ITEM 3. KEY INFORMATION

 

A. SELECTED CONSOLIDATED FINANCIAL DATA

 

We have prepared our historical consolidated financial statements in accordance with generally accepted accounting principles in the United States (U.S GAAP). The following financial data for the years ended December 31, 2005, 2006 and 2007, for the period from March 9, 2000 (date of inception) through December 31, 2007 and as of December 31, 2006 and 2007 have been derived from our audited financial statements which are included elsewhere in this Annual Report. The following financial data for the years ended December 31, 2003 and 2004 and as of December 31, 2003, 2004 and 2005 have been derived from our audited financial statements which are not included in this Annual Report. You should read this information in conjunction with our consolidated financial statements, including the related notes, and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this Annual Report. Our historical results for any prior period are not necessarily indicative of results to be expected for any future period.

 

 

 

 

B. CAPITALIZATION AND INDEBTEDNESS

 

Not applicable.

 

C. REASONS FOR THE OFFER AND USE OF PROCEEDS

 

Not applicable.

 

D. RISK FACTORS

 

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

 

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

 

The approach we are taking to discover and develop novel diagnostic and therapeutic products is new and may never lead to marketable products.

 

We have concentrated our efforts on diagnostic and therapeutic product research in the new field of microRNAs. To date, no one has applied for, or been granted, regulatory approval to market diagnostic or therapeutic products based on microRNAs. The scientific discoveries that form the basis for our efforts to develop new diagnostic and therapeutic products are relatively new. The scientific evidence to support the feasibility of developing products based on these discoveries is both preliminary and limited. Further, our focus solely on developing microRNA-based diagnostic and therapeutic products as opposed to multiple or more proven technologies for the development of diagnostic and therapeutic products increases the risks associated with the ownership of our ordinary shares. If we or a collaborative partner are not successful in developing microRNA-based products, we may be required to change the scope and direction of our product development activities. In that case, if we are not be able to identify and successfully implement an alternative product development strategy, our business may fail.

 

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

 

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

 

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build and maintain a strong intellectual property portfolio;

 

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execute product development activities using an unproven technology;

 

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continue to develop and maintain successful strategic relationships;

 

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

 

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gain regulatory and commercial acceptance of our products.

 

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

 

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

 

We have experienced significant operating losses since our inception in 2000, and as of December 31, 2007, we had an accumulated deficit of $35.5 million. We had a net loss of $14.7 million for the year ended December 31, 2007. Furthermore, we do not expect to generate any significant revenues from the sale of diagnostic or therapeutic products in the near future. We expect our annual operating losses to increase over the next several years as we expand our efforts to discover, develop and commercialize diagnostic and therapeutic products based on microRNAs. We anticipate that the majority of any revenues we generate over the next several years will be from collaborations and licensing arrangements with pharmaceutical, biotechnology or diagnostic companies and diagnostic products using our microRNA technology that may be commercialized. We cannot be certain, however, that we will be able to secure any collaborations or achieve any milestones that may be required to receive payments or that any diagnostic products based on our technologies will achieve market acceptance. If we are unable to secure revenues from collaborations and the sale of products, we may be unable to continue our efforts to discover, develop and commercialize microRNA-based diagnostic and therapeutic products without raising additional funds from other sources.

 

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

 

We have used substantial funds to discover, develop and protect our microRNA technologies and will require substantial additional funds to conduct further research and development, including any required preclinical testing and clinical trials of any diagnostic or therapeutic product, and to manufacture and market any products that are approved for commercial sale. Because the successful development and commercialization of microRNA-based diagnostic and therapeutic products is uncertain, we are unable to estimate the actual funds we will require to develop, obtain required regulatory approval and commercialize them. The timing of our need for additional funds will depend on a number of factors, many of which are difficult to predict or are outside of our control, including:

 

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progress in our research and development programs;

 

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

 

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

 

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costs necessary to protect our intellectual property; and

 

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the timing, receipt and amount of sales, if any, by us of any approved products.

 

If our estimates and predictions relating to these factors are incorrect, we may need to modify our operating plan. We will be required to seek additional funding in the future and intend to do so through collaborative arrangements and public or private equity offerings and debt financings. However, additional funds may not be available to us when needed on acceptable terms, or at all. In addition, the terms of any financing may adversely affect the holdings or the rights of our existing shareholders. For example, if we raise additional funds by issuing equity securities, further dilution to our then-existing shareholders may result. Debt financing, if available, may involve restrictive covenants that could limit our flexibility in conducting future business activities. If we are unable to obtain funding on a timely basis, we may be required to significantly curtail one or more of our research or development programs. We also could be required to seek funds through arrangements with collaborators or others that may require us to relinquish rights to some of our technologies, products in development or approved products that we would otherwise pursue on our own.

 

If uncertainties in the credit and capital markets continue, these markets deteriorate further or we experience any additional ratings downgrades on any ongoing investments in our portfolio, we may incur additional impairments to our long term investment portfolio, which could affect our financial condition, liquidity, cash flow and results of operations.

 

As of December 31, 2007, we had $7.4 million of principal invested in Auction Rate Securities, or ARS, rated AAA/Aaa at the time of purchase. All of these securities retained at least AAA or Aaa rating as of December 31, 2007. All securities continue to pay interest in accordance with their stated terms as of December 31, 2007. However, since these ARS have experienced multiple failed auctions due to a lack of liquidity in the market for these securities, we revalued our ARS portfolio, based on a valuation model, and as a result, we have recorded an impairment charge of $5 million in our statement of operations to reflect other than temporary decline in the value of our investment in ARS. We believe that based on our current cash, cash equivalents and marketable securities balances at December 31, 2007 and expected operating cash flows, the current lack of liquidity of these securities will not have a material impact on our liquidity, cash flow or our ability to fund our operations through at least the second quarter of 2009. However, if uncertainties in the credit and capital markets continue, these markets deteriorate further or we experience any additional ratings downgrades on any ongoing investments in our portfolio (including on ARSs), we may incur additional impairments to our long term investment portfolio, which could affect our financial condition, liquidity, cash flow and results of operations.

