NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1.
PRINCIPAL BUSINESS ACTIVITY AND BASIS OF PRESENTATION
PolarityTE,
Inc. is a commercial-stage biotechnology and regenerative biomaterials company focused on transforming the lives of patients by
discovering, designing and developing a range of regenerative tissue products and biomaterials for the fields of medicine, biomedical
engineering and material sciences.
Discontinued
Operations.
On June 23, 2017, the Company sold Majesco Entertainment Company, a Nevada corporation and wholly-owned subsidiary
of the Company (“Majesco Sub”), to Zift Interactive LLC, a Nevada limited liability company (“Zift”),
pursuant to a purchase agreement. Pursuant to the terms of the agreement, the Company sold 100% of the issued and outstanding
shares of common stock of Majesco to Zift, including all of the right, title and interest in and to Majesco Sub’s business
of developing, publishing and distributing video game products through mobile and online digital downloading. Pursuant to the
terms of the agreement, the Company will receive total cash consideration of approximately $100,000 ($5,000 upon signing the agreement
and 19 additional monthly payments of $5,000) plus contingent consideration based on net revenues with a fair value of
$0. As of April 30, 2018, the Company received $55,000 in cash consideration and $45,000 remains receivable.
Segments.
With the sale of Majesco Sub on June 23, 2017, the Company now solely operates in its Regenerative Medicine segment.
The
accompanying interim condensed consolidated financial statements of the Company are unaudited, but in the opinion of management,
reflect all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results for the interim
period. Accordingly, they do not include all information and notes required by generally accepted accounting principles for complete
financial statements. The results of operations for interim periods are not necessarily indicative of results to be expected for
the entire fiscal year. The balance sheet at October 31, 2017 has been derived from the audited financial statements at that date
but does not include all of the information and footnotes required by accounting principles generally accepted in the United States
of America for complete financial statements. These interim condensed consolidated financial statements should be read in conjunction
with the Company’s consolidated financial statements and notes thereto for the year ended October 31, 2017 filed with the
Securities and Exchange Commission on Form 10-K on January 30, 2018.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation.
The accompanying condensed consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries: PolarityTE, Inc., a Nevada corporation, and Majesco Sub (through the date sold). Majesco Sub was sold
on June 23, 2017. Significant intercompany accounts and transactions have been eliminated in consolidation.
Cash
and Cash Equivalents.
Cash equivalents consist of highly liquid investments with original maturities of three months or less
at the date of purchase. At various times, the Company has deposits in excess of the Federal Deposit Insurance Corporation limit.
The Company has not experienced any losses on these accounts.
Accounts
Payable and Accrued Expenses.
The carrying amounts of accounts payable and accrued expenses approximate fair value as these
accounts are largely current and short term in nature.
Property
and Equipment.
Property and equipment is stated at cost. Depreciation and amortization is being provided for by the straight-line
method over the estimated useful lives of the assets, generally range from three to eight years. Amortization of leasehold improvements
is provided for over the shorter of the term of the lease or the life of the asset.
Capitalized
Software Development Costs
. Software development costs are capitalized once technological feasibility is established and management
expects such costs to be recoverable against future revenues. Amounts related to software development that are not capitalized
are charged immediately to expense. Capitalized costs are amortized straight-line over the expected life of the software.
Income
Taxes.
The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date. The Company evaluates the potential for realization of deferred tax
assets at each quarterly balance sheet date and records a valuation allowance for assets for which realization is not more likely
than not.
POLARITYTE,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Stock
Based Compensation.
The Company measures all stock-based compensation to employees using a fair value method and records such
expense in general and administrative and research and development expenses. Compensation expense for stock options with cliff
vesting is recognized on a straight-line basis over the vesting period of the award, based on the fair value of the option on
the date of grant. For stock options with graded vesting, the Company recognizes compensation expense over the service period
for each separately vesting tranche of the award as though the award were in substance, multiple awards.
The
fair value for options issued is estimated at the date of grant using a Black-Scholes option-pricing model. The risk-free rate
is derived from the U.S. Treasury yield curve in effect at the time of the grant. The volatility factor is determined based on
the Company’s historical stock prices.
The
value of restricted stock and restricted stock unit grants is measured based on the fair market value of the Company’s common
stock on the date of grant and amortized over the vesting period of, generally, six months to three years.
Loss
Per Share.
Basic loss per share of common stock is computed by dividing net loss attributable to common stockholders by the
weighted average number of shares of common stock outstanding for the period. Diluted loss per share excludes the potential impact
of common stock options, unvested shares of restricted stock and outstanding common stock purchase warrants because their effect
would be anti-dilutive due to our net loss.
Commitments
and Contingencies.
We are subject to claims and litigation in the ordinary course of our business. We record a liability for
contingencies when the amount is both probable and reasonably estimable. We record associated legal fees as incurred.
Accounting
for Warrants
. The Company accounts for the issuance of common stock purchase warrants issued in connection with the equity
offerings in accordance with the provisions of ASC 815, Derivatives and Hedging (“ASC 815”). The Company classifies
as equity any contracts that (i) require physical settlement or net-share settlement or (ii) gives the Company a choice of net-cash
settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies as assets or
liabilities any contracts that (i) require net-cash settlement (including a requirement to net-cash settle the contract if an
event occurs and if that event is outside the control of the Company) or (ii) gives the counterparty a choice of net-cash settlement
or settlement in shares (physical settlement or net-share settlement). In addition, under ASC 815, registered common stock warrants
that require the issuance of registered shares upon exercise and do not expressly preclude an implied right to cash settlement
are accounted for as derivative liabilities. The Company classifies these derivative warrant liabilities on the condensed consolidated
balance sheet as a current liability.
