Our
authorized capital stock consists of 250,000,000 shares of Common Stock, $0.001 par value, and 10,000,000 shares of preferred
stock, $0.001 par value. As of January 17, 2017, there were 4,250,617 shares of Common Stock outstanding, 5,924,307 shares
of Series A Preferred Stock outstanding convertible into 987,384 shares of Common Stock, 48,109.25 shares of Series B Preferred
Stock outstanding convertible into 801,820 shares of Common Stock, 24,614.84 shares of Series C Preferred Stock outstanding convertible
into 410,247 shares of Common Stock and 94,666 shares of Series D Preferred Stock outstanding convertible into 157,776 shares
of Common Stock.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
1.
PRINCIPAL BUSINESS ACTIVITY AND BASIS OF PRESENTATION
The
accompanying financial statements present the financial results of Majesco Entertainment Company and Majesco Europe Limited, its
wholly-owned subsidiary, (together, “Majesco” or the “Company”) on a consolidated basis. Prior to the
November 2014 sale of its equity investment, the Company had 50% of the voting control of GMS Entertainment Limited (“GMS”)
and the right to appoint one-half of the directors of GMS. Accordingly, the Company accounted for GMS on the equity method as
a corporate joint venture.
The
Company is a provider of video game products primarily for the casual-game consumer and has published video games for interactive
entertainment hardware platforms, including Nintendo’s DS, 3DS, Wii and WiiU, Sony’s PlayStation 3 and 4, or PS3 and
PS4, Microsoft’s Xbox 360 and Xbox One and the personal computer, or PC. It has historically sold its products through two
sales channels, retail and digital. It has sold packaged software to large retail chains, specialty retail stores, video game
rental outlets and distributors and through digital distribution for platforms such as Xbox Live Arcade, PlayStation Network,
or PSN, and Steam, and for mobile devices and online platforms. In July 2015, the Company transferred retail distribution activities,
assets and obligations to a company owned by its former chief executive officer (see Note 15).
The
Company’s video game titles are targeted at various demographics at a range of price points. Due to the larger budget requirements
for developing and marketing premium console titles for core gamers, the Company has focused on publishing more lower-cost games
targeting casual-game consumers and independent game developer fans. In some instances, the Company’s titles are based on
licenses of well-known properties and, in other cases, original properties. The Company enters into agreements with content providers
and video game development studios for the creation of our video games.
The
Company’s operations involve similar products and customers worldwide. These products are developed and sold domestically
and internationally. The Company is centrally managed and our chief operating decision makers, the chief executive and other officers,
use consolidated and other financial information supplemented by sales information by product category, major product title and
platform for making operational decisions and assessing financial performance. Accordingly, it operates in a single segment.
Reverse
stock-split
. On July 27, 2016, Majesco Entertainment Company (the “Company”) filed a certificate of amendment
(the “Amendment”) to its Restated Certificate of Incorporation with the Secretary of State of the State of Delaware
in order to effectuate a reverse stock split of the Company’s issued and outstanding common stock, par value $0.001 per
share on a one (1) for six (6) basis, effective on July 29, 2016 (the “Reverse Stock Split”).
The
Reverse Stock Split was effective with The NASDAQ Capital Market (“NASDAQ”) at the open of business on August 1, 2016.
The par value and other terms of Company’s common stock were not affected by the Reverse Stock Split. The Company’s
post-Reverse Stock Split common stock has a new CUSIP number, 560690 406. The Company’s transfer agent, Equity Stock Transfer
LLC, is acting as exchange agent for the Reverse Stock Split.
As
a result of the Reverse Stock Split, every six shares of the Company’s pre-Reverse Stock Split common stock was combined
and reclassified into one share of the Company’s common stock. No fractional shares of common stock were issued as a result
of the Reverse Stock Split. Stockholders who otherwise would be entitled to a fractional share shall receive a cash payment in
an amount equal to the product obtained by multiplying (i) the closing sale price of our common stock on the business day immediately
preceding the effective date of the Reverse Stock Split as reported on NASDAQ by (ii) the number of shares of our common stock
held by the stockholder that would otherwise have been exchanged for the fractional share interest.
All
common share and per share amounts have been restated to show the effect of the Reverse Stock Split.
NASDAQ
listing.
On March 3, 2016, the Company was notified by The NASDAQ Stock Market, LLC (“Nasdaq”) that it was not
in compliance with Nasdaq Listing Rule 5550(a)(2) (the “Rule”) because the Company’s common stock failed to
maintain a minimum closing bid price of $1.00 per share for the prior 30 consecutive business days. The notice had no immediate
effect on the listing or trading of the Company’s common stock on The NASDAQ Capital Market.
The
Company had a period of 180 calendar days, or until August 30, 2016, to achieve compliance with the Rule. The Company regained
compliance with the Rule in August 2016 by effecting the Reverse Stock Split.
Major
customers.
Sony, Microsoft and Valve accounted for 47%, 37%, and 13%, respectively, of sales for the year ended October 31,
2016. Sony, Sidekick and Microsoft accounted for 41%, 25% and 20%, respectively, of accounts receivable as of October 31, 2016.
Sales to GameStop represented approximately 10% of net revenues in 2015. In 2015, Alliance Distributors and Microsoft Corporation
represented approximately 10% and 13% of total revenue, respectively. Sony, Microsoft, Valve and Nintendo accounted for 37%, 20%,
18% and 13% of total accounts receivable as of October 31, 2015, respectively.
Concentrations.
The Company develops and distributes video game software for proprietary platforms under licenses from Nintendo, Sony and
Microsoft, which must be periodically renewed. The Company’s agreements with these manufacturers also grant them certain
control over the Company’s products. In addition, for the years ended October 31, 2016 and 2015 sales of the Company’s
Zumba Fitness games accounted for approximately 9% and 28% of net revenues, respectively.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation.
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned
subsidiary located in the United Kingdom. Significant intercompany accounts and transactions have been eliminated in consolidation.
Revenue
Recognition.
Since July 2015 when retail distribution activities were transferred and retail sales ceased, the Company’s
software products are sold exclusively as downloads of digital content for which the consumer takes possession of the digital
content for a fee. Revenue from product downloads is generally recognized when the download is made available (assuming all other
recognition criteria are met).
Prior
to July 2015, when the Company entered into license or distribution agreements that provided for multiple copies of games in exchange
for guaranteed amounts, revenue was recognized in accordance with the terms of the agreements, generally upon delivery of a master
copy, assuming our performance obligations were complete and all other recognition criteria were met, or as per-copy royalties
are earned on sales of games.
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
and Other Receivables and Accounts Payable and Accrued Expenses.
The carrying amounts of accounts and other receivables and
accounts payable and accrued expenses approximate fair value as these accounts are largely current and short term in nature.
Allowance
for doubtful accounts
. The Company recognizes an allowance for losses on accounts receivable for estimated probable losses.
The allowance is based on historical experiences, current aging of accounts, and other expected future write-offs, including specific
identifiable customer accounts considered at risk or uncollectible. Any related expense associated with an allowance for doubtful
accounts is recognized as general and administrative expense.
Capitalized
Software Development Costs and License Fees.
Software development costs include fees in the form of milestone payments made
to independent software developers and licensors. Software development costs are capitalized once technological feasibility of
a product is established and management expects such costs to be recoverable against future revenues. For products where proven
game engine technology exists, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product
basis. Amounts related to software development that are not capitalized are charged immediately to product research and development
costs. Commencing upon a related product’s release, capitalized costs are amortized to cost of sales based upon the higher
of (i) the ratio of current revenue to total projected revenue or (ii) straight-line charges over the expected marketable life
of the product.
Prepaid
license fees represent license fees to owners for the use of their intellectual property rights in the development of the Company’s
products. Minimum guaranteed royalty payments for intellectual property licenses are initially recorded as an asset (prepaid license
fees) and a current liability (accrued royalties payable) at the contractual amount upon execution of the contract or when specified
milestones or events occur and when no significant performance remains with the licensor. Licenses are expensed to cost of sales
at the higher of (i) the contractual royalty rate based on actual sales or (ii) an effective rate based upon total projected revenue
related to such license. Capitalized software development costs and prepaid license fees are classified as non-current if they
relate to titles for which the Company estimates the release date to be more than one year from the balance sheet date.
The
amortization period for capitalized software development costs and prepaid license fees is usually no longer than one year from
the initial release of the product. If actual revenues or revised forecasted revenues fall below the initial forecasted revenue
for a particular license, the charge to cost of sales may be larger than anticipated in any given quarter. The recoverability
of capitalized software development costs and prepaid license fees is evaluated quarterly based on the expected performance of
the specific products to which the costs relate. When, in management’s estimate, future cash flows will not be sufficient
to recover previously capitalized costs, the Company expenses these capitalized costs to “cost of sales-software development
costs and license fees,” in the period such a determination is made. These expenses may be incurred prior to a game’s
release for games that have been developed. If a game is cancelled prior to completion of development and never released to market,
the amount is expensed to operating costs and expenses. If the Company was required to write off licenses, due to changes in market
conditions or product acceptance, its results of operations could be materially adversely affected.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Costs
of developing online free-to-play social games, including payments to third-party developers, are expensed as research and development
expenses. Revenue from these games is largely dependent on players’ future purchasing behavior in the game and currently
the Company cannot reliably project that future net cash flows from developed games will exceed related development costs.
Prepaid
license fees and milestone payments made to the Company’s third party developers are typically considered non-refundable
advances against the total compensation they can earn based upon the sales performance of the products. Any additional royalty
or other compensation earned beyond the milestone payments is expensed to cost of sales as incurred.
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 five years. Amortization of leasehold improvements is provided
for over the shorter of the term of the lease or the life of the asset.
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.
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 expenses. Compensation expense for stock options 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.
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 grants are 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.
Extinguishment
of Liabilities.
During the year ended October 31, 2015, the Company recognized a gain on extinguishment of liabilities of
$1.5 million. The Company determined that certain accounts payable balances and claims for license fees and services would never
be paid because they were no longer being pursued for payment and had passed the statute of limitations as of October 31, 2015.
Loss
Per Share.
Basic loss per share of common stock is computed by dividing net loss applicable 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.
Commitments
and Contingencies.
We are subject to claims and litigation in the ordinary course of our business. We record a liability for
commitments and contingencies when the amount is both probable and reasonably estimable.
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 consolidated balance
sheet as a current liability.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Change
in fair value of warrant liability.
The Company assessed the classification of common stock purchase warrants as of the date
of each offering and determined that such 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 the fair value of warrant liabilities” in the consolidated statements of
operations. The fair value of the warrants has been estimated using a Black-Scholes valuation model (see Note 3).
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 price protection
and customer allowances, the valuation of inventory, the recoverability of advance payments for capitalized software development
costs and intellectual property licenses, and the valuation allowances for deferred tax benefits. Actual results could differ
from those estimates.
Other
Nonoperating Gains, Net.
In the year ended October 31, 2015, in connection with the expiration of its prior facilities lease
and its relocation, the Company disposed of property and equipment with a net book value of $92 and received proceeds of $20 from
the sale of certain of the property and equipment. The $72 loss on the disposals is included in other non-operating gains, net.
In addition, the Company recorded a gain of $270 on the transfer of certain game rights.
Recent
Accounting Pronouncements.
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”)
creating a new Topic 606,
Revenue from Contracts with Customers
, which broadly establishes new standards for the recognition
of certain revenue and updates related disclosure requirements. The update becomes effective for the Company on November 1, 2018.
The Company is reviewing the potential impact of the statement on its financial position, results of operations, and cash flows.
In
January
2016,
FASB
issued
ASU
No. 2016-01,
Recognition and Measurement of Financial Assets
and Financial Liabilities
. ASU No. 2016-01 requires equity investments to be measured at fair value with changes in fair value
recognized in net income; simplifies the impairment assessment of equity investments without readily determinable fair values
by requiring a qualitative assessment to identify impairment; eliminates the requirement for public business entities to disclose
the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments
measured at amortized cost on the balance sheet; requires public business entities to use the exit price notion when measuring
the fair value of financial instruments for disclosure purposes; requires an entity to present separately in other comprehensive
income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit
risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial
instruments; requires separate presentation of financial assets and financial liabilities by measurement category and form of
financial assets on the balance sheet or the accompanying notes to the financial statements and clarifies that an entity should
evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with
the entity’s other deferred tax assets. ASU No. 2016-01 is effective for financial statements issued for fiscal years beginning
after December 15, 2017, and interim periods within those fiscal years. The Company is currently evaluating the impact that ASU
No. 2016-01 will have on its consolidated financial statements and related disclosures.
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. When adopted, the Company does not expect this guidance to have a material
impact on our financial statements.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
In
March 2016, the FASB issued ASU No. 2016-08, Revenue
from Contracts with Customers (Topic 606): Principal versus Agent Considerations
.
The purpose of ASU No. 2016-08 is to clarify the implementation of guidance on principal versus agent considerations. For public
entities, the amendments in ASU No. 2016-08 are effective for interim and annual reporting periods beginning after December 15,
2017. The Company is currently assessing the impact of ASU No. 2016-08 on its consolidated financial statements and related disclosures.
In
March 2016, the FASB issued ASU No. 2016-09,
Compensation-Stock Compensation (Topic 718), Improvements to Employee Share-Based
Payment Accounting
. Under ASU No. 2016-09, companies will no longer record excess tax benefits and certain tax deficiencies
in additional paid-in capital (“APIC”). Instead, they will record all excess tax benefits and tax deficiencies as
income tax expense or benefit in the income statement and the APIC pools will be eliminated. In addition, ASU No. 2016-09 eliminates
the requirement that excess tax benefits be realized before companies can recognize them. ASU No. 2016-09 also requires companies
to present excess tax benefits as an operating activity on the statement of cash flows rather than as a financing activity. Furthermore,
ASU No. 2016-09 will increase the amount an employer can withhold to cover income taxes on awards and still qualify for the exception
to liability classification for shares used to satisfy the employer’s statutory income tax withholding obligation. An employer
with a statutory income tax withholding obligation will now be allowed to withhold shares with a fair value up to the amount of
taxes owed using the maximum statutory tax rate in the employee’s applicable jurisdiction(s). ASU No. 2016-09 requires a
company to classify the cash paid to a tax authority when shares are withheld to satisfy its statutory income tax withholding
obligation as a financing activity on the statement of cash flows. Under current U.S. GAAP, it was not specified how these cash
flows should be classified. In addition, companies will now have to elect whether to account for forfeitures on share-based payments
by (1) recognizing forfeitures of awards as they occur or (2) estimating the number of awards expected to be forfeited and adjusting
the estimate when it is likely to change, as is currently required. The amendments of this ASU are effective for reporting periods
beginning after December 15, 2016, with early adoption permitted but all of the guidance must be adopted in the same period. The
Company is currently assessing the impact that ASU No. 2016-09 will have on its consolidated financial statements.
In
April 2016, the FASB issued ASU No. 2016-10,
Revenue from Contracts with Customers
. The new guidance is an update to ASC
606 and provides clarity on: identifying performance obligations and licensing implementation. For public companies, ASU No. 2016-10
is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. The
Company is currently evaluating the impact that ASU No. 2016-10 will have on its consolidated financial statements.
3.
FAIR VALUE
In
accordance with ASC 820,
Fair Value Measurements and Disclosures
, 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.
|
Prior
to the April 2015 exchange transaction described in Note 8, the Company had outstanding warrants, the December warrants, that
contained re-pricing provisions for “down-round” issuances and other events not indexed to the Company’s own
stock and were classified as liabilities in the Company’s consolidated balance sheets. The Company recognized these warrants
as liabilities at their fair value and re-measured them through the date of their exchange in April 2015. ASC 820,
Fair Value
Measurements and Disclosures
provides requirements for disclosure of liabilities that are measured at fair value on a recurring
basis in periods subsequent to the initial recognition.
The
Company uses Level 3 inputs for its valuation methodology for the warrant liabilities. The estimated fair values were determined
using a binomial option pricing model based on various assumptions. The Company’s derivative liabilities are adjusted to
reflect estimated fair value at each period end, with any decrease or increase in the estimated fair value being recorded in other
income or expense accordingly, as adjustments to the fair value of derivative liabilities. Various factors are considered in the
pricing models the Company uses to value the warrants, including the Company’s current common stock price, the remaining
life of the warrants, the volatility of the Company’s common stock price, and the risk-free interest rate. In addition,
as of the valuation dates, management assessed the probabilities of future financing and other re-pricing events in the binominal
valuation models.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
A
summary of the changes to the Company’s warrant liability, as measured at fair value on a recurring basis using significant
unobservable inputs (Level 3), for the year ended October 31, 2015 is presented below:
Beginning balance - November 1, 2014
|
|
$
|
-
|
|
Issuance of warrants
|
|
|
3,765
|
|
Change in fair value of warrant liability
|
|
|
1,548
|
|
Settlement of warrants
|
|
|
(5,313
|
)
|
Ending balance - October 31, 2015
|
|
$
|
-
|
|
Assumptions
used to determine the fair value of the warrants during the year ended October 31, 2015 were:
Market price of common stock
|
|
|
$3.54-$7.56
|
|
Expected warrant term
|
|
|
4.5-5.0
years
|
|
Risk-free rate
|
|
|
1.0%
-1.7 %
|
|
Expected volatility
|
|
|
80
|
%
|
Dividend yield
|
|
|
0
|
%
|
Probability of certain litigation costs
at each of three pricing thresholds
|
|
|
0-33
|
%
|
Probability of future down-round financing
|
|
|
0-50
|
%
|
Stock price discount
|
|
|
0-41
|
%
|
In
connection with the April 19, 2016 common stock offering, the Company issued warrants to purchase an aggregate of 187,500 shares
of common stock. These warrants are exercisable at $6.90 per share and expire on April 19, 2018. These warrants were analyzed
and it was determined that they require liability treatment. 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 consolidated balance sheet as a
current liability.
The
fair value of these warrants at April 19, 2016 and October 31, 2016 was determined to be approximately $318,000 and $70,000, respectively,
as calculated using Black-Scholes with the following assumptions: (1) stock price of $4.74 and $3.58, respectively; (2) a risk
free rate of 0.77% and 0.75%, respectively; and (3) an expected volatility of 86% and 61%, respectively.
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. At October 31, 2016, the warrant liability balance of $70,000 was classified as a Level 3 instrument.
The
following table sets forth the changes in the estimated fair value for our Level 3 classified derivative warrant liability (from
April 19, 2016 through October 31, 2016) (in thousands):
|
|
Warrants
|
|
Fair value - November 1, 2015
|
|
$
|
-
|
|
Additions
|
|
|
318
|
|
Change in fair
value
|
|
|
(248
|
)
|
Fair value - October 31, 2016
|
|
$
|
70
|
|
4.
PREPAID EXPENSES AND OTHER CURRENT ASSETS
The
following table presents the major components of prepaid expenses and other current assets (in thousands):
|
|
October
31,
|
|
|
|
2016
|
|
|
2015
|
|
Prepaid insurance
|
|
$
|
22
|
|
|
$
|
61
|
|
Tax receivable
|
|
|
18
|
|
|
|
-
|
|
Other
|
|
|
7
|
|
|
|
40
|
|
Total
prepaid expenses and other current assets
|
|
$
|
47
|
|
|
$
|
101
|
|
5.
PROPERTY AND EQUIPMENT, NET
The
following table presents the components of property and equipment, net (in thousands):
|
|
October
31,
|
|
|
|
2016
|
|
|
2015
|
|
Computers and software
|
|
$
|
61
|
|
|
$
|
61
|
|
Furniture and
equipment
|
|
|
78
|
|
|
|
78
|
|
|
|
|
139
|
|
|
|
139
|
|
Accumulated depreciation
|
|
|
(121
|
)
|
|
|
(94
|
)
|
|
|
$
|
18
|
|
|
$
|
45
|
|
Depreciation
expense was approximately $27,000 and $61,000 for the year ended October 31, 2016 and 2015, respectively.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
6.
