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EX-32 - EXHIBIT 32 - POLARITYTE, INC.v367204_ex32.htm

 
 
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 January 31, 2014
 
Commission File No. 000-51128
 
Majesco Entertainment Company
(Exact name of registrant as specified in its charter)
 
DELAWARE
06-1529524
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)
 
160 Raritan Center Parkway, Edison, NJ 08837
(Address of principal executive offices)
 
Registrant’s Telephone Number, Including Area Code: (732) 225-8910
 
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 
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 þ   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 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 þ No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company þ
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No þ
 
As of March 5, 2014, there were 46,459,764 shares of the Registrant’s common stock outstanding.
 
 
 
 
 
MAJESCO ENTERTAINMENT COMPANY AND SUBSIDIARY
INDEX
 
 
Page
PART I — FINANCIAL INFORMATION
 
Item 1. Financial Statements:
 
Condensed Consolidated Balance Sheets as of January 31, 2014 (unaudited) and October 31, 2013
3
Condensed Consolidated Statements of Operations for the three months ended January 31, 2014 and 2013 (unaudited)
4
Condensed Consolidated Statements of Comprehensive Loss for the three months ended January 31, 2014 and 2013 (unaudited)
5
Condensed Consolidated Statements of Cash Flows for the three months ended January 31, 2014 and 2013 (unaudited)
6
Notes to Condensed Consolidated Financial Statements (unaudited)
7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
14
Item 3. Quantitative and Qualitative Disclosures about Market Risk
21
Item 4. Controls and Procedures
21
PART II — OTHER INFORMATION
 
Item 1. Legal Proceedings
22
Item 1A. Risk Factors
22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
22
Item 3. Defaults Upon Senior Securities
22
Item 4. Mine Safety Disclosures
22
Item 5. Other Information
22
Item 6. Exhibits
23
SIGNATURES
23
 
 
2

 
PART I. FINANCIAL INFORMATION
 
Item 1. Financial Statements
 
MAJESCO ENTERTAINMENT COMPANY AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
 
 
 
January 31,
2014
 
October 31,
2013
 
 
 
(unaudited)
 
 
 
ASSETS
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
12,349
 
$
13,385
 
Due from factor, net
 
 
1,597
 
 
2,134
 
Accounts and other receivables
 
 
1,485
 
 
1,169
 
Inventory
 
 
3,003
 
 
4,859
 
Advance payments for inventory
 
 
160
 
 
1,064
 
Capitalized software development costs and license fees
 
 
2,121
 
 
7,825
 
Prepaid expenses and other current assets
 
 
248
 
 
2,827
 
Total current assets
 
 
20,963
 
 
33,263
 
Property and equipment, net
 
 
1,025
 
 
817
 
Investment in GMS Entertainment Limited
 
 
3,316
 
 
3,500
 
Other assets
 
 
69
 
 
69
 
Total assets
 
$
25,373
 
$
37,649
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
Accounts payable and accrued expenses
 
$
9,369
 
$
8,994
 
Inventory financing
 
 
-
 
 
1,764
 
Advances from customers and deferred revenue
 
 
30
 
 
6,838
 
Total current liabilities
 
 
9,399
 
 
17,596
 
Commitments and contingencies
 
 
 
 
 
 
 
Stockholders’ equity:
 
 
 
 
 
 
 
Common stock — $.001 par value; 250,000,000 shares authorized; 46,374,302
     and 46,295,969 shares issued and outstanding at January 31, 2014 and
     October 31, 2013, respectively
 
 
46
 
 
46
 
Additional paid-in capital
 
 
124,521
 
 
124,148
 
Accumulated deficit
 
 
(108,042)
 
 
(103,530)
 
Accumulated other comprehensive loss
 
 
(551)
 
 
(611)
 
Net stockholders’ equity
 
 
15,974
 
 
20,053
 
Total liabilities and stockholders’ equity
 
$
25,373
 
$
37,649
 
 
See accompanying notes to condensed consolidated financial statements
 
 
3

 
MAJESCO ENTERTAINMENT COMPANY AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except share and per share amounts)
 
 
 
Three months ended
January 31
 
 
 
2014
 
2013
 
Net revenues
 
$
21,934
 
$
23,472
 
Cost of sales
 
 
 
 
 
 
 
Product costs
 
 
7,542
 
 
8,414
 
Software development costs and license fees
 
 
11,003
 
 
7,906
 
Total cost of sales
 
 
18,545
 
 
16,320
 
Gross profit
 
 
3,389
 
 
7,152
 
Operating costs and expenses
 
 
 
 
 
 
 
Product research and development
 
 
1,246
 
 
2,082
 
Selling and marketing
 
 
4,056
 
 
3,729
 
General and administrative
 
 
2,107
 
 
2,251
 
Workforce reduction
 
 
-
 
 
776
 
Loss on impairment of capitalized software development costs and
   license fees – cancelled games
 
 
-
 
 
175
 
Depreciation and amortization
 
 
81
 
 
111
 
Total operating costs and expenses
 
 
7,490
 
 
9,124
 
Operating loss
 
 
(4,101)
 
 
(1,972)
 
Other expenses (income)
 
 
 
 
 
 
 
Interest and financing costs
 
 
162
 
 
183
 
Loss from equity method investment
 
 
247
 
 
-
 
Change in fair value of warrant liability
 
 
-
 
 
(17)
 
Loss before income taxes
 
 
(4,510)
 
 
(2,138)
 
Income taxes
 
 
2
 
 
3
 
Net loss
 
$
(4,512)
 
$
(2,141)
 
Net loss per share:
 
 
 
 
 
 
 
Basic
 
$
(0.10)
 
$
(0.05)
 
Diluted
 
$
(0.10)
 