Change
in Fair Value of Derivatives.
The Company assessed the classification of common stock purchase warrants as of the date of
each offering and determined that certain instruments met the criteria for liability classification. Accordingly, the Company
classified the warrants as a liability at their fair value and adjusts the instruments to fair value at each reporting period.
This liability is subject to re-measurement at each balance sheet date until the warrants are exercised or expired, and any change
in fair value is recognized as “change in fair value of derivatives” in the consolidated statements of operations.
The fair value of the warrants has as well as other derivatives have been estimated using a Monte-Carlo or Black-Scholes valuation
model.
Revenue
Recognition.
The Company recognizes revenue upon the shipment of products when each of the following four criteria is met:
(i) persuasive evidence of an arrangement exists; (ii) products are delivered; (iii) the sales price is fixed or determinable;
and (iv) collectability is reasonably assured.
Estimates.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities or the
disclosure of gain or loss contingencies at the date of the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Among the more significant estimates included in these financial statements are the valuation of
warrant liability, valuation of derivative liability, stock-based compensation and the valuation allowances for deferred tax benefits.
Actual results could differ from those estimates.
Recently
Adopted Accounting Pronouncements
In
April 2016, the FASB issued ASU No. 2016-09,
Share-Based Payment: Simplifying the Accounting for Share-Based Payments
.
The standard addresses several aspects of the accounting for employee share-based payment transactions, including the accounting
for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows.
The Company adopted ASU 2016-09 during the first quarter of fiscal 2018 and the Company elected to account for forfeitures as
they occur. The amendment was applied using a modified retrospective transition method. The provisions of ASU 2016-09 had no impact
on the Company’s consolidated financial statements.
POLARITYTE,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Recent
Accounting Pronouncements.
In
February 2016, FASB issued ASU No. 2016-02,
Leases (Topic 842),
which supersedes FASB ASC Topic 840,
Leases (Topic 840)
and provides principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors.
The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on
the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine
whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease,
respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater
than twelve months regardless of classification. Leases with a term of twelve months or less will be accounted for similar to
existing guidance for operating leases. The standard is effective for annual and interim periods beginning after December 15,
2018, with early adoption permitted upon issuance. The Company is currently assessing the potential impact of this guidance, but
expects it to have a material impact on the Company’s balance sheet.
In
May 2017, the FASB issued ASU 2017-09,
Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting
. ASU
2017-09 provides clarity and reduces both (1) diversity in practice and (2) cost and complexity when applying the guidance in
Topic 718, to a change to the terms or conditions of a share-based payment award. The amendments in ASU 2017-09 should be applied
prospectively to an award modified on or after the adoption date. This ASU is effective for fiscal years, and interim periods
within those years, beginning after December 15, 2017. The Company is currently assessing the potential impact of adopting ASU
2017-09 on its consolidated financial statements and related disclosures.
In
July 2017, the FASB issued ASU 2017-11,
Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480)
and Derivatives and Hedging (Topic 815)
:
I. Accounting for Certain Financial Instruments with Down Round Features; II.
Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain
Mandatorily Redeemable Noncontrolling Interests with a Scope Exception,
(ASU 2017-11). Part I of this update addresses the
complexity of accounting for certain financial instruments with down round features. Down round features are features of certain
equity-linked instruments (or embedded features) that result in the strike price being reduced on the basis of the pricing of
future equity offerings. Current accounting guidance creates cost and complexity for entities that issue financial instruments
(such as warrants and convertible instruments) with down round features that require fair value measurement of the entire instrument
or conversion option. Part II of this update addresses the difficulty of navigating Topic 480, Distinguishing Liabilities from
Equity, because of the existence of extensive pending content in the FASB Accounting Standards Codification. This pending content
is the result of the indefinite deferral of accounting requirements about mandatorily redeemable financial instruments of certain
nonpublic entities and certain mandatorily redeemable noncontrolling interests. The amendments in Part II of this update do not
have an accounting effect. This ASU is effective for fiscal years, and interim periods within those years, beginning after December
15, 2018. The Company is currently assessing the potential impact of adopting ASU 2017-11 on its financial statements and related
disclosures.
In
August 2016, the FASB issued ASU 2016-15,
Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments
,
which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain
cash receipts and cash payments are presented and classified in the statement of cash flows. The standard is effective for fiscal
years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted, including
adoption in an interim period. The adoption of this update is not expected to have a material impact on the Company’s consolidated
financial statements and related disclosures.
In
May 2014, the FASB issued ASU 2014-09, “
Revenue from Contracts with Customers (Topic 606)
”, a new accounting
standard that requires recognition of revenue to depict the transfer of promised goods or services to customers in an amount that
reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. The FASB has also
issued several updates to ASU 2014-09. The new standard supersedes U.S. GAAP guidance on revenue recognition and requires the
use of more estimates and judgments than the present standards. It also requires additional disclosures regarding the nature,
amount, timing and uncertainty of cash flows arising from contracts with customers. Topic 606 is effective for our fiscal year
2019 beginning on November 1, 2018. The Company is currently evaluating the overall effect that the standard will have on our
consolidated financial statements and accompanying notes to the consolidated financial statements.
3
.
