10-Q 1 ecte10q_june302016.htm FORM 10-Q ecte10q_june302016.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
________________
 
FORM 10-Q
________________
 
 
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

or

 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the transition period from _________ to __________
 
Commission File Number: 000-35218
 
ECHO THERAPEUTICS, INC.
(Exact name of registrant as specified in its charter)

________________
 
Delaware
41-1649949
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)

99 Wood Avenue South, Suite 302, Iselin, NJ
08830
(Address of principal executive offices)
(Zip Code)
 
732-201-4189
(Registrant’s telephone number, including area code)
________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R  No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R  No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer £
Accelerated filer £

Non-accelerated filer £ (Do not check if a smaller reporting company)
Smaller reporting company R

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes £  No R

As of August 3, 2016, 11,537,586 shares of the registrant’s Common Stock, $0.01 par value, were issued and outstanding.
 
 
 
 


 
 
ECHO THERAPEUTICS, INC.
 
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2016
 
TABLE OF CONTENTS

         
           
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PART I—FINANCIAL INFORMATION
 
ITEM 1.FINANCIAL STATEMENTS.
 
ECHO THERAPEUTICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

   
June 30,
   
December 31,
 
   
2016
   
2015
 
ASSETS
           
             
Current assets:
           
Cash and cash equivalents
  $ 938,661     $ 56,210  
Prepaid and other
    262,913       244,534  
Total current assets
    1,201,574       300,744  
                 
Property and equipment, net
    209,507       267,671  
                 
Other assets:
               
Cash restricted pursuant to letters of credit
    217,492       236,425  
Capitalized software development costs
    242,641        
Other
    250       250  
Total other assets
    460,383       236,675  
       Total assets
  $ 1,871,464     $ 805,090  
                 
LIABILITIES AND STOCKHOLDERS’ DEFICIT
               
                 
Current liabilities:
               
Accounts payable
  $ 1,615,339     $ 2,176,083  
Accrued and other
    383,963       602,345  
Secured convertible notes, net
    2,351,317        
Bridge loans
          330,000  
Premium financing
    112,299        
Derivative liabilities
    4,686,520       127,000  
Total current liabilities
    9,149,438       3,235,428  
Deferred revenue, net
    95,535       95,535  
       Total liabilities
    9,244,973       3,330,963  
                 
Commitments and contingencies
               
                 
Stockholders’ deficit:
               
Preferred Stock, $0.01 par value; 40,000,000 shares authorized:
               
Convertible Series
               
C - 10,000 shares authorized;1,000 issued and outstanding
    10       10  
D - 3,600,000 shares authorized;1,000,000 issued and outstanding
    10,000       10,000  
E - 1,748,613 shares authorized; issued and outstanding
    17,486       17,486  
F - 6,000,000 shares authorized; 5,276,180 issued and outstanding
    52,762       52,762  
Common stock, $0.01 par value; 150,000,000 shares authorized; issued and outstanding 11,512,586 and 11,124,496 shares, respectively
               
    115,124       111,243  
Additional paid-in capital
    148,123,118       147,412,559  
Accumulated deficit
    (155,692,009 )     (150,129,933 )
Total stockholders’ deficit
    (7,373,509 )     (2,525,873 )
Total liabilities and stockholders’ deficit
  $ 1,871,464     $ 805,090  
 
See accompanying notes to the condensed consolidated financial statements.
 

ECHO THERAPEUTICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
   
For the Three Months Ended June 30,
   
For the Six Months Ended
June 30,
 
   
2016
   
2015
   
2016
   
2015
 
                         
Licensing revenue
  $     $     $     $  
    Total revenues
                       
                                 
Operating expenses:
                               
    Research and development
    665,717       698,802       1,354,735       1,468,901  
    Selling, general and administrative
    792,761       1,451,585       1,729,388       2,995,084  
    Impairment charge
          9,625,000             9,625,000  
    Loss (gain) on disposal of property and equipment
    (4,000 )     130,594       (4,000 )     239,434  
    Depreciation and amortization
    27,509       361,616       58,165       448,320  
    Total operating expenses
    1,481,987       12,267,597       3,138,288       14,776,739  
                                 
Loss from operations
    (1,481,987 )     (12,267,597 )     (3,138,288 )     (14,776,739 )
                                 
Other income (expense):
                               
    Gain (loss) on revaluation of derivative liabilities
    1,086,999       250,000       761,950       (7,845 )
    Financing gain (loss)
          1,177,000             (4,357,000 )
    Loss on early extinguishment of bridge loans
    (1,728,235 )           (2,143,960 )      
    Amortization of debt discount
    (710,252 )           (895,218 )      
    Interest expense
    (107,373 )     (2,001 )     (146,560 )     (4,726 )
Other income (expense), net
    (1,458,861 )     1,424,999       (2,423,788 )     (4,369,571 )
Net loss
  $ (2,940,848 )   $ (10,842,598 )   $ (5,562,076 )   $ (19,146,310 )
Deemed dividend on beneficial conversion feature of preferred stock
    (6,460,818 )           (6,460,818 )      
Net loss applicable to common shareholders
  $ (9,401,666 )   $ (10,842,598 )   $ (12,022,894 )   $ (19,146,310 )
                                 
Net loss per common share, basic and diluted
  $ (0.82 )   $ (0.97 )   $ (1.06 )   $ (1.69 )
                                 
Basic and diluted weighted average common shares outstanding
    11,446,862       11,128,275       11,325,028       11,337,272  
 
See accompanying notes to the condensed consolidated financial statements.
 

ECHO THERAPEUTICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICIT
FOR THE SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)
 
 
Preferred Stock
   
Common Stock
                   
 
Shares
   
Amount
   
Shares
   
Amount
   
Additional Paid-in
Capital
   
 Accumulated 
Deficit
   
Total Stockholders’ 
Deficit
 
Balance at December 31,
2015
  8,025,793     $ 80,258       11,124,496     $ 111,243     $ 147,412,559     $ (150,129,933 )   $ (2,525,873 )
Share-based compensation,
net of restricted stock cancellations
              276,194       2,762       555,674             558,436  
Exercise of stock options
              2,246       23       (23 )            
Settlement of account payable
              57,121       571       93,079             93,650  
Payment of interest
              27,529       275       30,079             30,354  
Payment of investor relations
              25,000       250       31,750             32,000  
Net loss
                                (5,562,076 )     (5,562,076 )
Balance at June 30,
2016
  8,025,793     $ 80,258       11,512,586     $ 115,124     $ 148,123,118     $ (155,692,009 )   $ (7,373,509 )
 
See accompanying notes to the condensed consolidated financial statements.
 