 

 

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

 

Fluctuations in currency exchange rates may have a significant impact on our reported results of operations. Although our reporting currency is the U.S. dollar significant portion of our expenses are denominated in New Israeli Shekels, or NIS. In periods when the U.S. dollar is devalued against the NIS, our reported results of operations may be adversely affected. In addition, fluctuations in currencies may result in valuation adjustments in our assets and liabilities which could affect our reported results of operations.

 

Risks Related to Our Intellectual Property

 

If we are not able to obtain and enforce patent protection for our discoveries, our ability to develop and commercialize microRNA-based diagnostic and therapeutic products will be harmed.

 

Our success depends, in large part, on our ability to protect proprietary methods and technologies that we develop under the patent and other intellectual property laws of the U.S., Israel and other countries, so that we can prevent others from unlawfully using our inventions and proprietary information. As of June 10, 2008, our patent portfolio included a total of two issued U.S. patents, 65 pending patent applications worldwide, consisting of 39 U.S. patent applications, two of which received notice of allowance, eight PCT applications, five applications that were nationalized in Europe, three applications nationalized in Israel, and two applications nationalized in Japan, Canada, Australia, China and India. There can be no assurance, however, that any of these pending patent applications will result in issued patents. The patent position of pharmaceutical or biotechnology companies, including ours, is generally uncertain and involves complex legal and factual considerations. The standards that the U.S. Patent and Trademark Office, or PTO, and its foreign counterparts use to grant patents are not always applied predictably or uniformly and may change. There is also no uniform, worldwide policy regarding the subject matter and scope of claims granted or allowable in pharmaceutical or biotechnology patents. Furthermore, the field of microRNAs is new and developing. Accordingly, there is significant uncertainty about what patents will be issued, and what their claims may cover. It is likely that there will be significant litigation and other proceedings, such as interference proceedings and opposition proceedings, in certain patent offices, relating to patent rights in the microRNA field. Others may attempt to invalidate our intellectual property rights. Even if our rights are not directly challenged, disputes among third parties could lead to the weakening or invalidation of our intellectual property rights. Accordingly, we do not know the degree of future protection for our proprietary rights or the breadth of claims that will be allowed in any patents issued to us or to others. Additionally, the mere issuance of a patent does not guarantee that it is valid or enforceable, so even issued patents may not be valid or enforceable against third parties.

 

In addition, we cannot be certain that we hold the rights to the technology covered by our pending patent applications or to other proprietary technology required for us to commercialize our proposed products. Because certain U.S. patent applications are confidential until patents issue, such as applications filed prior to November 29, 2000, or applications filed after this date which will not be filed in foreign countries, third parties may have filed patent applications for technology covered by our pending patent applications without our being aware of those applications, and our patent applications may not have priority over those applications. For this and other reasons, we may be unable to secure desired patent rights, thereby losing desired exclusivity. Thus, it is possible that one or more organizations will hold patent rights to which we will need a license. If those organizations refuse to grant us a license to such patent rights on reasonable terms, we will not be able to market our products.

 

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

 

A third party may sue us for infringing its patent rights. Likewise, we may need to resort to litigation to enforce a patent issued or licensed to us or to determine the scope and validity of third-party proprietary rights. In addition, a third party may claim that we have improperly obtained or used its confidential or proprietary information. The cost to us of any litigation or other proceeding relating to intellectual property rights, even if resolved in our favor, could be substantial, and the litigation would divert our management’s efforts. Some of our competitors may be able to sustain the costs of complex patent litigation more effectively than we can because they have substantially greater resources. Uncertainties resulting from the initiation and continuation of any litigation could limit our ability to continue our operations.

 

If we are found to infringe upon intellectual property rights of third parties, we could be forced to pay damages, potentially including treble damages, if we are found to have willfully infringed on such parties’ patent rights. In addition to any damages we might have to pay, a court could require us to stop the infringing activity or obtain a license. Any license required under any patent may not be made available on commercially acceptable terms, if at all. In addition, such licenses are likely to be non-exclusive and, therefore, our competitors may have access to the same technology licensed to us. If we fail to obtain a required license and are unable to design around a patent, we may be unable to effectively market some of our technology and products, which could limit our ability to generate revenues or achieve profitability and possibly prevent us from generating revenues sufficient to sustain our operations. Moreover, we expect that a number of our collaborations will provide that royalties payable to us for licenses to our intellectual property may be offset by amounts paid by our collaborators to third parties who have competing or superior intellectual property positions in the relevant fields, which could result in significant reductions in our revenues from products developed through collaborations.

 

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

 

We are a party to license agreements that give us rights to third-party intellectual property that we believe may be necessary or useful for our business, such as our agreements with The Rockefeller University, Max Planck Innovation GmbH, or Max Planck, and Johns Hopkins University. We intend to enter into additional licenses of intellectual property with third parties in the future. Our success will depend in part on the ability of our licensors to obtain, maintain and enforce patent protection for our licensed intellectual property, in particular, those patents to which we have secured exclusive rights. Our licensors may not successfully prosecute the patent applications which we have licensed. Even if patents issue in respect of these patent applications, our licensors may fail to maintain these patents, may determine not to pursue litigation against other companies that are infringing these patents, or may pursue such litigation less aggressively than we would. Without protection for the intellectual property we license, other companies might be able to offer substantially identical products for sale, which could adversely affect our competitive business position and harm our business prospects. Under our license agreements with The Rockefeller University, if Rockefeller University fails to prosecute the patents we licensed, we have the right to prosecute the patents and pursue litigation against any infringement of such patents. Under our license agreement with Max Planck for diagnostic purposes, we have the responsibility to assist in the prosecution of any patent infringement actions undertaken by Max Planck. Under our license agreement with Max Planck for research purposes, Max Planck controls the filing, prosecution, maintenance and abandonment of all patents. Under our agreement with Johns Hopkins University, Johns Hopkins is responsible for prosecution and maintenance of patents, and we have the right but not the obligation to enforce the patents against any infringement by third parties.