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
The
following table presents the major components of accounts payable and accrued expenses (in thousands):
|
|
October
31,
|
|
|
|
2016
|
|
|
2015
|
|
Accounts payable-trade
|
|
$
|
130
|
|
|
$
|
479
|
|
Royalties, fees and development
|
|
|
680
|
|
|
|
681
|
|
Salaries and other compensation
|
|
|
463
|
|
|
|
510
|
|
Other accruals
|
|
|
11
|
|
|
|
16
|
|
Total
accounts payable and accrued expenses
|
|
$
|
1,284
|
|
|
$
|
1,686
|
|
During
the year ended October 31, 2015, the Company recognized a gain on the extinguishment of liabilities for approximately $1.5 million
related to certain accounts payable balances and claims for license fees and services that the Company determined would never
be paid because they were no longer being pursued for payment and had passed the statute of limitations.
Salaries
and other compensation includes accrued payroll expense and estimated employer 401K plan liabilities.
7.
SHORT-TERM FINANCING ARRANGEMENTS
Accounts
receivable and inventory
Prior
to July 31, 2015, the Company used a factor to approve credit and to collect the proceeds from a substantial portion of its sales.
Under the terms of the agreement, the Company sold to the factor and the factor purchased from the Company, eligible accounts
receivable.
The
factor, in its sole discretion, determined whether or not it would accept the credit risk associated with a receivable. If the
factor did not accept the credit risk on a receivable, the Company sold the accounts receivable to the factor while retaining
the credit risk. In both cases, the Company surrendered all rights and control over the receivable to the factor. However, in
cases where the Company retained the credit risk, the amount could be charged back to the Company in the case of non-payment by
the customer. The factor was required to remit payments to the Company for the accounts receivable purchased from it, provided
the customer did not have a valid dispute related to the invoice. The amount remitted to the Company by the factor equaled the
invoiced amount, adjusted for allowances and discounts the Company provided to the customer, less factor charges.
The
Company reviewed the collectability of accounts receivable for which it held the credit risk quarterly, based on a review of an
aging of open invoices and payment history, to make a determination if any allowance for bad debts was necessary.
In
addition, the Company could request that the factor provide it with cash advances based on its accounts receivable and inventory,
up to a maximum amount.
Amounts
to be paid to the Company by the factor for any accounts receivable were offset by any amounts previously advanced by the factor.
The interest rate was prime plus 1.5%, annually, subject to a 5.5% floor. In certain circumstances, an additional 1.0% annually
was charged for advances against inventory.
The
Company also maintained purchase order financing, up to a maximum of $2,500, to provide funding for the manufacture of its products.
In connection with these arrangements, the factor had a security interest in substantially all of the Company’s assets.
The factor charged 0.5% of invoiced amounts, subject to certain minimum charges per invoice.
Inventory
purchases
Prior
to July 31, 2015, certain manufacturers required the Company to prepay or present letters of credit upon placing a purchase order
for inventory. The Company had arrangements with a finance company which provided financing secured by the specific goods underlying
the goods ordered from the manufacturer. The finance company made the required payment to the manufacturer at the time a purchase
order is placed, and was entitled to demand payment from the Company when the goods are delivered. The Company paid a financing
fee equal to 1.5% of the purchase order amount for each transaction, plus administrative fees. Additional charges of 0.05% per
day (18% annualized) were incurred if the financing remained open for more than 30 days.
The
agreements were terminated in the year ended October 31, 2015.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
8.
STOCKHOLDERS’ EQUITY
Preferred
stock
Under
the Company’s Amended and Restated Certificate of Incorporation, the Company is authorized to issue two classes of shares:
preferred and common stock. The preferred stock is issuable in series, and the Company’s Board of Directors is authorized
to determine the rights, preferences, and terms of each series.
Convertible
preferred stock as of October 31, 2016 consisted of the following:
|
|
Shares
Authorized
|
|
|
Shares
Issued and Outstanding
|
|
|
Net
Carrying Value
|
|
|
Aggregate
Liquidation Preference
|
|
|
Common
Shares Issuable Upon Conversion
|
|
Series A
|
|
|
8,830,000
|
|
|
|
7,138,158
|
|
|
$
|
1,745
|
|
|
$
|
4,854
|
|
|
|
1,189,693
|
|
Series B
|
|
|
54,250
|
|
|
|
54,201
|
|
|
|
4,569
|
|
|
|
-
|
|
|
|
903,362
|
|
Series C
|
|
|
26,000
|
|
|
|
25,763
|
|
|
|
2,010
|
|
|
|
-
|
|
|
|
429,392
|
|
Series D
|
|
|
170,000
|
|
|
|
156,332
|
|
|
|
1,829
|
|
|
|
-
|
|
|
|
260,553
|
|
Other authorized,
unissued
|
|
|
919,750
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
|
10,000,000
|
|
|
|
7,374,454
|
|
|
$
|
10,153
|
|
|
$
|
4,854
|
|
|
|
2,783,000
|
|
Convertible
preferred stock as of October 31, 2015 consisted of the following:
|
|
Shares
Authorized
|
|
|
Shares
Issued and Outstanding
|
|
|
Net
Carrying Value
|
|
|
Aggregate
Liquidation Preference
|
|
|
Common
Shares Issuable Upon Conversion
|
|
Series A
|
|
|
8,830,000
|
|
|
|
8,776,968
|
|
|
$
|
2,146
|
|
|
$
|
5,968
|
|
|
|
1,462,828
|
|
Series B
|
|
|
54,250
|
|
|
|
54,201
|
|
|
|
4,569
|
|
|
|
-
|
|
|
|
903,362
|
|
Series C
|
|
|
26,000
|
|
|
|
25,763
|
|
|
|
2,010
|
|
|
|
-
|
|
|
|
429,392
|
|
Series D
|
|
|
170,000
|
|
|
|
168,333
|
|
|
|
1,969
|
|
|
|
-
|
|
|
|
280,555
|
|
Other authorized,
unissued
|
|
|
919,750
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
|
10,000,000
|
|
|
|
9,025,265
|
|
|
$
|
10,694
|
|
|
$
|
5,968
|
|
|
|
3,076,137
|
|
December
Units and Series A Preferred Shares
On
December 17, 2014, pursuant to subscription agreements (the “December Subscription Agreements”) entered into with
certain accredited investors (the “December Investors”) the Company completed a private placement of $6.0 million
of units (the “December Units”) at a purchase price of $0.68 per Unit, with each December Unit consisting of one share
of the Company’s 0% Series A Convertible Preferred Stock (each a “Series A Preferred Share”) and a five-year
warrant (each a “December Warrant”) to purchase one sixth of a share of the Company’s common stock at an initial
exercise price of $4.08 per share (such issuance and sale, the “December Private Placement”). The December Warrants
were subsequently exchanged for shares of the Company’s 0% Series B Convertible Preferred Stock (the “Series B Preferred
Shares”) and shares of the Company’s common stock (see below). The offering was made in reliance upon an exemption
from registration under Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”).
The
Series A Preferred Shares are convertible into shares of common stock based on a conversion calculation equal to the stated value
of such Series A Preferred Share, plus all accrued and unpaid dividends, if any, on such Series A Preferred Share, as of such
date of determination, divided by the conversion price. The stated value of each Preferred Share is $0.68 and the initial conversion
price is $4.08 per share, each subject to adjustment for stock splits, stock dividends, recapitalizations, combinations, subdivisions
or other similar events. In addition, in the event the Company issues or sells, or is deemed to issue or sell, shares of its common
stock at a per share price that is less than the conversion price then in effect, the conversion price shall be reduced to such
lower price, subject to certain exceptions. Pursuant to the Certificate of Designations, Preferences and Rights of the 0% Series
A Convertible Preferred Stock of Majesco Entertainment Company, the Company is prohibited from incurring debt or liens, or entering
into new financing transactions without the consent of the lead investor (as defined in the December Subscription Agreements)
as long as any of the Series A Preferred Shares are outstanding. The Series A Preferred Shares bear no dividends.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
holders of Series A Preferred Shares shall vote together with the holders of common stock on all matters on an as if converted
basis, subject to certain conversion and ownership limitations, and shall not vote as a separate class. Notwithstanding the foregoing,
the conversion price for purposes of calculating voting power shall in no event be lower than $3.54 per share. At no time may
all or a portion of the Series A Preferred Shares be converted if the number of shares of common stock to be issued pursuant to
such conversion would exceed, when aggregated with all other shares of common stock owned by the holder at such time, the number
of shares of common stock which would result in such Holder beneficially owning (as determined in accordance with Section 13(d)
of the 1934 Act and the rules thereunder) more than 4.99% of all of the common stock outstanding at such time; provided, however,
that the holder may waive the 4.99% limitation at which time he may not own beneficially own more than 9.99% of all the common
stock outstanding at such time.
Prior
to the exchange transaction described below, the December Warrants were exercisable at any time at a price of $4.08 per share,
subject to adjustment, and expired five years from the date of issuance. The holders could exercise the December Warrants for
shares of common stock on a cashless basis if there was no effective registration statement or no current prospectus available
for resale of the underlying shares of common stock. The December Warrants were subject to certain adjustments upon certain actions
by the Company as outlined in the December Warrants, including, for twenty-four months following the initial issuance date, the
issuance or sale, or deemed issuance or sale, by the Company of shares of its common stock at a per share price that is less than
the exercise price then in effect.
The
proceeds of the offering and certificates representing the Series A Preferred Shares and December Warrants underlying the December
Units issued in the offering were deposited into escrow accounts. Upon the closing of the December Private Placement on December
17, 2014 (such date, the “December Closing Date”), $1.0 million of the December Escrow Amount was released to the
Company and $1.0 million of December Units to the December Investors, on a pro rata basis. Effective upon the approval of the
Company’s stockholders on March 30, 2015, in one or multiple tranches, the remaining $5.0 million became eligible to be
released to the Company and $5.0 million of December Units became eligible to be released to the December Investors from their
respective escrow accounts, if either, (i) the lead investor has approved the release, (ii) the approval of the requisite number
of December Investors has been obtained, (iii) the Company has executed definitive binding documents for certain transactions,
as described in the December Subscription Agreements, and such transaction(s) are to close contemporaneously with the release,
following approval by the Company’s stockholders or (iv) the following conditions are present: (a) nine months has elapsed
from the December Closing Date and release is approved by each of the directors appointed at closing (being the non-continuing
directors); (b) no subsequent release of the December Escrow Amount has been consummated; and (c) no more than $1.0 million is
released (the “December Release Conditions”). In the event that on and as of the twelve month anniversary of the December
Closing Date none of the December Release Conditions have been satisfied, $5.0 million would be returned on a pro rata basis to
the December Investors, without interest or deduction, and $5,000 of December Units would be returned to the Company for cancellation.
On September 25, 2015, the lead investor approved the release and the escrow agent released all funds and corresponding December
Units remaining in escrow.
The
Company received net proceeds of $801,000 for the December Units released from escrow, net of offering costs, and has accounted
for each of the Series A Preferred Shares released from escrow, the December Warrants released from escrow and the Series A Preferred
Shares and December Warrants remaining in escrow as freestanding instruments.
The
Company has evaluated the guidance ASC 480-10 Distinguishing Liabilities from Equity and ASC 815-40 Contracts in an Entity’s
Own Equity to determine the appropriate classification of the instruments. Prior to the exchange described below, the exercise
price of the released December Warrants could be adjusted downward if the Company issued securities at a price below the initial
exercise price and in certain other circumstances outside the control of the Company and therefore contain contingent settlement
terms not indexed solely to the Company’s own shares of common stock. Accordingly, $603,000 of proceeds were recorded as
a derivative liability representing the fair value of the December Warrants released from escrow at issuance and $120,000 of offering
costs allocated to the December Warrants were expensed. As a result of the allocations, described above, the Series A Preferred
Shares released were deemed to have a beneficial conversion feature at issuance amounting to $397,000, which was recorded in stockholders’
equity and immediately charged as a dividend in determining net loss attributable to common stockholders.
The
remaining net proceeds of $318,000 were allocated to the Series A Preferred Shares net of $79,000 of offering costs. The Series
A Preferred Shares do not represent an unconditional obligation to be settled in a variable number of shares of common stock,
are not redeemable and do not contain fixed or indexed conversion provisions similar to debt instruments. Accordingly, the Series
A Preferred Shares are considered equity hosts and recorded in stockholders’ equity.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Upon
stockholder approval in March 2015 of full conversion provisions of the escrowed December Warrants, the Company recorded a warrant
liability and a discount on the Series A Preferred Shares amounting to $3,162, based on the estimated fair value of the warrants.
In addition, upon shareholder approval of the full conversion provisions of the escrowed Series A Preferred Shares, the carrying
value of such Series A Preferred Shares, net of proceeds remaining in escrow was reclassified from temporary equity to paid-in
capital. The Company recorded a beneficial conversion feature and a discount on the Series A Preferred Shares amounting to $1.8
million, which was immediately recognized as a deemed dividend in determining net loss attributable to common shareholders.
In
connection with the December Private Placement, the Company also entered into separate Registration Rights Agreements with each
December Investor, (as amended on January 30, 2015 and March 31, 2015, the “December Registration Rights Agreement”).
The Company agreed to use its best efforts to file by March 31, 2015 a registration statement covering the resale of the shares
of common stock issuable upon exercise or conversion of the Series A Preferred Shares and December Warrants and to maintain its
effectiveness until all such securities have been sold or may be sold without restriction under Rule 144 of the Securities Act.
In the event the Company fails to satisfy its obligations under the December Registration Rights Agreements, the Company is required
to pay to the December Investors on a monthly basis an amount equal to 1% of the investors’ investment, up to a maximum
of 12%. On March 31, 2015, the Company and the required holders of December Units amended the registration rights agreement to
extend the filing deadline for the registration statement to June 30, 2015.
April
2015 Exchange and Series B Preferred Shares
On
April 30, 2015, pursuant to warrant exchange agreements, the Company retired the 1,470,590 December Warrants issued in the December
Private Placement, including those subject to the escrow conditions and those released from escrow, in exchange for shares of
the Company’s common stock, or shares of 0% Series B Convertible Preferred Stock (the “Series B Preferred Shares”),
in lieu of shares of common stock equal, on an as-converted basis, to the number of shares of common stock that would have otherwise
been received by the holder, if such issuance would result in the recipient holder exceeding certain thresholds. An aggregate
of 1,050,421 shares of common stock, which amount includes the shares of common stock issuable upon conversion of the Series B
Preferred Shares, were issuable in connection with the exchange agreements. The Company re-measured the fair value of the December
Warrants through the date of their exchange and recorded related losses in its statement of operations. In the year ending October
31, 2015, the Company recorded a change in fair value of $1.5 million related to the increase in the fair value of the December
Warrants during the period outstanding. Upon exchange, the contingent-conversion features of the December Warrants expired and
the carrying value of the warrant liability of $5.3 million was reclassified to paid-in capital and allocated to the Series B
Preferred Shares and the common shares distributed. Such Series B Shares and shares of common stock exchanged for the December
Warrants are not held in escrow and as such are not subject to the December Release Conditions.
The
Series B Preferred Shares are convertible into shares of common stock based on a conversion calculation equal to the stated value
of such Series B Preferred Shares, plus all accrued and unpaid dividends, if any, on such Series B Preferred Shares, as of such
date of determination, divided by the conversion price. The stated value of each Series B Preferred Share is $140.00 and the initial
conversion price is $8.40 per share, each subject to adjustment for stock splits, stock dividends, recapitalizations, combinations,
subdivisions or other similar events. The Company is prohibited from effecting a conversion of the Series B Preferred Shares to
the extent that, as a result of such conversion, such holder would beneficially own more than 4.99% of the number of shares of
common stock outstanding immediately after giving effect to the issuance of shares of common stock upon conversion of the Series
B Preferred Shares, which beneficial ownership limitation may be increased by the holder up to, but not exceeding, 9.99%. Subject
to such beneficial ownership limitations, each holder is entitled to vote on all matters submitted to stockholders of the Company
on an as converted basis, based on a conversion price of $8.40 per share. The Series B Preferred Shares rank junior to the Series
A Preferred Shares and bear no dividends. All of the convertible preferred shares do not represent an unconditional obligation
to be settled in a variable number of shares, are not redeemable and do not contain fixed or indexed conversion provisions similar
to debt instruments. Accordingly, the convertible preferred shares are considered equity hosts and recorded in stockholders’
equity.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
May
2015 Units and Series C Preferred Shares
On
May 15, 2015 (the “May Closing Date”), the Company completed a private placement pursuant to separate subscription
agreements (the “May Subscription Agreements”) with accredited investors (the “May Investors”) of $5,050
of units (the “May Units”), at a purchase price of $7.20 per Unit, resulting in net proceeds to the Company of $5.0
million. Each May Unit consists of one share of the Company’s common stock, provided that, if the issuance of any such shares
of common stock would have resulted in the recipient May Investor owning in excess of 4.99% of the Company’s issued and
outstanding common stock, then such May Investor could elect to receive shares of the Company’s 0% Series C Convertible
Preferred Stock (the “Series C Preferred Shares”) in lieu of common stock that are, on an as converted basis, equal
to one share of common stock for every May Unit purchased, and a three-year warrant (the “May Warrants”) to purchase
one share of the Company’s common stock at an exercise price of $8.40 per share (such sale and issuance, the “May
Private Placement”). An aggregate of 25,763 Series C Preferred Shares, 271,997 shares of common stock and 701,390 May Warrants
were issued under the May Units. The offering was made in reliance upon an exemption from registration under Section 4(a)(2) of
the Securities Act of 1933, as amended (the “Securities Act”).
The
Series C Preferred Shares are convertible into shares of common stock based on a conversion calculation equal to the stated value
of such Series C Preferred Shares, plus all accrued and unpaid dividends, if any, on such Series C Preferred Shares, as of such
date of determination, divided by the conversion price. The stated value of each Series C Preferred Share is $120.00 per share,
and the initial conversion price is $7.20 per share, each subject to adjustment for stock splits, stock dividends, recapitalizations,
combinations, subdivisions or other similar events. In addition, in the event the Company issues or sells, or is deemed to issue
or sell, shares of common stock at a per share price that is less than the conversion price then in effect, the conversion price
shall be reduced to such lower price, subject to certain exceptions and provided that the conversion price may not be reduced
to less than $5.16, unless and until such time as the Company obtains shareholder approval to allow for a lower conversion price.
The Company is prohibited from effecting a conversion of the Series C Preferred Shares to the extent that, as a result of such
conversion, such May Investor would beneficially own more than 4.99% of the number of shares of common stock outstanding immediately
after giving effect to the issuance of shares of common stock upon conversion of the Series C Preferred Shares, which beneficial
ownership limitation may be increased by the holder up to, but not exceeding, 9.99%. Subject to the beneficial ownership limitations
discussed previously, each holder is entitled to vote on all matters submitted to stockholders of the Company, and shall have
the number of votes equal to the number of shares of common stock issuable upon conversion of such holder’s Series C Preferred
Shares, based on a conversion price of $7.20 per share. The Series C Preferred Shares bear no dividends and shall rank junior
to the Company’s Series A Preferred Shares but senior to the Company’s Series B Preferred Shares.
The
May Warrants are exercisable, at any time, following the date the May Warrants are issued, at a price of $8.40 per share, subject
to adjustment, and expire three years from the date of issuance. The holders may, subject to certain limitations, exercise the
May Warrants on a cashless basis. The Company is prohibited from effecting an exercise of any May Warrant to the extent that,
as a result of any such exercise, the holder would beneficially own more than 4.99% of the number of shares of common stock outstanding
immediately after giving effect to the issuance of shares of common stock upon exercise of such May Warrant, which beneficial
ownership limitation may be increased by the holder up to, but not exceeding, 9.99%.