 
ECHO THERAPEUTICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
   
For the Six Months Ended June 30,
 
   
2016
   
2015
 
    Cash Flows From Operating Activities:
           
    Net loss
  $ (5,562,076 )   $ (19,146,310 )
    Adjustments to reconcile net loss to net cash used in operating activities:
               
    Depreciation and amortization
    58,165       448,320  
    Amortization of debt discount
    895,218        
    Share-based compensation, net
    558,436       610,971  
    Loss on early extinguishment of bridge loans
    2,143,960        
    Gain on revaluation of derivative liabilities
    (761,950 )     7,845  
    Warrant repricing charged to legal expense
          328,000  
    Gain on disposal of assets
          239,434  
    Impairment charge
          9,625,000  
    Financing loss
          4,357,000  
    Changes in assets and liabilities:
               
    Prepaid and other
    (18,379 )     (124,342 )
    Accounts payable
    (435,096 )     (5,503 )
    Accrued and other
    (184,407 )     232,371  
    Net cash used in operating activities
    (3,306,129 )     (3,427,214 )
    Cash Flows from Investing Activities:
               
    Purchase of property and equipment
          (12,207 )
    Decrease  in restricted cash
    18,933       (126,968 )
    Capitalization of software development costs
    (242,641 )      
    Proceeds on disposal of property and equipment
          19,600  
    Net cash used in investing activities
    (223,708 )     (119,575 )
    Cash Flows From Financing Activities:
               
    Proceeds from secured convertible notes, net of related costs
    2,549,989        
    Proceeds from bridge loans
    1,750,000        
    Proceeds from equity financing
          2,500,000  
    Proceeds from premium financing
    199,671       272,622  
    Principal payments from premium financing
    (87,372 )     (226,676 )
    Capital contribution
          59,325  
    Net cash provided by financing activities
    4,412,288       2,605,271  
    Net increase in cash and cash equivalents
    882,451       (941,518 )
    Cash and cash equivalents:
               
   Beginning of period
    56,210       1,278,941  
   End of period
  $ 938,661     $ 337,423  
                 
    Supplemental disclosure of  cash flow information:
               
    Cash paid during the year:
               
   Interest
  $ 12,306     $ 4,781  
   Income taxes
  $ 2,799     $  
    Supplemental disclosure of non-cash financing transactions:
               
   Deemed dividend on beneficial conversion feature of convertible preferred stock
  $ 6,460,818     $  
   Directors fees payable offset against prepaid insurance
  $     $ 272,200  
   Security deposit offset against accounts payable
  $     $ 9,740  
   Accrued legal fees settled with stock
  $     $ 550,000  
   Accrued interest settled with stock
  $ 30,354     $  
   Account payable settled with stock
  $ 125,650     $  
   Bridge loans exchanged for secured convertible notes
  $ 2,080,000     $  
   Derivatives offset against secured convertible notes
  $ 5,321,470     $  
   Conversion of convertible preferred stock into common stock at par value
  $     $ 15,000  
 
See accompanying notes to the condensed consolidated financial statements.

 
Echo Therapeutics, Inc.
Notes to Condensed Consolidated Financial Statements
 (Unaudited)

(1)
    ORGANIZATION AND BASIS OF PRESENTATION

Echo Therapeutics, Inc. (the "Company") is a medical device company with expertise in advanced skin permeation technology. The Company is developing its non-invasive, wireless continuous glucose monitoring (CGM) system with potential use in the outpatient diabetes market. A significant opportunity may also exist in the wearable-health consumer market and in the hospital setting. Echo has also developed its needle-free skin preparation device as a platform technology that allows for enhanced skin permeation enabling extraction of analytes, such as glucose, enhanced delivery of topical pharmaceuticals and other applications.

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Sontra Medical, Inc., a Delaware corporation. All significant intercompany balances and transactions have been eliminated in consolidation. These financial statements have been prepared in conformity with generally accepted accounting principles (“GAAP”) in the United States consistent with those applied in, and should be read in conjunction with, the Company’s audited consolidated financial statements and related footnotes for the year ended December 31, 2015 included in the Company’s Annual Report on Form 10-K as filed with the United States Securities and Exchange Commission (“SEC”) on March 30, 2016. These financial statements reflect all adjustments, consisting only of normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the Company’s financial position as of June 30, 2016 and its results of operations and cash flows for the interim periods presented and are not necessarily indicative of results for subsequent interim periods or for the full year. These interim financial statements do not include all of the information and footnotes required by GAAP for complete financial statements as allowed by the relevant SEC rules and regulations; however, the Company believes that its disclosures are adequate to ensure that the information presented is not misleading. Certain amounts in prior periods have been reclassified to conform to the current presentation.

(2)       LIQUIDITY AND MANAGEMENT’S PLANS

The accompanying financial statements have been prepared on a basis that assumes that the Company will continue as a going concern and that contemplates the continuity of operations, the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. As of June 30, 2016, the Company had cash of $938,661, working capital deficit of ($7,947,864) and an accumulated deficit of ($155,692,009). The Company continues to incur recurring losses from operations. The Company’s losses have resulted principally from costs incurred in connection with its research and development activities and from general and administrative costs associated with its operations. The Company also expects to have negative cash flows for the foreseeable future as it funds its operational losses and capital expenditures. This will result in decreases in the Company’s working capital, total assets and stockholders’ equity, which may not be offset by future funding. The Company will need to secure additional capital to fund its product development, research, manufacturing and clinical programs in accordance with its current planned operations. The Company has funded its operations in the past primarily through debt and equity issuances. Management will continue to pursue financing to fund its operations. No assurances can be given that additional capital will be available on terms acceptable to the Company. The accompanying financial statements do not include any adjustments that might result from the outcome of the uncertainty.

(3)       PROPERTY AND EQUIPMENT

The principal categories and estimated useful lives of property and equipment were:

   
06/30/16
   
12/31/15
   
Estimated
Useful Lives
 
Computer equipment
  $ 332,764     $ 332,764       3  
Office and laboratory equipment
    603,227       628,726       3-5  
Furniture and fixtures
    228,099       228,099       7  
Manufacturing equipment
    61,998       61,998       5  
Leasehold improvements
    41,968       41,968       3-7  
  Total property and equipment
    1,268,056       1,293,555          
Less accumulated depreciation and amortization
    1,058,549       1,025,884          
 Property and equipment, net
  $ 209,507     $ 267,671          

 
(4)       CAPITALIZED SOFTWARE DEVELOPMENT COSTS
 
Software development costs associated with the planning and designing phase of software development, including coding and testing activities necessary to establish technological feasibility, are expensed as incurred. Once technological feasibility has been determined, a portion of the costs incurred in development, including coding, testing, and quality assurance, are capitalized. $82,641 and $242,641 of costs associated with the application programming of the Company’s smartphone application for its CGM were capitalized in the quarter and six months ended June 30, 2016, respectively.

