SPO MEDICAL INC AND ITS SUBSIDIARY

NOTES TO FINANCIAL STATEMENTS

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

NOTE 1  -

General

 

SPO Medical Inc. (hereinafter referred to as "SPO" or the "Company") is engaged in the design, development and marketing of non-invasive pulse oximetry technologies to measure blood oxygen saturation and heart rate. The applications are marketed, in the following sectors; homecare, professional medical care, sports, safety and search & rescue.

SPO was originally incorporated under the laws of the State of Delaware in September 1981 under the name "Applied DNA Systems, Inc." On November 16, 1994, the Company changed its name to "Nu-Tech Bio-Med, Inc." On December 23, 1998, the Company changed its name to "United Diagnostic, Inc." Effective April 21, 2005, the Company acquired (the "Acquisition Transaction") 100% of the outstanding capital stock of SPO Medical Equipment Ltd., a company incorporated under the laws of the State of Israel ("SPO Ltd."), pursuant to a Capital Stock Exchange Agreement dated as of February 28, 2005 between the Company, SPO Ltd. and the shareholders of SPO Ltd., as amended and restated on April 21, 2005 (the "Exchange Agreement"). In exchange for the outstanding capital stock of SPO Ltd., the Company issued to the former shareholders of SPO Ltd. a total of 5,769,106 shares of the Company's common stock, par value $0.01 per share ("Common Stock"), representing approximately 90% of the Common Stock then issued and outstanding after giving effect to the Acquisition Transaction. As a result of the Acquisition Transaction, SPO Ltd. became a wholly owned subsidiary of the Company as of April 21, 2005 and, subsequent to the Acquisition Transaction, the Company changed its name to "SPO Medical Inc." Upon consummation of the Acquisition Transaction, the Company effectuated a forward subdivision of the Company's Common Stock issued and outstanding on a 2.65285:1 basis.  

 

The merger between UNDI and the SPO Ltd was accounted for as a reverse merger. As the shareholders of SPO Ltd received the largest ownership interest in the Company, SPO Ltd was determined to be the "accounting acquirer" in the reverse acquisition. As a result, the historical financial statements of the Company were replaced with the historical financial statements of SPO Ltd.

 

The Company and its subsidiary, SPO Ltd., are collectively referred to as the "Company".

 

NOTE 2  -

Basis of Presentation

 

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SPO MEDICAL INC AND ITS SUBSIDIARY

NOTES TO FINANCIAL STATEMENTS

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

 

NOTE 3  -

Going Concern

As reflected in the accompanying financial statements, the Company’s operations for the six and three months ended June 30, 2008, resulted in a net loss of $1,073 and $572, respectively, and the Company’s balance sheet reflects a net stockholders’ equity of $195. The Company’s ability to continue operating as a “going concern” is dependent on its ability to raise additional working capital. Management’s plans in this regard include raising additional cash from current and potential stockholders and increasing the marketing of its current and new products.

NOTE 4  -

Financial Expenses

FINANCIAL EXPENSES, NET . Financial expenses, net, for the six and three months ended June 30, 2008 were $251 and $138. Financial expenses, net, for the corresponding periods in 2007 were $439 and $ 199. The principal expenses comprising the financial expenses during the six month period ended June 30, 2008 were:- (i) non cash amortization of loan discounts - $49 (ii) one time non cash expenses relating to the issue of warrants for the conversion to equity of certain loan notes and accrued interest thereon - $105 and (iii) interest in respect of debt instruments issued by the Company between April 2005 and October 2006 - $54

 

NOTE 5  -

Stockholders Equity

On March 31, 2008, the Company received from an investor gross proceeds of $250 on account for the purchase of Common Stock. The net proceeds from this financing were $223 after payment of a cash fee to the placement agent and other related expenses. In connection therewith, on May 22, 2008 the Company issued to such investor 312,500 shares of its Common Stock and a warrant, exercisable through the third anniversary of issuance, to purchase an additional 156,250 shares of its Common Stock at a per share exercise price of $0.80.

