UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT

PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 20192020

Commission File No. 000-51128001-32404

POLARITYTE, INC.

(Exact name of registrant as specified in its charter)

DELAWAREdelaware06-1529524
(State or Other Jurisdiction of(I.R.S. Employer
Incorporation or Organization)Identification No.)

123 Wright Brothers Drive

1960 S. 4250 West, Salt Lake City, UT 8411684104

(Address of principal executive offices)

Registrant’s Telephone Number, Including Area Code:(800)560-3983

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each classTrading SymbolName of each exchange on which registered
Common Stock, Par Value $0.001PTENasdaq Capital MarketNASDAQ

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.4.05(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X]☒ No [  ]☐

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

Large accelerated filer[  ]☐Accelerated filer[X]☒
Non-accelerated filer[  ]☐Smaller reporting company[X]☒
Emerging growth company[  ]☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [  ] ☐ No [X]☒

As of November 8, 2019,5, 2020, there were 26,985,630 39,241,323 shares of the Registrant’s common stock outstanding.

 

 

 

INDEX

INDEX

Page
PART I - FINANCIAL INFORMATION3
Item 1. Financial Statements:43
Condensed Consolidated Balance Sheets as of September 30, 2019 (unaudited)2020 and December 31, 20182019 (unaudited)43
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2020 and 2019 and 2018 (unaudited)54
Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2020 and 2019 and 2018 (unaudited)65
Condensed Consolidated Statements of Stockholders’ Equity for the three and nine months ended September 30, 2020 and 2019 and 2018 (unaudited)76
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and 2019 and 2018 (unaudited)87
Notes to Condensed Consolidated Financial Statements (unaudited)98
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations2622
Item 3. Quantitative and Qualitative Disclosures about Market Risk3234
Item 4. Controls and Procedures3234
PART II - OTHER INFORMATION35
Item 1. Legal Proceedings1A. Risk Factors3435
Item 6. Exhibits3436
SIGNATURES3537

2

 

Forward-looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements. Risks and uncertainties are inherent in forward-looking statements. Furthermore, such statements may be based on assumptions that fail to materialize or prove incorrect. Consequently, our business development, operations, and results could differ materially from those expressed in forward-looking statements made in this Quarterly Report. We make such forward-looking statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and other federal securities laws. All statements other than statements of historical facts contained in this Quarterly Report are forward-looking statements. In some cases, you can identify forward-looking statements by words such as “anticipate,” “believe,” “contemplate,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “target,” “would,” or the negative of these words or other comparable terminology. These forward-looking statements include, but are not limited to, statements about:

●the initiation, timing, progress, and results of our research and development programs;
●the timing or success of commercialization of our products;
●the pricing and reimbursement of our products;
●the initiation, timing, progress, and results of our preclinical and clinical studies;
●the scope of protection we can establish and maintain for intellectual property rights covering our product candidates and technology;
●estimates of our expenses, future revenues, and capital requirements;
●our need for, and ability to obtain, additional financing in the future;
●our ability to comply with regulations applicable to the manufacture, marketing, sale and distribution of our products;
●the potential benefits of strategic collaboration agreements and our ability to enter into strategic arrangements;
●our views about our prospects in ongoing litigation and SEC investigation;
●developments relating to our competitors and industry; and
●other risks and uncertainties, including those listed under Part I, Item 1A. Risk Factors of our Transition Report on Form 10-K filed with the Securities and Exchange Commission on March 18, 2019.

Given the known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by our forward-looking statements, you should not place undue reliance on these forward-looking statements. Except as required by law, we assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements:

POLARITYTE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except share and per share amounts)

 September 30, 2019  December 31, 2018 
 (Unaudited)   September 30, 2020  December 31, 2019 
ASSETS                
        
Current assets:        
Current assets        
Cash and cash equivalents $27,273  $55,673  $23,186  $10,218 
Short-term investments  18,675   6,162   –   19,022 
Accounts receivable  1,593   712 
Accounts receivable, net  3,379   1,731 
Inventory  346   336   907   252 
Prepaid expenses and other current assets  1,306   1,432   1,596   1,264 
Total current assets  49,193   64,315   29,068   32,487 
Property and equipment, net  15,662   13,736   11,970   14,911 
Operating lease right-of-use assets  5,028   –   3,110   4,590 
Intangible assets, net  778   924   589   731 
Goodwill  278   278   278   278 
Other assets  353   913   472   602 
TOTAL ASSETS $71,292  $80,166  $45,487  $53,599 
                
LIABILITIES AND STOCKHOLDERS’ EQUITY                
        
Current liabilities:        
Current liabilities        
Accounts payable and accrued expenses $10,233  $6,508  $4,818  $7,095 
Other current liabilities  2,582   316   2,311   2,338 
Current portion of long-term note payable  538   529 
Current portion of long-term notes payable  1,887   528 
Deferred revenue  134   170   25   98 
Total current liabilities  13,487   7,523   9,041   10,059 
Long-term note payable, net  247   479 
Common stock warrant liability  7,233   – 
Operating lease liabilities  3,358   –   1,817   2,994 
Other long-term liabilities  1,808   131   872   1,630 
Long-term notes payable  1,964   – 
Total liabilities  18,900   8,133   20,927   14,683 
                
Commitments and Contingencies        
Commitments and Contingencies (Note 14)  -   - 
                
STOCKHOLDERS’ EQUITY:        
Preferred stock - 25,000,000 shares authorized, 0 shares issued and outstanding at September 30, 2019 and December 31, 2018  –   – 
Common stock - $.001 par value; 250,000,000 shares authorized; 26,932,764 and 21,447,088 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively  27   21 
STOCKHOLDERS’ EQUITY        
Preferred stock - 25,000,000 shares authorized, 0 shares issued and outstanding at September 30, 2020 and December 31, 2019  –   – 
Common stock – $.001 par value; 250,000,000 shares authorized; 38,912,005 and 27,374,653 shares issued and outstanding at September 30, 2020 and December 31, 2019, respectively  39   27 
Additional paid-in capital  466,514   414,840   492,676   474,174 
Accumulated other comprehensive income  63   36   –   72 
Accumulated deficit  (414,212)  (342,864)  (468,155)  (435,357)
Total stockholders’ equity  52,392   72,033   24,560   38,916 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $71,292  $80,166  $45,487  $53,599 

The accompanying notes are an integral part of these condensed consolidated financial statements

3

 

POLARITYTE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except share and per share amounts)

 2020  2019  2020  2019 
 For the three months ended For the nine months ended  For the Three Months Ended For the Nine Months Ended 
 September 30,  September 30,  September 30,  September 30, 
 2019  2018  2019  2018  2020  2019  2020  2019 
Net revenues                                
Products $839  $197  $1,640  $389  $1,156  $839  $2,528  $1,640 
Services  556   528   2,546   659   2,181   556   4,008   2,546 
Total net revenues  1,395   725   4,186   1,048   3,337   1,395   6,536   4,186 
Cost of sales                                
Products  315   267   930   393   210   315   825   930 
Services  330   400   1,087   441   1,142   330   1,925   1,087 
Total cost of sales  645   667   2,017   834   1,352   645   2,750   2,017 
Gross profit  750   58   2,169   214   1,985   750   3,786   2,169 
Operating costs and expenses                                
Research and development  2,956   4,111   13,072   12,598   2,698   2,956   9,235   13,072 
General and administrative  16,044   15,135   48,299   33,998   6,264   16,044   22,080   48,299 
Sales and marketing  4,988   1,618   12,922   1,618   1,606   4,988   7,324   12,922 
Restructuring and other charges  –   –   2,536   – 
Total operating costs and expenses  23,988   20,864   74,293   48,214   10,568   23,988   41,175   74,293 
Operating loss  (23,238)  (20,806)  (72,124)  (48,000)  (8,583)  (23,238)  (37,389)  (72,124)
Other income (expenses)                                
Interest income, net  27   227   126   314 
Other (expense) income, net  228   –   650   – 
Change in fair value of derivatives  –   –   –   1,850 
Loss on extinguishment of warrant liability  –   –   –   (520)
Change in fair value of common stock warrant liability  1,503   –   4,444   – 
Interest (expense) income, net  (58)  27   (135)  126 
Other income, net  57   228   282   650 
Net loss  (22,983)  (20,579)  (71,348)  (46,356) $(7,081) $(22,983) $(32,798) $(71,348)
Deemed dividend – accretion of discount on Series F preferred stock  –   –   –   (698)
Deemed dividend – exchange of Series F preferred stock  –   –   –   (7,057)
Cumulative dividends on Series F preferred stock  –   –   –   (191)
Net loss attributable to common stockholders $(22,983) $(20,579) $(71,348) $(54,302)
                
Net loss per share, basic and diluted:                
Net loss $(0.87) $(0.97) $(2.94) $(2.80)
Deemed dividend – accretion of discount on Series F preferred stock  –   –   –   (0.04)
Deemed dividend – exchange of Series F preferred stock  –   –   –   (0.43)
Cumulative dividends on Series F preferred stock  –   –   –   (0.01)
Net loss attributable to common stockholders $(0.87) $(0.97) $(2.94) $(3.28)
Weighted average shares outstanding, basic and diluted:  26,405,307   21,154,661   24,273,774   16,535,419 
Net loss per share, basic and diluted $(0.18) $(0.87) $(0.89) $(2.94)
Weighted average shares outstanding, basic and diluted  38,761,141   26,405,307   36,743,864   24,273,774 

The accompanying notes are an integral part of these condensed consolidated financial statements

54

 

POLARITYTE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited, in thousands)

 2020  2019  2020  2019 
 For the three months ended For the nine months ended  For the Three Months Ended For the Nine Months Ended 
 September 30,  September 30,  September 30,  September 30, 
 2019  2018  2019  2018  2020  2019  2020  2019 
Net loss $(22,983) $(20,579) $(71,348) $(46,356) $(7,081) $(22,983) $(32,798) $(71,348)
Other comprehensive income:                
Unrealized (loss)/gain on available-for-sale securities  (16)  –   27   – 
Other comprehensive income/(loss):                
Unrealized gain on available-for-sale securities  –   113   11   425 
Reclassification of realized gains included in net loss  –   (129)  (83)  (398)
Comprehensive loss $(22,999) $(20,579) $(71,321) $(46,356) $(7,081) $(22,999) $(32,870) $(71,321)

The accompanying notes are an integral part of these condensed consolidated financial statements

65

 

POLARITYTE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited, in thousands, except share and per share amounts)

 For the nine months ended September 30, 2019  Number  Amount  Capital  Income  Deficit  Equity 
 Common Stock  Additional Paid-in  Accumulated Other Comprehensive  Accumulated  Total Stockholders’  For the Three and Nine Months Ended September 30, 2020 
 Number  Amount  Capital  Income  Deficit  Equity  Common Stock  Additional Paid-in  Accumulated Other Comprehensive  Accumulated  Total Stockholders’ 
December 31, 2018  21,447,088  $21  $414,840  $36  $(342,864) $72,033 
 Number  Amount  Capital  Income  Deficit  Equity 
Balance – December 31, 2019  27,374,653  $27  $474,174  $72  $(435,357) $38,916 
Issuance of common stock, net of issuance costs of $1.3 million  10,854,710   11   12,588   –   –   12,599 
Proceeds received from issuance of common stock, net of issuance costs of $1,146  0                     
Stock-based compensation expense  –   –   3,221   –   –   3,221 
Stock option exercises  10,000   –   31   –   –   31 
Issuance of restricted stock awards  -                     
Purchase of ESPP shares  -                     
Vesting of restricted stock units  158,513   –   –   –   –   – 
Shares withheld for tax withholding  (4,587)  –   (5)  –   –   (5)
Forfeiture of restricted stock awards  -                     
Other comprehensive loss  –   –   –   (69)  –   (69)
Net loss  –   –   –   –   (13,040)  (13,040)
Balance – March 31, 2020  38,393,289   38   490,009   3   (448,397)  41,653 
Balance – March 31, 2020  38,393,289   38   490,009   3   (448,397)  41,653 
Stock-based compensation expense  –   –   563   –   –   563 
Purchase of ESPP shares  38,293   –   40   –   –   40 
Vesting of restricted stock units  119,132   –   –   –   –   – 
Shares withheld for tax withholding  (6,918)  –   (9)  –   –   (9)
Forfeiture of restricted stock awards  (46,886)  –   –   –   –   – 
Other comprehensive loss  –   –   –   (3)  –   (3)
Net loss  –   –   –   –   (12,677)  (12,677)
Balance – June 30, 2020  38,496,910   38   490,603   –   (461,074)  29,567 
Balance – June 30, 2020  38,496,910   38   490,603   –   (461,074)  29,567 
Stock-based compensation expense  –   –   10,327   –   –   10,327   –   –   2,179   –   –   2,179 
Stock option exercises  283,250   1   528   –   –   529   208   –   –   –   –   – 
Vesting of restricted stock units  100,912   –   –   –   –   –   485,614   1   (1)  –   –   – 
Shares withheld for tax withholding  (82,011)  –   (740)  –   –   (740)  (70,727)  –   (105)  –   –   (105)
Other comprehensive income  –   –   –   17   –   17 
Net loss  –   –   –   –   (25,573)  (25,573)  –   –   –   –   (7,081)  (7,081)
March 31, 2019  21,749,239  $22  $424,955  $53  $(368,437) $56,593 
Proceeds received from issuance of common stock, net of issuance costs of $1,146  3,418,918   3   27,945   –   –   27,948 
Stock-based compensation expense  –   –   8,618   –   –   8,618 
Stock option exercises  9,167   –   –   –   –   – 
Shares issued under the ESPP  7,260   –   35   –   –   35 
Vesting of restricted stock units  51,440   –   –   –   –   – 
Shares withheld for tax withholding  (17,418)  –   (62)  –   –   (62)
Other comprehensive income  –   –   –   26   –   26 
Net loss  –   –   –   –   (22,792)  (22,792)
June 30, 2019  25,218,606  $25  $461,491  $79  $(391,229) $70,366 
Stock-based compensation expense  –   –   5,025   –   –   5,025 
Issuance of restricted stock awards  1,590,710   2   (2)  –   –   – 
Vesting of restricted stock units  123,448   –   –   –   –   – 
Other comprehensive income  –   –   –   (16)  –   (16)
Net loss  –   –   –   –   (22,983)  (22,983)
September 30, 2019  26,932,764  $27  $466,514  $63  $(414,212) $52,392 
Balance – September 30, 2020  38,912,005  $39  $492,676  $–  $(468,155) $24,560 

  For the nine months ended September 30, 2018 
  Preferred Stock  Common Stock  Additional Paid-in  Accumulated  Total Stockholders’ 
  Number  Amount  Number  Amount  Capital  Deficit  Equity 
December 31, 2017  1,656,838  $109,104   7,082,836  $7  $157,395  $(269,920) $(3,414)
Issuance of common stock in connection with:                            
Conversion of Series A preferred stock to common stock  (1,602,099)  (391)  363,036   –   391   –   – 
Conversion of Series B preferred stock to common stock  (47,689)  (4,020)  794,820   1   4,019   –   – 
Conversion of Series E preferred stock to common stock  (7,050)  (104,693)  7,050,000   7   104,686   –   – 
Exchange of Series F preferred stock and dividends to common stock  –   –   1,003,393   1   13,060   –   13,061 
Extinguishment of warrant liability  –   –   151,871   –   3,045   –   3,045 
Stock-based compensation expense  –   –   –   –   7,445   –   7,445 
Deemed dividend – accretion of discount on Series F preferred stock  –   –   –   –   (698)  –   (698)
Cumulative dividends on Series F preferred stock  –   –   –   –   (191)  –   (191)
Series F preferred stock dividends paid in common stock  –   –   11,708   –   306   –   306 
Net loss  –   –   –   –   –   (11,777)  (11,777)
March 31, 2018  –  $–   16,457,664  $16  $289,458  $(281,697) $7,777 
Proceeds received from issuance of common stock, net of issuance costs of $2,782  –   –   4,791,819   4   92,672   –   92,676 
Stock-based compensation expense  –   –   –   –   8,344   –   8,344 
Issuance of restricted stock awards  –   –   175,887   –   –   –   – 
Stock option exercises  –   –   20,000   –   64   –   64 
Net loss  –   –   –   –   –   (14,000)  (14,000)
June 30, 2018  –  $–   21,445,370  $20  $390,538  $(295,697) $94,861 
Stock-based compensation expense  –   –   –   –   10,453   –   10,453 
Issuance of restricted stock awards  –   –   7,613   –   –   –   – 
Stock option exercises  –   –   43,516   1   157   –   158 
Net loss  –   –   –   –   –   (20,579)  (20,579)
September 30, 2018  –  $–   21,496,499  $21  $401,148  $(316,276) $84,893 

  Number  Amount  Capital  Income  Deficit  Equity 
  For the Three and Nine Months Ended September 30, 2019 
  Common Stock  Additional Paid-in  Accumulated Other Comprehensive  Accumulated  Total Stockholders’ 
  Number  Amount  Capital  Income  Deficit  Equity 
Balance – December 31, 2018  21,447,088  $21  $414,840  $36  $(342,864) $72,033 
Stock-based compensation expense  –   –   10,327   –   –   10,327 
Stock option exercises  283,250   1   528   –   –   529 
Vesting of restricted stock units  100,912   –   –   –   –   – 
Shares withheld for tax withholding  (82,011)  –   (740)  –   –   (740)
Other comprehensive income  –   –   –   17   –   17 
Net loss  –   –   –   –   (25,573)  (25,573)
Balance – March 31, 2019  21,749,239   22   424,955   53   (368,437)  56,593 
Balance – March 31, 2019  21,749,239   22   424,955   53   (368,437)  56,593 
Proceeds received from issuance of common stock, net of issuance costs of $1,146  3,418,918   3   27,945   –   –   27,948 
Stock-based compensation expense  –   –   8,618   –   –   8,618 
Stock option exercises  9,167   –   –   –   –   – 
Purchase of ESPP shares  7,260   –   35   –   –   35 
Vesting of restricted stock units  51,440   –   –   –   –   – 
Shares withheld for tax withholding  (17,418)  –   (62)  –   –   (62)
Other comprehensive income  –   –   –   26   –   26 
Net loss  –   –   –   –   (22,792)  (22,792)
Balance – June 30, 2019  25,218,606   25   461,491   79   (391,229)  70,366 
Balance – June 30, 2019  25,218,606   25   461,491   79   (391,229)  70,366 
Stock-based compensation expense  –   –   5,025   –   –   5,025 
Issuance of restricted stock awards  1,590,710   2   (2)  –   –   – 
Vesting of restricted stock units  123,448   –   –   –   –   – 
Other comprehensive loss  –   –   –   (16)  –   (16)
Net loss                  (22,983)  (22,983)
Balance – September 30, 2019  26,932,764  $27  $466,514  $63  $(414,212) $52,392 

The accompanying notes are an integral part of these condensed consolidated financial statements

76

 

POLARITYTE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 2020  2019 
 For the nine months ended September 30,  