(5)       FINANCING TRANSACTIONS

On January 29, 2016, the Company entered into a securities purchase agreement (the “Purchase Agreement”) with certain institutional and other accredited investors (the “Investors”) pursuant to which the Company agreed to issue up to $5,148,620 principal amount of 10% senior secured convertible notes of the Company (the “Notes”) and related common stock purchase warrants (the “Warrants”) in two tranches.  The Notes are secured by substantially all of the assets of the Company pursuant to a Security Agreement, dated January 29, 2016 (the “Security Agreement”).  The initial closing of $1,787,000 occurred on January 29, 2016.  The second tranche of the financing, or $3,361,620, was subject to the Company obtaining shareholder approval which occurred on April 14, 2016. The Notes and Warrants are subject to customary antidilution provisions. With stockholder approval, the conversion price for the Notes is subject to a reset to eighty percent (80%) of the average of the ten lowest closing prices of the Common Stock less than $1.50 , subject to equitable adjustment, if any, as reported by Bloomberg LP for the principal market on which the Common Stock then trades during the ninety (90) days following the first effective date of a registration statement filed pursuant to the Registration Rights Agreement, but in no event less than $.80, subject to equitable adjustment. For the first closing, bridge notes in the principal amount of $680,000 were surrendered to the Company as payment by certain Investors. This was inclusive of $330,000 of bridge notes outstanding at December 31, 2015 and a $350,000 of promissory notes received at various dates in January 2016 from Beijing Yi Tang Bio Science & Technology, Ltd. (BYT). The Company recorded a loss on early extinguishment of these bridge loans of $415,725, representing the excess value of the consideration consisting of the $680,000 secured convertible note, and a proportional amount of the Warrants totaling $320,761 and the embedded conversion feature of the Notes totaling $94,964, exchanged for certain bridge loans to cancel them. Fees aggregating $368,080 were paid to the placement agent and others. The Notes issued in the first closing are initially convertible into 1,191,333 shares of common stock, par value $.01 per share, of the Company (the “Common Stock”), at $1.50 per share. In connection with the initial closing, the Company issued five-year Class A warrants to purchase 1,274,280 shares of Common Stock, inclusive of Class A warrants to purchase 82,947 share of Common Stock issued to the placement  agent, at an exercise price of $1.50 per share, which are not exercisable for six months. These Warrants, whose exercise price is subject to adjustments should the Company do a future financing at a price less than $1.50, is considered a derivative. The initial value of these derivative warrants was $901,631 which was determined utilizing a Monte Carlo Binomial Model. The assumptions utilized for these derivative warrants, as well as embedded conversion feature, described hereafter, are disclosed in Note 10. Additionally the Notes contain an embedded conversion feature which adjusts the conversion price should the Company have a price reset during the ninety days after April 29, 2016 (the effective date of the Company’s registration) or do a future financing at a price less than $1.50, and is also considered a derivative. The initial value of the embedded conversion feature within the Notes was $249,559 which was also determined utilizing a Monte Carlo Binomial Model.
 
On February 4, 2016, the Company issued a promissory note to BYT (the “Lender”) in the aggregate principal amount of $300,000 in respect of a bridge loan made by such party.  On February 11, 2016, the Company issued a promissory note to Platinum Partners Value Arbitrage Fund L.P. (the “Lender” and “PPVA”) in the aggregate principal amount of $100,000 in respect of a bridge loan made by such party.  On March 21, 2016, the Company issued a promissory note to PPVA in the aggregate principal amount of $150,000 in respect of a bridge loan made by such party.  On April 4, 2016, the Company issued a promissory note to PPVA in the aggregate principal amount of $350,000 in respect of a bridge loan made by such party.  On April 18, 2016, the Company issued a promissory note to PPVA in the aggregate principal amount of $450,000 in respect of a bridge loan made by such party. On April 29, 2016, the Company issued a promissory note to BYT in the aggregate principal amount of $50,000 in respect of a bridge loan made by such party.  These promissory notes, aggregating $1,400,000, which bore interest at the prime rate (or 3.5%), were exchanged for the May 3, 2016 second tranche financing of the Notes described below.
 
On April 14, 2016, the Company held a Special Meeting of Stockholders. Of the 11,124,496 shares of common stock outstanding and entitled to vote, 6,197,024 shares, or 56%, were represented at the meeting in person or by proxy. The stockholders approved the issuance by the Company of shares of its Common Stock pursuant to and in accordance with the terms of the private placement financing transaction contemplated by the Securities Purchase Agreement, dated January 29, 2016, by and among the Company and the investors named therein, and the other documents and agreements related thereto, and the other transactions contemplated thereby, including the amendment to Company's Certificate of Designations governing the terms of its Series F Convertible Preferred Stock as described therein, for purposes of complying with applicable Delaware law and NASDAQ Listing Rule 5635(d), as disclosed in the Company’s proxy statement.
 
On May 3, 2016, the Company closed the second tranche of the Note financing and issued Notes in an aggregate principal amount of $3,361,620, inclusive of $3,620 of interest due on bridge loans. In exchange for the Notes, the Company received $1,188,000 in gross cash proceeds, a note receivable, payable in 30 days and bearing interest at 12%, of $770,000, from BYT, and $1,400,000 of bridge notes were cancelled. The Company recorded a loss on early extinguishment of these bridge loans of $1,728,235, representing the excess value of the consideration consisting of the $1,400,000 secured convertible note, and a proportional amount of the Warrants totaling $510,348 and the embedded conversion feature of the Notes totaling $1,217,887, exchanged for certain bridge loans to cancel them. The Company incurred placement, legal and other fees aggregating $146,931 which were deducted from the gross cash proceeds. Additionally, the placement agent received Class B warrants, with a 1½ year term, to purchase 37,520 shares of the Company’s Common Stock at $1.50 per share. The Notes are initially convertible into 2,241,075 shares of Common Stock at $1.50 per share. The Company also issued Class B warrants, with a 1½ year term, to purchase 2,241,075 shares of Common Stock at $1.50 per share. The Company may call the Class B Warrants in the event that Company’s Common Stock is trading at 200% above the strike price for 10 consecutive trading days (at $100,000 value traded per day) if the Warrant is saleable into the public markets, provided that the holder will have the option of ten trading days to exercise. These Warrants, whose exercise price is subject to adjustments should the Company do a future financing at a price less than $1.50, is considered a derivative. The initial value of these derivative warrants was $1,245,943 which was determined utilizing a Monte Carlo Binomial Model. The assumptions utilized for these derivative warrants, as well as embedded conversion feature, described hereafter, are disclosed in Note 10. Additionally the Notes contain an embedded conversion feature which adjusts the conversion price should the Company have a price reset during the ninety days after April 29, 2016 (the effective date of the Company’s registration) or do a future financing at a price less than $1.50, and is also considered a derivative. The initial value of the embedded conversion feature within the Notes was $2,924,337 which was also determined utilizing a Monte Carlo Binomial Model.