 

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

 

Our current licenses impose, and any future licenses we enter into are likely to impose, various development, commercialization, funding, royalty, diligence, sublicensing, insurance and other obligations on us. Such obligations may include:

 

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royalty payments;

 

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annual maintenance fees;

 

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

 

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maintaining insurance coverage; and

 

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using commercially reasonable efforts to develop products using the licensed technology.

 

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

 

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

 

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

 

Risks Related to Development, Clinical Testing and Regulatory Approval of Diagnostic and Therapeutic Products

 

We, our collaborators and third-party licensees developing diagnostic tests applying our microRNA technology are subject to a variety of regulatory frameworks.

 

We have a four-part business model as described in detail in “Item 4. Information on the Company - B. Business Overview.” Under this business model, we have four lines of business: (1) RG Laboratory Tests; (2) RG Diagnostic Products; (3) RG MicroRNA Technology; and (4) RG Therapeutic Products, each of which is referred to as a “Line of Business” herein. Each Line of Business is designed to capitalize on a number of different approaches to the development and commercialization of microRNA-based products and presents unique challenges and risks, which are set forth in more detail herein.

 

In addition, there are certain risks that are applicable to every Line of Business. We, our collaborators and third-party licensees developing diagnostic tests applying our microRNA technology are subject to a variety of regulatory frameworks promulgated by both the federal government and the states in which they, and we conduct, or will conduct, business, including:

 

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the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and state clinical laboratory licensure laws and regulations;

 

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Federal Food, Drug, and Cosmetic Act laws and regulations and applicable state public health laws;

 

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Medicare billing and payment regulations applicable to clinical laboratories;

 

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Federal Medicare and Medicaid Anti-kickback Law and state anti-kickback prohibitions;

 

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Federal physician self-referral prohibition, commonly known as the Stark Law, and the state equivalents;

 

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Federal Health Insurance Portability and Accountability Act of 1996;

 

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Medicare civil money penalty and exclusion requirements; and

 

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Federal civil and criminal False Claims Act.

 

The growth of our business may increase the potential of violating these laws. The risk of us, our collaborators or third-party licensees being found in violation of these laws and regulations is further increased by the fact that many of these laws and regulations have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Any action brought against us, or any business partners, for violation of these laws or regulations, even if we or they successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. If their or our operations are found to be in violation of any of these laws and regulations, they or we may be subject to any applicable penalty associated with the violation, including civil and criminal penalties, damages and fines, and they or we could be required to curtail or cease operations. Any of the foregoing consequences could seriously harm our business and our financial results.

 

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

 

Clinical laboratory tests that are developed and validated by a laboratory for its own use are called laboratory developed tests, or LDTs. We expect that the first diagnostic tests applying our microRNA technology will be launched as laboratory developed tests, or LDTs, by third-party CLIA-certified clinical laboratories that license our RG MicroRNA Technology and develop their own LDTs and/or by us as RG Laboratory Tests if we are successful in acquiring or opening a CLIA-certified laboratory. While in vitro diagnostic tests that are sold and distributed through interstate commerce are regulated as medical devices by the U.S. Food and Drug Administration, or FDA, most LDTs currently are not subject to FDA regulation, although reagents or software provided by third parties and used to perform LDTs may be subject to regulation. While we believe these initial diagnostic products should not be subject to regulation under established FDA policies, these tests may fall under FDA regulation as medical devices.

 

Although the first clinical laboratory tests applying our microRNA technology are being developed as LDTs regulated under CLIA and state laboratory laws, these tests may fall under FDA regulation as medical devices in the future. In September 2006, the FDA issued draft guidance on a new class of tests called “In Vitro Diagnostic Multivariate Index Assays,” or IVDMIAs. Under this draft guidance, some LDTs, including some that may be developed by applying our microRNA technology, may be determined to be IVDMIAs and could be classified as Class II or Class III medical devices, which may require varying levels of FDA pre-market review depending upon intended use and on the level of control necessary to assure the safety and effectiveness of the test. In July 2007, the FDA posted revised draft guidance on IVMDIAs that includes an 18 month transition period of FDA enforcement discretion following release of final guidance for currently available tests if the laboratory submits a pre-market review submission within 12 months of the publication of final guidance. The comment period for this revised guidance expired in October 2007, and it is not clear whether or when FDA may finalize this draft guidance.

 

We cannot provide any assurance that FDA regulation, including pre-market review, will not be required in the future for LDTs applying our microRNA technology. Extension of FDA regulation to LDTs may occur through new enforcement policies adopted by the FDA or new legislation enacted by Congress. If pre-market review is required, our business could be negatively impacted because the CLIA-certified laboratories offering LDTs applying our microRNA technology (including any such laboratories owned and/or operated by us in the future) may be required to stop selling these LDTs pending pre-market clearance or approval. If LDTs applying our microRNA technology are allowed to remain on the market but there is uncertainty about the tests or if these are labeled investigational by the FDA, orders or reimbursement may decline.

 

If FDA regulation is extended to LDTs applying our microRNA technology, the regulatory approval process may involve, among other things, successfully completing clinical trials and submitting a pre-market clearance notice or filing a pre-market approval application, or PMA, with the FDA. If pre-market review is required by the FDA, there can be no assurance that LDTs applying our microRNA technology will be cleared or approved on a timely basis, if at all. Ongoing compliance with the FDA regulations would increase the cost of conducting business for laboratories offering LDTs applying our microRNA technology (including any such laboratories owned and/or operated by us in the future), and subject those laboratories to inspection by FDA, to the requirements of FDA, and penalties for failure to comply with these requirements. Should any of the reagents used in conducting tests applying our microRNA technology be affected by future regulatory actions, our business could be adversely affected by those actions because the clinical laboratories using our microRNA technology could incur increased costs of testing or could experience delays, limitations or stoppages in their ability to purchase reagents necessary to perform testing.

