zk1618179.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 20-F

¨
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the fiscal year ended December 31, 2015
 
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
¨
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
for the transition period from __________ to ___________
   

Commission file number 001-36848
 
Check-Cap Ltd.

(Exact name of the Registrant as specified in its charter)
 
Israel

 (Jurisdiction of incorporation or organization)
 
Check-Cap Building
Abba Hushi Avenue
P.O. Box 1271
Isfiya, 30090
Mount Carmel, Israel

 (Address of principal executive offices)
 
 
 

 

 
Securities registered or to be registered pursuant to Section 12(b) of the Act:
 
Title of Each Class  
 
Ordinary Shares, par value NIS 0.20

Name of each exchange on which registered
 
NASDAQ Capital Market
 
Securities registered or to be registered pursuant to Section 12(g) of the Act:

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

As of December 31, 2015, the registrant had 11,811,709 ordinary shares outstanding, NIS 0.2 par value per share.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Yes o        No x
 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
Yes o        No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes x        No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes x        No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer.

o  Large Accelerated filer
o  Accelerated filer
x  Non-accelerated filer
                               
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
 
x US GAAP
 o International Financial Reporting Standards as issued by the International Accounting Standards Board
o  Other
 
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
 
o  Item 17       o Item 18
 
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o        No x
 
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)
 
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of the securities under a plan confirmed by a court.
 
Yes o        No o
 
 
ii

 
 
TABLE OF CONTENTS


 
  PART I
  Page
3
     
3
     
3
A.
Selected financial data
3
B.
Capitalization and indebtedness
4
C.
Reasons for the offer and use of proceeds
4
D.
Risk factors
4
     
34
A.
History and Development of the Company
34
B.
Business Overview
35
C.
Organizational Structure
61
D.
Property, Plants and Equipment
61
     
61
     
62
A.
Operating Results
65
B.
Liquidity and Capital Resources
69
C.
Research and development, patents and licenses, etc.
78
D.
Trend Information
78
E.
Off-balance Sheet Arrangements
78
F.
Tabular Disclosure of Contractual Obligations.
78
     
79
A.
Directors and senior management
79
B.
Compensation
84
C.
Board Practices
88
D.
Employees
101
E.
Share Ownership
101
     
105
A.
Major shareholders
105
B.
Related party transactions
107
C.
Interests of experts and counsel
111
     
111
A.
Statements and Other Financial Information
111
B.
Significant Changes
111
     
112
A.
Offer and listing details
112
B.
Plan of distribution
112
C.
Markets
112
D.
Selling shareholders
112
E.
Dilution
113
F.
Expenses of the issue
113
 
 
iii

 
 
113
A.
Share capital
113
B.
Memorandum and articles of association
113
C.
Material contracts
118
D.
Exchange controls
118
E.
Taxation
118
F.
Dividends and paying agents
130
G.
Statement by experts
130
H.
Documents on display
130
I.
Subsidiary Information
130
     
131
     
131
     
 
PART II
 
     
131
     
131
     
131
     
132
     
132
     
132
     
133
     
133
     
133
     
133
     
133
     
134
     
 
PART III
 
     
135
     
135
     
135
     
  137
 
 
iv

 

 
CERTAIN INFORMATION

In this Annual Report on Form 20-F, or the Annual Report, unless the context indicates otherwise, references to “NIS” are to the legal currency of Israel, “U.S. dollars,” “$” or “dollars” are to United States dollars, and the terms “we,” “us,” “our company,” “our,” and “Check-Cap” refer to Check-Cap Ltd. Unless otherwise indicated, U.S. dollar translation of NIS amounts presented in this Annual Report are translated using the rate of $1.00 = NIS 3.902, the exchange rate published by the Bank of Israel on December 31, 2015, and U.S. dollar translation of Euro amounts presented in this Annual Report are translated using the rate of $1.00 = Euro 0.9208, the exchange rates published by the Wall Street Journal on December 31, 2015.

We are a clinical stage medical diagnostics company engaged in the development of an ingestible capsule system that utilizes ultra low-dose X-rays for the detection and imaging of colonic polyps and colorectal cancers, or CRC.  While CRC is the second leading cause of death from cancer for both sexes combined in the United States and is largely preventable with early detection, according to 2013 National Health Interview Survey, only 58% of Americans between the ages of 50 to 75 reported being current with CRC screening recommendations.  Unlike other screening modalities that are designed to generate structural information of the internal colon for the detection of colonic polyps and CRC, such as optical colonoscopy, computed tomographic colonography, or CTC, and other capsule-based technologies, our system is designed to be ingested without any cathartic preparation of the colon, and to travel through the gastrointestinal tract naturally while the patient continues his or her normal daily routine.  Furthermore, unlike existing CRC imaging modalities currently on the market, all of which require the patient to fast for several hours prior to administration, the procedure for the Check-Cap system is designed to enable patients to continue eating normally. Our system is comprised of three main components: (1) ingestible scanning capsule; (2) Capsule Positioning System, or CPS, a recorder worn on the patient’s back; and (3) a PC-based work station for data reconstruction and image processing.  We believe that this solution will be attractive to both physicians and patients, with the potential to increase the number of people undergoing CRC screening.

Beginning with the fourth quarter of 2015, we prepared our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. We recast the comparative amounts included in our financial statements and in this report to U.S. GAAP. Prior to the fourth quarter of 2015, we prepared our financial reports in accordance with International Financial Reporting Standards as issued by International Accounting Standard Board, or IFRS. We elected to use U.S. GAAP to increase transparency and comparability of our financial reports and facilitate research and analysis by shareholders, analysts and other participants in the U.S. capital markets.
 
We effected a 1-for-20 reverse stock split of our ordinary shares effective immediately prior to the consummation of our initial public offering on February 24, 2015, in accordance with the approval of our shareholders at a meeting held on January 15, 2015. All share numbers in this Annual Report are reflected on a post- reverse stock split basis.

FORWARD-LOOKING STATEMENTS

This Annual Report contains statements that may be deemed to be “forward-looking statements” within the meaning of the federal securities laws. These statements relate to anticipated future events, future results of operations and/or future financial performance. In some cases, you can identify forward-looking statements by their use of terminology such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “future,” “intend,” “may,” “ought to,” “plan,” “possible,” “potentially,” “predicts,” “project,” “should,” “will,” “would,” negatives of such terms or other similar terms. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. The forward-looking statements in this Annual Report include, without limitation, statements relating to:

 
our goals, targets and strategies;
 
 
the timing and conduct of the clinical trials for our scanning system, including statements regarding the timing, progress and results of current and future preclinical studies and clinical trials, and our research and development programs;
 
 
the clinical utility, potential advantages and timing or likelihood of regulatory filings and approvals of our  system;
 
 
 

 
 
 
our future business development, results of operations and financial condition;
 
 
our ability to protect our intellectual property rights;
 
 
our plans to develop, launch and commercialize our system and any future products;
 
 
the timing, cost or other aspects of the commercial launch of our system;
 
 
market acceptance of our product;
 
 
our estimates regarding expenses, future revenues, capital requirements and our need for additional financing and strategic partnerships;
 
 
our estimates regarding the market opportunity for our system;
 
 
the impact of government laws and regulations;
 
 
our ability to recruit and retain qualified clinical, regulatory and research and development personnel;
 
 
unforeseen changes in healthcare reimbursement for any of our approved product;
 
 
difficulties in maintaining commercial scale manufacturing capacity and capability; our ability to generate growth;
 
 
our failure to comply with regulatory guidelines;
 
 
uncertainty in industry demand and patient wellness behavior;
 
 
general economic conditions and market conditions in the medical device industry;
 
 
future sales of large blocks or our securities, which may adversely impact our share price;
 
 
depth of the trading market in our securities; and
 
 
our expectations regarding the use of proceeds of our initial public offering and the concurrent private placement.

The preceding list is not intended to be an exhaustive list of all of our forward-looking statements. Forward-looking statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties, including those described in Item 3D “Key Information - Risk factors.”

You should not unduly rely on any forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that future results, levels of activity, performance and events and circumstances reflected in the forward-looking statements will be achieved or will occur. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Annual Report, to conform these statements to actual results or to changes in our expectations.

 
2

 

PART I

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
 
A.
Directors and Senior Management
 
Not required.                      
 
B.
Advisers
 
Not required.                      
 
C.
Auditors
 
Not required.                      

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not required.                      
  
ITEM 3. KEY INFORMATION

A.
  Selected financial data

The following selected consolidated financial data should be read in conjunction with Item 5 “Operating and Financial Review and Prospects” and the consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report.

The following table summarizes our historical consolidated financial data. We have derived the selected consolidated statements of operations data for the years ended December 31, 2015, 2014 and 2013 and the selected consolidated balance sheet data as of December 31, 2015 and 2014 from our audited consolidated financial statements included elsewhere in this Annual Report. We have derived the selected consolidated financial data as of December 31, 2013 and 2012 from our audited consolidated financial statements not included in this Annual Report. Selected financial data as of, and for the year ended, December 31, 2011 have been omitted from this Annual Report because of our status as an emerging growth company under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and as per related guidance provided by the SEC. Our Consolidated Financial Statements have been prepared in accordance with U.S. GAAP.

Certain factors that affect the comparability of the information set forth in the following table are described in Item 5 “Operating and Financial Review and Prospects” and the Consoliated Financial Statements and related notes thereto included elsewhere in this Annual Report.

Consolidated Statements of Operations Data

   
Year Ended December 31,
 
   
2015
   
2014
   
2013
   
2012
 
   
(US$ in thousands, except per share data)
 
Operating expenses(1)
                       
Research and development expenses, net(2) 
  $ 5,837     $ 2,832     $ 2,893     $ 2,377  
General and administrative expenses
    6,626       1,703       1,090       1,118  
Other income (expenses)
    -       -       11       (14
Operating loss
    12,463       4,535       3,972       3,509  
Finance income (expenses),  net
    173       3,925       604       (841
Net loss
  $ 12,290     $ 610     $ 3,368     $ 4,350  
Net loss per ordinary share of NIS 0.20 par value, basic and diluted(3)
  $ 1.06     $ 1.18     $ 3.27     $ 3.88  
Weighted average number of ordinary shares outstanding – basic and diluted (in thousands)(3)
    11,918       2,181       1,627       1,627  
 
 
3

 
 
Consolidated Balance Sheet Data
 
   
As of December 31,
 
   
2015
 
2014
 
2013
   
2012
 
   
(US$ in thousands, except per share data)
 
Cash and cash equivalents
  $ 9,392     $ 1,075     $ 4,975       4,579  
Working capital(4)                                                                          
    12,856       (1,622 )     4,134       7,931  
Total assets
    15,298       2,985        5,374       8,975  
Capital stock                                                                            
    46,763       20,999       20,687       20,631  
Total shareholders’ equity (deficiency)                                                                          
  $ 12,648     $ (826 )   $ (528 )     2,782  
_____________________
 
(1)  
Includes share-based compensation expense in the total amount of $3.7 million, $312,000 and $56,000 for the years ended December 31, 2015, 2014 and 2013, respectively.  For additional information, see Item 5B “Operating and Financial Review and Prospects—Liquidity and Capital Resources—Application of Critical Accounting Policies and Estimates-Share-based compensation.”
 
(2)
Research and development expenses, net is presented net of amount of grants received from the Office of the Chief Scientist of the Ministry of Economy and Industry (formerly named the Ministry of Economy), or the OCS, and Israel-United States Binational Industrial Research and Development Foundation, or the BIRD Foundation. The effect of the participation by the OCS and BIRD totaled $354,000, $643,000 and $148,000 for the years ended December 31, 2015, 2014 and 2013, respectively. See Item 5A “Operating and Financial Review and Prospects—Operating Results - Financial Operations Overview—Research and Development, Expenses, Net” for more information.
 
(3)  
Basic and diluted loss per ordinary share is computed based on the basic and diluted weighted average number of ordinary shares outstanding during each period. For purposes of these calculations, the following ordinary shares were deemed to be outstanding: (i) 99,774 ordinary shares that were issuable to Mr. Guy Neev upon exercise of options, referred to as the Neev Options, which options were exercised immediately prior to the consummation of our initial public offering on February 24, 2015; (ii) 375,204 ordinary shares issuable under warrants that are automatically exercised, for no consideration (unless the holder thereof objects to such exercise), upon the exercise by Mr. Guy Neev of the Neev Options, of which warrants to purchase 195,012 ordinary shares were exercised during the year ended December 31, 2015; (iii) 2,658,463 ordinary shares issuable upon the exercise of outstanding warrants with an exercise price of NIS 0.20 per share, of which warrants to purchase 1,557,507 ordinary shares were exercised during the year ended December 31, 2015; and (iv) 210,964 ordinary shares issuable upon the exercise of certain outstanding options and warrants with an exercise price of NIS 0.20 per share.   For additional information, see Note 15 to our Consoliated Financial Statements for the year ended December 31, 2015 included elsewhere in this Annual Report.
 
(4)  
Working capital is defined as total current assets minus total current liabilities.

B.
Capitalization and Indebtedness
 
Not required.

C.
Reasons for the Offer and Use of Proceeds

Not required.
  
D.
Risk factors

In conducting our business, we face many risks that may interfere with our business objectives. Some of these risks could materially and adversely affect our business, financial condition and results of operations. In particular, we are subject to various risks resulting from changing economic, political, industry, business and financial conditions. The risks and uncertainties described below are not the only ones we face.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business operations.

You should carefully consider the following factors and other information in this Annual Report before you decide to invest in our ordinary shares. If any of the risks referred to below occur, our business, financial condition and results of operations could suffer. In any such case, the trading price of our ordinary shares could decline, and you may lose all or part of your investment.
 
 
4

 

 
Risks Related to Our Business
 
We have a history of losses, may incur future losses and may not achieve profitability.

We are a clinical and development-stage medical diagnostics company with a limited operating history. We have incurred net losses in each fiscal year since we commenced operations in 2009. We incurred net losses of $3.4 million in 2013, $610,000 in 2014 and $12.3 million in 2015. As of December 31, 2015, our accumulated deficit was $34.1 million. Our losses could continue for the foreseeable future as we continue our investment in research and development and clinical trials to complete the development of our technology and to attain regulatory approvals, begin the commercialization efforts for our system, increase our marketing and selling expenses, and incur additional costs as a result of being a public company in the United States. As discussed in Note 1B to the financial statements presented elsewhere in this Annual Report, successful completion of our development program and, ultimately, the attainment of profitable operations is dependent upon future events, including obtaining adequate financing to fulfill its development activities and achieving a level of sales adequate to support our cost structure. The extent of our future operating losses and the timing of becoming profitable are highly uncertain, and we may never achieve or sustain profitability.
 
We may not succeed in completing the development of our product, commercializing our product and generating significant revenues.

Since commencing our operations, we have focused on the research and development and limited clinical trials of our capsule. Our product is not approved for commercialization and has never generated any revenues. Our ability to generate revenues and achieve profitability depends on our ability to successfully complete the development of our product, obtain market approval and generate significant revenues. The future success of our business cannot be determined at this time, and we do not anticipate generating revenues from product sales for the foreseeable future. In addition, we have no experience in commercializing our capsule and face a number of challenges with respect to our commercialization efforts, including, among others, that:
 
 
we may not have adequate financial or other resources to complete the development of our product;
 
 
we may not be able to manufacture our products in commercial quantities, at an adequate quality or at an acceptable cost;
 
 
we may not be able to establish adequate sales, marketing and distribution channels;
 
 
healthcare professionals and patients may not accept our system;
 
 
we may not be aware of possible complications from the continued use of our system since we have limited clinical experience with respect to the actual use of our system;
 
 
other technological breakthroughs in colorectal cancer, or CRC screening, treatment and prevention may reduce the demand for our system;
 
 
changes in the market for CRC screening, new alliances between existing market participants and the entrance of new market participants may interfere with our market penetration efforts;
 
 
third-party payors may not agree to reimburse patients for any or all of the purchase price of our capsule, which may adversely affect patients’ willingness to purchase our capsule;
 
 
uncertainty as to market demand may result in inefficient pricing of our system;
 
 
we may face third-party claims of intellectual property infringement;
 
 
we may fail to obtain or maintain regulatory approvals for our system in our target markets or may face adverse regulatory or legal actions relating to our system even if regulatory approval is obtained; and
 
 
we are dependent upon the results of ongoing clinical studies relating to our system and the products of our competitors.
 
 
5

 

 
If we are unable to meet any one or more of these challenges successfully, our ability to effectively commercialize our system could be limited, which in turn could have a material adverse effect on our business, financial condition and results of operations.

Clinical failure can occur at any stage of clinical development.  Our clinical experience to date does not necessarily predict future results and may not have revealed certain potential limitations of the technology and potential complications from our system and may require further clinical validation. Any product version we advance through clinical trials may not have favorable results in later clinical trials or receive regulatory approval

Clinical failure can occur at any stage of clinical development. To date, we have performed clinical studies with several versions of both scanning and non-scanning capsules, in conjunction with iterative versions of the tracking and recording systems (CPS). Our clinical trials have been conducted using prior versions of our scanning capsules and were conducted under differing protocols and using limited groups of patients. Therefore, we have a limited ability to identify potential problems and/or inefficiencies concerning current and future versions of our system in advance of its use in expanded groups of patients and we cannot assure you that its actual clinical performances will be satisfactory to support proposed indications and regulatory approvals, or that its use will not result in unanticipated complications. Furthermore, the results from laboratory, pre-clinical, and completed clinical studies, as well as preliminary analyses of the currently ongoing clinical studies, may not be indicative of final clinical results obtained from our current system or future versions of our system on expanded screening populations. In addition, the results of our clinical trials are subject to human analyses and interpretation of the data accumulated, which could be affected by various errors due to, among others, lack of sufficient clinical experience with our system, interpretation errors in the analysis of the clinical trials results, including the reconstructed images by our system, or due to uncertainty in the actual efficacy of our system in its current clinical stage. Therefore, the safety and efficacy of our system and the clinical results to date will require further independent professional validation and require further clinical study.  If our system does not function as expected over time, we may not be able to develop our system at the rate or to the stage we desire, we could be subject to liability claims, our reputation may be harmed, our system may not achieve regulatory clearances, and our system may not be widely adopted.
 
We expect to derive most of our revenues from sales of one product or product line. Our inability to successfully commercialize this product, or any subsequent decline in demand for this product, could severely harm our ability to generate revenues.

We are currently dependent on the successful commercialization of our system to generate revenues. As a result, factors adversely affecting our ability to successfully commercialize, or the pricing of or demand for, this product could have a material adverse effect on our financial condition and results of operations. If we are unable to successfully commercialize or create market demand for our system, we will have limited ability to generate revenues.
 
Furthermore, and consequently, we are vulnerable to fluctuations in demand for our system. Such fluctuations in demand may be due to many factors, including, among others:
 
 
market acceptance of a new product, including healthcare professionals’ and patients’ preferences;
 
 
development of similarly cost-effective products by our competitors;
 
 
development delays of our system;
 
 
technological innovations in CRC screening, treatment and prevention;
 
 
adverse medical side effects suffered by patients using our system, whether actually resulting from the use of our system or not;
 
 
changes in regulatory policies toward CRC screening or imaging technologies;
 
 
changes in regulatory approval or clearance requirements for our product;
 
 
third-party claims of intellectual property infringement;
 
 
budget constraints and the availability of reimbursement or insurance coverage from third-party payors for our system;
 
 
increases in market acceptance of other technologies; and
 
 
6

 
 
 
adverse responses from certain of our competitors to the offering of our system.
 
If healthcare professionals do not recommend our product to their patients, our system may not achieve market acceptance and we may not become profitable.

CRC screening candidates are generally referred by their healthcare professional to a specified device and screening technologies are purchased by prescription. If healthcare professionals, including physicians, do not recommend or prescribe our product to their patients, our system may not achieve market acceptance and we may not become profitable. In addition, physicians have historically been slow to change their medical diagnostic and treatment practices because of perceived liability risks arising from the use of new products. Delayed adoption of our system by healthcare professionals could lead to a delayed adoption by patients and third-party payors. Healthcare professionals may not recommend or prescribe our system until certain conditions have been satisfied including, among others:
 
 
there is sufficient long-term clinical and health-economic evidence to convince them to alter their existing screening methods and device recommendations;
 
 
there are recommendations from other prominent physicians, educators and/or associations that our system is safe and effective;
 
 
we obtain favorable data from clinical and health-economic studies for our system;
 
 
reimbursement or insurance coverage from third-party payors is available; and
 
 
they become familiar with the complexities of our system.
 
We cannot predict when, if ever, healthcare professionals and patients may adopt the use of our system. Even if favorable data is obtained from clinical and health-economic studies for our system, there can be no assurance that prominent physicians would endorse it or that future clinical studies will continue to produce favorable data regarding our system. In addition, prolonged market exposure may also be a pre-requisite to reimbursement or insurance coverage from third-party payors. If our system does not achieve an adequate level of acceptance by patients, healthcare professionals and third-party payors, we may not generate significant product revenues and we may not become profitable.

If we are unable to market and sell our system, we may not become profitable.

We have not had any sales of our system to date. There can be no assurance that we will be able to receive regulatory clearance for our system in the foreseeable future or ever or that our system will be accepted as comparable or superior to existing technologies for the visualization, imaging or screening of the colon. Our ability to market and sell our system successfully depends on one or more of the following:
 
 
the existence of clinical and health-economic data sufficient to support the use of our system for the visualization, imaging, or screening of the colon as compared to other colon visualization, imaging or screening methods (if clinical trials indicate that our system is not as clinically effective as other current methods, or if our technology causes unexpected complications or other unforeseen negative effects, we may not obtain regulatory clearance or approval to market and sell our system or physicians may be reluctant to use it);
 
 
the availability of sufficient clinical and health-economic data for physicians to use our system in their practice and for private third-party payors to make an adequate reimbursement decision to provide coverage for our system; or
 
 
the availability of a reliable contrast agent for our system that is accepted by and health-economic physicians and patients.
 
If one or more of the above conditions is not satisfied, we may not be able to market and sell our system or the demand for our system may be lower than expected and sales of our system may not contribute to our growth at the rate we expect or at all.
 
 
7

 

 
We expect to face competition from large, well-established manufacturers of traditional technologies for detecting gastrointestinal disorders, as well as from other manufacturers of optical capsule endoscopy systems or new competitive technologies.

Competition for our system comes from traditional well-entrenched manufacturers of equipment for detecting gastrointestinal disorders and diseases, such as colonoscopy, sigmoidoscopy, optical capsule endoscopy and CTC. The principal manufacturers of equipment for optical colonoscopy, sigmoidoscopy and optical capsule endoscopy are Olympus, Pentax, Richo Company Ltd., Hoya, Covidien plc and Fuji Film. The principal manufacturers of equipment for CTC are General Electric Healthcare Systems, Siemens Medical Solutions, Philips Medical Systems Ltd. and Toshiba Corporation. All of these companies have substantially greater financial resources than we do, and they have established reputations as well as worldwide distribution channels for providing medical instruments to physicians.

In addition, several companies have developed or are developing technologies based on molecular diagnostics (from blood and other bodily fluids), or MDx, tests that investigate the link between genes and the function of metabolic pathways, drug metabolism and disease development with a primary focus on the study of DNA, RNA and proteins. Genetic markers can be traced within stool samples in minute quantities. A U.S. based company, Exact Sciences, has developed a special collecting kit for stool samples and an analyzer to detect neoplasia associated DNA markers and the presence of occult hemoglobin in human stool. The method of screening is included in colorectal cancer screening guidelines, including those of the American Cancer Society.
 
To our knowledge, certain companies are developing or commercializing optics-based capsule endoscopy systems. The existing capsule technology requires intense bowel cleansing, more so than is required for optical colonoscopy, and the potential ingestion of agents to boost capsule transit through the colon. Given Imaging, an Israeli-based company that was acquired by Covidien plc (NYSE: COV) in February 2014 (subsequently acquired by Medtronic), has developed visualization capsules for the detection of disorders of the esophagus, small bowel and colon. It received the CE Mark to market PillCam™ COLON throughout the European Union in 2006. In early 2014, the FDA cleared PillCam COLON 2 system with an indication to provide visualization of the colon. It may be used for detection of colon polyps in patients after an incomplete optical colonoscopy with adequate preparation, and when a complete evaluation of the colon was not technically possible. In Early 2016, the FDA cleared PillCam COLON2 system with an expended indication for use: High risk population to undergo colonoscopy. Patients with major risks for colonoscopy or moderate sedation, but who tolerate colonoscopy and moderate sedation in the event a clinically significant colon abnormality was identified on capsule endoscopy. Other companies, including Olympus, CapsoVision, Intromedic and RF System, are developing similar approaches for optical capsule endoscopy. 
 
Procedures for bowel cleansing that are less onerous are constantly being developed, which could make our entry into the market more difficult. For instance, bowel cleansing initiated by the ingestion of pills rather than through drinking large amounts of distasteful liquids may be viewed as an improvement to the cleansing process, but other screening methods may be even more palatable to patients.
 
If we are unable to convince physicians to adopt our system over the current technologies marketed by our competitors, our results of operations may suffer.
 
We are planning to rely on local distributors and/or strategic partners to market and distribute our system in those countries where we intend to market and distribute our system.

We are planning to rely on local distributors and/or strategic partners for the marketing and distribution of our system. Our success in generating sales in countries or regions where we will engage local distributors will depend in part on the efforts of third parties over whom we have limited control. If we are unable to identify suitable local distributors in the countries where we intend to market and distribute our system, our business, financial condition and results of operations could be negatively affected.

We have limited manufacturing capabilities and if we are unable to scale our manufacturing operations to meet anticipated market demand, our growth could be limited and our business, financial condition and results of operations could be materially adversely affected.

We currently have limited resources, facilities and experience in commercially manufacturing sufficient quantities of our system, external receiver and software application to meet the demand we expect from our expanded commercialization efforts. We expect to face certain technical challenges as we increase manufacturing capacity, including, among others, logistics associated with the handling of radioactive materials, equipment design and automation, material procurement, lower than expected yields and increased scrap costs, as well as challenges related to maintaining quality control and assurance standards. Furthermore, we may encounter similar or unforeseen challenges initiating and later expanding production of any new products. If we are unable to scale our manufacturing capabilities to meet market demand, our growth could be limited and our business, financial condition and results of operations could be materially adversely affected.
 
 
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In addition, we have received and may receive in the future grants from the Government of the State of Israel through the OCS (for more information, see “Risks Related to Our Operations in Israel”), the terms of which require that products developed with OCS grants be manufactured in Israel and that the technology developed thereunder may not be transferred outside of Israel, unless prior approval is received from the OCS, which we may not receive. We are currently considering whether it would be possible to assemble the capsule without the X-ray source in Israel, and have the X-ray source subsequently inserted into our system at a reactor or cyclotron site or at a distribution center outside Israel. Even following the full repayment of any OCS grants, we must nevertheless continue to comply with the requirements of the Encouragement of Industrial Research and Development Law 5744-1984, or the Research Law. The foregoing restrictions may impair our ability to outsource or transfer development or manufacturing activities with respect to any product or technology outside of Israel.

Our reliance on single source suppliers could harm our ability to meet demand for our product in a timely manner or within budget.
 
We currently depend on single source supplier for some of the components necessary for the production of our system. For example, for the current version of the system used in clinical trials, we currently have a single supplier for the motor that we are using to rotate the collimated X-ray source in our system and for the X-ray detectors used in our system. There are a limited number of manufacturers worldwide who are capable of manufacturing the motor and the specially designed X-ray detectors that we currently use in our system. In addition, the application-specific integrated circuit, or ASIC, residing in our system is currently manufactured for us by a single semiconductor fabrication plant, or FAB. There are many alternative FABs worldwide and the design of our current ASIC could be adapted in the event it became necessary to use an alternative FAB. Our X-ray source manufacturer is considered a single source supplier. Our X-ray source is custom made and therefore, would require us to qualify an alternative supplier, if required. Our current suppliers have been able to supply the required quantities of such components to date. However, if the supply of these components is disrupted or terminated or if our current suppliers are unable to supply required quantities of components, we may not be able to find alternative sources for these key components in a timely manner. Although we are planning to maintain strategic inventory of key components, the inventory may not be sufficient to satisfy the demand for our system if such supply is interrupted or otherwise affected by catastrophic events such as a fire at our storage facility. As a result, we may be unable to meet the demand for our system, which could harm our ability to generate revenues, lead to customer dissatisfaction and damage our reputation. If we are required to change the manufacturer of any of these key components, there may be a significant delay in locating a suitable alternative manufacturer. In addition, we may be required to verify that the new manufacturer maintains facilities and procedures that comply with FDA and other applicable quality standards and with all applicable regulations and guidelines. The delays associated with the identification of a new manufacturer could delay our ability to manufacture our system in a timely manner or within budget. Furthermore, in the event that the manufacturer of a key component of our system ceases operations or otherwise ceases to do business with us, we may not have access to the information necessary to enable another supplier to manufacture the component. The occurrence of any of these events could harm our ability to meet demand for our system in a timely manner or within budget.

The use of any of our scanning capsule, cps or workstation could result in product liability or similar claims that could be expensive damage our reputation and harm our business.

Our business exposes us to an inherent risk of potential product liability or similar claims related to the manufacturing, marketing and sale of medical devices. The medical device industry has historically been litigious, and we face financial exposure to product liability or similar claims if the use of any of our scanning capsule, cps or workstation were to cause or contribute to injury or death, including, without limitation, harm to the body caused by the procedure or inaccurate diagnoses from the procedure that could affect treatment options. There is also the possibility that defects in the design or manufacture of any of these products might necessitate a product recall. Although we plan to maintain product liability insurance, the coverage limits of these policies may not be adequate to cover future claims. In the future, we may be unable to maintain product liability insurance on acceptable terms or at reasonable costs and such insurance may not provide us with adequate coverage against potential liabilities. A product liability claim, regardless of merit or ultimate outcome, or any product recall could result in substantial costs to us, damage to our reputation, customer dissatisfaction and frustration, and a substantial diversion of management attention. A successful claim brought against us in excess of, or outside of, our insurance coverage could have a material adverse effect on our business, financial condition and results of operations.