LIQUIDITY
The
Company has experienced net losses and negative cash flows from operations during each of the last two fiscal years. The Company
has experienced negative cash flows from continuing operations of approximately $10.0 million for the six months ended
April 30, 2018. Given these negative cash flows and forecasted increased spending, the continuation of the Company as a going
concern is dependent upon continued financial support from its shareholders, potential collaborations, the ability of the Company
to obtain necessary equity and/or debt financing to continue operations, and the attainment of profitable operations. The Company
cannot make any assurances that additional financings will be available to it and, if available, completed on a timely basis,
on acceptable terms or at all. If the Company is unable to complete a debt or equity offering, execute a collaboration arrangement
or otherwise obtain sufficient financing when and if needed, it would negatively impact its business and operations and could
also lead to the reduction or suspension of the Company’s operations and ultimately force the Company to cease operations.
POLARITYTE,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
On
April 12, 2018, the Company completed a public offering providing for the issuance and sale of 2,335,937 shares of the Company’s
common stock, par value $0.001 per share, at an offering price of $16.00 per share, for net proceeds of approximately $34.6 million,
after deducting offering expenses payable by the Company (see Note 7).
On
June 7, 2018, the Company completed an underwritten offering with Cantor Fitzgerald & Co., as underwriter, providing for the
issuance and sale of 2,455,882 shares of the Company’s common stock, par value $0.001 per share, at an offering price of
$23.65 per share, for net proceeds of approximately $58 million, after deducting offering expenses payable by the Company (see
Note 14).
4
.
PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid
expenses and other current assets consist of the following (in thousands):
|
|
April 30, 2018
|
|
|
October 31, 2017
|
|
Legal retainer
|
|
$
|
-
|
|
|
$
|
15
|
|
Prepaid insurance
|
|
|
121
|
|
|
|
69
|
|
Other prepaids
|
|
|
149
|
|
|
|
126
|
|
Other assets
|
|
|
24
|
|
|
|
27
|
|
Total prepaid expenses and other current assets
|
|
$
|
294
|
|
|
$
|
237
|
|
5.
PROPERTY AND EQUIPMENT, NET
Property
and equipment, net, consist of the following (in thousands):
|
|
April 30, 2018
|
|
|
October 31, 2017
|
|
Medical equipment
|
|
$
|
6,272
|
|
|
$
|
2,418
|
|
Computers and software
|
|
|
999
|
|
|
|
211
|
|
Furniture and equipment
|
|
|
163
|
|
|
|
30
|
|
Total property and equipment, gross
|
|
|
7,434
|
|
|
|
2,659
|
|
Accumulated depreciation
|
|
|
(1,092
|
)
|
|
|
(486
|
)
|
Total property and equipment, net
|
|
$
|
6,342
|
|
|
$
|
2,173
|
|
Depreciation
expense for the three months ended April 30, 2018 and 2017 was approximately $350,000 and $101,000, respectively. Depreciation
expense for the six months ended April 30, 2018 and 2017 was approximately $606,000 and $184,000, respectively.
6.
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts
payable and accrued expenses consist of the following (in thousands):
|
|
April 30, 2018
|
|
|
October 31, 2017
|
|
Accounts payable
|
|
$
|
20
|
|
|
$
|
25
|
|
Due to Zift
|
|
|
-
|
|
|
|
36
|
|
Medical study and supplies
|
|
|
48
|
|
|
|
362
|
|
Medical equipment purchase
|
|
|
385
|
|
|
|
54
|
|
Salaries and other compensation
|
|
|
637
|
|
|
|
574
|
|
Legal and accounting
|
|
|
978
|
|
|
|
555
|
|
Consulting
|
|
|
283
|
|
|
|
-
|
|
Other accruals
|
|
|
656
|
|
|
|
333
|
|
Total accounts payable and accrued expenses
|
|
$
|
3,007
|
|
|
$
|
1,939
|
|
Salaries
and other compensation include accrued payroll expense and employer 401K plan contributions.
POLARITYTE,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
7.
PREFERRED SHARES AND COMMON SHARES
Common
Stock Issuance
On
April 12, 2018, the Company completed a public offering providing for the issuance and sale of 2,335,937 shares of the Company’s
common stock, par value $0.001 per share, at an offering price of $16.00 per share, for net proceeds of approximately $34.6 million,
after deducting offering expenses payable by the Company.
Exchange
of 100% of Outstanding Series F Preferred Stock Shares and Warrants
On
September 20, 2017, the Company sold an aggregate of $17,750,000 worth of units (the “Units”) of the Company’s
securities to accredited investors at a purchase price of $2,750 per Unit with each Unit consisting of (i) one share of the Company’s
newly authorized 6% Series F Convertible Preferred Stock, par value $0.001 per share (the “Series F Preferred Shares”),
which are each convertible into one hundred (100) shares of the Company’s common stock, and (ii) a two-year warrant to purchase
up to 322,727 shares of the Company’s common stock, at an exercise price of $30.00 per share.
The
Series F Preferred Shares were convertible into shares of the Company’s common stock based on a conversion calculation equal
to the stated value of the Series F Preferred Shares, plus all accrued and unpaid dividends, if any, on such Series F Preferred
Shares, as of such date of determination, divided by the conversion price. The stated value of each Series F Preferred Share was
$2,750 and the initial conversion price was $27.50 per share, each subject to adjustment for stock splits, stock dividends, recapitalizations,
combinations, subdivisions or other similar events.