$
(0.05)
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
 
 
44,695,611
 
 
40,482,898
 
Diluted
 
 
44,695,611
 
 
40,482,898
 
 
See accompanying notes to condensed consolidated financial statements
 
 
4

 
MAJESCO ENTERTAINMENT COMPANY AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited, in thousands)
 
 
 
Three months ended
January 31
 
 
 
2014
 
2013
 
Net loss
 
$
(4,512)
 
$
(2,141)
 
Other comprehensive (loss) income
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
 
60
 
 
(47)
 
Other comprehensive (loss) income
 
 
60
 
 
(47)
 
Comprehensive loss
 
$
(4,452)
 
$
(2,188)
 
 
See accompanying notes to condensed consolidated financial statements
 
 
5

 
MAJESCO ENTERTAINMENT COMPANY AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
 
 
Three months ended
January 31,
 
 
 
2014
 
2013
 
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
 
 
 
Net loss
 
$
(4,512)
 
$
(2,141)
 
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
 
 
 
Depreciation and amortization
 
 
81
 
 
111
 
Loss from equity method investment
 
 
247
 
 
-
 
Non-cash compensation expense
 
 
373
 
 
280
 
Provision for price protection
 
 
2,722
 
 
763
 
Amortization of capitalized software development costs and license fees
 
 
7,226
 
 
2,336
 
Loss on impairment of capitalized software development costs and license fees
 
 
-
 
 
175
 
Provision for excess inventory
 
 
28
 
 
229
 
Change in fair value of warrant liability
 
 
-
 
 
(17)
 
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
Due from factor
 
 
(2,185)
 
 
7,054
 
Accounts and other receivables
 
 
(316)
 
 
1,912
 
Inventory
 
 
1,828
 
 
4,226
 
Capitalized software development costs and license fees
 
 
(1,522)
 
 
(2,855)
 
Advance payments for inventory
 
 
904
 
 
15
 
Prepaid expenses and other assets
 
 
2,579
 
 
1,311
 
Accounts payable and accrued expenses
 
 
378
 
 
(204)
 
Advances from customers and deferred revenue
 
 
(6,808)
 
 
(4,402)
 
Net cash provided by operating activities
 
 
1,023
 
 
8,793
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
 
 
 
 
Purchases of property and equipment
 
 
(289)
 
 
(26)
 
Net cash used in investing activities
 
 
(289)
 
 
(26)
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
 
 
 
 
Repayment of inventory financing
 
 
(1,767)
 
 
-
 
Net cash used in financing activities
 
 
(1,767)
 
 
-
 
Effect of exchange rates on cash and cash equivalents
 
 
(3)
 
 
(42)
 
Net (decrease) increase in cash and cash equivalents
 
 
(1,036)
 
 
8,725
 
Cash and cash equivalents — beginning of period
 
 
13,385
 
 
18,038
 
Cash and cash equivalents — end of period
 
$
12,349
 
$
26,763
 
SUPPLEMENTAL CASH FLOW INFORMATION
 
 
 
 
 
 
 
Cash paid during the period for interest and financing costs
 
$
137
 
$
144
 
Cash paid during the period for income taxes
 
$
-
 
$
-
 
 
See accompanying notes to condensed consolidated financial statements
 
 
6

 
   
MAJESCO ENTERTAINMENT COMPANY AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, dollars in thousands, except per-share amounts)
 
1. PRINCIPAL BUSINESS ACTIVITY AND BASIS OF PRESENTATION
 
The accompanying financial statements present the financial results of Majesco Entertainment Company and Majesco Europe Limited, its wholly owned subsidiary, (“Majesco” or “the Company”) on a consolidated basis.
 
The Company is a provider of video game products primarily for the mass-market consumer. It sells its products primarily to large retail chains, specialty retail stores, and distributors. It publishes video games for major current generation interactive entertainment hardware platforms, including Nintendo’s DS, 3DS, Wii and WiiU, Sony’s PlayStation 3, or PS3, and PlayStation Portable, or PSP®, Microsoft’s Xbox 360 and Xbox One and the personal computer, or PC.  It also publishes games for digital platforms, including mobile platforms like the iPhone, iPad and Android devices, as well as online sites such as Facebook and Steam.
 
The Company’s video game titles are targeted at various demographics at a range of price points. Due to the larger budget requirements for developing and marketing premium console titles for core gamers, it focuses on publishing more casual games targeting mass-market consumers. In some instances, its titles are based on licenses of well-known properties and, in other cases based on original properties. The Company enters into agreements with content providers and video game development studios for the creation of its video games.
 
The Company’s operations involve similar products and customers worldwide. These products are developed and sold domestically and internationally. The Company may also enter into agreements with licensees, particularly for sales of its products internationally. The Company is centrally managed and its chief operating decision makers, the chief executive and other officers, use consolidated and other financial information supplemented by sales information by product category, major product title and platform for making operational decisions and assessing financial performance. Accordingly, the Company operates in a single reportable segment. In fiscal 2013, the Company acquired an interest in GMS Entertainment Limited, which is focused on the development and operation of real money online games, social casinos and lottery systems (See Note 18).
 
Geographic regions.  Net revenues by geographic region were as follows:
 
 
 
Three months ended January 31,
 
 
 
2014
 
%
 
2013
 
%
 
United States
 
$
18,937
 
86
 
$
17,328
 
74
 
Europe
 
 
2,997
 
14
 
 
6,144
 
26
 
Total net revenues
 
$
21,934
 
100
 
$
23,472
 
100
 
 
The accompanying interim condensed consolidated financial statements of the Company are unaudited, but in the opinion of management, reflect all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results for the interim period. Accordingly, they do not include all information and notes required by generally accepted accounting principles for complete financial statements. The Company’s financial results are impacted by the seasonality of the retail selling season and the timing of the release of new titles. The results of operations for interim periods are not necessarily indicative of results to be expected for the entire fiscal year. The balance sheet at October 31, 2013 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. These interim condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the year ended October 31, 2013 filed with the Securities and Exchange Commission on Form 10-K on January 14, 2014.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Principles of Consolidation.  The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary located in the United Kingdom. Significant intercompany accounts and transactions have been eliminated in consolidation. The Company has 50% of the voting control of GMS Entertainment Limited (GMS) and the right to appoint one-half of the directors of GMS.  All business activities and transactions that significantly impact GMS must be approved by both equity owners. Accordingly, the Company accounts for GMS on the equity method as a corporate joint venture.
 