Our system is a complex medical device that requires training for qualified personal and care for data analysis.

Our system is a complex medical device that requires training for qualified personal, including physicians, and care for data analysis. Although our distributors will be required to ensure that our system is only prescribed by trained clinicians, the potential for misuse of our system still exists due to its complexity. Such misuse could result in adverse medical consequences for patients that could damage our reputation, subject us to costly product liability litigation and otherwise have a material adverse effect on our business, financial condition and results of operations.
 
 
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We depend on third parties to manage our clinical studies and trials and to perform related data collection and analysis and to enroll patients for our clinical trials, and, as a result, we may face costs and delays that are beyond our control.

We rely on third parties, including clinical investigators and clinical sites, to manage our clinical trials and to perform data collection and analysis and to enroll patients for our clinical trials. Although we have and expect to continue to have contractual arrangements with these third parties, we may not be able to control the amount and timing of resources that these parties devote to our studies and trials or the quality of these resources. If these third parties fail to properly manage our studies and trials or enroll patients for our clinical trials, we will be unable to complete them at all or in a satisfactory or timely manner, which could prevent us from obtaining regulatory approvals for, or achieving market acceptance of, our product.
 
In addition, termination of relationships with third parties may result in delays, inability to enter into arrangements with alternative third parties or do so on commercially reasonable terms. Switching or adding additional clinical sites involves additional cost and requires management time and focus. In addition, there is a natural transition period when a new clinical site commences work. As a result, delays occur, which can materially impact our ability to meet our desired clinical development timelines.

We intend to sell our products in the United States, Europe and Japan and, if we are unable to manage our operations in these territories, our business, financial condition and results of operations could be materially adversely affected.

Our headquarters and substantially all of our operations and employees are presently located in Israel, but we intend to market our products in the United States, Europe and Japan. Accordingly, we are subject to risks associated with international operations, and our international sales and operations will require significant management attention and financial resources. In addition, our international sales and operations will subject us to risks inherent in international business activities, many of which are beyond our control and include, among others:
 
 
foreign certification, registration and other regulatory requirements;
 
 
customs clearance and shipping delays;
 
 
import and export controls;
 
 
trade restrictions;
 
 
multiple and possibly overlapping tax structures;
 
 
difficulty forecasting the results of our international operations and managing our inventory due to our reliance on third-party distributors;
 
 
differing laws and regulations, business and clinical practices, third-party payor reimbursement policies and patient preferences;
 
 
differing standards of intellectual property protection among countries;
 
 
difficulties in staffing and managing our international operations;
 
 
difficulties in penetrating markets in which our competitors’ products are more established;
 
 
currency exchange rate fluctuations; and
 
 
political and economic instability, war or acts of terrorism.
 
If we are unable to manage our international operations effectively, our business, financial condition and results of operations could be materially adversely affected.
 
 
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We will require additional funding and may license certain rights to third parties in order to complete the development and commercialization of our system and the development and commercialization of any future products.

Our operations have consumed substantial amounts of cash. We expect that we will need to continue to spend substantial amounts in order to complete the development, clinical development, regulation and commercialization of our system. Although we intend to use the proceeds of our initial public offering and the concurrent private placement to finance these efforts, we will need to raise additional funds and may license certain rights to third parties to obtain the required capital prior to completing the development and commercialization of our product. Additional financing may not be available to us on a timely basis on terms acceptable to us, or at all. In addition, any additional financing may be dilutive to our shareholders or may require us to grant a lender a security interest in our assets.
 
Furthermore, if adequate additional financing on acceptable terms is not available, we may not be able to develop our system at the rate or to the stage we desire and we may have to delay or abandon the commercialization of our system. Alternatively, we may be required to prematurely license to third parties the rights to further develop or to commercialize our system on terms that are not favorable to us. Any of these factors could materially adversely affect our business, financial condition and results of operations.

If we lose our key personnel or are unable to attract and retain additional personnel, our business and ability to compete will be harmed.

Our success relies upon the continued service and performance of the principal members of our management and research and development team. In order to implement our business strategy, we will need to retain our key personnel with expertise in the areas of research and development, clinical testing, government regulation, manufacturing, finance, marketing and sales. Our product development plans depend in part on our ability to retain engineers with expertise in a variety of technical fields. The loss of a number of these persons or our inability to attract and retain qualified personnel could harm our business and our ability to compete.

Substantially all of our operations are currently conducted at a single location near Haifa, Israel, and any disruption at our facility could materially adversely affect our business, financial condition and results of operations.

Substantially all of our operations are conducted at a single location near Haifa, Israel. We take precautions to safeguard our facility, including obtaining insurance coverage and implementing health and safety protocols. However, a natural or other disaster, such as a fire, flood or an armed conflict involving Israel, as detailed further below, could damage or destroy our facility and our manufacturing equipment or inventory, cause substantial delays in our operations and otherwise cause us to incur additional unanticipated expenses. In addition, the insurance we maintain against fires, floods and other natural disasters may not be adequate to cover our losses in any particular case and it does not cover losses resulting from armed conflicts or terrorist attacks in Israel. Damage to our facility, our other property or to any of our suppliers, whether located in Israel or elsewhere, due to fire, a natural disaster or casualty event or an armed conflict, could materially adversely affect our business, financial condition and results of operations, with or without insurance.

We have and will incur significant increased costs as a result of operating as a public company in the United States, and our management will be required to devote substantial time to compliance initiatives.

As a public company whose securities are traded in the United States, we have and will continue to incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act of 2002, as well as rules and regulations implemented by the U.S. Securities and Exchange Commission and the NASDAQ Stock Market, impose various requirements on public companies, including requiring the establishment and maintenance of effective disclosure and financial controls. Our management and other personnel will need to devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations have and will increase our legal and financial compliance costs and will make some activities more time consuming and costly.  These rules and regulations make it more difficult and more expensive for us to obtain certain types of insurance including director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantial costs to maintain the same or similar coverage. The impact of these requirements could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We cannot predict or estimate the amount or timing of additional costs we may incur in order to comply with such requirements.
 
 
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We are required to develop and maintain proper and effective internal controls over financial reporting. We may not complete our analysis of our internal controls over financial reporting in a timely manner, or these internal controls may have one or more material weaknesses, which may adversely affect investor confidence in our company and, as a result, the value of our securities.

Ensuring that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis will be a costly and time-consuming effort that will need to be evaluated frequently. Section 404 of the Sarbanes-Oxley Act requires the management of public companies to conduct an annual review and evaluation of their internal controls and to obtain an attestation report from their registered public accounting firm regarding the effectiveness of internal controls. We are required to perform the annual review and evaluation of our internal controls no later than in connection with the second annual report on Form 20-F filed after closing of our initial public offering, which occurred on February 24, 2015. However, if we qualify as a smaller reporting company and/or emerging growth company, which we expect to, we will be exempt from the auditors’ attestation requirement until such time as we no longer qualify as a smaller reporting company and/or emerging growth company. We would no longer qualify as a smaller reporting company if the market value of our public float exceeded $75 million as of the last day of our second fiscal quarter in any fiscal year following the date of our initial public offering. We would no longer qualify as an emerging growth company at such time as described in the risk factor immediately below.
 
We are in the early stages of the costly and challenging process of compiling the system and processing documentation necessary to evaluate and correct a material weakness in internal controls needed to comply with Section 404. The material weakness relates to our being a small company with a limited number of employees which limits our ability to assert the controls related to the segregation of duties. During the evaluation and testing process, if we identify one or more additional material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal controls are effective. If we are unable to assert that our internal control over financial reporting is effective, we could lose investor confidence in the accuracy and completeness of our financial reports, which would cause the price of our securities to decline.

While we currently qualify as an “emerging growth company” under the JOBS Act, we will cease to be an emerging growth company on or before the end of 2020, and at such time our costs and the demands placed upon our management will increase.

We will continue to be deemed an emerging growth company until the earliest of (i) the last day of the fiscal year in which our annual gross revenues exceed $1 billion (as indexed for inflation); (ii) the last day of the fiscal year in which the fifth anniversary of the date of the first sale of securities under this registration statement; (iii) the date on which we have, during the previous three-year period, issued more than $1 billion in non-convertible debt; or (iv) the date on which we are deemed to be a ‘large accelerated filer,’ as defined by the U.S. Securities and Exchange Commission, which would generally occur upon our attaining a public float of at least $700 million. Once we lose emerging growth company status, we expect the costs and demands placed upon our management to increase, as we will be required to comply with additional disclosure and accounting requirements, particularly if we also no longer qualify as a smaller reporting company.
 
Risks Related to Regulations

If we are unable to obtain, or experience significant delays in obtaining, FDA clearances or approvals, CE Certificates of Conformity, or equivalent third country approvals for our system or future products or product enhancements, our ability to commercially distribute and market our products could suffer.

Our products are subject to rigorous regulation by FDA and numerous other federal, state and foreign governmental authorities and notified bodies. The process of obtaining regulatory clearances or approvals, CE Certificates of Conformity, or equivalent third country approvals to market a medical device can be costly and time consuming, and we may not be able to obtain these clearances or approvals, CE Certificates of Conformity, or equivalent third country approvals on a timely basis, if at all. In particular, we expect to eventually generate a portion of our revenues from sales of our system and future products in the United States, the European Union, or third countries. Before a new medical device, or a new use of, or claim for, an existing product can be marketed in the United States, it must first receive clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act, or FDA approval of a premarket approval application, or PMA, unless an exemption applies. FDA will clear marketing of a low to moderate risk medical device through the 510(k) process if sufficiently similar predicate devices have previously been cleared via this pathway. In the 510(k) clearance process, FDA must only determine that the proposed device is “substantially equivalent” to a device legally on the market, known as a “predicate” device, with respect to intended use/indications for use, technological characteristics and principles of operation in order to clear the proposed device for marketing. Clinical data is sometimes required to support substantial equivalence.

High risk devices deemed to pose the greatest risk, such as life-sustaining, life-supporting, or implantable devices, or devices not deemed substantially equivalent to a previously cleared device, require approval of a PMA. The PMA process is more costly, lengthy and uncertain than the 510(k) clearance process. The PMA pathway requires an applicant to demonstrate the safety and effectiveness of the device based, in part, on the data obtained in clinical trials. A PMA application must be supported by extensive data, including, but not limited to, technical, preclinical, clinical trial, manufacturing and labeling data, to demonstrate to FDA’s satisfaction the safety and efficacy of the device for its intended use.
 
 
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In instances where a device is novel and there is no suitable predicate device, but that device is deemed to be of low to moderate risk, FDA can reclassify the device to class I or class II via de novo reclassification. This process involves the submission of a reclassification petition, and FDA accepting that “special controls” are adequate to ensure the product’s performance and safety. FDA now allows “direct” de novo reclassification petitions, a mechanism by which a sponsor can directly submit a detailed de novo reclassification petition as the device’s initial submission without having to first receive a not substantially equivalent, or NSE, decision on a 510(k) submission.
 
These processes can be expensive and lengthy. FDA’s 510(k) clearance process usually takes from 6 to 9 months, but it can last longer. Direct de novo reclassification typically takes at least 9 to 12 months from filing to clearance. The PMA pathway is much more costly and uncertain than the 510(k) clearance process or de novo reclassification, and generally takes at least 12 to 18 months, or even longer, from the time the application is filed with FDA to ultimate approval.
 
We are not aware of any legally marketed predicate device upon which FDA could base a determination of substantial equivalence under a 510(k) clearance process. Our strategy therefore is to submit a direct de novo reclassification petition for our system. To support this petition, our objective is to demonstrate that the device poses a low to moderate risk to patients. We cannot assure you that FDA will not demand that we obtain PMA approval of our system.
 
FDA can delay, limit or deny clearance or approval of an application for many reasons, including, among others:
 
 
we may not be able to demonstrate to FDA’s satisfaction that our products are safe and effective for their intended use;
 
 
the data from our pre-clinical studies and clinical trials may be insufficient to support clearance or approval;
 
 
in the case of a PMA submission, that the manufacturing process or facilities we use may not meet applicable requirements; and
 
 
changes in FDA’s 510(k) clearance, de novo reclassification, or PMA approval processes and policies, or the adoption of new regulations may require additional data.
 
We may not obtain the necessary regulatory clearances, approvals, CE Certificates of Conformity or equivalent third country approvals to market our system or future products in the United States or elsewhere. Any delay in, or failure to receive or maintain, clearance, approval or CE Certificates of Conformity for our system or other products under development could prevent us from generating revenue from these products or achieving profitability.

There is no guarantee that the FDA will grant de novo reclassification or PMA approval of our system and failure to obtain necessary 510(k) clearances or approvals for our future products would adversely affect our ability to grow our business.

Our system and some of our future products will require FDA clearance of a 510(k), de novo reclassification, or may require FDA approval of a PMA. The FDA may not approve or clear our system or our future products for the indications that are necessary or desirable for successful commercialization. Indeed, the FDA may refuse our requests for 510(k) clearance, de novo reclassification or PMA for our system or any other future product, new intended uses or modifications to these products once they are cleared or approved for marketing.
 
Our strategy is to submit a direct de novo reclassification petition for our system. A de novo reclassification generally applies where there is no predicate device and the FDA believes the device poses a low to moderate risk. De novo reclassifications can either be submitted in lieu of a 510(k) notice, such as in our case, or after a 510(k) notice has been filed and found NSE. If a 510(k) notice is found NSE, a de novo petition must be submitted within 30 days from the receipt of the NSE determination.
 
To support our direct de novo reclassification petition, our objective is to demonstrate that the device poses a low to moderate risk to patients. If the FDA determines that our system is not a candidate for de novo reclassification, it will require approval of the device for market through the PMA process. A PMA application must be supported by extensive data, including, but not limited to, technical, preclinical, clinical trial, manufacturing and labeling data, to demonstrate to the FDA’s satisfaction the safety and efficacy of the device for its intended use. By statute, the FDA has 180 days to review the “accepted application,” although, generally, review of the application can take between one and three years. During this review period, the FDA may request additional information or clarification of information already provided or even request new data that may require us to conduct additional tests. Also during the review period, an advisory panel of experts from outside the FDA may be convened to review and evaluate the application and provide recommendations to the FDA as to the approvability of the device. In addition, the FDA will conduct a preapproval inspection of the manufacturing facility to ensure compliance with quality system regulations. The FDA’s review of a PMA could significantly delay our plans to get to market. There is also no guarantee that the FDA would approve a PMA. Failure to receive clearance or approval for our system or future products would have an adverse effect on our ability to expand our business.
 
 
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If we or our future distributors do not obtain and maintain the necessary regulatory clearances or approvals, or CE Certificates of Conformity, or equivalent third country approvals in a specific country or region, we will not be able to market and sell our system or future products in that country or region.

We intend to market our system in a number of international markets. To be able to market and sell our system in a specific country or region, we and/or our distributors must comply with the regulations of that country or region. While the regulations of some countries do not impose barriers to marketing and selling part or all of our products or only require notification, others require that we and/or our distributors obtain the approval of a specified regulatory authorities or that we obtain CE Certificates of Conformity from a Notified Body. We are engaged with Dekra Certification as our Notified Body for such purposes. These regulations, including the requirements for approvals or CE Certificates of Conformity, and the time required for regulatory review, vary from country to country. Obtaining regulatory approvals or CE Certificates of Conformity is expensive and time-consuming, and we cannot be certain that we or our distributors will receive regulatory approvals or CE Certificates of Conformity for our system or any future products in each country or region in which we plan to market such products. If we modify our system or any future products, we or our distributors may need to apply for new regulatory approvals or our Notify Body may need to review the planned changes before we are permitted to sell them. We may not meet the quality and safety standards required to maintain the authorizations or CE Certificates of Conformity that we or our distributors have received. If we or our distributors are unable to maintain our authorizations or CE Certificates of Conformity in a particular country or region, we will no longer be able to sell our system or any future products in that country or region, and our ability to generate revenues will be materially and adversely affected.

Our system may be considered a drug-device combination product because of the preparatory use of Iodine or barium sulfate to provide a coating for colonic imaging. We cannot be sure how the FDA or the competent regulatory authorities of foreign countries will regulate this product. The review of combination products is often more complex and more time consuming than the review of products under the jurisdiction of only one center within the FDA.

Our system may be considered a combination product because of the preparatory use of barium sulfate or Iodine to provide a coating for colonic imaging. A combination product is the combination of two or more regulated components, i.e., drug/device, biologic/device, drug/biologic, or drug/device/biologic, that are combined or mixed and produced as a single entity; packaged together in a single package or as a unit; or a drug, device, or biological product packaged separately that according to its investigational plan or proposed labeling is intended for use only with an approved individually specified drug, device, or biological product where both are required to achieve the intended use, indication or effect. For a combination product, the FDA must determine which center or centers within the FDA will review the product and under what legal authority the product candidate will be reviewed. The combination product’s primary mode of action is used to determine which center within the FDA has primary regulatory jurisdiction over the product. The other centers within the agency also may provide consulting or collaborative reviews of the product as necessary. We believe that we have put forth a reasonable argument to the FDA that our system should be regulated as a device and or a combination product with a device primary mode of action. However, we cannot be sure as to whether the FDA will treat our system as a device or a combination product. The review of combination products is often more complex and more time consuming than the review of a product under the jurisdiction of only one center within the FDA. In the case of the system, should the FDA determine that the barium sulfate is not being used in accordance with its approved labeling, the Center for Drug Evaluation and Research may take a prominent role it its regulation. If the FDA does not approve or clear our system, or any future products, in a timely fashion, or at all, our business and financial condition will be adversely affected.
 
Similar obstacles may be encountered in foreign countries should our system be considered as a combination product.
 
 
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If the indications for use or instructions for use for which the Iodine-based contrast agent or the barium sulfate- based contrast agent is approved are not sufficiently broad to support its use prior to the ingestion of our capsules, the FDA or the competent regulatory authorities in the EU Member States and other foreign countries may consider that contrast agent is being used off-label.

Ingestion of our system requires the preparatory use of Iodine or barium sulfate to provide a coating for colonic imaging. We cannot be sure that the indications for which Iodine-based contrast agent or the barium sulfate-based contrast agent are approved in the United States, the EU Member States or in other countries is sufficiently broad to cover such use. If the FDA or the competent regulatory authorities in the EU Member States and in other countries consider that Iodine and/or barium sulfate is not approved for the purpose for which it is used with the system, we may be considered to promote the off-label use of the Iodine and/or barium sulfate. Because the promotion of off-label use of drugs or medicinal products is prohibited in the United States, the EU Member States and in other countries, we could face both related issues with the FDA and/or the competent authorities of the EU Member States and/or other countries. In these circumstances, the FDA and/or the competent regulatory authorities in the EU Member States and/or other countries may require us to obtain appropriate regulatory approvals for the Iodine-based contrast agent or the barium sulfate-based contrast agent prior to marketing our system with such substances. Under such circumstances, should we fail to obtain approval of the contrast agent for use with our system, in a timely fashion, or at all, our business and financial condition will be adversely affected.

If we are unable to successfully complete clinical trials with respect to our system, we may be unable to receive regulatory approvals or clearances, CE Certificates of Conformity or equivalent third country approvals for our system and/or our ability to achieve market acceptance of our system will be harmed.

The development of medical devices typically includes pre-clinical studies. Certain other devices require the submission of data generated from clinical trials, which can be long, expensive and uncertain processes, subject to delays and failure at any stage. The data obtained from the studies and trials may be inadequate to support regulatory clearances or approvals, or to obtain CE Certificates of Conformity or equivalent third country approval, or to allow market acceptance of the products being studied. Our system technology is currently undergoing clinical development and clinical trials. To date, we have performed clinical studies with several versions of our system and with several versions of our non-scanning capsules.

The development of sufficient and appropriate clinical protocols to demonstrate safety and efficacy are required, and we may not adequately develop such protocols to support clearance, approval, or to obtain CE Certificates of Conformity or equivalent third country approval. The clinical trials that were conducted using prior versions of our system, were conducted under differing protocols and used groups of patients different from those we intend to study in future clinical trials. Further, FDA, the competent regulatory authorities of other countries, or our Notified Body in the EU may require us to submit data on a greater number of patients than we originally anticipated and/or for a longer follow-up period or they may change the data collection requirements or data analysis applicable to our clinical trials.
 
The commencement or completion of any of our clinical studies or trials may be delayed or halted, or be inadequate to support regulatory clearance, approval or product acceptance, or to obtain CE Certificates of Conformity or equivalent third country approval, for numerous reasons, including, among others:
 
 
patients do not enroll in the clinical trial at the rate we expect;
 
 
patients do not comply with trial protocols;
 
 
patient follow-up is not at the rate we expect;
 
 
undetected capsule retention in patients
 
 
patients experience adverse side effects, including related to excessive radiation exposure as a result of capsule malfunction or break down;
 
 
patients die during a clinical trial, even though their death may be unrelated to our product;
 
 
FDA, institutional review boards, or IRBs, or other regulatory authorities do not approve a clinical trial protocol or a clinical trial, or place a clinical trial on hold;
 
 
IRBs, Ethics Committees and third-party clinical investigators may delay or reject our trial protocol and Informed Consent Form;
 
 
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third-party clinical investigators decline to participate in a study or trial or do not perform a study or trial on our anticipated schedule or consistent with the investigator agreements, study or trial protocol, good clinical practices or other FDA or IRBs, Ethics Committees, or any other applicable requirements;
 
 
third-party organizations do not perform data collection, monitoring and analysis in a timely or accurate manner or consistent with the study or trial protocol or investigational or statistical plans;
 
 
regulatory inspections of our studies, trials or manufacturing facilities may require us to, among other things, undertake corrective action or suspend or terminate our studies or clinical trials;
 
 
 
changes in governmental regulations or administrative actions;
 
we may not be able to develop our system at the rate or to the stage we desire:
         
 
the interim or final results of the study or clinical trial are inconclusive or unfavorable as to safety or efficacy;
 
 
 
a regulatory agency or our Notified Body concludes that our trial design is or was inadequate to demonstrate safety and efficacy; and
 
If we not continue to obtain a permit to employ Jewish employees on Saturdays and Jewish holidays to conduct our clinical trials, as required under the Israeli Hours of Work and Rest Law, 1951, and we are unsuccessful in employing only non-Jewish employees on Jewish rest days and holidays, we may be compelled to cease or halt our clinical trials during Saturdays and Jewish holidays, which could decrease our clinical capacity.
 
The results of pre-clinical and clinical studies do not necessarily predict future clinical trial results, and predecessor clinical trial results may not be repeated in subsequent clinical trials. Additionally, FDA, the competent regulatory authorities of EU Member States, other third country regulatory entities, or our Notified Body may disagree with our interpretation of the data from our pre-clinical studies and clinical trials, or may find the clinical trial design, conduct or results inadequate to demonstrate safety or efficacy, and may require us to pursue additional pre-clinical studies or clinical trials, which could further delay the clearance, approval, or CE Certificate of Conformity of our products. The data we collect from our non-clinical testing, our pre-clinical studies and other clinical trials may not be sufficient to support regulatory clearance, approval or to obtain CE Certificates of Conformity.

If the third parties on which we rely to conduct our clinical trials and clinical development do not perform as contractually required or expected, we may not be able to obtain regulatory clearance or approval, CE Certificates of Conformity, or equivalent third country approval for, or commercialize, our system or future products.

We do not have the ability to independently conduct our clinical trials for our system and we must rely on third parties, such as contract research organizations, medical institutions, clinical investigators and contract laboratories to conduct such trials. If these third parties do not successfully carry out their contractual duties or regulatory obligations or meet expected deadlines, if these third parties need to be replaced, or if the quality or accuracy of the data they obtain is compromised due to the failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our pre-clinical development activities or clinical trials may be extended, delayed, suspended or terminated, and we may not be able to obtain CE Certificates of Conformity, regulatory clearance, approval for, or successfully commercialize, our system or future products on a timely basis, if at all, and our business, operating results and prospects may be adversely affected. Furthermore, our third-party clinical trial investigators may be delayed in conducting our clinical trials for reasons outside of their control.

The results of our current or future clinical trials may not support our product candidate requirements or intended use claims or may result in the discovery of adverse side effects.

Even if our current or future clinical trials are completed as planned, we cannot be certain that their results will support our product requirements or intended use claims, which could inhibit our marketing strategies,  or that the FDA, foreign authorities or our Notified Body will agree with our conclusions regarding them. Success in pre-clinical studies and early clinical trials does not ensure that later clinical trials will be successful, and we cannot be sure that clinical trials will replicate the results of prior trials and pre-clinical studies. The clinical trial process may fail to demonstrate that our system, or any future products, are safe and effective for the desired or proposed indicated uses, which could cause us to abandon a product and may delay development of others. Any delay or termination of our clinical trials will delay the filing of our product submissions and, ultimately, our ability to commercialize our system, or any future products, and generate revenues. It is also possible that patients enrolled in clinical trials will experience adverse side effects that are not currently part of the product candidate’s profile.
 
 
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Even if our system or future products are cleared or approved by regulatory authorities or if we obtain CE Certificates of Conformity from our Notified Body, modifications to our system or future products may require new regulatory clearances or approvals, new CE Certificates of Conformity, or may require us to recall or cease marketing it until the necessary clearances, approvals or CE Certificates of Conformity are obtained.

Once marketed, modifications to our system or future products may require new regulatory approvals, clearances, including 510(k) clearances or premarket approvals, or require us to recall or cease marketing the modified devices until these clearances or approvals are obtained. Any modification to a 510(k)-cleared device that could significantly affect its safety or efficacy, or that would constitute a major change in its intended use, requires a new 510(k) clearance or, possibly, a PMA. The FDA requires device manufacturers to initially make and document a determination of whether or not a modification requires a new approval, supplement or clearance. A manufacturer may determine that a modification could not significantly affect safety or efficacy and does not represent a major change in its intended use, so that no new 510(k) clearance is necessary. However, the FDA can review a manufacturer’s decision and may disagree. The FDA may also on its own initiative determine that a new clearance or approval is required. We may make modifications to our system in the future that we believe do not or will not require additional clearances or approvals. Further, our products could be subject to recall if the FDA determines, for any reason, that our products are not safe or effective. Any recall or FDA requirement that we seek additional approvals or clearances could result in significant delays, fines, increased costs associated with modification of a product, loss of revenue and potential operating restrictions imposed by the FDA.
 
If a manufacturer determines that a modification to an FDA-cleared device could significantly affect its safety or efficacy, or would constitute a major change in its intended use, then the manufacturer must file for a new 510(k) clearance or possibly a premarket approval application. Where we determine that modifications to our products require a new 510(k) clearance or premarket approval application, we may not be able to obtain those additional clearances or approvals for the modifications or additional indications in a timely manner, or at all.
 
Any modification to a PMA-approved device must either be approved in a PMA Supplement, or if the modification does not impact the device’s safety or effectiveness, described in a 30-Day Notice or in the device’s Annual Report.  The FDA may not approve a modification described in a PMA Supplement, in which case the modified device cannot be marketed.  The FDA can also disagree that a change described in a 30-Day Notice or Annual Report is appropriately described in either filing, and request that the company file a PMA Supplement and/or request that the company cease marketing the modified device until the PMA Supplement is approved.
 
Similar rules also apply in foreign jurisdictions. In the European Union, or EU, we must inform the Notified Body that carried out the conformity assessment of the medical devices we market or sell in the EU of any planned substantial changes to our quality system or changes to our devices which could affect compliance with the Essential Requirements laid down in Annex I to the Council Directive 93/42/EEC concerning medical devices, or Medical Devices Directive, or the devices’ intended purpose. The Notified Body will then assess the changes and verify whether they affect the products’ conformity with the Essential Requirements laid down in Annex I to the Medical Devices Directive or the conditions for the use of the device. If the assessment is favorable, the Notified Body will issue a new CE Certificate of Conformity or an addendum to the existing CE Certificate of Conformity attesting compliance with the Essential Requirements laid down in Annex I to the Medical Devices Directive.
 
If the Notified Body or relevant regulatory authorities disagree with our assessments and require modifications to an existing CE Certificate of Conformity, the preparation of a new CE Certificates of Conformity or new regulatory clearances or approvals for modifications, we may be required to recall and to stop marketing the modified devices.
 
Obtaining clearances and approvals, or new or amended CE Certificates of Conformity for device modifications can be a time consuming process, and delays in obtaining required future clearances, approvals, or CE Certificates of Conformity would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our future growth.
 
 
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Even if our system and future products are cleared or approved by regulatory authorities or if we obtain CE Certificates of Conformity from our Notified Body, if we or our suppliers fail to comply with ongoing FDA or other foreign regulatory authority requirements, or if we experience unanticipated problems with our products, our products could be subject to restrictions or withdrawal from the market.

The manufacturing processes, reporting requirements, post-approval clinical data and promotional activities associated with any product for which we obtain clearance or approval CE Certificates of Conformity, or equivalent third country approval will be subject to continuous regulatory review, oversight and periodic inspections by FDA other domestic and foreign regulatory authorities and our Notified Body. In particular, we and certain of our suppliers are required to comply with FDA’s Quality System Regulations, or QSR, as well as current good manufacturing practices, or cGMP. In the EU, we will also be subject to the quality system requirements laid down in the Annexes to the Medical Devices Directive. Such compliance can be facilitated by, among other things, a certificate of compliance with ISO 13485:2003. Through compliance with the ISO 13485:2003 standard, we will benefit from a presumption of conformity with the relevant quality system requirements laid down in the Annexes to Medical Devices Directive. These regulations and standards govern the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, storage and shipping of any product for which we obtain clearance or approval, CE Certificates of Conformity, or equivalent third country approval. Regulatory authorities, such as FDA, and our Notified Body enforce the QSR and other regulations through periodic inspections. The failure by us or one of our suppliers to comply with applicable statutes and regulations falling within the competence of FDA and other regulatory authorities or our Notified Body, or the failure to timely and adequately respond to any adverse inspectional observations or product safety issues, could result in, among other things, any of the following enforcement actions:
 
 
untitled letters, warning letters, fines, injunctions, corporate integrity agreements, consent decrees and civil penalties;
 
 
unanticipated expenditures to address or defend such actions;
 
 
customer notifications for repair, replacement or refunds;
 
 
recall, detention or seizure of our products;
 
 
operating restrictions or partial suspension or total shutdown of production;
 
 
refusing or delaying our requests for 510(k) clearance or premarket approval of new products or modified products;
 
 
operating restrictions;
 
 
withdrawing 510(k) clearances on PMA approvals that have already been granted;
 
 
suspension or withdrawal of our CE Certificates of Conformity;
 
 
refusal to grant export approval for our products; or
 
 
criminal prosecution.
 