On
the two year anniversary of the initial issuance date, any Series F Preferred Shares outstanding and not otherwise already
converted, shall, at the option of the holder, will either (i) automatically convert into common stock of the Company at the conversion
price then in effect or (ii) be repaid by the Company based on the stated value of such outstanding Series F Preferred Shares.
The
warrants issued in connection with the Series F Preferred Shares were determined to be liabilities pursuant to ASC 815. The warrant
agreement provides for an adjustment to the number of common shares issuable under the warrant and/or adjustment to the exercise
price, including but not limited to, if: (a) the Company issues shares of common stock as a dividend or distribution to holders
of its common stock; (b) the Company subdivides or combines its common stock (i.e., stock split); (c) adjustment of exercise price
upon issuance of new securities at less than the exercise price. Under ASC 815, warrants that provide for down-round exercise
price protection are recognized as derivative liabilities.
The
conversion feature within the Series F Preferred Shares was determined to not be clearly and closely related to the identified
host instrument and, as such, was recognized as a derivative liability measured at fair value pursuant to ASC 815.
The
initial fair value of the warrants and bifurcated embedded conversion feature, estimated to be approximately $4.3 million and
$9.3 million, respectively, was deducted from the gross proceeds of the Unit offering to arrive at the initial discounted carrying
value of the Series F Preferred Shares. The resulting discount to the aggregate stated value of the Series F Preferred Shares
of approximately $13.6 million will be recognized as accretion using the effective interest method similar to preferred stock
dividends, over the two-year period prior to optional redemption by the holders.
On
March 6, 2018, the Company entered into separate exchange agreements (the “Exchange Agreements”) with holders (each
a “Holder”, and collectively the “Holders”) of 100% of the Company’s outstanding Series F Preferred
Shares, and the Company’s warrants to purchase shares of the Company’s common stock issued in connection with the
Series F Preferred Shares (such “Warrants” and Series F Preferred Shares collectively referred to as the “Exchange
Securities”) to exchange the Exchange Securities and unpaid dividends on the Series F Preferred Shares, for common stock
(the “Exchange”).
The Exchange resulted
in the following issuances: (A) all outstanding Series F Preferred Shares were converted into 972,070 shares of restricted common
stock at an effective conversion price of $18.26 per share of common stock (the closing price of Common Stock on the NASDAQ Capital
Market on February 26, 2018); (B) the right to receive 6% dividends underlying Series F Preferred Shares was terminated and in
exchange 31,321 shares of restricted common stock were issued; (C) 322,727 Warrants to purchase common stock were
exchanged for 151,871 shares of restricted common stock; and (D) the Holders of the Warrants relinquished any and all other
rights pursuant to the Warrants, including exercise price adjustments.
As
part of the Exchange, the Holders also relinquished any and all other rights related to the issuance of the Exchange Securities,
the respective governing agreements and certificates of designation, including any related dividends, adjustment of conversion
and exercise price, and repayment option. The existing registration rights agreement with the holders of the Series F Preferred
Shares was also terminated and the holders of the Series F Preferred Shares waived the obligation of the Company to register the
common shares issuable upon conversion of Series F Preferred Shares or upon exercise of the warrants, and waived any damages,
penalties and defaults related to the Company failing to file or have declared effective a registration statement covering those
shares.
POLARITYTE,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The
exchange of all outstanding Series F Preferred Shares, and the holders’ right to receive 6% dividends, for common stock
of the Company was recognized as follows:
Fair market value of 1,003,391 shares of common stock issued at $20.05 (Company’s
closing stock price on March 5, 2018) in exchange for Series F Preferred Shares and accrued dividends
|
|
$
|
20,117,990
|
|
Carrying value of Series F Preferred Shares at March 5, 2018, including dividends
|
|
|
(5,898,274
|
)
|
Carrying value of bifurcated conversion option at March 5, 2018
|
|
|
(7,162,587
|
)
|
Deemed dividend on Series F Preferred Shares exchange
|
|
$
|
7,057,129
|
|
As
the Warrants were classified as a liability, the exchange of the Warrants for common shares should be recognized as a liability
extinguishment. As of March 5, 2018, the fair market value of the 151,871 common shares issued in the Exchange was $3,045,034
and the fair value of the common stock warrant liability was $2,525,567 resulting in a loss on extinguishment of warrant liability
of $519,467 during the three and six months ended April 30, 2018.
The
Company recognized accretion of the discount to the stated value of the Series F Preferred Shares of approximately $386,000 and
$1,290,000 in the three months ended April 30, 2018 (through March 5, 2018) and six months ended April 30, 2018, respectively,
as a reduction of additional paid-in capital and an increase in the carrying value of the Series F Preferred Shares. The accretion
is presented in the Statement of Operations as a deemed dividend, increasing net loss to arrive at net loss attributable to common
stockholders.
Preferred
Stock Conversion and Elimination
On
February 6, 2018, 15,756 shares of Series B Convertible Preferred Stock (“Series B Preferred Shares”) were converted
into 262,606 shares of common stock.
On
March 6, 2018, the Company received conversion notices (in accordance with original terms) from holders of 100% of the outstanding
shares of Series A Convertible Preferred Stock (the “Series A Preferred Shares”), Series B Preferred Shares and Series
E Convertible Preferred Stock (the “Series E Preferred Shares”) and issued an aggregate of 7,945,250 shares of common
stock to such holders.