 

The clinical laboratories performing tests applying our microRNA technology are subject to CLIA, a federal law that regulates clinical laboratories that perform testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease. CLIA is intended to ensure the quality and reliability of clinical laboratories in the United States by mandating specific standards in the areas of personnel qualifications, administration, and participation in proficiency testing, patient test management, quality control, quality assurance and inspections. To renew CLIA certification, the laboratories are subject to survey and inspection every two years. Moreover, CLIA inspectors may make random inspections of these laboratories.

 

In addition to CLIA, laboratories are also required to maintain licenses to conduct testing in the states where the laboratories are located. These states establish standards for day-to-day operation of the clinical laboratory, including the training and skills required of personnel and quality control. Moreover, several states require that laboratories hold licenses to test specimens from patients residing in those states. Finally, laboratories applying our microRNA technology when performing testing on specimens from foreign countries may be subject to regulation in foreign jurisdictions.

 

If clinical laboratories performing clinical laboratory tests using our microRNA technology were to lose their CLIA certification or state licensure, whether as a result of a revocation, suspension or limitation, those laboratories would no longer be able to offer and sell tests applying our microRNA technology, which would limit our revenues and harm our business. If the laboratories were to lose their licenses in other states where they are required to hold licenses, they would not be able to test specimens from those states.

 

LDTs applying our microRNA technology may require clinical trial testing, which can be lengthy, costly and burdensome.

 

If the FDA decides to regulate LDTs applying our microRNA technology, it may require extensive pre-market clinical testing prior to submitting a regulatory application for commercial sales of such an LDT. If we or laboratories licensing our microRNA technology are required to conduct pre-market clinical trials, whether using prospectively acquired samples or archival samples, delays in the commencement or completion of clinical testing could significantly increase LDT development costs and delay commercialization. Many of the factors that may cause or lead to a delay in the commencement or completion of clinical trials may also ultimately lead to delay or denial of regulatory clearance or approval. The commencement of clinical trials may be delayed due to insufficient patient enrollment, which is a function of many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites and the eligibility criteria for the clinical trial.

 

It also may be necessary to engage contract research organizations to perform data collection and analysis and other aspects of these clinical trials, which might increase the cost and complexity. We may also depend on clinical investigators, medical institutions and contract research organizations to perform the trials properly. If these parties do not successfully carry out their contractual duties or obligations or meet expected deadlines, or if the quality, completeness or accuracy of the clinical data they obtain is compromised due to the failure to adhere to our clinical protocols or for other reasons, these clinical trials may have to be extended, delayed or terminated. Many of these factors would be beyond our control. We may not be able to enter into replacement arrangements without undue delays or considerable expenditures. If there are delays in testing or approvals as a result of the failure to perform by third parties, our research and development costs would increase, and regulatory clearance or approval for tests applying our technology may not be obtainable. In addition, we may not be able to establish or maintain relationships with these parties on favorable terms, if at all. Each of these outcomes would harm our ability to conduct timely clinical trials.

 

 

Any RG Diagnostic Products developed using our microRNA technology will be regulated by the FDA as medical devices.

 

In addition to licensing our microRNA technology to third-party clinical laboratories for use in the development of their own LDTs and developing our own RG Laboratory Tests, we intend to develop RG Diagnostic Products, including in vitro diagnostic test kits, using our microRNA technology. Unlike LDTs, in vitro diagnostic test kits are not offered solely by the laboratory that developed them, rather they are shipped through interstate commerce and sold. In the United States, diagnostic products, including in vitro diagnostic test kits, are regulated by the FDA as medical devices. Accordingly, before any RG Diagnostic Product, including any in vitro diagnostic test kit, can be marketed by us or a collaborator, we or the collaborator must obtain marketing clearance or approval from the FDA.

 

Medical devices are cleared or approved by the FDA through either a pre-market notification under Section 510(k) of the Federal Food, Drug and Cosmetic Act or the FDA’s approval of a pre-market approval application, or PMA, unless the particular class of product is exempt from pre-market review.

 

A 510(k) pre-market notification must demonstrate that the device in question is substantially equivalent to another legally marketed device, or predicate device, that does not require pre-market approval. In evaluating the 510(k), the FDA must determine that (1) the device (a) has the same intended use as the predicate device and (b) has the same technological characteristics as the predicate device; or that (2) the device (a) has the same intended use as the predicate device and (b) has different technological characteristics, but the information submitted contains information, including clinical or scientific data if deemed necessary by the FDA, that demonstrates (i) that the device is as safe and as effective as a legally marketed device and (ii) the device does not raise different questions of safety and effectiveness than the predicate device. Most 510(k)s do not require clinical data for clearance, but it is possible that the FDA will require that we, or a collaborator, submit clinical trial data regarding the validity of the microRNA technology underlying the RG Diagnostic Product under consideration.

 

The PMA process, on the other hand, is more complex, costly and time consuming than the 510(k) clearance procedure. A PMA must be supported by more detailed and comprehensive scientific evidence than a 510(k) notice, including clinical trial data to demonstrate the safety and efficacy of the device. Therefore, it is likely that Rosetta Genomics, or a collaborator, will be required to submit clinical trial data regarding the validity of the microRNA technology underlying the RG Diagnostic Product under consideration. A PMA can take several years to complete and there is no assurance that any submitted PMA will be approved. Even when approved, the FDA may limit the indication for which the medical device may be marketed or to whom it may be sold.

 

We may be unable to obtain regulatory approval of any RG Therapeutic Products that we or a collaborator may develop.