In
connection with the sale of the May Units, the Company also entered into separate registration rights agreements (the “May
Registration Rights Agreement”) with each May Investor. The Company agreed to use its best efforts to file a registration
statement to register the Shares and the common stock issuable upon the conversion of the Series C Preferred Shares, within thirty
days following the May Closing Date, to cause such registration statement to be declared effective within ninety days of the filing
day and to maintain the effectiveness of the registration statement until all of such shares of common stock have been sold or
are otherwise able to be sold pursuant to Rule 144 without restriction. In the event the Company fails to satisfy its obligations
under the Registration Rights Agreement, the Company is obligated to pay to the May Investors on a monthly basis, an amount equal
to 1% of the May Investor’s investment, up to a maximum of 12%. Effective as of the original filing deadline of the registration
statement, the Company obtained the requisite approval from the May Investors for the waiver of its obligations under the May
Registration Rights Agreement.
The
proceeds of the May Private Placement were deposited into an escrow account (the “May Escrow Amount”) with Signature
Bank, as escrow agent (the “May Escrow Agent”) pursuant to an escrow agreement (the “May Escrow Agreement”),
entered into by and between the Company, the lead investor (as defined in the May Subscription Agreements) and the May Escrow
Agent, and certificates representing the May Warrants and a record of the Shares and Series C Preferred Shares, sold in the May
Private Placement were deposited and recorded with the Company’s corporate secretary (the “May Securities Escrow Agent”)
to be held in escrow. On the May Closing Date, twenty percent (20%) of the May Escrow Amount ($1.0 million) was released by the
May Escrow Agent to the Company in exchange for the release of twenty percent (20%) of May Units by the May Securities Escrow
Agent to the May Investors. The remaining eighty percent (80%) of the May Escrow Amount ($4.0 million) was released by the May
Escrow Agent to the Company and the corresponding percentage of May Units were released to the May Investors, under amendments
to the May subscription agreements. On September 25, 2015, the lead investor approved the release and the May Escrow Agent and
the May Securities Escrow Agent released all funds and May Units remaining in escrow.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
Company evaluated the guidance ASC 480-10
Distinguishing Liabilities from Equity
and ASC 815-40
Contracts in an Entity’s
Own Equity
to determine the appropriate classification of the instruments. The Series C Preferred Shares do not represent
an unconditional obligation to be settled in a variable number of shares of common stock, are not redeemable and do not contain
fixed or indexed conversion provisions similar to debt instruments. Accordingly, the Series C Preferred Shares are considered
equity hosts and recorded in stockholders’ equity. The May Warrants do not contain contingent settlement terms not indexed
solely to the Company’s own shares of common stock and, accordingly, were also recorded in stockholders’ equity. The
Company allocated $2.0 million, $1.3 million and $1.8 million of gross proceeds to the Series C Preferred Stock, the common stock
and the warrants, respectively, based on their relative fair values. The Company incurred $25,000 of offering expenses.
September
2015 Exchange and Series D Preferred Shares
On
September 25, 2015, the Company entered into Amendment Agreements (the “Amendments”) which amended the terms of the
December Subscription Agreements and May Subscription Agreements. Under the Amendments, the lead investors under the subscription
agreements agreed to release all funds remaining held in escrow ($5.0 million under the December 17, 2014 closing and $4.0 million
under the May 15, 2015 closing) upon the appointment of certain persons as officers and directors of the Company.
In
connection with the Amendments, the Company also entered into Exchange Agreements with the holders of the May Warrants (the “September
Exchange Agreements”) and authorized the issuance of .4 shares of common stock for each share of our Common Stock into which
the May Warrants was then convertible, in exchange for cancellation of the May Warrants. The Company agreed that holders of the
May Warrants could exchange their May Warrants and receive either: (1) .4 shares of common stock for each share of common stock
into which the May Warrant was exercisable immediately, or (2) at the election of any holder who would, as a result of receipt
of the common stock hold in excess of 4.99% of the Company’s issued and outstanding common stock, shares of 0% Series D
Convertible Preferred Stock (the “Preferred D Shares”) exercisable for common stock on the same basis, but subject
to 4.9% beneficial ownership blocker provisions which at the election of the holder, could be reduced to 2.49%. Under the agreement,
the Company exchanged all of its May Warrants for an aggregate of 168,333 new shares of 0% Series D Convertible Preferred Stock,
which upon full conversion on a fully-diluted basis, convert into 280,555 shares of newly issued common stock.
The
Preferred D Shares are convertible into shares of common stock based on a conversion calculation equal to the stated value of
such Preferred D Share, plus all accrued and unpaid dividends, if any, on such Preferred D Share, as of such date of determination,
divided by the conversion price. The stated value of each Preferred D Share is $1,000.00 per share and the initial conversion
price is $600.00 per share, each subject to adjustment for stock splits, stock dividends, recapitalizations, combinations, subdivisions
or other similar events. The Company is prohibited from effecting a conversion of the Preferred D Shares to the extent that, as
a result of such conversion, such investor would beneficially own more than 4.99% of the number of shares of common stock outstanding
immediately after giving effect to the issuance of shares of common stock upon conversion of the Preferred D Shares. Upon 61 days
written notice, the beneficial ownership limitation may be increased by the holder up to, but not exceeding, 9.99%. Except as
otherwise required by law, holders of Series D Preferred Shares shall not have any voting rights. Pursuant to the Certificate
of Designations, Preferences and Rights of the 0% Series D Convertible Preferred Stock, the Preferred D Shares bear no interest
and shall rank senior to the Company’s other classes of capital stock. The Company accounted for the exchange as a redemption
of the warrants and recorded the estimated fair value of Series D Convertible Preferred Stock issued, amounting to $1,969 with
a charge to paid-in capital. As the value of the preferred shares issued was less than the value of the warrants redeemed, no
excess value needed to be attributed and no portion of the redemption was deemed a dividend.
April
2016 Registered Common Stock and Warrant Offering
On
April 13, 2016, the Company entered into a Securities Purchase Agreement with certain institutional investors providing for the
issuance and sale by the Company of 250,000 shares of the Company’s common stock, par value $0.001 per share at an offering
price of $6.00 per share, for net proceeds of $1.4 million after deducting placement agent fees and expenses. In addition, the
Company sold to purchasers of common stock in this offering, warrants to purchase 187,500 shares of its common stock. The common
shares and the warrant shares were offered by the Company pursuant to an effective shelf registration statement on Form S-3, which
was initially filed with the Securities and Exchange Commission on October 22, 2015 and declared effective on December 7, 2015.
The closing of the offering occurred on April 19, 2016.
Each
warrant is immediately exercisable for two years, but not thereafter, at an exercise price of $6.90 per share. Subject to limited
exceptions, a holder of warrants will not have the right to exercise any portion of its warrants if the holder, together with
its affiliates, would beneficially own in excess of 4.99% of the number of shares of our common stock outstanding immediately
after giving effect to such exercise. The exercise price and number of warrants are subject to adjustment in the event of any
stock dividends and splits, reverse stock split, stock dividend, recapitalization, reorganization or similar transaction.
The
warrants require the issuance of registered shares upon exercise and do not expressly preclude an implied right to cash settlement
by the holder.
The warrants were classified as liabilities and measured at fair value, with changes in fair value recognized
in the Consolidated Statements of Operations in other expenses (income). The initial recognition of the warrants resulted in an
allocation of the net proceeds from the offering to a warrant liability at fair value of approximately $318,000, with the remainder
being attributable to the common stock sold in the offering.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Preferred
Share Conversion Activity
During
the year ended October 31, 2016, 1,638,810 shares of Convertible Preferred Stock Series A and 12,001 shares of Convertible Preferred
Stock Series D were converted into 293,137 shares of common stock.
Warrants
A
summary of the status of the Company’s outstanding warrants as of October 31 and changes during the years then ended is
presented below:
|
|
October
31,
|
|
|
|
2016
|
|
|
2015
|
|
Outstanding at beginning
of year
|
|
|
-
|
|
|
|
1,191
|
|
Issued in offerings of units
|
|
|
187,500
|
|
|
|
2,171,979
|
|
Settled under exchange agreements
|
|
|
-
|
|
|
|
(2,171,979
|
)
|
Expired
|
|
|
-
|
|
|
|
(1,191
|
)
|
Outstanding at
end of year
|
|
|
187,500
|
|
|
|
-
|
|
Special
Cash Dividend
On
January 4, 2016, the Company declared a special cash dividend of an aggregate of $10.0 million to holders of record on January
14, 2016 of its outstanding shares of: (i) common stock (ii) Series A Convertible Preferred Stock; (iii) Series B Convertible
Preferred Stock; (iv) Series C Convertible Preferred Stock and (v) Series D Convertible Preferred Stock. The holders of record
of the Company’s outstanding preferred stock participated in the dividend on an “as converted” basis. Approximately,
$6.0 million of the special cash dividend relates to Preferred Stock shares.
9.
STOCK-BASED COMPENSATION
In
the years ended October 31, 2016 and 2015, the Company recorded stock-based compensation expense amounting to $3.1 million and
$1.4 million, respectively, related to restricted stock awards and stock options.
Incentive
Compensation Plans
In
the fiscal years ended October 31, 2016 and 2015, the Company made stock-based compensation awards under its 2016 Equity Incentive
Plan (the “2016 Plan”), 2014 Equity Incentive Plan (the “2014 Plan”) and its Amended and Restated 2004
Employee, Director and Consultant Incentive Plan (the “2004 Plan”).
2016
Plan
In
the fiscal year ended October 31, 2016, the Company adopted the 2016 Plan, an omnibus equity incentive plan administered by the
Company’s board of directors, or by one or more committees of directors appointed by the Board, pursuant to which the Company
may issue up to 666,665 shares of the Company’s common stock under equity-linked awards to certain officers, employees,
directors and consultants. The 2016 Plan permits the grant of stock options, including incentive stock options and nonqualified
stock options, stock appreciation rights, restricted shares, restricted share units, cash awards, or other awards, whether at
a fixed or variable price, upon the passage of time, the occurrence of one or more events, or the satisfaction of performance
criteria or other conditions, or any combination thereof. As of October 31, 2016, the Company had zero shares available for future
issuances under the 2016 Plan.
2014
Plan
In
the fiscal year ended October 31, 2015, the Company adopted the 2014 Plan, an omnibus equity incentive plan administered by the
Company’s board of directors, or by one or more committees of directors appointed by the Board, pursuant to which the Company
may issue up to 375,000 shares of the Company’s common stock under equity-linked awards to certain officers, employees,
directors and consultants. The 2014 Plan permits the grant of stock options, including incentive stock options and nonqualified
stock options, stock appreciation rights, restricted shares, restricted share units, cash awards, or other awards, whether at
a fixed or variable price, upon the passage of time, the occurrence of one or more events, or the satisfaction of performance
criteria or other conditions, or any combination thereof. As of October 31, 2016, the Company had approximately 83,262 shares
available for future issuances under the 2014 Plan.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
2004
Plan
The
2004 Plan covers employees, directors and consultants and also provides for the issuance of restricted stock, non-qualified stock
options, incentive stock options and other awards under terms determined by the Company. In April 2014, the Company’s stockholders
and Board of Directors approved an amendment to the Plan to increase the number of common shares available for issuance under
the Plan by 71,429 shares. As of October 31, 2016, the Company had approximately 19,217 shares available for future issuances
under the 2004 Plan.
Stock
Options
Stock-option
activity in the fiscal year ended October 31, 2016:
|
|
Number
Of
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
Outstanding, November
1, 2014
|
|
|
71,533
|
|
|
$
|
39.24
|
|
Granted
|
|
|
55,070
|
|
|
$
|
4.44
|
|
Forfeited
|
|
|
(14,188
|
)
|
|
$
|
31.98
|
|
Expired
|
|
|
(15,834
|
)
|
|
$
|
61.08
|
|
Outstanding, October 31, 2015
|
|
|
96,581
|
|
|
$
|
16.92
|
|
Granted
|
|
|
347,010
|
|
|
$
|
4.84
|
|
Forfeited
|
|
|
(12,258
|
)
|
|
$
|
36.97
|
|
Exercised
|
|
|
(31,657
|
)
|
|
$
|
4.08
|
|
Expired
|
|
|
(17,656
|
)
|
|
$
|
30.72
|
|
Outstanding,
October 31, 2016
|
|
|
382,020
|
|
|
$
|
5.73
|
|
Options exercisable,
October 31, 2016
|
|
|
205,941
|
|
|
$
|
6.50
|
|
Weighted-average
grant date fair value of options granted during the year
|
|
|
|
|
|
$
|
3.38
|
|
Stock
options are generally granted to employees or directors at exercise prices equal to the fair market value of the Company’s
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 options granted during the year ended October 31, 2016 was approximately $1.2 million. The intrinsic value of options
outstanding at October 31, 2016 was $0. The intrinsic value of options exercised during the fiscal years ended October 31, 2016
was $15,000. The weighted average remaining contractual term of exercisable and outstanding options at October 31, 2016 was 8.3
years and 8.7 years, respectively.
The
fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions for the years ended October 31:
|
|
October
31,
|
|
|
|
2016
|
|
|
2015
|
|
Risk free annual interest
rate
|
|
|
1
.0-1.7%
|
|
|
|
1.4
|
%
|
Expected volatility
|
|
|
77-79%
|
|
|
|
80
|
%
|
Expected life
|
|
|
2.75-5.00
years
|
|
|
|
4.77
years
|
|
Assumed dividends
|
|
|
None
|
|
|
|
None
|
|
The
fair value of stock option grants is amortized over the vesting period rally, one to three years. A oober 31, 2016, there was
approximately $5,000 of unrecognized compensation cost related to non-vested stock option awards, which is expected to be recognized
over a remaining weighted-average vesting period of 0.1 year. Additionally, approximately 165,000 options are subject to vesting
upon the achievement of a performance condition. The grant date fair value of these options is approximately $551,000.
Restricted-stock
activity in the fiscal year ended October 31, 2016:
|
|
|
Number
of shares
|
|
|
Weighted-Average
Grant-Date Fair Value
|
|
Unvested,
January 1, 2015
|
|
|
|
21,040
|
|
|
$
|
28.56
|
|
Granted
|
|
|
|
339,813
|
|
|
$
|
6.66
|
|
Vested
|
|
|
|
(113,482
|
)
|
|
$
|
8.88
|
|
Forfeited
|
|
|
|
(16,572
|
)
|
|
$
|
7.98
|
|
Unvested, December
31, 2015
|
|
|
|
230,799
|
|
|
$
|
7.47
|
|
Granted
|
|
|
|
356,666
|
|
|
$
|
5.14
|
|
Vested
|
|
|
|
(312,636
|
)
|
|
$
|
6.10
|
|
Unvested, December
31, 2016
|
|
|
|
274,829
|
|
|
$
|
6.00
|
|
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
weighted-average grant date fair value of restricted shares granted during the year ended October 31, 2016 was $5.14. The total
fair value of restricted stock vested during the years ended October 31, 2016 and 2015 was approximately $1.8 million and $865,000,
respectively.
The
value of restricted stock grants are 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 October 31, 2016, there was approximately
$6,000 of unrecognized compensation cost related to unvested restricted stock awards, which is expected to be recognized over
a remaining weighted-average vesting period of 0.2 years. Additionally, approximately 169,000 restricted shares are subject to
vesting upon the achievement of a performance condition. The grant date fair value of these restricted shares is approximately
$871,000.
10.
INCOME TAXES
The
provision (benefit) for income taxes for the years ended October 31, 2016 and 2015 consisted of (in thousands):
|
|
2016
|
|
|
2015
|
|
Current:
|
|
|
|
|
|
|
Federal
|
|
$-
|
|
|
$-
|
|
State
|
|
|
(3
|
)
|
|
|
3
|
|
Deferred:
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(1,709
|
)
|
|
|
182
|
|
State
|
|
|
(692
|
)
|
|
|
181
|
|
Impact of change in effective tax
rates on deferred taxes
|
|
|
-
|
|
|
|
-
|
|
Change
in: valuation allowance
|
|
|
2,404
|
|
|
|
(363
|
)
|
|
|
$
|
-
|
|
|
$
|
3
|
|
The
difference between income taxes computed at the statutory federal rate and the provision for income taxes for 2016 and 2015 related
to the following (in thousands, except percentages):
|
|
2016
|
|
|
2015
|
|
|
|
Amount
|
|
|
Percent
of
Pretax
income
|
|
|
Amount
|
|
|
Percent
of
Pretax
income
|
|
Tax (benefit) at federal
statutory rate
|
|
$
|
(1,577
|
)
|
|
|
34
|
%
|
|
$
|
(1,297
|
)
|
|
|
34
|
%
|
State income taxes, net of federal
income taxes
|
|
|
(695
|
)
|
|
|
15
|
%
|
|
|
184
|
|
|
|
(5
|
)%
|
Effect of warrant liability
|
|
|
(84
|
)
|
|
|
2
|
%
|
|
|
526
|
|
|
|
(14
|
)%
|
Effect of other permanent items
|
|
|
144
|
|
|
|
(3
|
)%
|
|
|
574
|
|
|
|
(15
|
)%
|
Change in valuation allowance
|
|
|
2,404
|
|
|
|
(52
|
)%
|
|
|
(363
|
)
|
|
|
10
|
%
|
Reduction
of deferred benefits
|
|
|
(192
|
)
|
|
|
4
|
%
|
|
|
379
|
|
|
|
(10
|
)%
|
|
|
$
|
-
|
|
|
|
-%
|
|
|
$
|
3
|
|
|
|
-%
|
|
The
components of deferred income tax assets (liabilities) were as follows (in thousands):
|
|
October
31,
|
|
|
|
2016
|
|
|
2015
|
|
Impairment of development
costs
|
|
$
|
641
|
|
|
$
|
597
|
|
Depreciation and amortization
|
|
|
224
|
|
|
|
144
|
|
Impairment of inventory
|
|
|
-
|
|
|
|
14
|
|
Compensation expense not deductible
until options are exercised
|
|
|
1,116
|
|
|
|
174
|
|
All other temporary differences
|
|
|
629
|
|
|
|
370
|
|
Net operating loss carry forward
|
|
|
2,461
|
|
|
|
1,368
|
|
Less valuation
allowance
|
|
|
(5,071
|
)
|
|
|
(2,667
|
)
|
Deferred tax
asset
|
|
$
|
-
|
|
|
$
|
-
|
|
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Realization
of deferred tax assets, including those related to net operating loss carryforwards, are dependent upon future earnings, if any,
of which the timing and amount are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance.
Based upon the Company’s current operating results management cannot conclude that it is more likely than not that such
assets will be realized.
As
a result of the Company’s private placements during the fiscal year ended October 31, 2015, a change of ownership under
Internal Revenue Service Section 382 has occurred and, accordingly, the annual utilization of the Company’s federal net
operating loss carryforwards will be severely limited. The annual limitations are expected to result in the expiration of federal
net operating loss carryforwards of approximately $94.0 million before full utilization. The federal net operating loss carryforwards
expected to be available for income tax purposes at October 31, 2016 after application of these limitations are estimated to be
approximately $9.2 million, which expire between 2027 and 2036 for federal income taxes, and approximately $35.4 million for state
income taxes, which primarily expire between 2013 and 2036.
The
Company files income tax returns in the U.S., various states and the United Kingdom. As of October 31, 2016, the Company had no
unrecognized tax benefits, which would impact its tax rate if recognized. As of October 31, 2016, the Company had no accrual for
the potential payment of penalties. As of October 31, 2015, the Company was not subject to any U.S. federal, state or foreign
income tax examinations. The Company’s U.S. federal tax returns have been examined for tax years through 2011, and income
taxes for Majesco Europe Limited have been examined for tax years through 2006 in the United Kingdom with the results of such
examinations being reflected in the Company’s results of operations as of October 31, 2013. The Company does not anticipate
any significant changes in its unrecognized tax benefits over the next 12 months.
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 years ended October 31, 2016 and 2015, as the
effect of their inclusion would be anti-dilutive.