The Series E Preferred
Shares were held by Dr. Denver Lough, the Company’s Chief Executive Officer. On March 6, 2018, the Company entered into
a new registration rights agreement (the “Lough Registration Rights Agreement”) with Dr. Lough, pursuant to which
the Company agreed to file a registration statement to register the resale of 7,050,000 shares of Common Stock issued upon conversion
of the Series E Preferred Shares within six months, to cause such registration statement to be declared effective by the Securities
and Exchange Commission as promptly as possible following its filing and, with certain exceptions set forth in the Lough Registration
Rights Agreement, to maintain the effectiveness of the registration statement until all of such shares have been sold or are otherwise
able to be sold pursuant to Rule 144 under the Securities Act without restriction. Any sales of shares under the registration
statement are subject to certain limitations as specified with more particularity in the Lough Registration Rights Agreement.
In April 2018, Dr. Lough entered into a lock up agreement for 180 days, which prohibits him from selling
any shares that may be registered until October 2018.
On March 7, 2018, the
Company filed a Certificate of Elimination with the Secretary of State of the State of Delaware terminating the Company’s
Series A, Series B, Series C, Series D, Series E and Series F Preferred Stock. As a result, the Company has 10,000,000 shares
of authorized and unissued preferred stock with no designation as to series.
POLARITYTE,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Convertible
preferred stock activity for the six months ended April 30, 2018 consisted of the following:
|
|
Shares
Outstanding –
October 31, 2017
|
|
|
First Quarter 2018 -Preferred Stock Conversions
|
|
|
First Quarter 2018 – Common Stock Shares Issued
|
|
|
Second Quarter 2018 -Preferred Stock Conversions and Series F Exchange
|
|
|
Second Quarter 2018 – Common Stock Shares Issued
|
|
|
Year to Date 2018 -Preferred Stock Conversions and Series F Exchange
|
|
|
Year to Date 2018 – Common Stock Shares Issued
|
|
Series A
|
|
|
3,146,671
|
|
|
|
(1,544,572
|
)
|
|
|
350,000
|
|
|
|
(1,602,099
|
)
|
|
|
363,036
|
|
|
|
(3,146,671
|
)
|
|
|
713,036
|
|
Series B
|
|
|
47,689
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(47,689
|
)
|
|
|
794,820
|
|
|
|
(47,689
|
)
|
|
|
794,820
|
|
Series C
|
|
|
2,578
|
|
|
|
(2,578
|
)
|
|
|
59,950
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(2,578
|
)
|
|
|
59,950
|
|
Series D
|
|
|
26,667
|
|
|
|
(26,667
|
)
|
|
|
44,445
|
|
|
|
-
|
|
|
|
|
|
|
|
(26,667
|
)
|
|
|
44,445
|
|
Series E
|
|
|
7,050
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(7,050
|
)
|
|
|
7,050,000
|
|
|
|
(7,050
|
)
|
|
|
7,050,000
|
|
Series F
|
|
|
6,455
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(6,455
|
)
|
|
|
972,070
|
|
|
|
(6,455
|
)
|
|
|
972,070
|
|
Total
|
|
|
3,237,110
|
|
|
|
(1,573,817
|
)
|
|
|
454,395
|
|
|
|
(1,663,293
|
)
|
|
|
9,179,926
|
|
|
|
(3,237,110
|
)
|
|
|
9,634,321
|
|
8.
FAIR VALUE MEASUREMENTS
In
accordance with ASC 820, Fair Value Measurements, financial instruments were measured at fair value using a three-level hierarchy
which maximizes use of observable inputs and minimizes use of unobservable inputs:
●
|
Level
1: Observable inputs such as quoted prices in active markets for identical instruments
|
|
|
●
|
Level
2: Quoted prices for similar instruments that are directly or indirectly observable in the market
|
|
|
●
|
Level
3: Significant unobservable inputs supported by little or no market activity. Financial instruments whose values are determined
using pricing models, discounted cash flow methodologies, or similar techniques, for which determination of fair value requires
significant judgment or estimation.
|
In
connection with the offering of Units in September 2017, the Company issued warrants to purchase an aggregate of 322,727 shares
of common stock. These warrants were exercisable at $30.00 per share and expire in two years. The warrants were liabilities pursuant
to ASC 815. The warrant agreement provided for an adjustment to the number of common shares issuable under the warrant and/or
adjustment to the exercise price, including but not limited to, if: (a) the Company issues shares of common stock as a dividend
or distribution to holders of its common stock; (b) the Company subdivides or combines its common stock (i.e., stock split); (c)
adjustment of exercise price upon issuance of new securities at less than the exercise price. Under ASC 815, warrants that provide
for down-round exercise price protection are recognized as derivative liabilities.
The
Series F Preferred Shares contained an embedded conversion feature that was not clearly and closely related to the identified
host instrument and, as such, was recognized as a derivative liability measured at fair value. The Company classified these derivatives
on the consolidated balance sheet as a current liability.
As
noted in Note 7. above, both the warrants and the Series F Preferred Shares were exchanged for common stock on March 6, 2018.