In connection with the Note closing, the Certificate of Amendment to the Certificate of Designations of the Company’s Series F Convertible Preferred Stock was filed which provides the holders of 5,276,180 shares of the Company’s Series F Convertible Preferred Stock the same reset rights afforded the Note holders. This modification to the Series F provided them with a more beneficial conversion feature. As a result of this change, the Company recorded a deemed dividend to the holders of $6,460,818.

The Purchase Agreement for the above described Note financing contains customary representations, warranties and affirmative and negative covenants.  The Purchase Agreement also requires management and certain shareholders to lock-up certain of their shares for the earlier of six months after the effective date of a registration statement, the first anniversary of the initial closing (January 29, 2017), or the date, if applicable, such holder of securities is no longer an officer or directors of the Company, subject to certain exceptions.  In addition, for up to one year following the effective date of a registration statement, the Investors have the right to participate, on a pro rata basis, in certain subsequent financings by the Company, subject to certain limitations. In connection with the transaction, the Company entered into a registration rights agreement (the “Registration Rights Agreement”) that requires the Company to file one or more registration statements in respect of the shares of Common Stock underlying the Notes and Warrants. If the Company fails to make its filing deadlines or fails to maintain the registration statement for required periods of time, the Company will be subject to certain liquidated damages provisions. Newbridge Securities Corporation/Life Tech Capital (the “Placement Agent”) acted as the sole placement agent for the financing.  

The Company may redeem the Notes at par when the Company stock price remains above $5.00 for ten consecutive days, or alternatively, at 125% of principal below $5.00. Interest is payable quarterly or, subject to receipt of stockholder approval, at the Company’s option, in shares of Common Stock.

The assumptions utilized for the embedded conversion feature valuation, which reflect the initial valuation at January 29th , May 3rd and subsequent valuation at June 30, 2016, were as follows:

Risk-free interest rate %                                                                             
    0.38 – 0.53  
Expected dividend yield                                                                             
     
Expected term - years (contractual term)                                                                             
    0.59 – 1.01  
Forfeiture rate                                                                             
     
Expected volatility %                                                                             
    103  
Timing of down-round triggering event                                                                             
 
August 2016
 


Follows is a summary of the Notes and related discounts and the loss on the early extinguishment of bridge loans:

   
Original Value
   
Loss on Early
Extinguishment of Bridge Loans
   
Secured
Convertible
Notes, net
 
Cash and other proceeds received from financing
              $ 5,148,620  
  Warrants
  $ 2,147,574       (831,109 )     (1,316,465 )
  Embedded conversion feature in notes
  $ 3,173,896       (1,312,851 )     (1,861,045 )
  Financing costs
                (515,011 )
  Amortization of debt discount
                895,218  
Totals, net
  $ 5,321,470     $ (2,143,960 )   $ 2,351,317  


(6)       DERIVATIVE LIABILITIES

As a result of having warrants which are outstanding, issued in connection with a 2012 Credit Facility (which was terminated in October 2014), the Company is required to record the changes in the value of these derivative warrants through their expirations in November 2017. Additionally as indicated in Note 5 above, Notes and Warrants issued in connection with the Company’s January and May 2016 financing, included certain price/conversion features, which require them to be accounted for as derivatives.

The table below presents the changes in the derivative liability, which is measured at fair value on a recurring basis and classified as Level 3 in fair value hierarchy:

   
06/30/16
   
12/31/15
 
Derivative liabilities as of January 1
  $ 127,000     $ 208,155  
Secured convertible note derivatives:
               
  Warrants
    2,147,574        
  Embedded conversion feature in Notes
    3,173,896        
Loss (gain) on revaluation
    (761,950 )     (81,155 )
Derivative liabilities as of end of period
  $ 4,686,520     $ 127,000  

None of the derivative warrants were exercised in 2016 or 2015 pursuant to cashless exercise provisions.

(7)       EQUITY COMPENSATION PLANS

In March 2003, the Company’s shareholders approved its 2003 Stock Option and Incentive Plan (the “2003 Plan”). Pursuant to the 2003 Plan, the Company’s Board of Directors (or its committees and/or executive officers delegated by the Board of Directors) may grant incentive and nonqualified stock options, restricted stock, and other stock-based awards to the Company’s employees, officers, directors, consultants and advisors.  As of June 30, 2016, there were 5,000 restricted shares of Common Stock issued and options to purchase an aggregate of 26,500 shares of Common Stock outstanding under the 2003 Plan and no shares are available for future grants due to the 2003 Plan’s expiration.

In May 2008, the Company’s shareholders approved the 2008 Equity Compensation Plan, as amended (the “2008 Plan”). The 2008 Plan provides for grants of incentive stock options to employees and nonqualified stock options and restricted stock to employees, consultants and non-employee directors of the Company. The maximum number of shares available under the 2008 Plan is 10,000,000 shares.  As of June 30, 2016, there were 291,148 restricted shares of Common Stock issued and options to purchase 2,763,043 shares of Common Stock outstanding under the 2008 Plan and 6,922,309 shares available for future grants.

The following table shows the remaining shares available for future grants for each plan and outstanding shares:
 
   
Equity Compensation Plans
   
Not Pursuant
 
   
2003 Plan
   
2008 Plan
   
to a Plan
 
Shares Available For Issuance
                 
Total reserved for stock options and restricted stock
    160,000       10,000,000        
Net restricted stock issued net of cancellations
    (5,000 )     (291,148 )      
Stock options granted
    (154,449 )     (4,293,693 )      
Add back options cancelled before exercise
    92,349       1,507,150        
Less shares no longer available due to Plan expiration
    (92,900 )            
Remaining shares available for future grants at June 30, 2016
          6,922,309        
       
Stock options granted
    154,449       4,293,693       310,000  
Less:   Stock options cancelled
    (92,349 )     (1,507,150 )     (243,333 )
Stock options exercised
    (35,600 )     (23,500 )     (66,667 )
Net shares outstanding before restricted stock
    26,500       2,763,043        
Net restricted stock issued net of cancellations
    5,000       291,148       6,485  
Outstanding shares at  June 30, 2016
    31,500       3,054,191       6,485  
 
(8)       STOCK OPTIONS

The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model with certain assumptions noted below. Expected volatilities are based on historical volatility of the Common Stock using historical periods consistent with the expected term of the options. The Company uses historical data, as well as subsequent events occurring prior to the issuance of the financial statements, to estimate option exercise and employee termination and forfeitures within the valuation model. The expected term of stock options granted under the Company’s stock plans is based on the average of the contractual term (generally 10 years) and the vesting period (generally 24 to 42 months). The risk-free rate is based on the yield of a U.S. Treasury security with a term consistent with the option.