The
table below provides total potential shares outstanding, including those that are anti-dilutive, on October 31:
|
|
October
31,
|
|
|
|
2016
|
|
|
2015
|
|
Shares issuable upon
conversion of preferred stock
|
|
|
2,783,000
|
|
|
|
3,076,137
|
|
Shares issuable upon exercise of
warrants
|
|
|
187,500
|
|
|
|
-
|
|
Shares issuable upon exercise of
stock options
|
|
|
382,020
|
|
|
|
96,581
|
|
Non-vested shares under restricted
stock grants
|
|
|
274,832
|
|
|
|
230,799
|
|
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, the Company and a number of other
game publisher defendants. The complaint alleges that the Company’s 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 Company, in conjunction with Microsoft, is defending itself against the claim and has
certain third party indemnity rights from developers for costs incurred in the litigation. In August 2015, the defendants jointly
moved to transfer the case to the Western District of Washington. On May 17, 2016, the Washington Court issued a scheduling order
that provides that defendants leave to jointly file an early motion for summary judgement in June 2016. On June 17, 2016, the
defendants jointly filed a motion for summary judgment that stated that none of the defendants, including the Company, infringed
upon the asserted patent. On July 9, 2016, Mr. Baker opposed the motion. On July 15, 2016, the defendants jointly filed a reply.
The briefing on the motion is now closed. The Court has not yet issued a decision or indicated if or when there will be oral argument
on the motion.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Intelligent
Verification Systems, LLC (“IVS”), filed a patent infringement complaint on September 20, 2012, in the United States
District Court for the Eastern District against the Company and Microsoft Corporation. In March 2015, the court issued an order
excluding the evidence proffered by IVS in support of its alleged damages, including the opinion of its damages expert. IVS appealed
that decision. On January 19, 2016, the Federal Circuit denied IVS’ appeal and affirmed the district court’s orders
that excluded the plaintiff’s damages expert and dismissed the case.
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 at 4041 T Hadley Road, South Plainfield, New Jersey at a cost of approximately $1,613 per month under
a lease agreement that expires in March 2017. Total rent expense amounted to approximately $20,000 and $165,000 for the years
ended October 31, 2016 and 2015, respectively, including charges incurred upon vacating its previous administrative offices in
2015.
The
Company has entered into employment agreements with key executives that contain severance terms and change of control provisions.
13.
WORKFORCE REDUCTION
In
the year ended October 31, 2015, the Company incurred severance charges in connection with employee layoffs.
Changes
in accrued severance liabilities in the year ended October 31, 2015 (in thousands):
|
|
2015
|
|
Accrued severance liability,
beginning of period
|
|
$
|
323
|
|
Severance costs accrued
|
|
|
840
|
|
Payments
|
|
|
(1,163
|
)
|
Accrued severance
liability, end of period
|
|
$
|
-
|
|
14.
RELATED PARTY TRANSACTIONS
Prior
to its termination in October 2014, the Company had a consulting agreement with Morris Sutton, the Company’s former Chief
Executive Officer and Chairman Emeritus. The Company estimates that Morris Sutton and another relative of Jesse Sutton, the Company’s
former Chief Executive Officer, earned compensation of approximately $26,000 in the year ended October 31, 2015 from a supplier
of its Zumba belt accessory, based on the value of the Company’s purchases.
In
January 2015, the Company entered into an agreement with Equity Stock Transfer for transfer agent services. A Board member of
the Company is a co-founder and chief executive officer of Equity Stock Transfer. Fees under the agreement were approximately
$2,000 and $8,000 for the years ended October 31, 2016 and 2015, respectively.
15.
ASSIGNMENT OF ASSETS AND LIABILITIES
On
July 31, 2015, the Company transferred to Zift Interactive LLC (“Zift”), a newly-formed subsidiary, certain rights
under certain of its publishing licenses related to developing, publishing and distributing video game products through retail
distribution for a term of one year. The Company transferred Zift to its former chief executive officer, Jesse Sutton. In exchange,
the Company received Mr. Sutton’s resignation from the position of chief executive officer of the Company, including waiver
of any severance payments and the execution of a separation agreement, together with his agreement to serve as a consultant to
the Company.
In
addition, the Company entered into a conveyance agreement with Zift under which it assigned to Zift certain assets used in the
retail business and Zift agreed to assume and indemnify the Company for liabilities and claims related to the retail business,
including customer claims for price protection and promotional allowances. The assets transferred to Zift included cash in an
amount of $800,000, of which $400,000 was transferred immediately and the remaining $400,000 was payable by the Company in twelve
equal consecutive monthly installments of $33,000 commencing August 1, 2015, and certain accounts receivable and inventory with
an aggregate carrying value of approximately $87,000. In connection with the transfer of distribution rights and the assumption
of liabilities by Zift, the Company reduced its estimated accrued liabilities for royalties, customer credits and other related
liabilities by approximately $1.2 million with a credit to gains on sales of assets, net of transferred assets of $269,000. The
Company has accrued approximately $219,000 of contingent liabilities for certain potential licensor and customer liabilities and
claims not extinguished by the transactions. The net gain of approximately $50,000 resulting from the transactions is included
in gain on asset sales, net in 2015. As of October 31, 2016, the Company did not have a balance payable to or receivable from
Zift.
MAJESCO
ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
16.
EMPLOYEE RETIREMENT PLAN
The
Company has a defined contribution 401(k) plan covering all eligible employees. The Company had no charge to operations for contributions
to the retirement plan for the years ended October 31, 2016 and 2015. Certain stockholders and key employees of the Company serve
as trustees of the plan. The Company believes that the operation of its 401k plan may not be in compliance with certain plan provisions.
The Company is currently assessing what corrective actions may be needed to be taken to bring the plan back into compliance. The
Company has recorded a liability for the estimated cost of correcting any plan deficiencies, including additional plan contributions,
if required.
17.
SUBSEQUENT EVENTS
PolarityTE,
Inc.
On
December 1, 2016, the Company entered into an Agreement and Plan of Reorganization (the “Agreement”) with Majesco
Acquisition Corp., a Nevada corporation and wholly-owned subsidiary of the Company, PolarityTE, Inc., a Nevada corporation (“Polarity”)
and Dr. Denver Lough, the owner of 100% of the issued and outstanding shares of capital stock of Polarity (the “Seller”).
The closing is subject to various closing conditions, including, approval of stockholders of the Company in accordance with Delaware
law and NASDAQ Listing Rule 5635 and a minimum cash balance available to the Company.
At
closing, upon satisfaction of each of the closing conditions, the Seller will be issued 7,050 shares of the Company’s newly
authorized Series E Preferred Stock (the “Preferred Shares”) convertible into an aggregate of 7,050,000 shares of
the Company’s common stock (the “Merger Consideration” and such transaction, the “Merger”), expected
to constitute approximately 50% of the issued and outstanding shares of common stock of the Company on a fully diluted basis at
closing and depending in part, upon the Company’s expected cash balance at closing. Until converted, each Preferred Share
is entitled to two votes for every share of common stock into which it is convertible on any matter submitted for a vote of stockholders.
The
Company is still in the process of analyzing the accounting treatment for this transaction.
Series
E Preferred Stock
On
or prior to the effective time of the Merger, the Company will file a Certificate of Designations, Preferences and Rights of the
0% Series E Convertible Preferred Stock (the “Certificate of Designation”) with the Delaware Secretary of State pursuant
to which the Company will designate 7,050 shares of the Company’s authorized shares of preferred stock as Series E Preferred
Stock. The Series E Preferred Stock are convertible into shares of common stock based on a conversion calculation equal to the
stated value of such preferred stock, plus all accrued and unpaid dividends, if any, on such preferred stock, as of such date
of determination, divided by the conversion price. The stated value of each Series E Preferred Stock is $1,000 and the initial
conversion price is $1.00 per share, each subject to adjustment for stock splits, stock dividends, recapitalizations, combinations,
subdivisions or other similar events. The Series E Preferred Stock, with respect to dividend rights and rights on liquidation,
winding-up and dissolution, in each case will rank senior to the Company’s common stock and all other securities of the
Company that do not expressly provide that such securities rank on parity with or senior to the Series E Preferred Stock. Until
converted, each share of Series E Preferred Stock is entitled to two votes for every share of common stock into which it is convertible
on any matter submitted for a vote of stockholders.
2017
Equity Incentive Plan
On
December 1, 2016, the Company’s Board of Directors (the “Board”) approved the Company’s 2017 Equity Incentive
Plan (the “2017 Plan”). The purpose of the 2017 Plan is to promote the success of the Company and to increase stockholder
value by providing an additional means through the grant of awards to attract, motivate, retain and reward selected employees,
consultants and other eligible persons. The 2017 Plan provides for the grant of incentive stock options, nonqualified stock options,
restricted stock, restricted stock units, stock appreciation rights and other types of stock-based awards to the Company’s
employees, officers, directors and consultants. The Compensation Committee of the Board will administer the 2017 Plan, including
determining which eligible participants will receive awards, the number of shares of common stock subject to the awards and the
terms and conditions of such awards. Up to 3,450,000 shares of common stock are issuable pursuant to awards under the 2017 Plan.
Unless earlier terminated by the Board, the 2017 Plan shall terminate at the close of business on December 1, 2026.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
PolarityTE,
Inc. is an innovative developer, marketer, publisher and distributor of interactive entertainment for consumers around the world.
Building on more than 25 years of operating history, the Company develops and publishes a wide range of video games on digital
networks through its Midnight City label, including Nintendo’s DS, 3DS, Wii and WiiU, Sony’s PlayStation 3 and 4,
or PS3 and PS4, Microsoft’s Xbox 360 and Xbox One and the personal computer, or PC. Although, historically, we have sold
packaged software to large retail chains, specialty retail stores, video game rental outlets and distributors and through digital
distribution for platforms such as Xbox Live Arcade, PlayStation Network, or PSN, and Steam, and for mobile devices and online
platforms, we are now purposed to operate, almost exclusively, in our digital software business unit.
Video
Game Products
Net
Revenues.
Our revenues are principally derived from sales of our video games. We provide video games primarily for the mass
market and casual-game player. Our revenues are recognized net of estimated provisions for price protection and other allowances.
When we act as an agent in the distribution of games developed by others, we recognize revenue net of the share of revenue due
to the developer in the form of wholesale price, royalties and/or distribution fees.
Cost
of Sales.
Cost of sales consists of product costs and amortization and impairment of software development costs and license
fees. A significant component of our cost of sales of packaged games is product costs. Product costs are comprised primarily of
manufacturing and packaging costs of the disc or cartridge media, royalties to the platform manufacturer and manufacturing and
packaging costs of peripherals. Commencing upon the related product’s release, capitalized software development and intellectual
property license costs are amortized to cost of sales.
Gross
Profit.
Gross profit is the excess of net revenues over product costs and amortization and impairment of software development
and license fees. Development and license fees incurred to produce video games are generally incurred up front and amortized to
cost of sales. The recovery of these costs and total gross profit is dependent upon achieving a certain sales volume, which varies
by title.
Product
Research and Development Expenses.
Product research and development expenses have historically related principally to our
cost of supervision of third party video game developers, testing new products, development of social games and conducting quality
assurance evaluations during the development cycle that are not allocated to games for which technological feasibility has been
established. Costs incurred have been primarily employee-related, may include equipment, and are not allocated to cost of sales.
Ongoing research and development activities have been substantially reduced since fiscal 2014.
Selling
and Marketing Expenses.
Our selling and marketing expenses previously consisted of advertising and promotion expenses, including
television advertising, the cost of shipping products to customers, and related employee costs. Credits to retailers for trade
advertising were components of these expenses. Following the transfer of retail distribution activities in July 2015, such expenses
are now limited to selected activities online and in social media.
General
and Administrative Expenses.
General and administrative expenses primarily represent employee related costs, including stock
compensation, for corporate executive and support staff, general office expenses, professional fees and various other overhead
charges. Professional fees, including legal and accounting expenses, typically represent one of the largest components of our
general and administrative expenses. These fees are partially attributable to our required activities as a publicly traded company,
such as SEC filings, and corporate- and business-development initiatives.
Interest
and Financing Costs.
Interest and financing costs are directly attributable to our factoring and our purchase-order financing
arrangements. Such costs include commitment fees and fees based upon the value of customer invoices factored.
Income
Taxes.
Income taxes consist of our provisions for income taxes, as affected by our net operating loss carryforwards. Future
utilization of our net operating loss, or NOL, carryforwards may be subject to a substantial annual limitation due to the “change
in ownership” provisions of the Internal Revenue Code. The annual limitation may result in the expiration of NOL carryforwards
before utilization. Due to our history of losses, a valuation allowance sufficient to fully offset our NOL and other deferred
tax assets has been established under current accounting pronouncements, and this valuation allowance will be maintained unless
sufficient positive evidence develops to support its reversal.
Seasonality
and Variations in Interim Quarterly Results
Our
quarterly net revenues, gross profit, and operating income from sales of products are impacted significantly by the seasonality
of the retail selling season and the timing of the release of new titles. Sales of our catalog and other products are generally
higher in the first and fourth quarters of our fiscal year (ending January 31 and October 31, respectively) due to increased retail
sales during the holiday season. Sales and gross profit as a percentage of sales also generally increase in quarters in which
we release significant new titles because of increased sales volume as retailers make purchases to stock their shelves and meet
initial demand for the new release. These quarters also benefit from the higher selling prices that we are able to achieve early
in the product’s life cycle. Therefore, sales results in any one quarter are not necessarily indicative of expected results
for subsequent quarters during the fiscal year.
Critical
Accounting Estimates
Our
discussion and analysis of the financial condition and results of operations is based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP.
The
preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts
of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. We base our estimates
on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results could differ materially from these estimates under different assumptions or conditions.
We
have identified the policies below as critical to our business operations and to the understanding of our financial results. The
impact and any associated risks related to these policies on our business operations is discussed throughout management’s
discussion and analysis of financial condition and results of operations when such policies affect our reported and expected financial
results.
Revenue
Recognition.
We recognized revenue on the sale of packaged goods upon the shipment of our product when: (1) risks and rewards
of ownership are transferred; (2) persuasive evidence of an arrangement exists; (3) we have no continuing obligations to the customer;
and (4) the collection of related accounts receivable is probable. Certain products are sold to customers with a street date (the
earliest date these products may be resold by retailers). Revenue for sales of these products is not recognized prior to their
street date. Some of our software products provide limited online features at no additional cost to the consumer. Generally, we
have considered such features to be incidental to our overall product offerings and an inconsequential deliverable. Accordingly,
we do not defer any revenue related to products containing these limited online features. However, in instances where online features
or additional functionality is considered a substantive deliverable in addition to the software product, such characteristics
will be taken into account when applying our revenue recognition policy. To date, the Company has not earned significant revenues
from such features. In addition, some of our software products are sold exclusively as downloads of digital content for which
the consumer takes possession of the digital content for a fee. Revenue from product downloads is generally recognized when the
download is made available (assuming all other recognition criteria are met).
When
we enter into license or distribution agreements that provide for multiple copies of games in exchange for guaranteed amounts,
revenue is recognized in accordance with the terms of the agreements, generally upon delivery of a master copy, assuming our performance
obligations are complete and all other recognition criteria are met, or as per-copy royalties are earned on sales of games.
Price
Protection and Other Allowances.
We generally sold our products on a no-return basis, although in certain instances, we provide
price protection or other allowances on certain unsold products in accordance with industry practices. Price protection, when
granted and applicable, allows customers a partial credit with respect to merchandise unsold by them. Revenue is recognized net
of estimates of these allowances. Sales incentives and other consideration that represent costs incurred by us for benefits received,
such as the appearance of our products in a customer’s national circular advertisement, are generally reflected as selling
and marketing expenses. We estimate potential future product price protection and other discounts related to current period product
revenue. In addition, some of our software products are sold exclusively as downloads of digital content for which the consumer
takes possession of the digital content for a fee. Revenue from product downloads is generally recognized when the download is
made available (assuming all other recognition criteria are met).
Our
provisions for price protection and other allowances fluctuate over periods as a result of a number of factors including analysis
of historical experience, current sell-through of retailer inventory of our products, current trends in the interactive entertainment
market, the overall economy, changes in customer demand and acceptance of our products and other related factors. Significant
management judgments and estimates must be made and used in connection with establishing the allowance for returns and price protection
in any accounting period. However, actual allowances granted could materially exceed our estimates as unsold products in the distribution
channels are exposed to rapid changes in consumer preferences, market conditions, technological obsolescence due to new platforms,
product updates or competing products. For example, the risk of requests for allowances may increase as consoles pass the midpoint
of their lifecycle and an increasing number of competitive products heighten pricing and competitive pressures.
We
limit our exposure to credit risk by factoring a portion of our receivables to a third party that buys without recourse. For receivables
that are not sold without recourse, we analyze our aged accounts receivables, payment history and other factors to make a determination
if collection of receivables is likely, or a provision for uncollectible accounts is necessary.
Capitalized
Software Development Costs and License Fees.
Software development costs include development fees, primarily in the form of
milestone payments made to independent software developers. Software development costs are capitalized once technological feasibility
of a product is established and management expects such costs to be recoverable against future revenues. For products where proven
game engine technology exists, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product
basis. Amounts related to software development that are not capitalized are charged immediately to product research and development
costs. Commencing upon a related product’s release capitalized software development costs are amortized to cost of sales
based upon the higher of (i) the ratio of current revenue to total projected revenue or (ii) straight-line charges over the expected
marketable life of the product.
Prepaid
license fees represent license fees to holders for the use of their intellectual property rights in the development of our products.
Minimum guaranteed royalty payments for intellectual property licenses are initially recorded as an asset (capitalized license
fees) and a current liability (accrued royalties payable) at the contractual amount upon execution of the contract or when specified
milestones or events occur and when no significant performance commitment remains with the licensor. Licenses are expensed to
cost of sales at the higher of (i) the contractual royalty rate based on actual sales or (ii) an effective rate based upon total
projected revenue related to such license. Capitalized software development costs are classified as non-current if they relate
to titles for which we estimate the release date to be more than one year from the balance sheet date.
The
amortization period for capitalized software development costs and license fees is usually no longer than one year from the initial
release of the product. If actual revenues or revised forecasted revenues fall below the initial forecasted revenue for a particular
license, the charge to cost of sales may be larger than anticipated in any given quarter. The recoverability of capitalized software
development costs and license fees is evaluated quarterly based on the expected performance of the specific products to which
the costs relate.
When,
in management’s estimate, future cash flows will not be sufficient to recover previously capitalized costs, we expense these
capitalized costs to cost of sales — loss on impairment of capitalized software development costs and license fees –
future releases, in the period such a determination is made. These expenses may be incurred prior to a game’s release. If
a game is cancelled and never released to market, the amount is expensed to operating costs and expenses – loss on impairment
of capitalized software development costs and license fees – cancelled games. If we were required to write off licenses
or capitalized software development costs, due to changes in market conditions or product acceptance, our results of operations
could be materially adversely affected.
License
fees and milestone payments made to our third party developers are typically considered non-refundable advances against the total
compensation they can earn based upon the sales performance of the products. Any additional royalty or other compensation earned
beyond the milestone payments is expensed to cost of sales as incurred.
We
expense as research and development costs associated with the development of mobile and social games when we cannot reliably project
that future net cash flows from developed games will exceed related development costs. These games have not earned significant
revenues to date and we are continuing to evaluate alternatives for future development and monetization.
Inventory.
Inventory is stated at the lower of cost or market. Cost is determined by the first-in, first-out method. We estimate the
net realizable value of slow-moving inventory on a title-by-title basis and charge the excess of cost over net realizable value
to cost of sales. Some of our inventory items are packaged with accessories. The purchase of these accessories involves longer
lead times and minimum purchase amounts, which may require us to maintain higher levels of inventory than for other games. Therefore,
these items have a higher risk of obsolescence, which we review periodically based on inventory and sales levels.
Accounting
for Stock-Based Compensation.