For the Nine Months Ended

September 30,

 
 2019  2018  2020  2019 
CASH FLOWS FROM OPERATING ACTIVITIES                
Net loss $(71,348) $(46,356) $(32,798) $(71,348)
Adjustments to reconcile net loss to net cash used in operating activities:                
Stock based compensation expense  23,932   26,242   5,963   23,932 
Change in fair value of derivatives  –   (1,850)
Depreciation and amortization  2,243   1,088   2,337   2,243 
Loss on extinguishment of warrant liability  –   520 
Amortization of intangible assets  146   83   142   146 
Amortization of debt discount  40   30   17   40 
Change in fair value of common stock warrant liability  (4,444)  – 
Change in fair value of contingent consideration  (48)  20   –   (48)
Loss on disposal of property and equipment  265   – 
Loss on abandonment and disposal of property and equipment  1,566   265 
Other non-cash adjustments  3   –   (21)  3 
Changes in operating assets and liabilities:                
Accounts receivable  (881)  (788)  (1,648)  (881)
Inventory  (10)  (238)  (655)  (10)
Prepaid expenses and other current assets  126   (561)  (332)  126 
Operating lease right-of-use assets  1,214   –   1,348   1,214 
Other assets  25   (210)  130   25 
Accounts payable and accrued expenses  4,095   2,484   (2,349)  4,095 
Other current liabilities  155   –   –   155 
Deferred revenue  (36)  116   (73)  (36)
Operating lease liabilities  (1,142)  –   (1,353)  (1,142)
Other long-term liabilities  571   –   –   571 
Net cash used in operating activities  (40,650)  (19,420)  (32,170)  (40,650)
CASH FLOWS FROM INVESTING ACTIVITIES                
Purchase of property and equipment  (2,386)  (6,640)  (1,225)  (2,386)
Purchase of available-for-sale securities  (29,002)  –   (14,144)  (29,002)
Proceeds from maturities of available-for-sale securities  14,636   –   16,945   14,636 
Proceeds from sale of available-for-sale securities  1,877   –   16,171   1,877 
Acquisition of IBEX  –   (2,258)
Net cash used in investing activities  (14,875)  (8,898)
Net cash provided by (used in) investing activities  17,747   (14,875)
CASH FLOWS FROM FINANCING ACTIVITIES                
Net proceeds from the sale of common stock  27,948   92,676 
Net proceeds from the sale of common stock and warrants  24,276   27,948 
Proceeds from stock options exercised  529   222   31   529 
Proceeds from ESPP purchase  35   –   40   35 
Cash paid for tax withholdings related to net share settlement  (679)  –   (114)  (679)
Payment of contingent consideration liability  (109)  (30)  –   (109)
Principal payments on financing leases  (336)  (39)  (376)  (336)
Principal payments on term note payable  (263)  – 
Proceeds from term note payable and financing arrangements  4,630   – 
Principal payments on term note payable and financing arrangements  (1,096)  (263)
Net cash provided by financing activities  27,125   92,829   27,391   27,125 
        
Net (decrease) increase in cash and cash equivalents  (28,400)  64,511 
Net increase (decrease) in cash and cash equivalents  12,968   (28,400)
Cash and cash equivalents - beginning of period  55,673   12,517   10,218   55,673 
Cash and cash equivalents - end of period $27,273  $77,028  $23,186  $27,273 
        
Supplemental schedule of non-cash investing and financing activities:        
Conversion of Series A, B, E preferred stock to common stock $–  $109,104 
Exchange of Series F preferred stock for common stock  –   13,061 
Extinguishment of warrant liability  –   2,525 
Non-cash investing and financing activities:        
Unpaid liability for acquisition of property and equipment  249   699  $10  $249 
Deemed dividend – accretion of discount on Series F preferred stock  –   698 
Cumulative dividends on Series F preferred stock  –   191 
Series F preferred stock dividends paid in common stock  –   306 
Reclassification of stock-based compensation expense that was previously classified as a liability to paid-in capital  38   –  $–  $38 
Contingent consideration for IBEX acquisition  –   278 
Contingent consideration earned and recorded in accounts payable  –   33 
Note payable issued as partial consideration for IBEX acquisition  –   1,220 
Unpaid tax liability related to net share settlement $5  $– 
Allocation of proceeds from sale of common stock and warrants to warrant liability $11,677  $– 
Property and equipment acquired through finance lease  2,341   141  $–  $2,341 
Property and equipment acquired through financing arrangement  58   –  $–  $58 
Unrealized gain on short-term investments  27   – 

The accompanying notes are an integral part of these condensed consolidated financial statements

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POLARITYTE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. PRINCIPAL BUSINESS ACTIVITY AND BASIS OF PRESENTATION

PolarityTE, Inc. and(together with its subsidiaries, (thethe “Company”) is a commercial-stage biotechnology company developing and regenerative biomaterials company focused on transforming the lives of patients by discovering, designing and developing a range ofcommercializing regenerative tissue products and biomaterials for the fields of medicine, biomedical engineering and material sciences.biomaterials.

Change in Fiscal Year end.On January 11, 2019, the Board approved an amendment to the Restated Bylaws of the Company changing the Company’s fiscal year end from October 31 to December 31. As such, the end of the quarters in the new fiscal year do not coincide with the end of the quarters in the Company’s previous fiscal years. The Company made this change to align its fiscal year end with other companies within its industry.

The accompanying interim condensed consolidated financial statements of the Company are unaudited, but in the opinion of management, reflect all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results for the interim period.periods presented. Accordingly, they do not include all information and notes required by generally accepted accounting principles for complete financial statements. The results of operations for interim periods are not necessarily indicative of results to be expected for the entire fiscal year. The balance sheet at December 31, 20182019 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (U.S. GAAP) for complete financial statements. These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the two-month periodyear ended December 31, 2018 included in the Company’s Transition Report on Form 10-KT2019 filed with the Securities and Exchange Commission on Form 10-K on March 18, 2019.12, 2020.

2. LIQUIDITY AND NEED FOR ADDITIONAL CAPITAL

The Company has experienced recurring losses and cash outflows from operating activities. As of September 30, 2020, the Company had an accumulated deficit of $468.2 million. As of September 30, 2020, the Company had cash and cash equivalents of $23.2million. The Company has been funded historically through sales of equity and debt.

On April 10, 2019, the Company completed an underwritten offering providing for the issuance and sale of 3,418,918 shares of the Company’s common stock, par value $0.001per share, at an offering price of $8.51 per share, for net proceeds of approximately $27.9million, after deducting offering expenses payable by the Company.

On December 5, 2019, the Company entered into an Equity Purchase Agreement (the “Purchase Agreement”), with Keystone Capital Partners, LLC (“Keystone”), pursuant to which Keystone has agreed to purchase from the Company up to $25.0 million of shares of its common stock, subject to certain limitations including a minimum stock price of $2.00, at the direction of the Company from time to time during the 36-month term of the Purchase Agreement. Concurrently, the Company entered into a Registration Rights Agreement with Keystone, pursuant to which it agreed to register the sales of its common stock pursuant to the Purchase Agreement under the Company’s existing shelf registration statement on Form S-3 or a new registration statement. On December 19, 2019, the Company sold 54,090 shares under the Purchase Agreement at a purchase price of $2.31 per share, for total proceeds of $0.1 million. During the three months ended March 31, 2020, the Company completed four additional sales of common stock to Keystone under the Purchase Agreement for a total of 216,412shares generating total gross proceeds of $0.6 million.

On February 14, 2020, the Company completed an underwritten offering of 10,638,298 shares of its common stock and warrants to purchase 10,638,298 shares of common stock. Each common share and warrant were sold together for a combined public purchase price of $2.35 before underwriting discount and commission. The exercise price of each warrant is $2.80 per share, the warrants were exercisable immediately, and they will expire February 12, 2027. The net proceeds to the Company from the offering were $22.5 million, after offering expenses payable by the Company. In connection with this agreement, the Company agreed not to sell any additional shares under the Keystone Purchase Agreement for a period of 90 days after the closing date of the offering.

The Company entered into a promissory note for $3.6 million under the Paycheck Protection Program on April 12, 2020. Additional details are available in note 12.

In the second quarter of 2020 the Company took steps to reduce cash burn by reducing payroll expense, adopting a salary and wage reduction, and reducing discretionary spending across the organization to minimal levels.

8

 

2.

The Company does not expect existing cash as of September 30, 2020 to be sufficient to fund the Company’s operations for at least twelve months from the date of filing. The Company will seek additional capital through equity offerings or debt financing. However, such financing may not be available in the future on favorable terms, if at all. If adequate financing is not available, the Company may be required to delay, reduce the scope of, or eliminate one or more of its product development programs, or be unable to continue operations over a longer term. These financial statements have been prepared on a going concern basis, which assumes the Company will continue to realize its assets and settle its liabilities in the normal course of business. The Company has incurred recurring losses and negative cash flows, has not yet generated material revenue from operations, and will require additional funds to maintain its operations. These factors raise substantial doubt regarding the Company’s ability to continue as a going concern within one year after these condensed consolidated financial statements are issued. No adjustments have been made to these consolidated financial statements as a result of these uncertainties.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation.Consolidation.The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.

Use of estimates.estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”)GAAP 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 is the extent of progress toward completion of contracts, stock-based compensation, valuation of common stock warrant liability, and the valuation allowances for deferred tax benefits, and the valuation of tangible and intangible assets included in acquisitions.benefits. Actual results could differ from those estimates.

Segments.The Company’s operations are based in the United States and involve products and services which are managed separately. Accordingly, it operates in two segments: 1) regenerative medicine products and 2) contract services. The Chief Operating Decision Maker (CODM) is our Office of the Chief Executive consisting of the Chief Operating Officer, the Chief Financial Officer, and the President of Corporate Development. The CODM allocates resources to and assesses the performance of each operating segment using information about its revenue and operating income (loss). Prior to the acquisition of IBEX, the Company operated in one segment.

Cash and cash equivalents.equivalents. Cash equivalents consist of highly liquid investments with original maturities of three months or less from the date of purchase.

Investments. Investments in debt securities have been classified as available-for-sale and are carried at fair value, with unrealized gains and losses reported as a component of accumulated other comprehensive income. Realized gains and losses are included in other income (expenses), net. The cost of securities sold is based on the specific-identification method. Interest on marketable securities is included in interest income, net. Investments with original maturities of greater than three months but less than one year from the date of purchase are classified as current. Investments with original maturities of greater than one year from the date of purchase are classified as non-current.

Loss Per Share.Basic loss per share of common stock is computed by dividing net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding for the period. Since the Company was in a loss position for all periods presented, basic net loss per share is the same as diluted net loss per share since the effects of potentially dilutive securities are antidilutive.

Leases. The Company determines if an arrangement is a lease at inception. Right-of-use (“ROU”) assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Finance leases are reported in ourthe condensed consolidated balance sheet in property and equipment and other current and long-term liabilities. The short-term portion of operating lease obligations are included in other current liabilities. The classification of the Company’s leases as operating or finance leases along with the initial measurement and recognition of the associated ROU assets and lease liabilities is performed at the lease commencement date. The measurement of lease liabilities is based on the present value of future lease payments over the lease term. As the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of future lease payments. The ROU asset is based on the measurement of the lease liability and also includes any lease payments made prior to or on lease commencement and excludes lease incentives and initial direct costs incurred, as applicable. The lease terms may include options to extend or terminate the lease when it is reasonably certain the Company will exercise any such options. Rent expense for the Company’s operating leases is recognized on a straight-line basis over the lease term. Amortization expense for the ROU asset associated with its finance leases is recognized on a straight-line basis over the term of the lease and interest expense associated with its finance leases is recognized on the balance of the lease liability using the effective interest method based on the estimated incremental borrowing rate.

The Company has lease agreements with lease and non-lease components. As allowed under TopicASC 842, the Company has elected not to separate lease and non-lease components for any leases involving real estate and office equipment classes of assets and, as a result, accounts for the lease and non-lease components as a single lease component. The Company has also elected not to apply the recognition requirement of TopicASC 842 to leases with a term of 12 months or less for all classes of assets.

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Stock- Based Compensation.Revenue Recognition. Revenue is recognized when a customer obtains control of promised goods or services, in an amount that reflects the consideration that the Company expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation.

The Company measures all stock-based compensationrecords product revenues primarily from the sale of its regenerative tissue products. The Company sells its products to employees usinghealthcare providers (customers), primarily through direct sales representatives. Product revenues consist of a fair value method and records such expensesingle performance obligation that the Company satisfies at a point in time. In general, and administrative, research and development, and sales and marketing expenses. For stock options with graded vesting, the Company recognizes compensation expenseproduct revenue upon delivery to the customer.

The Company records service revenues from the sale of its preclinical research services and contract services. Preclinical research services include delivery of preclinical studies and other research services to unrelated third parties. These customer contracts generally consist of a single performance obligation that the Company satisfies over time using an input method based on costs incurred to date relative to the total costs expected to be required to satisfy the performance obligation. The Company believes that this method provides an appropriate measure of the transfer of services over the service period for each separately vesting trancheterm of the award as though the award were in substance, multiple awardsperformance obligation based on the fair valueremaining services needed to satisfy the obligation. This requires the Company to make reasonable estimates of the extent of progress toward completion of the contract. As a result, unbilled receivables and deferred revenue are recognized based on payment timing and work completed. Generally, a portion of the datepayment is due upfront and the remainder upon completion of grant.the contract, with most contracts completing in less than a year. Contract services include research and laboratory testing services to unrelated third parties on a contract basis. These customer contracts generally consist of a single performance obligation that the Company satisfies at a point in time. The Company recognizes revenue upon delivery of testing results to the customer.

The fair value

For the three months ended September 30, 2020 revenue from two hospital systems accounted for options issued is estimated at55% of total revenue in the dateregenerative medicine product segment. For the nine months ended September 30, 2020 revenue from one hospital system accounted for 33% of grant using a Black-Scholes option-pricing model. The risk-free rate is derivedtotal revenue in the regenerative medicine product segment. As of September 30, 2020, accounts receivable from the U.S. Treasury yield curve in effect attwo hospital systems represented 10% of total accounts receivable.

For the timethree months ended September 30, 2020 revenue from 32 facilities controlled by a single company accounted for 94% of COVID-19 testing revenues. For the grant. The volatility factor is determined based onnine months ended September 30, 2020 revenue from 32 facilities controlled by a single company accounted for 96% of COVID-19 testing revenues. As of September 30, 2020, accounts receivable from the Company’s historical stock prices. Forfeitures are recognized as they occur.32 facilities represented 40% of total accounts receivable.

The value of restricted stock grants is measured based on the fair market value of the Company’s common stock on the date of grant and amortized over the vesting period of, generally, six months to three years.

The accounting for non-employee options and restricted stock is similar to that of employees. Stock-based compensation expense for nonemployee services has historically been subject to remeasurement at each reporting date as the underlying equity instruments vest and was recognized as an expense over the period during which services are received. Upon the adoption of ASU 2018-07, Compensation – Stock Compensation on January 1, 2019, the valuation was fixed at the implementation date and will be recognized as an expense on a straight-line basis over the remaining service period.

Research and Development Expenses.Expenses. Costs incurred for research and development are expensed as incurred.

Nonrefundable advance payments for goods or services that have the characteristics that will be used or rendered for future research and development activities pursuant to executory contractual arrangements with third party research organizations are deferred and recognized as an expense as the related goods are delivered or the related services are performed.

Accruals for Research and Development Expenses and Clinical Trials.Trials. As part of the process of preparing its financial statements, the Company is required to estimate its expenses resulting from its obligations under contracts with vendors, clinical research organizations and consultants and under clinical site agreements in connection with conducting clinical trials. The financial terms of these contracts are subject to negotiations, which vary from contract to contract and may result in payment terms that do not match the periods over which materials or services are provided under such contracts. The Company’s objective is to reflect the appropriate expenses in its financial statements by matching those expenses with the period in which services are performed and efforts are expended. The Company accounts for these expenses according to the timing of various aspects of the expenses. The Company determines accrual estimates by taking into account discussion with applicable personnel and outside service providers as to the progress of clinical trials, or the services completed. During the course of a clinical trial, the Company adjusts its clinical expense recognition if actual results differ from its estimates. The Company makes estimates of its accrued expenses as of each balance sheet date based on the facts and circumstances known to it at that time. The Company’s clinical trial accruals are dependent upon the timely and accurate reporting of contract research organizations and other third-party vendors. Although the Company does not expect its estimates to be materially different from amounts actually incurred, its understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in it reporting amounts that are too high or too low for any particular period.

Common Stock Warrant Liability. The Company accounts for common stock warrants issued as freestanding instruments in accordance with applicable accounting guidance as either liabilities or as equity instruments depending on the specific terms of the warrant agreement. The Company’s warrants under certain change of control situations, could require settlement in cash, which require the warrants to be recorded as liabilities. Warrants classified as liabilities are remeasured each period until settled or until classified as equity.

10

 

Revenue Recognition.Stock-Based Compensation Revenue is recognized when. The Company measures all stock-based compensation to employees and non-employees using a customer obtains control of promised goods or services,fair value method and records such expense in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606,general and administrative, research and development, and sales and marketing expenses. For stock options with graded vesting, the Company performsrecognizes compensation expense over the following five steps: (i) identifyservice period for each separately vesting tranche of the contract(s) withaward as though the award were in substance, multiple awards based on the fair value on the date of grant.

The fair value of options issued is estimated at the date of grant using a customer; (ii) identifyBlack-Scholes option-pricing model. The risk-free rate is derived from the performance obligationsU.S. Treasury yield curve in effect at the contract; (iii) determinetime of the transaction price; (iv) allocategrant. The volatility factor is determined based on the transaction priceCompany’s historical stock prices. Forfeitures are recognized as they occur.

The fair value of restricted stock grants is measured based on the fair market value of the Company’s common stock on the date of grant and amortized over the vesting period of, generally, six months to three years.

Loss Per Share. Basic net loss per share of common stock is computed by dividing net loss attributable to common stockholders by the performance obligations inweighted average number of shares of common stock outstanding for the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation.

In the regenerative medicine products segment,period. Since the Company records products revenues primarily fromwas in a loss position for all periods presented, basic net loss per share is the salesame as diluted net loss per share since the effects of its regenerative tissue products.potentially dilutive securities are antidilutive. Further, any gain on the warrant liability may be considered dilutive when the average market price of the common stock during the period exceeds the exercise price of the warrant.

Impairment of Long-Lived Assets. The Company sells its products to healthcare providers, primarily through direct sales representatives. Products revenues consistsreviews long-lived assets, including property and equipment, intangible assets, and goodwill for impairment whenever events or changes in business circumstances indicate that the carrying amount of a single performance obligationthe assets may not be fully recoverable. Factors that the Company satisfies atconsiders in deciding when to perform an impairment review include significant underperformance of the business in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in the use of the assets. If an impairment review is performed to evaluate a point in time. In general,long-lived asset for recoverability, the Company recognizes products revenues upon deliverycompares forecasts of undiscounted cash flows expected to the customer.

In the contract services segment, the Company records services revenuesresult from the saleuse and eventual disposition of the long-lived asset to its contract research services, which includes delivery of preclinical studies and other research services to unrelated third parties. Services revenues generally consist of a single performance obligation that the Company satisfies over time using an input method based on costs incurred to date relative to the total costscarrying value. An impairment loss would be recognized when estimated undiscounted future cash flows expected to be required to satisfyresult from the performance obligation.use of an asset are less than its carrying amount. The Company believes that this method provides a faithful depiction of the transfer of services over the term of the performance obligationimpairment loss would be based on the remaining services needed to satisfy the obligation. This requires the Company to make reasonable estimatesexcess of the extent of progress toward completioncarrying value of the contract. As a result, unbilled receivables and deferred revenue are recognizedimpaired asset over its fair value, determined based on payment timing and work completed. Generally, a portion of the payment is due upfront and the remainder upon completion of the study, with most studies completing in less than a year. As of September 30, 2019 and December 31, 2018, the Company had unbilled receivables of $222,000 and $157,000 and deferred revenue of $134,000 and $170,000, respectively. The unbilled receivables balance is included in consolidated accounts receivable. Revenues of $170,000 were recognized during the nine months ended September 30, 2019 that were included in the deferred revenue balance at the beginning of the period.discounted cash flows.

Costs to obtain the contract are incurred for products revenues as they are shipped and are expensed as incurred.