 

Any RG Therapeutic Products that we or our collaborators may develop will be subject to extensive governmental regulations relating to development, clinical trials, manufacturing and commercialization. Rigorous preclinical testing and clinical trials and an extensive regulatory approval process are required to be successfully completed in the United States and in many foreign jurisdictions before a new therapeutic product can be sold. Satisfaction of these and other regulatory requirements is costly, time consuming, uncertain and subject to unanticipated delays. The time required to obtain FDA and other approvals for therapeutic products is unpredictable but typically exceeds several years following the commencement of clinical trials. It is possible that none of the RG Therapeutic Products we or our collaborators may develop will obtain the appropriate regulatory approvals necessary for us or our collaborators to begin selling them.

 

Furthermore, the FDA has not yet established any definitive policies, practices or guidelines in relation to the newly discovered class of therapeutic products we seek to develop as RG Therapeutic Products. The lack of such policies, practices or guidelines may hinder or slow review by the FDA of any regulatory filings that we or our collaborators may submit. Moreover, the FDA may respond to these submissions by defining requirements we may not have anticipated. Such responses could lead to significant delays in the development of RG Therapeutic Products. Any delay or failure in obtaining required approvals could have a material adverse effect on our ability to generate revenues from a particular RG Therapeutic Product.

 

Furthermore, any regulatory approval to market an RG Therapeutic Product may be subject to limitations on the indicated uses for which we may market. These limitations may limit the size of the market for the RG Therapeutic Product. Any RG Therapeutic Products that we or our collaborators may develop will also be subject to numerous foreign regulatory requirements governing the conduct of clinical trials, manufacturing and marketing authorization, pricing and third-party reimbursement. The foreign regulatory approval process includes all of the risks associated with FDA approval described above as well as risks attributable to the satisfaction of local regulations in foreign jurisdictions. Therefore, approval by the FDA of an RG Therapeutic Product does not assure approval by regulatory authorities outside the United States.

 

We have no experience in conducting, managing or sponsoring clinical trials for potential RG Diagnostic Products or RG Therapeutic Products.

 

We have no experience in conducting and managing the clinical trials necessary to obtain regulatory approvals for any RG Diagnostic Products or RG Therapeutic Product, and we intend to rely on third parties such as contract research organizations, medical institutions and clinical investigators to perform these functions. Our reliance on third parties for clinical development activities reduces our control over these activities. Third-party contractors may not complete activities on schedule, or may not conduct clinical trials in accordance with regulatory requirements or our trial design. If these third parties do not successfully carry out their contractual duties or meet expected deadlines, we might be required to replace them, which may result in a delay of the affected trial.

 

Even if we obtain regulatory approvals, our RG Diagnostic Products and RG Therapeutic Products will be subject to ongoing regulatory review. If we fail to comply with continuing U.S. and foreign regulations, we could lose our approvals to market these products and our business would be seriously harmed.

 

Following any initial regulatory approval of any RG Diagnostic Products or RG Therapeutic Products we or our collaborators may develop, the approved products will also be subject to continuing regulatory review, including the review of adverse experiences and clinical results that are reported after our products are made commercially available. This would include results from any post-marketing tests or monitoring required as a condition of approval, and any unsolicited post-market reporting from physicians regarding their patients’ experiences with such products. The manufacturer and manufacturing facilities we or our collaborators use to make any approved RG Diagnostic Products or RG Therapeutic Products will also be subject to periodic review and inspection by the FDA. The discovery of any previously unknown problems with tsuch manufacturer or facility may result in restrictions on the RG Diagnostic Product or RG Therapeutic Product, manufacturer or facility, including withdrawal of the product from the market. The promotion and advertising of any approved RG Diagnostic Products or RG Therapeutic Products will also be subject to ongoing regulatory requirements and continuing FDA review. If we or our collaborators fail to comply with applicable continuing regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approval, product recalls and seizures, operating restrictions, criminal prosecutions, and civil suits by patients, and the legal expenses associated with responding to these enforcement actions.

 

If we or our collaborators, or any third party manufacturers with which we may enter into agreements in the future, fail to comply with regulatory laws and regulations, we or they could be subject to enforcement actions, which could affect our ability to market and sell microRNA-based diagnostic and therapeutic products and may harm our reputation.

 

If we or our collaborators, or any third party manufacturers with which we may enter into agreements in the future fail to comply with applicable federal, state or foreign laws or regulations, we could be subject to enforcement actions, which could affect the ability to successfully develop, market and sell diagnostic tests or therapeutic products using our microRNA technology and could harm our reputation and lead to reduced acceptance of such products by the market. These enforcement actions include:

 

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warning letters;

 

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recalls, public notification or medical product safety alerts;

 

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restrictions on, or prohibitions against, marketing such products;

 

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restrictions on importation of such products;

 

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suspension of review or refusal to approve new or pending applications;

 

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suspension or withdrawal of product approvals;

 

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product seizures;

 

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injunctions;

 

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civil and criminal penalties and fines; and

 

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debarment or other exclusions from government programs and research.

 

 

In addition, clinical research subjects and/or patients could bring civil actions against us and/or our collaborators for tort and contract actions relating to their participation in clinical trials or the use of the test or product in their treatment or diagnosis.

 

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

 

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

 

Risks Related to Competition and Commercialization

 

We do not currently own or operate a certified laboratory in order to provide RG Laboratory Tests.

 

Before we can develop, validate and offer our own RG Laboratory Tests, we will need to acquire a certified laboratory or build and obtain certification and licensure for our own laboratory. On June 5, 2008 we signed a binding term sheet to acquire Parkway Clinical Laboratories Inc., or Parkway, a privately-held CLIA-certified lab located in Bensalem, Pennsylvania. The closing of the acquisition is subject to certain closing conditions, including completion of financial, accounting, operating, legal and regulatory due diligence by us and receipt of all necessary approvals and consents. Accordingly, we cannot provide any assurance that this acquisition will close on a timely basis, or at all. If we are unable to close the acquisition of Parkway, we do not know if we will be able to identify an appropriate laboratory with the necessary regulatory approvals and with qualified staff to develop and validate RG Laboratory Tests. Delays in identifying an appropriate laboratory target would delay our development and commercialization of our own RG Laboratory Tests, which would reduce our revenues. If we need to build and license our own laboratory, it would take time and substantial resources to build the laboratory and obtain applicable licenses and certifications.