For options issued and outstanding during the six month periods ended June 30, 2016 and 2015, the Company recorded additional paid-in capital and non-cash compensation expense of $516,013 and $585,000, respectively, each net of estimated forfeitures.

The assumptions used principally for stock options granted to employees and members of the Company’s Board of Directors in the six months ended June 30, 2016 and 2015 were as follows:

 
 
2016
   
2015
 
Risk-free interest rate %
    0.98 – 1.07       1.52 – 1.61  
Expected dividend yield
           
Expected term -  years
    3 – 4       5 – 5.5  
Forfeiture rate % (excluding fully vested stock options)
 
­­2 – 5
      15  
Expected volatility %
    0.94 – 1.02       0.80 – 1.06  

A summary of stock option activity for the six months ended June 30, 2016 is as follows:

 
 
 
 
Stock Options
 
 
 
 
Shares
   
Weighted-
Average
Exercise
Price
   
Weighted-
Average
Remaining
Contractual
Term (years)
   
 
Aggregate
Intrinsic
Value
 
Outstanding options at January 1, 2016
    1,667,233     $ 2.01              
Granted
    1,222,810     $ 1.28              
Exercised
    (10,500 )   $ 1.19              
Forfeited or expired
    (90,000 )   $ 5.69              
Outstanding options at June 30, 2016
    2,789,543     $ 1.57       8.89     $  
Exercisable options at June 30, 2016
    1,332,531     $ 1.68       8.58     $  
 
The weighted-average grant-date fair value of stock options granted for the six month period ended June 30, 2016 was $1.28 per share. As of June 30, 2016, there was $997,504 of total unrecognized compensation expense related to non-vested share-based option compensation arrangements. With the exception of the unrecognized share-based compensation related to certain restricted stock grants to officers and employees that contain performance conditions related to FDA approval for the Company’s CGM system or the sale of substantially all of the stock or assets of the Company, unrecognized compensation is expected to be recognized over the next four years.

(9)       RESTRICTED STOCK

For restricted stock issued and outstanding during the six months ended June 30, 2016 and 2015, the Company incurred non-cash compensation expense of $42,423 and $26,000, respectively, each net of estimated forfeitures.

During the six months ended June 30, 2016, the Company granted 280,000 restricted shares of Common Stock to its officers and Vice President of Operations and Product Development of the Company, in connection with their respective salary deferrals.

A summary of non-vested restricted stock activity for the six months ended June 30, 2016 is as follows:
Restricted Stock
 
 
 
Shares
   
Weighted-
Average
Grant-Date
Fair Value
 
Non-vested shares at January 1, 2016
    27,842     $ 13.06  
Granted
    280,000     $ 1.13  
Vested
    (1,403 )   $ 8.54  
Forfeited
    (3,806 )   $ 7.73  
Non-vested shares at June 30, 2016
    302,633     $ 2.11  

Among the 302,633 shares of non-vested restricted stock, the various vesting criteria include the following:

·
14,185 shares of restricted stock vest upon the FDA approval of the Company’s CGM system or the sale of the Company; and
 
·
8,448 shares of restricted stock vest over 4 years, at each of the anniversary dates of the grants, and
 
·
280,000 shares of restricted stock vest 18 months from the date of issuance.

 
As of June 30, 2016, there was $585,415 of total unrecognized compensation expense related to non-vested share-based restricted stock arrangements granted pursuant to the Company’s equity compensation plans that vest over time in the foreseeable future. As of June 30, 2016, the Company cannot estimate the timing of completion of performance vesting requirements required by certain of these restricted stock grant arrangements. Compensation expense related to these restricted share grants will be recognized when the Company concludes that achievement of the performance vesting conditions is probable.

(10)     WARRANTS

In the six months ended June 30, 2016, the Company issued warrants to purchase 3,552,875 shares of the Company’s common stock in connection with its Note financing. See Note 5.

A summary of warrant activity for the six months ended June 30, 2016 is as follows:

 
 
 
Warrants
 
 
 
 
Shares
   
Weighted-
Average
Exercise
Price
 
Outstanding warrants at January 1, 2016
    4,530,428     $ 3.68  
Granted
    3,552,875     $ 1.50  
Forfeited
        $  
Outstanding warrants at June 30, 2016
    8,083,303     $ 2.72  
 
At June 30, 2016, the Company had the following outstanding warrants:
 
Type of Warrant/ Range of
Exercise Prices
 
 
 
 
 
Expirations
 
 
 
Number Outstanding
   
Weighted- Average Remaining Contractual Life (years)
   
Weighted- Average Exercise Price
   
 
 
Number Exercisable
 
Derivative:
                           
$ 1.50  
7/29/21
    1,274,280       5.08     $ 1.50       1,274,280  
$ 1.50  
5/3/18
    2,278,595       1.84     $ 1.50       2,278,595  
$ 7.50  
8/31/17 to 11/6/17
    700,000       1.23     $ 7.50       700,000  
Equity:
                                   
$ 2.75 - $3.00  
12/10/18 to 10//30/20
    3,830,428       3.69     $ 2.98       3,830,428  
Total outstanding
        8,083,303                       8,083,303  

The Company uses valuation methods and assumptions that consider among other factors the fair value of the underlying stock, risk-free interest rate, volatility, expected life and dividend rates in estimating fair value for the warrants considered to be derivative instruments.

The following assumptions were utilized by the Company:
 
By expiration:
 
7/29/21
   
5/3/18
   
8/31/17 - 11/6/17
 
Risk-free interest rate %
    1.03       0.56       0.73  
Expected dividend yield
                 
Expected term - years (contractual term)
    5.15       1.87       1.17 - 1.35  
Forfeiture rate
                 
Expected volatility %
    103       103       84.95  
Timing of down-round triggering event
 
August 2016
   
August 2016
      N/A  

Expected volatilities are based on historical volatility of the Common Stock using historical periods consistent with the expected term of the warrant. The risk-free rate is based on the yield of a U.S. Treasury security with a term consistent with the warrant.
 