Recent Accounting Pronouncements

In August 2018, the FASB issued ASU 2018-13,Fair Value Measurement (Topic 820), Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. The ASU modifies the disclosure requirements for fair value measurements by removing, modifying or adding certain disclosures. The standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years with early adoption permitted. The Company is currently evaluating the impact that the standard will have on its consolidated financial statements and related disclosures.

In June 2016, the FASB issued ASU No. 2016-13,Financial Instruments-Credit Losses (Topic 326), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost. This standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years with early adoption permitted. In November 2019, the FASB issued ASU No. 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815) and Leases (Topic 842): Effective Dates, which defers the effective date of Topic 326. As a smaller reporting company, Topic 326 will now be effective for the Company beginning January 1, 2023. As such, the Company plans to adopt this ASU beginning January 1, 2023. The Company is currently evaluating the impact that the standard will have on its consolidated financial statements and related disclosures.

Recently Adopted Accounting Pronouncements

On January 1, 2019 the Company adopted ASU 2016-02,Leases (ASC 842) and related amendments, which require lease assets and liabilities to be recorded on the balance sheet for leases with terms greater than twelve months. 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. The standard was adopted using the modified retrospective transition approach by applying the new standard to all leases existing at the date of the initial application and not restating comparative periods.

We elected the package of practical expedients permitted under the transition guidance, which allowed us to carryforward our historical lease classification, our assessment on whether a contract was or contains a lease, and our initial direct costs for any leases that existed prior to January 1, 2019. The impact of the adoption of ASC 842 on the accompanying Condensed Consolidated Balance Sheet as of January 1, 2019 was as follows (in thousands):

  December 31, 2018  

Adjustments Due to the

Adoption of ASC 842

  January 1, 2019 
Operating lease right-of-use assets $–  $                                5,305  $5,305 
Liabilities:            
Accounts payable and accrued expenses $6,508  $(75) $6,433 
Other current liabilities  316   1,432   1,748 
Operating lease liabilities  –   3,948   3,948 

The adjustments due to the adoption of ASC 842 related to the recognition of operating lease right-of-use assets and operating lease liabilities for the existing operating leases. A cumulative-effect adjustment to beginning accumulated deficit was not required.

In JuneAugust 2018, the FASB issued ASU 2018-07,2018-13, Compensation – Stock CompensationFair Value Measurement (Topic 718): Improvements820), Disclosure Framework-Changes to Nonemployee Share-based Payment Accountingthe Disclosure Requirements for Fair Value Measurement. The standard expandsASU modifies the scope of Topic 718 to include share-based payments issued to nonemployeesdisclosure requirements for goodsfair value measurements by removing, modifying or services, simplifying the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, withadding certain exceptions.disclosures. The standard is effective for fiscal years beginning after December 15, 2018,2019, including interim periods within those fiscal years with early adoption permitted, including adoption in an interim period.permitted. The Company adopted this ASUstandard on January 1, 2019.2020. The adoption of this ASU did not have a material impact on the Company’s condensed consolidated financial statements and related disclosures.

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3. LIQUIDITY

In August 2018, the FASB issued ASU 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The ASU aligns the requirements of capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. Adoption of the ASU is either retrospective or prospective. The Company has experienced recurring losses and cash outflows from operating activities. Since inception through September 30, 2019, the Company has an accumulated deficitadopted this standard prospectively on January 1, 2020. The adoption of $414.2 million. As of September 30, 2019, the Company had cash and cash equivalents and short-term investments of $45.9 million.

On April 10, 2019, the Company completed an underwritten offering providing for the issuance and sale of 3,418,918 shares ofthis ASU did not have a material impact on the Company’s common stock, par value $0.001 per share, at an offering price of $8.51 per share, for net proceeds of approximately $27.9 million, after deducting offering expenses payable by the Company.condensed consolidated financial statements and related disclosures.

Based upon the current status of the Company’s product development and commercialization plans, the Company believes that its existing cash, cash equivalents and short-term investments will be adequate to satisfy its capital needs for at least the next 12 months from the date of filing. The Company anticipates needing substantial additional financing to continue clinical deployment and commercialization of its lead product SkinTE, development of its other product candidates, and scaling the manufacturing capacity for its products and product candidates and prepare for commercial readiness. However, the Company will continue to pursue fundraising opportunities when available, but such financing may not be available in the future on terms favorable to the Company, if at all. If adequate financing is not available, the Company may be required to delay, reduce the scope of, or eliminate one or more of its product development programs. The Company may also implement additional spending reductions. The Company plans to meet its capital requirements primarily through issuances of equity securities, debt financing, revenue from product sales and future collaborations. Failure to generate revenue or raise additional capital would adversely affect the Company’s ability to achieve its intended business objectives.

4. FAIR VALUE

In accordance withASC 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. This methodology applies to our Level 1 investments, which are composed of money market funds.
●Level 2: Quoted prices for similar instruments that are directly or indirectly observable in the market. This methodology applies to our Level 2 investments, which are composed of corporate debt securities, commercial paper, and U.S. government debt securities.
●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. This methodology applies to our Level 3 financial instruments, which are composed of contingent consideration.

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. There were no transfers within the hierarchy for any of the periods presented.

In connection withDuring the offering of Units innine months ended September 2017 (see Note 10),30, 2020, the Company issued Series F Preferred Shares and warrantstransferred all available-for-sale securities to purchase an aggregate of 322,727 shares of common stock. The Series F Preferred Shares contained an embedded conversion feature that was not clearly and closely related to the identified host instrument and, as such, was recognized as a derivative liability measured at fair value. The Company classified these derivatives on the consolidated balance sheet as a current liability. The warrants were exercisable at $30.00 per share and had a two year expiration. The warrants were liabilities pursuant to ASC 815. The warrant agreement provided for an adjustment to the number of common shares issuable under the warrant or adjustment to the exercise price, including but not limited to, if: (a) the Company issues shares of common stock as a dividend or distribution to holders of its common stock; (b) the Company subdivides or combines its common stock (i.e., stock split); or (c) the Company issues new securities for consideration less than the exercise price. Under ASC 815, warrants that provide for down-round exercise price protection are recognized as derivative liabilities.cash accounts.

As discussed in Note 10, both the warrants and the Series F Preferred Shares were exchanged for common stock on March 6, 2018.

The fair value of the bifurcated embedded conversion feature was estimated to be approximately $7.2 million at March 5, 2018, as calculated using the Monte Carlo simulation with the following assumptions:

  Series F
Conversion
Feature		 
  March 5, 2018 
Stock price $20.05 
Exercise price $27.50 
Risk-free rate  2.2%
Volatility  88.2%
Term  1.5 

The fair value of the warrant liability was estimated to be approximately $2.5 million at March 5, 2018 as calculated using the Monte Carlo simulation with the following assumptions:

  Warrant Liability 
  March 5, 2018 
Stock price $20.05 
Exercise price $30.00 
Risk-free rate  2.2%
Volatility  88.2%
Term  1.5 

The following table sets forth the changes in the estimated fair value for our Level 3 classified derivative liabilities (in thousands):

  2017 Series F Preferred Stock – Warrant Liability  2017 Series F Preferred Stock – Embedded Derivative  Total Warrant and Derivative Liability 
Fair value – December 31, 2017 $3,388  $8,150  $11,538 
Change in fair value  (863)  (987)  (1,850)
Exchange / conversion to common shares  (2,525)  (7,163)  (9,688)
Fair value – September 30, 2018 $–  $–  $– 

The following table sets forth the fair value of the Company’s financial assets and liabilities measured on a recurring basis by level within the fair value hierarchy (in thousands):

SCHEDULE OF FAIR VALUE OF FINANCIAL INSTRUMENTS MEASURED ON RECURRING BASIS

  September 30, 2020 
  Level 1  Level 2  Level 3  Total 
Liabilities:                
Common stock warrant liability $–  $–  $7,233  $7,233 
Total $–  $–  $7,233  $7,233 

  December 31, 2019 
  Level 1  Level 2  Level 3  Total 
Assets:            
Money market funds $2,019  $–  $–  $2,019 
Commercial paper  –   11,064   –   11,064 
Corporate debt securities  –   8,982   –   8,982 
U.S. government debt securities  –   3,770   –   3,770 
Total $2,019  $23,816  $–  $25,835 
Liabilities:                
Contingent consideration $–  $–  $31  $31 
Total $–  $–  $31  $31 

The fair value of the common stock warrant liability is estimated using a Monte Carlo simulation model, which uses certain assumptions related to risk-free interest rates, expected volatility, and expected term. The fair value of the warrant liability was $11.7 million upon the issuance date of February 14, 2020 and $7.2million as of September 30, 2019 and December 31, 2018 (in thousands):2020.

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  Fair Value Measurement as of September 30, 2019 
  Level 1  Level 2  Level 3  Total 
Assets:            
Money market funds $7  $–  $–  $7 
Commercial paper  –   12,053   –   12,053 
Corporate debt securities  –   13,995   –   13,995 
U.S. government debt securities  –   4,632   –   4,632 
Total $7  $30,680  $–  $30,687 
Liabilities:                
Contingent consideration $–  $–  $135  $135 
Total $–  $–  $135  $135 

  Fair Value Measurement as of December 31, 2018 
  Level 1  Level 2  Level 3  Total 
Assets:            
Money market funds $7  $–  $–  $7 
Commercial paper  –   21,392   –   21,392 
Corporate debt securities  –   5,448   –   5,448 
U.S. government debt securities  –   3,226   –   3,226 
Total $7  $30,066  $–  $30,073 
Liabilities:                
Contingent consideration $–  $–  $261  $261 
Total $–  $–  $261  $261 

In May 2018, the Company purchased the assets of a preclinical research sciences business and related real estate from Ibex Group, L.L.C., a Utah limited liability company, and Ibex Preclinical Research, Inc., a Utah corporation (collectively, “IBEX”). The aggregate purchase price was $3.8 million, of which $2.3 million was paid at closing and the balance satisfied by a promissory note payable to IBEX with an initial fair value of $1.2 million and contingent consideration with an initial fair value of $0.3 million.

The contingent consideration represents the estimated fair value of future payments due to the Seller of IBEX based on IBEX’s revenue generated from studies quoted prior to but completed after the transaction. Contingent consideration was initially recognized at fair value as purchase consideration and is subsequently remeasured at fair value through earnings. The initial fair value of the contingent consideration was based on the present value of estimated future cash flows using a 20% discount rate. The contingent consideration is the payment of 15% of the actual revenues received for work on any study initiated within 18 months following the closing of the purchase on the basis of certain specific customer prospects that received service proposals prior to the closing, provided that the total payments will not exceed $650,000. Adjustments toassumptions were used in estimating the fair value of the warrant liability as of September 30, 2020 and upon the issuance date of February 14, 2020:

SCHEDULE OF FAIR VALUE ASSUMPTIONS OF WARRANTS LIABILITY

  September 30, 2020  

February 14, 2020

 
Stock price $1.04  $1.69 
Exercise price $2.80  $2.80 
Risk-free rate  0.41%  1.51%
Volatility  99.6%  93.40%
Term  6.37   6.99 

The contingent consideration liability is included in general and administrative expense inrelated to the accompanying consolidated statementsIBEX acquisition of operations.

The following table sets forth$31,000 outstanding at December 31, 2019, was paid during the changes innine months ended September 30, 2020. As of September 30, 2020, the estimated fair value of ourobligation related to the contingent consideration liability (in thousands) which is included in other current liabilities:was fully satisfied.

  Contingent Consideration 
Fair value – December 31, 2018 $261 
Change in fair value  (48)
Earned and paid  (78)
Fair value – September 30, 2019 $135 

5. CASH EQUIVALENTS AND AVAILABLE FOR SALE MARKETABLE SECURITIESSHORT-TERM INVESTMENTS

During the nine months ended September 30, 2020, the Company transferred all available-for-sale securities to cash accounts.

Cash equivalents and available-for-sale marketable securitiesshort-term investments consisted of the following as of September 30, 2019 and December 31, 20182019 (in thousands):

  September 30, 2019 
  Amortized
Cost		  Unrealized
Gains		  Unrealized
Losses		  Market Value 
Cash equivalents:                
Money market funds $7  $–  $–  $7 
Commercial paper  10,037   32   –   10,069 
U.S. government debt securities  1,930   6   –   1,936 
Total cash equivalents (1)  11,974   38   –   12,012 
Short-term investments:                
Commercial paper  1,980   4   –   1,984 
U.S. government debt securities  2,686   10   –   2,696 
Corporate debt securities  13,984   11   –   13,995 
Total short-term investments  18,650   25   –   18,675 
Total $30,624  $63  $–  $30,687 

SCHEDULE OF CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

  December 31, 2019 
  Amortized Cost  Unrealized Gains  Unrealized Losses  Market Value 
Cash equivalents:                
Money market funds $2,019  $–  $–  $2,019 
Commercial paper  1,020   4   –   1,024 
U.S. government debt securities  3,761   9   –   3,770 
Total cash equivalents (1)  6,800   13   –   6,813 
Short-term investments:                
Commercial paper  9,986   54   –   10,040 
Corporate debt securities  8,977   5   –   8,982 
Total short-term investments  18,963   59   –   19,022 
Total $25,763  $72  $–  $25,835 

(1)Included in cash and cash equivalents in the Company’s consolidated balance sheet as of September 30, 2019 in addition to $15.3 million of cash.

  December 31, 2018 
  Amortized Cost  Unrealized Gains  Unrealized Losses  Market Value 
Cash equivalents:                
Money market funds $7  $–  $–  $7 
Commercial paper  20,648   30   –   20,678 
U.S. government debt securities  3,224   2   –   3,226 
Total cash equivalents (1)  23,879   32   –   23,911 
Short-term investments:                
Commercial paper  714   –   –   714 
Corporate debt securities  5,444   5   (1)  5,448 
Total short-term investments  6,158   5   (1)  6,162 
Total $30,037  $37  $(1) $30,073 

(1)Included in cash and cash equivalents in the Company’s consolidated balance sheet as of December 31, 20182019 in addition to $31.8 $3.4 million of cash.

All investments in debt securities held as of September 30, 2019 and December 31, 2018 had maturities of less than one year. For the three and nine months ended September 30, 2020 and 2019, the Company recognized net realized gains on available-for-sale securities and cash equivalents of $0.1 $0.1million and $0.4 $0.4 million, respectively.

6. PROPERTY AND EQUIPMENT, NET

The following table presents the components of property and equipment, net (in thousands):

SCHEDULE OF PROPERTY AND EQUIPMENT, NET

  September 30, 2020  December 31, 2019 
Machinery and equipment $12,215  $12,083 
Land and buildings  2,000   2,000 
Computers and software  1,240   1,189 
Leasehold improvements  3,057   2,282 
Construction in progress  169   1,606 
Furniture and equipment  233   470 
Total property and equipment, gross  18,914   19,630 
Accumulated depreciation and amortization  (6,944)  (4,719)
Total property and equipment, net $11,970  $14,911 

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  September 30, 2019  December 31, 2018 
Machinery and equipment $11,814  $8,276 
Land and buildings  2,000   2,000 
Computers and software  1,173   1,372 
Leasehold improvements  2,272   1,230 
Construction in progress  1,903   2,402 
Furniture and equipment  470   614 
Total property and equipment, gross  19,632   15,894 
Accumulated depreciation  (3,970)  (2,158)
Total property and equipment, net $15,662  $13,736 

Depreciation and amortization expense for property and equipment, including assets acquired under financing leases for the three and nine months ended September 30, 2019 and 2018 was as follows (in thousands):

  For the three months ended  For the nine months ended 
  September 30,  September 30, 
  2019  2018  2019  2018 
General and administrative expense $407  $80  $1,171  $89 
Research and development expense  390   336   1,072   999 
Total depreciation and amortization expense $797  $416  $2,243  $1,088 

For the three and nine months ended September 30, 2019, the Company recognized a loss on disposal of property and equipment of $265,000.SCHEDULE OF DEPRECIATION AND AMORTIZATION EXPENSE

  For the Three Months Ended  For the Nine Months Ended 
  September 30,  September 30, 
  2020  2019  2020  2019 
General and administrative expense $402  $407  $1,202  $1,171 
Research and development expense  386   390   1,135   1,072 
Total depreciation and amortization expense $788  $797  $2,337  $2,243 

7. LEASES

7. LEASES

The Company leases facilities and certain equipment under noncancelable leases that expire at various dates through November 2024. These leases require monthly lease payments that may be subject to annual increases throughout the lease term. Certain of these leases may include options to extend or terminate the lease at the election of the Company.These optional periods have not been considered in the determination of the right-of-use-assets or lease liabilities associated with these leases as the Company did not consider it reasonably certain it would exercise the options.

In April 2019,May 2020, the Company entered into anreduced space under one of its facility leases, which resulted in a remeasurement of the operating lease to obtain 6,307 square feetliability. See Note 15 for further discussion of manufacturing, laboratory, and office space. The lease expires April 2024 and requires monthly lease payments subject to annual increases. During the nine months ended September 30, 2019, the Company also increased office space under an existing lease, which requires additional monthly lease payments.modification.

As of September 30, 2019,2020, the maturities of our operating and finance lease liabilities were as follows (in thousands):

  Operating leases  Finance leases 
2019 (excluding the nine months ended September 30, 2019) $551  $149 
2020  2,114   597 
2021  1,730   594 
2022  1,345   329 
2023  132   253 
Thereafter  87   43 
Total lease payments  5,959   1,965 
Less:        
Imputed interest  (787)  (310)
Total $5,172  $1,655 

SCHEDULE OF OPERATING AND FINANCE LEASE LIABILITIES 

  Operating leases  Finance leases 
2020 (excluding the nine months ended September 30, 2020) $416  $166 
2021  1,646   656 
2022  1,345   405 
2023  132   336 
2024  86   42 
Total lease payments  3,625   1,605 
Less imputed interest  (369)  (206)
Total lease liabilities $3,256  $1,399 

Supplemental balance sheet information related to leases was as follows (in thousands):

Finance leases

SCHEDULE OF SUPPLEMENTAL BALANCE SHEET INFORMATION RELATED TO FINANCE AND OPERATING LEASES

  

September 30,

2020

  

December 31,

2019

 
Finance lease right-of-use assets included within property and equipment, net $1,466  $2,177 
         
Current finance lease liabilities included within other current liabilities $544  $508 
Non-current finance lease liabilities included within other long-term liabilities  855   1,267 
Total finance lease liabilities $1,399  $1,775 

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Finance leases

  As of
September 30, 2019		 
Finance lease right-of-use assets included within property and equipment, net $2,112 
     
Current finance lease liabilities included within other current liabilities $456 
Non-current finance lease liabilities included within other long-term liabilities  1,199 
Total $1,655 

Operating leases

 As of
September 30, 2019		  

September 30,

2020

  

December 31,

2019

 
Current operating lease liabilities included within other current liabilities $1,814  $1,439  $1,746 
Operating lease liabilities – non current  3,358   1,817   2,994 
Total $5,172 
Total operating lease liabilities $3,256  $4,740 

The components of lease expense were as follows (in thousands):

  Three months ended September 30, 2019  Nine months ended September 30, 2019 
Operating lease costs included within operating costs and expenses $556  $1,617 
Finance lease costs:        
Amortization of right of use assets $171  $479 
Interest on lease liabilities  42   109 
Total $213  $588 

SUMMARY OF COMPONENTS OF LEASE EXPENSE 

  For the Three Months Ended  For the Nine Months Ended 
  September 30,  September 30, 
  2020  2019  2020  2019 
Operating lease costs included within operating costs and expenses $531  $556  $1,635  $1,617 
Finance lease costs:                
Amortization of right-of-use assets $175  $171  $524  $479 
Interest on lease liabilities  36   42   118   109 
Total $211  $213  $642  $588 

Supplemental cash flow information related to leases was as follows (in thousands):

  

Nine months ended

September 30, 2019

 
Cash paid for amounts included in the measurement of lease liabilities:    
Operating cash out flows from operating leases $1,550 
Operating cash out flows from finance leases  109 
Financing cash out flows from finance leases  336 
Lease liabilities arising from obtaining right-of-use assets:    
Finance leases $1,828 
Lease payments made in prior period reclassified to property and equipment  535 
Remeasurement of finance lease liability due to lease modification  (22)
Operating leases  936 

SCHEDULE OF SUPPLEMENTAL CASH FLOW INFORMATION RELATED TO LEASES 

  For the Nine Months Ended September 30, 
  2020  2019 
Cash paid for amounts included in the measurement of lease liabilities:      
Operating cash out flows from operating leases $1,640  $1,550 
Operating cash out flows from finance leases $118  $109 
Financing cash out flows from finance leases $376  $336 
Lease liabilities arising from obtaining right-of-use assets:        
Finance leases $–  $1,828 
Lease payments made in prior period reclassified to property and equipment $–  $535 
Remeasurement of finance lease liability due to lease modification $–  $(22)
Operating leases $–  $936 
Remeasurement of operating lease liability due to lease modification $131  $– 

As of September 30, 2020 and December 31, 2019, the weighted average remaining operating lease term is 3.0 for operating leases was 2.3 and 2.8 years, respectively, and the weighted average discount rate used to determinefor operating leases was 9.79% and 9.83%, respectively. As of September 30, 2020 and December 31, 2019, the operating lease liability was 9.82%. The weighted average remaining finance lease term is 3.6 for finance leases was 2.8and 3.5years, respectively, and the weighted average discount rate used to determine thefor finance lease liabilityleases was 9.70%.9.77% for both periods.