The
fair value of the bifurcated embedded conversion feature was estimated to be approximately $7.2 million and $9.2 million, respectively,
at March 5, 2018 and October 31, 2017 as calculated using a Monte Carlo simulation with the following assumptions:
|
|
Series F Conversion Feature
|
|
|
|
March 5, 2018
|
|
|
October 31, 2017
|
|
Stock price
|
|
$
|
20.05
|
|
|
$
|
25.87
|
|
Exercise price
|
|
$
|
27.50
|
|
|
$
|
27.50
|
|
Risk-free rate
|
|
|
2.158
|
%
|
|
|
1.581
|
%
|
Volatility
|
|
|
88.2
|
%
|
|
|
96.0
|
%
|
Term
|
|
|
1.54
|
|
|
|
1.89
|
|
POLARITYTE,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The
fair value of the warrant liability was estimated to be approximately $2.5 million and $4.3 million, respectively, at March 5,
2018 and October 31, 2017 as calculated using the Monte Carlo simulation with the following assumptions:
|
|
Warrant Liability
|
|
|
|
March 5, 2018
|
|
|
October 31, 2017
|
|
Stock price
|
|
$
|
20.05
|
|
|
$
|
25.87
|
|
Exercise price
|
|
$
|
30.00
|
|
|
$
|
30.00
|
|
Risk-free rate
|
|
|
2.158
|
%
|
|
|
1.581
|
%
|
Volatility
|
|
|
88.2
|
%
|
|
|
96.0
|
%
|
Term
|
|
|
1.54
|
|
|
|
1.89
|
|
Financial
instruments measured at fair value are classified in their entirety based on the lowest level of input that is significant to
the fair value measurement.
The
fair value hierarchy of financial instruments, measured at fair value on a recurring basis on the consolidated balance sheets
as of October 31, 2017 is as follows (in thousands):
|
|
Fair Value Measurement as of October 31, 2017
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
4,256
|
|
|
$
|
4,256
|
|
Derivative liability
|
|
|
-
|
|
|
|
-
|
|
|
|
9,246
|
|
|
|
9,246
|
|
Total
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
13,502
|
|
|
$
|
13,502
|
|
As
of April 30, 2018, there were no outstanding financial instruments.
The
following table sets forth the changes in the estimated fair value for our Level 3 classified derivative liabilities (in thousands):
|
|
2017 Series F Preferred Stock -
Warrant Liability
|
|
|
2017 Series F Preferred Stock - Embedded Derivative
|
|
|
Total Warrant and Derivative Liability
|
|
Fair value - October 31, 2017
|
|
$
|
4,256
|
|
|
$
|
9,246
|
|
|
$
|
13,502
|
|
Change in fair value
|
|
|
(1,731
|
)
|
|
|
(2,083
|
)
|
|
|
(3,814
|
)
|
Exchange / conversion to common shares
|
|
|
(2,525
|
)
|
|
|
(7,163
|
)
|
|
|
(9,688
|
)
|
Fair value - April 30, 2018
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
9.
STOCK BASED COMPENSATION ARRANGEMENTS
In
the three and six months ended April 30, 2018 and 2017, the Company recorded stock-based compensation expense related to restricted
stock awards and stock options as follows (in thousands):
|
|
For the Three Months Ended
April 30,
|
|
|
|
2018
|
|
|
2017
|
|
General and administrative expense:
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
5,155
|
|
|
$
|
3,805
|
|
Discontinued operations
|
|
|
-
|
|
|
|
402
|
|
|
|
|
5,155
|
|
|
|
4,207
|
|
Research and development expense:
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
|
1,465
|
|
|
|
-
|
|
Total stock-based compensation expense
|
|
$
|
6,620
|
|
|
$
|
4,207
|
|
POLARITYTE,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
For the Six Months Ended
April 30,
|
|
|
|
2018
|
|
|
2017
|
|
General and administrative expense:
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
14,065
|
|
|
$
|
7,780
|
|
Discontinued operations
|
|
|
-
|
|
|
|
844
|
|
|
|
|
14,065
|
|
|
|
8,624
|
|
Research and development expense:
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
|
3,687
|
|
|
|
-
|
|
Total stock-based compensation expense
|
|
$
|
17,752
|
|
|
$
|
8,624
|
|
A
summary of the Company’s employee stock option activity in the six months ended April 30, 2018 is presented below:
|
|
Number of
shares
|
|
|
Weighted-Average
Exercise Price
|
|
Outstanding - October 31, 2017
|
|
|
3,525,530
|
|
|
$
|
6.34
|
|
Granted
|
|
|
1,127,500
|
|
|
$
|
23.84
|
|
Exercised
|
|
|
(25,794
|
)
|
|
$
|
3.95
|
|
Forfeited
|
|
|
(34,167
|
)
|
|
$
|
18.90
|
|
Outstanding - April 30, 2018
|
|
|
4,593,069
|
|
|
$
|
10.55
|
|
Options exercisable - April 30, 2018
|
|
|
2,450,666
|
|
|
$
|
6.76
|
|
Weighted-average fair value of options granted during the period
|
|
|
|
|
|
$
|
16.15
|
|
A
summary of the Company’s non-employee stock option activity in the six months ended April 30, 2018 is presented below:
|
|
Number of
shares
|
|
|
Weighted-Average
Exercise Price
|
|
Outstanding - October 31, 2017
|
|
|
293,000
|
|
|
$
|
19.61
|
|
No activity
|
|
|
-
|
|
|
$
|
-
|
|
Outstanding - April 30, 2018
|
|
|
293,000
|
|
|
$
|
19.61
|
|
Options exercisable - April 30, 2018
|
|
|
99,917
|
|
|
$
|
16.21
|
|
Stock
options are generally granted to employees or non-employees at exercise prices equal to the fair market value of the Company’s
common stock at the dates of grant. Stock options generally vest over one to three years and have a term of five to ten years.