If any of these actions were to occur, it would harm our reputation and cause our product sales and profitability to suffer and may prevent us from generating revenue. Furthermore, our key suppliers may not currently be or may not continue to be in compliance with all applicable regulatory requirements which could result in our failure to produce our products on a timely basis and in the required quantities, if at all.
 
Even if regulatory clearance or approval of a product is granted, or if we obtain CE Certificates of Conformity, such clearance or approval, or CE Certificates of Conformity may be subject to limitations on the intended uses for which the product may be marketed and reduce our potential to successfully commercialize the product and generate revenue from the product. If FDA or the competent regulatory authorities of foreign countries determines that our promotional materials, labeling, training or other marketing or educational activities constitute the promotion of an unapproved use or the promotion of an intended purpose not covered by our CE mark, they could request that we cease or modify our training or promotional materials or subject us to regulatory enforcement actions. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our training or other promotional materials to constitute promotion of an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement.
 
In addition, we may be required to conduct costly post-market testing and surveillance to monitor the safety or effectiveness of our products, and we must comply with medical device reporting requirements, including the reporting of adverse events and malfunctions related to our products. Later discovery of previously unknown problems with our products, including unanticipated adverse side effects or adverse side effects of unanticipated severity or frequency, manufacturing problems, or failure to comply with regulatory requirements such as QSR, may result in changes to labeling, restrictions on such products or manufacturing processes, withdrawal of the products from the market, voluntary or mandatory recalls, a requirement to repair, replace or refund the cost of any medical device we manufacture or distribute, fines, suspension or withdrawal of regulatory approvals or CE Certificates of Conformity, product seizures, injunctions or the imposition of civil or criminal penalties, all of which would adversely affect our business, financial condition and operating results and prospects.
 
 
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If we fail to maintain necessary regulatory clearances or CE Certificates of Conformity for our system and indications in our target foreign markets, if clearances or approvals, or CE Certificates of Conformity for future products and indications are delayed or not issued, or if there are regulatory changes in our existing or future target markets, our commercial operations could be harmed.
 
Our system is a medical device that is subject to extensive regulations that are intended to assure its safety, effectiveness and compliance with applicable consumer laws. If we fail to obtain and maintain these regulatory approvals or clearances, or CE Certificates of Conformity, our ability to sell our system and generate revenues will be materially harmed.
 
These laws and regulations relate to the design, development, testing, manufacturing, storage, labeling, packaging, content and language of the instructions for use of the device, sale, promotion, distribution, importing and exporting, shipping, post-sale surveillance and recall from our system’s markets, and all countries in which we intend to sell our system apply some form of regulations of this kind. Most notably, we must comply with the Medical Devices Directive and are subject to extensive regulation in the United States by FDA and other federal, state and local authorities. In the EU, compliance with the requirements laid down in the Medical Devices Directive, including the Essential Requirements laid down its Annex I thereto, is a prerequisite to be able to affix the CE mark of conformity to our medical devices. Without such CE mark, our products cannot be marketed or sold in the EU. To demonstrate compliance with the Essential Requirements laid down in Annex I to the Medical Devices Directive we must undergo a conformity assessment procedure, which varies according to the type of medical device and its classification. Apart from low risk medical devices (Class I with no measuring function and which are not sterile), in relation to which the manufacturer can make an EC Declaration of Conformity based on self-assessment of the conformity of its products with the Essential Requirements laid down in Annex I to the Medical Devices Directive, a conformity assessment procedure requires the intervention a Notified Body. The Notified Body would typically audit and examine products’ Technical File, which we must create, and the quality system for manufacture, design and final inspection of our devices before issuing a CE Certificate of Conformity demonstrating compliance with the relevant Essential Requirements laid down in Annex I to the Medical Devices Directive or the quality system requirements laid down in the other Annexes to the Directive. Following the issuance of this CE Certificate of Conformity, we can draw up an EC Declaration of Conformity and affix the CE mark to the products covered by this CE Certificate of Conformity and by the EC Declaration of Conformity Other countries outside the EU also accept the CE mark as a certification of quality, efficacy and safety of medical devices and an element of related authorization of the products in their territory.

We will be subject to annual audits by a Notified Body under the Medical Devices Directive. During this audit, the third-party assessor or Notified Body will examine the maintenance and implementation of our quality control system, device post-marketing vigilance system and any changes or modifications made to our products.
 
On September 26, 2012, the European Commission adopted a package of legislative proposals designed to replace the existing regulatory framework for medical devices in the EU. These proposals are intended to strengthen the medical devices rules in the EU. On October 22, 2013, the European Parliament voted in favor of an amended draft of the Regulation. The proposed text is currently being discussed by the Council of the European Union. These adopted or expected regulatory changes may adversely affect our business, financial condition and results of operations or restrict our operations.

Our failure to comply with radiation safety or radio frequency regulations in a specific country or region could impair our ability to commercially distribute and market our system in that country or region.

Our system includes a small X-ray source and wireless radio frequency transmitter and receiver, and is therefore subject to equipment authorization requirements in a number of countries and regions. In the United States, the EU and Japan, authorities often require advance clearance of all radiation and radio frequency devices before they can be sold or marketed in these jurisdictions, subject to limited exceptions. Modifications to the approved system design and specifications may require new or further regulatory clearances or approvals before we are permitted to market and sell a modified system. If we are unable to obtain any required clearances or approvals from the authorities responsible for the radiation as well as the radio frequency regulations in these and other jurisdictions, the sale or use of our system could be prevented in these countries. Any such action could negatively affect our business, financial condition and results of operations.
 
 
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Our system may in the future be subject to product recalls that could harm our reputation, business and financial results.

FDA and similar foreign governmental authorities have the authority to require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture or a public health/safety issue. In the case of FDA, the authority to require a recall must be based on an FDA finding that there is a reasonable probability that the device would cause injury or death. In addition, foreign governmental bodies have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. Manufacturers may, under their own initiative, recall a product if any material deficiency in a device is found. A government-mandated or voluntary recall by us or one of our distributors could occur as a result of component failures, manufacturing errors, design or labeling defects or other deficiencies and issues. Once marketed, recalls of any of our products, including our system, would divert managerial and financial resources and have an adverse effect on our business, financial condition and results of operations. FDA requires that certain classifications of recalls be reported to FDA within 10 working days after the recall is initiated. Companies are required to maintain certain records of recalls, even if they are not reportable to FDA. We may initiate voluntary recalls involving our products in the future that we determine do not require us to notify FDA. If FDA disagrees with our determinations, they could require us to report those actions as recalls. A future recall announcement could harm our reputation with customers and negatively affect our sales. In addition, FDA could take enforcement action against us based on our failure to report the recalls when they were conducted.

If our system or future products cause or contribute to a death or a serious injury, or malfunction in such a way that causes or contributes to a death or serious injury, we will be subject to medical device reporting regulations, which can result in corrective actions or enforcement actions from regulatory authorities.

Under FDA medical device reporting regulations, medical device manufacturers are required to report to FDA information that a device has or may have caused or contributed to a death or serious injury or has malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction of our device (or any similar future product) were to recur. If we fail to investigate and report these events to FDA within the required timeframes, or at all, FDA could take enforcement action against us. Any such adverse event involving our products also could result in future corrective actions, such as recalls or customer notifications, or agency action, such as inspection or enforcement action. Any corrective action, whether voluntary or involuntary, including any legal action taken against us, will require us to devote sufficient time and capital to the matter, distract management from operating our business, and may harm our reputation and financial results.

In addition, we must also comply with the EU Medical Device Vigilance System (MEDDEV 2.12/1 rev.8), which is intended to protect the health and safety of patients, users and others by establishing reporting procedures and reducing the likelihood of reoccurrence of incidents related to the use of a medical device. Under this system, incidents (which are defined as any malfunction or deterioration in the characteristics and/or performance of a device, as well as any inadequacy in the labeling or the instructions for use which, directly or indirectly, may lead to or may have led to the death of a patient, or user or other persons or to a serious deterioration in such person’s state of health) must be reported by manufacturers through a Manufacturer’s Incident Reports to competent authorities within periods of time specified in the MEDDEV 2.12/1 rev. 8. Such incidents are evaluated and, where appropriate, information is disseminated between the competent authorities of the EU Member States. The MEDDEV 2.12/1 rev. 8 is also intended to facilitate a direct, early and harmonized establishment of Field Safety Corrective Actions, or FSCAs, across the EU Member States in which the device is being marketed. An FSCA is an action taken by a manufacturer to reduce a risk of death or serious deterioration in the state of health associated with the use of a medical device that is already placed on the market. An FSCA may include device recall, modification, exchange, or destruction. FSCAs must be reported by the manufacturer or the manufacturer’s European Authorized Representative, to its customers and/or the end users of the device through a Field Safety Notice. FSCAs must also be reported to the competent authorities of the EU Member States.

Our business is subject to complex environmental legislation that may increase our costs and our risk of noncompliance.
 
Our research and development and manufacturing processes involve the handling of potentially harmful radioactive and other hazardous materials. We are subject to local laws and regulations governing the use, shipping, handling, storage and disposal of these materials, and we incur expenses related to compliance with these laws and regulations. If we are found to have violated environmental, health and safety laws, whether as a result of human error, equipment failure or other causes, we could be held liable for damages, penalties and costs of remedial actions which could materially adversely affect our business, financial condition and results of operations. In the future, we could be subject to additional environmental requirements or existing environmental laws could become more stringent, which could lead to greater compliance costs and increasing risks and penalties associated with violations. For example, changes to, or restrictions on, permitting requirements or processes, hazardous or radioactive material storage or handling might require an unplanned capital investment or relocation. If we fail to comply with existing or new environmental laws or regulations, our business, financial condition and results of operations could be materially adversely affected.
 
 
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If we are unable to achieve reimbursement and coverage from third-party payors for procedures using our system, or if reimbursement is insufficient to create an economic benefit for purchasing or using our system when compared to alternative procedures, demand for our products may not grow at the rate we expect.

The demand for our system will depend significantly on the eligibility of the procedures performed using our system for reimbursement through government-sponsored healthcare payment systems and private third-party payors. Reimbursement practices vary significantly from country to country and within some countries, by region, and we must obtain reimbursement approvals on a country-by-country and/or region-by-region basis. In general, the process of obtaining reimbursement and coverage approvals has been longer outside of the United States. We may not be able to obtain reimbursement approvals in a timely manner or at all and existing reimbursement and coverage policies may be revised from time to time by third-party payors. If physicians, hospitals and other healthcare providers are unable to obtain sufficient coverage and reimbursement from third-party payors for procedures using our system, if reimbursement is, or is perceived by our customers to be, insufficient to create an economic incentive for purchasing or using our system, or if such reimbursement does not adequately compensate physicians and health care providers compared to the other procedures they offer, demand for our products may not grow at the rate we expect.

Federal and state privacy laws, and equivalent laws of third countries, may increase our costs of operation and expose us to civil and criminal sanctions.

The Health Insurance Portability and Accountability Act of 1996, as amended, and the regulations that have been issued under it, to which we refer collectively as HIPAA, and similar laws outside the United States, contain substantial restrictions and requirements with respect to the use and disclosure of individuals’ protected health information. The HIPAA privacy rules prohibit “covered entities,” such as healthcare providers and health plans, from using or disclosing an individual’s protected health information, unless the use or disclosure is authorized by the individual or is specifically required or permitted under the privacy rules. Under the HIPAA security rules, covered entities must establish administrative, physical and technical safeguards to protect the confidentiality, integrity and availability of electronic protected health information maintained or transmitted by them or by others on their behalf. While we do not believe that we are a covered entity under HIPAA, many of our customers are covered entities subject to HIPAA. Such customers may require us to enter into business associate agreements, which will obligate us to safeguard certain health information we obtain in the course of our relationship with them, restrict the manner in which we use and disclose such information and impose liability on us for failure to meet our contractual obligations.
 
In addition, under The Health Information Technology for Economic and Clinical Health Act of 2009, or HITECH, which was signed into law as part of the U.S. stimulus package in February 2009, certain of HIPAA’s privacy and security requirements are now also directly applicable to “business associates” of covered entities and subject them to direct governmental enforcement for failure to comply with these requirements. We may be deemed as a “business associate” of some of our customers. As a result, we may be subject as a “business associate” to civil and criminal penalties for failure to comply with applicable privacy and security rule requirements. Moreover, HITECH created a new requirement obligating “business associates” to report any breach of unsecured, individually identifiable health information to their covered entity customers and imposes penalties for failing to do so.
 
In addition to HIPAA, most U.S. states have enacted patient confidentiality laws that protect against the disclosure of confidential medical information, and many U.S. states have adopted or are considering adopting further legislation in this area, including privacy safeguards, security standards, and data security breach notification requirements. These U.S. state laws, which may be even more stringent than the HIPAA requirements, are not preempted by the federal requirements, and we are therefore required to comply with them to the extent they are applicable to our operations.
 
These and other possible changes to HIPAA or other U.S. federal or state laws or regulations, or comparable laws and regulations in countries where we conduct business, could affect our business and the costs of compliance could be significant. Failure by us to comply with any of the standards regarding patient privacy, identity theft prevention and detection, and data security may subject us to penalties, including civil monetary penalties and in some circumstances, criminal penalties. In addition, such failure may damage our reputation and adversely affect our ability to retain customers and attract new customers.
 
The protection of personal data, particularly patient data, is subject to strict laws and regulations in many countries. The collection and use of personal health data in the EU is governed by the provisions of Directive 95/46/EC of the European Parliament and of the Council of 24 October 1995 on the protection of individuals with regard to the processing of personal data and on the free movement of such data, commonly known as the Data Protection Directive. The Directive imposes a number of requirements including an obligation to seek the consent of individuals to whom the personal data relates, the information that must be provided to the individuals, notification of data processing obligations to the competent national data protection authorities of individual EU Member States and the security and confidentiality of the personal data. The Data Protection Directive also imposes strict rules on the transfer of personal data out of the EU to the US. Failure to comply with the requirements of the Data Protection Directive and the related national data protection laws of the EU Member States may result in fines and other administrative penalties and harm our business. We may incur extensive costs in ensuring compliance with these laws and regulations, particularly if we are considered to be a data controller within the meaning of the Data Protection Directive.
 
 
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The adoption of healthcare reform and deficit reduction measures in the United States may adversely affect our business and financial results.

On March 23, 2010, President Obama signed into law major healthcare reform legislation under the Patient Protection and Affordable Care Act of 2010, or the PPACA, which was modified on March 30, 2010 by the enactment of the Health Care and Education Reconciliation Act of 2010. This law substantially changes the way healthcare is financed by both governmental and private insurers, and significantly impacts the device industry. The PPACA is intended to broaden access to health insurance, reduce or constrain the growth of healthcare spending, enhance remedies against fraud and abuse, add new transparency requirements for healthcare and health insurance industries, impose new taxes and fees on pharmaceutical and medical device manufacturers, and impose additional health policy reforms. Under the PPACA, it is expected that expanded healthcare coverage will be made available to millions of Americans. The increased costs to the U.S. government from the PPACA are expected to be funded through a combination of payment reductions for providers over time and several new taxes. The PPACA imposes, among other things, an annual excise tax of 2.3% on any entity that manufactures or imports medical devices offered for sale in the United States beginning in 2013, resulting in an anticipated cost to the medical device industry of up to $20 billion over the next decade. We likely will be subject to the excise tax with respect to our system if it is approved for sale in the United States. The PPACA also limits the rate of growth in Medicare payments to providers and authorizes certain voluntary demonstration projects beginning no later than 2013 around development of bundling payments for acute, inpatient hospital services, physician services, and post acute services for episodes of hospital care. In addition, the PPACA provides for the establishment of an Independent Payment Advisory Board, or IPAB, that, beginning in 2014, could recommend changes in Medicare payments to physicians and other providers that would take effect unless Congress passes an alternative measure to achieve the same amount of savings. The IPAB has not yet been created. The PPACA also increases fraud and abuse penalties and expands the scope and reach of the Federal Civil False Claims Act and government enforcement tools, which may adversely impact healthcare companies.
 
The U.S. Supreme Court heard a constitutional challenge to the PPACA and in June 2012 held that the PPACA is constitutional. However, states are allowed to opt out of the expansion of eligibility criteria for Medicaid under the PPACA and many states have chosen to do so, causing many uninsured patients to remain without coverage. In addition to the PPACA, the effect of which cannot presently be quantified given its recent enactment, various healthcare reform proposals have also emerged at the state level. We cannot predict whether future healthcare initiatives will be implemented at the federal or state level or the effect any future legislation or regulation will have on us. However, we anticipate that the PPACA, as well as other healthcare reform measures that may be adopted in the future, may result in more rigorous coverage criteria and an additional downward pressure on the price that we receive for any approved product, and could adversely affect our business. Any reduction in reimbursement from Medicare or other government programs may result in a similar reduction in payments from private payors. Insurers may also refuse to provide any coverage of uses of approved products for medical indications other than those for which the FDA has granted market approvals, all of which may adversely affect our business, financial condition and results of operations, possibly materially.
 
In addition to health reform, other deficit reduction measures could affect reimbursement for our device and related procedures. For example, beginning April 1, 2013, Medicare payments for all items and services have been reduced by 2% under the sequestration (i.e., automatic spending reductions) required by the Budget Control Act of 2011, as amended by the American Taxpayer Relief Act of 2012. These cuts will remain in effect until 2024 unless Congress enacts legislation to cancel or delay the cuts. These payment reductions, or similar efforts to reduce Medicare spending to control the federal deficit, could adversely affect our business by reducing reimbursement to the providers who purchase and use our devices and perform related procedures.
 
The implementation of the reporting and disclosure obligations of the Physician Payment Sunshine Act provisions of health care reform could adversely affect our business. A health care reform provision, generally referred to as the Physician Payment Sunshine Act or Open Payments Program, has imposed new reporting and disclosure requirements for drug and device manufacturers with regard to payments or other transfers of value made to certain practitioners (including physicians, dentists and teaching hospitals), and for such manufacturers and for group purchasing organizations, with regard to certain ownership interests held by physicians in the reporting entity. On February 1, 2013, the Centers for Medicare and Medicaid Services, or CMS, released the final rule to implement the Physician Payment Sunshine Act. As required under the Physician Payment Sunshine Act, CMS will publish information from these reports on a publicly available website, including amounts transferred and physician, dentist and teaching hospital identities.
 
 
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The final rule implementing the Physician Payment Sunshine Act is complex, ambiguous, and broad in scope. If we participate in federal healthcare programs, meaning our product is reimbursed by a federal healthcare program such as Medicare, Medicaid, or Children’s Health Insurance Program, our product would be considered a “covered device.” Within 180 days of becoming “covered,” we would be required to collect and report detailed information regarding certain financial relationships we have with physicians and teaching hospitals. The Physician Payment Sunshine Act preempts similar state reporting laws, although we may be required to report under certain of such state laws. Our compliance with the new final rule imposes additional costs on us and requires additional resources including dedicated personnel with experience and expertise in this area. Failure to comply may expose us to federal and/or state enforcement action and fines.
 
If we fail to comply with the U.S. federal Anti-Kickback Statute and similar state and third country laws, we could be subject to criminal and civil penalties and exclusion from federally funded healthcare programs including the Medicare and Medicaid programs and equivalent third country programs, which would have a material adverse effect on our business and results of operations.

A provision of the Social Security Act, commonly referred to as the federal Anti-Kickback Statute, prohibits the knowing and willful offer, payment, solicitation or receipt of any form of remuneration, directly or indirectly, in cash or in kind, to induce or reward the referring, ordering, leasing, purchasing or arranging for, or recommending the ordering, purchasing or leasing of, items or services payable, in whole or in part, by Medicare, Medicaid or any other federal healthcare program. PPACA, among other things, clarified that a person or entity needs not to have actual knowledge of the federal Anti-Kickback Statute or specific intent to violate it. Although there are a number of statutory exemptions and regulatory safe harbors to the federal Anti-Kickback Statute protecting certain common business arrangements and activities from prosecution or regulatory sanctions, the exemptions and safe harbors are drawn narrowly, and practices that do not fit squarely within an exemption or safe harbor may be subject to scrutiny. The federal Anti-Kickback Statute is very broad in scope and many of its provisions have not been uniformly or definitively interpreted by existing case law or regulations. In addition, most of the states have adopted laws similar to the federal Anti-Kickback Statute, and some of these laws are even broader than the federal Anti-Kickback Statute in that their prohibitions may apply to items or services reimbursed under Medicaid and other state programs or, in several states, apply regardless of the source of payment. Violations of the federal Anti-Kickback Statute may result in substantial criminal, civil or administrative penalties, damages, fines and exclusion from participation in federal healthcare programs.

All of our financial relationships with healthcare providers, purchasers, formulary managers, and others who provide products or services to federal healthcare program beneficiaries are potentially governed by the federal Anti-Kickback Statute and similar state laws. We believe our operations are in compliance with the federal Anti-Kickback Statute and similar state laws. However, we cannot be certain that we will not be subject to investigations or litigation alleging violations of these laws, which could be time-consuming and costly to us and could divert management’s attention from operating our business, which in turn could have a material adverse effect on our business. In addition, if our arrangements were found to violate the federal Anti-Kickback Statute or similar state laws, the consequences of such violations would likely have a material adverse effect on our business, results of operations and financial condition.
 
There are other federal and state laws that may affect our ability to operate, including the federal civil False Claims Act, which prohibits, among other things, individuals or entities from knowingly presenting, or causing to be presented, a false or fraudulent claim for payment of government funds or knowingly making, using or causing to be made or used, a false record or statement material to an obligation to pay money to the government or knowingly concealing or knowingly and improperly avoiding, decreasing, or concealing an obligation to pay money to the federal government. PPACA amended the Social Security Act to provide that the government may assert that a claim including items or services resulting from a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the federal civil False Claims Act. Moreover, we may be subject to other federal false claim laws, including, among others, federal criminal healthcare fraud and false statement statutes that extend to non-government health benefit programs. Moreover, there are analogous state laws. Violations of these laws can result in substantial criminal, civil or administrative penalties, damages, fines and exclusion from participation in federal healthcare programs.
 
Similar restrictions are imposed by the national legislation of many third countries in which our medical devices will be marketed. Moreover, the provisions of the Foreign Corrupt Practices Act of 1997 and other similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from providing money or anything of value to officials of foreign governments, foreign political parties, or international organizations with the intent to obtain or retain business or seek a business advantage. Recently, there has been a substantial increase in anti-bribery law enforcement activity by U.S. regulators, with more aggressive and frequent investigations and enforcement by both the U.S. Securities and Exchange Commission and the Department of Justice. A determination that our operations or activities violated United States or foreign laws or regulations could result in imposition of substantial fines, interruption of business, loss of supplier, vendor or other third-party relationships, termination of necessary licenses and permits, and other legal or equitable sanctions. In addition, lawsuits brought by private litigants may also follow as a consequence.
 
 
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If the U.S. Nuclear Regulatory Commission, or NRC, or other nuclear regulatory commissions around the world, would take the position that a system containing radioactive material cannot be passed in excreta into the sanitary sewer system without limitation, we may be subject to further regulations and patients may be required to retrieve our system after use.

As our system includes an ingestible capsule with a radioactive source, we must address NRC regulations in addition to FDA requirements as well as regulations of other nuclear regulatory commissions in jurisdictions in which we intend to commercialize our system. Our system is loaded with the X-ray source, sealed and then ingested by the patient. Although the NRC places conditions and limitations on the disposal of radioactive material in the sanitary sewer, such conditions and limitations do not apply to radioactive material contained in the excreta of individuals that are undergoing medical diagnosis or therapy with radioactive material. However, there is no assurance that the NRC or other regulatory commissions worldwide will take a similar position in relation to our system and we may face limitations by the NRC or other nuclear regulatory commissions in jurisdictions in which we intend to commercialize our system in relation to the disposal of our capsule in the sanitary system, such as requiring patients to retrieve our system after use, which could make our system less attractive.

Our failure to comply with the necessary regulatory approval regarding the use of radioactive materials could significantly impair our ability to develop, manufacture and/or sell our system.

The manufacture of our system requires the use and storage of radioactive materials. In order to use such materials in the development and manufacture of our system in Israel, we are required to obtain a permit from the Israeli Commissioner for Environmental Radiation, or the Commissioner, pursuant to the Israeli Pharmaceutical Regulations (Radioactive Elements and By-Products) – 1980. Should we fail to comply with the conditions of our currently existing permit, the Commissioner would have authority to cancel our permit. Should the Commissioner determine that our activities or facilities constitute a danger to the health and well-being of a person, the public or the environment, the cancellation of our permit could be immediate and without prior notice. Furthermore, we cannot guarantee the annual renewal of our permit and/or annual renewal subject to identical conditions, as the approval of an annual application and the conditions thereof are at the discretion of the Commissioner. Similar requirements and regulations may apply to the manufacture of our system in other countries. Cancellation of or failure to renew our permit could have materially adverse consequences on our ability to manufacture and sell our products and therefore on our ability to continue our business and operations.
 
Risks Related to Our Intellectual Property
 
If we are unable to protect our intellectual property rights, our competitive position could be harmed.

Our success and ability to compete depends in large part upon our ability to protect our intellectual property. Although we have patents issued in Israel, Europe, United States, Japan, China, India, Hong Kong, and Australia, we continue to file and prosecute in many of the same countries and additional countries such as Canada and South Korea. We face several risks and uncertainties in connection with our intellectual property rights, including, among others:
 
 
pending and future patent applications may not result in the issuance of patents or, if issued, may not be issued in a form that will be advantageous to us;
 
 
our issued patents may be challenged, invalidated or legally circumvented by third parties;
 
 
our patents may not be upheld as valid and enforceable or prevent the development of competitive products;
 
 
the eligibility of certain inventions related to diagnostic medicine, more specifically diagnostic methods and processes, for patent protection in the United States has been limited recently which may affect our ability to enforce our issued patents in the United States or may make it difficult to obtain broad patent protection going forward in the United States;
 
 
for a variety of reasons, we may decide not to file for patent protection on various improvements or additional features; and
 
 
intellectual property protection and/or enforcement may be unavailable or limited in some countries where laws or law enforcement practices may not protect our proprietary rights to the same extent as the laws of the United States, the European Union, Canada or Israel.
 
 
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Consequently, our competitors could develop, manufacture and sell products that directly compete with our products, which could decrease our sales and diminish our ability to compete. In addition, competitors could attempt to develop their own competitive technologies that fall outside of our intellectual property rights. If our intellectual property does not adequately protect us from our competitors’ products and methods, our competitive position could be materially adversely affected.

Because the medical device industry is litigious, we are susceptible to intellectual property suits that could cause us to incur substantial costs or pay substantial damages or prohibit us from selling our system.

There is a substantial amount of litigation over patent and other intellectual property rights in the medical device industry. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. We are presently unaware of any other parties’ valid patents and proprietary rights which our evolving product designs would infringe. Searches typically performed to identify potentially infringed patents of third parties are often not conclusive and, because patent applications can take many years to issue, there may be applications now pending, which may later result in issued patents which our current or future products may infringe. In addition, our competitors or other parties may assert that our system and the methods it employs may be covered by patents held by them. If our system infringes a valid patent, we could be prevented from manufacturing or selling it unless we can obtain a license or redesign the product to avoid infringement. A license may not always be available or may require us to pay substantial royalties. We also may not be successful in any attempt to redesign our product to avoid infringement. Infringement and other intellectual property claims, with or without merit, can be expensive and time-consuming to litigate and could divert our management’s attention from operating our business.

The steps we have taken to protect our intellectual property may not be adequate, which could have a material adverse effect on our ability to compete in the market.

In addition to patents, we rely on confidentiality, non-compete, non-disclosure and assignment of inventions provisions, as appropriate, with our employees, consultants and, to some extent, our distributors, to protect and otherwise seek to control access to, and distribution of, our proprietary information. These measures may not be adequate to protect our intellectual property from unauthorized disclosure, third-party infringement or misappropriation, for the following reasons:
 
 
the agreements may be breached, may not provide the scope of protection we believe they provide or may be determined to be unenforceable;
 
 
we may have inadequate remedies for any breach;
 
 
proprietary information could be disclosed to our competitors; or
 
 
others may independently develop substantially equivalent or superior proprietary information and techniques or otherwise gain access to our trade secrets or disclose such technologies.
 
Specifically with respect to non-compete agreements, under current United States and Israeli law, we may be unable to enforce these agreements, in whole or in part, and it may be difficult for us to restrict our competitors from gaining the expertise that our former employees gained while working for us. For example, Israeli courts have recently required employers seeking to enforce non-compete undertakings of a former employee to demonstrate that the competitive activities of the former employee will harm one of a limited number of material interests of the employer which have been recognized by the courts, such as the secrecy of a company’s confidential commercial information or its intellectual property. If we cannot demonstrate that harm would be caused to us, we may be unable to prevent our competitors from benefiting from the expertise of our former employees. In addition, some states in the United States, such as California, have laws which severely restrict the use of non-compete undertakings.

If, for any of the above reasons, our intellectual property is disclosed or misappropriated, it could harm our ability to protect our rights and could have a material adverse effect on our business, financial condition and results of operations.

Furthermore, although our employees and consultants have agreed to assign to us all rights to any intellectual property created in the scope of their employment or engagement with us and most of our current employees and consultants, have agreed to waive their economic rights with respect to our intellectual property, we cannot assure you that such claims will not be brought against us by current or former employees or consultants, despite their contractual representations and obligations toward us, or by any of the medical and/or governmental institutions that employ or engage such consultants, claiming alleged rights to our intellectual property or demanding remuneration in consideration for assigned intellectual property rights, which could result in litigation and adversely affect our business, financial condition and results of operations.

