scope of ASC 480, the Company further analyses the provisions of ASC 815-10 in order to determine whether the instrument should be classified within equity or rather classified as an asset or liability, with subsequent changes in fair value recognized in the Statements of Operations in each period. See also notes 6 and 8.

According to ASC 480, a financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares shall be classified as a liability if, at inception, the monetary value of the obligation is based solely or predominantly on a fixed monetary amount known at inception. These liabilities are measured subsequently at fair value with

 
F-A-10
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

changes in fair value recognized in the Statements of Operations. The Company’s 2017 Convertible Loan meet the above criteria and accordingly is accounted for as a liability in accordance with ASC 480, and measured subsequently at fair value with changes in fair value recognized in the Statements of Operations. Any issuance costs incurred should be charged to the Statements of Operations. For 2016 Convertible Loan which did not meet the above ASC 480 criteria, the Company has elected to measure it at fair value, as permitted by ASC 825.

i.
Share-based Compensation

The Company accounts for share-based compensation in accordance with ASC 718, “Compensation-Stock Compensation” (“ASC 718”). ASC 718 requires companies to estimate the fair value of equity-based payment awards on the grant date. The grant date fair value of the award is recognized as an expense in the Company’s consolidated statements of operations based on the straight-line method over the related requisite service period, including employee award with graded vesting that is subject only to a service condition.

Effective January 1, 2018, the Company applies the requirements of Accounting Standards Update (ASU) 2018-07, Improvements to Nonemployee Share-Based Payment Accounting. Accordingly, share-based payment transactions with non-employees are accounted for similarly to employees accounted for under ASC 718.

The Company selected the Black-Scholes-Merton option pricing model as the most appropriate fair value method for its stock options awards. The Company’s option pricing model requires the input of highly subjective assumptions, including estimated fair value of ordinary share price, the expected share price volatility and expected term. Any changes in these highly subjective assumptions would significantly impact the share-based compensation expense.

The fair value of options granted to employees and non-employee is estimated at the date of grant using the following assumptions:

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 of the Company’s options. The dividend yield assumption is based on the Company’s historical experience and expectation of no future dividend payouts and may be subject to substantial changes in the future. The Company has historically not paid cash dividends and has no foreseeable plans to pay cash dividends in the future. The expected share price volatility is based on the historical volatility of the ordinary shares of comparable companies that are publicly traded. The expected term of options granted represents the period of time that options granted are expected to be outstanding. The fair value of the Company’s ordinary shares underlying the share-based awards in 2018 were estimated using the hybrid method which takes into consideration a probability-weighted of a non-IPO scenario (which is based on the income approach). The Company has elected to recognize forfeitures as they occur.

j.
Research and development expenses, net


 
F-A-11
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

Research and development expenses include costs directly attributable to the conduct of research and development programs, including the cost of salaries, share-based compensation expenses, payroll taxes and other employee benefits, subcontractors and materials used for research and development activities, including clinical trials, manufacturing costs and professional services. All costs associated with research and developments are expensed as incurred.

Grants received by the Israel Innovation Authority, formerly known as the Office of the Chief Scientist of Israel’s Ministry of Industry, Trade and Labor (the “IIA”) or by the American government agency, are recognized when the grant becomes receivable, provided there is reasonable assurance that the Company or the Subsidiaries will comply with the conditions attached to the grant and there is reasonable assurance the grant will be received. The grant is deducted from the research and development expenses as the applicable costs are incurred, refer to note 9c.

Clinical trial expenses are charged to research and development expense as incurred. The Company accrues for expenses resulting from obligations under contracts with clinical research service providers. The financial terms of these contracts are subject to negotiations, which vary from contract to contract and may result in payment flows that do not match the periods over which materials or services are provided. The Company’s objective is to reflect the appropriate trial expense in the consolidated financial statements by matching the appropriate expenses with the period in which services and efforts are expended. In the event advance payments are made, the payments are recorded as other assets, which will be recognized as expenses as services are rendered.

k.
Income taxes:

Deferred taxes

Income taxes are computed using the asset and liability method. Under the asset and liability method, deferred income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using the currently enacted tax rates and laws. A valuation allowance is recognized to the extent that it is more likely than not that the deferred taxes will not be realized in the foreseeable future. The Company has provided a full valuation allowance with respect to its deferred tax assets.

l.
Fair value measurement

Fair value is based on the price that would be received from the sale of an asset or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, the guidance establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described as follows:

Level 1:    Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.


 
F-A-12
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

Level 2:    Observable prices that are based on inputs not quoted on active markets but corroborated by market data.

Level 3:    Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible and considers counterparty credit risk in its assessment of fair value.