 

The intensely competitive biotechnology market could diminish demand for RG Diagnostic Products or RG Therapeutic Products or for LDTs applying our RG MicroRNA Technology.

 

The biopharmaceutical market is intensely competitive and rapidly changing. Many diagnostic, pharmaceutical and biotechnology companies, academic institutions, governmental agencies and other public and private research organizations are pursuing the research of technologies and development of novel diagnostic tests and therapeutic products for the same diseases that we, our collaborators, or third-party licensees are targeting or expect to target. We and they will face intense competition from products that have already been approved and accepted by the medical community for the diseases for which we or they may develop products. We, our collaborators, or third-party licensees also expect to face competition from new tests or products that enter the market. We believe a significant number of tests and products are currently under development, and may become commercially available in the future, for the diseases for which we our collaborators, or third-party licensees may try to develop tests and products. In addition to the competition we face from existing tests and products in development, we, our collaborators, or third-party licensees also face competition from other companies working to develop novel tests and products using technology that competes more directly with our microRNA technologies. We are aware of several other companies, including some of our current collaborators, that are working to develop microRNA-based diagnostic and therapeutic products, including Alnylam Pharmaceuticals, Inc., Asuragen, the Celera Group of Applera Corporation, Exiqon A/S, Invitrogen Corporation, Isis Pharmaceuticals, Merck & Co., Inc., Santaris Pharma A/S, Sirna Therapeutics, Inc., Regulus Therapeutics and others. Any of these companies may develop microRNA-based products more rapidly and more effectively than we or our collaborators will. If we are unable to compete effectively with existing products, new treatment methods and new technologies, we, our collaborators or third-party licenseees may be unable to commercialize any diagnostic tests or therapeutic products that we or they develop.

 

Many of our competitors have:

 

·

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

 

·

more extensive experience in preclinical testing, conducting clinical trials, obtaining regulatory approvals, and in manufacturing and marketing diagnostic and therapeutic products;

 

·

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

 

 

·

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

 

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

 

Reimbursement for LDTs applying our microRNA technology and for RG Diagnostic Products and RG Therapeutic Products may be difficult to obtain and maintain at levels consistent with our business plans.

 

Physicians and patients may decide not to order LDTs applying our microRNA technology or to purchase RG Diagnostic Products or RG Therapeutic Products unless third-party payors, such as managed care organizations, as well as government payors, such as Medicare and Medicaid, pay all or a substantial portion of the price. In addition, there is significant uncertainty concerning third-party reimbursement of any test or product incorporating new technology, including tests or other products applying our microRNA technology. Reimbursement by a third-party payor may depend on a number of factors, including a payor’s determination that diagnostic or therapeutic products using our microRNA technology are:

 

·

not experimental or investigational,

 

·

medically necessary,

 

·

appropriate for the specific patient,

 

·

cost-effective, and

 

·

supported by peer-reviewed publications.

 

Since each payor makes its own decision as to whether to establish a policy to cover LDTs, and may establish a policy regarding new technologies, seeking these approvals is a time-consuming and costly process. To date, neither we nor any clinical laboratories developing tests applying our microRNA technology have secured policy-level reimbursement approval from any third-party payors for any test applying our microRNA technology. We cannot be certain that coverage for any of diagnostic tests applying our microRNA technology or for any RG Therapeutic Products will be provided in the future by any third-party payors or that payment policies will be favorable in the future.

 

Third party payors, government payors and health plans, including managed care organizations as well as Medicare, have increased their efforts to control the cost, utilization and delivery of health care services. From time to time, Congress has considered and implemented changes in the Medicare fee schedules in conjunction with budgetary legislation. Further reductions of reimbursement for Medicare services may be implemented from time to time. Reductions in the reimbursement rates of other third-party payors have occurred and may occur in the future. These measures have resulted in reduced prices, added costs and decreased test utilization for the clinical laboratory industry. Several entities conduct technology assessments of new medical tests and devices and provide the results of their assessments for informational purposes to other parties. These assessments may be used by third-party payors, government payors and health plans, as grounds to deny coverage for a test or procedure.

 

If we or any clinical laboratories developing tests applying our microRNA technology are unable to obtain coverage from third party payors, government payors or health plans, or if the amount reimbursed is inadequate, our ability to generate revenues could be limited. Even if diagnostic tests and/or therapeutics using our microRNA technology are being reimbursed, payors and health plans may withdraw their coverage policies or cancel contracts with clinical laboratories at any time or stop paying for these diagnostic tests and therapeutics, which would reduce our revenues.

 

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

 

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

 

·

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

 

·

the safety, efficacy and ease of administration;

 

·

the success of physician education programs;

 

·

the availability of alternative diagnostic and therapeutic products; and

 

·

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

 

Risks Related to Our Dependence on Third Parties

 

We may not be able to execute our business strategy if we are unable to enter into collaborations with other companies that can provide capabilities and funds for the development and commercialization of our RG Diagnostic Products or RG Therapeutic Products.

 

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

 

If any collaborator terminates or fails to perform its obligations under agreements with us, the development and commercialization of RG Diagnostic Products or RG Therapeutic Products could be delayed or terminated.

 

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

 

·

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

 

·

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

 

·

if it has marketing rights and obligations, choose to devote fewer resources to the marketing of our RG Diagnostic Products or RG Therapeutic Products, if any are approved for marketing, than they do for products of their own development, or of their co-development with third parties.

 

If any of these occur, the research, development and commercialization of one or more RG Diagnostic Products or RG Therapeutic Products could be delayed, curtailed or terminated because we may not have sufficient financial resources or capabilities to continue such development and commercialization on our own.