 
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Third-party claims of infringement or other claims against us could require us to redesign our system, seek licenses, or engage in future costly intellectual property litigation, which could negatively affect our future business and financial performance.

Substantial litigation over intellectual property rights exists in the medical device industry in general and in the medical imaging or screening sectors in particular. We expect that we may be subject to third-party infringement claims as our revenues increase, the number of competitors grows and the functionality of products and technology in different industry segments converges. Third parties may currently have, or may eventually be issued, patents on which our current or future products or technologies may infringe.

In addition, litigation in which we are accused of infringement may cause negative publicity, adversely impact prospective customers, cause product shipment delays, prohibit us from manufacturing, marketing or selling our current or future products, require us to develop non-infringing technology, make substantial payments to third parties or enter into royalty or license agreements, which may not be available on acceptable terms, or at all. If a successful claim of infringement were made against us and we could not develop non-infringing technology or license the infringed or similar technology in a timely and cost-effective manner, our ability to generate significant revenues may be substantially harmed and we could be exposed to significant liability. A court could enter orders that temporarily, preliminarily or permanently enjoin us or our customers from making, using, selling, offering to sell or importing our current or future products, or could enter an order mandating that we undertake certain remedial activities. Claims that we have misappropriated the confidential information or trade secrets of third parties can have a similar negative impact on our reputation, business, financial condition or results of operations.
 
We may also become involved in litigation in connection with our brand name rights. We do not know whether others will assert that our brand name infringes their trademark rights. In addition, names we choose for our products may be claimed to infringe names held by others. If we have to change the names we use, we may experience a loss in goodwill associated with our brand name, customer confusion and a loss of sales.

Third parties may challenge the validity of our issued patents or challenge patent applications in administrative proceedings before various patent offices which, if successful, could negatively affect our future business and financial performance.

Various patent offices, including in the United States and Europe, provide administrative proceedings by which a third party can challenge the validity of an issued patent or challenge an application that is being examined absent any threat of litigation. In some instances, including in the United States, the administrative proceedings provide a more efficient and favorable forum to challenge our patents which may lead to more opportunities for competitors to do so, particularly smaller competitors with limited resources. Moreover, the standards utilized in these administrative proceedings, at least in the United States, provide certain legal advantages versus challenging the validity of a patent in a district court. If a third party is successful in one of these administrative proceedings, the patent will no longer be enforceable in the corresponding jurisdiction. With this loss in patent rights, we will not be able to prevent third parties from offering identical or similar competing products which may result in lower profits and a less substantial market share.

We may need to initiate lawsuits to protect or enforce our patents and other intellectual property rights, which could be expensive and, if we lose, could cause us to lose some of our intellectual property rights, which would harm our ability to compete in the market.

We rely on patents to protect a portion of our intellectual property and our competitive position. Patent law relating to the scope of claims in the technology fields in which we operate is still evolving and, consequently, patent positions in the medical device industry are generally uncertain. In order to protect or enforce our patent rights, we may initiate patent and related litigation against third parties, such as infringement suits or interference proceedings. Any lawsuits that we initiate could be expensive, take significant time and divert our management’s attention from other business concerns and the outcome of litigation to enforce our intellectual property rights in patents, copyrights, trade secrets or trademarks is highly unpredictable. Litigation also puts our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. In addition, we may provoke third parties to assert claims against us. We may not prevail in any lawsuits that we initiate and the damages or other remedies awarded, including attorney fees, if any, may not be commercially valuable. The occurrence of any of these events could have a material adverse effect on our business, financial condition and results of operations.
 
 
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We may not be able to enforce covenants not to compete at all or, we may be unable to enforce them for the duration contemplated in our employment contracts and may, therefore, be unable to prevent competitors from benefiting from the expertise of some of our former employees involved in research and development activities.

We currently have non-competition agreements with substantially all of our employees who are involved in research and development, all of whom are located in Israel. These agreements prohibit our employees, if they cease working for us, from directly competing with us or working for our competitors for a limited period of time following termination of employment. In many jurisdictions, courts are increasingly refusing to enforce restrictions on competition by former employees or have interpreted them narrowly. For example, in Israel, where all of our employees reside, courts have required employers seeking to enforce non-compete undertakings of a former employee to demonstrate that the competitive activities of the former employee will harm one of a limited number of material interests of the employer which have been recognized by the courts, such as the secrecy of a company’s confidential commercial information or its intellectual property. If we cannot demonstrate that harm would be caused to us, an Israeli court may refuse to enforce our non-compete restrictions or reduce the contemplated period of non-competition such that we may be unable to prevent our competitors from benefiting from the expertise of our former employees.
 
Risks Related to Our Operations in Israel

Our principal offices, research and development facilities and some of our suppliers are located in Israel and, therefore, our business, financial condition and results of operation may be adversely affected by political, economic and military instability in Israel.

Our principal offices, research and development facilities are located in northern Israel. In addition, substantially all of our employees and officers, and certain of our directors, are residents of Israel. Accordingly, political, economic and military conditions in Israel may directly affect our business. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its neighboring countries. Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its trading partners could adversely affect our operations and results of operations.
 
During the Second Lebanon War of 2006, between Israel and Hezbollah, a militant Islamic movement, rockets were fired from Lebanon into Israel, including into the Haifa area, where our facility is located, causing casualties and major disruption of economic activities in northern Israel. An escalation in tension and violence between Israel and the militant Hamas movement (which controls the Gaza Strip) and other Palestinian Arab groups, culminated with Israel’s military campaign in Gaza in December 2008, in November 2012 and again in July and August 2014 in an endeavor to prevent continued rocket attacks against Israel’s southern towns, as well as other tension and violence between Israel and Palestinian Arab groups and individuals. It is unclear whether any negotiations that may occur between Israel and the Palestinian Authority will result in an agreement. In addition, Israel faces threats from more distant neighbors, in particular, Iran, an ally of Hezbollah and Hamas.

Popular uprisings in various countries in the Middle East and North Africa are affecting the political stability of those countries. Such instability may lead to deterioration in the political and trade relationships that exist between the State of Israel and these countries. Furthermore, several countries, principally in the Middle East, restrict doing business with Israel and Israeli companies, and additional countries may impose restrictions on doing business with Israel and Israeli companies if hostilities in the region continue or intensify. Such restrictions may seriously limit our ability to sell our products to customers in those countries. Parties with whom we may do business could decline to travel to Israel during periods of heightened unrest or tension. In addition, the political and security situation in Israel may result in parties with whom we may have agreements involving performance in Israel claiming that they are not obligated to perform their commitments under those agreements pursuant to force majeure provisions in such agreements. In addition, any hostilities involving Israel could have a material adverse effect on our facilities including our corporate office or on the facilities of our local suppliers, in which event all or a portion of our inventory may be damaged, and our ability to deliver products to customers could be materially adversely affected. Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners, or significant downturns in the economic or financial condition of Israel, could adversely affect our operations and product development, cause our revenues to decrease and adversely affect our share price. Similarly, Israeli corporations are limited in conducting business with entities from several countries.
 
 
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Our commercial insurance policy does not cover losses associated with terrorist attacks. Although the Israeli government in the past covered the reinstatement value of certain damages that were caused by terrorist attacks or acts of war, we cannot assure you that this government coverage will be maintained, or if maintained, will be sufficient to compensate us fully for damages incurred. Any losses or damages incurred by us could have a material adverse effect on our business. Any armed conflicts, terrorist activities or political instability in the region would likely negatively affect business conditions generally and could harm our results of operations.
 
Our operations could also be disrupted by the obligations of personnel to perform military service. As of February 15, 2016, we had 59 employees and independent contractors, all of whom were based in Israel. Some of these employees may be called upon to perform up to 54 days in each three year period (and in the case of military officers, up to 84 days in each three year period) of military reserve duty until they reach the age of 40 (and in some cases, depending on their specific military profession up to 45 or even 49 years of age) and, in certain emergency circumstances, may be called to immediate and unlimited active duty. In response to increases in terrorist activity, there have been periods of significant call-ups of military reservists and it is possible that there will be similar large-scale military reserve duty call-ups in the future. Our operations could be disrupted by the absence of a significant number of employees related to military service, which could materially adversely affect our business and results of operations.

Pursuant to the terms of the Israeli government grants we received for research and development expenditures, we are obligated to pay certain royalties on our revenues to the Israeli government. The terms of the grants require us to satisfy specified conditions and to make additional payments in addition to repayment of the grants upon certain events

We have received grants from the Government of the State of Israel through the OCS for the financing of a portion of our research and development expenditures pursuant to the Research Law and related regulations.  As of December 31, 2015, we had received funding from the OCS in the aggregate amount of $3.6 million.  As of December 31, 2015, we had not paid any royalties to the OCS and had a contingent obligation to the OCS in the amount of $3.8 million. In December 2015, we received approval for an additional grant from the OCS in the amount of up to $340,000. In January 2016, we applied for an additional grant from the OCS in the amount of up to $6.9 million. We may apply for additional OCS grants in the future. However, as the funds available for OCS grants out of the annual budget of the State of Israel have been reduced in the past and may be further reduced in the future, we cannot predict whether we will be entitled to any future grants, or the amounts of any such grants.

The terms of the Israeli government participation require that products developed with OCS grants be manufactured in Israel and that the technology developed thereunder may not be transferred outside of Israel, unless prior approval is received from the OCS, which we may not receive. In addition, payment of additional amounts would be required if manufacturing is moved outside of Israel, in which case the royalty repayment rate is increased and the royalty ceiling can reach up to three times the amount of the grants received, and if OCS developed know-how is transferred outside of Israel, the royalty ceiling can reach up to six times the amount of grants received (plus interest). We are currently considering whether it would be possible to assemble the capsule without the X-ray source in Israel, and have the X-ray source subsequently inserted into our system at a reactor or cyclotron site or at a distribution center outside Israel. Even following the full repayment of any OCS grants, we must nevertheless continue to comply with the requirements of the Research Law. The foregoing restrictions and requirements for payment may impair our ability to sell our technology assets outside of Israel or to outsource or transfer development or manufacturing activities with respect to any product or technology outside of Israel. Furthermore, the consideration available to our shareholders in a transaction involving the transfer outside of Israel of technology or know-how developed with OCS funding (such as a merger or similar transaction) may be reduced by any amounts that we are required to pay to the OCS.
 
If we fail to comply with any of the conditions and restrictions imposed by the Research Law, or by the specific terms under which we received the grants, we may be required to refund any grants previously received together with interest and penalties, and, in certain circumstances, may be subject to criminal charges.

Your rights and responsibilities as a shareholder are governed by Israeli law which differs in some material respects from the rights and responsibilities of shareholders of U.S. companies.

The rights and responsibilities of the holders of our ordinary shares are governed by our amended articles of association and by Israeli law. These rights and responsibilities differ in some material respects from the rights and responsibilities of shareholders in U.S. based corporations. In particular, a shareholder of an Israeli company has a duty to act in good faith and in a customary manner in exercising its rights and performing its obligations towards the company and other shareholders, and to refrain from abusing its power in the company, including, among other things, in voting at a general meeting of shareholders on matters such as amendments to a company’s articles of association, increases in a company’s authorized share capital, mergers and acquisitions and related party transactions requiring shareholder approval. In addition, a shareholder who is aware that it possesses the power to determine the outcome of a shareholder vote or to appoint or prevent the appointment of a director or executive officer in the company or prevent any other power granted to a shareholder under the company's articles of association, has a duty of fairness toward the company. There is limited case law available to assist us in understanding the nature of this duty or the implications of these provisions. These provisions may be interpreted to impose additional obligations and liabilities on holders of our ordinary shares that are not typically imposed on shareholders of U.S. corporations.
 
 
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It may be difficult to enforce a judgment of a U.S. court against us, certain of our officers and directors or the Israeli experts named in this Annual Report in Israel or the United States, to assert U.S. securities laws claims in Israel or to serve process on certain of our officers and directors and these experts.

We are incorporated in Israel. All but one of our executive officers, the Israeli experts and two of our directors listed in this Annual Report reside in Israel, and substantially all of our assets and a substantial portion of the assets of these persons are located in Israel. Therefore, a judgment obtained against us, or any of these persons, including a judgment based on the civil liability provisions of the U.S. federal securities laws, may not be collectible in the United States and may not be enforced by an Israeli court. It also may be difficult for you to effect service of process on these persons in the United States or to assert U.S. securities law claims in original actions instituted in Israel. Israeli courts may refuse to hear a claim based on an alleged violation of U.S. securities laws on the grounds that Israel is not the most appropriate forum in which to bring such a claim. In addition, even if an Israeli court agrees to hear a claim, it may determine that Israeli law and not U.S. law is applicable to the claim. If U.S. law is found to be applicable, the content of applicable U.S. law must be proven as a fact by expert witnesses, which can be a time consuming and costly process. Certain matters of procedure will also be governed by Israeli law. There is little binding case law in Israel that addresses the matters described above. As a result of the difficulty associated with enforcing a judgment against us in Israel, you may not be able to collect any damages awarded by either a U.S. or foreign court.

Provisions of Israeli law and our amended articles of association may delay, prevent or otherwise impede a merger with, or an acquisition of, us, even when the terms of such a transaction are favorable to us and our shareholders.

Israeli corporate law regulates mergers, requires tender offers for acquisitions of shares above specified thresholds, requires special approvals for transactions involving directors, officers or significant shareholders and regulates other matters that may be relevant to such types of transactions. For example, a full tender offer for all of a company’s issued and outstanding shares can only be completed if the acquirer receives positive responses from the holders of at least 95% of the issued share capital and the approval of a majority of the offerees that do not have a personal interest in the tender offer, unless at least 98% of the company’s outstanding shares are tendered. Furthermore, the shareholders, including those who indicated their acceptance of the tender offer (unless the acquirer stipulated in its tender offer that a shareholder that accepts the offer may not seek appraisal rights), may, at any time within six months following the completion of the tender offer, petition an Israeli court for an appraisal right, to alter the consideration for the acquisition. In addition, a statutory merger may not be consummated unless at least 50 days have passed from the date on which a proposal for approval of the merger was filed by each party with the Israeli Registrar of Companies and at least 30 days have passed from the date on which the merger was approved by the shareholders of each party.
 
Under the Israeli Patents Law, 5727-1967
 
We may become subject to claims for payment of compensation for assigned service inventions by our current or former employees or consultants, , which could result in litigation and adversely affect our business.

Under the Israeli Patents Law, 5727-1967, or the Patents Law, inventions conceived by an employee during the scope of his or her employment are regarded as “service inventions” and are owned by the employer, absent a specific agreement between the employee and employer giving the employee service invention rights. The Patents Law also provides that if no such agreement between an employer and an employee exists, which prescribes whether, to what extent, and on what conditions the employee is entitled to remuneration for his or her service inventions, then such matters may, upon application by the employee, be decided by a government-appointed compensation and royalties committee established under the Patents Law, or the Committee.   A significant portion of our intellectual property has been developed by our employees in the course of their employment. our employees, consultants and third party with whom we are engaged, such as certain clinical investigators, have agreed to waive and assign to us all rights to any intellectual property created in the scope of their employment or engagement with us, and most of our current employees and consultants, including all those involved in the development of our intellectual property, have agreed to waive their economic rights with respect to service inventions. However, despite such contractual obligations, we cannot assure you that claims will not be brought against us by current or former employees or consultants, or by any of the medical institutions in which our clinical trials are being performed among else, in light of certain provisions and regulations of government medical institutions which provide for certain limitations on intellectual property rights arise during medical research performed in government institutions, demanding remuneration in consideration for assigned alleged service inventions or any other intellectual rights. If any such claims were filed, we could potentially be required to pay remuneration to our current or former employees, consultants or any of the medical institutions or their investigators, for such assigned service inventions, or for any intellectual property rights allegedly incurred during the engagement with us, or be forced to litigate such claims, which could negatively affect our business.
 
 
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Risks Related to the Company

For as long as we are an “emerging growth company,” we will not be required to comply with certain reporting requirements that apply to other public companies. We cannot predict whether the reduced disclosure requirements applicable to emerging growth companies will make our securities less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act. For as long as we continue to be an emerging growth company, we may choose to take advantage of certain exemptions from reporting requirements applicable to other public companies that are not emerging growth companies. These include: (i) not being required to comply with the auditor attestation requirements for the assessment of our internal controls over financial reporting provided by Section 404 of the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley Act; (ii) not being required to comply with any requirements adopted by the Public Company Accounting Oversight Board, or PCAOB, requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer; (iii) not being required to comply with any new audit rules adopted by the PCAOB after April 5, 2012 unless the U.S. Securities and Exchange Commission determines otherwise, (iv) not being required to provide certain disclosure regarding executive compensation required of larger public companies; and (v) not being required to hold a non-binding advisory vote on executive compensation or seek shareholder approval of any golden parachute payments not previously approved. We could be an emerging growth company for up to five years from the end of our current fiscal year, although, if the market value of our ordinary shares that is held by non-affiliates exceeds $700 million as of any June 30 before the end of that five-year period, we would cease to be an emerging growth company as of the following December 31. We cannot predict if investors will find our securities less attractive if we choose to rely on these exemptions. If some investors find our securities less attractive as a result of any choices to reduce future disclosure, there may be a less active trading market for our securities and the price for our securities may be more volatile. Further, as a result of these scaled regulatory requirements, our disclosure may be more limited than that of other public companies and you may not have the same protections afforded to security holders of such companies.

We are a foreign private issuer and, as a result, we are not be subject to U.S. proxy rules and are subject to the Exchange Act reporting obligations that, to some extent, are more lenient and less frequent than those applicable to a U.S. issuer.

We report under the Exchange Act as a foreign private issuer. Because we qualify as a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the Exchange Act that are applicable to U.S. public companies, including (i) the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations in respect of a security registered under the Exchange Act; (ii) the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for insiders who profit from trades made in a short period of time; and (iii) the rules under the Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q containing unaudited financial and other specified information, or current reports on Form 8-K, upon the occurrence of specified significant events. We intend to furnish quarterly reports to the SEC on Form 6-K for so long as we are subject to the reporting requirements of Section 13(g) or 15(d) of the Exchange Act, although the information we furnish may not be the same as the information that is required in quarterly reports on Form 10-Q for U.S. domestic issuers. In addition, while U.S. domestic issuers that are not large accelerated filers or accelerated filers are required to file their annual reports on Form 10-K within 90 days after the end of each fiscal year, foreign private issuers are not required to file their annual report on Form 20-F until 120 days after the end of each fiscal year. Foreign private issuers are also exempt from the Regulation Fair Disclosure, aimed at preventing issuers from making selective disclosures of material information. Although we intend to make interim reports available to our shareholders in a timely manner, you may not have the same protections afforded to shareholders of companies that are not foreign private issuers.

As a foreign private issuer, we are permitted, to follow, and follow certain home country corporate governance practices instead of otherwise applicable NASDAQ requirements, which may result in less protection than is accorded to investors under rules applicable to domestic U.S. issuers.

As a foreign private issuer, we are permitted to follow certain home country corporate governance practices instead of those otherwise required under the Listing Rules of the NASDAQ Stock Market for domestic U.S. issuers. For instance, we follow home country practice in Israel with regard to, among other things, director nomination procedures, the approval of compensation of officers, and quorum requirements at general meetings of our shareholders. In addition, we intend to follow our home country law instead of the Listing Rules of the NASDAQ Stock Market that require us to obtain shareholder approval for certain dilutive events, such as the establishment or amendment of certain equity based compensation plans, an issuance that will result in a change of control of the company, certain transactions other than a public offering involving issuances of a 20% or greater interest in the company, and certain acquisitions of the stock or assets of another company. Following our home country governance practices as opposed to the requirements that would otherwise apply to a United States company listed on NASDAQ may provide less protection to you than what is accorded to investors under the Listing Rules of the NASDAQ Stock Market applicable to domestic U.S. issuers.
 
 
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Exchange rate fluctuations between the U.S. dollar and the NIS and the Euro and inflation may negatively affect our earnings and we may not be able to hedge our currency exchange risks successfully.

The dollar is our functional and reporting currency. However, a significant portion of our operating expenses, including personnel and facilities related expenses, are incurred in NIS. As a result, we are exposed to the risks that the NIS may appreciate relative to the U.S. dollar, or, if the NIS instead devalues relative to the U.S. dollar, that the inflation rate in Israel may exceed such rate of devaluation of the NIS, or that the timing of such devaluation may lag behind inflation in Israel. In any such event, the dollar cost of our operations in Israel would increase and our dollar-denominated results of operations would be adversely affected. The Israeli rate of inflation has not had a material adverse effect on our financial condition during the years 2013, 2014 and 2015. In addition, we expect to incur operating expenses denominated in Euros, and therefore, our operating results are also subject to fluctuations due to changes in the U.S. dollar/Euro exchange rate. Given our general lack of currency hedging arrangements to protect us from fluctuations in the exchange rates of the NIS, the Euro and other foreign currencies in relation to the U.S. dollar (and/or from inflation of such foreign currencies), we may be exposed to material adverse effects from such movements. We cannot predict any future trends in the rate of inflation in Israel or the rate of devaluation (if any) of the NIS against the U.S. dollar.

Our management team’s lack of experience as officers of publicly-traded companies may hinder our ability to comply with the Sarbanes-Oxley Act.

It may be time-consuming, difficult and costly for us to develop and implement the internal controls and reporting procedures required by the Sarbanes-Oxley Act. We may need to hire additional financial reporting, internal controls and other finance staff or consultants in order to develop and implement appropriate internal controls and reporting procedures. If we are unable to comply with the Sarbanes-Oxley Act’s internal controls requirements, we may not be able to obtain the independent auditor certifications that the Sarbanes-Oxley Act requires publicly-traded companies to obtain.

Additional financing may result in dilution to our shareholders.

We may need to raise additional funds in the future to finance internal growth, to make acquisitions or for other reasons. Any required additional financing may not be available on terms acceptable to us, or at all. If we raise additional funds by issuing equity securities, you may experience significant dilution of your ownership interest and the newly issued securities may have rights senior to those of the holders of our ordinary shares. Alternatively, if we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operational flexibility, and would also require us to fund additional interest expense. If additional financing is not available when required or is not available on acceptable terms, we may be unable to successfully commercialize our product or continue our research and development.

We have never declared or paid a dividend and currently do not intend to pay cash dividends in the foreseeable future. Any return on investment may be limited to the value of our securities.

We have never declared and do not anticipate paying cash dividends on our ordinary shares in the foreseeable future. Our board of directors has discretion to declare and pay dividends on our ordinary shares and will make any determination to do so based on a number of factors, such as our operating results, financial condition, current and anticipated cash needs and other business and economic factors that our board of directors may deem relevant. In addition, we are only permitted to pay dividends out of “profits” (as defined by the Israeli Companies Law, 1999, or the Israeli Companies Law), provided that there is no reasonable concern that the dividend distribution will prevent us from meeting our existing and foreseeable obligations, as they become due. If we do not pay dividends, our ordinary shares may be less valuable because a return on your investment will only occur if the trading price of our securities appreciates. Further, you should not rely on an investment in us if you require dividend income from your investments.

If securities or industry analysts do not publish research or reports about us or our business or publish unfavorable research about us or our business, the price of our securities and their trading volume could decline.

The trading market for our securities will depend in part on the research and reports that securities or industry analysts publish about us or our business. We currently have limited research coverage by securities and industry analysts. If one or more of the analysts who covers us downgrades our securities, the price of our securities would likely decline. We do not have control over these analysts and we do not have commitments from them to continue to write research reports about us or our business. The price of our ordinary shares could decline if one or more equity research analysts downgrade our ordinary shares or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business.
 
 
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Our stock price has and may be subject to fluctuation, and purchasers of our securities could incur substantial losses.

Our stock price has been and may be subject to fluctuation. The stock market in general has experienced extreme volatility that has often been unrelated to the operating performance of particular companies. As a result of this volatility, investors may not be able to sell their securities at or above the purchase price. The market price for our ordinary shares on the NASDAQ Capital Market may be may fluctuate as a result of a number of factors, some of which are beyond our control, including the following:
 
 
 
we may not be able to develop our system at the rate or to the stage we desire;
 
inability to obtain the approvals necessary to commence further clinical trials;
 
 
unsatisfactory results of clinical trials;

 
announcements of regulatory approval or the failure to obtain it, or specific label indications or patient populations for its use, or changes or delays in the regulatory review process;
 
 
any intellectual property infringement actions in which we may become involved;
 
 
announcements concerning our competitors or the medical device industry in general;
 
 
achievement of expected product sales and profitability or our failure to meet expectations;
 
 
our commencement of, or involvement in, litigation;
 
 
any major changes in our board of directors or management;
 
 
legislation in the United States relating to the sale or pricing of medical device; or

 
Ÿ
future substantial sales of our ordinary shares.
 
In addition, the stock market in general, and NASDAQ Stock Market in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of small companies. Broad market and industry factors may negatively affect the market price of our ordinary shares, regardless of our actual operating performance. Further, a systemic decline in the financial markets and related factors beyond our control may cause our share price to decline rapidly and unexpectedly.

We have broad discretion in how we use the net proceeds from our recent initial public offering and concurrent private placement, and we may not use these proceeds effectively.

Our management has broad discretion as to the application of the net proceeds of our recent initial public offering and concurrent private placement. Our shareholders may not agree with the manner in which our management chooses to allocate and spend the net proceeds. Moreover, our management may use the net proceeds for corporate purposes that may not increase our profitability or our market value.
 
 
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Risks Related to Taxation
 
There is a risk that we could be treated as a domestic (U.S.) corporation for U.S. federal income tax purposes by reason of the transactions related to our acquisition of all of the business operations and substantially all of the assets of Check-Cap LLC on May 31, 2009 (hereinafter sometimes referred to as the “reorganization”).

Section 7874(b) of the Internal Revenue Code of 1986, as amended, or the Code, generally provides that a foreign corporation (i.e., a corporation created or organization under the laws of a jurisdiction outside of the United States) would be treated as a domestic (U.S.) corporation for U.S. federal income tax purposes if, pursuant to a plan or a series of related transactions, (1) the foreign corporation acquires, directly or indirectly, substantially all of the assets of a domestic corporation (or substantially all of the properties constituting a trade or business of a domestic partnership), (2) after the acquisition, the former shareholders of the acquired corporation by reason of holding shares of the acquired corporation (or, in the case of an acquisition with respect to a domestic partnership, the former partners of the domestic partnership by reason of holding a capital or profits interest in the domestic partnership) own at least 80% of the stock (by vote or value) of the acquiring corporation, and (3) after the acquisition, the expanded affiliated group that includes the acquiring corporation does not have substantial business activities in the foreign country in which, or under the laws of which, the acquiring corporation is created or organized when compared to the total business activities of such expanded affiliated group. On the basis of analysis of the relevant facts and circumstances and the relevant law (including the temporary regulations under Section 7874 applicable at the time of the reorganization), it was determined that the third condition described in the preceding sentence was not met with respect to the reorganization and, therefore, that the inversion tax rules of Section 7874(b) would not apply to treat us as a domestic corporation for U.S. federal income tax purposes. However, since this determination was made on the basis of all of the relevant facts and circumstances, and it is not clear which facts and circumstances the Internal Revenue Service, or the IRS, may consider more important than others, this conclusion is not free from doubt.

If Section 7874(b) were to apply to the reorganization (and we were to be treated as a domestic corporation for U.S. federal income tax purposes), then, among other things, (i) we would be subject to U.S. federal income tax on our worldwide taxable income (if and when we have taxable income); (ii) certain payments (e.g., interest and dividends) that we make (or have made) to our foreign investors may be (or may have been) subject to U.S. withholding taxes; (iii) we may be subject to significant penalties for the failure to file certain tax returns and reports, including reports with respect to our foreign bank accounts; and (iv) the U.S. unitholders of Check-Cap LLC would not have been subject to U.S. federal income tax on royalties that are deemed to be paid to them under Section 367(d) of the Code as a result of the reorganization. As discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations- Liquidity and Capital Resources – Application of Critical Accounting Policies and Estimates – Royalties provision – Reimbursement liability to Check-Cap LLC unitholders,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Tabular Disclosure of Contractual Obligations,” as part of the reorganization, we committed to reimburse the unitholders of Check-Cap LLC for any tax burdens that may be imposed on them due to the reorganization, including royalties that are deemed to be paid to the U.S. unitholders under Section 367(d) of the Code.
 
Prospective investors are urged to consult their own advisors on these issues. The balance of this discussion, including the discussion under Item 10E “Additional Information - Taxation – U.S. Federal Income Taxation,” assumes that we will be and have been treated as a foreign corporation for U.S. federal income tax purposes.

We may be eligible for tax benefits from government programs, which require us to meet certain conditions, including regarding the location of our property, plant and equipment and manufacturing in Israel. We can provide no assurance that we would continue to be eligible for such benefits and/or that any such benefits will not be terminated in the future.

Our manufacturing facilities in Israel may qualify as a “Benefited Enterprise” under the Israeli Law for Encouragement of Capital Investments, 1959, or the Investment Law, which would entitle us to receive certain tax benefits. In order to be eligible for such benefits, we would be required to meet certain conditions, including the making of a minimum capital investment in our productive assets and the carrying on of a required portion of our manufacturing in Israel. The amount of the benefit will be determined in accordance with various conditions, including the location of our property, plant and equipment and the location of certain of our sub-contractors. If we cease to meet the required conditions for eligibility, the tax benefits could be cancelled and we could be required to pay increased taxes or to refund the amounts of the benefits received with interest and penalties. We can provide no assurance as to the amount of future capital investment in our productive assets, our future manufacturing location and the future location of our property, plant and equipment and certain of our sub-contractors, and therefore, we cannot provide assurance that we will be eligible for such tax benefits or assurance as to the amount of such tax benefits. Even if we continue to meet the relevant requirements, the tax benefits that Benefited Enterprises receive may not be continued in the future at their current levels or at all. If these tax benefits were reduced or eliminated, the amount of taxes that we would be required to pay would likely increase, as all of our operations would consequently be subject to corporate tax at the standard rate, which could adversely affect our results of operations. See Item 10E “Additional Information - Taxation— Israeli Tax Considerations and Government Programs —Law for the Encouragement of Capital Investments, 5719-1959” for additional information concerning these tax benefits.
 