The carrying amount of the cash and cash equivalents, other receivable and accrued expenses and other liabilities approximates their fair value.

m.
Concentration of credit risks

Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalents. The Company deposits cash and cash equivalents with highly rated financial institutions, and, as a matter of policy, limits the amounts of credit exposure to any single financial institution. The Company has not experienced any credit losses in these accounts and does not believe it is exposed to significant credit risk on these instruments.

n.
Comprehensive loss

There are no items of other comprehensive income or loss generated or incurred by the Company other than net loss. Thus, there are no differences between net loss and comprehensive loss.

o.
Recently adopted accounting pronouncement

1)
In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers” (Topic 606), (“ASU 2014-09”). ASU 2014-09 requires entities to recognize revenue that represents the transfer of promised goods or services to customers in an amount equivalent to the consideration to which the entity expects to be entitled to in exchange for those goods or services. The following steps should be applied to determine this amount: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 supersedes the revenue recognition requirements in ASU 605, “Revenue Recognition,” and most industry-specific guidance in the Accounting Standards Codification. Effective January 1, 2018, the Company elected to adopt the ASU 2014-09, using the modified retrospective method. The adoption of this standard did not result in a significant change to the Company's historical revenue recognition and there were no significant adjustments that required a cumulative adjustment upon transition.


 
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INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

2)
In 2018, the Financial Accounting Standards Board (“FASB”) issued ASU 2018-07, “Compensation-Stock Compensation (Topic 718): Improvements to nonemployee Share-Based Payment Accounting” (“ASU 2018-07”). The Company early adopted ASU 2018-07 commencing on January 1, 2018, with no material impact on its consolidated financial statements. Prior to the adoption of ASU 2018-07, stock options issued to consultants and other non-employees, as compensation for services provided to the Company, were accounted for based upon the fair value of the options. The fair value of the options granted were measured on a final basis at the end of the related service period and were recognized over the related service period using the straight line method. After the adoption of ASU 2018-07, the measurement date for non-employee awards is the date of the grant. The compensation expense for non-employees is recognized, without changes in the fair value of the award, over the requisite service period, which is the vesting period of the respective award.

p.    Newly issued accounting pronouncements:

1)
In June 2016, the FASB issued Accounting Standards Update No. 2016-13 (ASU 2016-13) “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss model that requires the use of forward-looking information to calculate credit loss estimates. The Company will adopt ASU 2016-13 effective January 1, 2022. The Company is currently evaluating the effect of the adoption of ASU 2016-13 on our consolidated financial statements.

2)
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 supersedes existing guidance in Leases (Topic 840). The revised standard requires lessees to recognize the assets and liabilities arising from leases with lease terms greater than twelve months on the balance sheet, including those currently classified as operating leases, and to disclose key information about leasing arrangements. Lessees will be required to recognize a lease liability and a right-of-use asset on their balance sheets, while lessor accounting will remain largely unchanged. The guidance is effective for annual periods beginning after December 15, 2019, with early adoption permitted. The Company is currently evaluating the impact of ASU 2016-02 will have on its consolidated financial statements and related disclosures.

NOTE 3 - PROPERTY AND EQUIPMENT:

Composition of assets and the accumulated depreciation thereon, grouped by major classifications for 2018 and 2017 are as follows:

 
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INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

 
December 31
 
2018
2017
 
U.S. dollars in thousands
Cost:
 
 
Computers
$
13

$
13

Electronic equipment
24

24

Office furniture
17

5

Leasehold improvements
23


 
77

42

Accumulated depreciation:
 
 
Computers
(12)

(10)

Electronic equipment
(13)

(11)

Office furniture
(2)

(2)

Leasehold improvements
(1)


 
(28)

(23)

Depreciated balance
$
49

$
19



Depreciation expense was $5 thousands and $5 thousands for the years ended December 31, 2018 and 2017, respectively.

NOTE 4 - EMPLOYEE SEVERANCE BENEFITS

The Company is required by Israeli law to make severance payments to Israeli employees upon dismissal or upon termination of employment in certain other circumstances.

The Company operates a number of post-employment defined contribution plans. A defined contribution plan is a program that benefits an employee after termination of employment, under which the Company regularly makes fixed payments to a separate and independent entity so that the Company has no legal or constructive obligation to pay additional contributions if the fund does not hold sufficient assets to pay all employees the benefits relating to employee service in the current and prior periods. The fund assets are not included in the Company’s financial position.

The Company operates pension and severance compensation plans subject to Section 14 of the Israeli Severance Pay Law. The plans are funded through payments to insurance companies or pension funds administered by trustees. In accordance with its terms, the plans meet the definition of a defined contribution plan, as defined above.

As of December 31, 2017 and 2018, all the Company’s employees in Israel are subject to Section 14. The liability for employees rights upon retirement presented in the balance sheet reflects obligation with respect to the services provided by employees up to the date the Company changes the plan to include all employees under Section 14.



 
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INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

NOTE 5 - COMMITMENTS AND CONTINGENCIES:
    
a.
Lease agreement

On October 16, 2012, the Company entered into an office lease agreement (hereafter – the Lease). The Lease was for a period of 12 months. After expiration of the Lease, the parties agreed to extend it, including granting an option to both parties to terminate the agreement by a 60-day advance notice. On March 28, 2018, the Company entered into a new office lease agreement for a period of 18 months (hereafter – the New Lease). In July 2018, the term of the New Lease was extended until September 2020. The annual rental costs are approximately $22 thousand.

b.
Grants from the IIA

In May 2013, the Company received an approval notice under a normal research and development program of the Israel Innovation Authority (IIA) (the- First and Second Programs, respectively). Under the First and the Second Programs, the Company is obligated to pay royalties to the government of Israel at a rate of 3%-4.5% revenues. The liability is up to the amount of the grants received. Until December 31, 2018, the Company received a total amount of approximately $ 280 thousands from the IIA.

c.
Commercial License Agreement

In October 2017 the Company entered into a Commercial License Agreement (hereinafter- “CLA”) with a Canadian company (hereinafter- the Licensee), pursuant to which the Company manufactures and delivers the product to the Licensee for resale by the Licensee in the territory as defined in the CLA. As of the balance sheet date, the Company has not completed the development. As stipulated in the CLA, the Licensee paid an execution fee of $100 thousands. In addition, the Licensee shall pay the Company additional milestone payments of up to approximately $700 thousands and tiered royalty payments as a percentage of the net sales of the licensed product all as stated in the agreement.