15

 

8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

The following table presents the major components of accounts payable and accrued expenses (in thousands):

  September 30, 2019  December 31, 2018 
Accounts payable $3,716  $2,918 
Salaries and other compensation  1,263   1,280 
Legal and accounting  1,905   640 
Accrued severance  2,519   – 
Other accruals  830   1,670 
Total accounts payable and accrued expenses $10,233  $6,508 

Salaries and other compensation include accrued payroll expense, accrued bonus, and estimated employer 401(k) plan contributions.SCHEDULE OF ACCOUNTS PAYABLE AND ACCRUED EXPENSES

  

September 30,

2020

  

December 31,

2019

 
Accounts payable $1,384  $1,689 
Salaries and other compensation  1,362   1,462 
Legal and accounting  317   1,404 
Accrued severance  571   1,053 
Benefit plan accrual  588   557 
Other  596   930 
Total accounts payable and accrued expenses $4,818  $7,095 

Accrued severance includes $2.3 million for accrued compensation due to Dr. Denver Lough, a former officer and director, under a settlement terms agreement dated August 21, 2019. The remaining amount due of $0.6 million is included in other long-term liabilities.

Other current liabilities are comprised of the current portion of operating lease liabilities and finance lease liabilities, contingent consideration, and short-term debt. The short-term debt had a balance of $0.2 $0.3 million as of September 30, 2019,2020, while the other components are disclosed in the footnotesNote 7 above.

9. LONG TERM NOTE PAYABLE

In connection with the IBEX Acquisition in May 2018, the Company issued a promissory note payable to the Seller with an initial fair value of $1.2 million. The promissory note has a principalshort-term debt balance of $1.3 million and bears interest at a rate of 3.5% interest per annum. Principal and interest are payable in five equal installments that began on November 3, 2018 and continuing on each six-month anniversary thereafter (“Payment Date”). The promissory note may be prepaid by the Company at any time and becomes due and payable at the earlier of the maturity date of November 3, 2020 or upon an event of default, which includes failure to pay any installment on each Payment Date, breach of any negative covenants, insolvency or bankruptcy. Upon the occurrence of an event of default, the promissory note will bear an accelerated interest rate of 7% per annum from the date of the event of default.

The Company initially recognized the promissory note at its fair value, using an estimated market rate of interest for the Company, which was higher than the promissory note’s stated rate. The result of imputing a market rate of interest resulted in an initial discount to the principal balance of approximately $113,000, which is being amortized to interest expense over the term of the promissory note using the effective interest method. The unamortized debt discount was approximately $28,000 and $68,000 at September 30, 2019 and December 31, 2018, respectively. Amortization of debt discount of $12,000 and $40,000 was included in interest income, net for the three and nine months ended September 30, 2019.

10. PREFERRED SHARES AND COMMON SHARES

Exchange of 100% of Outstanding Series F Preferred Stock Shares and Warrants

On September 20, 2017, the Company sold an aggregate of $17,750,000 worth of units of the Company’s securities (the “Units”) to accredited investors at a purchase price of $2,750 per Unit. Each Unit consisted of (i) one share of the Company’s newly authorized 6% Series F Convertible Preferred Stock, par value $0.001 per share (the “Series F Preferred Shares”), convertible into one hundred (100) shares of the Company’s common stock, and (ii) a two-year warrant to purchase up to 322,727 shares of the Company’s common stock, at an exercise price of $30.00 per share.

The Series F Preferred Shares were convertible into shares of the Company’s common stock based on a conversion calculation equal to the stated value of the Series F Preferred Shares, plus all accrued and unpaid dividends, if any, on such Series F Preferred Shares, as of such date of determination, divided by the conversion price. The stated value of each Series F Preferred Share was $2,750 and the initial conversion price was $27.50 per share, each subject to adjustment for stock splits, stock dividends, recapitalizations, combinations, subdivisions or other similar events.

On the two-year anniversary of the initial issuance date, any Series F Preferred Shares outstanding and not otherwise already converted, would, at the option of the holder, either (i) automatically convert into common stock of the Company at the conversion price then in effect or (ii) be repaid by the Company based on the stated value of such outstanding Series F Preferred Shares.

The warrants issued in connection with the Series F Preferred Shares were determined to be liabilities pursuant to ASC 815. The warrant agreement provided for an adjustment to the number of common shares issuable under the warrant or adjustment to the exercise price, including but not limited to, if: (a) the Company issued shares of common stock as a dividend or distribution to holders of its common stock; (b) the Company subdivided or combined its common stock (i.e., stock split); or (c) the Company issues new securities for consideration less than the exercise price. Prior to the adoption of ASU 2017-11, warrants that provide for down-round exercise price protection were recognized as derivative liabilities.

The conversion feature within the Series F Preferred Shares was determined to not be clearly and closely related to the identified host instrument and, as such, was recognized as a derivative liability measured at fair value pursuant to ASC 815.

The initial fair value of the warrants and bifurcated embedded conversion feature, estimated to be approximately $4.3 million and $9.3 million, respectively, was deducted from the gross proceeds of the Unit offering to arrive at the initial discounted carrying value of the Series F Preferred Shares. The resulting discount to the aggregate stated value of the Series F Preferred Shares of approximately $13.6 million was recognized as accretion using the effective interest method similar to preferred stock dividends, over the two-year period prior to optional redemption by the holders.

On March 6, 2018, the Companytwo financing arrangements entered into separate exchange agreements (the “Exchange Agreements”) with holders (each a “Holder”, and collectively the “Holders”) of 100% of the Company’s outstanding Series F Preferred Shares, and the Company’s warrants to purchase shares of the Company’s common stock issued in connection with the Series F Preferred Shares (such “Warrants” and Series F Preferred Shares collectively referred to as the “Exchange Securities”) to exchange the Exchange Securities and unpaid dividends on the Series F Preferred Shares for common stock (the “Exchange”).

The Exchange resulted in the following issuances: (A) all outstanding Series F Preferred Shares were converted into 972,070 shares of restricted common stock at an effective conversion price of $18.26 per share of common stock (the closing price of Common Stock on the NASDAQ Capital Market on February 26, 2018); (B) the right to receive 6% dividends underlying Series F Preferred Shares was terminated in exchange for 31,321 shares of restricted common stock; (C) 322,727 Warrants to purchase common stock were exchanged for 151,871 shares of restricted common stock; and (D) the Holders of the Warrants relinquished any and all other rights pursuant to the Warrants, including exercise price adjustments.

As part of the Exchange, the Holders also relinquished all other rights related to the issuance of the Exchange Securities, the respective governing agreements and certificates of designation, including any related dividends, adjustment of conversion and exercise price, and repayment option. The existing registration rights agreement with the holders of the Series F Preferred Shares was also terminated and the holders of the Series F Preferred Shares waived the obligation of the Company to register the common shares issuable upon conversion of Series F Preferred Shares or upon exercise of the warrants, and waived any damages, penalties and defaults related to the Company failing to file or have declared effective a registration statement covering those shares.

The exchange of all outstanding Series F Preferred Shares, and the holders’ right to receive 6% dividends, for common stock of the Company was recognized as follows:

Fair market value of 1,003,393 shares of common stock issued at $20.05 (Company’s closing stock price on March 5, 2018) in exchange for Series F Preferred Shares and accrued dividends $20,117,990 
Carrying value of Series F Preferred Shares at March 5, 2018, including dividends  (5,898,274)
Carrying value of bifurcated conversion option at March 5, 2018  (7,162,587)
Deemed dividend on Series F Preferred Shares exchange $7,057,129 

As the Warrants were classified as a liability, the exchange of the Warrants for common shares was recognized as a liability extinguishment. As of March 5, 2018, the fair market value of the 151,871 common shares issued in the Exchange was $3,045,034 and the fair value of the common stock warrant liability was $2,525,567 resulting in a loss on extinguishment of warrant liability of $519,467 during the nine months ended September 30, 2018.

The Company recognized accretion of2020 to fund an insurance contract. Under the discount to the stated value of the Series F Preferred Shares of approximately $698,000 during the nine months ended September 30, 2018, as a reduction of additional paid-in capital and an increase in the carrying value of the Series F Preferred Shares. The accretion is presented in the Statement of Operations as a deemed dividend, increasing net loss to arrive at net loss attributable to common stockholders.

Preferred Stock Conversion and Elimination

On February 6, 2018, 15,756 shares of Series B Convertible Preferred Stock (“Series B Preferred Shares��) were converted into 262,606 shares of common stock.

On March 6, 2018,financing arrangements, the Company received conversion notices (in accordanceborrowed $0.8 million and $0.2 million. The amounts will be repaid in nine equal monthly installments, with original terms) from holdersan interest rate of 100% of the outstanding shares of Series A Convertible Preferred Stock (the “Series A Preferred Shares”)4.25% and 6.35%, Series B Preferred Shares and Series E Convertible Preferred Stock (the “Series E Preferred Shares”) and issued an aggregate of 7,945,250 shares of common stock to such holders.respectively.

The shares of Series E Preferred Stock were held by Dr. Denver Lough, the Company’s former Chief Executive Officer. On March 6, 2018, the Company entered into a new registration rights agreement (the “Lough Registration Rights Agreement”) with Dr. Lough, pursuant to which the Company agreed to file a registration statement to register the resale of 7,050,000 shares of common stock issued upon conversion of the Series E Preferred Shares within six months, to cause such registration statement to be declared effective by the Securities and Exchange Commission as promptly as possible following its filing. On March 14, 2019, the Company’s registration obligation was waived, and the Lough Registration Rights Agreement amended to provide that Dr. Lough may demand registration by written request to the Company. Dr. Lough demanded registration of his 7,050,000 common shares in August

9. STOCK-BASED COMPENSATION

2020, 2019 and pursuant to that demand a registration statement on Form S-3 was filed with the Securities and Exchange Commission in October 2019. Once the registration statement is effective, the Company is obligated to keep it effective until the earlier of the date all the registered shares have been sold pursuant to the registration statement or the date one year from the date the registration statement is first effective.2017 Equity Incentive Plans

On March 7, 2018, the Company filed a Certificate of Elimination with the Secretary of State of the State of Delaware terminating the Company’s Series A, Series B, Series C, Series D, Series E and Series F Preferred Stock. As a result, the Company has 25,000,000 shares of authorized and unissued preferred stock as of September 30, 2019 with no designation as to series.2020 Plan

There was no convertible preferred stock outstanding as of September 30, 2019 and December 31, 2018.

11. STOCK-BASED COMPENSATION

For the three and nine months ended September 30, 2019 and 2018, the Company recorded stock-based compensation expense related to stock options, restricted stock awards, and the employee stock purchase plan as follows (in thousands):

  For the three months ended  For the nine months ended 
  September 30,  September 30, 
  2019  2018  2019  2018 
General and administrative expense $4,822  $10,118  $20,751  $22,925 
Research and development expense  (164)  335   2,401   3,317 
Sales and marketing expense  367   –   780   – 
Total stock-based compensation expense $5,025  $10,453  $23,932  $26,242 

Incentive Compensation Plans

2019 Plan

On October 5, 2018,25, 2019, the Company’s Board of Directors (the “Board”) approved the Company’s 2020 Stock Option and Incentive Plan (the “2020 Plan”). The 2020 Plan became effective on December 19, 2019, the date approved by the stockholders. The 2020 Plan provides for the grant of incentive stock options, nonqualified stock options, restricted stock, restricted stock units, stock appreciation rights, unrestricted stock awards, dividend equivalent rights, and cash-based awards to the Company’s employees, officers, directors and consultants. The Compensation Committee of the Board will administer the 2020 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 3,000,000 shares of common stock are issuable pursuant to awards under the 2020 Plan. No grants of awards may be made under the 2020 Plan after the later of December 19, 2029, or the tenth anniversary of the latest material amendment of the 2020 Plan and no grants of incentive stock options may be made after October 25, 2029. As of September 30, 2020, the Company had 70,190 shares available for future issuances under the 2020 Plan.

2019 Plan

On October 5, 2018, the Company’s Board approved the Company’s 2019 Equity Incentive Plan (the “2019 Plan”). The 2019 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 2019 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 3,000,000 shares of common stock are issuable pursuant to awards under the 2019 Plan. Unless earlier terminated by the Board, the 2019 Plan shall terminate at the close of business on October 5, 2028.2028. As of September 30, 2019,2020, the Company had approximately 290,875 287,615 shares available for future issuances under the 2019 Plan.

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2017 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 7,300,000 (increased from 3,450,000 in October 2017) 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, 2026.2026. As of September 30, 2019,2020, the Company had approximately 379,641 1,013,450 shares available for future issuances under the 2017 Plan.

Stock Options

A summary of the Company’s employee and non-employee stock option activity for the nine months ended September 30, 20192020 is presented below:

  

Number of

shares

  

Weighted-Average

Exercise Price

 
Outstanding – December 31, 2018  6,499,885  $14.02 
Granted  818,403  $13.75 
Exercised (1)  (292,417) $4.31 
Forfeited  (668,842) $20.50 
Outstanding – September 30, 2019  6,357,029  $13.91 
Options exercisable – September 30, 2019  4,815,831  $12.69 
Weighted-average grant date fair value of options granted during the nine months ended September 30, 2019     $9.84 

(1)The number of exercised options includes shares withheld on behalf of employees to satisfy minimum statutory tax withholding requirements.

Restricted StockSCHEDULE OF SHARE-BASED COMPENSATION, STOCK OPTIONS, ACTIVITY

  

Number of

Shares

  

Weighted-

Average

Exercise Price

 
Outstanding – December 31, 2019  4,529,988  $15.26 
Granted  1,882,888  $1.23 
Exercised  (10,208) $3.08 
Forfeited  (1,363,754) $16.30 
Outstanding – September 30, 2020  5,038,914  $9.75 
Options exercisable, September 30, 2020  3,447,648  $12.69 

A summary of the Company’s employee and non-employee restricted-stock activity for the nine months ended September 30, 2019 is presented below:

  

Number of

shares

  Weighted-Average
Grant-Date Fair Value		 
Unvested - December 31, 2018  651,110  $23.65 
Granted  1,919,675  $5.03 
Vested (1)  (415,290) $20.84 
Forfeited  (128,395) $22.44 
Unvested – September 30, 2019  2,027,100  $7.64 

(1)The number of vested restricted stock units includes shares that were withheld on behalf of employees to satisfy the minimum statutory tax withholding requirements.

Employee Stock Purchase Plan (ESPP)

In May 2018, the Company adopted the Employee Stock Purchase Plan (“ESPP”). The Company has initially reserved 500,000 shares of common stock for purchase under the ESPP. The initial offering period began January 1, 2019 and ended on June 30, 2019 with the first purchase date. Subsequent offering periods will automatically commence on each January 1 and July 1 and will have a duration of six months ending with a purchase date June 30 and December 31 of each year. On each purchase date, ESPP participants will purchase shares of common stock at a price per share equal to 85% of the lesser of (1) the fair market value per share of the common stock on the offering date or (2) the fair market value of the common stock on the purchase date. Total

Restricted Stock

A summary of the Company’s employee and non-employee restricted-stock activity is presented below:

SCHEDULE OF SHARE-BASED COMPENSATION, RESTRICTED STOCK ACTIVITY

Number of

Shares

Unvested - December 31, 20191,843,001
Granted3,628,204
Vested (1)(1,501,072)
Forfeited(95,188)
Unvested – September 30, 20203,874,945

(1)The number of vested restricted stock units and awards includes shares that were withheld on behalf of employees to satisfy the minimum statutory tax withholding requirements.

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Stock-Based Compensation Expense

The stock-based compensation expense related to stock options, restricted stock awards, and the ESPP foremployee stock purchase plan was as follows (in thousands):

SCHEDULE OF SHARE-BASED COMPENSATION RELATED TO RESTRICTED STOCK AWARDS AND STOCK OPTIONS

  For the Three Months Ended  For the Nine Months Ended 
  September 30,  September 30, 
  2020  2019  2020  2019 
General and administrative expense $1,655  $4,822  $4,875  $20,751 
Research and development expense  388   (164)  755   2,401 
Sales and marketing expense  136   367   333   780 
Total stock-based compensation expense $2,179  $5,025  $5,963  $23,932 

10. COMMON STOCK WARRANTS

On February 14, 2020, the threeCompany completed an underwritten offering of 10,638,298 shares of its common stock and nine months ended September 30, 2019 was $14,000 and $33,000, respectively. A total of 7,260 warrants to purchase 10,638,298 shares of common stockstock. Each common share and warrant were purchased pursuantsold together for a combined public purchase price of $2.35 before underwriting discount and commission. The exercise price of each warrant is $2.80 per share, the warrants were exercisable immediately, and they will expire February 12, 2027. As the warrants could require cash settlement in certain scenarios, the warrants were classified as a liability and are recorded at an estimated fair value using a Monte Carlo simulation model. The total proceeds from the offering were allocated first to the ESPP duringwarrant liability based on the nine months ended September 30, 2019 for total proceeds of $35,000.

12. INCOME TAXES

The Company has evaluated its income tax positions and determined that no material uncertain tax positions existed at September 30, 2019. The Company does not expect a significant change in its unrecognized tax benefits withinestimated fair value with the next twelve months.

residual allocated to the common shares. As of September 30, 2019 and December 31, 2018,2020, none of the Company maintained a valuation allowance to fully offset its net deferred tax assets primarily attributable to operationswarrants had been exercised.

The change in fair value of the common stock warrant liability is presented in the United States,following table and is reported as the realizationa change in fair value of such assets was not considered more likely than not.