On March 11, 2008 the Company issued to a service provider 75,000 restricted shares in consideration of services rendered. The service provider is entitled to an additional 75,000 shares of Common Stock upon the occurrence of certain specified events. In connection therewith, on June 23, 2008 the Company issued to the service provider an additional 9,375 restricted shares in respect of this commitment.   On April 11, 2008 the Company issued to three designees of a service provider 100,000 restricted shares of Common Stock in consideration for investor relations services rendered. Subject to certain events being achieved by the service provider, the Company originally committed to issue up to an additional 300,000 restricted shares of Common Stock. On July 7, 2008, the Company signed an amendment to the agreement with this service provider reducing the additional commitment to 100,000 additional restricted shares and, in connection therewith, on July 23, 2008, the Company issued to two designees an aggregate of 50,000 restricted shares.   On April 14, 2008, the Company issued to its Chief Financial Officer under its 2005 Equity Incentive Plan options to purchase up to 100,000 shares of Common Stock at a per share exercise price of $0.78   On April 16, 2008, the Company entered in to a settlement agreement with an entity that had originally been retained by the Company to distribute one of the Company’s then contemplated future products. Pursuant to such agreement, the Company received advance payments in the amount of $485 in several installments between June 2006 and January 2007. In respect of the full settlement of this outstanding amount, on May 15, 2008, the Company issued to such entity 400,000 restricted shares of the Company’s Common Stock.   On May 13, 2008, the Company received from an investor gross proceeds of $190 for the purchase of Common Stock. The net proceeds from this financing were $172 after payment of a cash fee to a placement agent and other related expenses. In connection therewith. On July 7, 2008 the Company issued to such investor 237,500 shares of its Common Stock and a warrant, exercisable through the third anniversary of issuance, to purchase an additional 118,750 shares of its Common Stock at a per share exercise price of $0.80.   On May 22, 2008 the Company received from certain investors gross proceeds of $175 on account for stock capital. The net proceeds from this financing were $161 after cash fee paid to the placement agent and other related expenses. In connection therewith. On July 7, 2008 the Company issued to such investors an aggregate of 218,750 shares of its Common Stock and a warrant, exercisable through the third anniversary of issuance, to purchase an additional 109,375 shares of its Common Stock at a per share exercise price of $0.80.

 

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		In respect of all the gross amounts raised in the six month period ended June 30, 2008, the Company will issue to the finders 61,500 warrants under the same terms as the warrants issued to the investors.
		In March 2008, the Company offered to the holders of the April 2005 Notes to apply the amounts payable to them on the April 2005 Notes to the exercise price of the warrants issued in connection with the issuance of these notes (collectively, the “April 2005 Warrants”), thereby exercising these warrants, and to convert into Common Stock the accrued interest on the 2005 Notes at a per share conversion price of $0.60. Note holders that accepted this offer were issued new warrants for such number of shares of Common Stock equal to 25% of the number shares issued to them upon exercise of their existing warrants and conversion of the interest accrued on the note. The new warrants are exercisable over three years at an exercise price of $0.60. The Company issued an aggregate of 766,815 shares of Common Stock to seven holders of the April 2005 Notes upon such holders’ agreement to (i) apply the aggregate principal amount of $389 payable to them in respect thereof to the exercise of the April 2005 Warrants previously issued to them and (ii) convert the interest accrued of $71 with respect to the 2005 Notes into shares of Common Stock. The warrants were exercised in accordance with their terms and the interest was converted, in each case at a per share price of $0.60. In addition, these holders were issued warrants, exercisable over three years from the date of issuance, to purchase up to 191,707 shares of Common Stock at a per share exercise price of $0.60. Warrants for an additional 50,000 shares of Common Stock will be issued to three other holders of the April 2005 Note after such holders agreed to extend the maturity date of their notes through March 26, 2010. The exercise period of the new warrants for the extending note holders will be co-terminus with their existing April 2005 Warrants (September 2010) and such warrants will be exercisable at a per share exercise price of $0.60. The interest accrued through March 26, 2008, the original maturity date, with respect to notes in the aggregate amount of $40 will be paid to the extending holders of which $15 has been paid as of June 30, 2008. In the quarter ended June 30, 2008, the Company repaid certain holders of the April 2005 Notes principal of $250 and the interest accrued thereon. On July 28, 2008 a holder of $50 in principal amount agreed to convert the principal and accrued interest under the terms offered in March 2008 by the Company. Accordingly, the Company will issue to such holder 99,713 shares of Common Stock and 24,929 new warrants exercisable over three years at an exercise price of $0.60.

 

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND THE NOTES RELATED TO THOSE STATEMENTS. SOME OF OUR DISCUSSION IS FORWARD-LOOKING AND INVOLVES RISKS AND UNCERTAINTIES. FOR INFORMATION REGARDING RISK FACTORS THAT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, REFER TO THE RISK FACTORS SECTION OF THE ANNUAL REPORT ON FORM 10-KSB FOR THE YEAR ENDED DECEMBER 31, 2007.