 
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There is a risk that we may be classified as a passive foreign investment company, or PFIC, which could result in adverse U.S. federal income tax consequences to U.S. investors.

In general, we will be treated as a PFIC for any taxable year in which either (1) at least 75% of our gross income (including our pro rata share of the gross income of our 25% or more-owned corporate subsidiaries) is passive income or (2) at least 50% of the average value of our assets (including our pro rata share of the assets of our 25% or more-owned corporate subsidiaries) is attributable to assets that produce, or are held for the production of, passive income. Passive income generally includes dividends, interest, rents, royalties, and gains from the disposition of passive assets. If we are determined to be a PFIC for any taxable year (or portion thereof) that is included in the holding period of a U.S. Holder (as defined in Item 10E “Additional Information - Taxation—U.S. Federal Income Taxation—General”) of our securities, the U.S. Holder may be subject to increased U.S. federal income tax liability upon a sale or other disposition of our securities or the receipt of certain excess distributions from us and may be subject to additional reporting requirements.
 
Our actual PFIC status for our current taxable year or any subsequent taxable year is uncertain and will not be determinable until after the end of such taxable year. Accordingly, there can be no assurance with respect to our status as a PFIC for our current taxable year or any subsequent taxable year.
 
U.S. investors are urged to consult their own tax advisors regarding the possible application of the PFIC rules. For more information, see Item 10E “Additional Information - Taxation—U.S. Federal Income Taxation—U.S. Holders—Passive Foreign Investment Company Rules.”

There is a risk that a holder of Long Term Incentive Warrants will recognize ordinary compensation income on the exercise of the Long Term Incentive Warrants, which may result in U.S. federal and Israeli income tax liability to such holder without the receipt of cash.

While not free from doubt, the Long Term Incentive Warrants may be treated for U.S. federal and Israeli income tax purposes as compensatory warrants (i.e., issued to compensate an original purchaser of units in our initial public offering for holding the ordinary shares underlying the units for a certain period of time after the closing date of our initial public offering).  Based on this characterization, a holder may recognize ordinary compensation income for U.S. federal and Israeli income tax purposes on the exercise of the Long Term Incentive Warrants, as described under Item 10E “Additional Information - Taxation - Israeli Tax Considerations and Government Programs - Taxation of our Shareholders - Taxation of Non-Israeli Shareholders upon Exercise of Long Term Incentive Warrants” and “Item 10E “Additional Information - Taxation - U.S. Federal Income Taxation - U.S. Holders - Exercise of Long Term Incentive Warrants” and “Non-U.S. Holders.”  Such compensation income may result in U.S. federal or Israeli income tax liability to such holder without the receipt of cash.  Holders of Long Term Incentive Warrants are urged to consult their own tax advisors with respect to the U.S. federal and Israeli income tax consequences that may arise with respect to the Long Term Incentive Warrants.

ITEM 4. INFORMATION ON OUR COMPANY

A.  History and Development of the Company
 
Our History
 
Our legal and commercial name is Check-Cap Ltd.  We were formed as a company in Israel on April 5, 2009. On May 31, 2009, we acquired all of the business operations and substantially all of the assets of Check-Cap LLC, a Delaware limited liability company formed in December 2004.  On May 15, 2015, we formed our wholly-owned subsidiary Check-Cap US, Inc., a Delaware corporation.
 
 On February 24, 2015, we successfully completed an initial public offering in the United States and the listing of our securities on the NASDAQ Capital Market.
 
We are subject to the provisions of the Israeli Companies Law.  Our principal executive offices are located at Check-Cap Building, Abba Hushi Avenue, P.O. Box 1271, Isfiya, 30090, Mount Carmel, Israel.  Our telephone number is +972-4-8303400 and our website is located at www.check-cap.com (the information contained therein or linked thereto shall not be considered incorporated by reference in this annual report).  Our U.S. agent is Puglisi & Associates, located at 850 Library Avenue, Suite 204, Newark, Delaware 19711.
 
Principal Capital Expenditures

For a discussion of our capital expenditures, see Item 5. “Operating and Financial Review and Prospects—Liquidity and Capital Resources.”
 
 
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B.  Business Overview
 
Our Company

We are a clinical stage medical diagnostics company engaged in the development of an ingestible capsule system that utilizes ultra low-dose X-rays for the detection and imaging of colonic polyps and CRC. While CRC is the second leading cause of death from cancer for both sexes combined in the United States and is largely preventable with early detection, according to 2013 National Health Interview Survey, only 58% of Americans between the ages of 50 to 75 reported being current with CRC screening recommendations. Unlike other screening modalities that are designed to generate structural information of the internal colon for the detection of colonic polyps and CRC, such as optical colonoscopy, CTC, and other capsule-based technologies, our system is designed to be ingested without any cathartic preparation of the colon, and to travel through the gastrointestinal tract naturally while the patient continues his or her normal daily routine.  Furthermore, unlike existing CRC imaging modalities currently on the market, all of which require the patient to fast for several hours prior to administration, the procedure for our system is designed to enable patients to continue eating normally. Our system is comprised of three main components: (1) ingestible scanning capsule; (2) CPS, a recorder worn on the patient’s back; and (3) a PC-based work station for data reconstruction and image processing.  We believe that this solution will be attractive to both physicians and patients, with the potential to increase the number of people undergoing CRC screening.

Our scanning capsule will be swallowed and propelled by natural motility through the gastrointestinal tract and excreted naturally with no need for retrieval for data collection. Unlike other CRC screening methods, this process should not disrupt a patient’s normal activities or require fasting. Our scanning capsule employs ultra low-dose X-rays, which allow the system to image the interior lining of the colon even when surrounded by intestinal content.  As such, we believe that patients using our system will not be required to undergo any prior bowel preparation. The Radiation Safety Division of the Soreq Nuclear Research Center found, as set forth in its report of November 2010 that was prepared at our request and based on the information provided by us and the relevant methods and principles known at such time, or the Report, that the radiation dose to the patient in the proposed screening procedure utilizing the scanning device developed by us at that time in routine operation and normal conditions is low relative to the radiation dose involved in conventional imaging procedures using X-rays (such as fluoroscopy and CT) and is also low when compared to the radiation dose involved in established screening procedures such as mammography, all as more fully described in the Report.

Our scanning capsule is being designed to transmit position, motility, and the data it collects to an external data recorder and capsule positioning system (CPS) that will be worn by the patient. The external data recorder is being designed to enable the transfer of the data to our PC-based work station with viewer software application to allow physicians to analyze the data collected by our scanning capsule. The CPS is being designed to provide the physician with accurate localization data aligned with a reconstructed image. We intend for physicians to be able to review the colon’s inner images at any location at any time, in less time than is required to perform an optical colonoscopy.

Colonic polyps are tissue growths that occur on the lining of the colon. Polyps in the colon are extremely common, and certain types of polyps can become cancerous over time. In the event that polyps are identified through our system, the patient may be advised to undergo a subsequent traditional colonoscopy procedure to examine, remove and biopsy the polyps. For those patients who require a subsequent polypectomy, concerns regarding pain, discomfort and embarrassment may still remain with respect to the subsequent polypectomy. We do not, however, believe that these concerns will make the use of our system any less attractive to physicians and patients. Although patients who are initially screened utilizing a traditional colonoscopy could avoid the need for a second procedure if polyps are discovered because they could undergo a polypectomy during the initial screening, if necessary, we believe that our system will still be attractive to physicians and patients as a majority of patients who are screened will not require a subsequent polypectomy. Published data from a multi-center CT colonography screening study of 2,531 asymptomatic adults showed that if all patients with a lesion measuring 5mm or more on CT colonography were referred for colonoscopy, the colonoscopy-referral rate would have been 17%.

A clinical proof-of-concept study, which was based on a 10-case study conducted at Tel Aviv Sourasky Medical Center in Israel and used a prior version of our system, did not identify any material safety or feasibility issues. The study demonstrated the applicability of our system to the human colon, generating images taken in the colon without any prior bowel preparation. All subjects ingested the capsule easily with smooth passage within the designated transit time, on average, within two to three days. There were no reported device-related adverse events. Mild effects on bowel movements were noted, which were determined to be related to the contrast agent and passed within one to two days after the capsule was excreted.

Another objective of the 10-case study was to estimate total radiation exposure for each case study. This was calculated using standard established factors for calculating effective radiation exposure, such as the duration of the capsule inside the body, and was based on the activity of the radiation source inside the scanning capsule and radiation energy, both of which were measured for each case study. The average calculated exposure for the entire procedure in the 10-case study, from ingestion of the capsule to excretion, was 0.03 mSv (STD 0.007 mSv). This level of radiation exposure is similar to a single chest X-ray (approximately 0.06mSv) and two orders of magnitude less than a CTC.
 
 
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The 10-case clinical proof-of-concept study focused on assessing the safety and feasibility of the our system.  The 10-case study was the first phase of a multi-center, prospective clinical feasibility study to establish the safety, functionality and preliminary efficacy of our system in patients eligible for CRC screening, by comparing results from the clinical feasibility study with those from non-invasive, low-sensitivity FOBTs and FITs, as well as from optical colonoscopies. The feasibility study is designed allow for recruitment of 100 subjects. The study is being conducted at multiple centers in Israel, with the potential to be conducted at a single site in the Netherlands. The clinical feasibility study will evaluate the image resolution generated by the capsule in an a human colon without cathartic preparation, will assess polyp imaging in various shapes and in different segments of the colon and will evaluate the safety of the device in terms of total and segmental transit time and analyze the effects of the presence of polyps and variable colon dimensions on these parameters. The study will seek to create a clinical atlas of images that will enable comparisons between images acquired by different CRC screening modalities. During the feasibility study we will collect data about the overall imaging of the colon’s internal surfaces during the passage of the capsule to support the development of a correlation map of polyps identified through our imaging system with polyps imaged by optical colonoscopy and CTC. Additionally, the feasibility study will measure total radiation exposure and the distribution of contrast material within the colon.

 A preliminary analysis conducted on the first 49 capsules swallowed by participants enrolled in the multi-center, prospective clinical feasibility study showed 48 of 49 capsules swallowed and naturally eliminated without major or minor side effects after 73.2±45.4 hours. Image reconstructions allowed 3D views of the colonic wall and lumen with the typical contour of different segments (hepatic flexure, triangular shape of the transverse colon). Both pedunculated and sessile polyps were detected in several patients and validated later by colonoscopy.

To date, we have achieved key product development milestones, including the demonstrated ability of our system to reconstruct the human colon and to identify polyps, and design freeze of the current version of our system. Following the successful completion of the multi-center, prospective clinical feasibility study and design release and transfer to manufacturing phases, we plan to submit during the second half of 2016, a request for CE marking for the marketing and sale of our capsule in the European Union. We expect to perform post-marketing studies in Europe following CE marking for the purpose of collecting additional clinical data to support market adoption. Subject to regulatory approvals, available capital, and engagement with strategic partners, we anticipate launching our system commercially in Europe during 2017.

We plan to conduct a pre-submission meeting with the FDA, during 2016. Subject to this meeting, we plan subsequently to submit a request for the approval of an investigational device exemption, or IDE, for a pilot study in the United States. Subject to successful completion of the pilot study and receipt of required approvals, we plan to initiate during 2017, a pivotal study in the United States to (i) demonstrate device safety as evidenced by a lack of device-related serious adverse events; and (ii) provide efficacy data concerning our system’s performance. We anticipate that FDA approval for the pivotal study will be subject to our providing sufficient clinical data from previous clinical studies, which may include the multi-center, prospective clinical feasibility study and U.S. pilot study. However, there can be no assurance that the FDA will grant approval for the pilot and/or pivotal studies to be conducted in the United States.
 
We also intend to pursue clinical trials for regulatory approvals in Japan and China in parallel to the U.S. pivotal study, subject to available capital and engagement with strategic partners.  Pivotal studies are expected, among other things, to compare polyps identified by our system with the polyps identified by traditional optical colonoscopy. These clinical findings may be analyzed in comparison with results obtained from FOBTs and FITs.

Following and subject to the successful completion of our pivotal trial, our current strategy is to submit a direct de novo reclassification petition, which we anticipate submitting in 2018, for initial FDA clearance for the marketing of our system in the United States. Direct de novo reclassification typically takes at least 9 to 12 months from filing to clearance. If the FDA determines that our system is not a candidate for de novo reclassification, it will require approval of the device for market through the PMA process. The PMA pathway is much more costly and uncertain than the 510(k) clearance process or de novo reclassification, and generally takes at least 12 to 18 months, or even longer, from the time the application is filed with FDA to ultimate approval.

Timelines expectations are based on our current estimations and expectations, which may continue to be updated along with our progress, which is subject to the occurrence of various factors and future events, among others, the satisfactory completion of system’s development process, testing, and integration, which may require more time than currently expected, as well as the success of our clinical trials and the completion of our required regulatory approvals, all of which are uncertain as of the date of this Annual Report.
 
 
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We have submitted patent applications covering our technology in the United States, member states of the European Patent Organisation, Australia, Brazil, Canada, China, Hong Kong, India, Israel, Japan and South Korea. We have been granted patents for our core patent by the U.S. Patent and Trademark Office as well as from the European Patent Office, Australia, China, Hong Kong, Israel, India and Japan. We also filed patent applications describing the use of our technology in several other medical applications.

Since our formation, we have not generated any revenue. We do not anticipate generating any revenue for the foreseeable future and we do not yet have any specific launch dates for our product. We incurred net losses of $3.4 million in 2013, $610,000 in 2014 and $12.3 million in 2015. As of December 31, 2015, we had an accumulated deficit of $34.1 million and a total shareholders’ equity of $12.6 million.
 
Our Solution

CRC screening can reduce the incidence of and mortality from  the disease by detecting polyps at an earlier, more treatable stage. CRC is one of the few cancers that can be prevented through screening because pre-cancerous polyps, from which colon cancers often develop, can be identified and removed. Today, there is a range of options for CRC screening in the average-risk population, with current technology falling into two general categories: (i) structural exams, such as optical colonoscopy (which is currently regarded as the “gold standard” for CRC screening), sigmoidoscopy, CTC and optical capsules (all of which require aggressive bowel preparation), which are invasive exams that enable physicians to visualize the colon for abnormalities; and (ii) stool-based tests, such as FOBTs, FITs and stool DNA tests, which test for blood and irregularities in DNA. Notwithstanding the many CRC screening alternatives, the fact that the tests are encouraged by clinicians and insurers and the clinical value of screening for CRC, a large portion of the population are still reticent to go for CRC screening and are not satisfied with the currently available alternatives.

We believe that our system could represent a potential breakthrough in CRC screening by providing a structural exam without the pain, discomfort and embarrassment experienced by some patients undergoing a traditional optical colonoscopy and other currently available screening methods by offering the following benefits:
 
 
eliminating the need for fasting and prior bowel preparation, which would differentiate our system from every other currently available structural screening exam;
 
 
providing patients with a procedure that requires them to swallow our capsule and small amounts of a contrast agent, thereby minimizing any disruption to their normal activities;
 
 
eliminating the need to sedate patients;
 
 
obviating the requirement for the insufflation (the forcing of air into the gastrointestinal tract) of patients;
 
 
administering our technology on an outpatient basis;
 
 
providing digital reporting, storage and remote consulting capabilities; and
 
 
enabling a physician to analyze the results in approximately 10 minutes, which would be less time than is required to conduct an optical colonoscopy.
 
Although our system utilizes radiation that is considered ultra low-dose, we believe that the risks associated with such radiation exposure are low compared to risks associated with other procedures such as perforation, bleeding or sedation related effects (optical colonoscopy and sigmoidoscopy) and dehydration and damage to kidneys (optical capsules).  Unlike FOBTs, FITs and stool DNA tests, our capsule-based imaging modality generates structural information on the colon, which could assist in the detection of pre-cancerous polyps. We therefore do not believe that the ultra low-dose radiation in our capsule will make our system less attractive to physicians and patients than other less-effective products that do not employ any radiation.

We believe that gastroenterologists will adopt our technology and encourage the use of our capsule. This may increase the number of people undergoing CRC screening and may cause more people with polyps to obtain a polypectomy – a therapeutic procedure during which polyps are removed and which currently receives higher reimbursement coverage than both screening and diagnostic colonoscopies.
 
 
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Our goal is to become a leading supplier of CRC screening technology and to establish our technology as a leading CRC screening method. Key elements of our strategy include:
 
 
obtaining CE marking for the marketing and sale of our system in the European Union, followed by obtaining regulatory approvals for the sale of our system initially in the United States and Japan;
 
 
In Europe and Japan, we intend to offer our system as an imaging and screening tool for the general population. In the United States, we may choose to first obtain regulatory clearance/approval for our system in a screening sub-population or as an adjunct tool to FOBTs and FITs, and after we have conducted more extensive clinical studies in the United States, we would anticipate applying to the FDA for the use of our system as an primary screening tool;
 
 
obtaining third-party reimbursement for our technology;
 
 
improving and enhancing our existing technology portfolio and developing new technologies; and
 
 
successfully marketing our product to establish a large customer base.
 
Our Technology

Our technology is based on an ingestible capsule, which is swallowed by the patient and propelled by natural motility through the gastrointestinal tract. Our capsule transmits information to a receiving device worn on the patient’s body that stores the information for off-line analysis. Our capsule consists of an X-ray source and several X-ray detectors. The X-ray source is contained in a rotating radiation shield, enabling the generation of 360-degree angular scans. The collection of successive angular scans is intended to enable the virtual reconstruction of a portion of the colon's inner surface. During movement of our capsule longitudinally through the colon, successive images of portions of the colon enable the three-dimensional reconstruction of the colon. Our system is also intended to enable identification of polyps, which protrude inward into the colon, through the detection of irregularities in the topography of the colon's inner surface.

Our system is intended to be prescribed to patients by physicians. Immediately prior to capsule ingestion, patients will drink a small amount of a contrast agent (such as barium sulfate or iodine) combined with oral fiber, and continue to do so with normal daily meals in order to enhance the contrast of the colon surface. The capsule is propelled by natural motility through the gastrointestinal tract. As it makes its way through the gastrointestinal tract, information is transmitted to a receiving device worn by the patient that stores the information for off-line analysis. After our capsule is expelled from a patient’s body, the CPS data will be downloaded into our workstation through which physicians will utilize our data viewer software application to analyze the data collected by our system. Our proprietary software is being designed to process the data and produce a two and three-dimensional visualization of the colon's inner surface. A physician will then analyze the visualization to determine whether any anatomical anomalies are present on the inner surface of the colon.
 
Our system consists of the following three main subsystems that together enable the generation of high resolution 3D imaging of the colon's inner surface, further described below: (i) ultra-low-dose X-ray based colon scanning capsule; (ii) CPS; and (iii) PC-based 3D imaging workstation.

Scanning Capsule
 
The scanning capsule, which is designed to measure, collect and transmit the clinical data, is comprised of the following components:
 
 
X-ray Source – including radioactive material sealed in a cylindrical housing.
 
 
Collimator – Radiation shield around the source, which absorbs most of the radiation. Several radial holes enable emission of radiation in defined directions.
 
 
X-ray Sensor – Comprised of several solid state X-ray detectors for measuring the scattered radiation intensity.
 
 
Tilt Sensor – Indication of capsule motion (3D acceleration).
 
 
 
Rotation Motor – For rotating the collimator and X-ray Source.
 
Compass sensor – indication of true north (reference coordinate system).  
 
 
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Source Concealment Mechanism – Conceals the source inside the radiation shield.
 
 
R-T – Radio frequency transceiver device to communicate with the receiver.
 
 
Batteries – Electrical power supply for the capsule.
 
 
Memory – Data storage. The capsule should be able to store up to an hour of measured data.
 
 
CPS coil – Transmits a continuous electromagnetic filed utilized by an external localization system to track 3D position.
 
         Image for illustration purpose only
 
Capsule Positioning System

The Capsule Positioning System, or CPS, is a small, disposable system of biocompatible stickers which are deigned to automatically track the imaging capsule’s positioning and orientation throughout the gastrointestinal tract transition, control the capsule scan mechanism through an embedded scan control algorithm or SCA, capture imaging data from the capsule through radio frequency communication to a non-volatile memory device and enable data retrieval through either wired or wireless communication to an external processor.
 
The CPS is comprised of the following components:
 
 
Sticker Housings – Biocompatible and water-resistant stickers and housing integrating all functional components, attached to the patient’s back, enabling five days of continuous operation.
 
 
Recorder–Consists of receiver electronics embedded software and nonvolatile memory.
 
 
Antennas – Radio frequency antennas are embedded into the sticker housings and used to communicate with the capsule.
 
 
Activation/Deactivation Circuit – Used to activate/deactivate the CPS through a specialized protocol.
 
 
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UI Indicators - Provides user with vocal, light or vibration indication as required.
 
 
PCB – Electronics’ printed circuit boards.
 
 
Microcontroller – Runs embedded software, logic that manages the CPS and SCA.
 
 
RF Transceivers – Several transceivers used to communicate with the capsule.
 
 
TILT/Compass Sensors – To determinate patient’s body movements.
 
 
Batteries – Electrical power supply for the CPS.
 
 
Memory – Non-volatile data storage to store data acquired by the system.
 
Image for illustration purpose only
 
Workstation
 
The workstation is a specialized, user friendly, personal computer-based software package designed to retrieve and process clinical data from the CPS and to reconstruct and produce 3D visualization of the colon's inner surface. The workstation is comprised of the following software components:
 
 
Communication Driver Software – to communicate with the CPS and retrieve collected data following procedure completion.
 
 
Data Processing Software – to process and reconstruct clinical data into a 3D structure.
 
 
Data Display and Management Software – includes the following functions:
 
 
3D visualization of the reconstructed colon surface.
 
 
Annotation tools.
 
 
 
Registration of patient and capsule data and management of the patient database.
 
Report – to enable generation of clinical results report out.
 
 
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Image for illustration purpose only

Our System – Non-Clinical, Pre-Clinical and Clinical History
 
We have developed and validated our capsule-based imaging modality for providing structural information on colonic polypoid lesions and masses for CRC screening. Below is a summary of the validation tests carried out by us in the laboratory, in phantoms, animals and humans, which were designed to evaluate this new imaging modality’s performance and potential clinical value.
 
Non-Clinical and Pre-Clinical Testing
 
Imaging Performance Testing

The Check-Cap ingestible capsule transmits data as the capsule progresses through the colon. This data consists of imaged slices perpendicular to the capsule’s longitudinal axis; slices are then reconstructed by the workstation to produce 2D and 3D images of the inner surface of the colon. Following are performance measurements of the capsule imaging.
 
•           Modulation Transfer Function, or MTF. The capsule was moved along a longitudinal-edge phantom setup in 3mm steps. The figure below shows a typical raw signal after filtering for peak detection. The same test was carried out using an angular-edge phantom setup, which demonstrated similar results to those shown below. These tests do not take into account noise characteristics.
 
 
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Image for illustration purpose only

For each position of the capsule in the phantom, the mean signal intensity (peak) was measured, the result of which is shown in the right figure below. Resulting line spread function, or LSF, which is the differential of the curve in the left figure below.
 
 
Image for illustration purpose only
 
The graphs above demonstrate that the existing design of our system can detect objects of approximately 2-3mm when noise is not taken into account.

            Resolution Limit: Estimation of the Smallest Visible Object Size. In order to estimate the size of the smallest visible object, both spatial resolution and noise characteristics must be taken into account. The graph below presents the estimated MTF of our system. Noise analysis indicates MTF 1/3 for minimum visibility, which demonstrates that the smallest visible object that can be detected with the existing design of our system (in the conditions used, which included a colon diameter of 30mm) is of approximately 5-6 mm (see graph below).
 
 
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Image for illustration purpose only
 
Image Reconstruction
 
Two main characteristics of our system contribute to the image reconstruction performance:
 
 
The number of photons hitting the detector per time frame.
 
 
The angular spread of the photon beam coming out of the capsule collimator.
 
Based on the laboratory tests performed with the current version of our system, polyps of 6 mm and larger should be visible and 10 mm polyps and larger are expected to be detected at high sensitivity. To further enhance the visibility of 6 mm - 9 mm polyps, a new design of the collimator was successfully tested in a prototype version of our capsule, which  is expected to enable 2.5 times the number of photons to be detected by the detectors, allowing the implementation of an image enhancement algorithm, which is expected to improve the imaging performance.

Animal Testing and Tissue Equivalent Phantom Image Reconstruction
 
The physics of  our imaging modality was tested in the laboratory on phantoms with tissue equivalent material and in animals to ensure that laboratory conditions mimic real life clinical scenarios.
 
Following the initial proof of concept, we performed a series of studies in order to evaluate the feasibility and preliminary safety of our technology. All of the studies were performed in pigs ranging from 60 to 90 kg. Pigs, which are commonly used in gastrointestinal studies, were selected as the animal model for preliminary evaluation of our system based on the resemblance of the porcine colon size and morphology to the human colon. However, there are marked differences between the colon of pigs and that of humans. The pig colon is much longer, has a larger diameter in addition to other anatomical differences. In the pig model, the pressure waves of peristalsis are believed to be more frequent and shorter than in humans. As a result, we believe that colon content movement is substantially slower and more frequent in pigs than in humans. In these studies, we did not intend to collect statistically significant data; hence, the tests were repeated a limited number of times until adequate data was collected.
 
The first test was performed to demonstrate imaging proof-of-concept using a wired system. This technology included all the basic features intended to be included in the clinical system, but on a larger scale due to the use of off-the-shelf components. The subsequent studies used versions of the system that integrated most of the imaging components, software and electronics of the system that we used with humans. Since off-the-shelf components were used, the animal capsules were larger and heavier than the version of our system that are used clinically.
 
Raw data from an animal colon showing a decrease in X-ray florescence, or XRF photon signals and an increase in Compton backscattering, or CMT, signals corresponding to the position of a polyp that was detected when our  capsule passed over the polyp is shown in the image below. These two signals are combined in order to form a three dimensional image below.
 
 
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Image for illustration purpose only

The animal studies conducted to date demonstrate that our technology provides sufficient resolution, in these studies, for the detection of 10 mm polyps which is the size of clinically significant polyps. The animal studies also demonstrated that 5 mm polyps can be detected, though with lower resolution than 10 mm polyps in the first animal capsule. Animal health was maintained throughout the studies. No adverse effects related to passage of our capsule were noted.
 
The capsules evaluated in the animal studies were significantly larger than the capsules that we are using with humans. The differences in anatomy, physiology, and capsules may have several effects on the data compared to use in the human population. Motility of the capsules through the digestive system was slow due to the specific shape of the porcine gastrointestinal tract. In addition, because of the size of the capsule, it was retained in the stomach for many hours and even days. Accordingly, the animal model required that normal ingestion be replaced by direct insertion of the capsule into the small bowel. In order to simplify the development and animal testing, we used Tungsten radiation source with long half-life (120 days).
 
Following the success of the animal testing, a series of in-vitro tests were conducted to simulate different clinical scenarios in the laboratory using a miniaturized human capsule. Polyps were created and reconstruction of the laboratory phantoms with a human capsule was generated to assess the ability to detect polyps as the capsule advances in the colon. The in-vitro tests demonstrated the imaging capabilities of our imaging technology. Below is the reconstruction of a laboratory phantom image.
 
 
Image for illustration purpose only
 
 
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Polyp Detection Analysis
 
Laboratory tests were carried out to estimate the capsule’s ability to detect polyps in phantoms and demonstrate sensitivity and specificity of such detection. Below is an example of the reconstruction of a scan composed of three slices: XRF, CMT and a fused (combined) image.
 

Receiver Operating Characteristics

Standard receiver operating characteristics, or ROC, curves were generated from phantom data with 8 mm polyp in a 30 mm barrel phantom with 3% iodine concentration mimicking the colon contents. CMT, XRF and fused (combined) data were analyzed based on 2D slices that were generated and standard deviation indicator. There were a few cases where the noise in the phantoms was high enough to generate polyp false positive condition separately for each data type, especially in CMT. However, fusion of CMT and XRF data contributed to noise reduction and enabled to demonstrate 100% true positive and 0% false positive.
 
 
Clinical Trials

We initiated our first human clinical study in Germany in January 2010. The purpose of the study was to collect pressure and motility information from the digestive system of human volunteers. This study was conducted with a passive capsule that contained no X-ray source or detectors. It included several electronic components of the system and had similar dimensions to the current capsule.
 
 
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We concluded a limited, single-center, feasibility study at Rambam Medical Center in Haifa to assess the motility of our capsule in healthy subjects, with the objective of optimizing the daily routine of the subjects in order to shorten the transit time of our capsule. The study, in which 15 healthy subjects participated and used a dummy capsule with the same weight and dimensions as our current capsule, did not identify any safety issues and all capsules were retrieved. A structured daily routine determined the timing of the following: capsule ingestion, the subjects’ daily meals, the contrast agent ingestion and one daily dose of 10 mg of Bisacodyl, and all subjects continued their regular active lifestyles (such as work and sports). The average transit time of the dummy capsule in the 15 subjects was approximately 24 hours less than the average transit time of our capsule in subjects participating in the multi-center feasibility study in which the participants do not ingest a daily dose of Bisacodyl, are less active and are continuously monitored in a designated apartment until the capsule is excreted.
 
A clinical proof-of-concept study, which was based on a 10-case study conducted at Tel Aviv Sourasky Medical Center in Israel and used a prior version of our system, did not identify any material safety or feasibility issues. The study demonstrated the applicability of our system to the human colon, generating images taken in the colon without any prior bowel preparation. All subjects ingested the capsule easily with smooth passage within the designated transit time, on average, within two to three days. There were no reported device-related adverse events. Mild effects on bowel movements were noted, which were determined to be related to the contrast agent and passed within one to two days after the capsule was excreted.