The Company files income tax returnscommon stock warrant liability in the U.S. Federal and various state and local jurisdictions.statements of operations (in thousands):

13. SCHEDULE OF FAIR VALUE OF COMMON STOCK WARRANT LIABILITY

  

September 30,

2020

 
Beginning balance $– 
Initial value of common stock warrant liability  11,677 
Change in fair value of common stock warrant liability  (4,444)
Ending balance $7,233 

11. LOSS PER SHARE

The following outstanding potentially dilutive sharessecurities have been excluded from the calculation of diluted net loss per share for the periods presented due to their anti-dilutive effect:

SCHEDULE OF ANTI-DILUTIVE POTENTIAL SHARES OUTSTANDING ACTIVITY

  As of September 30, 
  2020  2019 
Stock options  5,038,914   6,357,029 
Restricted stock  3,874,945   2,027,100 
Common stock warrants  10,638,298   15,235 

12. DEBT

On April 12, 2020, our subsidiary PolarityTE MD, Inc. (the “Borrower”) entered into a promissory note evidencing an unsecured loan in the amount of $3,576,145 made to it under the Paycheck Protection Program (the “Loan”). The Paycheck Protection Program (or “PPP”) was established under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) and is administered by the U.S. Small Business Administration. The Loan to the Borrower was made through KeyBank, N.A., a national banking association (the “Lender”). The interest rate on the Loan is 1.00%. Beginning seven months from the date of the Loan the Borrower is required to make 24 monthly payments of principal and interest in the amount of $150,563. The promissory note evidencing the Loan contains customary events of default relating to, among other things, payment defaults, making materially false and misleading representations to the SBA or Lender, or breaching the terms of the Loan documents. The occurrence of an event of default may result in the repayment of all amounts outstanding, collection of all amounts owing from the Borrower, or filing suit and obtaining judgment against the Borrower. Under the terms of the CARES Act, PPP loan recipients can apply for and be granted forgiveness for all or a portion of a loan granted under the PPP. Such forgiveness will be determined, subject to limitations, based on the use of loan proceeds for payment of payroll costs and any payments of mortgage interest, rent, and utilities. No assurance is provided that the Company will obtain forgiveness of the Loan in whole or in part.

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  As of September 30, 
  2019  2018 
Stock options  6,357,029   6,125,628 
Restricted stock  2,027,100   685,730 
Shares committed under ESPP  15,235   – 

13. RESTRUCTURING

In the second quarter of 2020, management approved several actions as part of a restructuring plan designed to improve operational efficiency and financial results. Management approved a reduction in force, which affected 40 of the 126 employees in the regenerative medicine business segment, or approximately 31.7% of that workforce. The Company did not make any change in the workforce of its contract services segment. The Company recognized $0.6 million of expense related to employee severance and benefit arrangements for the second quarter restructuring. The Company also recognized $0.4 million of other employee severance expense during the first quarter of 2020. Total severance expense recorded during the nine months ended September 30, 2020 was $1.0 million. It is expected that the full amount of severance will be paid by the end of 2020. Management also recorded $1.5 million of asset abandonments within the Company’s regenerative medicine business segment.

14. COMMITMENTS AND CONTINGENCIES

Contingencies

On June 26, 2018, a class action complaint alleging violations of the Federal securities laws was filed in the United States District Court, District of Utah, by Jose Moreno against the Company and two directors of the Company, Case No. 2:18-cv-00510-JNP (the “Moreno Complaint”). On July 6, 2018, a similar complaint was filed in the same court against the same defendants by Yedid Lawi, Case No. 2:18-cv-00541-PMW (the “Lawi Complaint”). Both the Moreno Complaint and Lawi Complaint allege that the defendants made statements or were responsible for, disseminatingdisseminated information to the public through reports filed with the Securities and Exchange Commission and other channels that contained material misstatements or omissions in violation of Sections 10 and 20(a) of the Exchange Act and Rule 10b-5 adopted thereunder. Specifically, both complaints allege that the defendants misrepresented the status of one of the Company’s patent applications while touting the unique nature of the Company’s technology and its effectiveness. Plaintiffs are seeking damages suffered by them and the class consisting of the persons who acquired the publicly-traded securities of the Company between March 31, 2017, and June 22, 2018. Plaintiffs have filed motions to consolidate and for appointment as lead plaintiff. On November 28, 2018, the Court consolidated the Moreno and Lawi cases under the caption In re PolarityTE, Inc. Securities Litigation (the(the “Consolidated Securities Litigation”), and requested the appointment of the plaintiff in Lawi as the lead plaintiff. On January 16, 2019, the Court granted the motion of Yedid Lawi for appointment as lead plaintiff, and on February 1, 2019, the Court granted the lead plaintiff’s motion for approval of lead counsel and liaison counsel. The Court also ordered that the lead plaintiff file and serve a consolidated complaint no later than 60 days after February 1, 2019, the defendants shall have 60 days after filing and service of the consolidated complaint to answer or otherwise respond, and the2019. The lead plaintiff must file a motion for class certification within 90 days of service of the consolidated complaint. The Lead Plaintiff filed a consolidated complaint on April 2, 2019, and asserted essentially the same violations of Federal securities laws recited in the original complaints. The Company believes the allegations in the consolidated complaint are without merit, and intends to defend the litigation, vigorously. The Company filed a motion to dismiss the consolidated complaint on June 3, 2019. Plaintiffs’ opposition to the Company’s motion to dismiss was filed on August 2, 2019, and the Company filed a reply to the opposition on September 13, 2019. A hearing on the Company’s motion to dismiss is scheduled forwas held on November 19, 2019.2019; no order has been issued to date. At this early stage of the proceedings the Company is unable to make any prediction regarding the outcome of the litigation.

In November 2018, a shareholder derivative lawsuit was filed in the United States District Court, District of Utah, with the caption Monther v. Lough, et al., case no. 2:18-cv-00791-TC, alleging violations of the Exchange Act, breach of fiduciary duty, and unjust enrichment on the part of certain officers and directors based on the facts and circumstances recited in the Consolidated Securities Litigation. On November 26, 2018, the court issued an order staying all proceedings until after the disposition of motions to dismiss the Consolidated Securities Litigation.

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Other Matters

In the ordinary course of business, wethe Company may become involved in lawsuits, claims, investigations, proceedings, and threats of litigation relating to intellectual property, commercial arrangements, employment, regulatory compliance, and other matters. Except as noted above, atas of September 30, 2019, we were2020, the Company was not party to any legal or arbitration proceedings that may have significantmaterial effects on ourits financial position or results of operations. WeNo governmental proceedings are pending or, to the Company’s knowledge, contemplated against the Company. The Company is not a party to any material proceedings in which any director, member of senior management or affiliate of oursthe Company is either a party adverse to usthe Company or ourits subsidiaries or has a material interest adverse to usthe Company or ourits subsidiaries.

Commitments

The Company has entered into employment agreements with key executives and adopted a change in control plan that contain severance terms and change of control provisions.

On September 2, 2020, Arches Research, Inc., a subsidiary of PolarityTE, Inc. (“Arches”) entered into two agreements with Co-Diagnostics, Inc. (“Co-Diagnostics”). The COVID-19 Laboratory Services Agreement between the parties provides that Arches will perform specimen testing services for customers referred by Co-Diagnostics to Arches. Co-Diagnostics will arrange all logistics for delivering specimens to Arches for COVID-19 testing for those customers of Co-Diagnostics electing to use the service. Arches bills Co-Diagnostics for the testing services and Co-Diagnostics manages all customer billing. The Rental Agreement for LGC Genomics Oktopure Extraction Machine between Arches and Co-Diagnostics provides that Co-Diagnostics will make available to Arches the Oktopure high throughput extraction machine that Arches will use to perform COVID-19 testing. The term of the agreement is 12 months, requires Arches to use Co-Diagnostics tests exclusively in the machine, and establishes for Arches a minimum monthly purchase obligation, valued at approximately $1.1 millionannually for Co-Diagnostics tests and related consumables used in the testing process.

15. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

On August 21, 2019, the Company and Dr. Denver Lough, a principal shareholder and former officer and director, signed a settlement terms agreement that provides, in part, that the Company pay to Dr. Lough $1,500,000 $1,500,000 in cash on October 1, 2019 and an additional $1,500,000 $1,500,000 in cash in equal monthly installments beginning November 1, 2019 and ending April 1, 2021. In addition, the Company agreed to award to Dr. Lough 200,000 restricted stock units that vest in 18 equal monthly installments beginning October 1, 2019.The fair value of the restricted stock units was $0.8 million. The Company expensed the cash portion and equity portion of these awards upon Dr. Lough’s termination. As of September 30, 2020, the Company has recorded a liability of $0.6 millionrelated to future cash payments under the agreement.

In October 2018, the Company entered into an office lease covering approximately 7,250 square feet of rental space in the building located at 40 West 57th Street in New York City. The lease is for a term of three years.years. The annual lease rate is $60 $60 per square foot. Initially the Company will occupyoccupied and paypaid for only 3,275 square feet of space, and the Company is not obligated under the lease to pay for the remaining 3,975 square feet covered by the lease unless we elect to occupy that additional space.The Company believes the terms of the lease are very favorable to us, and the Company obtained these favorable terms through the assistance of Peter A. Cohen, a director, which he provided so that the company he owns, Peter A. Cohen, LLC (“Cohen LLC”), could sublease a portion of the office space.

During 2019, the Company increased the space from 3,275 square feet to 6,232 square feet. In May 2020, the Company reduced the space from 6,232 to 4,554. The Company is using 1,648 1,099 square feet, and Cohen LLC is using approximately 4,584 3,455 square feet as of September 30, 2019.2020. The monthly lease payment for 6,2324,554 square feet is $31,160.$22,771. Of this amount $22,920 $17,277 is allocatedcharged pro rata to Cohen LLC based on square footage occupied. Additional lease charges for operating expenses and taxes are allocatedalso charged under the sublease based on the ratio of rent paid by the Company and Cohen LLC to total rent. OnceIf the space isbecomes fully occupied, the Company will reduce the overall annual lease rate for the Cohen LLC space to $58.60 per square foot.The Company recognized $69,000 and $195,000 of sublease income related to this agreement of $52,000and $69,000 for the three months ended September 30, 2020 and 2019, respectively, and $184,000and $195,000 for the nine months ended September 30, 2020 and 2019, respectively. The sublease income is included in other income, net in the statementstatements of operations. As of September 30, 20192020 and December 31, 2018,2019, there was $17,000 and $0were 0amounts due from the related party under this agreement.

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16. SEGMENT REPORTING

The Company’s current operations involve products and services whichReportable segments are managed separately. Accordingly, it operatespresented in two segments: 1) regenerative medicine and 2) contract services.

Duringa manner consistent with the three months ended September 30, 2019, the Company’s CODM changed theinternal reporting of segment net income and loss to allocate additional noncash expenses from the regenerative medicine segmentprovided to the contract services segment. Forchief operating decision maker (CODM). In April 2020, the three months ended September 30, 2019Company designated its Chief Executive Officer (CEO) to be its Chief Operating Decision Maker (CODM) and 2018, this resulted in reallocationdissolved the function of noncash expensethe Office of $0.4 millionthe Chief Executive consisting of the President, Chief Operating Officer, and $0.2 million, respectively. ForChief Financial Officer, which previously acted as its CODM.

The CODM allocates resources to and assesses the nine months ended September 30, 2019performance of each segment using information about its revenue and 2018, this resulted in reallocation of noncash expense of $1.4 million and $0.3 million, respectively. The change is reflected in the three and nine months ended September 30, 2019 and 2018 net loss amounts presented below.

Certain information concerning our segments for the three and nine months ended September 30, 2019 and 2018 isoperating income (loss). These measures are presented in the following tabletables (in thousands):. Asset information by segment is not presented, as this measure is not used by the CODM to assess the segment’s performance.

  For the three months ended  For the nine months ended 
  September 30,  September 30, 
  2019  2018  2019  2018 
Net revenues:                
Reportable segments:                
Regenerative medicine $839  $197  $1,640  $389 
Contract services  556   528   2,546   659 
Total net revenues $1,395  $725  $4,186  $1,048 
                 
Net (loss) income:                
Reportable segments:                
Regenerative medicine $(22,466) $(20,332) $(70,247) $(45,845)
Contract services  (517)  (247)  (1,101)  (511)
Total net loss $(22,983) $(20,579) $(71,348) $(46,356)

SCHEDULE OF SEGMENT INFORMATION

  For the Three Months Ended  For the Nine Months Ended 
  September 30,  September 30, 
  2020  2019  2020  2019 
Net revenues by segment:                
Regenerative medicine $1,156  $839  $2,528  $1,640 
Contract services  2,181   556   4,008   2,546 
Total net revenues $3,337  $1,395  $6,536  $4,186 
                 
Net income (loss) by segment:                
Regenerative medicine $(7,246) $(22,466) $(32,516) $(70,247)
Contract services  165   (517)  (282)  (1,101)
Total net loss $(7,081) $(22,983) $(32,798) $(71,348)

17. SUBSEQUENT EVENTS

PursuantOn October 15, 2020, the Borrower applied to the demand made by Dr. Denver LoughLender for forgiveness of the PPP loan described under his Registration Rights AgreementNote 12 in August 2019,its entirety based on the Borrower’s use of the PPP loan for payroll costs, rent, and utilities. On October 26, 2020, the Borrower was advised that the Lender approved the application and that the Lender was submitting the application to the SBA for a final decision. The SBA may take up to 90 days to make a decision on the Borrower’s forgiveness application. The Company filed a registration statementclassified the principal balance of the PPP loan within “Current portion of long-term notes payable” and “Long-term notes payable” on Form S-3 with the Securities and Exchange Commissionconsolidated balance sheet as of September 30, 2020. If the Borrower’s application for forgiveness of the PPP loan is not approved or approved only in part, it will be obligated to repay the unforgiven portion of the loan after the SBA makes its decision on October 21, 2019 to register 7,050,000 shares of common stock held by Dr. Lough, which was declared effective November 1, 2019.the application for forgiveness.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following informationdiscussion and analysis below includes certain forward-looking statements that are subject to risks, uncertainties and other factors, as described in “Risk Factors” in our Annual Report on Form 10-K and this report, that could cause our actual growth, results of operations, performance, financial position and business prospects and opportunities for this fiscal year and periods that follow to differ materially from those expressed in or implied by those forward-looking statements. Readers are cautioned that forward-looking statements contained in this Quarterly Report on Form 10-Q should be read in conjunction with our disclosure under the consolidated financial statements and related notes thereto included in this Quarterly Report on Form 10-Q.heading “Disclosure Regarding Forward-Looking Statements” below.

In addition to historical information, this report contains forward-looking statements that involve risks and uncertainties that may cause our actual results to differ materially from plans and results discussed in forward-looking statements. We encourage you to review the risks and uncertainties discussed in the section entitled “Forward-Looking Statements” included at the beginning of this Quarterly Report on Form 10-Q and under Part I, Item 1A. Risk Factors of our Transition Report on Form 10-K filed with the Securities and Exchange Commission on March 18, 2019. The risks and uncertainties can cause actual results to differ significantly from those in our forward-looking statements or implied in historical results and trends. We caution readers not to place undue reliance on any forward-looking statements made by us, which speak only as of the date they are made. We disclaim any obligation, except as specifically required by law and the rules of the SEC, to publicly update or revise any such statements to reflect any change in our expectations or in events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements.Overview

Overview

We are a commercial-stage biotechnology and regenerative biomaterials company focused on transforming the lives of patients by discovering, designing and developing a range of regenerative tissue products and biomaterials for the fields of medicine, biomedical engineering and material sciences. We operateHistorically, we have operated two segments;segments: the regenerative medicine businessproduct segment and the contract services segment.

Segment Reporting

Regenerative Medicine Product Segment

The regenerative medicine businessproduct segment overis engaged in the last year has established and advanced our core “TE” program, which includesdevelopment of SkinTE, our first commercial product, SkinTE. The commercial launchand also the development of SkinTE POC (point-of-care device for on-site SkinTE processing and deployment), Skin TE Cryo (cryopreservation of SkinTE for multiple deployments on a single patient), and PTE 11000 (allogeneic, biologically active dressing for use in wound care).

SkinTE was registered and listed with the United States Food and Drug Administration (FDA) in August 2017 based on our determination that SkinTE is appropriately regulated solely under Section 361 of the Public Health Service Act and Part 1271 of Title 21 of the Code of Federal Regulations (i.e., as a so-called “361 HCT/P”) and that, as a result, no premarket review or approval by the FDA is required. We proceeded to develop sales and manufacturing capabilities for SkinTE and focused on advancing commercialization of SkinTE.

Following informal, voluntary discussions between us and the FDA we were advised by the FDA in April 2020 that its preliminary assessment is that SkinTE does not meet the requirements to be regulated as a 361 HCT/P. Rather, FDA’s view is that SkinTE is a biological product that should be regulated under Section 351 of the Public Health Service Act. We re-evaluated our regulatory approach and determined it is prudent to submit an investigational new drug application (IND), and thereafter a biologics license application (BLA) for SkinTE, and to adjust the focus of our commercial effort for SkinTE based on the following factors:

●license exclusivity for 12 years that arises under a BLA could enhance the value of SkinTE;
●clinical testing in the BLA process could accelerate commercial acceptance of SkinTE;
●the possibility the FDA could restrict our commercial sale of SkinTE in the future; and
●the contraction of the commercial opportunity for SkinTE in March and April 2020 because healthcare providers were dedicating resources to the care and treatment of COVID-19 patients and the acute and traumatic care needs of the general population and, as a result, were putting a hold on elective procedures in many regions across the country.

In August 2020 we submitted a Type B Pre-IND meeting request to FDA regarding an indication for SkinTE to treat diabetic foot ulcers (DFUs), and we received written responses to our meeting request and questions in October 2020. FDA’s responses included, among other things, feedback and recommendations on SkinTE manufacturing, preclinical studies, and clinical data submitted in the Company’s briefing package, and guidance on additional information for the Company to include in its IND submission. Consistent with published FDA guidance documents, including “Guidance for Industry: Providing Clinical Evidence of Effectiveness for Human Drug and Biological Products,” the Agency stated that for a condition like DFUs, it would generally expect at least two adequate and well-controlled studies to provide substantial evidence of effectiveness and evidence of safety to support a future marketing application. The Agency noted that our ongoing randomized controlled trial (RCT) in DFUs has includedelements of an adequate and well-controlled study, but stated that it would not accept our ongoing post-marketing RCT in DFUs as one of the build outtwo adequate and well-controlled studies to support a future marketing application.

With this FDA feedback we are re-evaluating our development plan for SkinTE. We believe much of commercial,the chemistry, manufacturing and corporate structure to supportcontrols (CMC) work, as well as non-clinical work, we will do for the growthDFU indication can be leveraged for multiple indications. Based on our experience with the deployment of SkinTE, revenuewe believe SkinTE can be successful in closing complex wounds such as DFU Wagner grade 2 through 4, grade 3 & 4 pressure injuries, and deploymentsacute wounds. Our present intention is to focus our efforts on these wound types, where we believe there are significant unmet needs, and pursue these indications in 2019our IND submission for approval either in parallel or a tight sequential process.

In the coming months we will pursue the preparation of an IND filing with FDA, which we believe we will be able to file in the second half of 2021. This effort will include, among other things, the completion of CMC and beyond. This includes equipment, personnel, systems,pre-clinical work to satisfy FDA requirements, interaction with FDA on additional indications, trials design, preparation and leased properties. Researchsubmission of the IND, and development continueplanning for clinical trial enrollment to expand to advance the product development pipeline.begin as soon as we have an open IND.

22

 

In May 2018 we acquired assets of

Contract Services Segment

The contract services segment operates a preclinical research and veterinary sciences business and related real estate, which we now operate through our subsidiary, Ibex Preclinical Research, Inc. The aggregate purchase price was $3.8 million, of which $2.3 million was paid at closing and the balance satisfied by a promissory note payable to the Seller with an initial fair value of $1.2 million and contingent consideration with an initial fair value of approximately $0.3 million. As a result, we have significant research facilities and a well-educated and skilled team of scientists and researchers that comprise the contract research segment of our business. These resources are highly beneficial to the work we are doing on our TE products and other research initiatives. We also offer research and laboratory testing services to unrelated third parties on a contract basis through our subsidiary, Arches Research, Inc. (“Arches”).