Revenue Recognition. The Company recognizes revenue upon the shipment of its products when: (1) title and the risks and rewards of ownership are transferred; (2) persuasive evidence of an arrangement exists; (3) there are no continuing obligations to the customer; and (4) the collection of related accounts receivable is probable. Certain products are sold to customers with a street date (the earliest date these products may be resold by retailers). Revenue for sales of these products is not recognized prior to their street date. Some of the Company’s software products provide limited online features at no additional cost to the consumer. Generally, such features have been considered to be incidental to the Company’s overall product offerings and an inconsequential deliverable. Accordingly, the Company does not defer any revenue related to products containing these limited online features. However, in instances where online features or additional functionality is considered a substantive deliverable in addition to the software product, such characteristics will be taken into account when applying the Company’s revenue recognition policy.
 
 
7

 
The Company generally sells its products on a no-return basis, although in certain instances, the Company provides price protection or other allowances on certain unsold products. Price protection, when granted and applicable, allows customers a partial credit against amounts they owe the Company with respect to merchandise unsold by them. Revenue is recognized, and accounts receivable is presented, net of estimates of these allowances.
 
The Company estimates potential future product price protection and other allowances related to current period product revenue. The Company analyzes historical experience, current sell through of retailer inventory of the Company’s products, current trends in the video game market, the overall economy, changes in customer demand and acceptance of the Company’s products and other related factors when evaluating the adequacy of price protection and other allowances.
 
Sales incentives or other consideration given by the Company to customers that are considered adjustments of the selling price of its products, such as rebates and product placement fees, are reflected as reductions of revenue. Sales incentives and other consideration that represent costs incurred by the Company for benefits received, such as the appearance of the Company’s products in a customer’s national circular ad, are reflected as selling and marketing expenses, in accordance with Accounting Standards Codification (“ASC”) 605-50, Customer Payments and Incentives.
 
In addition, some of the Company’s software products are sold exclusively as downloads of digital content for which the consumer takes possession of the digital content for a fee. Revenue from product downloads is generally recognized when the download is made available (assuming all other recognition criteria are met).
 
When the Company operates hosted online games in which players can play for free and purchase virtual goods for use in the games, it recognizes revenues from the sale of virtual goods as service revenues over the estimated period in which players use the game. It currently estimates these periods of use to be three to four months. The Company periodically assesses its estimates for this period of use and future increases or decreases in these estimates and adjusts recognized revenues prospectively.  The Company also recognizes advertising revenue as ads are served.  The Company has not earned significant revenue to date related to its online games.
 
The Company records revenue for distribution agreements where it is acting as an agent as defined by ASC Topic 605, Revenue Recognition, Subtopic 45, Principal Agent Considerations, on a net basis. When the Company enters into license or distribution agreements that provide for multiple copies of games in exchange for guaranteed amounts, revenue is recognized in accordance with the terms of the agreements, generally upon delivery of a master copy, assuming our performance obligations are complete and all other recognition criteria are met, or as per-copy royalties are earned on sales of games.
 
In certain instances, customers and distributors provide the Company with cash advances on their orders. These advances are then applied against future sales to these customers.  Advances are classified as advances from customers and deferred revenue in the accompanying balance sheets. 
 
Inventory.  Inventory is stated at the lower of cost as determined by the first-in, first-out method, or market.  The Company estimates the net realizable value of slow-moving inventory on a title-by-title basis and charges the excess of cost over net realizable value to cost of sales.  Such estimates may change and additional charges may be incurred until the related inventory items are sold.
 
Capitalized Software Development Costs and License Fees. Software development costs include fees in the form of milestone payments made to independent software developers and licensors. Software development costs are capitalized once technological feasibility of a product is established and management expects such costs to be recoverable against future revenues. For products where proven game engine technology exists, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product basis. Amounts related to software development that are not capitalized are charged immediately to product research and development costs. Commencing upon a related product’s release capitalized costs are amortized to cost of sales based upon the higher of (i) the ratio of current revenue to total projected revenue or (ii) straight-line charges over the expected marketable life of the product.
 
Prepaid license fees represent license fees to owners for the use of their intellectual property rights in the development of the Company’s products. Minimum guaranteed royalty payments for intellectual property licenses are initially recorded as an asset (prepaid license fees) and a current liability (accrued royalties payable) at the contractual amount upon execution of the contract or when specified milestones or events occur and when no significant performance remains with the licensor. Licenses are expensed to cost of sales at the higher of (i) the contractual royalty rate based on actual sales or (ii) an effective rate based upon total projected revenue related to such license. Capitalized software development costs and prepaid license fees are classified as non-current if they relate to titles for which the Company estimates the release date to be more than one year from the balance sheet date. 
 
 
8

 
The amortization period for capitalized software development costs and prepaid license fees is usually no longer than one year from the initial release of the product. If actual revenues or revised forecasted revenues fall below the initial forecasted revenue for a particular license, the charge to cost of sales may be larger than anticipated in any given quarter. The recoverability of capitalized software development costs and prepaid license fees is evaluated quarterly based on the expected performance of the specific products to which the costs relate. When, in management’s estimate, future cash flows will not be sufficient to recover previously capitalized costs, the Company expenses these capitalized costs to “cost of sales-software development costs and license fees,” in the period such a determination is made. These expenses may be incurred prior to a game’s release for games that have been developed. If a game is cancelled prior to completion of development and never released to market, the amount is expensed to operating costs and expenses. If the Company was required to write off licenses, due to changes in market conditions or product acceptance, its results of operations could be materially adversely affected.
 