The four basic criteria of ASC 605 were met as of December 31, 2017: (1) persuasive evidence of an arrangement exists since the Company and  the Licensee engaged with a binding agreement; (2) delivery has occurred or services have been rendered since all documents and data the Licenser has requested relating to the Company’s know-how were provided before December 31, 2017 and the Licensee can use the license for its intended purposes without the  Company’s supply services (except for immaterial support services);  (3) the fee is fixed or determinable, as indicated in the license agreement; and (4) collectability is reasonably assured.

Therefore, as of December 31, 2017, the Company recorded the execution fee of $ 100 thousands as a revenue.

As described above, the Company is also entitled to milestone payments and royalties based on the Licensee’s revenue from its product, which are not considered fixed or determinable until their occurrence. Therefore, these amounts would only be recognized when they meet the revenue recognition criteria under Topic 606 as described in note 2o.

 
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INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows


d.
Grants from a US government agency

In November 2017, RDD Inc. received an approval for a grant under a program of an US government agency for the product that is being developed by the Company (hereinafter - “the Program”). Under the Program, the Company will receive up to $1,286 thousands. The grant is recognized as a deduction from research and development expenses, as they incurred. As of December 31, 2018 and 2017 amounts of approximately $1,071 thousands and $179 thousands were received, respectively.

NOTE 6 - FINANCIAL LIABILITIES:

a.
Warrants for preferred shares:

1)
In July, 2012 the Company entered into a Series A Preferred Share Purchase Agreement (the “2012 SPA). As part of the 2012 SPA the Company issued warrants for preferred A shares (the “Preferred A warrants”) to a new investor (hereinafter - the Investor), see also note 8d.

The Preferred A warrants are exercisable into series A preferred shares with NIS 0.01 par value per share, for an exercise price of $35.98 per share commencing on the date of the issuance and until the earlier of an IPO, M&A event, as defined in the agreement, or four years. In April 2015 an extension was agreed upon, and the Preferred A warrants shall expire on the eighth anniversary starting on April 16, 2015. The Preferred A warrants may be exercised in consideration for cash representing the exercise price or net share basis.

The Preferred A warrants are classified as liabilities in accordance with ASC 480-10-35-5, as they are considered freestanding financial instruments, exercisable into Series A preferred shares, which are redeemable upon certain events that represent “Deemed Liquidation Events” (see also note 8d and 8g). Accordingly, the Preferred A warrants are measured at fair value in every reporting period, and changes in their fair value are recognized in the Statements of Operations within financial income (expense).

The fair value as of December 31, 2017 was measured and determined mainly based on the 2017 SPA price per share of Series B preferred shares at $27.18 and assumptions related to achieving the required milestone for additional investment that was determined in the SPA, risk-free interest rate of 1.73% and expected volatility at a rate of 88.14%.

The fair value as of December 31, 2018 was measured and determined mainly based on estimation of the Company’s equity value derived from Discounted Cash Flow (“DCF”) calculation and on assumption relating to future revenue forecast, clinical success probabilities, relevant discount at a rate of 19.5%, risk-free interest rate of 1.73% and expected volatility at a rate of 87.5%.

2)
In 2017, as part of 2017 SPA, the Company issued warrants for Series B-1 preferred shares (the “Preferred B-1 Warrants”), see note 8f.

 
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INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows


The Preferred B-1 warrants are exercisable into Series B-1 preferred shares, of NIS 0.01 par value per share, for an exercise price of $27.18 per share commencing on the date of issuance and until the earlier of an IPO, M&A event or fifteen years. The Preferred B-1 Warrants may be exercised in consideration for cash representing the exercise price or net share basis.

The Preferred B-1 Warrants are classified as liabilities in accordance with ASC 480-10-35-5, as they are considered freestanding financial instruments, exercisable into Series B-1 preferred shares, which are redeemable upon certain events that represent “Deemed Liquidation Events” (see also note 8f and 8g). Accordingly, the Preferred B-1 Warrants are measured at fair value in every reporting period, and changes in their fair value are recognized in the statement of operations within financial income (expense).

The fair value as of December 31, 2017 was measured and determined mainly based on the SPA price per share of Series B preferred shares at $27.18 and assumptions related to achieving the required milestone for additional investment that was determined in the SPA, risk-free interest rate of 1.73% and expected volatility at a rate of 88.14%.