(11)     LITIGATION & OTHER SIGNIFICANT MATTERS

From time to time, the Company is subject to legal proceedings, claims, investigations, and proceedings in the ordinary course of business. In accordance with generally accepted accounting principles, the Company makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss or range of loss can be reasonably estimated. These provisions, if any, are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. At June 30, 2016, no litigation loss is deemed probable or reasonably estimated.

 (12)    SUBSEQUENT EVENTS

Effective as of July 29, 2016, notice was given that the Conversion Price of the Notes issued to the note holders pursuant to the Securities Purchase Agreement, dated January 29, 2016 (the “Purchase Agreement”), between Echo Therapeutics, Inc. and the purchasers, had been reset from $1.50 per share to $0.91 per share, Additionally and also effective as of the same date, notice was given that, pursuant to Section 5(c)(v) of the Certification of Designation, Preferences and Rights of the Series F Convertible Preferred Stock of Echo Therapeutics, Inc. (the “Series F Designation”),  the Conversion Ratio has been reset from 1:1 to 1:1.65. These resets were based on an amount equal to 80% of the average of the ten lowest closing prices of the Common Stock less than $1.50 per share during the ninety day period immediately following the effectiveness of the Registration Statement, as contemplated by Section 4(b) of the Notes.


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

The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 and elsewhere in this report. The matters discussed herein contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 27A of the Securities Act of 1933, as amended, which involve risks and uncertainties. This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 27A of the Securities Act of 1933, as amended, which involve risks and uncertainties. All statements other than statements of historical information provided herein may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects” and similar expressions are intended to identify forward-looking statements. Factors that could cause actual results to differ materially from those reflected in the forward-looking statements include, but are not limited to, those discussed elsewhere in this report and the risks discussed in our other filings with the Securities and Exchange Commission (the “SEC”). Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis, judgment, belief or expectation only as of the date hereof. Except as required by law, we undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof.

Business

We are a medical device company with expertise in advanced skin permeation technology. We are developing a non-invasive, wireless continuous glucose monitoring (CGM) system for initial use in the outpatient diabetes market and potentially in the wearable-health consumer market. The transdermal skin preparation component of our CGM system allows for enhanced skin permeation that will enable extraction of analytes such as glucose, enhanced delivery of topical pharmaceuticals and other applications.

Research and Development

We believe that ongoing research and development (“R&D”) efforts are essential to our success. A major portion of our operating expenses to date is related to our research and development activities. R&D expenses generally consist of internal salaries and related costs, and third-party vendor expenses for product design and development. In addition, R&D costs include regulatory consulting, feasibility product testing (internal and external) and conducting nonclinical and clinical studies. R&D expenses were $1,354,735 for the six months ended June 30, 2016. We intend to maintain our commitment to R&D as an essential component of our product development efforts. Our ability to raise sufficient financing may impact our level of R&D spending and progress towards milestones.

Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.

On an ongoing basis, we evaluate our estimates and judgments for all assets and liabilities, including those related to long-lived asset impairment, stock-based compensation expense and the fair value of stock purchase warrants classified as derivative liabilities. We base our estimates and judgments on historical experience, current economic and industry conditions and on various other factors that are believed to be reasonable under the circumstances. This forms the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. There have been no changes in our critical accounting policies and estimates subsequent to those disclosed in our Annual Report on Form 10-K as filed with the SEC on March 30, 2016.

We believe that full consideration has been given to all relevant circumstances that we may be subject to, and the consolidated financial statements accurately reflect our best estimate of the results of operations, financial position and cash flows for the periods presented.
 
Results of Operations

 
Comparison of the Three and Six Months ended June 30, 2016 and 2015

Net Loss — As a result of the factors described below, we had a net loss of $5,562,076 and $2,940,348 for the six and three months ended 2016, respectively, compared to $19,146,310 and $10,842,598 for the six and three months ended 2015, respectively.

Research and Development Expenses — R&D expenses decreased by $33,085, or 5%, to $665,717 for the three months ended 2016 from $698,802 for the same period in 2015. R&D expenses represented 45% and 26% of total operating expenses (excluding the impairment charge in 2015) during the three months ended 2016 and 2015, respectively. We incurred some unplanned turnover in our staffing during the quarter exemplary of a better economic climate. Declines for the quarter were primarily attributable to approximate decreases in: salaries (including stock compensation) and benefits of $30,000, and rent and utilities of $78,000. These declines were offset by increases in consulting and contracted services of $37,000, and supplies and prototype costs of $39,000.

R&D expenses decreased by $114,166, or 8%, to $1,354,735 for the six months ended 2016 from $1,468,901 for the same period in 2015. R&D expenses represented 43% and 29%, of total operating expenses (excluding the impairment charge in 2015) during the six months ended 2016 and 2015, respectively. The decrease in R&D expenses was primarily attributable to lower facility costs of approximately $165,000. This was slightly offset by approximately $64,000 in higher wages and benefits due to the use of additional technical staff in the first quarter of 2016.

We relocated our facilities in July 2015 to less costly and more efficient space. R&D expenses for the quarter and six months 2016 were additionally impacted by $82,641 and $242,641, respectively, of capitalized software development costs, consisting of contracted services, related to a smartphone API used with our CGM.

During the second quarter of 2016, the Research and Development team continued to further develop and begin testing of the NextGen CGM system and completed the transfer of our existing CGM technology to our Chinese partner, Medical Technologies Innovation Asia, Ltd. (MTIA).

We began stand-alone and integrated testing of our NextGen continuous glucose monitoring system prototype components and formally selected a Clinical Research Organization (CRO) for our regulatory and clinical strategy. Rigorous testing of each component independently and as an integrated system will continue as the Company optimizes its system in preparation for future clinical and regulatory trials. With respect to specific components of the NextGen system, our progress was as follows during this second quarter:

·
Skin Preparation Device: We completed prototype software for the new self-use exfoliator and began hardware and software testing of the NextGen Exfoliator. This new self-exfoliator will be lower cost, easier to use and fully integrated with the new sensor and Target Base. 

·
Sensor: We developed and continue internal clinical testing of our NextGen sensor module. This new sensor module includes a new sensor element, new hydrogel, bluetooth transmitter, and new flexible housing. New electronics were also developed that allow the new sensor module to be compatible with our new Application Programming Interface (API) and software application (APP). 

·
Application Programming Interface: We continue to make improvements in the API that will allow Android programmers to write software applications, or APPs, that use our sensors. Verification testing of the new API and APP is complete.

·
CGM APP: We implemented a CGM APP that will be able to display glucose information from either the original Echo technology, or the NextGen sensor. 