Costs of developing online free-to-play social games, including payments to third-party developers are expensed as research and development expenses. Revenue from these games is largely dependent on players’ future purchasing behavior in the game and currently the Company cannot reliably project that future net cash flows from developed games will exceed related development costs.
 
Prepaid license fees and milestone payments made to the Company’s third party developers are typically considered non-refundable advances against the total compensation they can earn based upon the sales performance of the products. Any additional royalty or other compensation earned beyond the milestone payments is expensed to cost of sales as incurred.
 
Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities or the disclosure of gain or loss contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Among the more significant estimates included in these financial statements are price protection and customer allowances, the valuation of inventory, the recoverability of advance payments for capitalized software development costs and intellectual property licenses, and the valuation allowances for deferred tax benefits. Actual results could differ from those estimates.
 
Any loss in value of the Company’s investment in GMS Entertainment Limited, after the application of the equity method, that is other than a temporary decline would be recognized in the period the loss in value occurs.  GMS has a limited operating history and its assets consist primarily of software and intangible assets. Key assuptions in the Company’s estimates of the fair value of GMS include the timely completion of future license and distribution arrangements for its technology and developments in the online gaming industry as a whole, which are subject to significant uncertainty. Accordingly, the Company’s estimates of the fair value of GMS may change significantly in the near term.
 
Loss Per Share. Basic loss per share of common stock is computed by dividing net loss applicable to common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted (loss) per share excludes the potential impact of common stock options, unvested shares of restricted stock and outstanding common stock purchase warrants because their effect would be anti-dilutive.
 
Commitments and Contingencies.  We are subject to claims and litigation in the ordinary course of our business. We record a liability for commitments and contingencies when the amount is both probable and reasonably estimable.
 
Concentrations.  The Company develops and distributes video game software for proprietary platforms under licenses from Nintendo, Sony and Microsoft, which must be periodically renewed. The Company’s agreements with these manufacturers also grant them certain control over the supply and manufacturing of the Company’s products. In addition, for the three months ended January 31, 2014, sales of the Company’s Zumba Fitness games accounted for approximately 72% of net revenues and for the three months ended January 31, 2013, sales of the Company’s Zumba Fitness games accounted for approximately 67% of net revenues.
 
Recent Accounting Pronouncements.
 
Income Taxes — In July 2013, the FASB issued an update to ASC 740, Income Taxes. The update to ASC 740 establishes standards for the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The update becomes effective for the Company on November 1, 2014. Adoption of the update is not expected to have a material impact on the Company’s financial position, results of operations, and cash flows.
 
 
9

 
3. FAIR VALUE
 
The table below segregates all financial assets and liabilities that are measured at fair value on a recurring basis into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date.
 
 
 
January 31,
2014
 
Quoted prices 
in active
markets
for identical
assets
(level 1)
 
Significant
other
observable
inputs
(level 2)
 
Significant
unobservable
inputs
(level 3)
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
7,786
 
$
7,786
 
$
 
$
 
Bank deposits
 
 
4,563
 
 
4,563
 
 
 
 
 
Total financial assets
 
$
12,349
 
$
12,349
 
$
 
$
 
  
 
 
 
October 31,
2013
 
 
Quoted prices
 in active
markets
for identical
assets
(level 1)
 
 
Significant
other
observable
inputs
(level 2)
 
 
Significant
unobservable
inputs
(level 3)
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
7,283
 
$
7,283
 
$
 
$
 
Bank deposits
 
 
6,102
 
 
6,102
 
 
 
 
 
Total financial assets
 
$
13,385
 
$
13,385
 
$
 
$
 
 
In the three months ended January 31, 2013, the Company had outstanding warrants that required settlement by transferring assets under certain change of control circumstances and were classified as liabilities in the Company’s consolidated balance sheets.  The Company measured the fair value of the warrants at each balance sheet date, using the Black-Scholes method, and recorded a gain or loss in earnings each period as change in fair value of warrants.  The warrants expired in March 2013. A summary of the changes to the Company’s warrant liability, as measured at fair value on a recurring basis using significant unobservable inputs (Level 3), for the three months ended January 31, 2013 is presented below:
 
Beginning balance
 
$
17
 
Total (gain) included in net loss
 
 
(17)
 
Ending balance
 
$
-
 
 
Assumptions used to determine the fair value of the warrants in the three months ended January 31, 2013 were:
 
Estimated fair value of stock
 
 
$0.61-$1.00
 
 
Expected warrant term
 
 
0.1-0.3 years
 
 
Risk-free rate
 
 
0.0-0.1
%
 
Expected volatility
 
 
77.4-84.8
%
 
Dividend yield
 
 
0
%
 
 
The carrying value of accounts receivable, accounts payable and accrued expenses, due from factor, and advances from customers are reasonable estimates of their fair values because of their short-term maturity.

4. DUE FROM FACTOR, NET
 
Due from factor consists of the following:
 
 
January 31,
2014
 
October 31,
2013
 
Outstanding accounts receivable sold to factor
 
$
8,285
 
$
9,131
 
Less: customer allowances
 
 
(3,253)
 
 
(3,319)
 
Less: provision for price protection
 
 
(3,435)
 
 
(1,943)
 
Less: advances from factor
 
 
-
 
 
(1,735)
 
 
 
$
1,597
 
$
2,134
 
 
Outstanding accounts receivable sold to the factor as of January 31, 2014 and October 31, 2013 for which the Company retained credit risk amounted to $167 and $260, respectively.  As of January 31, 2014 and October 31, 2013, there were no allowances for uncollectible accounts.  Allowances include provisions for customer payments and incentives deductible in future periods.
  