The fair value as of December 31, 2018 was measured and determined mainly based on estimation of the Company’s equity value derived from DCF calculation and on assumption relating to future revenue forecast, clinical success probabilities, relevant discount at a rate of 19.5%, risk-free interest rate of 1.73% and expected volatility at a rate of 87.5%.

b.
Convertible loans from shareholders:

1)
In July 2016, the Company entered into a convertible loan agreement with existing shareholders (hereafter – the “Lenders”) (the “2016 Convertible Loan”), under which the Company borrowed a total amount of $2,900 thousand. The convertible loan is convertible into Preferred B-1 Shares of NIS 0.01 par value each at a price of $ 55.35 per share. The loan bears interest of 3.41% per annum. According to the convertible loan agreement, the principal of the loan together with accrued interest are payable upon the earlier of: (i) the lapse of twelve months as of the effective date (“maturity date”, as defined in the agreement), (ii) the occurrence of an event of default, as defined in the agreement. In November 2017, all of the convertible loans were converted into 95,587 Preferred B-1 Shares of NIS 0.01 par value each (see also note 8f).

The fair value as of the conversion date, November 2017, was measured and determined mainly based on the 2017 SPA price per share of Series B preferred shares at $27.18 and assumptions related to achieving the required milestone for additional investment that was determined in the 2017 SPA, risk-free interest rate of 1.73% and expected volatility at a rate of 88.14%.

2)
In August 2017, the Company entered into a convertible loan agreement with existing shareholders (hereafter – the “Lenders”) (the - “2017 Convertible Loan”), under which the Company borrowed a total amount of $500 thousand. The convertible loan is convertible

 
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INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

into Preferred B Shares of NIS 0.01 par value per share. The loan bears interest of 3.41% per annum. According to the convertible loan agreement, in the event that within a period of three months from the date hereof the Company consummates a transaction or a series of related transactions in which the Company issues securities in consideration for investment in the Company of no less than $1,000 thousand, (the “Financing Transaction”, as defined in the agreement), the principal amount shall be automatically subject to the terms of such Financing Transaction. During November 2017, all of the convertible loans were converted into 18,525 Preferred B Shares of NIS 0.01 par value each (see also note 8f).

The fair value as of the conversion date, November 2017, was measured and determined mainly based on the 2017 SPA price per share of Series B preferred shares at $27.18 and assumptions related to achieving the required milestone for additional investment that was determined in the 2017 SPA, risk-free interest rate of 1.73% and expected volatility at a rate of 88.14%.

c.
The Company financial instruments measured in fair value and classified as Level 3

The table below sets forth a summary of the changes in the fair value of the warrants for preferred shares and the convertible loans classified as Level 3:

 
Convertible loans from shareholders
Warrants liabilities
 
December 31
December 31
 
2018
2017
2018
2017
Balance at beginning of year
$

$
2,560

$
730

$
678

Issuance of warrants for
  preferred shares



570

Issuance of convertible loans

500



Changes in fair value

255

(77
)
(518
)
Conversion of convertible loans

(3,315
)


Balance at end of year
$

$

$
653

$
730


Other than the conversion of the Convertible Loans in 2017 into redeemable convertible preferred shares, there were no transfers into or out of Level 3 measurement.
d.
As of December 31, 2018 and 2017 the fair value of all financial assets and liabilities, approximate their carrying amounts.


NOTE 7 - SHARE CAPITAL:

a.    The share capital as of December 31, 2018 and 2017 are composed as follows:


 
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INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

 
Number of shares
Amount
 
Authorized
Issued
Authorized
Issued
Ordinary shares
 
 
 
 
NIS 0.01 par value
615,241
48,895
6,152
489

b.
Share-based compensation:

In February 2009, the Company’s Board of Directors (the – “Board”) approved an employee and service providers share option plan (the – “Plan).
The Board selected the capital gains tax track for options granted to employees in accordance with Section 102 of the Israeli Tax Ordinance.
1)
Options granted to employees and directors

In 2018 and 2017, the Company granted 43,038 and 0 options of NIS 0.01 par values each, respectively, to employees and directors with an exercise price of $3.2 per share.

The fair value as of December 31, 2018 and 2017 of options granted to employees and directors in 2018 and 2017 was $164 thousands and $0, respectively.

The fair value of options granted to employees and directors on the date of grant was computed using the Black-Scholes model. The underlying data used for computing the fair value of the options are as follows:

 
2018
Value of ordinary shares
$4.91
Dividend yield
0%
Expected volatility
87.51%
Risk-free interest rate
2.90%
Expected term
5.54-5.57

2)
Options granted to consultants and other service providers

In 2018 and 2017, the Company granted 14,086 and 0 options, respectively, to consultants and service providers with an exercise price of $3.2 per share.

The fair value as of December 31, 2018 and 2017 of options granted to consultants and other service providers in 2018 and 2017 was $54 thousands and $0, respectively.