There was a substantial surge in COVID-19 testing throughout the United States as a result of the COVID-19 pandemic, which began in the spring of 2020. In the course of its operations, Arches maintains equipment and staff capable of performing molecular polymerase chain reaction testing for COVID-19, which made it possible for Arches to begin providing COVID-19 testing services on May 27, 2020. We believe that COVID-19 testing offers an opportunity to use existing resources to generate additional revenue in the contract services segment and thereby help defray our operating expenses. We have pursued this opportunity during the third quarter of 2020 and expect to continue to do so as long as we offer underbelieve COVD-19 testing services are beneficial to supporting our operations.

Revenue Recognition

In the trademark POLARITYRD. Contractregenerative medicine products segment, we record product revenues primarily from the sale of our regenerative tissue products. We sell our products to healthcare providers, primarily through direct sales representatives. Product revenues consist of a single performance obligation that we satisfy at a point in time. In general, we recognize product revenue upon delivery to the customer. In the contract services segment, we earn service revenues from the provision of contract research services, help us defraywhich includes delivery of preclinical studies and other research services to unrelated third parties. Service revenues generally consist of a single performance obligation that we satisfy over time using an input method based on costs incurred to date relative to the total costs expected to be required to satisfy the performance obligation. Contract services also includes research and laboratory testing services to unrelated third parties on a contract basis. These customer contracts generally consist of maintaining a first-rate research facility and allow ussingle performance obligation that the Company satisfies at a point in time. The Company recognizes revenue upon delivery of testing results to meet companies pursuing new technologies that may be opportunities for collaborative or strategic relationships going forward.the customer.

Research and Development Expenses.Expenses

Research and development expenses primarily represent employee related costs, including stock compensation for research and development executives and staff, lab and office expenses, clinical trial costs, and other overhead charges.

General and Administrative Expenses.Expenses

General and administrative expenses primarily represent employee related costs, including stock compensation for corporate executiveexecutives 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, with the Securities and Exchange Commission (SEC),corporate and corporate- and business-developmentbusiness development initiatives.

23

 

Income Taxes. Income taxes consist

Sales and Marketing Expenses

Sales and marketing expenses primarily represent employee related costs, including stock compensation for sales and marketing executives and staff, marketing and advertising expenses, trade shows and other promotional costs, and other related charges.

Results of Operations

Comparison of the three months ended September 30, 2020 compared to the three months ended September 30, 2019.

  For the Three Months Ended  

Increase

(Decrease)

 
(in thousands) 

September 30,

2020

  

September 30,

2019

  Amount  % 
  (Unaudited)       
Net revenues                
Products $1,156  $839  $317   38%
Services  2,181   556   1,625   292%
Total net revenues  3,337   1,395   1,942   139%
Cost of sales                
Products  210   315   (105)  (33)%
Services  1,142   330   812   246%
Total cost of sales  1,352   645   707   110%
Gross profit  1,985   750   1,235   165%
                 
Operating costs and expenses                
Research and development  2,698   2,956   (258)  (9)%
General and administrative  6,264   16,044   (9,780)  (61)%
Sales and marketing  1,606   4,988   (3,382)  (68)%
Total operating costs and expenses  10,568   23,988   (13,420)  (56)%
Operating loss  (8,583)  (23,238)  14,655   (63)%
Other income (expense)                
Change in fair value of common stock warrant liability  1,503   –   1,503   * 
Interest income (expense), net  (58)  27   (85)  (315)%
Other income, net  57   228   (171)  (75)%
Net loss $(7,081) $(22,983) $15,902   (69)%

Net Revenues

For the three-month period ended September 30, 2020, we recorded net revenues of $3.337 million, which represents an increase of $1.942 million or 139% from the $1.395 million of net revenues recorded for the three months ended September 30, 2019. The increase in net revenues was due to an increase in revenue in both our provisionsregenerative medicine product segment and the contract services segment.

Regenerative Medicine Product Segment

For the three-month period ended September 30, 2020, net revenues from the regenerative medicine product segment are $1.156 million, which represents an increase of $0.317 million or 38% from the $0.839 million of net revenues recorded for income taxes, as affectedthe three months ended September 30, 2019. This change is attributable to an increase of 51% in the number of paid cases from 81 in the third quarter of 2019 to 122 in the third quarter of 2020, and to a lesser extent the higher average revenue per paid case we experienced in the third quarter of 2020. Of SkinTE revenues for the third quarter, $0.639 million, or 55%, of net revenues was generated by two hospital systems, and one of these hospital systems alone was the source of 44% of the net revenues.

24

As noted above, we plan to submit to FDA an IND and BLA for SkinTE. We are in the process of preparing our net operating loss carryforwards. Future utilizationIND submission and FDA has not asked us to stop marketing SkinTE pending submission or approval of our net operating loss,a BLA. FDA announced in revised final guidance issued in July 2020 that it would generally observe its practice of enforcement discretion established in prior guidance unless there are reported or NOL, carryforwards may bepotential significant safety concerns until May 31, 2021. It is not customary for the FDA to allow wide-spread commercial sales of a product subject to a pending BLA, but we plan to discuss with FDA the possibility of continued marketing of SkinTE as a 361 HCT/P on a limited basis at a future meeting.

At the same time as the regulatory development described above, we were experiencing the effects of the COVID-19 pandemic. Throughout the country, healthcare assets in terms of facilities and providers were dedicated in March, April, and May to the care and treatment of COVID-19 patients while still trying to meet the acute and traumatic care needs of the general population. The substantial annual limitationrise in COVID-19 cases since the spring of 2020 indicates that the dedication of resources to the treatment of COVID-19 will continue for the immediate future. Consequently, medical care and procedures that are considered “elective” have been put on hold in many regions across the country. We experienced the effect of the COVID-19 pandemic in our commercial operations in March 2020, when there was a drop in paid cases in that month followed by cancellation or postponement of SkinTE procedures scheduled for April 2020. This negative impact was most evident in chronic wounds without amputation risk and we expect this impact to continue in subsequent periods as long as the pandemic continues to surge.

We do not know, and cannot predict, whether FDA will allow us to continue selling SkinTE while our BLA is pending. Accordingly, management determined it was prudent under the circumstances discussed above to focus our commercialization effort on the territories where we have current and repeat users of SkinTE. As a result, in May 2020 we eliminated 40 positions in the regenerative medicine product segment, including 24 positions engaged in performing sales and marketing functions.

Contract Services Segment

For the three-month period ended September 30, 2020, net revenues from the contract services segment are $2.181 million, which represents an increase of $1.625 million or 292% from the $0.556 million of net revenues recorded for the three months ended September 30, 2019. This change is primarily attributable to the revenues generated by the new COVID-19 testing services offered by Arches. COVID-19 testing service contributed $1.751 million to net revenues in the third quarter of 2020 and the remainder was generated by our historical clinical service offerings. Net revenues from our historical clinical service offerings decreased from $0.556 million for the three months ended September 30, 2019 to $0.430 million for the three months ended September 30, 2020.

As noted above we began COVID-19 testing at the end of May 2020. At September 30, 2020, we had testing agreements with 29 nursing homes and three pharmacies in the northeast, controlled by a single company, 29 of which are located in the state of New York. These 32 facilities accounted for $1.651 million, or 94%, of COVID-19 testing revenues in the third quarter ended September 30, 2020, most of which was generated in New York. On May 10, 2020, the Governor of the State of New York issued an order requiring COVID-19 testing of all employees working in nursing homes within the state weekly, which has been renewed on a monthly basis. Previously the New York Governor issued an order, Executive Order 202.10 (the “Executive Order’) that, among other things, suspended the requirement that a laboratory outside New York obtain a clinical laboratory permit from New York State if the laboratory holds a CLIA certificate and is engaged to test for COVID-19 in specimens collected from persons in New York State. The Executive Order had a limited duration until April 22, 2020 but has been extended monthly and now expires December 3, 2020. We have not received any indication from the State of New York that the Executive Order will not be renewed in December 2020. Furthermore, our testing service agreements for the 32 facilities controlled by a single company in the northeast are on a month-to-month basis.

25

On September 2, 2020, Arches entered into two agreements with Co-Diagnostics, Inc. (“Co-Diagnostics”). The COVID-19 Laboratory Services Agreement between the parties provides that Arches will perform specimen testing services for customers referred by Co-Diagnostics to Arches. Co-Diagnostics will arrange all logistics for delivering specimens to Arches for COVID-19 testing for those customers of Co-Diagnostics electing to use the service. Arches bills Co-Diagnostics for the testing services and Co-Diagnostics manages all customer billing. The Rental Agreement for LGC Genomics Oktopure Extraction Machine between Arches and Co-Diagnostics provides that Co-Diagnostics will make available to Arches the Oktopure high throughput extraction machine that Arches will use to perform COVID-19 testing. The term of the agreement is 12 months, requires Arches to use Co-Diagnostics tests exclusively in the machine, and establishes for Arches a minimum monthly purchase obligation, valued at approximately $1.1 million annually for Co-Diagnostics tests and related consumables used in the testing process.

Gross Profit

Cost of sales for the product segment as a percentage of product revenues was 18% in the third quarter of 2020 compared to 38% for the third quarter of 2019. Built in production capacity results in a lower incremental cost per unit as product sales increase. There was a reduction in staff during 2020 that reduced fixed overhead costs increasing gross profit. Cost of sales for the services segment as a percentage of service revenues was 59% in the third quarter of 2019 compared to 52% for the third quarter of 2020, which we primarily attribute to cost variations in the services provided by our historical clinical service business and by Arches including the new COVID-19 testing in the third quarter of 2020, which was not being performed in 2019. As a result of the changes in net revenues and cost of sales in both segments, the combined effect is that gross profit increased as a percentage higher than net revenues period over period from $0.750 million for the three-month period ended September 30, 2019 to $1.985 million for the three-month period ended September 30, 2020, or an increase in gross profit of 165%.

Research and Development

For the three-month period ended September 30, 2020, we recorded research and development expenses totaling $2.698 million, which represents a decrease of $0.258 million, or 9%, from $2.956 million of research and development expenses for the three months ended September 30, 2019. There was a reduction in staff in research and development that reduced compensation and benefits costs by $0.443 million, which was offset by an increase in the portion of allocated operating costs assigned to research and development.

General and Administrative Expenses

General and administrative expenses totaled $6.264 million for the three-month period ended September 30, 2020, which represents a decrease of $9.780 million as compared to $16.044 million of general and administrative expenses incurred during the three months ended September 30, 2019. The primary drivers for this decrease are a $3.167 million reduction in stock-based compensation expense, due to restricted stock and option forfeitures related to the “changereductions in ownership” provisionsforce taken during 2020, a $2.888 million decrease in severance expense, a $1.684 million reduction in legal, accounting, and consulting fees, and a $2.414 million reduction in compensation-related expenses in the third quarter of 2020 compared to the third quarter of 2019.

Sales and Marketing

Sales and marketing expenses totaled $1.606 million for the three-month period ended September 30, 2020, which represents a decrease of $3.382 million, as compared to $4.988 million of sales and marketing expenses incurred during the three months ended September 30, 2019. There was a reduction in staff that reduced compensation and benefits costs by $0.807 million and stock-based compensation expense of $0.231 million in the third quarter of 2020 compared to the third quarter of 2019. Furthermore, we recognized a reduction of marketing and consultant spending of $1.452 million and travel expense of $0.232 million, and allocated a lower portion of operating costs to sales and marketing in the third quarter of 2020 compared to the third quarter of 2019. The contract service segment does not have a meaningful sales and marketing component to its business.

26

Comparison of the Internal Revenue Code.nine months ended September 30, 2020 compared to the nine months ended September 30, 2019.

  For the Nine Months Ended  

Increase

(Decrease)

 
(in thousands) 

September 30,

2020

  

September 30,

2019

  Amount  % 
  (Unaudited)       
Net revenues                
Products $2,528  $1,640  $888   54%
Services  4,008   2,546   1,462   57%
Total net revenues  6,536   4,186   2,350   56%
Cost of sales                
Products  825   930   (105)  (11)%
Services  1,925   1,087   838   77%
Total cost of sales  2,750   2,017   733   36%
Gross profit  3,786   2,169   1,617   75%
                 
Operating costs and expenses                
Research and development  9,235   13,072   (3,837)  (29)%
General and administrative  22,080   48,299   (26,219)  (54)%
Sales and marketing  7,324   12,922   (5,598)  (43)%
Restructuring and other charges  2,536   –   2,536   * 
Total operating costs and expenses  41,175   74,293   (33,118)  (45)%
Operating loss  (37,389)  (72,124)  34,735   (48)%
Other income (expense)                
Change in fair value of common stock warrant liability  4,444   –   4,444   * 
Interest income, net  (135)  126   (261)  (207)%
Other income, net  282   650   (368)  (57)%
Net loss $(32,798) $(71,348) $38,550   (54)%

Net Revenues

For the nine-month period ended September 30, 2020, we recorded net revenues of $6.536 million, which represents an increase of $2.350 million or 56% from the $4.186 million of net revenues recorded for the nine months ended September 30, 2019.

Regenerative Medicine Product Segment

Net revenues for SkinTE in the nine-month period ended September 30, 2020 increased by 54% over the comparable period in 2019 to $2.528 million for the nine months ended September 30, 2020, compared to $1.640 million for the nine months ended September 30, 2019. This change is attributable to an increase of 74% in the number of paid SkinTE cases from 168 in the first nine months of 2019 to 291 for the first nine months of 2020, and the higher average revenue per paid case we experienced in the second and third quarters of 2020. Of SkinTE revenues for the nine months ended September 30, 2020, $0.836 million, or 33%, of net revenues was generated by one hospital system.

As noted above, we plan to submit to FDA an IND and BLA for SkinTE. We are in the process of preparing our IND submission and FDA has not asked us to stop marketing SkinTE pending submission or approval of a BLA. FDA announced in revised final guidance issued in July 2020 that it would generally observe its practice of enforcement discretion established in prior guidance unless there are reported or potential significant safety concerns until May 31, 2021. It is not customary for the FDA to allow wide-spread commercial sales of a product subject to a pending BLA, but we plan to discuss with FDA the possibility of continued marketing of SkinTE as a 361 HCT/P on a limited basis at a future meeting.

27

At the same time as the regulatory development described above, we were experiencing the effects of the COVID-19 pandemic. Throughout the country, healthcare assets in terms of facilities and providers were dedicated in March, April, and May to the care and treatment of COVID-19 patients while still trying to meet the acute and traumatic care needs of the general population. The annual limitationsubstantial rise in COVID-19 cases since the spring of 2020 indicates that the dedication of resources to the treatment of COVID-19 will continue for the immediate future. Consequently, medical care and procedures that are considered “elective” have been put on hold in many regions across the country. We experienced the effect of the COVID-19 pandemic in our commercial operations in March 2020, when there was a drop in paid cases in that month followed by cancellation or postponement of SkinTE procedures scheduled for April 2020. This negative impact was most evident in chronic wounds without amputation risk and we expect this impact to continue in subsequent periods as long as the pandemic continues to surge.

We do not know, and cannot predict, whether FDA will allow us to continue selling SkinTE while our BLA is pending. Accordingly, management determined it was prudent under the circumstances discussed above to focus our commercialization effort on the territories where we have current and repeat users of SkinTE. As a result, in May 2020 we eliminated 40 positions in the regenerative medicine product segment, including 24 positions engaged in performing sales and marketing functions.

Contract Services Segment

Net revenues for contract services segment in the nine months ended September 30, 2020 are $4.008 million compared to $2.546 million for the nine months ended September 30, 2019, which is an increase of 57% for the first nine months of 2020 over the comparable period in 2019. This change is attributable to net revenues generated by the new COVID-19 testing services offered by Arches. COVID-19 testing service contributed $2.462 million to net revenues for the contract services segment in the first nine months of 2020 and the remainder was generated by our historical clinical service offerings. Net revenues from our historical clinical service offerings decreased from $2.546 million for the nine months ended September 30, 2019 to $1.546 million for the nine months ended September 30, 2020. As noted above we began COVID-19 testing at the end of May 2020. At September 30, 2020, we had testing agreements with 29 nursing homes and three pharmacies in the northeast, controlled by a single company, 29 of which are located in the state of New York. These 32 facilities accounted for accounted for $2.362 million, or 96%, of COVID-19 testing revenues for the nine-month ended September 30, 2020, most of which was generated in New York.

Gross Profit

Cost of sales for the product segment as a percentage of product revenues was 57% in the first nine months of 2019 compared to 33% for the first nine months of 2020. Built in production capacity resulted in a lower incremental cost per unit as product sales increased in 2020. There was also a reduction in staff during 2020 that reduced fixed overhead costs increasing gross profit. Cost of sales for the services segment as a percentage of service revenues was 43% in the first nine months of 2019 compared to 48% for the first nine months of 2020, which we primarily attribute to the higher cost of sales for the COVID-19 testing service in the first nine months of 2020, which was not being performed in 2019. As a result of the changes in net revenues and cost of sales in both segments, the combined effect is that gross profit increased as a percentage higher than net revenues period over period from $2.169 million for the nine-month period ended September 30, 2019 to $3.786 million for the nine-month period ended September 30, 2020, or an increase in gross profit of 75%.

Research and Development

For the nine-month period ended September 30, 2020, we recorded research and development expenses totaling $9.235 million, which represents a decrease of $3.837 million, or 29%, from $13.072 million of research and development expenses for the nine months ended September 30, 2019. There was a reduction in staff in research and development that reduced compensation and benefits costs by $1.427 million and stock-based compensation expense decreased $1.646 million.

28

General and Administrative Expenses

General and administrative expenses totaled $22.080 million for the nine-month period ended September 30, 2020, which represents a decrease of $26.219 million as compared to $48.299 million of general and administrative expenses incurred during the nine months ended September 30, 2019. The primary driver for this decrease is a $15.876 million reduction in stock-based compensation expense due to restricted stock and option forfeitures in addition to lower stock price and option values in the first nine months of 2020 compared to the first nine months of 2019.In addition, there was a decrease of $2.631 million in legal and consulting expense, a reduction of $2.422 million in compensation and benefit expense, severance expense decreased by $2.386 million, and a reduction in travel expense of $0.848 million in the first nine months of 2020 compared to the first nine months of 2019.

Sales and Marketing

Sales and marketing expenses totaled $7.324 million for the nine-month period ended September 30, 2020, compared to $12.922 million of sales and marketing expenses incurred during the nine months ended September 30, 2019. There was a reduction in staff that reduced compensation and benefit costs by $1.540 million and stock-based compensation expense of $0.447 million for the first nine months of 2020 compared to the same period in 2019. In addition, we recognized a reduction of marketing and consultant spending of $3.169 million and travel expense of $0.843 million, offset by an increase in severance expense of $0.447 million in the first nine months of 2020 compared to the same period in 2019. The contract service segment does not have a meaningful sales and marketing component to its business.

Restructuring and Other Charges

Restructuring and other charges totaled $2.536 million for the nine-month period ended September 30, 2020. There were no restructuring and other charges for the nine-month period ended September 30, 2019. Management approved several actions designed to improve operational efficiency and financial results including a reduction in force taken during the first nine months of 2020 that increased severance expense by $1.007 million. Management also recorded $1.566 million of asset abandonments within the Company’s regenerative medicine business segment during the nine-month period ended September 30, 2020.