 
10

 
5. ACCOUNTS AND OTHER RECEIVABLES, NET
 
Accounts and other receivables, net, consist of the following:
 
 
January 31,
2014
 
October 31,
2013
 
Royalties receivable
 
$
730
 
$
702
 
Trade accounts receivable, net of allowances of $0
 
 
755
 
 
467
 
Total accounts and other receivables, net
 
$
1,485
 
$
1,169
 

6. INVENTORIES
 
Inventories consist of the following:
 
 
January 31,
2014
 
October 31,
2013
 
Finished goods
 
$
2,750
 
$
3,969
 
Packaging and components
 
 
253
 
 
890
 
Total inventories
 
$
3,003
 
$
4,859
 

7. PREPAID EXPENSES AND OTHER CURRENT ASSETS
 
Prepaid expenses consist of the following:
 
 
January 31,
2014
 
October 31,
2013
 
Deferred cost of sales
 
$
-
 
$
1,748
 
Prepaid advertising
 
 
-
 
 
994
 
Other
 
 
248
 
 
85
 
Total prepaid expenses and other current assets
 
$
248
 
$
2,827
 

8. PROPERTY AND EQUIPMENT, NET
 
Property and equipment, net, consist of the following:
 
 
January 31,
2014
 
October 31,
2013
 
Computers and software
 
$
3,725
 
$
3,430
 
Furniture and equipment
 
 
1,548
 
 
1,554
 
Leasehold improvements
 
 
154
 
 
154
 
Total property and equipment, gross
 
 
5,427
 
 
5,138
 
Accumulated depreciation
 
 
(4,402)
 
 
(4,321)
 
Total property and equipment, net
 
$
1,025
 
$
817
 

9. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
 
Accounts payable and accrued expenses consist of the following:
 
 
January 31,
2014
 
October 31,
2013
 
Accounts payable-trade
 
$
2,844
 
$
4,436
 
Royalty and software development
 
 
5,473
 
 
3,612
 
Salaries and other compensation
 
 
711
 
 
742
 
Other accruals
 
 
341
 
 
204
 
Total accounts payable and accrued expenses
 
$
9,369
 
$
8,994
 

10. ADVANCES FROM CUSTOMERS AND DEFERRED REVENUE
 
Advances from customers and deferred revenue consist of the following:
 
 
January 31,
2014
 
October 31,
2013
 
Deferred sales revenue
 
$
27
 
$
5,204
 
Deferred license revenue
 
 
-
 
 
1,179
 
Advances from customers
 
 
3
 
 
455
 
Total advances from customers and deferred revenue
 
$
30
 
$
6,838
 
 
 
11

 
11.  STOCKHOLDERS’ EQUITY
 
Common stock warrants
  
In the three months ended January 31, 2014, there were no changes in the Company’s outstanding warrants.  As of January 31, 2014, the Company had warrants for 50,000 shares outstanding with and exercise price of $1.06 per share, which expire in March 2015.

12. STOCK BASED COMPENSATION ARRANGEMENTS
 
Stock-based compensation expense in the three months ended January 31, 2014 and 2013 amounted to $373 and $280, respectively, and is recorded in general and administrative expenses in the accompanying consolidated statements of operations.
 
In the three months ended January 31, 2014, there were no changes in the Company’s outstanding stock options.  As of January 31, 2014, the Company had options for 3,363,644 shares outstanding with a weighted-average exercise price of $2.10 per share.
 
A summary of the Company’s restricted stock activity in the three months ended January 31, 2014 is presented below:
  
Balance at beginning of period
 
 
1,601,157
Granted
 
 
78,332
Vested
 
 
(73,437)
Outstanding at end of period
 
 
1,606,052
 
The grant-date fair value of restricted shares granted during the three months ended January 31, 2014 was $47, based on the fair value of the Company’s common stock on the date of grant.

13. INCOME TAXES
 
Due to the Company’s history of losses and uncertainty of future taxable income, a valuation allowance sufficient to fully offset net operating losses and other deferred tax assets has been established. The valuation allowance will be maintained until sufficient positive evidence exists to support a conclusion that a valuation allowance is not necessary. The Company’s effective tax rate for the three months ended January 31, 2014 and 2013 differed from the expected U.S. federal statutory rate primarily due to the change in the valuation allowance.

14. LOSS PER SHARE
  
Options, warrants and restricted shares to acquire 5,019,736 and 4,442,436 shares of common stock were not included in the calculation of diluted loss per common share for the three months ended January 31, 2014 and 2013, respectively, as the effect of their inclusion would be anti-dilutive.

15. COMMITMENTS AND CONTINGENCIES
 
Infringement claims
 
On September 20, 2012, a complaint for patent infringement was filed in the United States District Court for the Eastern District of Virginia by Intelligent Verification Systems, LLC against Microsoft Corporation and the Company.  The complaint alleges that Kinect and certain of the Company’s Kinect games, including Zumba Fitness Rush, infringe the plaintiff’s patents relating to biometric facial recognition and facial expression recognition technology.  Intelligent Verification Systems is seeking injunctive relief and monetary damages in an unspecified amount for the alleged infringement. The Company, in conjunction with Microsoft, is defending itself against the claim and has certain third party indemnity rights from developers for costs incurred in the litigation. The Company cannot currently estimate a potential range of loss if the claim against the Company is successful.
 
In addition to the item above, the Company at times may be a party to claims and suits in the ordinary course of business.  We record a liability when it is both probable that a liability has been incurred and the amount of the loss or range of loss can be reasonably estimated. The Company has not recorded a liability with respect to the matter above.  While the Company believes that it has valid defenses with respect to the legal matter pending and intends to vigorously defend the matter above, given the uncertainty surrounding litigation and our inability to assess the likelihood of a favorable or unfavorable outcome, it is possible that the resolution of the matter could have a material adverse effect on our consolidated financial position, cash flows or results of operations.
 