The fair value of options granted to consultants and other service providers as of December 31, 2018 and 2017 was computed using the Black-Scholes model. The underlying data used for computing the fair value of the options are as follows:


 
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INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

 
2018
Value of ordinary shares
$4.91
Dividend yield
0%
Expected volatility
87.51%
Risk-free interest rate
2.90%
Expected term
Contractual term


3)
The following table summarizes the number of options outstanding under the Plan for the years ended December 31, 2018 and 2017, and related information:

 
Employees and directors
Consultants and service providers
 
Number of options
 
Weighted average price per share
Number of options
 
Weighted average price per share
Outstanding at January 1, 2017
39,610

 
$
8.08

6,802

 
$
3.14

Outstanding at December 31, 2017
39,610

 
$
8.08

6,802

 
$
3.14

Granted
43,038

 
$
3.20

14,086

 
$
3.20

Forfeited

 
$

(10,488
)
 
$
3.20

Outstanding at December 31, 2018
82,648

 
$
5.54

10,400

 
$
3.81



4)
The following tables summarize the outstanding and exercisable options as of December 31, 2018 for employees, directors, consultants and other service providers:

December 31, 2018
Options outstanding
Options exercisable
Exercise
price per
share
Number of options outstanding at end of year
Weighted average remaining contractual life
Number of options exercisable at end of year
Weighted average remaining contractual life
$0.00
4,970
3.81
4,970
3.81
 
$3.20
46,636
9.89
 
 
$8.00
30,732
3.62
29,645
3.62
 
$9.70
7,046
0.48
7,046
0.48
 
$11.63
1,832
4.21
1,832
4.21
 
$12.16
1,832
4.21
1,832
4.21
 
 
 
 
 
 
 
 
93,048
 
45,325
 
 

The total unrecognized compensation cost of the options at December 31, 2018 is $152 thousands, which is expected to be recognized over a weighted average period of 3.43 years.

 
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INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows


5)
The following table illustrates the effect of share-based compensation on the statements of operations:
 
Year ended December 31
 
2018
2017
 
U.S. dollars in thousands
Research and development expenses, net
26
11
General and administrative expenses
25
25
 
51
36

NOTE 8 - REDEEMABLE CONVERTIBLE PREFERRED SHARES:

a.
The Redeemable Convertible Preferred Shares as of December 31, 2018 are composed as follows:

 
Number of shares
Amount
 
Authorized
Issued
Authorized
Issued
Ordinary A shares
 
 
 
 
NIS 0.01 par value
92,089
92,089
921
921
Preferred A shares
 
 
 
 
NIS 0.01 par value
238,470
198,725
2,385
1,987
Preferred A1 shares
 
 
 
 
NIS 0.01 par value
54,200
54,200
542
542
Preferred B shares
 
 
 
 
NIS 0.01 par value
1,000,000
253,952
10,000
2,540
Preferred B1 shares
 
 
 
 
NIS 0.01 par value
114,983
95,587
1,150
956
 
1,499,742
694,553
14,998
6,946


The Redeemable Convertible Preferred Shares as of December 31, 2017 are composed as follows:


 
F-A-22
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

 
Number of shares
Amount
 
Authorized
Issued
Authorized
Issued
Ordinary A shares
 
 
 
 
NIS 0.01 par value
92,089
92,089
921
921
Preferred A shares
 
 
 
 
NIS 0.01 par value
238,470
198,725
2,385
1,987
Preferred A1 shares
 
 
 
 
NIS 0.01 par value
54,200
54,200
542
542
Preferred B shares
 
 
 
 
NIS 0.01 par value
1,000,000
166,424
10,000
1,664
Preferred B1 shares
 
 
 
 
NIS 0.01 par value
114,983
95,587
1,150
956
 
1,499,742
607,025
14,998
6,070

b.
Changes in the Redeemable Convertible Preferred Shares:
 
Number of shares
Amount
 
U.S. dollars in thousands
BALANCE AS OF JANUARY 1, 2017
345,014
8,798
CHANGES DURING 2017:
 
 
Issuance of Preferred B-1 Shares
95,587
2,083
Issuance of Preferred B Shares
166,424
3,775
BALANCE AS OF DECEMBER 31, 2017
607,025
14,656
CHANGES DURING 2018:
 
 
Issuance of Preferred B Shares
87,528
2,000
BALANCE AS OF DECEMBER 31, 2018
694,553
16,656

c.
In 2008 the Company entered into a share purchase agreement (hereafter - SPA), according to which the Company issued 62,449 Ordinary A of NIS 0.01 par value, for total consideration of $844 thousands. In addition, in October 2010 the Company entered into a convertible loan agreement with existing shareholders (hereafter – the “Lenders”) (the - “2010 Convertible Loan”), under which the Company borrowed a total amount of $343 thousands. In July 2012, the convertible loan was converted into 29,640 Ordinary A Share of NIS 0.01 par value each.

The Company analyzed the classification of the Ordinary A Share based, among others, the redemption obligation as agreed in the 2010 Convertible Loan. Based on ASC 480-10-S99-3A(f) the Company determined that since the redemption obligation is outside of its control, the Series Ordinary A Share is considered as contingently redeemable upon the occurrence of an event that is outside of its control and should be classified as a mezzanine equity. The Company concluded that it is not probable the instrument will become redeemable (e.g., it is not probable a contingency that triggers redemption will be met). Therefore, an adjustment of the initial carrying amount is not necessary until it is probable that the security will become redeemable. Accordingly, the amounts of $1,187 thousands were classified as “Redeemable Convertible Ordinary A Share” in the Consolidated Balance Sheet.


 
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INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

d.
As mentioned in note 6a(1) above, in accordance with the 2012 SPA, the Company issued to the Investor 115,344 Preferred A Shares of NIS 0.01 par value at a price per share of $35.9793, in total consideration of $4,150 thousands.