Liquidity and Capital Resources

As of September 30, 2020, our cash and cash equivalents totaled $23.186 million and our working capital was $20.027 million, compared to cash and cash equivalents and short-term investments of $29.240 million and our working capital of $22.428 million at December 31, 2019. Our accumulated deficit at September 30, 2020, was $468.155 million.

On April 12, 2020, our subsidiary PolarityTE MD, Inc. (the “Borrower”) entered into a promissory note evidencing an unsecured loan in the amount of $3,576,145 made to us under the Paycheck Protection Program (the “Loan”). The Paycheck Protection Program (or “PPP”) was established under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) and is administered by the U.S. Small Business Administration. The Loan to the Borrower was made through KeyBank, N.A., a national banking association (the “Lender”). The interest rate on the Loan is 1.00%. Beginning seven months from the date of the Loan the Borrower is required to make 24 monthly payments of principal and interest in the amount of $150,563. The promissory note evidencing the Loan contains customary events of default relating to, among other things, payment defaults, making materially false and misleading representations to the SBA or Lender, or breaching the terms of the Loan documents. The occurrence of an event of default may result in the expirationrepayment of NOL carryforwardsall amounts outstanding, collection of all amounts owing from the Borrower, or filing suit and obtaining judgment against the Borrower. Under the terms of the CARES Act, PPP loan recipients can apply for and be granted forgiveness for all or a portion of a loan granted under the PPP. Such forgiveness will be determined, subject to limitations, based on the use of loan proceeds for payment of payroll costs and any payments of mortgage interest, rent, and utilities. No assurance is provided that the Borrower will obtain forgiveness of the Loan in whole or in part. On October 15, 2020, the Borrower applied to the Lender for forgiveness of the PPP loan described under Note 12 in its entirety based on the Borrower’s use of the PPP loan for payroll costs, rent, and utilities. On October 26, 2020, the Borrower was advised that the Lender approved the application and that the Lender was submitting the application to the SBA for a final decision. The SBA may take up to 90 days to make a decision on the Borrower’s forgiveness application. If the Borrower’s application for forgiveness of the PPP loan is not approved or approved only in part, it will be obligated to repay the unforgiven portion of the loan after the SBA makes its decision on the application for forgiveness.

29

On February 14, 2020, we completed an underwritten offering of 10,638,298 shares of our common stock and warrants to purchase 10,638,298 shares of common stock. Each common share and warrant were sold together for a combined public purchase price of $2.35 before utilization. Dueunderwriting discount and commission. Each warrant has an exercise price of $2.80 per share, was exercisable immediately, and will expire February 12, 2027. The net proceeds to the Company from the offering were $22.5 million, after offering expenses payable by the Company. In connection with this offering, the Company agreed not to sell any additional shares under the Keystone Purchase Agreement described below for a period of 90 days after the closing date of the offering.

We are party to an Equity Purchase Agreement dated as of December 5, 2019 (the “Purchase Agreement”), with Keystone Capital Partners, LLC (“Keystone”), pursuant to which Keystone has agreed to purchase from us up to $25.0 million of shares of our common stock, subject to certain limitations including a minimum purchase price of $2.00 per share, at our direction from time to time during the 36-month term of the Purchase Agreement. Concurrently, we entered into a Registration Rights Agreement with Keystone, pursuant to which we agreed to register the sales of our common stock pursuant to the Purchase Agreement under our existing shelf registration statement on Form S-3 or a new registration statement. During the period from the date of the Purchase Agreement to the date of this filing, we have sold 270,502 shares of our common stock under the Purchase Agreement generating total gross proceeds of $725,000 and have up to $24,275,000 available for future sale under the Purchase Agreement. In connection with the underwritten offering described in the preceding paragraph, we agreed not to sell any additional shares under the Purchase Agreement for a period of 90 days after the closing date of the offering.

As of the date of issuance of these unaudited interim condensed financial statements, the Company expects that its cash and cash equivalents of $23.186 million as of September 30, 2020, will not be sufficient to fund its current business plan including related operating expenses and capital expenditure requirements into the second quarter of 2021. Accordingly, there is substantial doubt about the Company’s ability to continue as a going concern as the Company does not believe that its cash and cash equivalents will be sufficient to fund such business plan for at least twelve months from the date of issuance of these interim financial statements. The Company plans to address this condition by raising additional capital to finance its operations. Although the Company has been successful in raising capital in the past, financing may not be available on terms favorable to us, if at all, so there is no assurance that it will be successful in obtaining additional financing. Therefore, it is not considered probable, as defined in applicable accounting standards, that the Company’s plans to raise additional capital will alleviate the substantial doubt regarding its ability to continue as a going concern.

For the foreseeable future we will continue to pursue fundraising opportunities when available. If adequate funds are not available, we may be required to delay, reduce the scope of, or eliminate one or more of our product development programs or be unable to continue operations over a longer term. We plan to meet our future capital requirements primarily through issuances of equity securities, debt financing, or strategic partnership arrangements. Failure to generate revenue or raise additional capital would adversely affect our ability to achieve our intended business objectives

Our actual capital requirements will depend on many factors, including the cost and timing of pursuing a biologics license application for SkinTE we intend to file with FDA, the cost and timing of pre-clinical and clinical trials, the cost of establishing and maintaining our facilities in compliance with cGMP regulations, and the cost and timing of advancing our product development initiatives related to SkinTE. Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially. The foregoing factors, along with the other factors described in the section, Item 1A, “Risk Factors” in Part II of this Report on Form 10-Q will impact our future capital requirements and the adequacy of our available funds. If we are required to raise additional funds, any additional equity financing may be highly dilutive, or otherwise disadvantageous, to existing stockholders, and debt financing, if available, may involve restrictive covenants. If we elect to pursue collaborative arrangements, the terms of such arrangements may require us to relinquish rights to certain of our technologies, products, or marketing territories. Our failure to raise additional capital when needed, and on acceptable terms, would require us to reduce our operating expenses and would limit our ability to develop our product candidates and to continue operations, any of which would have a material adverse effect on our business, financial condition, and results of operation.

30

The following table sets forth the primary sources and uses of cash for each period indicated:

  Nine Months Ended 
(in thousands) 

September 30,

2020

  

September 30,

2019

 
Net cash provided by (used in)        
Operating activities $(32,170) $(40,650)
Investing activities  17,747   (14,875)
Financing activities  27,391   27,125 
Net increase/(decrease) in cash and cash equivalents $12,968  $(28,400)

Cash used in operating activities

During the nine-month period ended September 30, 2020, net cash used in operating activities was $32.170 million, which included $1.16 million of issuance fees related to the February equity raise. The cash used in operating activities was due to a net loss of $32.798 million plus $4.444 million due to remeasurement of the warrant liability arising from the underwritten offering of common stock and warrants in February 2020, which was offset by the non-cash expenses of $5.963 million for stock-based compensation expense.

During the nine-month period ended September 30, 2019, net cash used in operating activities was $40.650 million, which was due to a net loss of $71.348 million offset primarily by the non-cash expenses of $23.932 million for stock-based compensation expense.

Cash provided by (used in) investing activities

During the nine-month period ended September 30, 2020, net cash provided by investing activities was $17.747 million, which was due primarily to proceeds from the sale and maturities of available for sale securities.

During the nine-month period ended September 30, 2019, net cash used in investing activities was $14.875 million, which was due primarily due to purchases of available for sale securities.

Cash provided by financing activities

During the nine-month period ended September 30, 2020, net cash provided by financing activities was $27.391 million due to proceeds from financing arrangements and net proceeds received from the sale of common stock and warrants.

During the nine-month period ended September 30, 2019, net cash provided by financing activities was $27.125 million primarily due to proceeds received from the sale of common stock.

Critical Accounting Policies and Estimates

For a description of our significant accounting policies, see note 3 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.condensed consolidated financial statements.

Critical Accounting Estimates

Our discussion and analysis of the financial condition and results of operations is based upon our condensed 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 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 areis the valuationextent of warrant liability, valuationprogress toward completion of derivative liability,contracts, stock-based compensation, the valuation allowances for deferred tax benefits, and the valuation of tangible and intangible assets included in acquisitions. Actual results could differ from those estimates.

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We have identified

Revenue Recognition

Revenue is recognized when a customer obtains control of promised goods or services, in an amount that reflects the policies below as criticalconsideration which the entity expects to our business operations andreceive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the understandingperformance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation.

The Company records product revenues primarily from the sale of our financial results.its regenerative tissue products. The impactCompany sells its products to healthcare providers, primarily through direct sales representatives. Product revenues consists of a single performance obligation that the Company satisfies at a point in time. In general, the Company recognizes product revenue upon delivery to the customer.

The Company records service revenues from the sale of its preclinical research services and any associated risks relatedcontract services. Preclinical research services includes delivery of preclinical studies and other research services to these policiesunrelated third parties. Service revenues generally consist of a single performance obligation that the Company satisfies over time using an input method based on our business operations is discussed throughout management’s discussion and analysiscosts incurred to date relative to the total costs expected to be required to satisfy the performance obligation. The Company believes that this method provides a faithful depiction of financial condition and resultsthe transfer of operations when such policies affect our reported and expected financial results.

Goodwill and Intangible Assets.Goodwill represents the excess acquisition costservices over the fair value of net tangible and intangible assets acquired. Goodwill is not amortized and is subject to annual impairment testing or between annual tests if an event or change in circumstance occurs that would more likely than not reduce the fair value of a reporting unit below its carrying value. In testing for goodwill impairment, the Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, the Company concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is not required. If the Company concludes otherwise, the first stepterm of the two-step process must be performed. The goodwill impairment test is performed at the reporting unit level by comparing the estimated fair value of a reporting unit with its respective carrying value. If the estimated fair value exceeds the carrying value, goodwill at the reporting unit level is not impaired and the second step of the impairment test in unnecessary. If the estimated fair value is less than carrying value, the second step of the impairment test must be performed. The second step of the goodwill impairment test would be to record an impairment charge, if any,performance obligation based on the excessremaining services needed to satisfy the obligation. This requires the Company to make reasonable estimates of the extent of progress toward completion of the contract. As a result, unbilled receivables and deferred revenue are recognized based on payment timing and work completed. Generally, a portion of the payment is due upfront and the remainder upon completion of the contract, with most contracts completing in less than a year. Contract services includes research and laboratory testing services to unrelated third parties on a contract basis. These customer contracts generally consist of a reporting unit’s carrying amountsingle performance obligation that the Company satisfies at a point in time. The Company recognizes revenue upon delivery of testing results to the customer.

Costs to obtain the contract are incurred for products revenues as they are shipped and are expensed as incurred.

Stock-Based Compensation

The Company measures all stock-based compensation using a fair value method and records such expense in research and development, general and administrative, and sales and marketing expenses. Compensation expense for stock options with graded vesting is recognized over itsthe service period for each separately vesting tranche of the award as though the award were in substance, multiple awards.

The fair value.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. Forfeitures are recognized as they occur.

The fair value of reporting unitsrestricted stock grants is measured based on widely accepted valuation techniques thatthe 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.

Accruals for Research and Development Expenses and Clinical Trials

As part of the process of preparing its financial statements, the Company believes market participants would use, althoughis required to estimate its expenses resulting from its obligations under contracts with vendors, clinical research organizations and consultants and under clinical site agreements in connection with conducting clinical trials. The financial terms of these contracts are subject to negotiations, which vary from contract to contract and may result in payment terms that do not match the valuation process requires significant judgmentperiods over which materials or services are provided under such contracts. The Company’s objective is to reflect the appropriate expenses in its financial statements by matching those expenses with the period in which services are performed and often involves the use of significant estimates and assumptions.efforts are expended. The Company utilizesaccounts for these expenses according to the timing of various aspects of the expenses. The Company determines accrual estimates by taking into account discussion with applicable personnel and outside service providers as to the progress of clinical trials, or the services completed. During the course of a market cap approach in estimatingclinical trial, the fair valueCompany adjusts its clinical expense recognition if actual results differ from its estimates. The Company makes estimates of its accrued expenses as of each balance sheet date based on the facts and circumstances known to it at that time. The Company’s clinical trial accruals are dependent upon the timely and accurate reporting units. Theof contract research organizations and other third-party vendors. Although the Company does not expect its estimates to be materially different from amounts actually incurred, its understanding of the status and assumptions used in determining fair value could have a significant effect on whether or not an impairment charge is recordedtiming of services performed relative to the actual status and the magnitudetiming of such a charge. Adverse market or economic events couldservices performed may vary and may result in impairment charges in future periods.it reporting amounts that are too high or too low for any particular period.

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Intangible assets deemed to have finite lives are amortized on a straight-line basis over their estimated useful lives, which generally range from one to eleven years. The useful life is the period over which the asset is expected to contribute directly, or indirectly, to its future cash flows. Intangible assets are reviewed for impairment when certain events or circumstances exist. For amortizable intangible assets, impairment exists when the undiscounted cash flows exceed its carrying value. At least annually, the remaining useful life is evaluated.

Impairment of Long-Lived Assets.Assets

The Company reviews long-lived assets, including property and equipment, intangible assets and goodwill for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. Factors that the Company considers in deciding when to perform an impairment review include significant underperformance of the business in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in the use of the assets. If an impairment review is performed to evaluate a long-lived asset for recoverability, the Company compares forecasts of undiscounted cash flows expected to result from the use and eventual disposition of the long-lived asset to its carrying value. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset are less than its carrying amount. The impairment loss would be based on the excess of the carrying value of the impaired asset over its fair value, determined based on discounted cash flows. No impairment loss has been recognized.

Income Taxes.Common Stock and Warrant Transactions

The Company accounts for income taxes underissued units consisting of common stock and warrants and subsequently remeasured those warrants at fair value. Determining 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 using a fair value method and records such expense in research and development, general and administrative and sales and marketing expenses. Compensation Expense for stock options with graded vesting is recognized over the service period for each separately vesting tranche of the award as though the award were in substance, multiple awards.

The fair value for options issued is estimated at the date of grant using a Black-Scholes option-pricing model. The risk-free rate is derived from the U.S. Treasury yield curve in effect at the time of the grant. The volatility factor is determined based on the Company’s historical stock prices. Forfeitures are recognized as they occur.

The value of restricted stock grants is measured based on the fair market value of the Company’ssecurities 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 stock on the date of grant and amortized over the vesting period of, generally, six months to three years.stockholders.

Revenue Recognition. In the regenerative medicine products segment, the Company records product revenues primarily from the sale of its regenerative tissue products. The Company sells its products to healthcare providers, primarily through direct sales representatives. Product revenues consist of a single performance obligationDisclosure Regarding Forward-Looking Statements

Statements that the Company satisfies at a pointare not historical facts contained in time. In general, the Company recognizes product revenue upon delivery to the customer. In the contract services segment, the Company earns service revenues from the provision of contract research services, which includes delivery of preclinical studies and other research services to unrelated third parties. Service revenues generally consist of a single performance obligation that the Company satisfies over time using an input method based on costs incurred to date relative to the total costs expected to be required to satisfy the performance obligation.

Leases.On January 1, 2019 the Company adopted ASU 2016-02,Leases (ASC 842) and related amendments, which require lease assets and liabilities to be recorded on the balance sheet for leases with terms greater than twelve months. 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 purchaseincorporated 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. The standard was adopted using the modified retrospective transition approach by applying the new standard to all leases existing at the date of the initial application and not restating comparative periods. The most significant impact was the recognition of ROU assets and lease liabilities for operating leases, while our accounting for finance leases remained substantially unchanged. See Note 2 – Summary of Significant Accounting Policies and Note 7 – Leases in the notes to the condensed consolidated financial statements included in Part I, Item 1, ofreference into this Quarterly Report on Form 10-Q for additional information regardingare “forward-looking statements” within the adoption.

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Results of Operations

Three months ended September 30, 2019 versus three months ended September 30, 2018

Net Revenues. For the three-month period ended September 30, 2019, total net revenues were $1.4 million. Products revenues from the sale of SkinTE were $0.8 million for the three months ended September 30, 2019 compared to $0.2 million for the three months ended September 30, 2018. Net revenues from services for the three months ended September 30, 2019 were $0.6 million compared to $0.5 million for the three months ended September 30, 2018.

Cost of Sales. For the three-month period ended September 30, 2019, total cost of sales was approximately $0.6 million and approximately 46% of total net revenues. Products cost of sales were $0.3 million or approximately 38% of products revenues for the three-month period ended September 30, 2019. Products cost of sales consists primarily of direct manufacturing costs (materials, freight and labor) and fixed overhead costs.  Products cost of sales as a percentage of products revenues has declined quarter over quarter during the first nine months of 2019, primarily due to a reduction in direct manufacturing costs.  Services cost of sales were $0.3 million or approximately 59% of services revenues. Product cost of sales for the three-month period ended September 30, 2018 were $0.3 million or approximately 136% of products revenues. Services cost of sales for the three-month period ended September 30, 2018 were $0.4 million or approximately 76% of services revenues.

Research and Development Expenses. Research and development expenses decreased $1.1 million, or 28%, in the three-month period ended September 30, 2019, compared to the three-month period ended September 30, 2018. The decrease is primarily driven by a shift in mix between commercial and operational infrastructure build out in the current period as well as research and development costs in the prior period.

General and Administrative Expenses. General and administrative expenses increased $0.9 million, or 6%, in the three-month period ended September 30, 2019 compared to the three-month period ended September 30, 2018. The Company expanded its infrastructure to support the commercial launch of SkinTE. The resulting increase in expenses is driven primarily by employee-related costs, salaries, and benefits, and increased outside services expense, including legal and accounting fees and consulting expenses.

Sales and Marketing Expenses. For the three-month period ended September 30, 2019, sales and marketing expenses increased $3.4 million or 208%, in the three-month period ended September 30, 2019 compared to the three-month period ended September 30, 2018. This represents increased sales personnel and marketing costs due to the expansion and commercialization of SkinTE.

Other Income (Expenses). For the three-month period ended September 30, 2019, other income (expenses) increased approximately 12% compared to the three-month period ended September 30, 2018. This increase is due to rental income offset by a decrease in interest income.

Net loss. Net loss for the three-month period ended September 30, 2019 was approximately $23.0 million compared to a net loss of approximately $20.6 million for the three-month period ended September 30, 2018, primarily reflecting the increase in operating costs and expenses driven by expanding operations discussed above.

Nine months ended September 30, 2019 versus nine months ended September 30, 2018

Net Revenues. For the nine-month period ended September 30, 2019, total net revenues were $4.2 million. Products revenues from the sale of SkinTE were $1.6 million for the nine months ended September 30, 2019 compared to $0.4 million for the nine months ended September 30, 2018. Net revenues from services were $2.5 million for the nine months ended September 30, 2019 compared to $0.7 million for the nine months ended September 30, 2018. The IBEX business was acquired in May 2018 and contributed $0.7 million to revenues in the nine months ending September 30, 2018.

Cost of Sales. For the nine-month period ended September 30, 2019, total cost of sales was approximately $2.0 million and approximately 48% of total net revenues. Products cost of sales were $0.9 million or approximately 57% of products revenues primarily due to fixed overhead costs. Services cost of sales were $1.1 million or approximately 43% of services revenues. Products cost of sales for the nine-month period ended September 30, 2018 were $0.4 million and approximately 101% of products revenues. Services cost of sales for the nine-month period ended September 30, 2018 were $0.4 million or approximately 67% of services revenues.

Research and Development Expenses. Research and development expenses increased $0.5 million, or approximately 4%, in the nine-month period ended September 30, 2019, compared to the nine-month period ended September 30, 2018. The increase is primarily driven by an increase in research and clinical support personnel with associated wage and benefits cost, offset by a shift in mix between commercial and operational infrastructure build out in the current period as well as research and development costs in the prior period.