OVERVIEW

 

 SPO Medical Inc. is engaged in the design, development and marketing of non-invasive pulse oximetry technologies to measure blood oxygen saturation and heart rate. We have developed and patented proprietary technology that enables the measurement of heart rate and oxygen saturation levels in the blood which is known as Reflectance Pulse Oximetry (RPO). Using RPO, a sensor can be positioned on various body parts, hence minimizing problems from motion artifacts and poor perfusion. The unique design features contribute to substantially lower power requirements and enhances wireless, stand-alone configurations facilitating expanded commercial possibilities.

We hold four patents issued by the United States Patent and Trademark Office ("USPTO") covering various aspects of our unique RPO based technology. As further discussed below, our technologies are currently applied to products that are designed for use by the, homecare, professional medical care, sports, safety and search and rescue.

We were originally organized under the laws of the State of Delaware in September 1981 under the name "Applied DNA Systems, Inc." On November 16, 1994, we changed our name to "Nu-Tech Bio-Med, Inc." On December 23, 1998, we changed our name to "United Diagnostic, Inc." Effective April 21, 2005, we acquired 100% of the outstanding capital stock of SPO Ltd. pursuant to a Capital Stock Exchange Agreement dated as of February 28, 2005 among the Company, SPO Ltd. and the shareholders of SPO Ltd., as amended and restated on April 21, 2005 pursuant to which we issued to the former shareholders of SPO Ltd. a total of 5,769,106 shares of the Company's Common Stock representing approximately 90% of the Common Stock then issued and outstanding.

As of August 14 2008, we had 22 employees working on a full time basis.

 

CRITICAL ACCOUNTING POLICIES

 

The discussion and analysis of our financial condition and results of operations are based upon our unaudited consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, bad debts, investments, intangible assets and income taxes. Our estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.

 

We have identified the accounting policies below as critical to our business operations and the understanding of our results of operations.

REVENUE RECOGNITION

 

We generate revenues principally from sales of our products. Revenues from the sale of products are recognized when delivery has occurred, persuasive evidence of an arrangement exists, the vendor's fee is fixed or determinable, no further obligation exists and collection is probable and there are no remaining significant obligations. Delivery is deemed to have occurred upon shipment of products from any of our distribution centers.

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ITEM 4. CONTROLS AND PROCEDURES (T)

 

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 13a-14(c).

 

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

 

CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING. During the quarter ended June 30, 2008, there have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, these controls.

PART II - OTHER INFORMATION 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

The following paragraph sets forth certain information with respect to all securities sold by us during the three months ended June 30, 2008 without registration under the Securities Act.

On April 11, 2008 we issued to three designees of a service provider 100,000 restricted shares of shares of Common Stock in consideration of services rendered by such service provider.

On March 31, 2008, we received from an investor gross proceeds of $250,000 on account for stock capital and, in connection therewith, in May 2008 we issued to such investor 312,500 shares of our Common Stock and a warrant, exercisable through the third anniversary of issuance, to purchase an additional 156,250 shares of our Common Stock at a per share exercise price of $0.80.

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On May 15,, 2008, the Company issued 400,000 shares of its Common Stock in settlement of certain outstanding issues with a former distributor of the Company’s products.   On June 23, 2008, the Company issued to a service provider an additional 9,375 restricted shares of Common Stock in consideration for services rendered.   In May 2008, the Company received from investors, gross proceeds of $365,000 for stock capital. The net proceeds from this financing were $333,000 after cash fees paid to the placement agent and other related expenses. In connection therewith, On July 7, 2008 the Company issued to such investors an aggregate of 456,250 shares of its Common Stock and warrants, exercisable through the third anniversary of issuance, to purchase an additional 228,125 shares of its Common Stock at a per share exercise price of $0.80.

All of the securities issued in the transactions described above were issued without registration under the Securities Act in reliance upon the exemptions provided in Section 4(2) of the Securities Act or Regulation S under such Securities Act. Except with respect to securities sold under Regulation S, the recipients of securities in each such transaction acquired the securities for investment only and not with a view to or for sale in connection with any distribution thereof. Appropriate legends were affixed to the share certificates issued in all of the above transactions. Each of the recipients represented that they were “accredited investors” within the meaning of Rule 501(a) of Regulation D under the Securities Act, or had such knowledge and experience in financial and business matters as to be able to evaluate the merits and risks of an investment in its common stock. All recipients had adequate access, through their relationships with the Company and its officers and directors, to information about the Company. None of the transactions described above involved general solicitation or advertising.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

We disclosed in the Quarterly Report for the three months ended March 31, 2008, that we had not repaid principal and accrued interest that became due as of such date in the aggregate amount of $1,895,000 and that as of August 14, 2008, we settled with the holders of certain of these amounts and of such date, $1,073,000 remained due and outstanding.