The Company analyzed the classification of the Preferred A Shares based, among others, the redemption obligation as agreed in the 2012 SPA. Based on ASC 480-10-S99-3A(f) the Company determined that since the redemption obligation is outside of its control, the Series Preferred A Shares is considered as contingently redeemable upon the occurrence of an event that is outside of its control and should be classified as a mezzanine equity. The Company concluded that it is not probable the instrument will become redeemable (e.g., it is not probable a contingency that triggers redemption will be met). Therefore, an adjustment of the initial carrying amount is not necessary until it is probable that the security will become redeemable. Accordingly, the amounts of $3,907 thousands were classified as “Redeemable Convertible Preferred A Shares” in the Consolidated Balance Sheet.

In addition, the Company granted the Investor warrants to purchase 39,745 Preferred A Shares, see also note 6a(1).

e.
In July 2015, the Company entered into a Series A-1 Preferred Share Purchase Agreement (hereafter – 2015 SPA), according to which the Company issued 54,200 Preferred A-1 Shares of NIS 0.01 par value each at a price of $55.35 per share for total gross consideration of $2,985 thousands.

The Company analyzed the classification of the Preferred A-1 Shares based, among others, the redemption obligation as agreed in the 2015 SPA. Based on ASC 480-10-S99-3A(f) the Company determined that since the redemption obligation is outside of its control, the Series Preferred A-1 Shares is considered as contingently redeemable upon the occurrence of an event that is outside of its control and should be classified as a mezzanine equity. The company concluded that it is not probable the instrument will become redeemable (e.g., it is not probable a contingency that triggers redemption will be met). Therefore, an adjustment of the initial carrying amount is not necessary until it is probable that the security will become redeemable. Accordingly, the amounts of $2,985 thousands were classified as “Redeemable Convertible Preferred A-1 Shares” in the Consolidated Balance Sheet.

f.
In November 2017, the Company entered into an investment agreement with existing and new investors (hereafter – 2017 SPA), according to which the Company issued 147,899 Preferred B Shares of NIS 0.01 par value each, for total consideration of $ 4,020 thousands.

In addition, all of the Convertible Loans were converted into 18,525 Preferred B Shares of NIS 0.01 par value each and 95,587 Preferred B-1 Shares of NIS 0.01 par value each.

The Company analyzed the classification of the Preferred B-1 Shares and Preferred B Shares based, among others, the redemption obligation as agreed in the 2017 SPA. Based on ASC 480-10-S99-3A(f) the Company determined that since the Redemption Obligation is outside of its control, the Series Preferred B Shares and Preferred B-1 shares is considered as contingently redeemable upon the occurrence of an event that is outside of its control and should be classified as a mezzanine equity. The company concluded that it is not probable the instrument will become redeemable (e.g., it is not probable a contingency that triggers redemption will be met). Therefore, an adjustment of the initial

 
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INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

carrying amount is not necessary until it is probable that the security will become redeemable. Accordingly, the amounts of$3,775 thousands and $2,083 thousands, were classified as “Redeemable Convertible Preferred B Shares” and “Redeemable Convertible Preferred B-1 Shares” in the Consolidated Balance Sheet, respectively.
In accordance with the 2017 SPA, the Company will receive a milestone payment of up to $2,000 thousands in consideration for issuance of 87,528 Preferred B Shares of NIS 0.01 par
value each. In 2018 the milestone was achieved and the Company issued the additional Preferred B Shares. Accordingly, in 2018, at the payment date, the amount of $2,000 thousand was recorded as “Redeemable Convertible Preferred B Shares” in the consolidated balance sheet.

In addition, the Company granted the Investor warrants to purchase 19,396 of the Preferred B-1 Shares of NIS 0.01 par value each, see also note 6a(2).

g.
The rights, preferences and privileges with respect to the preferred shares are stipulated in the Company’s articles of association and a summary of significant provisions are as follows:

i.
Right of First Refusal: Until an IPO (as defined in the Company’s articles), each Preferred and Ordinary A shareholder have a right of first refusal with respect to a transfer, sell, assign or otherwise of all or any of the shares or other securities of the Company by any shareholder with certain specified exceptions.

ii.
Liquidation Preference: Until a qualified IPO, in the event of any liquidation or deemed liquidation, the assets shall be distributed among the shareholders as follows:

i.
The holders of Preferred B and B-1 Shares are entitled to receive from the distributable proceeds an amount that equals to (i) one-time (1x) the applicable original issue price of such Preferred B Share (adjusted for recapitalization events); plus (ii) an 8% annual interest on the applicable original issue price for such Preferred B Share, accrued daily and compounded annually from the date of the issuance of such Preferred B Share up to the date of distribution; plus (iii) an amount that equals to the declared but unpaid dividends on such Preferred B Share.
ii.
Second, and after payment in full of the Preferred B Preference Amounts, the holders of Preferred A and A-1 Shares are entitled to receive from the remaining distributable proceeds (if any) an amount that equals to (i) one-time (1x) the applicable Original Issue Price of such Preferred A Share (adjusted for Recapitalization Events); plus (ii) an 8% annual interest on the applicable Original Issue Price for such Preferred A Share, accrued daily and compounded annually from the date of the issuance of such Preferred A Share up to the date of distribution; plus (iii) an amount that equals to the declared but unpaid Dividends on such Preferred A Share.