Commitments
 
The Company routinely issues purchase orders and enters into short-term commitments in the ordinary course of business.  As of January 31, 2014, commitments under development agreements amounted to $1,505.
 
 
12

 
16. WORKFORCE REDUCTION
 
Workforce Reduction
 
In January 2013, the Company implemented a realignment of its workforce to reduce certain fixed costs and provide for a more flexible cost model in the development and distribution of its games. The realignment included a reduction in workforce of approximately 40 employees, including employees related to the closure of its studio in Massachusetts, which focused on social games for Facebook, game-testing personnel in its New Jersey facility, and other marketing and support personnel.
 
The Company recorded the following charges in the three months ended January 31, 2013:
 
Severance costs
 
$
766
 
Lease termination costs
 
 
10
 
Total workforce reduction costs
 
$
776
 
 
Changes in the Company’s accrued liabilities for workforce reduction costs in the three months ended January 31, 2013 were as follows:
 
Beginning balance
 
$
-
 
Workforce reduction costs accrued
 
 
776
 
Workforce reduction costs paid
 
 
(142)
 
Ending balance
 
$
634
 

17. RELATED PARTIES
 
The Company has an agreement with Morris Sutton, the Company’s former Chief Executive Officer and Chairman Emeritus, under which he provides services as a consultant. The agreement provides for a monthly retainer of $13.  For the three months ended January 31, 2014 and 2013, consulting fees incurred under the agreement amounted to $38 and $38, respectively. The Company purchases a portion of its Zumba belt accessories from a supplier, on terms equal to those of another supplier. The Company estimates that Morris Sutton and another relative of Jesse Sutton, the Company’s Chief Executive Officer, earned compensation from such supplier of approximately $16 and $10 in the three months ended January 31, 2014 and 2013, respectively, based on the value of the Company’s purchases.
 
The Company has an agreement with a Board member under which he provides specified strategic consulting services.  The agreement provides for a monthly retainer of $10. For the three months ended January 31, 2014 and 2013, consulting fees incurred under the agreement amounted to $30 and $30, respectively. 

18. INVESTMENT IN GMS ENTERTAINMENT LIMITED
 
In the fiscal year ended October 31, 2013, the Company formed GMS Entertainment Limited (“GMS”), an Isle of Man company, with a third party to pursue online casino gaming.  The Company accounts for GMS on the equity method as a corporate joint venture.
 
In the three months ended January 31, 2014, the Company’s share of GMS’s net loss was $247, which is included in loss from equity method investment in the statement of operations.  GMS’s fiscal year end is September 30, which differs from the Company’s fiscal year end by one month. The Company’s policy is to record its share of GMS’s periodic results on the basis of a one-month delay. In addition, the Company recognized $63 of foreign currency translation gain, which is included in foreign currency translation adjustments in other comprehensive loss.  The functional currency of GMS is the pound sterling.
 
As of December 31, 2013, the assets of GMS consisted of approximately $1,000 of cash and working capital and $2,600 of intangible assets and goodwill.
 
 
13

 
Item 2.      Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Statements in this quarterly report on Form 10-Q that are not historical facts constitute forward-looking statements that are made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, or the Exchange Act.  These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Those factors include, among other things, those listed under “Risk Factors” and elsewhere in our annual report on Form 10-K for the fiscal year ended October 31, 2013 and other filings with the Securities and Exchange Commission (“SEC”). In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. Moreover, neither we nor any other person assume responsibility for the accuracy or completeness of these statements. We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results. References herein to “we,” “us,” “our,” and the “Company” are to Majesco Entertainment Company.
 
Overview
 
We are a provider of video game products primarily for the casual-game consumer. We sell our products primarily to large retail chains, specialty retail stores, and distributors. We publish video games for major current generation interactive entertainment hardware platforms, including Nintendo’s DS, DSi, 3DS, Wii and WiiU, Sony’s PlayStation 3, or PS3, Microsoft’s Xbox 360 and Xbox One and the personal computer, or PC.  We also publish games for digital platforms such as Xbox Live Arcade and PlayStation Network, or PSN, mobile platforms such as the iOS and Android phones, and online sites such as Facebook and Steam.
 
Our video game titles are targeted at various demographics at a range of price points. Due to the larger budget requirements for developing and marketing premium console titles for core gamers, we focus on publishing more casual games targeting casual-game consumers. In some instances, our titles are based on licenses of well-known properties and, in other cases based on original properties. We enter into agreements with content providers and video game development studios for the creation of our video games.
 
Our operations involve similar products and customers worldwide. These products are developed and sold domestically and internationally. The Company is centrally managed and our chief operating decision makers, the chief executive and other officers, use consolidated and other financial information supplemented by sales information by product category, major product title and platform for making operational decisions and assessing financial performance. Accordingly, we operate in a single segment.
 
Net Revenues.  Our revenues are principally derived from sales of our video games. We provide video games primarily for the mass market and casual game player. Our revenues are recognized net of estimated provisions for price protection and other allowances.
 
Cost of Sales.  Cost of sales consists of product costs and amortization and impairment of software development costs and license fees. A significant component of our cost of sales is product costs. Product costs are comprised primarily of manufacturing and packaging costs of the disc or cartridge media, royalties to the platform manufacturer and manufacturing and packaging costs of peripherals. In cases where we act as a distributor for other publishers’ products, cost of sales may increase as we acquire products at a higher fixed wholesale price. While the product costs as a percentage of revenue is higher on these products, we do not incur upfront development and licensing fees or resulting amortization of capitalized software development costs. Commencing upon the related product’s release, capitalized software development and intellectual property license costs are amortized to cost of sales. When, in management’s estimate, future cash flows will not be sufficient to recover previously capitalized costs, we expense these capitalized costs to cost of sales — loss on impairment of capitalized software development costs and license fees – future releases. These expenses may be incurred prior to a game’s release.
 