Stock-based compensation expense is measured at the grant date based on the fair value of the
award and is recognized as expense over the vesting period. Determining the fair value of stock-based awards at the grant date
requires judgment, including, in the case of stock option awards, estimating expected stock volatility. In addition, judgment
is also required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly
from these estimates, stock-based compensation expense and our results of operations could be materially impacted.
Accounting
for Preferred Stock and Warrant transactions.
The Company issued units consisting of preferred shares and warrants and subsequently
remeasured certain of those warrants. Determining the fair value of of the securities in these transactions requires significant
judgment, including adjustments to quoted share prices and expected stock volatility. Such estimates may significantly impact
our results of operations and losses applicable to common stockholders.
Commitments
and Contingencies.
We record a liability for commitments and contingencies when the amount is both probable and reasonably
estimable. We record associated legal fees as incurred. The Company has accrued contingent liabilities for certain potential licensor
and customer liabilities and claims that were transferred to Zift but may not be extinguished by such transaction.
Results
of Operations
Year
ended October 31, 2016 versus the year ended October 31, 2015
Net
Revenues.
Net revenues for the year ended October 31, 2016 decreased 77% to approximately $1.5 million from $6.7 million for
the year ended October 31, 2015. The decrease was due to lower sales of Zumba titles. Additionally, there were no retail sales
due to the transfer of the retail distribution channel to Zift in July 2015.
Gross
Profit.
Gross profit for the year ended October 30, 2016 decreased 62% to approximately $1.3 million compared to a gross profit
of approximately $3.3 million for the year ended October 31, 2015. The decrease in gross profit reflects lower Zumba and other
sales as discussed above, as well as the Company’s withdrawal from the packaged software business. Gross profit as a percentage
of net revenues was 81% for the year ended October 31, 2016, compared to 49% for the year ended October 31, 2015. The increase
in gross profit is due to the dramatically lower cost of sales associated with a digitally sold product.
Product
Research and Development Expenses.
Product research and development expenses for the year ended October 31, 2016 was approximately
$90,000 compared to $174,000 for the year ended October 31, 2015. The decrease reflects the general reduction in this activity.
Selling
and Marketing Expenses.
Total selling and marketing expenses for the year ended October 31, 2016 decreased 98% to approximately
$14,000 compared to approximately $771,000 for the year ended October 31, 2015. The decrease is primarily due to lower personnel
costs and other marketing and distribution activities related to our switch to digital.
General
and Administrative Expenses.
For the year ended October 31, 2016, general and administrative expenses increased 13% to approximately
$6.0 million compared to $5.4 million for the year ended October 31, 2015. The increase reflects a $1.7 million increase in stock
based compensation partially offset by lower non-stock based compensation costs, consulting and professional fees and related
support expenses. Stock based compensation increased, because during the third quarter of fiscal 2016, a total of 356,666 restricted
shares and 347,010 stock options were granted, of which 177,084 restricted stock shares were granted with immediate vesting.
Workforce
Reduction.
For the year ended October 31, 2015, we incurred workforce reduction costs of $0.8 million pertaining to severance
costs, including primarily severance costs for finance and legal executives and other personnel.
Operating
loss.
Operating loss for the year ended October 31, 2016 increased 26% to approximately $4.9 million, compared to an operating
loss of approximately $3.9 million for the year ended October 31, 2015, primarily reflecting a greater decrease in net revenues
and gross profit than the expense reductions in development and marketing activities plus an increase in stock based compensation.
Extinguishment
of liabilities.
During the year ended October 31, 2015, we recognized a gain on extinguishment of liabilities of approximately
$1.5 million. We determined that certain accounts payable balances and claims for license fees and services would never be paid
because they were no longer being pursued for payment and had passed the statute of limitations.
Net
gains on asset sales and other nonoperating gains.
During the year ended October 31, 2015, we recognized approximately $198,000
in net gain from the sale of certain game rights and from the sale of office furniture and equipment upon the move to a smaller
office. Additionally, we recognized $50,000 from the transfer of retail distribution activities to Zift, a company owned by our
former chief executive officer.
Change
in fair value of warrant liability.
In our December 2014 private placement of units consisting of preferred stock and warrants,
we issued warrants containing certain contingent settlement terms not indexed to our own stock. We accounted for the warrants
as derivative liabilities and measured their fair value on a quarterly basis and recognized on a current basis any gains or losses.
In the year ended October 31, 2015, we recognized a loss of approximately $1.5 million reflecting an increase in our stock price
from the previous measurement date. In our April 19, 2016, equity offering, we issued warrants. We accounted for the warrants
as derivative liabilities and measure their fair value on a quarterly basis and recognize on a current basis any gains or losses.
In the year ended October 31, 2016, we recognized a gain of approximately $248,000 reflecting a decrease in our stock price from
the previous measurement date.
Income
Taxes.
In the year ended October 31, 2016, our income tax expense was not significant, representing primarily minimum state
income taxes.
Liquidity
and Capital Resources
As
of October 31, 2016, our cash and cash equivalents balance was $6.5 million and our working capital was approximately $5.4 million,
compared to cash and equivalents of $17.1 million and working capital of $15.6 million at October 31, 2015.
From
fiscal 2013 through the present, we have experienced net cash outflows from operations, generally to fund operating losses due
to declining revenues which we attribute to three factors: 1) the introduction of competing “freemium” games on competing
handheld devices such as the Apple iPhone or iTouch, and Android powered devices; 2) a shift in game distribution from retail
to digital downloads; and 3) a decline in the popularity of motion based fitness games including games we publish under the Zumba
fitness brand. As a result of these factors we have reduced our operating expenses, including the reduction of game production
and marketing personnel, and have eliminated substantially all of our new game development activities. In 2015, we transferred
our retail distribution activities to Zift and transferred related assets and liabilities, including accounts receivable, inventory,
customer credits and certain other liabilities.
On
December 1, 2016, we entered into an Agreement and Plan of Reorganization (the “Agreement”) with Majesco Acquisition
Corp., a Nevada corporation and wholly-owned subsidiary of the Company, PolarityTE, Inc., a Nevada corporation (“Polarity”)
and Dr. Denver Lough, the owner of 100% of the issued and outstanding shares of capital stock of Polarity (the “Seller”).
The closing is subject to various closing conditions. We believe we have sufficient cash on hand to fund operations though the
next year.
Private
Placements
The
private placements described below were completed in December 2014 and May 2015. A substantial portion of the proceeds of these
offerings remained subject to escrow agreements until September 2015, pending the satisfaction of release conditions.
December
2014
On
December 17, 2014, pursuant to subscription agreements (the “December Subscription Agreements”) entered into with
certain accredited investors (the “December Investors”) the Company completed a private placement of $6.0 million
of units (the “December Units”) at a purchase price of $0.68 per Unit, with each December Unit consisting of one share
of the Company’s 0% Series A Convertible Preferred Stock (each a “Series A Preferred Share”) and a five-year
warrant (each a “December Warrant”) to purchase one sixth of a share of the Company’s common stock at an initial
exercise price of $4.08 per share (such issuance and sale, the “December Private Placement”). The December Warrants
were subsequently exchanged for shares of the Company’s 0% Series B Convertible Preferred Stock (the “Series B Preferred
Shares”) and shares of the Company’s common stock (see below). The offering was made in reliance upon an exemption
from registration under Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”).
The
Series A Preferred Shares are convertible into shares of common stock based on a conversion calculation equal to the stated value
of such Series A Preferred Share, plus all accrued and unpaid dividends, if any, on such Series A Preferred Share, as of such
date of determination, divided by the conversion price. The stated value of each Preferred Share is $0.68 and the initial conversion
price is $4.08 per share, each subject to adjustment for stock splits, stock dividends, recapitalizations, combinations, subdivisions
or other similar events. In addition, in the event the Company issues or sells, or is deemed to issue or sell, shares of its common
stock at a per share price that is less than the conversion price then in effect, the conversion price shall be reduced to such
lower price, subject to certain exceptions. Pursuant to the Certificate of Designations, Preferences and Rights of the 0% Series
A Convertible Preferred Stock of Majesco Entertainment Company, the Company is prohibited from incurring debt or liens, or entering
into new financing transactions without the consent of the lead investor (as defined in the December Subscription Agreements)
as long as any of the Series A Preferred Shares are outstanding. The Series A Preferred Shares bear no dividends.
The
holders of Series A Preferred Shares shall vote together with the holders of common stock on all matters on an as if converted
basis, subject to certain conversion and ownership limitations, and shall not vote as a separate class. Notwithstanding the foregoing,
the conversion price for purposes of calculating voting power shall in no event be lower than $3.54 per share. At no time may
all or a portion of the Series A Preferred Shares be converted if the number of shares of common stock to be issued pursuant to
such conversion would exceed, when aggregated with all other shares of common stock owned by the holder at such time, the number
of shares of common stock which would result in such Holder beneficially owning (as determined in accordance with Section 13(d)
of the 1934 Act and the rules thereunder) more than 4.99% of all of the common stock outstanding at such time; provided, however,
that the holder may waive the 4.99% limitation at which time he may not own beneficially own more than 9.99% of all the common
stock outstanding at such time.
The
proceeds of the offering and certificates representing the Series A Preferred Shares and December Warrants were deposited into
escrow accounts. Upon the closing of the December Private Placement, $1.0 million of the proceeds was released to us and $1.0
million of Series A Preferred Shares and December Warrants, on a pro rata basis, was released to the investors. The remaining
$5.0 million was released by the escrow agent to us and the corresponding $5.0 million of Series A Preferred Shares and December
Warrants were released to the investors in September 2015, in connection with amendments to the December Subscription Agreements.
On
April 30, 2015, pursuant to warrant exchange agreements, the holders exchanged for cancellation 1,470,590 December Warrants, including
those then held in escrow, for shares of common stock or Series B Preferred Shares. An aggregate of 1,050,421 shares of common
stock, which amount includes the shares of common stock issuable upon conversion of the Series B Preferred Shares, were issued
or issuable in connection with the exchange agreements.
The
Series B Preferred Shares are convertible into shares of common stock based on a conversion calculation equal to the stated value
($140.00 per share) of the Series B Preferred Shares, plus all accrued and unpaid dividends, if any, divided by the conversion
price (initially $8.40 per share, subject to adjustment). We are prohibited from effecting a conversion of the Series B Preferred
Shares to the extent that, as a result of such conversion, such holder would beneficially own more than 4.99% of the number of
shares of common stock outstanding, subject to increase, up to 9.99%. Each holder is entitled to vote on all matters submitted
to our stockholders on an “as converted basis”, subject to beneficial ownership limitations, based on a conversion
price of $8.40 per share.
May
2015
On
May 15, 2015 (the “May Closing Date”), we closed the sale of $5.05 million of units (the “May Units”),
pursuant to separate subscription agreements (the “May Subscription Agreements”) with accredited investors entered
into on April 29, 2015, at a purchase price of $7.20 per May Unit. Each May Unit consists of one share of the our common stock,
provided that, if the issuance of any such shares would have resulted in the investor owning in excess of 4.99% of our issued
and outstanding common stock, then such investor could elect to receive shares of our 0% Series C Convertible Preferred Stock
(the “Series C Preferred Shares”), and a three-year warrant (the “May Warrants”) to purchase one share
of the our common stock at an exercise price of $8.40 per share (such sale and issuance, the “May Private Placement”).
The
Series C Preferred Shares are convertible into shares of common stock based on a conversion calculation equal to the stated value
of such Series C Preferred Shares ($120.00 per share), plus all accrued and unpaid dividends, if any, divided by the conversion
price ($7.20 per share, subject to adjustment). In addition, in the event the we issue or sell, or are deemed to issue or sell,
shares of our common stock at a per share price that is less than the conversion price then in effect, the conversion price shall
be reduced to such lower price, subject to certain exceptions. Notwithstanding the foregoing, until such time as we obtain the
required shareholder approval pursuant to the rules of The NASDAQ Stock Market, LLC, the conversion price of the Series C Preferred
Shares shall not be adjusted to a per share price below $5.16. We are prohibited from effecting a conversion of the Series C Preferred
Shares to the extent that, as a result of such conversion, such holder would beneficially own more than 4.99% of the number of
shares of common stock subject to increase, up to 9.99%. Each holder is entitled to vote on all matters submitted to our stockholders
on an “as converted basis”, subject to the beneficial ownership limitation, based on a conversion price of $7.20 per
share. The Series C Preferred Shares bear no interest and shall rank junior to our Series A Preferred Shares but senior to the
Company’s Series B Preferred Shares.
The
May Warrants are exercisable, at any time, following the date the May Warrants are issued, at a price of $8.40 per share, subject
to adjustment, and expire three years from the date of issuance. The holders may, subject to certain limitations, exercise the
May Warrants on a cashless basis. The Company is prohibited from effecting an exercise of any May Warrant to the extent that,
as a result of any such exercise, the holder would beneficially own more than 4.99% of the number of shares of common stock outstanding
immediately after giving effect to the issuance of shares of common stock upon exercise of such May Warrant, which beneficial
ownership limitation may be increased by the holder up to, but not exceeding, 9.99%.
The
proceeds of the May Private Placement along with certificates evidencing the Series C Preferred Shares and Series C Warrants were
deposited into an escrow accounts. On the May Closing Date, twenty percent (20%) of the proceeds of the May Private Placement
($1.01 million) and a corresponding number of Series C Preferred Shares and Series C Warrants were released to us and the investors,
respectively. The remaining eighty percent (80%) of the proceeds from the May Private Placement ($4.04 million) and the corresponding
percentage of Series C Preferred Shares and Series C Warrants were released to us and the investors, respectively, in September
2015 in connection with amendments to the May Subscription Agreements.
September
2015
On
September 25, 2015, we entered into amendment agreements to amend the terms of our subscription agreements for the private offerings
closed December 17, 2014 and May 15, 2015 to provide for the consent of the lead investor in such offerings to release of all
remaining escrowed funds to us ($5.0 million under the December Private Placement and $4.04 under the May Private Placement) upon
the satisfaction of certain obligations, which we satisfied. Pursuant to the amendment agreements, we were, among other things,
required to increase the size of its Board of Directors and appoint thereto, individuals deemed acceptable to the lead investor
and approved by The NASDAQ Stock Market, LLC; appoint a new Chief Executive Officer and a new Chief Financial Officer and exchange
the Series C Warrants, as described further below. On September 30, 2015 we received $9.04 million in proceeds from the foregoing
release of escrowed funds and the corresponding securities were released to the investors.
In
accordance with the aforementioned escrow release conditions, we entered into exchange agreements with holders of our outstanding
Series C Warrants pursuant to which each holder received .4 shares of our common stock for each 1 warrant share exchanged for
cancellation. At the election of any holder who would, as a result of receipt of the common stock hold in excess of certain beneficial
ownership thresholds of our issued and outstanding common stock, such holder could receive shares of our newly designated 0% Series
D Convertible Preferred Stock (the “Series D Preferred Shares”). Pursuant to the foregoing exchanges, on September
25, 2015, we issued 0 shares of common stock and 168,333 Series D Preferred Shares convertible into 280,555 shares of common stock
in exchange for the cancellation of Series C Warrants to purchase 701,390 shares of common stock. Certain of our officers and
directors who held Series C Warrants participated in the exchange.
The
Series D Preferred Shares are convertible into shares of common stock based on a conversion ratio equal to the stated value ($1,000.00
per share) of such Series D Preferred Shares to be converted, plus all accrued and unpaid dividends, if any, divided by the conversion
price ($600.00 per share, subject to adjustment). We are prohibited from effecting a conversion of the Series D Preferred Shares
to the extent that, as a result of such conversion, such holder would beneficially own more than 4.99% of the number of shares
of Common Stock outstanding, subject to increase, up to, 9.99%. The Series D Preferred Shares bear no interest and rank senior
to our common stock but junior to Series A Preferred Shares, Series B Preferred Shares and Series C Preferred Shares.
On
October 15, 2015, our Board of Directors approved a revised version of the Certificate of Designations, Preferences and Rights
of our 0% Series D Convertible Preferred Stock in order to remove any voting rights of the Series D Preferred Shares, except as
otherwise required by law.
Dividends
On
January 4, 2016, we declared a special cash dividend of an aggregate of $10.0 million to holders of record on January 14, 2016
of its outstanding shares of: (i) common stock (ii) Series A Preferred Shares; (iii) Series B Preferred Shares; (iv) Series C
Preferred Shares and (v) Series D Preferred Shares. The holders of record of the Company’s outstanding preferred stock participated
in the dividend on an “as converted” basis.
April
2016 Registered Common Stock and Warrant Offering
On
April 13, 2016, the Company entered into a Securities Purchase Agreement with certain institutional investors providing for the
issuance and sale by the Company of 250,000 shares of the Company’s common stock, par value $0.001 per share at an offering
price of $6.00 per share, for net proceeds of $1.4 million after deducting placement agent fees and expenses. In addition, the
Company sold to purchasers of common stock in this offering, warrants to purchase 187,500 shares of its common stock. The common
shares and the Warrant Shares were offered by the Company pursuant to an effective shelf registration statement on Form S-3, which
was initially filed with the Securities and Exchange Commission on October 22, 2015 and declared effective on December 7, 2015.
The closing of the offering occurred on April 19, 2016.
Each
Warrant is immediately exercisable for two years, but not thereafter, at an exercise price of $6.90 per share. Subject to limited
exceptions, a holder of warrants will not have the right to exercise any portion of its warrants if the holder, together with
its affiliates, would beneficially own in excess of 4.99% of the number of shares of our common stock outstanding immediately
after giving effect to such exercise. The exercise price and number of warrants are subject to adjustment in the event of any
stock dividends and splits, reverse stock split, stock dividend, recapitalization, reorganization or similar transaction.
Off-Balance
Sheet Arrangements
As
of October 31, 2016, we had no off-balance sheet arrangements.
Inflation
Our
management currently believes that inflation has not had, and does not currently have, a material impact on continuing operations.
Cash
Flows
Cash
and cash equivalents were $6.5 million as of October 31, 2016 compared to $17.1 million at October 31, 2015 and working capital
as of October 31, 2016 was $5.4 million compared to $15.6 million at October 31, 2015.
Operating
Cash Flows.
Our principal operating source of cash is revenue from distribution of our interactive entertainment products,
net of royalty and revenue-share payments to licensors, developers and publishers. During fiscal 2015, we reduced our development
and marketing activities and distributed a greater number of games published by others, compared to prior years. Accordingly,
the portion of operating cash flows used for associated working capital requirements, including pre-release development and costs
incurred to manufacture, sell and market our games has generally been reduced. We incurred $1.6 million of cash outflows from
operations during the year ended October 31, 2015, primarily reflecting operating losses and the settlement in cash of certain
outstanding royalty and customer-credit liabilities, partially offset by the liquidation of prior inventory balances and collection
of accounts receivable. We incurred $1.8 million of cash outflows from operations during the year ended October 31, 2016, primarily
reflecting current operating losses, partially offset by non-cash compensation expense.
Investing
Cash Flows.
Cash provided by investing activities in the year ended October 31, 2015 amounted to approximately $540,000, primarily
reflecting proceeds from the sale of certain game rights and the collection of certain outstanding advances to GMS.
Financing
Cash Flows.
Net cash used in financing activities for the year ended October 31, 2016 amounted to approximately $8.8 million,
mainly related to a payment of a $10.0 million special cash dividend, partially offset by an equity capital raise of approximately
$1.4 million. Net cash provided by financing activities for the year ended October 31, 2015 reflects $10.9 million of net proceeds
from private placements.
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There
were no changes in and disagreements with accountants on accounting and financial disclosure for the fiscal year ended October
31, 2016.
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not
required for Smaller Reporting Companies.