With respect to supporting MTIA, we made significant improvements to the API that MTIA will use on their mobile device. This API was transferred to MTIA and greatly simplifies the task of writing software apps to access our glucose information. In addition, we have developed and transferred a CGM APP, to provide calibrated glucose information on Android phones. 

Selling, General and Administrative Expenses — S,G&A expenses decreased by $658,824, or 45%, to $792,761 for the three months ended 2016 from $1,451,585 for the same period in 2015. S,G&A expenses represented 53% and 55% of total operating expenses (excluding the impairment charge in 2015) during the quarter ended 2016 and 2015, respectively. The decline for the 2016 quarter was primarily attributable to approximate declines in legal fees of $440,000 and salaries and benefits of $125,000 (including a stock compensation decline of $18,000).
 
S,G&A expenses decreased by $1,265,696, or 42%, to $1,729,388 for the six months ended 2016 from $2,995,084 for the same period in 2015. S,G&A expenses represented 55% and 58% of total operating expenses (excluding the impairment charge in 2015) during the six months ended 2016 and 2015, respectively. The decline for the 2016 quarter was primarily attributable to approximate declines in legal fees of $809,000 and salaries and benefits of $222,000 (including a stock compensation decline of $48,000).

In 2015, the Company settled its litigation with the former CEO, Patrick Mooney, and has not had any significant litigation since, causing the decrease in legal fees.  Stock compensation for 2015 included the stock compensation for new board members as well as recently hired executive staff, which was not present in 2016.
 
Impairment Charge — The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the asset’s carrying amount may not be recoverable. The Company conducts its long-lived asset impairment analyses by grouping assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities and evaluate the asset group against the sum of the undiscounted future cash flows. If the undiscounted cash flows do not indicate the carrying amount of the asset is recoverable, an impairment charge is measured as the amount by which the carrying amount of the asset group exceeds its fair value based on discounted cash flow analysis or appraisals. In connection with the preparation of the financial statements in the second quarter of fiscal 2015, the Company concluded it had a triggering event requiring assessment of impairment for its intangibles in conjunction with an expected out-licensing strategy that new management had hoped to pursue. Extremely limited financial resources coupled with the remaining short patent lives, discussions with previous consultants regarding their progress with bringing value to the intangibles, a review of competitive formulations and discussions with new consultants to explore out-licensing strategies led newly-hired corporate management to conclude it was best to abandon its initial hope to garner value from its intangibles. Accordingly, due to this change in strategy, no monies are now expected to be obtained relating to the Azone Drug Master File, the Durhalieve and MAZ Investigational New Drug applications and the MAZ Orphan Drug application (collectively, the AzoneTS-based technology acquired in 2007) intangibles. As a result, the Company reviewed its intangibles for impairment and recorded a $9.625 million impairment charge, or the full value of the intangibles, on the consolidated statement of operations in the second quarter of 2015.

Loss on disposal of property and equipment — We recorded a gain for the quarter and six months 2016 of $4,000 on the sale of certain excess fully depreciated equipment. The loss on disposal of $130,594 and $239,434 for the quarter and six months ended 2015 represented furniture and fixtures that were sold and the write-off of leasehold improvements in our Philadelphia office when we relocated to the Iselin, New Jersey office in January 2015.

Depreciation and amortization expense — Depreciation expense decreased by $334,107 and $390,155 for the quarter and six months ended 2016, to $27,509 and $58,165 from $361,616 and $448,320 for the same periods in 2015. This decline reflects the write-off of a substantial amount of leasehold improvements due to our relocations of our Massachusetts research facility and Philadelphia corporate office in 2015.

Gain on Revaluation of Derivative Liability — Changes in the fair value of derivative financial instruments are recognized each period as a derivative gain or loss. The primary underlying risk exposure pertaining to the secured convertible notes, consisting of derivative warrants and embedded conversion options, and other derivative warrants, is the change in fair value of the underlying common stock. The gain (loss) on revaluation of the derivative liabilities for the quarter ended 2016 and 2015 was $1,086,999 and $250,000, respectively, and for the six months ended 2016 and 2015, $761,950 and $(7,845), respectively.

Financing expense — This is a non-cash charge with two components representing: (i) the excess value given to investors in 2015, who received shares of Series F Stock and warrants to purchase the same number of shares of our common stock, when the closing market price was above the $1.50 purchase price they paid for their shares and warrants. We recorded a non-cash charge of $3,938,000 related to these investors, and (ii) the potential excess future value represented by the 333,333 shares and warrants to purchase the same number of shares for the remaining $500,000 of investment still outstanding under our December 2014 financing, based on our closing market price at June 30, 2015 of $1.70. We recorded a non-cash charge of $419,000 related to these future investments. For the three months ended 2015 we recorded a gain of $1,177,000 representing the difference between what we had estimated the value of the derivative transactions would cost the Company at the end of the first quarter and what they actually represented during the second quarter.
 
Loss on early extinguishment of bridge loans — We recorded a loss on early extinguishment of these bridge loans of $1,728,235 and $2,143,960 in the quarter and six months ended 2016 representing the aggregate excess consideration of the Notes and warrants exchanged for the bridge loans.
 
Amortization of debt discount — $710,252 and $895,218 for the quarter and six months ended 2016 represents the amortization of the various components offsetting the Notes issued on January 29, 2016 and May 3, 2016 over the one year respective terms of the Notes. Such amounts consisted of amortization of debt issuance costs, and values related to the derivative warrants and embedded conversion features that were not exchanged, respectively.

Interest Expense — Interest expense increased to $107,372 and $146,560 for the quarter and six months ended 2016 from $2,001 and $4,726 for similar periods in 2015, respectively. The increase is primarily related to the 10% interest on the secured convertible notes payable.

Deemed Dividend on Beneficial Conversion Feature of Preferred Stock — In connection with the sale of Secured convertible notes, we agreed to give the holders of Series F Convertible Preferred Stock the same rights as the holders of the Notes, i.e., a reset of their conversion price calculated during the ninety day period post the April 29, 2016 effective registration. This modification to the conversion of the Series F shares increased the value of the Series F and caused us to record a deemed dividend of $6,460,818 calculated using a Monte Carlo Valuation Model.
 
Liquidity and Capital Resources

We have financed our operations since inception primarily through sales of our equity, the issuance of convertible promissory notes, draws from a non-revolving credit facility, unsecured and secured promissory notes, non-refundable payments received under license agreements and cash received in connection with exercises of Common Stock options and warrants. As of June 30, 2016, we had $938,661 of cash and cash equivalents, with no other short-term investments.