General and Administrative Expenses. General and administrative expenses increased $14.3 million, or approximately 42%, in the nine-month period ended September 30, 2019 compared to the nine-month period ended September 30, 2018. The Company expanded its infrastructure to support the commercial launch of SkinTE. The resulting increase in expenses is driven primarily by employee-related costs, salaries, and benefits, and increased outside services expense, including legal and accounting fees and consulting expenses.

Sales and Marketing Expenses. For the nine-month period ended September 30, 2019, sales and marketing expenses increased $11.3 million or 699%, in the nine-month period ended September 30, 2019 compared to the nine-month period ended September 30, 2018. This represents increased sales personnel and marketing costs due to the expansion and commercialization of SkinTE.

Other Income (Expenses). For the nine-month period ended September 30, 2019, other income (expenses) decreased $0.9 million or approximately 53% compared to the nine-month period ended September 30, 2018. This decrease is due to a change in the fair value of derivatives of $1.9 million and a reduction of interest income of $0.2 million offset by loss on extinguishment of warrant liability of $0.5 million, realized investment gains of $0.4 million and rental income of $0.3 million. There were no warrants outstanding for the nine-month period ended September 30, 2019.

Net loss. Net loss for the nine-month period ended September 30, 2019 was approximately $71.3 million compared to a net loss of approximately $46.4 million for the nine-month period ended September 30, 2018, primarily reflecting the increase in operating costs and expenses driven by expanding operations discussed above.

Liquidity and Capital Resources

As of September 30, 2019, our cash, cash equivalents and short-term investments balance was approximately $45.9 million and our working capital was approximately $35.7 million, compared to cash and cash equivalents and short-term investments of $61.8 million and working capital of $56.8 million at December 31, 2018.

As reflected in the condensed consolidated financial statements, we had an accumulated deficit of approximately $414.2 million at September 30, 2019, and approximately $40.7 million net cash used in operating activities for the nine-month period then ended. At December 31, 2018, we had an accumulated deficit of approximately $342.9 million and approximately $19.4 million net cash used in operating activities for the nine-months ended September 30, 2018.

On April 10 and May 6, 2019, the Company completed an underwritten offering providing for the issuance and sale of 3,418,918 sharesmeaning of the Company’s common stock, par value $0.001 per share, at an offering pricePrivate Securities Litigation Reform Act of $8.51 per share, for net proceeds of approximately $27.9 million, after deducting offering expenses payable by the Company.

The Company has taken numerous steps to further reduce its cash burn during the three months ended September 30, 2019, including outsourcing various aspects of our business, conducting a thorough budget review by department, enhancing fiscal discipline and prioritizing resource allocation to those areas1995, Section 27A of the business that are most likely to generate revenue inSecurities Act of 1933, as amended, and Section 21E of the near term. We expect these efforts will continue in the fourth quarterSecurities Exchange Act of 2019, but the results of these efforts will be offset by the agreement on settlement terms we signed on August 21, 2019, with Dr. Denver Lough, a principal shareholder and former officer and director, that provides, in part, that the Company pay to Dr. Lough $1,500,000 in cash on October 1, 2019, pay an additional $1,500,000 in cash in equal monthly installments beginning November 1, 2019 and ending April 1, 2021, and award to Dr. Lough 200,000 restricted stock units that vest in 18 equal monthly installments beginning October 1, 2019. Approximately $2.3 million is included in accounts payable and accrued expenses at September 30, 2019, for the payment obligations to Dr. Lough. The remaining amount due is included in other long-term liabilities.

Based upon the current status of our product development and commercialization plans, we believe that our existing cash, cash equivalents and short-term investments will be adequate to satisfy our capital needs for at least the next 12 months from the date of filing. Nevertheless, it is likely in the future we may need additional financing to continue clinical deployment and commercialization of our TE products, development of our other product candidates, and scaling the manufacturing capacity for our products and product candidates. Accordingly, we will continue to pursue fundraising opportunities when available, however, such financing may not be available on terms favorable to us, if at all. If adequate funds are not available in the future, we may be required to delay, reduce the scope of, or eliminate one or more of our operational or development programs. The Company may also implement additional spending reductions. We plan to meet our future capital requirements primarily through issuances of equity securities, debt financing, revenue from product sales and future collaborations. Failure to generate revenue or raise additional capital1934, as needed in the future would adversely affect our ability to achieve our business objectives.

Our actual capital requirements will depend on many factors, including among other things: our ability to scale the manufacturing for and to commercialize successfully our lead product, SkinTE; the progress and success of clinical evaluation and acceptance of SkinTE; our ability to develop our other product candidates; and the costs and timing of obtaining any required regulatory registrations or approvals. Ouramended (the “Exchange Act”). Forward-looking statements regarding the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involvesinvolve risks and uncertainties andthat could cause actual results could vary materially.to differ from projected results. The foregoing factors, alongwords “anticipate,” “goal,” “seek,” “project,” “strategy,” “future,” “likely,” “may,” “should,” “will,” “believe,” “estimate,” “expect,” “plan,” “intend” and similar expressions and references to future periods, as they relate to us, are intended to identify forward-looking statements. Forward-looking statements reflect our current views with the other factors described in Part I, Item 1A. Risk Factorsrespect to future events and are subject to certain risks, uncertainties and assumptions. We cannot assure you that any of our Transition Report on Form 10-K filed with the SEC on March 18, 2019expectations will impactbe realized. Forward-looking statements include, among others, statements we make regarding:

●the timing or success of obtaining regulatory licenses or approvals for marketing our products;
●the initiation, timing, progress, and results of our research and development programs;
●the initiation, timing, progress, and results of our pre-clinical or clinical trials;
●the timing for the healthcare industry to resume performing elective procedures that may impact the timing and cost of clinical trials;
●the impact of new accounting pronouncements;
●size and growth of our target markets;
●sufficiency of our working capital to fund our operations over the next 12 months;
●infrastructure required to support operations in future periods, including the expected costs thereof;
●estimates associated with revenue recognition, asset impairments, and cash flows;
●variance in our estimates of future operating costs;

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●future vesting and forfeitures of compensatory equity awards;
●the effectiveness of our disclosure controls and our internal control over financial reporting; and
●our plans to remediate material weaknesses in our internal control over financial reporting.

Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, without limitation:

●the ability to comply with regulations applicable to the manufacture, marketing, sale and distribution of our products;
●the ability to gain adoption by healthcare providers of our products for patient care;
●the ability to manufacture product to meet demand;
●the acceptance and level of reimbursement to healthcare providers for application of our products by public and private payors;
●the scope of protection we can establish and maintain for intellectual property rights covering our product candidates and technology;
●developments relating to our competitors and industry;
●the development of new therapies or new discoveries that render our products obsolete;
●outbreaks of disease, including the COVID-19 pandemic, and related stay-at-home orders, quarantine policies and restrictions on travel, trade and business operations;
●political and economic instability, whether resulting from natural disasters, wars, terrorism, pandemics or other sources;
●decisions made by healthcare providers regarding elective procedures and use of facilities and resources when there is a major outbreak of life-threatening infectious disease, such as COVID-19;
●the ability to pursue sales activity in the healthcare industry when there is a major outbreak of life-threatening infectious disease, such as COVID-19;
●the ability to manufacture and deliver our products if employees are quarantined due to the impact of the COVID-19;
●the ability to find and retain skilled personnel;
●the need for, and ability to obtain, additional financing in the future;
●general economic conditions;
●inaccuracies in estimates of our expenses, future revenues, and capital requirements;
●future accounting pronouncements;
●unauthorized access to confidential information and data on our information technology systems and security and data breaches; and
●factors described under “Risk Factors” in our 2019 Annual Report on Form 10-K and under Item 1A of this Quarterly Report on Form 10-Q.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future capital requirements and the adequacy of our available funds. If weevents or otherwise. All forward-looking statements are required to raise additional funds, any additional equity financing may be highly dilutive, or otherwise disadvantageous, to existing stockholders, and debt financing, if available, may involve restrictive covenants. If we elect to pursue collaborative arrangements, the terms of such arrangements may require us to relinquish rights to certain of our technologies, products or marketing territories. Our failure to raise capital when needed, and on acceptable terms, would require us to reduce our operating expenses and would limit our ability to respond to competitive pressures or unanticipated requirements to develop our product candidates and to continue operations, any of which would have a material adverse effect on our business, financial condition and results of operation.

Off-Balance Sheet Arrangements

As of September 30, 2019, 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, cash equivalents and short-term investments were approximately $45.9 million as of September 30, 2019, compared to cash and cash equivalents and short-term investments of approximately $61.8 million as of December 31, 2018. Working capital was approximately $35.7 million as of September 30, 2019, compared to working capital of approximately $56.8 million as of December 31, 2018.

Operating Cash Flows

Cash used in operating activities for the nine-month period ended September 30, 2019, was approximately $40.7 million. Approximately $19.4 million of cash was used in operating activities for the nine-month period ended September 30, 2018. The increase in net cash used in operating activities mostly relates to the expansion of infrastructure and sales and marketing expenses related to the commercial expansion of SkinTE.

Investing Cash Flows

Cash used in investing activities for the nine-month period ended September 30, 2019, was approximately $14.9 million. Cash used in investing activities for the nine-month period ended September 30, 2018 amounted to approximately $8.9 million. For the nine-month period ended September 30, 2019, the activity relates to the net purchase of available-for-sale securities and the purchase of property and equipment. For the nine-month period ended September 30, 2018, the activity relates to the purchase of property and equipment and the acquisition of IBEX.

Financing Cash Flows

Net cash providedexpressly qualified by financing activities for the nine-month period ended September 30, 2019, was approximately $27.1 million. $92.8 million of cash was provided by financing activities for the nine-month period ended September 30, 2018. For the nine-month period ended September 30, 2019, the activity relates to proceeds from stock options exercised and the Company completed an underwritten offering providing for the issuance and sale of 3,418,918 shares of the Company’s common stock, par value $0.001 per share, at an offering price of $8.51 per share, for net proceeds of approximately $27.9 million, after deducting offering expenses payable by the Company, offset by principal payments on finance leases and contingent consideration liability payments. For the nine-month period ended September 30, 2018, the activity relates to a public offering of 2,335,937 shares of our common stock at an offering price of $16.00 per share, resulting in net proceeds of $34.6 million, after deducting offering expenses and another underwritten offering of 2,455,882 shares of our common stock at an offering price of $23.65 per share, resulting in net proceeds of approximately $58.0 million, after deducting offering expenses.these cautionary statements.

Recent Accounting Pronouncements

Refer to our discussion of recent accounting pronouncements in Note 2 - Summary of Significant Accounting Policies to the accompanying condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Item 3. Quantitative and Qualitative Disclosure about Market Risk

Not applicable.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial and accounting officer, as appropriate, to allow timely decisions regarding required disclosure.

Our management, with the participation of our principal executive and financial officers, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on the evaluation of the effectiveness of our disclosure controls and procedures as of September 30, 2019,2020, our principal executive and financial officers concluded that, as of such date, our disclosure controls and procedures were not effective due to the material weaknesseseffective. There were no changes in our internal control over financial reporting identified below. To addressduring the material weaknesses, management performed additional analyses and other procedures to determine whether the financial statements included herein fairly present our financial results. Subject to the limitations above, management believes that the consolidated financial statements and other financial information contained in this report, fairly present in all material respects our financial condition, results of operations, and cash flows for the periods presented.

Internal Control Over Financial Reporting.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America, or GAAP. Our management does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.

Two material weaknesses previously identified as of December 31, 2018, continued to exist as ofthree-month period ended September 30, 2019, which include (1) insufficient internal controls related to information technology general controls in the areas of user access and user provisioning, over certain systems that support the financial reporting process; and (2) ineffective controls related to the documentation and completeness of the Company’s stock-based compensation expense.2020.

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Changes to Internal Control over Financial Reporting

There were no significant changes in the Company’s internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We have taken several steps to remediate the material weaknesses identified above. These steps include the following:

●Stock-Based Compensation System – The Company is in the process of implementing a systemic solution to our stock-based compensation accounting, including internal processes and an external compensation account management tool. The tool was launched during the first quarter of 2019 and we continue to run parallel tests, including data reconciliations. The system implementation and additional procedures enable the Company to properly document the stock-based compensation expense. The Company expects this issue to be remediated during 2019 after adequate test sampling to evaluate operating effectiveness.
●IT Systems & Controls – The Company has hired additional IT personnel and adopted access restrictions and protocols to prevent unauthorized access and unauthorized changes to data and records. We are evaluating these changes and whether they address the system control issues.

As we continue to evaluate and work to improve our internal control over financial reporting, management may determine to take additional measures to address the material weaknesses or determine to modify the remediation plan described above. Until the remediation steps set forth above are fully implemented and operating for a sufficient period of time, the material weakness described above will continue to exist.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings1A. Risk Factors

On June 26, 2018, a class action complaint alleging violations ofYou should carefully consider the Federal securities laws was filedfactors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the United States District Court, District of Utah, by Jose Moreno againstfiscal year ended December 31, 2019, and our Quarterly Reports on Form 10-Q for the Company and two directors of the Company, Case No. 2:18-cv-00510-JNP (the “Moreno Complaint”). On July 6, 2018, a similar complaint was filed in the same court against the same defendants by Yedid Lawi, Case No. 2:18-cv-00541-PMW (the “Lawi Complaint”). Both the Moreno Complaint and Lawi Complaint allege that the defendants made or were responsible for, disseminating information to the public through reports filed with the Securities and Exchange Commission and other channels that contained material misstatements or omissions in violation of Sections 10 and 20(a) of the Exchange Act and Rule 10b-5 adopted thereunder. Specifically, both complaints allege that the defendants misrepresented the status of one of the Company’s patent applications while touting the unique nature of the Company’s technology and its effectiveness. Plaintiffs are seeking damages suffered by them and the class consisting of the persons who acquired the publicly-traded securities of the Company betweenperiods ended March 31, 2017,2020 and June 22, 2018. Plaintiffs have filed motions to consolidate and for appointment as lead plaintiff. On November 28, 2018, the Court consolidated the Moreno and Lawi cases under the caption In re PolarityTE, Inc. Securities Litigation (the “Consolidated Securities Litigation”), and requested the appointment of the plaintiff in Lawi as the lead plaintiff. On January 16, 2019, the Court granted the motion of Yedid Lawi for appointment as lead plaintiff, and on February 1, 2019, the Court granted the lead plaintiff’s motion for approval of lead counsel and liaison counsel. The Court ordered that the lead plaintiff file and serve a consolidated complaint no later than 60 days after February 1, 2019, the defendants shall have 60 days after filing and service of the consolidated complaint to answer or otherwise respond, and the lead plaintiff must file a motion for class certification within 90 days of service of the consolidated complaint. The Lead Plaintiff filed a consolidated complaint on April 2, 2019 and asserted essentially the same violations of Federal securities laws recited in the original complaints. The Company believes the allegations in the consolidated complaint are without merit, and intends to defend the litigation, vigorously. The Company filed a motion to dismiss the consolidated complaint on June 3, 2019. Plaintiffs’ opposition to the Company’s motion to dismiss was filed on August 2, 2019, and the Company filed a reply to the opposition on September 13, 2019. A hearing on the Company’s motion to dismiss is scheduled for November 19, 2019. At this early stage of the proceedings the Company is unable to make any prediction regarding the outcome of the litigation.

In the ordinary course of30, 2020, which could materially affect our business, we may become involved in lawsuits, claims, investigations, proceedings, and threats of litigation relating to intellectual property, commercial arrangements, regulatory compliance, and other matters. Except as noted above, at September 30, 2019, we were not party to any legal or arbitration proceedings that may have significant effects on our financial position, or future results of operations. WeThe risks described in that Annual Report and Quarterly Reports are not a party to any material proceedings in which any director, member of senior management or affiliate of ours is either a party adversethe only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our subsidiariesbusiness, financial position, or hasfuture results of operations. The risk factor set forth below updates, and should be read together with, the risk factors described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 and our Quarterly Reports on Form 10-Q for the periods ended March 31, 2020 and June 30, 2020.

Risks Related to Our Business

Changes in our relationships with any of our significant customers, including the loss or reduction in business from one or more of them, could have a material interest adverse effect on us.

Since the beginning of 2020 several factors have contributed to the concentration of net revenues among several customers in both the regenerative medicine product segment and the contract services segment.

Due to the shift in our regulatory approach with FDA we determined it was prudent to focus our commercialization effort on the territories where we have current and repeat users of SkinTE and reduce the number of employees performing sales and marketing functions. For the three months ended September 30, 2020, 55%, of net revenues from the regenerative medicine product segment was generated by two hospital systems, one of which was the source of 44% of the net revenues, and for the nine months ended September 30, 2020, 33% of net revenues was generated by one hospital system, which is the same system that was the major contributor in the three-month period ended September 30, 2020.

At September 30, 2020, we had testing agreements with 29 nursing homes and three pharmacies in the northeast, controlled by a single company, 29 of which are located in the state of New York. These 32 facilities accounted for 94% of COVID-19 testing revenues in the third quarter ended September 30, 2020, and 96% of COVID-19 testing revenues for the nine-month period then ended, most of which was generated in New York. Accordingly, most of this business is dependent on monthly renewal by the state of New York of an order suspending the regulatory requirement that a laboratory outside New York obtain a clinical laboratory permit before providing laboratory testing services in the state, New York State regulations mandating testing for nursing home employees, and our ability to compete with other laboratories that may offer similar services in the state of New York.

There is no agreement or arrangement that prevents our significant customers from reducing or ending purchases of our product or services at any time. Purchases in the regenerative medicine product segment by significant customers depends on the demand for SkinTE for patient care, which is not predictable, and our ability to continue offer SkinTE while our BLA is pending. Our COVID-19 testing business in New York facilities is dependent on New York State orders and regulations, which are subject to change at any time, and our ability to compete for the business on the basis of price and service. If the demand by one or more of our significant customers for our product or services significantly decreased or all or a portion of our business dealings or relationships with one or more significant customers were to terminate or be canceled, it could materially adversely affect us orand our subsidiaries.ability to defray operating expenses with net revenues generated by those customers, thereby increasing our need and dependence on financing activities to fund operations.

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Item 6. Exhibits

Except as otherwise noted, the following exhibits are included in this filing:

10.1Settlement TermsCOVID-19 Laboratory Services Agreement between Arches Research, Inc., and Co-Diagnostics, Inc., dated August 21, 2019 between Denver Lough and PolarityTE, Inc.September 2, 2020 (service pricing information is redacted from the exhibit)
10.2Change in Control Compensation PlanRental Agreement for LGC Genomics Oktopure Extraction Machine between Arches Research, Inc., and Co-Diagnostics, Inc., dated September 2, 2020 (product pricing information is redacted from the exhibit)
31.1Certification Pursuant to Rule 13a-14(a)
31.2Certification Pursuant to Rule 13a-14(a).
31.3Certification Pursuant to Rule 13a-14(a)
32.1Certification Pursuant to Rule 13a-14(b) and Section 1350, Chapter 63 of Title 18, United States Code
101.INSXBRL Instance Document.Document - the Instance Document does not appear in the interactive data file because its XBRL tags are embedded within the Inline XBRL document
101.SCHXBRL Schema Document.Document
101.CALXBRL Calculation Linkbase Document.Document
101.DEFXBRL Definition Linkbase Document.Document
101.LABXBRL Label Linkbase Document.Document
101.PREXBRL Presentation Linkbase Document.Document
104Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

POLARITYTE, INC.
Date: November 9, 2020/s/ Paul MannDavid Seaburg
Paul MannDavid Seaburg
Chief Executive Officer
Duly Authorized Officer
Date: November 9, 2020/s/ Jacob Patterson
Jacob Patterson
Interim Chief Financial Officer
Duly AuthorizedChief Accounting Officer
Date:November 12, 2019

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