The total fair value of employee options granted during the six months ended April 30, 2018 was approximately $18.2 million. The
intrinsic value of options outstanding at April 30, 2018 was $41.6 million. The intrinsic value of options exercised during the
six months ended April 30, 2018 was $344,000. The weighted average remaining contractual term of outstanding and exercisable options
at April 30, 2018 was 8.9 years and 8.7 years, respectively. As of April 30, 2018, there was approximately $12.6 million of unrecognized
compensation cost related to stock options, which is expected to be recognized over a remaining weighted-average vesting period
of 0.6 years.
The
fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following
assumptions for the six months ended April 30, 2018:
Risk free annual interest rate
|
|
|
2.01%-2.97
|
%
|
Expected volatility
|
|
|
80.86-85.54
|
%
|
Expected life
|
|
|
5.00-6.01
|
|
Assumed dividends
|
|
|
None
|
|
POLARITYTE,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Restricted
stock and restricted stock units activity for employees and non-employees in the six months ended April 30, 2018:
|
|
Number of
shares
|
|
|
Weighted-Average
Grant-Date
Fair Value
|
|
Unvested - October 31, 2017
|
|
|
227,132
|
|
|
$
|
7.83
|
|
Granted
|
|
|
137,387
|
|
|
$
|
22.02
|
|
Vested
|
|
|
(144,315
|
)
|
|
$
|
11.82
|
|
Unvested - April 30, 2018
|
|
|
220,204
|
|
|
$
|
14.06
|
|
The
total fair value of restricted stock and restricted stock units granted during the six months ended April 30, 2018 was approximately
$3.0 million.
The
fair value of restricted stock and restricted stock unit grants is measured based on the fair market value of the Company’s
common stock on the date of grant and amortized over the vesting period of, generally, six months to three years. As of April
30, 2018, there was approximately $1.9 million of unrecognized compensation cost related to unvested restricted stock and restricted
stock unit awards, which is expected to be recognized over a remaining weighted-average vesting period of 0.5 years.
10.
INCOME TAXES
The
Company calculates its provision for federal and state income taxes based on current tax law. The Tax Cuts and Jobs Act (tax reform)
was enacted on December 22, 2017 (“Enactment Date”), and has several key provisions impacting accounting for and reporting
of income taxes. The most significant provision reduces the U.S. corporate statutory tax rate from 35% to 21% beginning on January
1, 2018. Although most provisions of tax reform are not effective until 2018, the Company is required to record the effect of
a change in tax law as of the Enactment Date on its deferred tax assets. As the Company maintains a full valuation allowance against
its deferred tax assets, there is no income tax expense recorded related to this change. As of the Enactment Date, the Company
estimated that its deferred tax asset and related valuation allowance were each reduced by approximately $2.2 million.
Due
to the Company’s history of losses and uncertainty of future taxable income, a valuation allowance sufficient to fully offset
net operating losses and other deferred tax assets has been established. The valuation allowance will be maintained until sufficient
positive evidence exists to support a conclusion that a valuation allowance is not necessary. The issuance of the Series E Preferred
Stock in connection with its original acquisition of the PolarityTE, Inc., a Nevada corporation in April 2017, will likely result
in limitations on the utilization of the Company’s net operating loss carryforwards under IRS section 382.
11.
LOSS PER SHARE
Shares
of common stock issuable under convertible preferred stock, warrants and options and shares subject to restricted stock grants
were not included in the calculation of diluted earnings per common share for the three and six months ended April 30, 2018 and
2017, as the effect of their inclusion would be anti-dilutive.
For
periods when shares of participating preferred stock (as defined in ASC 260 earnings per share) are outstanding, the two-class
method is used to calculate basic and diluted earnings (loss) per common share. The two-class method is an earnings allocation
formula that determines earnings per share for each class of common stock and participating security according to dividends declared
(or accumulated) and participation rights in undistributed earnings. Under the two-class method, basic earnings (loss) per common
share is computed by dividing net earnings (loss) attributable to common shares after allocation of earnings to participating
securities by the weighted-average number of shares of common stock outstanding during the year. Diluted earnings (loss) per common
share, when applicable, is computed using the more dilutive of the two-class method or the if-converted method. In periods of
net loss, no effect is given to participating securities since they do not contractually participate in the losses of the Company.
The
table below provides total potential shares outstanding, including those that are anti-dilutive, on April 30, 2018 and 2017:
|
|
April 30,
|
|
|
|
2018
|
|
|
2017
|
|
Shares issuable upon conversion of preferred stock
|
|
|
-
|
|
|
|
9,281,275
|
|
Shares issuable upon exercise of stock options
|
|
|
4,886,069
|
|
|
|
3,028,512
|
|
Non-vested shares under restricted stock grants
|
|
|
220,204
|
|
|
|
380,341
|
|
POLARITYTE,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
12.
COMMITMENTS AND CONTINGENCIES
Contingencies
On February 26, 2015,
a complaint for patent infringement was filed in the United States District Court for the Eastern District of Texas by Richard
Baker, an individual residing in Australia, against Microsoft, Nintendo, Majesco Sub, and a number of other game publisher defendants.
The complaint alleged that the Zumba Fitness Kinect game infringed plaintiff’s patents in motion tracking technology. The
plaintiff is representing himself pro se in the litigation and is seeking monetary damages in the amount of $1.3 million. The
case was subsequently transferred to the Western District of Washington. On June 16, 2017, final judgment was entered in favor
of the defendants finding that the accused products did not literally infringe the asserted patent and that plaintiff was barred
from pursing infringement under the doctrine of equivalents due to prosecution history estoppel. The plaintiff appealed that
decision to the Court of Appeals for the Federal Circuit. On April 9, 2018, the Court of Appeals for the Federal Circuit affirmed
the judgment of the District Court for the Western District of Washington. On May 7, 2018, the plaintiff filed a petition for
panel rehearing and rehearing en banc by the Court of Appeals, which is pending. On June 23, 2017, as part of a purchase agreement,
liabilities and claims relating to this litigation were assumed by Zift. The Company cannot be certain about the outcome of the
appeal, or whether litigation regarding the assumption of liabilities by Zift may occur.