 

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

 

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

 

We have no manufacturing experience or resources and we must incur significant costs to develop this expertise or rely on third parties to manufacture our RG Diagnostic Products or RG Therapeutic Products.

 

We have no manufacturing experience. In order to develop RG Diagnostic Products or RG Therapeutic Products and/or apply for regulatory approvals and commercialize RG Diagnostic Products or RG Therapeutic Products, we will need to develop, contract for, or otherwise arrange for the necessary manufacturing capabilities. Manufacturing of RG Diagnostic Products and RG Therapeutic Products must comply with the Quality System Regulation, or QSR, and the Current Good Manufacturing Practice, or cGMP, respectively, each of which imposes testing, control, documentation and other quality assurance procedures. The manufacturing process for any RG Diagnostic Products or RG Therapeutic Products that we or our collaborators may develop is an element of the FDA approval process and we will need to contract with manufacturers who can meet the FDA requirements on an ongoing basis. In addition, if we receive the necessary regulatory approval for any RG Diagnostic Products or RG Therapeutic Products, we also expect to rely on third parties, including our collaborators, to produce materials required for commercial production. We may experience difficulty in obtaining adequate manufacturing capacity for our needs. If we are unable to obtain or maintain contract manufacturing, or to do so on commercially reasonable terms, we may not be able to successfully develop and commercialize our RG Diagnostic Products or RG Therapeutic Products.

 

We currently have no sales, marketing or distribution experience and may depend significantly on third parties to commercialize microRNA-based diagnostic tests or therapeutic products we may develop.

 

We currently have no sales, marketing or distribution experience. We will need to rely on our collaborators or other third parties to commercialize any RG Laboratory Tests, such as LDTs we may develop, or any approved RG Diagnostic Products or RG Therapeutic Products, or we will need to internally develop such capabilities. In addition, we expect that the first diagnostic tests applying our RG MicroRNA Technology will be launched in 2008 by CLIA-certified clinical laboratories to which we license RG MicroRNA Technology. We will have limited or no control over the sales, marketing and distribution activities of these laboratories, and our future revenues will depend on the success of the efforts of our collaborators and these third party licensees. To develop internal sales, distribution and marketing capabilities, we will have to invest significant amounts of financial and management resources, and we will face a number of additional risks, including:

 

·

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

 

·

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

 

·

our direct sales and marketing efforts may not be successful.

 

Risks Related to Our Operations

 

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

 

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

 

We may have difficulty managing our growth and expanding our operations successfully as we seek to evolve from a company primarily involved in discovery into one that develops and commercializes microRNA-based diagnostic tests and therapeutic products.

 

We will need to expand our development, regulatory, manufacturing, marketing and sales capabilities or enter into strategic collaborations or contract with other organizations to provide these capabilities for us. As our operations expand, we expect that we will need to manage additional relationships with various collaborators, suppliers and other organizations. Our ability to manage our operations and growth will require us to continue to improve our operational, financial and management controls, reporting systems and procedures in at least two different countries. We may not be able to implement improvements to our management information and control systems in an efficient or timely manner and may discover deficiencies in existing systems and controls.

 

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

 

Our business exposes us to significant potential product liability risks that are inherent in the development, manufacturing and marketing of diagnostic and therapeutic products. Product liability claims could delay or prevent completion of our clinical development programs. If we succeed in marketing products, such claims could result in an FDA investigation of the safety and effectiveness of our products, our manufacturing processes and facilities or our marketing programs, and potentially a mandatory or voluntary recall of our products or other significant enforcement action, or limitations on the indications for which they may be used, or suspension or withdrawal of approval. We currently have insurance for our cancer programs covering liability in an amount up to $1 million per incident and up to $3 million in the aggregate. We plan to obtain insurance for all research programs at appropriate levels prior to initiating any required clinical trials and at higher levels prior to marketing any of approved products. Any insurance we obtain may not provide sufficient coverage against potential liabilities. Furthermore, clinical trial and product liability insurance is becoming increasingly expensive. As a result, we may be unable to obtain sufficient insurance at a reasonable cost to protect us against losses caused by product liability claims that could have a material adverse effect on our business.

 

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

 

In addition to our operations in Rehovot, Israel, our wholly owned subsidiary, Rosetta Genomics Inc., operates an office in Jersey City, New Jersey and we have signed a binding term sheet to acquire a CLIA-certified laboratory in Bensalem, Pennsylvania. We are subject to a number of risks and challenges that specifically relate to these international operations. Our international operations may not be successful if we are unable to meet and overcome these challenges, which could limit the growth of our business and may have an adverse effect on our business and operating results. These risks include:

 

·

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

 

·

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

 

·

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

 

·

foreign protectionist laws and business practices that favor local competition;

 

·

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

 

·

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

 

·

laws and regulations governing U.S. immigration and entry into the United States that may restrict employment of Israeli citizens in our U.S. facilities.

 

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

 

Under the current rules of the SEC, we are now required to comply with the management assessment of internal control over financial reporting requirement of Section 404 of the Sarbanes-Oxley Act of 2002. We have evaluated our internal control systems to allow management to report on our internal control over financial reporting. We have not identified any internal control deficiencies that constitute a “material weakness” under applicable SEC and Public Company Accounting Oversight Board rules and regulations or that otherwise would materially affect internal controls over financial reporting. A “material weakness” is a control deficiency, or combination of control deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. We cannot guarantee that we or our auditors will not identify material weaknesses or significant control deficiencies in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in significant deficiencies or material weaknesses and cause us to fail to meet our periodic reporting obligations or result in material misstatements in our financial statements, which in turn could lead to a decline in our stock price. Any such failure could also adversely affect the results of periodic management evaluations and annual auditor attestation reports regarding the effectiveness of our internal control over financial reporting.