MARKET
FOR OUR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
As
of February 21, 2017, the number of stockholders of record of the Company’s Common Stock was approximately 132
which does not include stockholders whose shares are held in street or nominee names. The Company’s Common Stock is
traded on The NASDAQ Capital Market under the symbol COOL. Prior to October 31, 2015, we had never declared or paid any dividends
on our Common Stock. On January 4, 2016, we declared a special cash dividend of an aggregate of $10,000,000 to be paid to holders
of record on January 14, 2016 of our outstanding shares of: (i) Common Stock (ii) Series A Convertible Preferred Stock; (iii)
Series B Convertible Preferred Stock; (iv) Series C Convertible Preferred Stock and (v) Series D Convertible Preferred Stock.
The holders of record of our outstanding preferred stock participated in receiving their pro rata portion of the dividend on an
“as converted” basis. The dividend was paid January 15, 2016.
The
following table sets forth the high and low closing prices for our common stock, as reported by the NASDAQ Capital Market, for
the periods indicated (all adjusted for the August 2016 reverse stock split).
2016
|
|
High
|
|
|
Low
|
|
Fourth quarter
|
|
$
|
4.50
|
|
|
$
|
3.03
|
|
Third quarter
|
|
|
6.30
|
|
|
|
3.66
|
|
Second quarter
|
|
|
5.94
|
|
|
|
4.20
|
|
First quarter
|
|
|
13.68
|
|
|
|
3.66
|
|
2015
|
|
High
|
|
|
Low
|
|
Fourth quarter
|
|
$
|
11.52
|
|
|
$
|
6.48
|
|
Third quarter
|
|
|
10.38
|
|
|
|
6.54
|
|
Second quarter
|
|
|
14.22
|
|
|
|
5.64
|
|
First quarter
|
|
|
9.54
|
|
|
|
3.30
|
|
On
February 21, 2017, the closing price of our Common Stock, as reported by The NASDAQ Capital Market, was $6.42. As
of February 21, 2017, we had approximately 132 holders of record of our Common Stock, excluding stockholders whose
shares are held in street or nominee names.
Reverse
Stock Splits
On
July 27, 2016, the Company filed a certificate of amendment to its Certificate of Incorporation with the Secretary of State of
the State of Delaware in order to effectuate a reverse stock split of the Company’s issued and outstanding Common Stock
on a 1 for 6 basis, effective on July 29, 2016. The reverse stock split was effective with The NASDAQ Capital Market at the open
of business on August 1, 2016. The par value and other terms of the Company’s Common Stock were not affected by the reverse
stock split.
Appendix
A
POLARITYTE,
INC.
2017
EQUITY INCENTIVE PLAN
1.1
The purpose of this 2017 Equity Incentive Plan (this “
Plan
”) of PolarityTE, Inc., a Delaware corporation
(the “
Corporation
”), is to promote the success of the Corporation and to increase stockholder value by providing
an additional means through the grant of awards to attract, motivate, retain and reward selected employees and other eligible
persons.
2.1
The Administrator (as such term is defined in Section 3.1) may grant awards under this Plan only to those persons that the
Administrator determines to be Eligible Persons. An “
Eligible Person
” is any person who is either: (a) an officer
(whether or not a director) or employee of the Corporation or one of its Subsidiaries; (b) a director of the Corporation or one
of its Subsidiaries; or (c) an individual consultant who renders bona fide services (other than services in connection with the
offering or sale of securities of the Corporation or one of its Subsidiaries in a capital-raising transaction or as a market maker
or promoter of securities of the Corporation or one of its Subsidiaries) to the Corporation or one of its Subsidiaries and who
is selected to participate in this Plan by the Administrator;
provided, however,
that a person who is otherwise an Eligible
Person under clause (c) above may participate in this Plan only if such participation would not adversely affect either the Corporation’s
eligibility to use Form S-8 to register under the Securities Act of 1933, as amended (the “
Securities Act
”),
the offering and sale of shares issuable under this Plan by the Corporation, or the Corporation’s compliance with any other
applicable laws. An Eligible Person who has been granted an award (a “
participant
”) may, if otherwise eligible,
be granted additional awards if the Administrator shall so determine. As used herein, “
Subsidiary
” means any
corporation or other entity a majority of whose outstanding voting stock or voting power is beneficially owned directly or indirectly
by the Corporation; and “
Board
” means the Board of Directors of the Corporation.
3.1
The Administrator
. This Plan shall be administered by and all awards under this Plan shall be authorized by the Administrator.
The “
Administrator
” means the Board or one or more committees appointed by the Board or another committee (within
its delegated authority) to administer all or certain aspects of this Plan. Any such committee shall be comprised solely of one
or more directors or such number of directors as may be required under applicable law. A committee may delegate some or all of
its authority to another committee so constituted. The Board or a committee comprised solely of directors may also delegate, to
the extent permitted by Section 157 of the Delaware General Corporation Law and any other applicable law, to one or more officers
of the Corporation, its powers under this Plan (a) to Eligible Persons who will receive grants of awards under this Plan, and
(b) to determine the number of shares subject to, and the other terms and conditions of, such awards. The Board may delegate different
levels of authority to different committees with administrative and grant authority under this Plan. Unless otherwise provided
in the bylaws of the Corporation or the applicable charter of any Administrator: (a) a majority of the members of the acting Administrator
shall constitute a quorum, and (b) the affirmative vote of a majority of the members present assuming the presence of a quorum
or the unanimous written consent of the members of the Administrator shall constitute due authorization of an action by the acting
Administrator.
With
respect to awards intended to satisfy the requirements for performance-based compensation under Section 162(m) of the Internal
Revenue Code of 1986, as amended (the “
Code
”), this Plan shall be administered by a committee consisting solely
of two or more outside directors (as this requirement is applied under Section 162(m) of the Code);
provided, however,
that the failure to satisfy such requirement shall not affect the validity of the action of any committee otherwise duly authorized
and acting in the matter. Award grants, and transactions in or involving awards, intended to be exempt under Rule 16b-3 under
the Securities Exchange Act of 1934, as amended (the “
Exchange Act
”), must be duly and timely authorized by
the Board or a committee consisting solely of two or more non-employee directors (as this requirement is applied under Rule 16b-3
promulgated under the Exchange Act). To the extent required by any applicable stock exchange, this Plan shall be administered
by a committee composed entirely of independent directors (within the meaning of the applicable stock exchange). Awards granted
to non-employee directors shall not be subject to the discretion of any officer or employee of the Corporation and shall be administered
exclusively by a committee consisting solely of independent directors.
3.2
Powers of the Administrator
. Subject to the express provisions of this Plan, the Administrator is authorized and empowered
to do all things necessary or desirable in connection with the authorization of awards and the administration of this Plan (in
the case of a committee or delegation to one or more officers, within the authority delegated to that committee or person(s)),
including, without limitation, the authority to:
(a)
determine eligibility and, from among those persons determined to be eligible, the particular Eligible Persons who will receive
awards under this Plan;
(b)
grant awards to Eligible Persons, determine the price at which securities will be offered or awarded and the number of securities
to be offered or awarded to any of such persons, determine the other specific terms and conditions of such awards consistent with
the express limits of this Plan, establish the installments (if any) in which such awards shall become exercisable or shall vest
(which may include, without limitation, performance and/or time-based schedules), or determine that no delayed exercisability
or vesting is required, establish any applicable performance targets, and establish the events of termination or reversion of
such awards;
(c)
approve the forms of award agreements (which need not be identical either as to type of award or among participants);
(d)
construe and interpret this Plan and any agreements defining the rights and obligations of the Corporation, its Subsidiaries,
and participants under this Plan, further define the terms used in this Plan, and prescribe, amend and rescind rules and regulations
relating to the administration of this Plan or the awards granted under this Plan;
(e)
cancel, modify, or waive the Corporation’s rights with respect to, or modify, discontinue, suspend, or terminate any or
all outstanding awards, subject to any required consent under Section 8.6.5;
(f)
accelerate or extend the vesting or exercisability or extend the term of any or all such outstanding awards (in the case of options
or stock appreciation rights, within the maximum ten-year term of such awards) in such circumstances as the Administrator may
deem appropriate (including, without limitation, in connection with a termination of employment or services or other events of
a personal nature) subject to any required consent under Section 8.6.5;
(g)
adjust the number of shares of Common Stock subject to any award, adjust the price of any or all outstanding awards or otherwise
change previously imposed terms and conditions, in such circumstances as the Administrator may deem appropriate, in each case
subject to compliance with applicable stock exchange requirements, Sections 4 and 8.6 and the applicable requirements of Code
Section 162(m) and treasury regulations thereunder with respect to awards that are intended to satisfy the requirements for performance-based
compensation under Section 162(m), and provided that in no case (except due to an adjustment contemplated by Section 7 or any
repricing that may be approved by stockholders) shall such an adjustment constitute a repricing (by amendment, cancellation and
re-grant, exchange or other means) of the per share exercise or base price of any stock option or stock appreciation right or
other award granted under this Plan, and further provided that any adjustment or change in terms made pursuant to this Section
3.2(g) shall be made in a manner that, in the good faith determination of the Administrator will not likely result in the imposition
of additional taxes or interest under Section 409A of the Code;
(h)
determine the date of grant of an award, which may be a designated date after but not before the date of the Administrator’s
action (unless otherwise designated by the Administrator, the date of grant of an award shall be the date upon which the Administrator
took the action granting an award);
(i)
determine whether, and the extent to which, adjustments are required pursuant to Section 7 hereof and authorize the termination,
conversion, substitution, acceleration or succession of awards upon the occurrence of an event of the type described in Section
7;
(j)
acquire or settle (subject to Sections 7 and 8.6) rights under awards in cash, stock of equivalent value, or other consideration;
and
(k)
determine the Fair Market Value (as defined in Section 5.6) of the Common Stock or awards under this Plan from time to time and/or
the manner in which such value will be determined.
3.3
Binding Determinations.
Any action taken by, or inaction of, the Corporation, any Subsidiary, or the Administrator
relating or pursuant to this Plan and within its authority hereunder or under applicable law shall be within the absolute discretion
of that entity or body and shall be conclusive and binding upon all persons. Neither the Board, the Administrator, nor any Board
committee, nor any member thereof or person acting at the direction thereof, shall be liable for any act, omission, interpretation,
construction or determination made in good faith in connection with this Plan (or any award made under this Plan), and all such
persons shall be entitled to indemnification and reimbursement by the Corporation in respect of any claim, loss, damage or expense
(including, without limitation, legal fees) arising or resulting therefrom to the fullest extent permitted by law and/or under
any directors and officers liability insurance coverage that may be in effect from time to time.
3.4
Reliance on Experts.
In making any determination or in taking or not taking any action under this Plan, the Administrator
may obtain and may rely upon the advice of experts, including professional advisors to the Corporation. The Administrator shall
not be liable for any such action or determination taken or made or omitted in good faith based upon such advice.
3.5
Delegation of Non-Discretionary Functions.
In addition to the ability to delegate certain grant authority to officers
of the Corporation as set forth in Section 3.1, the Administrator may also delegate ministerial, non-discretionary functions to
individuals who are officers or employees of the Corporation or any of its Subsidiaries or to third parties.
4.
|
SHARES
OF COMMON STOCK SUBJECT TO THE PLAN; SHARE LIMIT
|
4.1
Shares Available.
Subject to the provisions of Section 7.1, the capital stock available for issuance under this Plan
shall be shares of the Corporation’s authorized but unissued Common Stock. For purposes of this Plan, “
Common Stock
”
shall mean the common stock of the Corporation and such other securities or property as may become the subject of awards under
this Plan, or may become subject to such awards, pursuant to an adjustment made under Section 7.1.
4.2
Share Limit.
The maximum number of shares of Common Stock that may be delivered pursuant to awards granted to Eligible
Persons under this Plan may not exceed 3,450,000 shares of Common Stock (the “
Share Limit
”).
The
foregoing Share Limit is subject to adjustment as contemplated by Section 4.3, Section 7.1, and Section 8.10.
4.3
Awards Settled in Cash, Reissue of Awards and Shares.
The Administrator may adopt reasonable counting procedures to
ensure appropriate counting, avoid double counting (as, for example, in the case of tandem or substitute awards) and make adjustments
in accordance with this Section 4.3. Shares shall be counted against those reserved to the extent such shares have been delivered
and are no longer subject to a substantial risk of forfeiture. Accordingly, (i) to the extent that an award under the Plan, in
whole or in part, is canceled, expired, forfeited, settled in cash, settled by delivery of fewer shares than the number of shares
underlying the award, or otherwise terminated without delivery of shares to the participant, the shares retained by or returned
to the Corporation will not be deemed to have been delivered under the Plan and will be deemed to remain or to become available
under this Plan; and (ii) shares that are withheld from such an award or separately surrendered by the participant in payment
of the exercise price or taxes relating to such an award shall be deemed to constitute shares not delivered and will be deemed
to remain or to become available under the Plan. The foregoing adjustments to the Share Limit of this Plan are subject to any
applicable limitations under Section 162(m) of the Code with respect to awards intended as performance-based compensation thereunder.
4.4
Reservation of Shares; No Fractional Shares.
The Corporation shall at all times reserve a number of shares of Common
Stock sufficient to cover the Corporation’s obligations and contingent obligations to deliver shares with respect to awards
then outstanding under this Plan (exclusive of any dividend equivalent obligations to the extent the Corporation has the right
to settle such rights in cash). No fractional shares shall be delivered under this Plan. The Administrator may pay cash in lieu
of any fractional shares in settlements of awards under this Plan.
5.1
Type and Form of Awards.
The Administrator shall determine the type or types of award(s) to be made to each selected
Eligible Person. Awards may be granted singly, in combination or in tandem. Awards also may be made in combination or in tandem
with, in replacement of, as alternatives to, or as the payment form for grants or rights under any other employee or compensation
plan of the Corporation or one of its Subsidiaries. The types of awards that may be granted under this Plan are:
5.1.1
Stock Options.
A stock option is the grant of a right to purchase a specified number of shares of Common Stock during
a specified period as determined by the Administrator. An option may be intended as an incentive stock option within the meaning
of Section 422 of the Code (an “
ISO
”) or a nonqualified stock option (an option not intended to be an ISO).
The award agreement for an option will indicate if the option is intended as an ISO; otherwise it will be deemed to be a nonqualified
stock option. The maximum term of each option (ISO or nonqualified) shall be ten (10) years. The per share exercise price for
each option shall be not less than 100% of the Fair Market Value of a share of Common Stock on the date of grant of the option.
When an option is exercised, the exercise price for the shares to be purchased shall be paid in full in cash or such other method
permitted by the Administrator consistent with Section 5.5.
5.1.2
Additional Rules Applicable to ISOs.
To the extent that the aggregate Fair Market Value (determined at the time of
grant of the applicable option) of stock with respect to which ISOs first become exercisable by a participant in any calendar
year exceeds $100,000, taking into account both Common Stock subject to ISOs under this Plan and stock subject to ISOs under all
other plans of the Corporation or one of its Subsidiaries (or any parent or predecessor corporation to the extent required by
and within the meaning of Section 422 of the Code and the regulations promulgated thereunder), such options shall be treated as
nonqualified stock options. In reducing the number of options treated as ISOs to meet the $100,000 limit, the most recently granted
options shall be reduced first. To the extent a reduction of simultaneously granted options is necessary to meet the $100,000
limit, the Administrator may, in the manner and to the extent permitted by law, designate which shares of Common Stock are to
be treated as shares acquired pursuant to the exercise of an ISO. ISOs may only be granted to employees of the Corporation or
one of its subsidiaries (for this purpose, the term “subsidiary” is used as defined in Section 424(f) of the Code,
which generally requires an unbroken chain of ownership of at least 50% of the total combined voting power of all classes of stock
of each subsidiary in the chain beginning with the Corporation and ending with the subsidiary in question). There shall be imposed
in any award agreement relating to ISOs such other terms and conditions as from time to time are required in order that the option
be an “incentive stock option” as that term is defined in Section 422 of the Code. No ISO may be granted to any person
who, at the time the option is granted, owns (or is deemed to own under Section 424(d) of the Code) shares of outstanding Common
Stock possessing more than 10% of the total combined voting power of all classes of stock of the Corporation, unless the exercise
price of such option is at least 110% of the Fair Market Value of the stock subject to the option and such option by its terms
is not exercisable after the expiration of five years from the date such option is granted.
5.1.3
Stock Appreciation Rights.
A stock appreciation right or “
SAR
” is a right to receive a payment,
in cash and/or Common Stock, equal to the number of shares of Common Stock being exercised multiplied by the excess of (i) the
Fair Market Value of a share of Common Stock on the date the SAR is exercised, over (ii) the Fair Market Value of a share of Common
Stock on the date the SAR was granted as specified in the applicable award agreement (the “
base price
”). The
maximum term of a SAR shall be ten (10) years.
5.1.4
Restricted Shares
.
(a)
Restrictions
. Restricted shares are shares of Common Stock subject to such restrictions on transferability, risk of forfeiture
and other restrictions, if any, as the Administrator may impose, which restrictions may lapse separately or in combination at
such times, under such circumstances (including based on achievement of performance goals and/or future service requirements),
in such installments or otherwise, as the Administrator may determine at the date of grant or thereafter. Except to the extent
restricted under the terms of this Plan and the applicable award agreement relating to the restricted stock, a participant granted
restricted stock shall have all of the rights of a shareholder, including the right to vote the restricted stock and the right
to receive dividends thereon (subject to any mandatory reinvestment or other requirement imposed by the Administrator).
(b)
Certificates for Shares
. Restricted shares granted under this Plan may be evidenced in such manner as the Administrator
shall determine. If certificates representing restricted stock are registered in the name of the participant, the Administrator
may require that such certificates bear an appropriate legend referring to the terms, conditions and restrictions applicable to
such restricted stock, that the Corporation retain physical possession of the certificates, and that the participant deliver a
stock power to the Corporation, endorsed in blank, relating to the restricted stock. The Administrator may require that restricted
shares are held in escrow until all restrictions lapse
(c)
Dividends and Splits
. As a condition to the grant of an award of restricted stock, subject to applicable law, the Administrator
may require or permit a participant to elect that any cash dividends paid on a share of restricted stock be automatically reinvested
in additional shares of restricted stock or applied to the purchase of additional awards under this Plan. Unless otherwise determined
by the Administrator, stock distributed in connection with a stock split or stock dividend, and other property distributed as
a dividend, shall be subject to restrictions and a risk of forfeiture to the same extent as the restricted stock with respect
to which such stock or other property has been distributed.
5.1.5
Restricted Share Units
.
(a)
Grant of Restricted Share Units
. A restricted share unit, or “
RSU
”, represents the right to receive
from the Corporation on the respective scheduled vesting or payment date for such RSU, one Common Share. An award of RSUs may
be subject to the attainment of specified performance goals or targets, forfeitability provisions and such other terms and conditions
as the Administrator may determine, subject to the provisions of this Plan. At the time an award of RSUs is made, the Administrator
shall establish a period of time during which the restricted share units shall vest and the timing for settlement of the RSU.
(b)
Dividend Equivalent Accounts
. Subject to the terms and conditions of the Plan and the applicable award agreement, as well
as any procedures established by the Administrator, prior to the expiration of the applicable vesting period of an RSU, the Administrator
may determine to pay dividend equivalent rights with respect to RSUs, in which case, the Corporation shall establish an account
for the participant and reflect in that account any securities, cash or other property comprising any dividend or property distribution
with respect to the shares of Common Stock underlying each RSU. Each amount or other property credited to any such account shall
be subject to the same vesting conditions as the RSU to which it relates. The participant shall have the right to be paid the
amounts or other property credited to such account upon vesting of the subject RSU.