On April 4, 2016, we issued a promissory note to Platinum Partners Value Arbitrage Fund, L.P. (PPVA) in the aggregate principal amount of $350,000 in respect of a bridge loan made by such party.  On April 18, 2016, we issued a promissory note to PPVA in the aggregate principal amount of $450,000 in respect of a bridge loan made by such party. On April 29, 2016, we issued a promissory note to Beijing Yi Tang Bio Science & Technology, Ltd. (BYT) in the aggregate principal amount of $50,000 in respect of a bridge loan made by such party.  The promissory notes, which bear interest at the prime rate (or 3.5%) were exchanged for the financing described below.

On May 3, 2016, we closed the second tranche of the financing pursuant to the January 29, 2016 Securities Purchase Agreement and issued Notes in an aggregate principal amount of $3,361,620, inclusive of $3,620 of interest due on bridge loans.  In exchange for the Notes, we received $1,188,000 in gross cash proceeds, a note receivable, payable in 30 days and bearing interest at 12%, of $770,000, from BYT and $1,400,000 of bridge notes were cancelled.  We incurred placement, legal and other fees aggregating approximately $85,000 which were deducted from the gross cash proceeds. Additionally, the placement agent received Class B warrants, with a 1½ year term, to purchase 37,520 shares of our Common Stock at $1.50 per share. The Notes were initially convertible into 2,241,080 shares of Common Stock at $1.50 per share. We also issued Class B warrants to purchase 2,241,075 shares of Common Stock at $1.50 per share. In connection with the closing, the Certificate of Amendment to the Certificate of Designations of our Series F Convertible Preferred Stock was filed which provides the holders of 5,276,180 shares of our Series F Convertible Preferred Stock the same reset rights afforded the Note holders.  Additionally, subsequent to the May 3, 2016 second tranche financing, we received payment of our outstanding $770,000 note receivable from BYT.

Cash Flows for the Six Months ended June 30, 2016

Net cash used in operating activities was $3,306,129. The use of cash in operating activities was primarily attributable to the net loss of $5,562,076 offset by non-cash expenses of $58,165 for depreciation and amortization, $895,218 for amortization of debt discount, $558,436 for share-based compensation expense, a loss on early extinguishment of bridge loans of $2,143,960, a gain on revaluation of $761,950 related to derivative credit facility warrants as well as derivative warrants and derivative embedded conversion feature of our secured convertible notes, offset decreases in: prepaid and other of $18,379, accounts payable of $435,096 and accrued expenses of approximately $184,407.

Net cash used in investing activities was $223,708. The Company suffered a minor charge to its letter of credit due to the landlord requiring a payment for certain construction related activities prior to its relocation to the Littleton, MA location. The Company capitalized software development costs of $242,641.
 
Net cash provided by financing activities was $4,412,288. We received $2,549,989 of net proceeds from our secured convertible notes as well as $1,750,000 from bridge loans received in the period subsequent to the closing of the January 29, 2016 financing. We also received $199,671 of insurance premium financing. Principal payments made on the premium financing used were $87,372.

Effect of Inflation and Changes in Prices

We do not believe that inflation and changes in prices will have a material effect on our operations.

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

ITEM 4.   CONTROLS AND PROCEDURES.

Disclosure Controls and Procedures

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In designing and evaluating our disclosure controls and procedures, our management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act. Based on that evaluation and the material weaknesses described below, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as a result of the material weaknesses.

Our Chief Executive Officer and Chief Financial Officer concluded that as of June 30, 2016 the following material weaknesses existed:

(1)   We lacked a sufficient complement of personnel with an appropriate level of knowledge and experience in the application of U.S. generally accepted accounting principles, or GAAP, commensurate with our financial reporting requirements. The monitoring of our accounting and reporting functions were either not designed and in place or not operating effectively, and

(2)   We lacked the quantity of resources to implement an appropriate level of review controls to properly evaluate the completeness and accuracy of transactions entered into by our Company.

Our management believes that these weaknesses are due in part to the small size of our staff and limited funding which makes it challenging to maintain adequate disclosure controls. To remediate the material weaknesses in disclosure controls and procedures, we have sought assistance with complex filing matters beginning in 2016 and continue to take additional steps to improve our financial reporting systems and implement new policies, procedures and controls.

Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the fiscal quarter to which this report relates that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
PART II—OTHER INFORMATION

ITEM 6.   EXHIBITS.

The Exhibits listed in the Exhibit Index immediately preceding such Exhibits are filed with or incorporated by reference in this report, except as noted.


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
  ECHO THERAPEUTICS, INC.
   
Date: August 12, 2016 By: /s/ Scott W. Hollander  
    Scott W. Hollander
    President and Chief Executive Officer
    (Principal Executive Officer)
     
     
  By: /s/ Alan W. Schoenbart  
    Alan W. Schoenbart
    Chief Financial Officer
    (Principal Financial and Accounting Officer)
     
 

Exhibit No.
 
Description
  3.1  
Amendment to Certificate of Designation, Preferences and Rights of its Series F Convertible Preferred Stock dated May 3, 2016 is incorporated by reference to Exhibit 3.1 on the Company’s Current Report on Form 8-K filed May 4, 2016.
  3.2  
Amended and Restated Bylaws of Echo Therapeutics, Inc., as amended and restated as of June 1, 2016  is incorporated by reference to Exhibit 3.2 on the Company’s Current Report on Form 8-K filed June 3, 2016.
  10.1  
Promissory Note with Platinum Partners Value Arbitrage Fund, L.P. dated April 4, 2016 is incorporated by reference to Exhibit 10.1 on the Company’s Current Report on Form 8-K filed April 6, 2016
  10.2  
Promissory Note with Platinum Partners Value Arbitrage Fund, L.P. dated April 18, 2016 is incorporated by reference to Exhibit 10.1 on the Company’s Current Report on Form 8-K filed April 19, 2016
  10.3  
Form of Note is incorporated by reference to Exhibit 10.2 on the Company’s Current Report on Form 8-K filed May 4, 2016.
  10.4  
Form of Warrant .is incorporated by reference to Exhibit 10.3 on the Company’s Current Report on Form 8-K filed May 4, 2016.
  10.5  
Promissory Note with Beijing Yi Tang Bio Science & Technology, Ltd. dated April 29, 2016 is incorporated by reference to Exhibit 10.4 on the Company’s Current Report on Form 8-K filed May 4, 2016.
  10.6  
Promissory Note with Beijing Yi Tang Bio Science & Technology, Ltd. dated May 2, 2016 is incorporated by reference to Exhibit 10.5 on the Company’s Current Report on Form 8-K filed May 4, 2016.
  31.1  
Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2  
Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1  
Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2  
Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  101  
The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended
June 30, 2016, formatted in XBRL (Extensible Business Reporting Language), (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Cash Flows, and (iv) Notes to Consolidated Financial Statements.
 

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