iii.
Third, and after payment in full of the Preferred B Preference Amount and the Preferred A Preference Amount, the holders of Ordinary A Shares are entitled to receive from the distributable proceeds an amount that equals to (i) one-time (1x) the Original Issue Price of such Ordinary A Share (adjusted for Recapitalization

 
F-A-25
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

Events); plus (ii) an 8% annual interest on the Original Issue Price for such Ordinary A Share, accrued daily and compounded annually. From the date of the issuance of such Ordinary A Share up to the date of distribution; plus (iii) an amount equal to the declared but unpaid dividends on such Ordinary A Share.

iv.
Any remaining distributable proceeds available for distribution, if any, are to be distributed pro rata among all of the Company’s Shareholders based on their holdings of the Company’s issued share capital, calculated on an as-converted to Ordinary Shares basis.

iii.
Dividend preference: the preferred shareholders will be entitled to receive, at a dividend distribution, the amount calculated according to the order of preference and ratio specified in the liquidation reference section above.

iv.
Protective provisions: In addition, until a qualified IPO, the Preferred Majority will have certain protective provision in decisions with regard to the amendment of the Articles of Association of the Company, the recapitalization of its shares, effecting a liquidation event, declaring dividends, or performing a merger or IPO.

v.
Conversion and conversion price adjustment: Each holder of Preferred Shares and Ordinary A Shares has the right to convert any or all of its Preferred Shares or Ordinary A Shares, as applicable, into Ordinary Shares at any time, at the conversion rate applicable to such Preferred Shares or Ordinary A Shares, respectively, at the time of conversion, without the payment of additional consideration by such holder. The Conversion Price of a Preferred Share or an Ordinary A Share upon the issuance thereof is the Original Issue Price thereof, and thereafter the respective conversion price and consequent conversion rate of any Preferred Share or Ordinary A Share are subject to adjustment from time to time.

vi.
Automatic conversion: The Preferred B Shares shall automatically be converted into Ordinary Shares, at the then applicable conversion rate with respect to Preferred B Shares, upon the earlier of: (i) the election of the holders of the majority of the Preferred B Shares, or (ii) upon the closing of a firm commitment underwritten public offering of the Company’s Ordinary Shares with Company valuation of at least $75,000,000, resulting in aggregate proceeds to the Company (net of the underwriting discounts or commissions and offering expenses) of not less than $20,000,000 (a “QIPO”). The Preferred B-1 Shares shall automatically be converted into Ordinary Shares, at the then applicable conversion rate with respect to Preferred B-1 Shares, upon the earlier of: (i) the election of the holders of the majority of the Preferred B-1 Shares, or (ii) upon a QIPO. The Preferred A and Preferred A-1 Shares shall automatically be converted into Ordinary Shares, at the then applicable conversion rate with respect to the Preferred A Shares and the Preferred A-1 Shares, respectively, upon the earlier of: (i) the election of the holders of the majority of the Preferred Shares, or (ii) upon the closing of a QIPO. The Ordinary A Shares shall automatically be converted into Ordinary Shares, at the then applicable conversion rate with respect to Ordinary A Shares, upon the earlier of: (i) the election of a majority of the shareholders of the Company and the majority

 
F-A-26
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

of the Preferred Shareholders, or (ii) immediately prior to the closing of an IPO, or (iii) upon the conversion of all the Preferred Shares.

Upon conversion as specified above, all outstanding Ordinary A Shares and/or Preferred Shares, as applicable, shall be deemed to have been converted into Ordinary Shares and all additional rights, privileges and obligations attached to such shares (i.e., all such rights in excess to the rights attached to Ordinary Shares) will be abolished.

vii.
Voting rights: each of the Ordinary Shares entitle the holder thereof to one vote per Ordinary Share. Each of the Preferred B-1 Shares, Preferred B Shares, Preferred A-1 Shares, Preferred A Shares and Ordinary A Shares entitle the holder thereof to a number of votes that equals the number of Ordinary Shares then issuable upon conversion into Ordinary Shares.

NOTE 9 - SUPPLEMENTARY FINANCIAL STATEMENT INFORMATION:

Balance sheet:
 
December 31
 
2018
2017
 
U.S. dollars in thousands
a.   Other receivable:
 
 
Prepaid expenses
$
20

 
$
45

 
Other
6

 

 
 
26

 
45

 
b. Accounts payables - other:
 
 
Accrued expenses
53

 
499

 
Employees and employee institutions
170

 
151

 
Other

 
75

 
 
$
223

 
$
725

 
Statements of operations:
 
Year ended December 31
 
2018
2017
 
U.S. dollars in thousands
c. Research and development
expenses, net:
 
 
Payroll and related expenses
$
644

$
642

Subcontractors and materials
1,950

2,558

Other
227

157

 
2,821

3,357

Less - grants
(892)

(179)

 
$
1,929

$
3,178



 
F-A-27
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

 
Year ended December 31
 
2018
2017
 
U.S. dollars in thousands
d. General and administrative expenses:
 
 
Payroll and related expenses
$
53

$
34

Professional services
464

285

Registration of patents
104

93

Office, rent and maintenance
11

91

 
$
632

$
503


e. Financial income, net:
 
 
Changes in fair value of warrants
   liabilities and convertible loans
$
(77
)
$
(263
)
Other finance expenses (income)
(3)

103

 
$
(80
)
$
(160
)


NOTE 10 - RELATED PARTIES - TRANSACTIONS AND BALANCES:

Related parties include the Chairman of the Board of Directors, the board members and the Chief Executive Officer of the Company.
 