Gross Profit.  Gross profit is the excess of net revenues over product costs and amortization and impairment of capitalized software development and license fees. Development and license fees incurred to produce video games are generally incurred up front and amortized to cost of sales. The recovery of these costs and total gross profit is dependent upon achieving a certain sales volume, which varies by title.
 
Product Research and Development Expenses.  Product research and development expenses relate principally to our cost of supervision of third party video game developers, testing new products, development of social games and conducting quality assurance evaluations during the development cycle that are not allocated to games for which technological feasibility has been established. Costs incurred are primarily employee-related, may include equipment, and are not allocated to cost of sales.
 
 
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Selling and Marketing Expenses.  Selling and marketing expenses consist of marketing and promotion expenses, including television advertising, the cost of shipping products to customers and related employee costs. Credits to retailers for trade advertising are a component of these expenses.
 
General and Administrative Expenses.  General and administrative expenses primarily represent employee related costs, including corporate executive and support staff, general office expenses, professional fees and various other overhead charges. Professional fees, including legal and accounting expenses, typically represent the second largest component of our general and administrative expenses. These fees are partially attributable to our required activities as a publicly traded company, such as SEC filings.
 
Loss on Impairment of Capitalized Software Development Costs and License Fees- Cancelled Games.  Loss on impairment of capitalized software development costs and license fees — cancelled games consists of contract termination costs, and the write-off of previously capitalized costs, for games that were cancelled prior to their release to market. We periodically review our games in development and compare the remaining cost to complete each game to projected future net cash flows expected to be generated from sales. In cases where we do not expect the projected future net cash flows generated from sales to be sufficient to cover the remaining incremental cash obligation to complete the game, we cancel the game, and record a charge to operating expenses. While we incur a current period charge on these cancellations, we believe we are limiting the overall loss on a game project that is no longer expected to perform as originally expected due to changing market conditions or other factors. Significant management estimates are required in making these assessments, including estimates regarding retailer and customer interest, pricing, competitive game performance, and changing market conditions.
 
Interest and Financing Costs.  Interest and financing costs are directly attributable to our factoring and our purchase-order financing arrangements.  Such costs include commitment fees and fees based upon the value of customer invoices factored.
 
Income Taxes.  Income taxes consists of our provision for income taxes, as affected by our net operating loss carryforwards. Future utilization of our net operating loss, or NOL, carryforwards may be subject to a substantial annual limitation due to the “change in ownership” provisions of the Internal Revenue Code. The annual limitation may result in the expiration of NOL carryforwards before utilization. Due to our history of losses, a valuation allowance sufficient to fully offset our NOL and other deferred tax assets has been established under current accounting pronouncements, and this valuation allowance will be maintained until sufficient positive evidence exists to support its reversal.
 
Seasonality and Variations in Interim Quarterly Results
 
Our quarterly net revenues, gross profit, and operating loss are impacted significantly by the seasonality of the retail selling season, and the timing of the release of new titles. Sales of our catalog and other products are generally higher in the first and fourth quarters of our fiscal year (ending January 31 and October 31, respectively) due to increased retail sales during the holiday season. Sales and gross profit as a percentage of sales also generally increase in quarters in which we release significant new titles because of increased sales volume as retailers make purchases to stock their shelves and meet initial demand for the new release. These quarters also benefit from the higher selling prices that we are able to achieve early in the product’s life cycle. Therefore, sales results in any one quarter are not necessarily indicative of expected results for subsequent quarters during the fiscal year.
 
Critical Accounting Estimates
 
Our discussion and analysis of the financial condition and results of operations is based upon our 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 these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ materially from these estimates under different assumptions or conditions.
 
We have identified the policies below as critical to our business operations and to the understanding of our financial results. The impact and any associated risks related to these policies on our business operations is discussed throughout management’s discussion and analysis of financial condition and results of operations when such policies affect our reported and expected financial results.
 
Revenue Recognition.  We recognize revenue upon the shipment of our product when: (1) risks and rewards of ownership are transferred; (2) persuasive evidence of an arrangement exists; (3) we have no continuing obligations to the customer; and (4) the collection of related accounts receivable is probable. Certain products are sold to customers with a street date (the earliest date these products may be resold by retailers). Revenue for sales of these products is not recognized prior to their street date. Some of our software products provide limited online features at no additional cost to the consumer. Generally, we have considered such features to be incidental to our overall product offerings and an inconsequential deliverable. Accordingly, we do not defer any revenue related to products containing these limited online features. However, in instances where online features or additional functionality is considered a substantive deliverable in addition to the software product, such characteristics will be taken into account when applying our revenue recognition policy. To date, the Company has not earned significant revenues from such features.  In addition, some of our software products are sold exclusively as downloads of digital content for which the consumer takes possession of the digital content for a fee. Revenue from product downloads is generally recognized when the download is made available (assuming all other recognition criteria are met).
 
 
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When we enter into license or distribution agreements that provide for multiple copies of games in exchange for guaranteed amounts, revenue is recognized in accordance with the terms of the agreements, generally upon delivery of a master copy, assuming our performance obligations are complete and all other recognition criteria are met, or as per-copy royalties are earned on sales of games.
 
When we operate hosted online games in which players can play for free and purchase virtual goods for use in the games, we recognize revenues from the sale of virtual goods as service revenues over the estimated period in which players use the game. We generally estimate these periods of use to be less than a year. We periodically assess our estimates for this period of use and future increases or decreases in these estimates will affect our recognized revenues prospectively.  We also recognize advertising revenue related to advertising placed on our game sites as ads are displayed.
 