 

 

Risks Related to Israeli Law and Our Operations in Israel

 

For the years ended December 31, 2006 and 2007, we were a passive foreign investment company, or PFIC, for U.S. federal income tax purposes, and there may be negative tax consequences for holders of our ordinary shares who are U.S. residents and do not make certain timely tax elections.

 

We are deemed to be a passive foreign investment company, or PFIC, if 75% or more of our gross income in a taxable year, including our pro rata share of the gross income of any company, U.S. or foreign, in which we are considered to own, directly or indirectly, 25% or more of the shares by value, is passive income. Alternatively, we are also deemed to be a PFIC if at least 50% of our assets in a taxable year, averaged over the year and ordinarily determined based on fair market value, including our pro rata share of the assets of any company in which we are considered to own, directly or indirectly, 25% or more of the shares by value, are held for the production of, or produce, passive income. We believe that we were a PFIC in 2003, but not in 2004 or 2005. We were a PFIC in 2006 and 2007. Accordingly, for any U.S. shareholders who held our ordinary shares during 2006 or 2007 or holds shares in any subsequent year that we are deemed a PFIC that does not make an election to treat us as a “qualified electing fund,” or QEF, or make a “mark-to-market” election, then “excess distributions” to a U.S. shareholder, and any gain recognized by a U.S. shareholder on a disposition or our ordinary shares, would be taxed in an unfavorable way. Among other consequences, “excess distributions” would be taxed at the highest rates applicable to ordinary income, rather than the potential 15% maximum rate applicable to certain dividends received by an individual from a qualified foreign corporation. PFIC status is determined annually and cannot be definitively determined until the close of the year in question. In addition, if the U.S. Internal Revenue Service determines that we are a PFIC for a year with respect to which we have determined that we were not a PFIC, it might be too late for a U.S. shareholder to make a timely QEF or mark-to-market election. U.S. shareholders who held or hold ordinary shares during a period when we are a PFIC (including 2006 and 2007) will be subject to the foregoing rules, even if we cease to be a PFIC in subsequent years, subject to exceptions for U.S. shareholders who made a timely QEF or mark-to-market election.

 

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

 

Our principal offices and research and development facilities and many of our suppliers are located in Israel. Accordingly, political, economic and military conditions in Israel may directly affect our business. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors, as well as incidents of civil unrest. During the summer of 2006, Israel was engaged in an armed conflict with Hezbollah, a Lebanese Islamist Shiite militia group and political party. This conflict involved missile strikes against civilian targets in northern Israel that resulted in economic losses. Since September 2000, terrorist violence in Israel has increased significantly and negotiations between Israel and Palestinian representatives have effectively ceased. The establishment of a government in the Palestinian Authority in early 2006 by representatives of the Hamas militant group has created additional unrest and uncertainty in the region.

 

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

 

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

 

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

 

Many of our male employees in Israel, including members of senior management, are obligated to perform military reserve duty annually for extended periods of time through the age of 45 (or older for citizens with certain occupations) and, in the event of a military conflict, could be called to active duty. In response to increases in terrorist activity, there have been periods of significant call-ups of military reservists, and recently some of our employees have been called up in connection with armed conflicts. It is possible that there will be additional call-ups in the future. Our operations could be disrupted by the absence of a significant number of our employees related to military service or the absence for extended periods of military service of one or more of our key employees.

 

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

 

Some of our operations in Israel have been granted “approved enterprise” status by the Investment Center in the Israeli Ministry of Industry, Trade and Labor that resulted in our currently being eligible for tax benefits under the Israeli Law for Encouragement of Capital Investments, 1959. These benefits will commence in the first year in which we produce taxable income. Pursuant to these benefits, undistributed income that we generate from our “approved enterprise” will be tax exempt for two years and, thereafter, will be subject to a tax rate of 10%-25% for an additional five to eight years, depending on the extent of foreign investment in us. The availability of these tax benefits, however, is subject to certain requirements, including, among other things, making specified investments in fixed assets and equipment, financing a percentage of those investments with our capital contributions, compliance with our marketing program which was submitted to the Investment Center, filing of certain reports with the Investment Center and compliance with Israeli intellectual property laws. If we do not meet these requirements in the future, these tax benefits may be cancelled. The tax benefits that we anticipate receiving under our current “approved enterprise” program may not be continued in the future at their current levels or at all. If these tax benefits were reduced or eliminated, the amount of taxes that we pay would likely increase, which could adversely affect our results of operations. See “Israeli Tax Considerations and Government Programs” for additional information concerning these tax benefits.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·

the rules under the Securities Exchange Act of 1934, as amended, or Exchange Act, requiring the filing with the SEC of quarterly reports on Form 10-Q and current reports on Form 8-K;

 

·

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

 

·

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

 

·

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

 

In addition, under the rules and regulations of The Nasdaq Stock Market, a foreign private issuer may follow its home country practice in lieu of certain Nasdaq listing requirements. For example, in November 2007, our Board of Directors authorized an increase of 500,000 ordinary shares for issuance under our Global Share Incentive Plan (2006), or 2006 Plan. Generally, under Nasdaq’s continued listing requirements, such an increase would require shareholder approval. However, we chose to follow our home country practice, which does not require shareholder approval, and did not seek or receive shareholder approval for the increase in shares under the 2006 Plan. Because of these SEC and Nasdaq exemptions, investors are not afforded the same protections or information generally available to investors holding shares in public companies organized in the United States.

 

Risks Related to Our Ordinary Shares

 

Insiders own a significant percentage of our outstanding ordinary shares and could delay or prevent a change in corporate control.

 

Our directors and executive officers, together with their affiliates, beneficially own, in the aggregate, approximately 21.0% of our outstanding ordinary shares. This concentration of ownership may harm the market price of our ordinary shares by:

 

·

delaying, deferring or preventing a change in control of our company;

 

·

entrenching our management and/or board of directors;

 

·

impeding a merger, consolidation, takeover or other business combination involving our company; or

 

·

discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of our company.