Another objective of the 10-case study was to estimate total radiation exposure for each case study. This was calculated using standard established factors for calculating effective radiation exposure, such as the duration of the capsule inside the body, and was based on the activity of the radiation source inside the scanning capsule and radiation energy, both of which were measured for each case study. The average calculated exposure for the entire procedure in the 10-case study, from ingestion of the capsule to excretion, was 0.03 mSv (STD 0.007 mSv). This level of radiation exposure is similar to a single chest X-ray (approximately 0.06mSv) and two orders of magnitude less than a CTC.

The 10-case clinical proof-of-concept study focused on assessing the safety and feasibility of our system. The 10-case study was the first phase of a multi-center, prospective clinical feasibility study to establish the safety, functionality and preliminary efficacy of our system in patients eligible for CRC screening, by comparing results from the clinical feasibility study with those from non-invasive, low-sensitivity FOBTs and FITs, as well as from optical colonoscopies. The feasibility study is designed allow for recruitment of 100 subjects. The study is being conducted at multiple centers in Israel, with the potential to be conducted at a single site in the Netherlands. The clinical feasibility study will evaluate the image resolution generated by the capsule in an a human colon without cathartic preparation, will assess polyp imaging in various shapes and in different segments of the colon and will evaluate the safety of the device in terms of total and segmental transit time and analyze the effects of the presence of polyps and variable colon dimensions on these parameters. The study will seek to create a clinical atlas of images that will enable comparisons between images acquired by different CRC screening modalities. During the feasibility study we will collect data about the overall imaging of the colon’s internal surfaces during the passage of the capsule to support the development of a correlation map of polyps identified through our imaging system with polyps imaged by optical colonoscopy and CTC. Additionally, the feasibility study will measure total radiation exposure and the distribution of contrast material within the colon.

 A preliminary analysis conducted on the first 49 capsules swallowed by participants enrolled in the multi-center, prospective clinical feasibility study showed 48 of 49 capsules swallowed and naturally eliminated without major or minor side effects after 73.2±45.4 hours. Image reconstructions allowed 3D views of the colonic wall and lumen with the typical contour of different segments (hepatic flexure, triangular shape of the transverse colon). Both pedunculated and sessile polyps were detected in several patients and validated later by colonoscopy.

To date, we have achieved key product development milestones, including the demonstrated ability of our system to reconstruct the human colon and to identify polyps, and design freeze of the current version of our system. Following the successful completion of the multi-center, prospective clinical feasibility study and design release and transfer to manufacturing phases, we plan to submit during the second half of 2016, a request for CE marking for the marketing and sale of our capsule in the European Union. We expect to perform post-marketing studies in Europe following CE marking for the purpose of collecting additional clinical data to support market adoption. Subject to regulatory approvals, available capital, and engagement with strategic partners, we anticipate launching our system commercially in Europe during 2017.

We plan to conduct a pre-submission meeting with the FDA, during 2016. Subject to this meeting, we plan subsequently to submit a request for the approval of an IDE, for a pilot study in the United States. Subject to successful completion of the pilot study and receipt of required approvals, we plan to initiate during 2017, a pivotal study in the United States to (i) demonstrate device safety as evidenced by a lack of device-related serious adverse events; and (ii) provide efficacy data concerning our system’s performance. We anticipate that FDA approval for the pivotal study will be subject to our providing sufficient clinical data from previous clinical studies, which may include the multi-center, prospective clinical feasibility study and U.S. pilot study. However, there can be no assurance that the FDA will grant approval for the pilot and/or pivotal studies to be conducted in the United States.
 
 
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We also intend to pursue clinical trials for regulatory approvals in Japan and China in parallel to the U.S. pivotal study, subject to available capital and engagement with strategic partners. Pivotal studies are expected, among other things, to compare polyps identified by our system with the polyps identified by traditional optical colonoscopy. These clinical findings may be analyzed in comparison with results obtained from FOBTs and FITs.

Following and subject to the successful completion of our pivotal trial, our current strategy is to submit a direct de novo reclassification petition, which we anticipate submitting in 2018, for initial FDA clearance for the marketing of our system in the United States. Direct de novo reclassification typically takes at least 9 to 12 months from filing to clearance. If the FDA determines that our system is not a candidate for de novo reclassification, it will require approval of the device for market through the PMA process The PMA pathway is much more costly and uncertain than the 510(k) clearance process or de novo reclassification, and generally takes at least 12 to 18 months, or even longer, from the time the application is filed with FDA to ultimate approval.

Timelines expectations are based on our current estimations and expectations, which may continue to be updated along with our progress, which is subject to the occurrence of various factors and future events, among others, the satisfactory completion of system’s development process, testing, and integration, which may require more time than currently expected, as well as the success of our clinical trials and the completion of our required regulatory approvals, all of which are uncertain as of the date of this Annual report.
 
We concluded a limited, single-center, feasibility study at Rambam Medical Center in Haifa to assess the motility of our capsule in healthy subjects, with the objective of optimizing the daily routine of the subjects in order to shorten the transit time of our capsule. The study, in which 15 healthy subjects participated and used a dummy capsule with the same weight and dimensions as our current capsule, did not identify any safety issues and all capsules were retrieved. A structured daily routine determined the timing of the following: capsule ingestion, the subjects’ daily meals, the contrast agent ingestion and one daily dose of 10 mg of Bisacodyl, and all subjects continued their regular active lifestyles (such as work and sports). The average transit time of the dummy capsule in the 15 subjects was approximately 24 hours less than the average transit time of our capsule in subjects participating in the multi-center feasibility study in which the participants do not ingest a daily dose of Bisacodyl, are less active and are continuously monitored in a designated apartment until the capsule is excreted.

We recently also initiated an in-house study, approved through Bnei-Zion Medical Center to assess the CPS CE version standalone functionality (no capsule ingestion required). Healthy subjects selected for this study will externally carry the CPS and a non-scanning capsule, through which we can assess the effect of human routine behavior on system performance. The study is conducted in-house and does not require any medical surveillance.

Research and Development

Our research and development strategy is centered on developing our system. Our research and development team is located at our facilities in Isfiya, Israel, and consists of 50 employees and independent contractors as of February 15, 2016 and is supported by highly experienced consultants.
 
We have received grants from the Government of the State of Israel through the OCS for the financing of a portion of our research and development expenditures pursuant to the Research Law and related regulations. As of December 31, 2015, we had received funding from the OCS in the aggregate amount of $3.6 million and had a contingent obligation to the OCS in the amount of $3.8 million. As of December 31, 2015, we had not paid any royalties to the OCS. In December 2015, we received approval for an additional grant from the OCS in the amount of up to $340,000, and in January 2016, we applied for an additional grant from the OCS in the amount of up to $6.9 million. We may apply for additional OCS grants in the future. However, as the funds available for OCS grants out of the annual budget of the State of Israel have been reduced in the past and may be further reduced in the future, we cannot predict whether we will be entitled to any future grants, or the amounts of any such grants.
 
We incurred approximately $5.8 million, $2.8 million and $2.9 million in research and development expenses, net (after deducting participation by others and government grants) for the years ended December 31, 2015, 2014 and 2013, respectively. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Operations Overview— Research and Development Expenses, Net.”
 
 
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Intellectual Property

An important part of our competitive strategy is to seek, when appropriate, protection for our products and proprietary technology through a combination of U.S. and foreign patents, trademarks, trade secrets and contractual arrangements with our employees, consultants and suppliers. These measures, however, may not be adequate to protect our technology from unauthorized disclosure, third-party infringement or misappropriation as these parties may breach these agreements, and we may not have adequate remedies for any such breach. We intend to prosecute and defend our proprietary technology. The primary test for patent protection eligibility includes novelty, non-obviousness and usefulness.
 
We submit applications under the Patent Cooperation Treaty, or PCT, which is an international patent law treaty that provides a unified procedure for filing a single initial patent application to seek patent protection for an invention simultaneously in each of the member states. Although a PCT application is not itself examined and cannot issue as a patent, it allows the applicant to seek protection in any of the member states through national-phase applications.
 
As of February 1, 2016, we had 20 granted patents (not including separate validations in Europe), 1 “allowed” patent application and 34 pending patent applications (not including “allowed”) worldwide relating to various elements and functions of our products and related enhancements. We have submitted patent applications covering our technology in the United States, member states of the European Patent Organisation, Australia, Brazil, Canada, China, Hong Kong, India, Israel, Japan and South Korea. We have received patent grants for our core patent by the United States Patent and Trademark Office as well as from the European Patent Office, Australia, China, Hong Kong, Israel, India and Japan.

Our registered U.S. Patent Number 7,787,926 discloses an ingestible capsule with a radiation source and radiation detectors that, when used in conjunction with a radio opaque contrast agent, is adapted to detect clinically relevant findings in the colon. Utilizing X-ray fluorescence and Compton back scatterings, the capsule is able to measure the distance between the capsule and the colon wall and to distinguish between gas, intestinal contents, and clinically significant findings in the gastrointestinal tract.
 
A second PCT patent application (PCT/IL2008/000163), which is pending in several countries in the national-phase and granted in Europe and Hong Kong, discloses additional features such as a rotating collimator and improved scanning mechanisms, the capability to determine tissue density to differentiate between different types of polyps, as well as the capability to determine capsule movement in the colon. Another PCT application (PCT/IL2011/000462), which is pending in several countries in the PCT national-phase, discloses a number of alternate fail safe concealment mechanisms that can be utilized in the capsule to ensure that the X-ray source is blocked when the capsule is not scanning and is open when it is scanning, allowing the capsule to image the colon. The fail safe feature ensures that in the event of power failure, the radiation source is blocked and X-rays do not escape. Recently the application filed in Australia has been granted and the application filed in Europe has been allowed.
 
In another PCT patent application (PCT/IL2008/000765), which was granted in the United States, Europe, Israel and Japan, we disclose an imaging catheter that utilizes X-ray fluorescence, Compton back scattering and electron back scattering. The imaging catheter is designed for use in cardiac applications as well as intra-operative imaging applications such as imaging inside blood vessels where optical imaging cannot be performed because of obscuring circumstances.
 
While our policy is to obtain patents by application, to maintain trade secrets and to seek to operate without infringing on the intellectual property rights of third parties, technologies related to our business have been rapidly developing in recent years. Additionally, patent applications that we may file may not result in the issuance of patents, and our issued patents and any issued patents that we may receive in the future may be challenged, invalidated or circumvented. For example, we cannot predict the extent of claims that may be allowed or enforced in our patents nor be certain of the priority of inventions covered by pending third-party patent applications. If third parties prepare and file patent applications that also claim technology or therapeutics to which we have rights, we may have to partake in proceedings to determine priority of invention, which could result in substantial costs to us, even if the eventual outcome is favorable to us. Moreover, because of the extensive time required for clinical development and regulatory review of a product we may develop, it is possible that, before our system can be commercialized, related patents will have expired or will expire a short period following commercialization, thereby reducing the advantage of such patent. Loss or invalidation of certain of our patents, or a finding of unenforceability or limited scope of certain of our intellectual property, could have a material adverse effect on us. See “Item 3D “Key Information - Risk Factors— Risks Related to Our Intellectual Property.”
 
 
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In addition to patent protection, we rely on trade secrets, including unpatented know-how, technology innovation, drawings, technical specifications and other proprietary. We also rely on protection available under trademark laws, and received a notice of allowance for the “CHECK-CAP” mark and design logo in the United States and hold a registered trademark for the “CHECK-CAP” design logo in Europe. Applications for additional marks and design logos are pending in the United States and Europe.
 
Competition

Competition for our system comes primarily from traditional well-entrenched technologies for detecting gastrointestinal disorders and diseases, such as optical colonoscopy, sigmoidoscopy and CTC. The principal manufacturers of equipment for optical colonoscopy and sigmoidoscopy are Olympus, Richo Company Ltd., Hoya and Fuji Film. The principal manufacturers of equipment for CTC are General Electric Healthcare Systems, Siemens Medical Solutions, Philips Medical Systems Ltd. and Toshiba Corporation. All of these companies have substantially greater financial resources than we do, and they have established reputations as well as worldwide channels for distribution medical instruments to physicians.
 
 Tests that investigate the link between genes and the function of metabolic pathways, drug metabolism and disease development with a primary focus on the study of DNA, RNA and proteins. Genetic markers can be traced within stool samples in minute quantities.
 
Olympus is a Japanese company that manufactures optics and imaging products in China. Olympus’ medical division develops and sells products in the endoscopy, endosurgery and endotherapy fields. The FDA approved Olympus’ Endo-Capsule product for the visualization of the small bowel in late 2007 and the company is currently developing a capsule-based technology for CRC screening.
 
IntroMedic is a private Korean medical device manufacturer specializing in the development of technologies in the field of optical capsule endoscopy. IntroMedic’s MiroCam product, which is currently undergoing FDA trials in the United States, uses an oxide silicone chip for imaging and human body communication technology for the transmission of images. The company is developing a capsule-based technology for CRC screening.
 
RF System is a Japanese manufacturer of medical device equipment and cameras for industrial use. Its Sayaka product is a new, “battery free” capsule endoscope that uses induction charging to draw power. The company is developing a capsule technology for CRC screening.
 
All of the abovementioned CRC optical capsule endoscopy products under development rely on similar optics (camera) and complementary metal oxide semiconductor or CMOS, based technology, thus requiring a significant bowel cleansing prior to performing the procedure.

In addition, several companies have developed or are developing technologies based on molecular diagnostics (from blood and other bodily fluids), or MDx, tests that investigate the link between genes and the function of metabolic pathways, drug metabolism and disease development with a primary focus on the study of DNA, RNA and proteins. Genetic markers can be traced within stool samples in minute quantities. A U.S. based company, Exact Sciences, has developed a special collecting kit for stool samples and an analyzer to detect neoplasia associated DNA markers and the presence of occult hemoglobin in human stool. The method of screening is included in the colorectal cancer screening guidelines, including the American Cancer Society.
 
To our knowledge, certain companies are developing or commercializing optics-based capsule endoscopy systems. The existing capsule technology requires intense bowel cleansing, more so than is required for optical colonoscopy, and the potential ingestion of agents to boost capsule transit through the colon. Given Imaging, an Israeli-based company that was acquired by Covidien plc (NYSE: COV) in February 2014 (subsequently acquired by Medtronic), has developed visualization capsules for the detection of disorders of the esophagus, small bowel and colon. It received the CE Mark to market PillCam™ COLON throughout the European in 2006. In early 2014, the FDA cleared PillCam COLON 2 system with an indication to provide visualization of the colon. It may be used for detection of colon polyps in patients after an incomplete optical colonoscopy with adequate preparation, and when a complete evaluation of the colon was not technically possible. In Early 2016, the FDA cleared PillCam COLON2 system with an expended indication for use: High risk population to undergo colonoscopy. Patients with major risks for colonoscopy or moderate sedation, but who tolerate colonoscopy and moderate sedation in the event a clinically significant colon abnormality was identified on capsule endoscopy. Other companies, including Olympus, CapsoVision, Intromedic and RF System, are developing similar approaches for optical capsule endoscopy.  

 
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Sales and Marketing

Our goal is to establish our position as a leading player in the CRC screening market. Although we do not currently generate revenues, we expect to generate revenues after we obtain regulatory clearance or approval through sales of our system.
 
Because we are still in the clinical and development stage, we are subject to certain challenges, including, among others, that:
 
 
our technology has been tested on a limited basis and therefore we cannot assure the product’s clinical value;

 
we need to receive CE Mark of conformity for the system in the European Union and obtain the requisite regulatory approvals in the United States, Japan and other markets where we plan to focus our commercialization efforts;
 
 
we need to raise an amount of capital sufficient to complete the development of our technology, obtain the requisite regulatory approvals and commercialize our current and future products;

 
we need to obtain reimbursement coverage from third-party payors for procedures using our system;

 
we need to increase our manufacturing capabilities; and
 
 
we need to establish and expand our user base while competing against other sellers of capsule endoscopy systems as well as other current and future CRC screening technologies and methods.

Our ability to operate our business and achieve our goals and strategies is subject to numerous risks as described more fully in “Risk Factors.”
 
Subject to our receipt of regulatory approvals, available capital, and engagement with strategic partners, we expect to commercialize our system during 2017 in selected markets in Europe, where regulatory hurdles are generally lower and in which current penetration of optical colonoscopy as a screening tool is low relative to the U.S. market. We intend to target major markets in Europe. In these markets, we are planning to work with strategic partners and/or local distributors who are active in the gastroenterology field and who have already demonstrated excellent performance in introducing new and innovative technologies.
 
In the European Union and Japan, we intend to offer our system as a primary screening tool for the general population. In the United States, we may target the population in a two-staged approach: first, we may seek to obtain the requisite regulatory clearance/approval for our system in a screening sub-population or as an adjunct tool to FOBTs and FITs, and after we have generated additional clinical data to support general screening indication, we would seek FDA clearance/approval for the use of our system as a primary screening tool for the general population.
 
Subject to the successful completion of our clinical trials and the receipt of our initial FDA clearance/approval, we expect to launch the product in the U.S. market, where we will consider setting up our own sales force or aligning with a strategic partner. Initially, we are planning to sell our system to the private sector. Simultaneously, we will work intensively to obtain reimbursement by Medicare and private insurers within the shortest possible time frame.
 
Subject to local regulatory approval, we also intend to market our system in key markets in Asia. Initial efforts will focus in Japan in view of its developed CRC screening market.

Manufacturing and Suppliers

Our manufacturing operations are conducted at a facility located in Isfiya, Mount Carmel, Israel. We lease approximately 610 square meters at this facility under a lease agreement providing for a term of 10 years, commencing on June 1, 2012 and ending on May 31, 2022, and in December 2015 we increased the leased area at our Isfia facility by an additional 290 square meters for clinical and development purposes, to a total of 900 square meters, under an addendum to the lease agreement with similar terms as in our current lease agreement. We have the right to terminate the agreement at any time, upon as least 60 days prior written notice. We currently have sufficient space to manufacture our system for the clinical studies but have limited resources, facilities and experience in commercially manufacturing large quantities of our system, external receiver and software application to meet the demand we expect from our expanded commercialization efforts. We expect to face certain technical challenges as we increase manufacturing capacity, including, among others, logistics associated with the handling of radioactive materials, equipment design and automation, material procurement, lower than expected yields and increased scrap costs, as well as challenges related to maintaining quality control and assurance standards. Our production objective is to establish a scalable capacity in order to meet such expanded demand for our system and market expansion. If we are unable to scale our manufacturing capabilities to meet market demand, our growth could be limited and our business, financial condition and results of operations could be materially adversely affected.
 
 
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We are currently  upgrading and expanding our production system and capacity and developing supply chain systems to support production for clinical trials and to meet standards for CE marking. Our current capacity was built to accommodate our clinical phase. We have integrated a product life management system to enable overall life cycle tracking and documentation including full configuration management control and manufacturing documentation.
 
During the clinical testing phase in Europe, we are planning to conduct both the assembling of our system and the insertion of the X-ray source at our facilities. As we proceed to the commercial phase in Europe and the U.S. clinical trial, we expect to collaborate with a third-party in the manufacturing and integration of the X-ray source into our system, in order to increase the time and cost efficiency of the process. We are currently in discussions with several potential partners for manufacturing and distribution purposes.

We do not currently have any sales. We are planning to develop a scale-up plan to meet our expected commercial supply needs. We are also working on a plan to expand our manufacturing capacity to support the expected larger clinical volume and subsequent higher volumes expected in the early commercialization stage. We are considering, among other options, the expansion of our assembly line in Israel, the buildup of new assembly lines in the United States and Europe, and alternative sources for the key capsule components (such as the motor, X-ray detectors, electrical components and PCBs). All of the facilities in which manufacturing and assembly of our products will be conducted will need to comply with applicable regulations and standards for medical devices.

We have received grants from Government of the State of Israel through the OCS, the terms of which require that products developed with OCS grants be manufactured in Israel and that the technology developed thereunder may not be transferred outside of Israel, unless prior approval is received from the OCS, which we may not receive.

We are currently considering whether it would be possible to assemble the capsule without the X-ray source in Israel, and have the X-ray source subsequently inserted into our capsule at a reactor or cyclotron site or at a distribution center outside Israel. Even following the full repayment of any OCS grants, we must nevertheless continue to comply with the requirements of the Research Law. The foregoing restrictions may impair our ability to outsource or transfer development or manufacturing activities with respect to any product or technology outside of Israel.  See “Risk Factors – Risks Related to Our Operations in Israel.”

We currently depend on single source suppliers for some of the components necessary for the production of our system. For example, for the current version of the capsule used in clinical trials, we currently have one leading supplier for the motor that we are using to rotate the collimated X-ray source in our capsule and we currently have one leading supplier for the X-ray detectors used in our capsule. There are a limited number of manufacturers worldwide who are capable of manufacturing the motor and the specially designed X-ray detectors that we currently use in our capsule. In addition, the ASIC residing in our capsule is currently manufactured for us by a single FAB. Our X-ray source manufacturer is considered a single source supplier. Since our X-ray source is custom made and not off-the-shelf product, we will be required to qualify an alternative supplier, should we need to engage with an alternative manufacturer. There are many alternative FABs worldwide and the design of our current ASIC could be adapted in the event it became necessary to use an alternative FAB. Our current suppliers have been able to supply the required quantities of such components to date. However, if the supply of these components is disrupted or terminated or if our current suppliers are unable to supply required quantities of components, we may not be able to find alternative sources for these key components in a timely manner. Although we are planning to maintain strategic inventory of key components, the inventory may not be sufficient to satisfy the demand for our system if such supply is interrupted, or subject to risk of loss due to catastrophic events such as a fire at our storage facility. As a result, we may be unable to meet the demand for our system, which could harm our ability to generate revenues, lead to customer dissatisfaction and damage our reputation. If we are required to change the manufacturer of any of these key components, there may be a significant delay in locating a suitable alternative manufacturer. In addition, we may be required to verify that the new manufacturer maintains facilities and procedures that comply with FDA and other applicable quality standards and with all applicable regulations and guidelines. The delays associated with the identification of a new manufacturer could delay our ability to manufacture our system in a timely manner or within budget. Furthermore, in the event that the manufacturer of a key component of our system ceases operations or otherwise ceases to do business with us, we may not have access to the information necessary to enable another supplier to manufacture the component. The occurrence of any of these events could harm our ability to meet demand for our system in a timely manner or within budget.

 
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Environmental Health and Safety Matters
 
We are subject to environmental health and safety laws and regulations in Israel, governing, among other things, the use of radioactive materials, including the Israeli Work Safety Regulations (Occupational Safety and Health of Ionizing Radiation Practitioners) 1992-5753 and Women Employment Regulations (Work with Ionizing Radiation), 1979-5739. Our current research and development activities require, and our currently contemplated commercial activities will require, permits from various governmental authorities including, Israel’s Ministry of Environmental Protection, Israel’s Ministry of Health and local municipal authorities. Failure to obtain or maintain any such permits could have a material adverse effect on our business, financial condition and results of operations. The Ministry of Environmental Protection and the Ministry of Health conduct periodic inspections in order to review and ensure our compliance with the various regulations.
 
These laws, regulations and permits could potentially require expenditure by us for compliance or remediation. If we fail to comply with such laws, regulations or permits, we may be subject to fines and other civil, administrative or criminal sanctions, including the revocation of permits and licenses necessary to continue our business activities. In addition, we may be required to pay damages or civil judgments in respect of third-party claims, including those relating to personal injury (including exposure to radioactive materials) or contribution claims. Some environmental, health and safety laws allow for strict, joint and several liability for remediation costs, regardless of comparative fault. We may be identified as a responsible party under such laws. Such developments could have a material adverse effect on our business, financial condition and results of operations.

In addition, laws and regulations relating to environmental, health and safety matters are often subject to change. In the event of any changes or new laws or regulations, we could be subject to new compliance measures or to penalties for activities which were previously permitted.
 
U.S. Government Regulation

Our system is a medical device subject to extensive regulation by FDA and other U.S. federal and state regulatory bodies. To ensure that medical products distributed in the United States are safe and effective for their intended use, FDA has imposed regulations that govern, among other things, the following activities that we or our partners perform and will continue to perform:

 
product design and development;
 
 
product testing;
 
 
validation and verifications;
 
 
product manufacturing;
 
 
product labeling;
 
 
product storage, shipping and handling;
 
 
premarket clearance or approval;
 
 
advertising and promotion;
 
 
product marketing, sales and distribution; and
 
 
post-market surveillance reporting death or serious injuries and medical device reporting.
 
FDA’s Premarket Clearance and Approval Requirements

Unless an exemption applies, before we can commercially distribute medical devices in the United States, we must obtain, depending on the type of device, either prior 510(k) clearance or PMA approval from FDA. FDA classifies medical devices into one of three classes:
 
 
Class I devices, which are subject to only general controls (e.g., labeling, medical devices reporting, and prohibitions against adulteration and misbranding) and, in some cases, to the 510(k) premarket clearance requirements;
 
 
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Class II devices, generally requiring 510(k) premarket clearance before they may be commercially marketed in the United States; and
 
 
Class III devices, consisting of devices deemed by FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or devices deemed not substantially equivalent to a predicate device, generally requiring submission of a PMA supported by clinical trial data.
 
510(k) Clearance Pathway

To obtain 510(k) clearance, we must submit a premarket notification, or 510(k) notice, demonstrating that the proposed device is substantially equivalent to a previously cleared 510(k) device or a device that was in commercial distribution before May 28, 1976 for which FDA has not yet called for the submission of premarket approval applications. FDA’s 510(k) clearance pathway takes approximately from 6 to 9 months, but it can take significantly longer. FDA may require additional information, including clinical data, to make a determination regarding substantial equivalence.
 
After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a new or major change in its intended use, will require a new 510(k) clearance or, depending on the modification, require premarket approval. FDA requires each manufacturer to determine whether the proposed change requires submission of a 510(k), or a premarket approval, but FDA can review any such decision and can disagree with a manufacturer’s determination. If FDA disagrees with a manufacturer’s determination, FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or premarket approval is obtained. If FDA requires us to seek 510(k) clearance or premarket approval for any modifications to a previously cleared product, we may be required to cease marketing or recall the modified device until we obtain this clearance or approval. Also, in these circumstances, we may be subject to significant regulatory fines or penalties.
 
De Novo Reclassification

If FDA finds that there is no suitable predicate device for our system, it will automatically be considered a class III device. However, in instances where a device is novel and there is no suitable predicate device, but that device is deemed to be of low to moderate risk, FDA can reclassify the device to class I or class II via de novo reclassification. This process involves the submission of a reclassification petition, and FDA accepting that “special controls” are adequate to ensure the product’s performance and safety.
 
FDA now allows “direct” de novo reclassification petitions, a mechanism by which a sponsor can directly submit a detailed de novo reclassification petition as the device’s initial submission without having to first receive a not substantially equivalent, or NSE, decision on a 510(k) submission. The direct de novo pathway takes at least 9 to 12 months from submission of the petition to device clearance.
 
Our current strategy is to submit a direct de novo reclassification petition for our system. To support a direct de novo reclassification petition, our objective is to demonstrate that the device poses a low to moderate risk to patients. If FDA determines that our system is not a candidate for de novo reclassification, it will require approval of the device for market through the PMA process.
 
Alternatively, if we seek 510(k) clearance and our device is found not substantially equivalent, or NSE, a de novo petition must be filed within 30 days from the receipt of the NSE determination. The request should include a description of the device, labeling for the device, reasons for the recommended classification and information to support the recommendation. The de novo process following an NSE determination has a 60-day review period, although it is typical for the review to take far longer. If FDA classifies the device into class II, the company will then receive an approval order to market the device. This device type can then be used as a predicate device for future 510(k) submissions. However, if FDA subsequently determines that the device will remain in the class III category, then the device may not be marketed until the company has obtained an approved PMA.
 
Premarket Approval Pathway

A premarket approval application must be submitted if the device cannot be cleared through the 510(k) process or is found ineligible for de novo reclassification. The premarket approval application process is generally more costly and time consuming than the 510(k) process. A premarket approval application must be supported by extensive data including, but not limited to, technical, preclinical, clinical trials, manufacturing and labeling to demonstrate to FDA’s satisfaction the safety and effectiveness of the device for its intended use.
 
 
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After a premarket approval application is sufficiently complete, FDA will accept the application and begin an in-depth review of the submitted information. By statute, FDA has 180 days to review the “accepted application,” although, generally, review of the application can take at least 12 to 18 months, but it may take significantly longer. During this review period, FDA may request additional information or clarification of information already provided. Also during the review period, an advisory panel of experts from outside FDA may be convened to review and evaluate the application and provide recommendations to FDA as to the approvability of the device. In addition, FDA will conduct a preapproval inspection of the manufacturing facility to ensure compliance with quality system regulations. New premarket approval applications or premarket approval application supplements are required for modifications that affect the safety or effectiveness of the device, including, for example, certain types of modifications to the device’s indication for use, manufacturing process, labeling and design. Premarket approval supplements often require submission of the same type of information as a premarket approval application, except that the supplement is limited to information needed to support any changes from the device covered by the original premarket approval application, and may not require as extensive clinical data or the convening of an advisory panel.
 
Clinical Trials

Clinical trials are almost always required to support a premarket approval application or de novo reclassification petition and are sometimes required for a 510(k) premarket notification. If the device presents a “significant risk,” as defined by FDA, to human health, FDA requires the device sponsor to file an IDE application with FDA and obtain IDE approval prior to commencing the human clinical trials. The investigational device exemption application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The investigational device exemption application must be approved in advance by FDA for a specified number of patients, unless the product is deemed a “non-significant risk” device and eligible for more abbreviated investigational device exemption requirements. Clinical trials for a significant risk device may begin once the investigational device exemption application is approved by FDA and the appropriate institutional review boards at the clinical trial sites. Future clinical trials of our motion preservation designs will require that we obtain an investigational device exemption from FDA prior to commencing clinical trials and that the trial be conducted under the oversight of an institutional review board at the clinical trial site. Our clinical trials must be conducted in accordance with FDA regulations and federal and state regulations concerning human subject protection, including informed consent and healthcare privacy. A clinical trial may be suspended by FDA or the investigational review board at any time for various reasons, including a belief that the risks to the study participants outweigh the benefits of participation in the study. Even if a study is completed, the results of our clinical testing may not demonstrate the safety and efficacy of the device, or may be equivocal or otherwise not be sufficient to obtain approval of our product. Similarly, in Europe the clinical study must be approved by the local ethics committee and in some cases, including studies of high-risk devices, by the Ministry of Health in the applicable country.
 