(c)
Rights as a Shareholder
. Subject to the restrictions imposed under the terms and conditions of this Plan and the applicable
award agreement, each participant receiving RSUs shall have no rights as a shareholder with respect to such RSUs until such time
as shares of Common Stock are issued to the participant. No shares of Common Stock shall be issued at the time a RSU is granted,
and the Company will not be required to set aside a fund for the payment of any such award. Except as otherwise provided in the
applicable award agreement, shares of Common Stock issuable under an RSU shall be treated as issued on the first date that the
holder of the RSU is no longer subject to a substantial risk of forfeiture as determined for purposes of Section 409A of the Code,
and the holder shall be the owner of such shares of Common Stock on such date. An award agreement may provide that issuance of
shares of Common Stock under an RSU may be deferred beyond the first date that the RSU is no longer subject to a substantial risk
of forfeiture, provided that such deferral is structured in a manner that is intended to comply with the requirements of Section
409A of the Code.
5.1.6
Cash Awards
.
The Administrator may, from time to time, subject to the provisions of the Plan and such other terms and
conditions as it may determine, grant cash bonuses (including without limitation, discretionary awards, awards based on objective
or subjective performance criteria, awards subject to other vesting criteria or awards granted consistent with Section 5.2 below).
Cash awards shall be awarded in such amount and at such times during the term of the Plan as the Administrator shall determine.
5.1.7
Other Awards.
The other types of awards that may be granted under this Plan include: (a) stock bonuses, performance
stock, performance units, dividend equivalents, or similar rights to purchase or acquire shares, whether at a fixed or variable
price or ratio related to the Common Stock (subject to the requirements of Section 5.1.1 and in compliance with applicable laws),
upon the passage of time, the occurrence of one or more events, or the satisfaction of performance criteria or other conditions,
or any combination thereof; or (b) any similar securities with a value derived from the value of or related to the Common Stock
and/or returns thereon.
5.2
Section 162(m) Performance-Based Awards
.
Without limiting the generality of the foregoing, any of the types of awards
listed in Sections 5.1.4 through 5.1.7 above may be, and options and SARs granted with an exercise or base price not less than
the Fair Market Value of a share of Common Stock at the date of grant (“
Qualifying Options
” and “
Qualifying
SARs
,” respectively) typically will be, granted as awards intended to satisfy the requirements for “performance-based
compensation” within the meaning of Section 162(m) of the Code (“
Performance-Based Awards
”). The grant,
vesting, exercisability or payment of Performance-Based Awards may depend (or, in the case of Qualifying Options or Qualifying
SARs, may also depend) on the degree of achievement of one or more performance goals relative to a pre-established targeted level
or levels using the Business Criteria provided for below for the Corporation on a consolidated basis or for one or more of the
Corporation’s subsidiaries, segments, divisions or business units, or any combination of the foregoing. Such criteria may
be evaluated on an absolute basis or relative to prior periods, industry peers, or stock market indices. Any Qualifying Option
or Qualifying SAR shall be subject to the requirements of Section 5.2.1 and 5.2.3 in order for such award to satisfy the requirements
for “performance-based compensation” under Section 162(m) of the Code. Any other Performance-Based Award shall be
subject to all of the following provisions of this Section 5.2.
5.2.1
Class; Administrator.
The eligible class of persons for Performance-Based Awards under this Section 5.2 shall be officers
and employees of the Corporation or one of its Subsidiaries. The Administrator approving Performance-Based Awards or making any
certification required pursuant to Section 5.2.4 must be constituted as provided in Section 3.1 for awards that are intended as
performance-based compensation under Section 162(m) of the Code.
5.2.2
Performance Goals.
The specific performance goals for Performance-Based Awards (other than Qualifying Options and Qualifying
SARs) shall be, on an absolute or relative basis, established based on such business criteria as selected by the Administrator
in its sole discretion (“
Business Criteria
”), including the following: (1) earnings per share, (2) cash flow
(which means cash and cash equivalents derived from either (i) net cash flow from operations or (ii) net cash flow from operations,
financing and investing activities), (3) total stockholder return, (4) price per share of Common Stock, (5) gross revenue, (6)
revenue growth, (7) operating income (before or after taxes), (8) net earnings (before or after interest, taxes, depreciation
and/or amortization), (9) return on equity, (10) capital employed, or on assets or on net investment, (11) cost containment or
reduction, (12) cash cost per ounce of production, (13) operating margin, (14) debt reduction, (15) resource amounts, (16) production
or production growth, (17) resource replacement or resource growth, (18) successful completion of financings, or (19) any combination
of the foregoing. To qualify awards as performance-based under Section 162(m), the applicable Business Criterion (or Business
Criteria, as the case may be) and specific performance goal or goals (“targets”) must be established and approved
by the Administrator during the first 90 days of the performance period (and, in the case of performance periods of less than
one year, in no event after 25% or more of the performance period has elapsed) and while performance relating to such target(s)
remains substantially uncertain within the meaning of Section 162(m) of the Code. Performance targets shall be adjusted to mitigate
the unbudgeted impact of material, unusual or nonrecurring gains and losses, accounting changes or other extraordinary events
not foreseen at the time the targets were set unless the Administrator provides otherwise at the time of establishing the targets;
provided that the Administrator may not make any adjustment to the extent it would adversely affect the qualification of any compensation
payable under such performance targets as “performance-based compensation” under Section 162(m) of Code. The applicable
performance measurement period may not be less than 3 months nor more than 10 years.
5.2.3
Form of Payment.
Grants or awards intended to qualify under this Section 5.2 may be paid in cash or shares of Common
Stock or any combination thereof.
5.2.4
Certification of Payment.
Before any Performance-Based Award under this Section 5.2 (other than Qualifying Options
and Qualifying SARs) is paid and to the extent required to qualify the award as performance-based compensation within the meaning
of Section 162(m) of the Code, the Administrator must certify in writing that the performance target(s) and any other material
terms of the Performance-Based Award were in fact timely satisfied.
5.2.5
Reservation of Discretion
.
The Administrator will have the discretion to determine the restrictions or other limitations
of the individual awards granted under this Section 5.2 including the authority to reduce awards, payouts or vesting or to pay
no awards, in its sole discretion, if the Administrator preserves such authority at the time of grant by language to this effect
in its authorizing resolutions or otherwise.
5.2.6
Expiration of Grant Authority
.
As required pursuant to Section 162(m) of the Code and the regulations promulgated thereunder,
the Administrator’s authority to grant new awards that are intended to qualify as performance-based compensation within
the meaning of Section 162(m) of the Code (other than Qualifying Options and Qualifying SARs) shall terminate upon the first meeting
of the Corporation’s stockholders that occurs in the fifth year following the year in which the Corporation’s stockholders
first approve this Plan (the “
162(m) Term
”).
5.2.7
Compensation Limitations
.
The maximum aggregate number of shares of Common Stock that may be issued to any Eligible
Person during the term of this Plan pursuant to Qualifying Options and Qualifying SARs may not exceed the Share Limit. The maximum
aggregate number of shares of Common Stock that may be issued to any Eligible Person pursuant to Performance-Based Awards granted
during the 162(m) Term (other than cash awards granted pursuant to Section 5.1.6 and Qualifying Options or Qualifying SARs) may
not exceed the Share Limit. The maximum amount that may be paid to any Eligible Person pursuant to Performance-Based Awards granted
pursuant to Sections 5.1.6 (cash awards) during the 162(m) Term may not exceed $1,000,000.
5.3
Award Agreements.
Each award shall be evidenced by a written or electronic award agreement in the form approved by
the Administrator and, if required by the Administrator, executed by the recipient of the award. The Administrator may authorize
any officer of the Corporation (other than the particular award recipient) to execute any or all award agreements on behalf of
the Corporation (electronically or otherwise). The award agreement shall set forth the material terms and conditions of the award
as established by the Administrator consistent with the express limitations of this Plan.
5.4
Deferrals and Settlements.
Payment of awards may be in the form of cash, Common Stock, other awards or combinations
thereof as the Administrator shall determine, and with such restrictions as it may impose. The Administrator may also require
or permit participants to elect to defer the issuance of shares of Common Stock or the settlement of awards in cash under such
rules and procedures as it may establish under this Plan. The Administrator may also provide that deferred settlements include
the payment or crediting of interest or other earnings on the deferral amounts, or the payment or crediting of dividend equivalents
where the deferred amounts are denominated in shares. All mandatory or elective deferrals of the issuance of shares of Common
Stock or the settlement of cash awards shall be structured in a manner that is intended to comply with the requirements of Section
409A of the Code.
5.5
Consideration for Common Stock or Awards.
The purchase price for any award granted under this Plan or the Common Stock
to be delivered pursuant to an award, as applicable, may be paid by means of any lawful consideration as determined by the Administrator
and subject to compliance with applicable laws, including, without limitation, one or a combination of the following methods:
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services
rendered by the recipient of such award;
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cash,
check payable to the order of the Corporation, or electronic funds transfer;
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notice
and third party payment in such manner as may be authorized by the Administrator;
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the
delivery of previously owned shares of Common Stock that are fully vested and unencumbered;
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by
a reduction in the number of shares otherwise deliverable pursuant to the award; or
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subject
to such procedures as the Administrator may adopt, pursuant to a “cashless exercise” with a third party who provides
financing for the purposes of (or who otherwise facilitates) the purchase or exercise of awards.
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In
the event that the Administrator allows a participant to exercise an award by delivering shares of Common Stock previously owned
by such participant and unless otherwise expressly provided by the Administrator, any shares delivered which were initially acquired
by the participant from the Corporation (upon exercise of a stock option or otherwise) must have been owned by the participant
at least six months as of the date of delivery (or such other period as may be required by the Administrator in order to avoid
adverse accounting treatment). Shares of Common Stock used to satisfy the exercise price of an option shall be valued at their
Fair Market Value on the date of exercise. The Corporation will not be obligated to deliver any shares unless and until it receives
full payment of the exercise or purchase price therefor and any related withholding obligations under Section 8.5 and any other
conditions to exercise or purchase, as established from time to time by the Administrator, have been satisfied. Unless otherwise
expressly provided in the applicable award agreement, the Administrator may at any time eliminate or limit a participant’s
ability to pay the purchase or exercise price of any award by any method other than cash payment to the Corporation.
5.6
Definition of Fair Market Value.
For purposes of this Plan “
Fair Market Value
” shall mean, unless
otherwise determined or provided by the Administrator in the circumstances, the closing price for a share of Common Stock on the
trading day immediately before the grant date, as furnished by the NASDAQ Stock Market or other principal stock exchange on which
the Common Stock is then listed for the date in question, or if the Common Stock is no longer listed on a principal stock exchange,
then by the Over-the-Counter Bulletin Board or OTC Markets. If the Common Stock is no longer listed on the NASDAQ Capital Market
or listed on a principal stock exchange or is no longer actively traded on the Over-the-Counter Bulletin Board or OTC Markets
as of the applicable date, the Fair Market Value of the Common Stock shall be the value as reasonably determined by the Administrator
for purposes of the award in the circumstances.
5.7
Transfer Restrictions.
5.7.1
Limitations on Exercise and Transfer.
Unless otherwise expressly provided in (or pursuant to) this Section 5.7, by
applicable law and by the award agreement, as the same may be amended, (a) all awards are non-transferable and shall not be subject
in any manner to sale, transfer, anticipation, alienation, assignment, pledge, encumbrance or charge; (b) awards shall be exercised
only by the participant; and (c) amounts payable or shares issuable pursuant to any award shall be delivered only to (or for the
account of) the participant.
5.7.2
Exceptions.
The Administrator may permit awards to be exercised by and paid to, or otherwise transferred to, other
persons or entities pursuant to such conditions and procedures, including limitations on subsequent transfers, as the Administrator
may, in its sole discretion, establish in writing (provided that any such transfers of ISOs shall be limited to the extent permitted
under the federal tax laws governing ISOs). Any permitted transfer shall be subject to compliance with applicable federal and
state securities laws.
5.7.3
Further Exceptions to Limits on Transfer.
The exercise and transfer restrictions in Section 5.7.1 shall not apply to:
(a)
transfers to the Corporation,
(b)
the designation of a beneficiary to receive benefits in the event of the participant’s death or, if the participant has
died, transfers to or exercise by the participant’s beneficiary, or, in the absence of a validly designated beneficiary,
transfers by will or the laws of descent and distribution,
(c)
subject to any applicable limitations on ISOs, transfers to a family member (or former family member) pursuant to a domestic relations
order if approved or ratified by the Administrator,
(d)
subject to any applicable limitations on ISOs, if the participant has suffered a disability, permitted transfers or exercises
on behalf of the participant by his or her legal representative, or
(e)
the authorization by the Administrator of “cashless exercise” procedures with third parties who provide financing
for the purpose of (or who otherwise facilitate) the exercise of awards consistent with applicable laws and the express authorization
of the Administrator.
5.8
International Awards.
One or more awards may be granted to Eligible Persons who provide services to the Corporation
or one of its Subsidiaries outside of the United States. Any awards granted to such persons may, if deemed necessary or advisable
by the Administrator, be granted pursuant to the terms and conditions of any applicable sub-plans, if any, appended to this Plan
and approved by the Administrator.
5.9
Vesting
. Subject to Section 5.1.2 hereof, awards shall vest at such time or times and subject to such terms and conditions
as shall be determined by the Administrator at the time of grant;
provided, however
, that in the absence of any award vesting
periods designated by the Administrator at the time of grant in the applicable award agreement, awards shall vest as to one-third
of the total number of shares subject to the award on each of the first, second and third anniversaries of the date of grant.
6.
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EFFECT
OF TERMINATION OF SERVICE ON AWARDS
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6.1
Termination of Employment.
6.1.1
The Administrator shall establish the effect of a termination of employment or service on the rights and benefits under each
award under this Plan and in so doing may make distinctions based upon, inter alia, the cause of termination and type of award.
If the participant is not an employee of the Corporation or one of its Subsidiaries and provides other services to the Corporation
or one of its Subsidiaries, the Administrator shall be the sole judge for purposes of this Plan (unless a contract or the award
agreement otherwise provides) of whether the participant continues to render services to the Corporation or one of its Subsidiaries
and the date, if any, upon which such services shall be deemed to have terminated.
6.1.2
For awards of stock options or SARs, unless the award agreement provides otherwise, the exercise period of such options or
SARs shall expire: (1) three months after the last day that the participant is employed by or provides services to the Corporation
or a Subsidiary (provided; however, that in the event of the participant’s death during this period, those persons entitled
to exercise the option or SAR pursuant to the laws of descent and distribution shall have one year following the date of death
within which to exercise such option or SAR); (2) in the case of a participant whose termination of employment is due to death
or disability (as defined in the applicable award agreement), 12 months after the last day that the participant is employed by
or provides services to the Corporation or a Subsidiary; and (3) immediately upon a participant’s termination for “cause”.
The Administrator will, in its absolute discretion, determine the effect of all matters and questions relating to a termination
of employment, including, but not by way of limitation, the question of whether a leave of absence constitutes a termination of
employment and whether a participant’s termination is for “cause.”
If
not defined in the applicable award agreement, “
Cause
” shall mean:
(i)
conviction of a felony or a crime involving fraud or moral turpitude; or
(ii)
theft, material act of dishonesty or fraud, intentional falsification of any employment or Company records, or commission of any
criminal act which impairs participant’s ability to perform appropriate employment duties for the Corporation; or
(iii)
intentional or reckless conduct or gross negligence materially harmful to the Company or the successor to the Corporation after
a Change in Control , including violation of a non-competition or confidentiality agreement; or
(iv)
willful failure to follow lawful instructions of the person or body to which participant reports; or
(v)
gross negligence or willful misconduct in the performance of participant’s assigned duties. Cause shall
not
include
mere unsatisfactory performance in the achievement of participant’s job objectives.
6.1.3
For awards of restricted shares, unless the award agreement provides otherwise, restricted shares that are subject to restrictions
at the time that a participant whose employment or service is terminated shall be forfeited and reacquired by the Corporation;
provided that,
the Administrator may provide, by rule or regulation or in any award agreement, or may determine in any
individual case, that restrictions or forfeiture conditions relating to restricted shares shall be waived in whole or in part
in the event of terminations resulting from specified causes, and the Administrator may in other cases waive in whole or in part
the forfeiture of restricted shares. Similar rules shall apply in respect of RSUs.
6.2
Events Not Deemed Terminations of Service.
Unless the express policy of the Corporation or one of its Subsidiaries,
or the Administrator, otherwise provides, the employment relationship shall not be considered terminated in the case of (a) sick
leave, (b) military leave, or (c) any other leave of absence authorized by the Corporation or one of its Subsidiaries, or the
Administrator; provided that unless reemployment upon the expiration of such leave is guaranteed by contract or law, such leave
is for a period of not more than 3 months. In the case of any employee of the Corporation or one of its Subsidiaries on an approved
leave of absence, continued vesting of the award while on leave from the employ of the Corporation or one of its Subsidiaries
may be suspended until the employee returns to service, unless the Administrator otherwise provides or applicable law otherwise
requires. In no event shall an award be exercised after the expiration of the term set forth in the award agreement.
6.3
Effect of Change of Subsidiary Status.
For purposes of this Plan and any award, if an entity ceases to be a Subsidiary
of the Corporation, a termination of employment or service shall be deemed to have occurred with respect to each Eligible Person
in respect of such Subsidiary who does not continue as an Eligible Person in respect of another entity within the Corporation
or another Subsidiary that continues as such after giving effect to the transaction or other event giving rise to the change in
status.
7.
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ADJUSTMENTS;
ACCELERATION
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7.1
Adjustments
. Upon or in contemplation of any of the following events described in this Section 7.1,: any reclassification,
recapitalization, stock split (including a stock split in the form of a stock dividend) or reverse stock split (“
stock
split
”); any merger, arrangement, combination, consolidation, or other reorganization; any spin-off, split-up, or similar
extraordinary dividend distribution in respect of the Common Stock (whether in the form of securities or property); any exchange
of Common Stock or other securities of the Corporation, or any similar, unusual or extraordinary corporate transaction in respect
of the Common Stock; then the Administrator shall in such manner, to such extent and at such time as it deems appropriate and
equitable in the circumstances (but subject to compliance with applicable laws and stock exchange requirements) proportionately
adjust any or all of (1) the number and type of shares of Common Stock (or other securities) that thereafter may be made the subject
of awards (including the number of shares provided for in this Plan), (2) the number, amount and type of shares of Common Stock
(or other securities or property) subject to any or all outstanding awards, (3) the grant, purchase, or exercise price (which
term includes the base price of any SAR or similar right) of any or all outstanding awards, (4) the securities, cash or other
property deliverable upon exercise or payment of any outstanding awards, and (5) the 162(m) compensation limitations set forth
in Section 5.2.7 and (subject to Section 8.8.3(a)) the performance standards applicable to any outstanding awards (provided that
no adjustment shall be allowed to the extent inconsistent with the requirements of Code section 162(m)). Any adjustment made pursuant
to this Section 7.1 shall be made in a manner that, in the good faith determination of the Administrator, will not likely result
in the imposition of additional taxes or interest under Section 409A of the Code. With respect to any award of an ISO, the Administrator
may make such an adjustment that causes the option to cease to qualify as an ISO without the consent of the affected participant.
7.2
Change
in Control
. Upon a Change in Control, each then-outstanding option and SAR shall automatically become fully vested,
all restricted shares then outstanding shall automatically fully vest free of restrictions, and each other award
granted under this Plan that is then outstanding shall automatically become vested and payable to the holder of such award
unless
the Administrator has made appropriate provision for the substitution, assumption, exchange or other continuation of the
award pursuant to the Change in Control. Notwithstanding the foregoing, the Administrator, in its sole and absolute
discretion, may choose (in an award agreement or otherwise) to provide for full or partial accelerated vesting of any award
upon a Change In Control (or upon any other event or other circumstance related to the Change in Control, such as an
involuntary termination of employment occurring after such Change in Control, as the Administrator may determine),
irrespective of whether such any such award has been substituted, assumed, exchanged or otherwise continued pursuant to the
Change in Control.