December 31
 
2018
2017
a. Transactions with related parties:
U.S. dollars in thousands
Payroll and related expenses
$
252

$
323

Professional services
143

93

 
$
395

$
416

b. Balances with related parties:
 
 
Employees and employees Institutions
17

66

 
$
17

$
66


NOTE 11 - TAXES ON INCOME:

a.
Tax rates

The income and capital gains of the Company are subject to the normal corporate tax rates in Israel, which is 23% in 2018 and thereafter.

The income of the U.S. subsidiary is subject to federal corporate tax rate, which is 21% in 2018.

b.
Tax assessments

All the tax assessments filed through 2013 are considered final.

 
F-A-28
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows


c.
Carryforward losses

As of December 31, 2018, the Company had approximately $14 million of net carry forward tax losses available for reducing future taxable income without limitation of use.

d.
Deferred income taxes:

 
December 31
 
2018
2017
 
U.S. dollars in thousands
In respect of:
 
 
Net operating carry forward loss
3,250
2,479
Research and development expenses
430
362
Other
24
26
Less - valuation allowance
(3,704)
(2,867)
Net deferred tax assets

 

 

The change in valuation allowance for the years ended December 31, 2018 and 2017 was as follows:
 
2018
2017
Balance at the beginning of the year
(2,867)
(1,961)
Changes during the year
(837)
(906)
Balance at the end of the year
(3,704)
(2,867)

The main reconciling item between the statutory tax rate of the Company and the effective rate is the share-based compensation and provision for full valuation allowance in respect of tax benefits from carry forward tax losses due to the uncertainty of the realization of such tax benefits.

NOTE 12 - SUBSEQUENT EVENTS:

a.
In February 2019, the Company's appointed new chief executive officer (the "New CEO"), replacing the prior chief executive officer (the "Prior CEO") in this capacity. Concurrently, the New CEO was appointed as a member of the board of directors (the “Board”) and the Prior CEO resigned from the Board. In connection with the New CEO employment, he was granted 28,930 options exercisable into one ordinary share of the Company at an exercise price of $3.2 per share. The options vest annually in 4 increments over 4 years, with the first increment vesting on February 2020, conditioned upon continuous employment through each date of vesting. The grant date fair value of these options is approximately $ 97 thousands.

b.
On March 15, 2019 (the "Effective Date") the Prior CEO's employment with the Company was terminated. As part of his separation agreement, he entitled to a redemption of any unused accumulated

 
F-A-29
 
 
 
 




INNOVATE BIOPHARMACEUTICALS, INC.
Unaudited Condensed Statements of Cash Flows

vacation days until the Effective Date in the total amount of approximately $ 28 thousands. In addition, all the fully vested options, as of the Effective Date, amounted to 15,822, purchase Ordinary shares of the Company, par value NIS 0.01 each, shall be exercisable for a period of two years from the Effective Date. The fair value of the extension period amounted to approximately $ 18 thousands and was recorded to the Statements of Operations. The unvested options, as of the Effective Date, granted to Prior the CEO were terminated and became null.

c.
On October 7, 2019 the Company entered into a Merger Agreement, as amended on December 17, 2019, with Innovate Biopharmaceuticals, Inc. a publicly traded company (Nasdaq: INNT) ("Innovate Biopharmaceuticals") (the "Merger Agreement"). Following the merger, the Company's stockholders will own, on a fully-diluted basis, approximately 38% of Innovate Biopharmaceuticals' shares. The exact percentage and the closing of the merger is subject to financing and several conditions as mentioned in the Merger Agreement. 

d.
On November 13, 2019 the Company entered into a Non-Binding Letter (the "Non-Binding Letter") of intent to acquire Naia Rare Diseases (“Naia”), for an amount of $ 4.85 million combined of cash and shares and additional milestones payments as determined in the Non-Binding Letter. The acquisition is subject to the closing of the Merger Agreement (see also note 12c).


 
F-A-30
 
 
 
 









RDD PHARMA LTD.
UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2019



TABLE OF CONTENTS



 
Page
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
 
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Changes In Capital Deficiency
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements



 
F-A-31
 
 
 
 




RDD PHARMA LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
September 30,
December 31,
 
2019
2018
 
U.S. dollars in thousands
Assets
 
 
CURRENT ASSETS:
 
 
Cash and cash equivalents
$
668

$
2,375

Prepaid expense and other receivable
23

26

TOTAL CURRENT ASSETS
691

2,401

 
 
 
NON-CURRENT ASSETS:
 
 
Property and equipment, net
44

49

TOTAL ASSETS
$
735

$
2,450

 
 
 
Liabilities net of capital deficiency
 
 
CURRENT LIABILITIES -
 
 
Accounts payables:
 
 
Trade
$
172

$
107

Other
468

223

   TOTAL CURRENT LIABILITIES
640

330

NON-CURRENT LIABILITIES -
 
 
Warrants liabilities
651

653

Liability for employees rights upon retirement
36