In
addition to the item above, the Company at times may be a party to claims and suits in the ordinary course of business. We record
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. The Company has not recorded a liability with respect to the matter above. While the Company believes that it has valid
defenses with respect to the legal matter pending and intends to vigorously defend the matter above, given the uncertainty surrounding
litigation and our inability to assess the likelihood of a favorable or unfavorable outcome, it is possible that the resolution
of the matter could have a material adverse effect on our consolidated financial position, cash flows or results of operations.
Commitments
The
Company leases office space in Hazlet, New Jersey at a cost of approximately $1,100 per month under a lease agreement that expires
on March 31, 2019.
The Company also leased
space in Salt Lake City, Utah at a cost of approximately $24,000 per month under a lease agreement that expired on March
31, 2018. The Company will continue to lease space in Salt Lake City, Utah at a cost of approximately $12,400 per month
under a lease agreement that expires on September 30, 2018.
On
December 27, 2017, the Company signed a five-year lease with one five-year option to renew on approximately 178,528 rentable square
feet in Salt Lake City, Utah. The base rent for the first year of the lease is $1,178,285 and escalates at the rate of 3% per
annum thereafter.
Rent
expense for the three months ended April 30, 2018 and 2017 was approximately $389,000 and $42,000, respectively. Rent expense
for the six months ended April 30, 2018 and 2017 was approximately $638,000 and $60,000, respectively.
The
Company has entered into employment agreements with key executives that contain severance terms and change of control provisions.
13.
DISCONTINUED OPERATIONS
The
results of operations from the discontinued business for the three and six months ended April 30, 2018 and 2017 are as follows
(in thousands):
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
April 30,
|
|
|
April 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Revenues
|
|
$
|
-
|
|
|
$
|
259
|
|
|
$
|
-
|
|
|
$
|
415
|
|
Expenses
|
|
|
-
|
|
|
|
243
|
|
|
|
-
|
|
|
|
831
|
|
Gain (loss) from discontinued operations
|
|
$
|
-
|
|
|
$
|
16
|
|
|
$
|
-
|
|
|
$
|
(416
|
)
|
POLARITYTE,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The
cash flows from the discontinued business for the six months ended April 30, 2018 and 2017 are as follows (in thousands):
|
|
For the six months ended
April 30,
|
|
|
|
2018
|
|
|
2017
|
|
CASH FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net loss from discontinued operations
|
|
|
-
|
|
|
|
(416
|
)
|
Adjustments to reconcile net loss from discontinued operations to net cash used in discontinued operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
-
|
|
|
|
11
|
|
Stock based compensation expense
|
|
|
-
|
|
|
|
844
|
|
Amortization of capitalized software development costs and license fees
|
|
|
-
|
|
|
|
50
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
-
|
|
|
|
48
|
|
Accounts payable and accrued expenses
|
|
|
-
|
|
|
|
10
|
|
Net cash provided by discontinued operating activities
|
|
|
-
|
|
|
|
547
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
Cash received from sale of Majesco Sub
|
|
|
30
|
|
|
|
-
|
|
Net cash provided by discontinued investing activities
|
|
|
30
|
|
|
|
-
|
|
14.
SUBSEQUENT EVENTS
Asset
Purchase Agreement
On
March 2, 2018, the Company, along with its wholly owned subsidiary, Utah CRO Services, Inc., a Nevada corporation (“Acquisition
Co.”), entered into an asset purchase agreement (the “APA”) with Ibex Group, L.L.C., a Utah limited liability
company, and Ibex Preclinical Research, Inc
.
, a Utah corporation (collectively, the “Seller”). The transaction
closed on May 3, 2018.
Under
the APA, the Company purchased from Seller the assets and rights to its preclinical research and veterinary sciences business
and related real estate. The business consists of a “
good laboratory practices
” (GLP) compliant preclinical
research facility, including vivarium, operating rooms, preparation rooms, storage facilities, and surgical and imaging equipment.
The
purchase price was $1.6 million in cash, of which $266,667 was paid at closing and the balance satisfied by a promissory note.
The promissory note payable to Seller is for a total amount of $1,333,333 and is payable in five equal installments beginning
on the six-month anniversary of issuance and continuing each six-month anniversary thereafter with interest at the rate of 3.5%
per annum.
Purchase
and Sale Agreement
Concurrently
with the execution and delivery of the APA, on March 2, 2018, the Company entered into a purchase and sale agreement with the
Seller to purchase two parcels of real property in Cache County, Utah, consisting of approximately 1.75 combined gross acres of
land, together with the buildings, structures, fixtures, and personal property located on the real property (the “Property”).
The transaction also closed on May 3, 2018. The purchase price for the Property was $2.0 million, which was paid in cash at closing.
Common
Stock Issuance
On
June 7, 2018, the Company completed an underwritten offering with Cantor Fitzgerald & Co., as underwriter, providing for the
issuance and sale of 2,455,882 shares of the Company’s common stock, par value $0.001 per share, at an offering price of
$23.65 per share, for net proceeds of approximately $58 million, after deducting offering expenses payable by the Company.