Pervasive and Continuing FDA Regulation

After a device is placed on the market, numerous regulatory requirements continue to apply. These include:
 
 
product listing and establishment registration, which helps facilitate FDA inspections and other regulatory action;
 
 
Quality System Regulation, or QSR, and current good manufacturing practices, or cGMP, which require manufacturers, including third-party manufacturers, to follow stringent design, testing, control, documentation and other quality assurance procedures during all aspects of the manufacturing process;
 
 
labeling regulations and FDA prohibitions against the promotion of products for uncleared, unapproved or off-label use or indication;
 
 
clearance of product modifications that could significantly affect safety or efficacy or that would constitute a major change in intended use of one of our cleared devices;
 
 
approval of product modifications that affect the safety or effectiveness of one of our approved devices;
 
 
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medical device reporting regulations, which require that manufacturers comply with FDA requirements to report if their device may have caused or contributed to a death or serious injury, or has malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction of the device or a similar device were to recur;
 
 
post-approval restrictions or conditions, including post-approval study commitments;
 
 
post-market surveillance regulations, which apply when necessary to protect the public health or to provide additional safety and effectiveness data for the device;
 
 
FDA’s recall authority, whereby it can ask, or under certain conditions order, device manufacturers to recall from the market a product that is in violation of governing laws and regulations;
 
 
regulations pertaining to voluntary recalls; and
 
 
notices of corrections or removals.

We and our third-party manufacturers must register with FDA as medical device manufacturers and must obtain all necessary state permits or licenses to operate our business. As manufacturers, we and our third-party manufacturers are subject to announced and unannounced inspections by FDA to determine our compliance with quality system regulation and other regulations. We have not yet been inspected by the FDA.
 
Failure to comply with applicable regulatory requirements can result in enforcement action by FDA, which may include any of the following sanctions:
 
 
untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties;
 
 
unanticipated expenditures to address or defend such actions;
 
 
customer notifications for repair, replacement, refunds;
 
 
recall, detention or seizure of our products;
 
 
operating restrictions or partial suspension or total shutdown of production;
 
 
refusing or delaying our requests for 510(k) clearance or premarket approval of new products or modified products;
 
 
operating restrictions;
 
 
withdrawing 510(k) clearances on PMA approvals that have already been granted;
 
 
refusal to grant export approval for our products; or
 
 
criminal prosecution.
 
Regulatory Pathway for our System
 

We have established a clinical and regulatory strategy with our advisors and have conducted a pre-IDE meeting, now referred to as a pre-submission meeting, with FDA (an informal interaction to facilitate a clearer understanding of FDA’s expectations). During this process, we received FDA’s feedback on our submission and our questions and we are planning to continue the dialogue with FDA before the submission of a formal request for the IDE that is necessary for us to conduct the U.S. pivotal clinical trial.
 
Our current strategy is to submit a direct de novo reclassification petition for our system. Although FDA could require us to submit a PMA, we believe that the device could be considered for evaluation under FDA’s de novo reclassification provisions, which allow a novel device to be reclassified into class I or class II. To support this, our objective is to demonstrate that device poses a low to moderate risk to patients.
 
We believe that important potential benefits of our system for CRC screening are the elimination of the need for bowel preparation, the elimination of the need for conscious sedation, the minimally invasive, painless nature of the examination, and the ability to pursue normal daily activities immediately following the procedure. Furthermore, the system is being designed to generate information from segments of the colon (e.g., cecum and ascending colon) that are difficult to access by conventional optical colonoscopy (i.e., incomplete colonoscopies) without the risks and discomforts of operative examination or other invasive methods. We believe these benefits will be attractive to a large number of patients from the target populations that so far refrained from any screening tests. Thus, we anticipate that our capsule will increase the public compliance to screening recommendation.
 
 
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If FDA determines that our system is not a candidate for de novo reclassification, it will require approval of the device for market through the PMA process. Because of the technological characteristics of this device, the non-clinical tests (including lab and animals) and clinical data required may not be significantly different between a de novo and PMA regulatory processes. We believe that under both scenarios, we will be required to conduct a multi-center clinical study to establish the safety and efficacy and to demonstrate sensitivity and specificity of our system in several hundreds of patients.
 
FCC Clearance and Regulation

Because our system includes a wireless radio frequency transmitter and receiver, it is subject to equipment authorization requirements in the United States. The U.S. Federal Communications Commission, or FCC, requires authorization of radio frequency devices before they can be sold or marketed in the United States, subject to limited exceptions. The authorization requirements are intended to confirm that the proposed products comply with FCC radio frequency emission, power level standards, and other technical requirements and will not cause interference. Our capsule is using the same frequency band as other approved capsules, and we expect that it will comply with the FCC’s technical requirements, so it is expected that it will be authorized by the FCC as well.
 
Third-Party Coverage and Reimbursement

Coverage of and reimbursement for our system and related procedures, after approval, will be subject to the requirements of various third-party payors, including government-sponsored healthcare payment systems and private third-party payors. Coverage policies and reimbursement methodologies vary significantly from program-to-program, and may be subject to federal and state regulations. For example, the Medicare statute requires all items and services to be “reasonable and necessary for the diagnosis or treatment of illness or injury or to improve the functioning of a malformed body member” in order to be covered. Medicare currently does not provide separate reimbursement for many devices, but may include payment for the device in the payment for the related procedure. Third-party payors’ coverage and reimbursement policies, including their interpretations of whether an item or service is “reasonable and necessary” or experimental and their payment methodologies, are subject to change pursuant to legislation, regulation, or, in the case of private payors, negotiations with providers.
 
Fraud and Abuse Laws

In the United States, the healthcare industry is subject to extensive federal, state, and local regulation. Both federal and state governmental agencies subject the healthcare industry to intense regulatory scrutiny, including heightened civil and criminal enforcement efforts. These laws constrain the sales, marketing and other promotional activities of manufacturers of medical devices, by limiting the kinds of financial arrangements (including sales programs) we may have with hospitals, physicians and other potential purchasers of the medical devices. The laws and regulations that may affect our ability to operate include, but are not limited to:
 
 
The federal Anti-Kickback Statute, which prohibits, among other things, knowingly or willingly offering, paying, soliciting or receiving remuneration, directly or indirectly, in cash or in kind, to induce or reward the purchasing, leasing, ordering or arranging for or recommending the purchase, lease or order of any health care items or service for which payment may be made, in whole or in part, by federal healthcare programs such as Medicare and Medicaid. This statute has been interpreted to apply to arrangements between medical device manufacturers on one hand and prescribers, purchasers and formulary managers on the other. Further, PPACA, among other things, clarified that a person or entity needs not to have actual knowledge of the federal Anti-Kickback Statute or specific intent to violate it. Although there are a number of statutory exemptions and regulatory safe harbors to the federal Anti-Kickback Statute protecting certain common business arrangements and activities from prosecution or regulatory sanctions, the exemptions and safe harbors are drawn narrowly, and practices that do not fit squarely within an exemption or safe harbor may be subject to scrutiny;
 
 
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The federal civil False Claims Act, which prohibits, among other things, individuals or entities from knowingly presenting, or causing to be presented, a false or fraudulent claim for payment of government funds or knowingly making, using or causing to be made or used, a false record or statement material to an obligation to pay money to the government or knowingly concealing or knowingly and improperly avoiding, decreasing, or concealing an obligation to pay money to the federal government. In addition, PPACA amended the Social Security Act to provide that the government may assert that a claim including items or services resulting from a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the federal civil False Claims Act. Many medical device manufacturers and other healthcare companies have been investigated and have reached substantial financial settlements with the federal government under the civil False Claims Act for a variety of alleged improper marketing activities, including providing free product to customers with the expectation that the customers would bill federal programs for the product; providing consulting fees, grants, free travel, and other benefits to physicians to induce them to use the company’s products. In addition, in recent years the government has pursued civil False Claims Act cases against a number of manufacturers for causing false claims to be submitted as a result of the marketing of their products for unapproved, and thus non-reimbursable, uses. Device manufacturers also are subject to other federal false claim laws, including, among others, federal criminal healthcare fraud and false statement statutes that extend to non-government health benefit programs;
 
 
Analogous state laws and regulations, such as state anti-kickback and false claims laws, may apply to items or services reimbursed under Medicaid and other state programs or, in several states, apply regardless of the payor. Several states now require medical device manufacturers to report expenses relating to the marketing and promotion or require them to implement compliance programs or marketing codes. For example, California, Connecticut and Nevada mandate implementation of corporate compliance programs, while Massachusetts and Vermont impose more detailed restrictions on device manufacturer marketing practices and tracking and reporting of gifts, compensation and other remuneration to health care providers;
 
 
The federal Foreign Corrupt Practices Act of 1997 and other similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from providing money or anything of value to officials of foreign governments, foreign political parties, or international organizations with the intent to obtain or retain business or seek a business advantage. Recently, there has been a substantial increase in anti-bribery law enforcement activity by U.S. regulators, with more frequent and aggressive investigations and enforcement proceedings by both the Department of Justice and the U.S. Securities and Exchange Commission. Violations of these laws can result in the imposition of substantial fines, interruptions of business, loss of supplier, vendor or other third-party relationships, termination of necessary licenses and permits, and other legal or equitable sanctions. Other internal or government investigations or legal or regulatory proceedings, including lawsuits brought by private litigants, may also follow as a consequence; and
 
 
The federal Physician Payment Sunshine Act, being implemented as the Open Payments Program, requires manufacturers of “covered products” (drugs, devices, biologics, or medical supplies for which payment is available under Medicare, Medicaid, or the Children’s Health Insurance Program) to track and publicly report payments and other transfers of value that they provide to U.S. physicians and teaching hospitals, as well as any ownership interests that U.S. physicians hold in applicable manufacturer.  Applicable manufacturers must submit a report to the Centers for Medicare & Medicaid Services, or CMS, by the 90th day of each calendar year disclosing payments and transfers of value made in the preceding calendar year.
 
Violations of any of the laws described above or any other governmental regulations that apply to us, we may be subject to significant civil, criminal and administrative penalties, damages, fines, exclusion from government-funded healthcare programs, like Medicare and Medicaid, and the curtailment or restructuring of our operations.
 
Privacy Laws

HIPAA/HITECH and related U.S. federal and state laws protect the confidentiality of certain patient health information, including patient records, and restrict the use and disclosure of that protected information. In particular, the U.S. Department of Health and Human Services promulgated patient privacy rules under the HIPAA.
 
These privacy rules protect medical records and other personal health information by limiting their use and disclosure, giving individuals the right to access, amend and seek accounting of their protected health information and limiting most use and disclosures of health information to the minimum degree reasonably necessary to accomplish the intended purpose. Because we intend to sell products, once approved, to persons and entities subject to HIPAA and are exposed to personally-identifiable health information in the course of our operations, we also may be subject to certain elements of HIPAA, particularly as a business associate to covered entities, as well as similar state laws. HIPAA imposes civil and criminal penalties for violations of its provisions, which could be substantial. State privacy laws have their own penalty provisions which may be applicable.
 
 
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NRC Regulatory Issues

As our system includes an ingestible capsule with a radioactive source, the company must address NRC regulations, or relevant Agreement State regulations, in addition to FDA requirements. An Agreement State is a state that has signed an agreement with the NRC authorizing the state to regulate certain uses of radioactive materials within the state. Agreement State regulations are substantially similar to the NRC’s regulations.
 
The capsule is loaded with the X-ray source, sealed and then ingested by the patient. The capsule is excreted naturally through the patient’s system and is not recovered and therefore is disposed of in the sanitary sewer system. Although the NRC regulations in 10 CFR Part 20 place certain conditions and limitations on the disposal of radioactive material in the sanitary sewer, such conditions and limitations do not apply to radioactive material contained in excreta of individuals that are undergoing medical diagnosis or therapy with radioactive material. Our regulatory advisors have advised us that the NRC staff likely would take the position that a capsule containing radioactive material can be passed in excreta into the sanitary sewer system without limitation. If, however, the NRC were to find that our capsule system could not be passed in excreta into the sanitary sewer system without limitation pursuant to 10 CFR 20.2003(b) the NRC may place restrictions on the disposal of the capsule system in the sanitary sewer system.
 
An entity which manufactures, prepares, or transfers a medical capsule containing radioactive byproduct material needs to be licensed or covered by a license issued by the NRC or an Agreement State. An NRC or Agreement State licensee authorized to possess and/or distribute byproduct material can transfer the byproduct material only to another NRC, or Agreement State, approved entity or licensee. The NRC’s regulations permit only individuals who are authorized users (e.g., individuals who meet certain training and experience criteria regarding the safe use of radioactive drugs) or persons working under the supervision of an authorized user to administer radioactive drugs for medical use.
 
The NRC regulations do exempt certain products from the NRC’s regulations. Existing exemptions from licensing requirements for the use of byproduct material include exemptions for specific products (e.g., time pieces), exemptions for classes of products (e.g., gas or aerosol detectors), and broader materials exemptions for “exempt concentrations” and “exempt quantities” of radioactive material. These two broad materials exemptions specifically exclude the transfer of byproduct material contained in any food, drug, or product designed for ingestion by a human being. Capsules containing our X-ray source would not qualify as an “exempt quantity” because of their intended use (i.e., for ingestion) even though they may contain a smaller quantity of the source than the exempt quantities set forth in the regulations.
 
Accordingly, we will need to obtain the appropriate licenses from the NRC or an Agreement State prior to the clinical investigation and/or marketing of the device. We intend to engage a radiopharmaceutical company to manufacture our system. The fact that another company will be manufacturing the capsule, however, does not exempt us from also obtaining radioactive materials licenses from the NRC or an Agreement State. Distribution activities are generally classified by the NRC as either “distribution” or “redistribution”, and both types of activities require a specific license. “Distribution” refers to the initial transfer from the manufacturing radiopharmacy, while “redistribution” refers to a subsequent transfer of the drug by an NRC licensee to an authorized user. In order to distribute the capsule commercially, we will need to obtain an NRC or Agreement State “medical distribution” radioactive materials license and may also need to obtain a radioactive materials license authorizing the possession of the radioactive material. Both types of licenses may be obtained by submitting a license application request to the NRC or an Agreement State. In the event that we develop the capsule outside the United States, we would be required to have one of our U.S. offices apply for and receive both the possession and medical distribution radioactive materials licenses. If we do not have an office in the United States, then we can contract with a company with a U.S. office to apply for and obtain these licenses, and that company would be the licensed U.S. distributor of the capsule.

We may be able to petition the NRC to carve out an exemption for the distribution licensing requirement to permit distribution to all health care professionals and not just those licensed by the NRC. This has been done successfully by other medical device companies. For example, Tri-Med, Inc. manufactures an ingestible capsule containing radioactive material for testing of H. Pylori. The company petitioned the NRC in 1994 for an exemption from the distribution licensing regulation. The NRC evaluated the petition and issued a proposed ruling for comments. After receiving comments on the proposed ruling, the NRC issued a final ruling, in 1997, providing for the exemption. This exemption is narrowly drawn, and specific to the distribution of a “radioactive drug containing one microcurie of carbon-14 urea to any person for ‘in vivo’ diagnostic use.” In creating the exemption, the NRC noted the importance of bringing an inexpensive and effective diagnostic tool to a large number of people, along with the minimum radiation contained in the capsule.
 
 
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We may consider petitioning the NRC in a similar manner to make the device more widely available. As our system imparts comparable radiation exposure to the Tri-Med device described above, and has the potential to be used widely for diagnosis, our system may be a candidate for such an exemption.
 
Regulation in Europe, Japan and Other Countries

In the EU, a company that wishes to bring a medical device to market must CE mark the device following demonstration of conformity with the Essential Requirements laid down in Annex I to the Medical Devices Directive.
 
Compliance with these requirements entitles manufacturers to affix the CE mark of conformity to their medical devices, without which the medical devices cannot be commercialized in the EU. To demonstrate compliance with the Essential Requirements laid down in Annex I to the Medical Devices Directive and obtain the right to affix the CE mark of conformity to our medical devices, we and our products must undergo a conformity assessment procedure, which varies according to the type of medical device and its classification. Apart from low risk medical devices (Class I with no measuring function and which are not sterile), in relation to which the manufacturer can issue an EC Declaration of Conformity based on self-assessment of the conformity of its products with the Essential Requirements laid down in the Medical Devices Directive, a conformity assessment procedure requires the intervention of a Notified Body, which is an organization designated by the competent authorities of a EU Member States to conduct conformity assessments. The Notified Body will typically audit and examine the Technical File that the manufacturer has created for the medical devices and the quality system for the manufacture, design and final inspection of the devices before issuing a CE Certificate of Conformity demonstrating compliance with the relevant Essential Requirements laid down in Annex I to the Medical Devices Directive or the quality system requirements laid down in the other Annexes to the Directive. Following the issuance of this CE Certificate of Conformity, the manufacturer is required to draw up an EC Declaration of Conformity and to affix the CE mark to the products covered by this CE Certificate of Conformity and the EC Declaration of Conformity.

We will be required to demonstrate that our products comply with the Essential Requirements laid down in Annex I to the Medical Devices Directive through a conformity assessment procedure. We cannot be certain that we will be able to fulfill the quality and performance requirements laid down in Annex I to the Medical Devices Directive and to obtain or maintain CE Certificates of Conformity for our products. If we are unable to obtain or maintain these CE Certificates of Conformity for our products, we will not be able to sell our products in any EU Member States nor in various other third countries where CE marking is accepted as evidence of compliance with relevant national laws.
 
In Japan, manufacturing and marketing medical devices are regulated by the Pharmaceutical Affairs Law, or PAL. In accordance with the PAL, manufacturers must obtain a license for manufacturing medical devices from the Ministry of Health, Labour and Welfare, or MHLW. A license is required for each manufacturing plant specified by an MHLW Ministerial Ordinance.

A licensed manufacturer is responsible only for manufacturing medical devices. In regard to the marketing of medical devices, the PAL specifies that a Marketing Authorization Holder, or MAH, licensed by MHLW is responsible for putting medical devices into marketplace. Licenses for marketing medical devices are divided into the following 3 types, which correspond to the classifications below:
 
 
No. 1 type license for marketing – Specially controlled medical devices (Class III, IV)
 
 
No. 2 type license for marketing – Controlled medical devices (Class II)
 
 
No. 3 type license for marketing – General medical devices (Class I)
 
Generally, the process for obtaining marketing clearance for medical devices in Japan ranges from twelve months for products with only very minor modifications from previously cleared product versions, to a few years in the case of a completely new device.
 
In order for us to market our products in countries other than the United States, the EU and Japan (which were described above), we must obtain regulatory approvals and comply with extensive safety and quality regulations in these countries. These regulations, including the requirements for approvals or clearance and the time required for regulatory review varies from country to country. It is customary that once a product has been cleared for sales in the US and is CE marked in the EU, many other countries will follow. Failure to obtain regulatory approval or clearance in any foreign country in which we plan to market our product may harm our ability to generate revenue and harm our business.
 
 
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Third-Party Reimbursement

Reimbursement in the United States

In the United States, healthcare providers that purchase medical devices generally rely on third-party payors, such as Medicare, Medicaid, private health insurance plans and health maintenance organizations, to reimburse all or a portion of the cost of the devices, as well as any related healthcare services utilizing the devices.

Coverage is not guaranteed simply because a product has received FDA clearance or approval. Medicare’s general definition of a medically necessary service is one that is reasonable and necessary for the diagnosis or treatment of an illness or injury, or that improves the functioning of a malformed body member. In order to be eligible for reimbursement, a device must be proven to be cost-effective, demonstrating potential decrease in spending to the U.S. health economy.
 
According to various studies and publications, a key criterion for to reimbursement for colon cancer screening is patient adherence (for instance, “Cost-Effectiveness of Colonoscopy in Screening for CRC,” Annals of Internal Medicine, October 17, 2000 vol. 133 no. 8 573-584). Adherence is strongly affected by patients’ willingness to use the device as a screening tool for CRC. Several models have been designed to demonstrate the cost effectiveness of optical colonoscopy, CTC, fecal testing and optical capsule endoscopy. Today, several technologies achieved Medicare coverage for CRC Screening, including: FOBT / FIT, Flexible Sigmoidoscopy, Optical Colonoscopy and Barium Enema, and stool DNA.

In 2009, the Centers for Medicare and Medicaid Services issued a decision memorandum rejecting federal reimbursement for CTC screening for CRC. Their main argument for the decision was that based on available evidence, screening with CTC would not necessarily result in cost saving, at least at current screening compliance rates. CTC was not seen as a tool which could potentially increase patients’ adherence. This procedure involves bowel preparation, as well as insufflations of the colon and the exposure of patients to very significant amount of radiation.
 
An important European study (C. Hassan et al, “Cost Effectiveness of Optical capsule endoscopy,” Endoscopy 2008, 40, 414-421) assessed the potential cost effectiveness of screening with optical capsule endoscopy and compared the cost-effectiveness with that of optical colonoscopy. Effectiveness of screening was measured in terms of life-years saved through prevention or down staging of CRC. The conclusion was that adherence to optical capsule endoscopy may be presumed to be substantially higher than that of optical colonoscopy.

Third-party payors in the United States began issuing coverage policies for optical capsule endoscopy in early 2002. Initially, all reimbursement policies provided coverage for optical capsule endoscopy of the small bowel only for the diagnosis of obscure gastrointestinal bleeding. Subsequently, reimbursement coverage has been expanded to include other diagnoses and as of December 31, 2012, approximately 220 million people in the United States are covered with most reimbursement policies providing coverage for a number of small bowel indications, including obscure gastrointestinal bleeding, suspected Crohn’s disease, suspected small bowel tumors and other small bowel pathologies.

In 2013, for procedures performed in a physician’s office, the national average global fee paid by Medicare under the CPT code for optical capsule endoscopy of the small bowel was $971. For procedures performed in an outpatient hospital setting, the national average physician fee paid by Medicare was $197 and the national average payment rate to the hospital for the technical component was $751. For optical capsule endoscopy of the esophagus, in 2013, the national average global fee paid by Medicare for a procedure in a physician’s office was $812. The national average physician fee paid by Medicare in an outpatient hospital setting was $54 and the national average payment rate to the hospital for the technical component was $927.

Below are the fees paid by Medicare in 2015 under the CPT code for screening optical colonoscopy for individuals not at high risk:
 
Payment for Physician’s Services:

Code
 
Description
 
Payment (1)
           
G0121
 
Colorectal cancer screening; colonoscopy on individual not meeting criteria for high risk
 
$
208.83

Payment for the Hospital:
               
Code
 
Short Description
 
APC
 
Payment (2)
G0105
 
Colorectal scrn; not high risk individual
 
0158 (CRC
 
$
646.73
 
 
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On December 2, 2015, Exact Sciences Corp. announced that it expects to be reimbursed 483.35 for Cologuard tests provided to Medicare beneficiaries.

Private Payers

The national average cost of an optical colonoscopy may range from $2,000 to $3,000. The cost also depends on the state or city in which the procedure takes place. Currently, there is no optical capsule endoscopy reimbursement available for the colon in the United States, nor is there a CPT code for such capsule or related method of screening. There can be no assurance that coverage will be obtained in the near future or at all. Third-party payors may deny coverage if they determine that a procedure was not reasonable or necessary as determined by the payor, was experimental or was used for an unapproved indication. During the past several years, the major third-party payors have substantially revised their reimbursement methodologies in an attempt to contain or reduce their healthcare reimbursement costs.
 
Reimbursement rates vary depending on the third-party payor and individual insurance plan involved, the procedure performed and other factors. Medicare reimbursement for in-patient hospital services is based on a fixed amount per admission based on the patient’s specific diagnosis and the procedure performed during the hospital stay. As a result, any illness to be treated or procedure to be performed in an in-patient setting will be reimbursed only at a prescribed rate set by the government.
 
Coverage Outside the United States

In countries outside the United States, coverage for CRC screening is obtained from various sources, including governmental authorities, private health insurance plans, and labor unions. In some countries, private insurance systems may also offer payments for some therapies. Although not as prevalent as in the United States, health maintenance organizations are emerging in certain European countries. Coverage systems in international markets vary significantly by country and, within some countries, by region. Coverage approvals must be obtained on a country-by-country or region-by-region basis.
 
C.  Organizational Structure
 
On May 15, 2015, we formed our wholly-owned subsidiary Check-Cap US, Inc., a Delaware corporation.
 
D.  Property, Plants and Equipment

Our principal executive offices and operations are conducted at a facility located in Isfiya, Mount Carmel, Israel since June 1, 2009. We lease approximately 610 square meters at this facility under a lease agreement providing for a term of 10 years, commencing on June 1, 2012 and ending on May 31, 2022, unless earlier terminated by us upon at least 60 days prior written notice, and in December 2015 we increased the leased premises at our Isfia facility by an additional 290 square meters for clinical and development purposes, to a total of 900 square meters, under an addendum to the lease agreement with similar terms as in our current lease agreement.. We believe that our current facilities are adequate to meet our current needs for the clinical phase of our development.
 
ITEM 4A. UNRESOLVED STAFF COMMENTS

None.
 
 
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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and related notes included in this Annual Report beginning on page F-1. The following discussion and analysis contain forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under Item 3D “Key Information - Risk factors” and elsewhere in this Annual Report.

Overview

We are a clinical stage medical diagnostics company engaged in the development of an ingestible capsule system that utilizes ultra low-dose X-rays for the detection and imaging of colonic polyps and colorectal cancers, or CRC.  While CRC is the second leading cause of death from cancer for both sexes combined in the United States and is largely preventable with early detection, according to 2013 National Health Interview Survey, only 58% of Americans between the ages of 50 to 75 reported being current with CRC screening recommendations.  Unlike other screening modalities that are designed to generate structural information of the internal colon for the detection of colonic polyps and CRC, such as optical colonoscopy, computed tomographic colonography, or CTC, and other capsule-based technologies, our system is designed to be ingested without any cathartic preparation of the colon, and to travel through the gastrointestinal tract naturally while the patient continues his or her normal daily routine.  Furthermore, unlike existing CRC imaging modalities currently on the market, all of which require the patient to fast for several hours prior to administration, the procedure for the Check-Cap system is designed to enable patients to continue eating normally. Our system is comprised of three main components: (1) ingestible scanning capsule; (2) Capsule Positioning System, or CPS, a recorder worn on the patient’s back; and (3) a PC-based work station for data reconstruction and image processing.  We believe that this solution will be attractive to both physicians and patients, with the potential to increase the number of people undergoing CRC screening.
 
Check-Cap LLC was formed in 2004 as a Delaware limited liability company to develop a novel and superior solution for colon cancer screening. In 2009, all of the business operations and substantially all of the assets of Check-Cap LLC were transferred to Check Cap Ltd., a newly-incorporated Israeli company. Our offices are located near Haifa, in the northern part of Israel. Our management team includes an experienced group of executives in the business, research, clinical and regulatory fields. As of February 15, 2016, our research and development team consists of 50 experienced professionals (including employees and independent contractors) in the fields of physics, electronics, software and mechanical engineering.

For the past several years, we have focused on the research and development of our imaging technology. We have successfully imaged sections of the colon's inner surfaces and detected polyps of various sizes in pigs without any prior bowel preparation through the insertion of a larger version of our system in their colons. We also conducted a clinical study in Europe with a passive (non-imaging) version of our capsule that has similar dimensions to our first prototype capsule, in order to collect pressure and motility data from humans. This information assisted in the development of the initial operational algorithm utilized by our capsule software or the version of our system used in humans.
 
A clinical proof-of-concept study, which was based on a 10-case study conducted at Tel Aviv Sourasky Medical Center in Israel and used a prior version of our system, did not identify any material safety or feasibility issues. The study demonstrated the applicability of our system to the human colon, generating images taken in the colon without any prior bowel preparation. All subjects ingested the capsule easily with smooth passage within the designated transit time, on average, within two to three days. There were no reported device-related adverse events. Mild effects on bowel movements were noted, which were determined to be related to the contrast agent and passed within one to two days after the capsule was excreted.

Another objective of the 10-case study was to estimate total radiation exposure for each case study. This was calculated using standard established factors for calculating effective radiation exposure, such as the duration of the capsule inside the body, and was based on the activity of the radiation source inside the scanning capsule and radiation energy, both of which were measured for each case study. The average calculated exposure for the entire procedure in the 10-case study, from ingestion of the capsule to excretion, was 0.03 mSv (STD 0.007 mSv). This level of radiation exposure is similar to a single chest X-ray (approximately 0.06mSv) and two orders of magnitude less than a CTC.

The 10-case clinical proof-of-concept study focused on assessing the safety and feasibility of our system. The 10-case study was the first phase of a multi-center, prospective clinical feasibility study to establish the safety, functionality and preliminary efficacy of our system in patients eligible for CRC screening, by comparing results from the clinical feasibility study with those from non-invasive, low-sensitivity FOBTs and FITs, as well as from optical colonoscopies. The feasibility study is designed allow for recruitment of 100 subjects. The study is being conducted at multiple centers in Israel, with the potential to be conducted at a single site in the Netherlands. The clinical feasibility study will evaluate the image resolution generated by the capsule in an a human colon without cathartic preparation, will assess polyp imaging in various shapes and in different segments of the colon and will evaluate the safety of the device in terms of total and segmental transit time and analyze the effects of the presence of polyps and variable colon dimensions on these parameters. The study will seek to create a clinical atlas of images that will enable comparisons between images acquired by different CRC screening modalities. During the feasibility study we will collect data about the overall imaging of the colon’s internal surfaces during the passage of the capsule to support the development of a correlation map of polyps identified through our imaging system with polyps imaged by optical colonoscopy and CTC.  Additionally, the feasibility study will measure total radiation exposure and the distribution of contrast material within the colon.
 