For
purposes of this Plan, “
Change in Control
” shall be deemed to have occurred if:
(i)
a tender offer (or series of related offers) shall be made and consummated for the ownership of 50% or more of the outstanding
voting securities of the Corporation, unless as a result of such tender offer more than 50% of the outstanding voting securities
of the surviving or resulting corporation shall be owned in the aggregate by the stockholders of the Corporation (as of the time
immediately prior to the commencement of such offer), any employee benefit plan of the Corporation or its Subsidiaries, and their
affiliates;
(ii)
the Corporation shall be merged or consolidated with another entity, unless as a result of such merger or consolidation more than
50% of the outstanding voting securities of the surviving or resulting entity shall be owned in the aggregate by the stockholders
of the Corporation (as of the time immediately prior to such transaction), any employee benefit plan of the Corporation or its
Subsidiaries, and their affiliates;
(iii) the Corporation shall sell substantially all of its assets to another entity that is not wholly
owned by the Corporation, unless as a result of such sale more than 50% of such assets shall be owned in the aggregate by the
stockholders of the Corporation (as of the time immediately prior to such transaction), any employee benefit plan of the Corporation
or its Subsidiaries and their affiliates; or
(iv)
a Person (as defined below) shall acquire 50% or more of the outstanding voting securities of the Corporation (whether directly,
indirectly, beneficially or of record), unless as a result of such acquisition more than 50% of the outstanding voting securities
of the surviving or resulting corporation shall be owned in the aggregate by the stockholders of the Corporation (as of the time
immediately prior to the first acquisition of such securities by such Person), any employee benefit plan of the Corporation or
its Subsidiaries, and their affiliates.
For
purposes of this Section 5(c), ownership of voting securities shall take into account and shall include ownership as determined
by applying the provisions of Rule 13d-3(d)(I)(i) (as in effect on the date hereof) under the Exchange Act. In addition, for such
purposes, “Person” shall have the meaning given in Section 3(a)(9) of the Exchange Act, as modified and used in Sections
13(d) and 14(d) thereof;
provided
,
however
, that a Person shall not include (A) the Company or any of its Subsidiaries;
(B) a trustee or other fiduciary holding securities under an employee benefit plan of the Company or any of its Subsidiaries;
(C) an underwriter temporarily holding securities pursuant to an offering of such securities; or (D) a corporation owned, directly
or indirectly, by the stockholders of the Company in substantially the same proportion as their ownership of stock of the Company.
Notwithstanding
the foregoing, (1) the Administrator may waive the requirement described in paragraph (iv) above that a Person must acquire more
than 50% of the outstanding voting securities of the Corporation for a Change in Control to have occurred if the Administrator
determines that the percentage acquired by a person is significant (as determined by the Administrator in its discretion) and
that waiving such condition is appropriate in light of all facts and circumstances, and (2) no compensation that has been deferred
for purposes of Section 409A of the Code shall be payable as a result of a Change in Control unless the Change in Control qualifies
as a change in ownership or effective control of the Corporation within the meaning of Section 409A of the Code.
7.3
Early Termination of Awards
. Any award that has been accelerated as required or permitted by Section 7.2 upon a Change
in Control (or would have been so accelerated but for Section 7.4 or 7.5) shall terminate upon such event, subject to any provision
that has been expressly made by the Administrator, through a plan of reorganization or otherwise, for the survival, substitution,
assumption, exchange or other continuation of such award and provided that, in the case of options and SARs that will not survive,
be substituted for, assumed, exchanged, or otherwise continued in the transaction, the holder of such award shall be given reasonable
advance notice of the impending termination and a reasonable opportunity to exercise his or her outstanding options and SARs in
accordance with their terms before the termination of such awards (except that in no case shall more than ten days’ notice
of accelerated vesting and the impending termination be required and any acceleration may be made contingent upon the actual occurrence
of the event).
The
Administrator may make provision for payment in cash or property (or both) in respect of awards terminated pursuant to this section
as a result of the Change in Control and may adopt such valuation methodologies for outstanding awards as it deems reasonable
and, in the case of options, SARs or similar rights, and without limiting other methodologies, may base such settlement solely
upon the excess if any of the per share amount payable upon or in respect of such event over the exercise or base price of the
award.
7.4
Other Acceleration Rules
. Any acceleration of awards pursuant to this Section 7 shall comply with applicable legal
and stock exchange requirements and, if necessary to accomplish the purposes of the acceleration or if the circumstances require,
may be deemed by the Administrator to occur a limited period of time not greater than 30 days before the event. Without limiting
the generality of the foregoing, the Administrator may deem an acceleration to occur immediately prior to the applicable event
and/or reinstate the original terms of an award if an event giving rise to the acceleration does not occur. Notwithstanding any
other provision of the Plan to the contrary, the Administrator may override the provisions of Section 7.2, 7.3, and/or 7.5 by
express provision in the award agreement or otherwise. The portion of any ISO accelerated pursuant to Section 7.2 or any other
action permitted hereunder shall remain exercisable as an ISO only to the extent the applicable $100,000 limitation on ISOs is
not exceeded. To the extent exceeded, the accelerated portion of the option shall be exercisable as a nonqualified stock option
under the Code.
7.5
Possible Rescission of Acceleration
. If the vesting of an award has been accelerated expressly in anticipation of an
event and the Administrator later determines that the event will not occur, the Administrator may rescind the effect of the acceleration
as to any then outstanding and unexercised or otherwise unvested awards;
provided, that
, in the case of any compensation
that has been deferred for purposes of Section 409A of the Code, the Administrator determines that such rescission will not likely
result in the imposition of additional tax or interest under Code Section 409A.
8.1
Compliance with Laws.
This Plan, the granting and vesting of awards under this Plan, the offer, issuance and delivery
of shares of Common Stock, the acceptance of promissory notes and/or the payment of money under this Plan or under awards are
subject to compliance with all applicable federal and state laws, rules and regulations (including but not limited to state and
federal securities law, federal margin requirements) and to such approvals by any applicable stock exchange listing, regulatory
or governmental authority as may, in the opinion of counsel for the Corporation, be necessary or advisable in connection therewith.
The person acquiring any securities under this Plan will, if requested by the Corporation or one of its Subsidiaries, provide
such assurances and representations to the Corporation or one of its Subsidiaries as the Administrator may deem necessary or desirable
to assure compliance with all applicable legal and accounting requirements.
8.2
Future Awards/Other Rights.
No person shall have any claim or rights to be granted an award (or additional awards,
as the case may be) under this Plan, subject to any express contractual rights (set forth in a document other than this Plan)
to the contrary.
8.3
No Employment/Service Contract.
Nothing contained in this Plan (or in any other documents under this Plan or in any
award) shall confer upon any Eligible Person or other participant any right to continue in the employ or other service of the
Corporation or one of its Subsidiaries, constitute any contract or agreement of employment or other service or affect an employee’s
status as an employee at will, nor shall interfere in any way with the right of the Corporation or one of its Subsidiaries to
change a person’s compensation or other benefits, or to terminate his or her employment or other service, with or without
cause. Nothing in this Section 8.3, however, is intended to adversely affect any express independent right of such person under
a separate employment or service contract other than an award agreement.
8.4
Plan Not Funded.
Awards payable under this Plan shall be payable in shares or from the general assets of the Corporation,
and no special or separate reserve, fund or deposit shall be made to assure payment of such awards. No participant, beneficiary
or other person shall have any right, title or interest in any fund or in any specific asset (including shares of Common Stock,
except as expressly otherwise provided) of the Corporation or one of its Subsidiaries by reason of any award hereunder. Neither
the provisions of this Plan (or of any related documents), nor the creation or adoption of this Plan, nor any action taken pursuant
to the provisions of this Plan shall create, or be construed to create, a trust of any kind or a fiduciary relationship between
the Corporation or one of its Subsidiaries and any participant, beneficiary or other person. To the extent that a participant,
beneficiary or other person acquires a right to receive payment pursuant to any award hereunder, such right shall be no greater
than the right of any unsecured general creditor of the Corporation.
8.5
Tax Withholding.
Upon any exercise, vesting, or payment of any award, the Corporation or one of its Subsidiaries shall
have the right at its option to:
(a)
require the participant (or the participant’s personal representative or beneficiary, as the case may be) to pay or provide
for payment of at least the minimum amount of any taxes which the Corporation or one of its Subsidiaries may be required to withhold
with respect to such award event or payment; or
(b)
deduct from any amount otherwise payable in cash to the participant (or the participant’s personal representative or beneficiary,
as the case may be) the minimum amount of any taxes which the Corporation or one of its Subsidiaries may be required to withhold
with respect to such cash payment.
In
any case where a tax is required to be withheld in connection with the delivery of shares of Common Stock under this Plan, the
Administrator may in its sole discretion (subject to Section 8.1) grant (either at the time of the award or thereafter) to the
participant the right to elect, pursuant to such rules and subject to such conditions as the Administrator may establish, to have
the Corporation reduce the number of shares to be delivered by (or otherwise reacquire) the appropriate number of shares, valued
in a consistent manner at their Fair Market Value or at the sales price in accordance with authorized procedures for cashless
exercises, necessary to satisfy the minimum applicable withholding obligation on exercise, vesting or payment. In no event shall
the shares withheld exceed the minimum whole number of shares required for tax withholding under applicable law.
8.6
Effective Date, Termination and Suspension, Amendments.
8.6.1
Effective Date and Termination.
This Plan was approved by the Board and became effective on December 1, 2016. Unless
earlier terminated by the Board, this Plan shall terminate at the close of business on December 1, 2026. After the termination
of this Plan either upon such stated expiration date or its earlier termination by the Board, no additional awards may be granted
under this Plan, but previously granted awards (and the authority of the Administrator with respect thereto, including the authority
to amend such awards) shall remain outstanding in accordance with their applicable terms and conditions and the terms and conditions
of this Plan.
8.6.2
Board Authorization.
The Board may, at any time, terminate or, from time to time, amend, modify or suspend this Plan,
in whole or in part. No awards may be granted during any period that the Board suspends this Plan.
8.6.3
Stockholder Approval.
To the extent then required by applicable law or any applicable stock exchange or required under
Sections 162, 422 or 424 of the Code to preserve the intended tax consequences of this Plan, or deemed necessary or advisable
by the Board, this Plan and any amendment to this Plan shall be subject to stockholder approval.
8.6.4
Amendments to Awards.
Without limiting any other express authority of the Administrator under (but subject to) the
express limits of this Plan, the Administrator by agreement or resolution may waive conditions of or limitations on awards to
participants that the Administrator in the prior exercise of its discretion has imposed, without the consent of a participant,
and (subject to the requirements of Sections 3.2 and 8.6.5) may make other changes to the terms and conditions of awards. Any
amendment or other action that would constitute a repricing of an award is subject to the limitations set forth in Section 3.2(g).
8.6.5
Limitations on Amendments to Plan and Awards.
No amendment, suspension or termination of this Plan or change of or
affecting any outstanding award shall, without written consent of the participant, affect in any manner materially adverse to
the participant any rights or benefits of the participant or obligations of the Corporation under any award granted under this
Plan prior to the effective date of such change. Changes, settlements and other actions contemplated by Section 7 shall not be
deemed to constitute changes or amendments for purposes of this Section 8.6.
8.7
Privileges of Stock Ownership.
Except as otherwise expressly authorized by the Administrator or this Plan, a participant
shall not be entitled to any privilege of stock ownership as to any shares of Common Stock not actually delivered to and held
of record by the participant. No adjustment will be made for dividends or other rights as a stockholder for which a record date
is prior to such date of delivery.
8.8
Governing Law; Construction; Severability.
8.8.1
Choice of Law.
This Plan, the awards, all documents evidencing awards and all other related documents shall be governed
by, and construed in accordance with the laws of the State of Delaware
8.8.2
Severability.
If a court of competent jurisdiction holds any provision invalid and unenforceable, the remaining provisions
of this Plan shall continue in effect.
8.8.3
Plan Construction.
(a)
Rule 16b-3.
It is the intent of the Corporation that the awards and transactions permitted by awards be interpreted in
a manner that, in the case of participants who are or may be subject to Section 16 of the Exchange Act, qualify, to the maximum
extent compatible with the express terms of the award, for exemption from matching liability under Rule 16b-3 promulgated under
the Exchange Act. Notwithstanding the foregoing, the Corporation shall have no liability to any participant for Section 16 consequences
of awards or events under awards if an award or event does not so qualify.
(b)
Section 162(m).
Awards under Sections 5.1.4 through 5.1.7 to persons described in Section 5.2 that are either granted or
become vested, exercisable or payable based on attainment of one or more performance goals related to the Business Criteria, as
well as Qualifying Options and Qualifying SARs granted to persons described in Section 5.2, that are approved by a committee composed
solely of two or more outside directors (as this requirement is applied under Section 162(m) of the Code) shall be deemed to be
intended as performance-based compensation within the meaning of Section 162(m) of the Code unless such committee provides otherwise
at the time of grant of the award. It is the further intent of the Corporation that (to the extent the Corporation or one of its
Subsidiaries or awards under this Plan may be or become subject to limitations on deductibility under Section 162(m) of the Code)
any such awards and any other Performance-Based Awards under Section 5.2 that are granted to or held by a person subject to Section
162(m) will qualify as performance-based compensation or otherwise be exempt from deductibility limitations under Section 162(m).
(c)
Code Section 409A Compliance.
The Board intends that, except as may be otherwise determined by the Administrator, any awards
under the Plan are either exempt from or satisfy the requirements of Section 409A of the Code and related regulations and Treasury
pronouncements (“
Section 409A
”) to avoid the imposition of any taxes, including additional income or penalty
taxes, thereunder. If the Administrator determines that an award, award agreement, acceleration, adjustment to the terms of an
award, payment, distribution, deferral election, transaction or any other action or arrangement contemplated by the provisions
of the Plan would, if undertaken, cause a participant’s award to become subject to Section 409A, unless the Administrator
expressly determines otherwise, such award, award agreement, payment, acceleration, adjustment, distribution, deferral election,
transaction or other action or arrangement shall not be undertaken and the related provisions of the Plan and/or award agreement
will be deemed modified or, if necessary, rescinded in order to comply with the requirements of Section 409A to the extent determined
by the Administrator without the content or notice to the participant. Notwithstanding the foregoing, neither the Company nor
the Administrator shall have any obligation to take any action to prevent the assessment of any excise tax or penalty on any participant
under Section 409A and neither the Company nor the Administrator will have any liability to any participant for such tax or penalty.
(d)
No Guarantee of Favorable Tax Treatment.
Although the Company intends that awards under the Plan will be exempt from, or
will comply with, the requirements of Section 409A of the Code, the Company does not warrant that any award under the Plan will
qualify for favorable tax treatment under Section 409A of the Code or any other provision of federal, state, local or foreign
law. The Company shall not be liable to any participant for any tax, interest or penalties the participant might owe as a result
of the grant, holding, vesting, exercise or payment of any award under the Plan.
8.9
Captions.
Captions and headings are given to the sections and subsections of this Plan solely as a convenience to facilitate
reference. Such headings shall not be deemed in any way material or relevant to the construction or interpretation of this Plan
or any provision thereof.
8.10
Stock-Based Awards in Substitution for Stock Options or Awards Granted by Other Corporation.
Awards may be granted
to Eligible Persons in substitution for or in connection with an assumption of employee stock options, SARs, restricted stock
or other stock-based awards granted by other entities to persons who are or who will become Eligible Persons in respect of the
Corporation or one of its Subsidiaries, in connection with a distribution, arrangement, business combination, merger or other
reorganization by or with the granting entity or an affiliated entity, or the acquisition by the Corporation or one of its Subsidiaries,
directly or indirectly, of all or a substantial part of the stock or assets of the employing entity. The awards so granted need
not comply with other specific terms of this Plan, provided the awards reflect only adjustments giving effect to the assumption
or substitution consistent with the conversion applicable to the Common Stock in the transaction and any change in the issuer
of the security. Any shares that are delivered and any awards that are granted by, or become obligations of, the Corporation,
as a result of the assumption by the Corporation of, or in substitution for, outstanding awards previously granted by an acquired
company (or previously granted by a predecessor employer (or direct or indirect parent thereof) in the case of persons that become
employed by the Corporation or one of its Subsidiaries in connection with a business or asset acquisition or similar transaction)
shall not be counted against the Share Limit or other limits on the number of shares available for issuance under this Plan, except
as may otherwise be provided by the Administrator at the time of such assumption or substitution or as may be required to comply
with the requirements of any applicable stock exchange.
8.11
Non-Exclusivity of Plan.
Nothing in this Plan shall limit or be deemed to limit the authority of the Board or the Administrator
to grant awards or authorize any other compensation, with or without reference to the Common Stock, under any other plan or authority.
8.12
No Corporate Action Restriction.
The existence of this Plan, the award agreements and the awards granted hereunder
shall not limit, affect or restrict in any way the right or power of the Board or the stockholders of the Corporation to make
or authorize: (a) any adjustment, recapitalization, reorganization or other change in the capital structure or business of the
Corporation or any Subsidiary, (b) any merger, arrangement, business combination, amalgamation, consolidation or change in the
ownership of the Corporation or any Subsidiary, (c) any issue of bonds, debentures, capital, preferred or prior preference stock
ahead of or affecting the capital stock (or the rights thereof) of the Corporation or any Subsidiary, (d) any dissolution or liquidation
of the Corporation or any Subsidiary, (e) any sale or transfer of all or any part of the assets or business of the Corporation
or any Subsidiary, or (f) any other corporate act or proceeding by the Corporation or any Subsidiary. No participant, beneficiary
or any other person shall have any claim under any award or award agreement against any member of the Board or the Administrator,
or the Corporation or any employees, officers or agents of the Corporation or any Subsidiary, as a result of any such action.
8.13
Other Corporation Benefit and Compensation Programs.
Payments and other benefits received by a participant under an
award made pursuant to this Plan shall not be deemed a part of a participant’s compensation for purposes of the determination
of benefits under any other employee welfare or benefit plans or arrangements, if any, provided by the Corporation or any Subsidiary,
except where the Administrator expressly otherwise provides or authorizes in writing or except as otherwise specifically set forth
in the terms and conditions of such other employee welfare or benefit plan or arrangement. Awards under this Plan may be made
in addition to, in combination with, as alternatives to or in payment of grants, awards or commitments under any other plans or
arrangements of the Corporation or its Subsidiaries.
8.14
Prohibition on Repricing
.
Subject to Section 4, the Administrator shall not, without the approval of the stockholders
of the Corporation (i) reduce the exercise price, or cancel and reissue options so as to in effect reduce the exercise price or
(ii) change the manner of determining the exercise price so that the exercise price is less than the fair market value per share
of Common Stock.
As
adopted by the Board of Directors of PolarityTE, Inc. on December 1, 2016.
Appendix
B
FORM
OF
CERTIFICATE
OF AMENDMENT
OF
RESTATED
CERTIFICATE OF INCORPORATION
OF
POLARITYTE,
INC. ENTERTAINMENT COMPANY
PolarityTE,
Inc. (the “Corporation”) organized and existing under and by virtue of the General Corporation Law of the State of
Delaware does hereby certify:
FIRST:
The name of the Corporation is PolarityTE, Inc. and the date of filing of its original Certificate of Incorporation with the
Secretary of State of the State of Delaware was on May 8, 1998.
SECOND
:
The Board of Directors and stockholders of the Corporation duly adopted, in accordance with Section 242 of the General Corporation
Law of the State of Delaware, a resolution proposing and declaring advisable the following amendment to Article FOURTH, Subparagraph
A of the Certificate of Incorporation of said Corporation:
FOURTH:
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A.
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Designation
and Number of Shares.
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The
total number of shares of all classes of stock which the Corporation shall have the authority to issue is 275,000,000
shares, consisting of 250,000,000 shares of common stock, par value $0.001 per share (the “Common Stock”) and
25,000,000 shares of Preferred Stock, par value $0.001 per share (the “Preferred Stock”).
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IN
WITNESS WHEREOF
, the Corporation has caused this Amendment to the Restated Certificate of Incorporation of the Corporation
to be duly executed by the undersigned this day of *, 2017.