 
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 A preliminary analysis conducted on the first 49 capsules swallowed by participants enrolled in the multi-center, prospective clinical feasibility study showed 48 of 49 capsules swallowed and naturally eliminated without major or minor side effects after 73.2±45.4 hours. Image reconstructions allowed 3D views of the colonic wall and lumen with the typical contour of different segments (hepatic flexure, triangular shape of the transverse colon). Both pedunculated and sessile polyps were detected in several patients and validated later by colonoscopy.

To date, we have achieved key product development milestones, including the demonstrated ability of our system to reconstruct the human colon and to identify polyps, and design freeze of the current version of our system. Following the successful completion of the multi-center, prospective clinical feasibility study and design release and transfer to manufacturing phases, we plan to submit during the second half of 2016, a request for CE marking for the marketing and sale of our capsule in the European Union. We expect to perform post-marketing studies in Europe following CE marking for the purpose of collecting additional clinical data to support market adoption. Subject to regulatory approvals, available capital, and engagement with strategic partners, we anticipate launching our system commercially in Europe during 2017.

We plan to conduct a pre-submission meeting with the U.S. Food and Drug Administration, or FDA, during 2016. Subject to this meeting, we plan subsequently to submit a request for the approval of an investigational device exemption, or IDE, for a pilot study in the United States. Subject to successful completion of the pilot study and receipt of required approvals, we plan to initiate during 2017, a pivotal study in the United States to (i) demonstrate device safety as evidenced by a lack of device-related serious adverse events; and (ii) provide efficacy data concerning our system’s performance.  We anticipate that FDA approval for the pivotal study will be subject to our providing sufficient clinical data from previous clinical studies, which may include the multi-center, prospective clinical feasibility study and U.S. pilot study. However, there can be no assurance that the FDA will grant approval for the pilot and/or pivotal studies to be conducted in the United States.
 
We also intend to pursue clinical trials for regulatory approvals in Japan and China in parallel to the U.S. pivotal study, subject to available capital and engagement with strategic partners.  Pivotal studies are expected, among other things, to compare polyps identified by our system with the polyps identified by traditional optical colonoscopy. These clinical findings may be analyzed in comparison with results obtained from FOBTs and FITs.

Following and subject to the successful completion of our pivotal trial, our current strategy is to submit a direct de novo reclassification petition, which we anticipate submitting in 2018, for initial FDA clearance for the marketing of our system in the United States. Direct de novo reclassification typically takes at least 9 to 12 months from filing to clearance. If the FDA determines that our system is not a candidate for de novo reclassification, it will require approval of the device for market through the PMA process The PMA pathway is much more costly and uncertain than the 510(k) clearance process or de novo reclassification, and generally takes at least 12 to 18 months, or even longer, from the time the application is filed with FDA to ultimate approval.

Timelines expectations are based on our current estimations and expectations, which may continue to be updated along with our progress, which is subject to the occurrence of various factors and future events, among others, the satisfactory completion of system’s development process, testing, and integration, which may require more time than currently expected, as well as the success of our clinical trials and the completion of our required regulatory approvals, all of which are uncertain as of the date of this Annual report.

Our system is being designed to create a reconstructed three-dimensional image of the interior surface of the colon and to enable detection of clinically significant polyps with a high degree of sensitivity. Colonic polyps are tissue growths that occur on the lining of the colon. Polyps in the colon are extremely common, and certain types of polyps can become cancerous over time.

Our scanning capsule will be swallowed by the patient and propelled by natural motility through the gastrointestinal tract and excreted naturally with no need for retrieval for data collection. Unlike other CRC screening methods, this process should not disrupt a patient’s normal activities or require fasting. Our scanning capsule employs low-dose X-rays, which allow the system to image the inner surface of the colon even when surrounded by intestinal content.  As such, we believe that patients using our system will not be required to undergo any prior bowel preparation. The Radiation Safety Division of the Soreq Nuclear Research Center found, as set forth in its report of November 2010 that was prepared at our request and based on the information provided by us and the relevant methods and principles known at such time, or the Report, that the radiation dose to the patient in the proposed screening procedure utilizing the scanning device developed by us at that time in routine operation and normal conditions is low relative to the radiation dose involved in conventional imaging procedures using X-rays (such as fluoroscopy and CT) and is also low when compared to the radiation dose involved in established screening procedures such as mammography, all as more fully described in the Report.
 
 
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Our scanning capsule is being designed to transmit position, motility, and the data it collects to an external data recorder and capsule positioning system (CPS) that will be worn by the patient. The external data recorder is being designed to enable the transfer of the data to our PC-based work station with viewer software application to allow physicians to analyze the data collected by our scanning capsule. The CPS is being designed to provide the physician with accurate localization data aligned with a reconstructed image. We intend for physicians to be able to review the colon’s inner images at any location at any time, in less time than is required to perform an optical colonoscopy.

In order to enable a complete view of capsule positioning and motility, we have designed a data recorder and Capsule Positioning System, or CPS, which is worn on the patient’s back throughout the entire procedure. The CPS is being designed to provide the physician with accurate localization data aligned with a reconstructed image.
 
In the event that polyps are identified through our system, the patient may be advised to undergo a subsequent traditional colonoscopy procedure to examine, remove and biopsy the polyps. For those patients who require a subsequent polypectomy, concerns regarding pain, discomfort and embarrassment may still remain with respect to the subsequent polypectomy. We do not, however, believe that these concerns will make the use of our system any less attractive to physicians and patients. Although patients who are initially screened utilizing a traditional colonoscopy could avoid the need for a second procedure if polyps are discovered because they could undergo a polypectomy during the initial screening, if necessary, we believe that our system will still be attractive to physicians and patients as a large majority of patients who are screened will not require a subsequent polypectomy. Published data from a multi-center CT colonography screening study of 2,531 asymptomatic adults showed that if all patients with a lesion measuring 5mm or more on CT colonography were referred for colonoscopy, the colonoscopy-referral rate would have been 17%.
 
We have submitted patent applications covering our technology in the United States, member states of the European Patent Organisation, Australia, Brazil, Canada, China, Hong Kong, India, Israel, Japan and South Korea. We have been granted patents for our core patent by the U.S. Patent and Trademark Office as well as from the European Patent Office, Australia, China, Hong Kong, Israel, India and Japan. We also filed patent applications describing the use of our technology in several other medical applications.

We have generated significant losses to date, and we expect to continue to generate losses for at least the next several years as we continue our investment in research and development and clinical trials in order to complete the development of our system and to attain regulatory approvals, begin the commercialization efforts for our products, increase our marketing and selling expenses, and incur additional costs as a result of becoming a public company in the United States. The extent of our future operating losses and the timing of becoming profitable are highly uncertain, and we may never achieve or sustain profitability. As of December 31, 2015, we had accumulated losses of approximately $34.1 million.

On February 24, 2015, we consummated an initial public offering of 2,000,000 units, each consisting of one ordinary share and one half of a Series A Warrant to purchase one ordinary share. The price per unit sold in the initial public offering was $6.00.  Each unit in the initial public offering was issued with one and one half Long Term Incentive Warrants. We granted the underwriters in the initial public offering a 45-day over-allotment option to purchase up to 300,000 additional units (together with an accompanying 450,000 Long Term Incentive Warrants) from us to cover over-allotments.  On March 6, 2015, the option to purchase additional 100,000 units was partially exercised. On March 18, 2015, the units were separated into one ordinary share and one-half of a Series A Warrant to purchase one ordinary share and the units ceased to exist. On April 6, 2015, the option to purchase additional 150,000 ordinary shares and 75,000 Series A Warrant was partially exercised.  The aggregate offering price of the securities sold in the initial public offering (including the over-allotment option) was approximately $13.5 million. The total expenses of the offering, including underwriting discounts and commissions, were approximately $2.9 million (including certain warrants with value of $196,000 issued in connection with the IPO). The net proceeds we received from the initial public offering (including the over-allotment option) was approximately $10.8 million.  Concurrently with our initial public offering, we consummated the private placement of 2,000,000 units in a private placement and received aggregate gross proceeds of $12,000,000 from the private placement.  We believe that the net proceeds from our initial public offering and concurrent private placement, together with our existing cash, will be sufficient to fund our currently anticipated cash requirements at least until March 31, 2017. Nevertheless, we will require significant additional financing in the future to fund our operations if and when we progress with our clinical trials in Europe and the United States, and other territories. 
 
For a more detailed description of our business and plans, see Item 4B “Information on Our Company – Business Overview.”
 
 
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A.  
Operating Results

Financial Operations Overview

Revenue

We have not generated any revenue since our inception. To date, we have funded our operations primarily through equity financings, as well as from grants that we received from the OCS. If our product development efforts result in clinical success, regulatory approval and the successful commercialization of our imaging system, we expect to generate revenue from sales of our imaging system.

Operating Cost and Expenses

Our operating costs and expenses are classified into two categories: research and development expenses and general and administrative expenses. For each category, the largest component is personnel costs, which consists of salaries, employee benefits and share-based compensation. Operating costs and expenses also include allocated overhead costs for depreciation of equipment. Operating costs and expenses are generally recognized as incurred. We expect personnel costs to continue to increase as we hire new employees to continue to grow our business.

Research and Development Expenses, Net

Research and development activities are central to our business model. We intend to increase our research and development operations in order to complete the development of our imaging system and to attain regulatory approvals.

Since 2013, we have spent approximately $11.6 million on research and development expenses as of December 31, 2015, of which $1.1 million was funded by government grants. Our total research and development expenses, net of participations in the years ended December 31, 2015, 2014 and 2013 were approximately $5.8 million, $2.8 million and $2.9 million, respectively. All research and development expenses are expensed as incurred. We expect research and development expenses to increase in absolute terms in the near term.

Research and development expenses consist primarily of costs incurred for our research activities, including:
 
 
employee-related expenses for research and development staff, including salaries, benefits and related expenses, including share-based compensation and travel expenses;

 
payments made to third-party contract research organizations, contract manufacturers, investigative sites and consultants;
 
 
manufacturing development costs;

 
costs associated with preclinical and clinical activities and regulatory operations;
 
 
facilities, depreciation and other expenses, which include direct and allocated expenses for rent and maintenance of facilities; and

 
costs associated with obtaining and maintaining patents.

Our research and development expenses, net are net of grants we have received from the Government of Israel through the OCS. In exchange for these grants, we are required to pay the OCS royalties from our revenues up to an aggregate of 100% (which may be increased under certain circumstances) of the U.S. dollar-linked value of the grant, plus interest at the rate of 12-month LIBOR. Pursuant to regulations under the Research Law, the rate of repayment ranges between 3% to 5% of revenues (or 6% with respect to certain limited programs and at an increased rate under certain circumstances). As of December 31, 2015, we had received funding from the OCS in the aggregate amount of $3.6 million. As of December 31, 2015, we had not paid any royalties to the OCS and had a contingent obligation to the OCS in the amount of  $3.8 million. In December 2015, we received approval for an additional grant from the OCS in the amount of up to $340,000, and in January 2016, we applied for an additional grant from the OCS in the amount of up to $6.9 million. For additional information regarding the OCS grants, see Item 5B “Operating and Financial Review and Prospects - Liquidity and Capital Resources – Application of Critical Accounting Policies and Estimates –Royalties provision - Government grants from the Office of the Chief Scientist and BIRD Foundation” and in Item 10E “Additional Information - Taxation - Israeli Tax Considerations and Government Programs - The Encouragement of Industrial Research and Development Law, 5744-1984.” There can be no assurance that we will continue to receive grants from the OCS in amounts sufficient for our operations, if at all.
 
 
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As of December 31, 2015, we had received funding from the BIRD Foundation of $127,000 as part of a grant for the funding of a project entitled “Collection & Analysis of Gastrointestinal Images for Diagnostic Adenomatic Polyps and Colorectal Cancer.” We expect to receive an aggregate of $900,000 to fund our expenditures for the project, in five installments. As of December 31, 2015, we had not paid any royalties to the BIRD Foundation and had a contingent liability to BIRD Foundation in the amount of $127,000. See Item 5B “Operating and Financial Review and Prospects — Liquidity and Capital Resources — Sources of Liquidity” for a description of the Cooperation and Project Funding Agreement with the BIRD Foundation and Synergy Research Inc., or Synergy.
 
General and Administrative Expenses

Our general and administrative expenses consist primarily of salaries and other related costs, including share-based compensation expense, for persons serving as our executive, finance, legal, human resources and administrative personnel, professional service fees and other general corporate expenses, such as communication, office and travel expenses. We expect that our general and administrative expenses will continue to increase in the future as we incur additional general and administrative costs associated with being a public company in the United States, including compliance under the Sarbanes-Oxley Act of 2002 and rules promulgated by the U.S. Securities and Exchange Commission. These public company-related expense increases will likely include costs of additional legal fees, accounting and audit fees, directors’ and officers’ liability insurance premiums and costs related to investor relations.

Financial Income and Finance

Our finance income and finance expenses consist primarily of fair value changes with respect to warrants to purchase Series D-1 and D-2 preferred shares issued to investors and service providers in connection with our D1 investment round, and warrants to purchase Series C-1 preferred shares and warrants to purchase Series C-2 preferred shares issued to Pontifax (investing through three affiliated funds: Pontifax (Cayman) II, L.P., Pontifax (Israel) II L.P., Pontifax (Israel) II- Individual Investors L.P. which we collectively refer to as the “Pontifax Funds”), interest earned on our cash, cash equivalents and short-term investments and changes in provision for royalties primarily to Check –Cap LLC unitholders.

Foreign currency transactions are translated into U.S. dollars using the exchange rates prevailing at the dates of the transactions or valuation where items are re-measured. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation of year-end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognized in the statement of operations to “finance expenses”/“finance income.”

Taxes on Income

The standard corporate tax rate in Israel for the 2015 and 2014 tax years is 26.5%, increased from 25% for the tax year 2013 and decreased to 25% for the 2016 tax year.

We do not generate taxable income in Israel, as we have historically incurred operating losses resulting in carry forward tax losses totaling approximately $23.6 million as of December 31, 2015. We anticipate that we will be able to carry forward these tax losses indefinitely to future tax years. However, a tax loss that can be utilized in a certain tax year, cannot be carried forward to future tax years. Accordingly, we do not expect to pay taxes in Israel until we have taxable income after the full utilization of our carry forward tax losses.

Under the Law for the Encouragement of Capital Investments, 5719-1959 and other Israeli legislation, we may be entitled to certain additional tax benefits, including reduced tax rates, accelerated depreciation and amortization rates for tax purposes on certain assets, deduction of public offering expenses in three equal annual installments and amortization of other intangible property rights for tax purposes. See Item 10E “Additional Information — Taxation— Israeli Tax Considerations and Government Programs” for additional information concerning these tax benefits.
 
 
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Results of Operations
 
         For convenience purposes, the numbers set forth in the management's discussion and analysis below are, where applicable, rounded up and presented in millions, whereas the numbers in the tables below are presented in thousands.  As result, the percentages set forth in the year-over-year comparisons below are based on numbers that have (where applicable) been rounded up to millions, which may slightly differ than the percentages that would result from the corresponding numbers set forth in the table that are presented in thousands.

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

   
Year Ended December 31,
 
   
2015
   
2014
 
   
(US$ in thousands, except per
share data)
 
Research and development expenses, net
 
$
5,837
   
$
2,832
 
General and administrative expenses
   
6,626
     
1,703
 
Operating loss
   
12,463
     
4,535
 
Finance income, net
   
173
     
3,925
 
Net loss
 
$
12,290
   
$
610
 
 
Research and Development Expenses, net. Our total research and development expenses for the year ended December 31, 2015 were $5.8 million, as compared with $2.8 million for the year ended December 31, 2014, an increase of $3.0 million or 107%. The increase in research and development expenses between 2015 and 2014 was primarily due to the progress in the development of our imaging system, including increased expenditures due to clinical trial costs associated with the recruitment of 28 employees and independent contractors to the research and development team.
 
   
2015
   
2014
   
Change
 
   
(US$ in thousands)
 
Salaries and related expenses
 
$
3,585
   
$
2,425
   
$
1,160
 
Share-based compensation
   
790
     
104
     
686
 
Materials
   
608
     
385
     
223
 
Subcontractors and consultants
   
688
     
294
     
394
 
Depreciation
   
85
     
 72
     
13
 
Cost for registration of patents
   
153
     
72
     
81
 
Other research and development expenses
   
282
     
123
     
159
 
     
6,191
     
3,475
     
2,716
 
Less participation of the OCS and BIRD Foundation
   
(354)
     
(643
)
   
289
 
Total research and development expenses, net
 
$
5,837
   
$
2,832
   
$
3,005
 
 
General and Administrative Expenses. Our general and administrative expenses for the year ended December 31, 2015 were $6.6 million, as compared to $1.7 million for the year ended December 31, 2014, an increase of $4.9 million, or 288%. The increase in general and administrative expenses is primarily due to the following:

·  
a $2.7 million increase in share-based compensation, of which $2.0 million relates to the grant of options to purchase 581,542 ordinary shares from October 14, 2015 to our management and warrants to purchase 221,539 ordinary shares to Pontifax in consideration of their commitment to provide us, for no additional consideration, business development services and a representative designated by Pontifax to serve as the chairman of our Board of Directors, as further described in Note 11B  to our financial statements appearing elsewhere in this Annual Report.

·  
a $2.2 million increase in salaries and related expenses, professional services and other general administrative expenses incurred in connection with our initial public offering and concurrent private placement and other public company costs.
 
   
2015
   
2014
   
Change
 
   
(US$ in thousands)
 
Salaries and related expenses
 
$
1,830
   
$
952
   
$
878
 
Share-based compensation
   
2,934
     
208
     
2,726
 
Professional services
   
609
     
114
     
495
 
Office rent and maintenance
   
108
     
105
     
3
 
Depreciation
   
7
     
7
     
-
 
Other general and administrative expenses
   
1,138
     
317
     
821
 
Total general and administrative expenses
 
$
6,626
   
$
1,703
   
$
4,923
 

 
 
67

 

Operating Loss. As a result of a $3.0 million increase in research and development expenses, net for the year ended December 31, 2015 compared to the year ended December 31, 2014, and a $4.9 million increase in general and administrative expenses in the same period, our operating loss for the year ended December 31, 2015 was $12.5 million, as compared with $4.5 million for the year ended December 31, 2014, an increase of $8.0 million, or 178%.

Finance Income, net. Our finance income, net for the year ended December 31, 2015 was $173,000, as compared to $3.9 million for the year ended December 31, 2014, a decrease of $3.8 million. The change in our finance income, net is primarily due to the following:

·  
For the year ended December 31, 2014 we had finance income of $3.5 million as a result of changes in fair value of the warrants to purchase Series D-1 and D-2 preferred shares issued to investors and service providers in connection with our D1 investment round and the warrants to purchase Series C-1 and C-2 preferred shares issued to Pontifax, as compared with $174,000 for the year ended December 31, 2015.

·  
For the year ended December 31, 2014, we had finance income of $415,000 as a result of changes in provision for royalties, as compared with a finance expense of $33,000 in the year ended December 31, 2015.
 
Net Loss. Our net loss for the year ended December 31, 2015 was $12.3 million, as compared to $610,000 for the year ended December 31, 2014, an increase of $11.7 million.

Year Ended December 31, 2014 Compared to Year Ended December 31, 2013
 
   
Year Ended December 31,
 
   
2014
   
2013
 
   
(US$ in thousands, except per share data)
 
Research and development expenses, net
 
$
2,832
   
$
2,893
 
General and administrative expenses
   
1,703
     
1,090
 
Other income
   
-
     
(11
)
Operating loss
   
4,535
     
3,972
 
Finance income, net
   
3,925
     
604
 
Net loss
 
$
610
   
$
3,368
 
 
Research and Development Expenses, net. Our total research and development expenses, net for the year ended December 31, 2014 were $2.83 million, as compared with $2.89 million for the year ended December 31, 2013, a decrease of $61,000 or 2.0%. The decrease in research and development expenses between 2014 and 2013 was primarily due to a $495,000 increase in grants we received from OCS and BIRD Foundation. This increase, however, was partially offset primarily by  increases in cost of salaries and related expenses, share-based compensation, materials, amounts payable to subcontractors and consultants, depreciation and other research and development expenses, mainly clinical trial-related expenses (all of which amounted to an increase of $478,000).

   
2014
   
2013
   
Change
 
   
(US$ in thousands)
 
Salaries and related expenses
 
$
2,425
   
$
2,178
   
$
247
 
Share-based compensation
   
104
     
40
     
64
 
Materials
   
385
     
307
     
78
 
Subcontractors and consultants
   
294
     
218
     
76
 
Depreciation
   
72
     
70
     
2
 
Cost for registration of patents
   
72
     
118
     
(46
)
Other research and development expenses
   
123
     
110
     
13
 
     
3,475
     
3,041
     
434
 
Less participation of the OCS and BIRD Foundation
   
(643
)
   
(148
)
   
(495
)
Total research and development expenses, net
 
$
2,832
   
$
2,893
   
$
(61
)

 
68

 
 
General and Administrative Expenses. Our general and administrative expenses for the year ended December 31, 2014 were $1.7 million, as compared to $1.1 million for the year ended December 31, 2013, an increase of $613,000, or 54.5%. The increase in general and administrative expenses is primarily related to expenses incurred in connection with our initial public offering and concurrent private placement.
 
   
2014
   
2013
   
Change
 
   
(US$ in thousands)
 
Salaries and related expenses
 
$
952
   
$
682
   
$
270
 
Share-based compensation
   
208
     
16
     
192
 
Professional fees
   
114
     
96
     
18
 
Office rent and maintenance
   
105
     
104
     
1
 
Depreciation
   
7
     
7
     
-
 
Other general and administrative expenses
   
317
     
185
     
132
 
Total general and administrative expenses
 
$
1,703
   
$
1,090
   
$
613
 
 
Operating Loss. As a result of a $61,000 decrease in research and development expenses, net for the year ended December 31, 2014 compared to the year ended December 31, 2013, and a $613,000 increase in general and administrative expenses in the same period, our operating loss for the year ended December 31, 2014 was $4.53 million, as compared to $3.97 million for the year ended December 31, 2013, an increase of $563,000, or 14.2%.

Finance Income, net. Our finance income, net for the year ended December 31, 2014 was $3,925,000, as compared to $604,000 for the year ended December 31, 2013, an increase of $3,321,000.  The change in our finance income, net is primarily due to the following:

·  
For the year ended December 31, 2014 we had a finance income of $3.5 million as a result of a changes in fair value of the warrants to purchase Series D-1 and D-2 preferred shares issued to investors and service providers in connection with our D1 investment round and the warrants to purchase Series C-1 and C-2 preferred shares issued to Pontifax, as compared with $623,000 in the year ended December 31, 2013.

·  
For the year ended December 31, 2014 we had a finance income of $415,000 as a result of changes in provision for royalties, as compared with a finance expense of $104,000 in the year ended December 31, 2013.
 
Net Loss. Our net loss for the year ended December 31, 2014 was $610,000, as compared to $3.4 million for the year ended December 31, 2013, a decrease of $2.8 million.
 
B.  
Liquidity and Capital Resources

Sources of Liquidity

To date, we have funded our operations primarily with the approximately $24.5 million raised through equity financings consummated prior to our initial public offering, $13.5 million through our initial public offering (including the over-allotment exercise), $12.0 million through the private placement consummated concurrently with our initial public offering, $3.6 million through grants that we received from the OCS and the BIRD Foundation and $1.0 million drawn down under a credit line.  The cash proceeds from our initial public offering and concurrent private placement were received subsequent to year end and do not form part of the cash, net asset or working capital figures noted above.
 
On July 13, 2014, we entered into a Cooperation and Project Funding Agreement with the BIRD Foundation and Synergy, pursuant to which the BIRD Foundation has agreed to award a grant in the maximum amount of the lesser of (i) $900,000; and (ii) 50% of the actual expenditures for the funding of a project entitled “Collection & Analysis of Gastrointestinal Images for Diagnostic Adenomatic Polyps and Colorectal Cancer.” The development work is expected to be performed over a 24 month period by Synergy (or a subcontractor on its behalf) and us. As of December 31, 2015, we had received funding from the BIRD Foundation in the aggregate amount of $127,000. Our research and development expenses, net is presented net the grant amount received from the BIRD Foundation. As of December 31, 2015 we had a contingent obligation to the BIRD foundation in the amount of $127,000.
 
 
69

 

 
We are required to repay the total sum granted to us and Synergy by the BIRD Foundation, linked to the U.S. Consumer Price Index from date of receipt of each payment, up to 100%, 113%, 125%, 138% and 150% of the linked sum granted by the BIRD Foundation if repaid within one year, two years, three years, four years and five or more years, respectively, of the original project completion date in accordance with the project proposal. Repayments are made at the rate of 5% of gross revenues derived from the product funded by the project. Under the terms of the agreement, if any portion of the product funded by the project is sold outright to a third party prior to full repayment of the grant to the BIRD Foundation, one-half of the sale proceeds will be applied to the repayment of the grant. If the funded product is licensed to a third party, 30% of all payments received under the respective license agreement must be paid to the BIRD Foundation in repayment of the grant.

On August 20, 2014, we entered into a certain credit line agreement, pursuant to which we obtained a credit line in an aggregate principal amount of $12 million from certain lenders and existing shareholders, or the Lenders. The credit line amount was deposited in an escrow account at the closing, which was consummated on October 14, 2014.

We issued to each Lender at closing a warrant, collectively referred to as the Credit Line Warrants, to purchase a number of our ordinary shares constituting 2% of our share capital on a fully diluted basis (assuming conversion of all of our then outstanding convertible securities into ordinary shares at a 1:1 conversion rate) as of the closing for each $1 million (or portion thereof) extended by such Lender. We issued Credit Line Warrants to purchase in the aggregate 2,658,463 of our ordinary shares. The Credit Line Warrants are exercisable for a period of ten years at an exercise price of NIS 0.20 per share, and may be exercised on a net issuance basis. As of December 31, 2015, Credit Line Warrants to purchase an aggregate 1,557,507 ordinary shares have been exercised and Credit Line Warrants to purchase an aggregate 24,277 warrants expired as a result of exercise, of certain Credit Line Warrants, on a net issuance basis.

Under the terms of the credit line agreement, we directed that the full credit line amount be invested in the private placement that was consummated simultaneously with our initial public offering that was consummated on February 24, 2015.  We issued to the Lenders a total of 2,000,000 units, each consisting of one ordinary share and one half of a Series A Warrant to purchase one ordinary share, together with 3,000,000 Long Term Incentive Warrants for aggregate gross proceeds of $12,000,000.

On January 4, 2015, we entered into a credit line agreement with Bank Leumi le-Israel B.M., or Bank Leumi, pursuant to which we were entitled to obtain a credit line in the principal amount of up to $1,000,000, or the Bank Leumi Credit Facility. The Bank Leumi Credit Facility was required to be repaid in full by us no later than April 1, 2015 and Bank Leumi’s consent was required for early repayment. The drawn portion of the Bank Leumi Credit Facility bore interest at an annual rate of LIBOR plus 5.25% on the basis of a 365-day year, until paid in full. We drew the entire $1,000,000 Bank Leumi Credit Facility. We paid Bank Leumi a facility fee of $20,000 in connection with the facility. To secure the repayment of the Bank Leumi Credit Facility, we granted Bank Leumi (i) a first ranking fixed charge over our goodwill; and (ii) a first ranking floating charge over all of the assets and rights of any type whatsoever, which we had or may acquire in the future, subject to the rights of the OCS and the BIRD Foundation and the rights under existing and future liens in favor of the First Intentional Bank of Israel Ltd. securing debt or indentures of up to an aggregate amount of $100,000.  On March 16, 2015, we repaid all amounts outstanding under the Bank Leumi Credit Facility with the proceeds of our initial public offering and concurrent private placement.

On February 24, 2015, we consummated an initial public offering in the United States of 2,000,000 units, each consisting of one ordinary share and one half of a Series A Warrant to purchase one ordinary share. The price per unit sold in the initial public offering was $6.00.  Each unit in the initial public offering was issued with one and one half Long Term Incentive Warrants. We granted the underwriters in the initial public offering a 45-day over-allotment option to purchase up to 300,000 additional units (together with an accompanying 450,000 Long Term Incentive Warrants) from us to cover over-allotments.  On March 6, 2015, the option to purchase additional 100,000 units was partially exercised. On March 18, 2015, the units were separated into one ordinary share and one-half of a Series A Warrant to purchase one ordinary share and the units ceased to exist. On April 6, 2015, the option to purchase additional 150,000 ordinary shares and 75,000 Series A Warrant was partially exercised. The aggregate offering price of the securities sold in the initial public offering (including the over-allotment option) was approximately $13.5 million. The total expenses of the offering, in cash, including underwriting discounts and commissions, were approximately $2.9 million. Issuance expenses include certain warrants with value of $196,000 issued in connection with the initial public offering. The net proceeds we received from the initial public offering (including the over-allotment option) was approximately $10.8 million, (net of issuance cost of approximately $1.2 million, including certain warrants with value of $125 issued in connection with the private placement). In January, 2015, we issued a total of 2,452,376 Long Term Incentive Warrants to purchasers of securities in our initial public offering who completed the required registration process by August 23, 2015.
 
 
70

 

 
Immediately prior to the consummation of the initial public offering, certain members of the Company's management exercised 307,467 options granted to them under the 2006 Unit Option Plan.

For the years ended December 31, 2015, 2014 and 2013, we received, in cash, $11,000, $558,000 and $647,000, respectively, in grants from the OCS for the financing of a portion of our research and development expenditure.

We believe that based on our current business plan, our existing cash resources and the net proceeds from our initial public offering and concurrent private placement will be sufficient to fund our currently anticipated cash requirements at least until March 31, 2017. Nevertheless, we will require significant additional financing in the future to fund our operations if and when we progress with our clinical trials in Europe and the United States, and other territories.

Historical Cash Flows

The following table summarizes our statement of cash flows for the years ended December 31, 2015, 2014 and 2013.

   
Year Ended December 31,
 
   
2015
   
2014
   
2013
 
   
(US$ in thousands)
 
Net cash used in operating activities
  $ (8,628 )   $ (3,855 )   $ (3,010 )
Net cash provided by (used in) investing activities
  $ (5,070 )