Price Protection and Other Allowances.  We generally sell our products on a no-return basis, although in certain instances, we provide price protection or other allowances on certain unsold products in accordance with industry practices. Price protection, when granted and applicable, allows customers a partial credit with respect to merchandise unsold by them. Revenue is recognized net of estimates of these allowances. Sales incentives and other consideration that represent costs incurred by us for benefits received, such as the appearance of our products in a customer’s national circular advertisement, are generally reflected as selling and marketing expenses. We estimate potential future product price protection and other discounts related to current period product revenue. In addition, some of our software products are sold exclusively as downloads of digital content for which the consumer takes possession of the digital content for a fee. Revenue from product downloads is generally recognized when the download is made available (assuming all other recognition criteria are met).
 
Our provisions for price protection and other allowances fluctuate over periods as a result of a number of factors including analysis of historical experience, current sell-through of retailer inventory of our products, current trends in the interactive entertainment market, the overall economy, changes in customer demand and acceptance of our products and other related factors. Significant management judgments and estimates must be made and used in connection with establishing the allowance for returns and price protection in any accounting period. However, actual allowances granted could materially exceed our estimates as unsold products in the distribution channels are exposed to rapid changes in consumer preferences, market conditions, technological obsolescence due to new platforms, product updates or competing products. For example, the risk of requests for allowances may increase as consoles pass the midpoint of their lifecycle and an increasing number of competitive products heighten pricing and competitive pressures. While management believes it can make reliable estimates regarding these matters, these estimates are inherently subjective. Accordingly, if our estimates change, this will result in a change in our provisions, which would impact the net revenues and/or selling and marketing expenses we report. Fluctuations in the provisions reflected our estimates of future price protection based on the factors discussed above. We limit our exposure to credit risk by factoring a portion of our receivables to a third party that buys without recourse.  For receivables that are not sold without recourse, we analyze our aged accounts receivables, payment history and other factors to make a determination if collection of receivables is likely, or a provision for uncollectible accounts is necessary.
 
Capitalized Software Development Costs and License Fees.  Software development costs include development fees, primarily in the form of milestone payments made to independent software developers. Software development costs are capitalized once technological feasibility of a product is established and management expects such costs to be recoverable against future revenues. For products where proven game engine technology exists, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product basis. Amounts related to software development that are not capitalized are charged immediately to product research and development costs. Commencing upon a related product’s release capitalized software development costs are amortized to cost of sales based upon the higher of (i) the ratio of current revenue to total projected revenue or (ii) straight-line charges over the expected marketable life of the product.
 
Prepaid license fees represent license fees to holders for the use of their intellectual property rights in the development of our products. Minimum guaranteed royalty payments for intellectual property licenses are initially recorded as an asset (capitalized license fees) and a current liability (accrued royalties payable) at the contractual amount upon execution of the contract or when specified milestones or events occur and when no significant performance commitment remains with the licensor. Licenses are expensed to cost of sales at the higher of (i) the contractual royalty rate based on actual sales or (ii) an effective rate based upon total projected revenue related to such license. Capitalized software development costs are classified as non-current if they relate to titles for which we estimate the release date to be more than one year from the balance sheet date.
 
 
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The amortization period for capitalized software development costs and license fees is usually no longer than one year from the initial release of the product. If actual revenues or revised forecasted revenues fall below the initial forecasted revenue for a particular license, the charge to cost of sales may be larger than anticipated in any given quarter. The recoverability of capitalized software development costs and license fees is evaluated quarterly based on the expected performance of the specific products to which the costs relate.
 
When, in management’s estimate, future cash flows will not be sufficient to recover previously capitalized costs, we expense these capitalized costs to cost of sales — loss on impairment of capitalized software development costs and license fees – future releases, in the period such a determination is made. These expenses may be incurred prior to a game’s release. If a game is cancelled and never released to market, the amount is expensed to operating costs and expenses – loss on impairment of capitalized software development costs and license fees – cancelled games. If we were required to write off licenses or capitalized software development costs, due to changes in market conditions or product acceptance, our results of operations could be materially adversely affected. As of January 31, 2014, the net carrying value of our licenses and capitalized software development costs was $2.1 million.
 
License fees and milestone payments made to our third party developers are typically considered non-refundable advances against the total compensation they can earn based upon the sales performance of the products. Any additional royalty or other compensation earned beyond the milestone payments is expensed to cost of sales as incurred.
 
We expense as research and development costs associated with the development of mobile and social games when we cannot reliably project that future net cash flows from developed games will exceed related development costs.  These games have not earned significant revenues to date and we are continuing to evaluate alternatives for future development and monetization. 
 
Inventory.  Inventory is stated at the lower of cost or market. Cost is determined by the first-in, first-out method. We estimate the net realizable value of slow-moving inventory on a title-by-title basis and charge the excess of cost over net realizable value to cost of sales.  Some of our inventory items are packaged with accessories.  The purchase of these accessories involves longer lead times and minimum purchase amounts, which may require us to maintain higher levels of inventory than for other games.  Therefore, these items have a higher risk of obsolescence, which we review periodically based on inventory and sales levels. 
 
Accounting for Stock-Based Compensation.  Stock-based compensation expense is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. Determining the fair value of stock-based awards at the grant date requires judgment, including, in the case of stock option awards, estimating expected stock volatility. In addition, judgment is also required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.
 
Commitments and Contingencies. We record a liability for commitments and contingencies when the amount is both probable and reasonably estimable.  We record associated legal fees as incurred.
 
Results of Operations
 
Three months ended January 31, 2014 versus three months ended January 31, 2013
 
Net Revenues. Net revenues for the three months ended January 31, 2014 decreased approximately 7% to $21.9 million from $23.5 million in the comparable quarter last year. The decrease is primarily due to lower licensing fees for our Zumba Fitness titles in Europe. Additionally, we have experienced a decline in sales of our Zumba products domestically when compared to the same quarter last year. However, the impact of this decline on our quarterly results is mitigated somewhat by the timing of shipments and street dates of our new holiday releases around our fiscal year end of October 31. We released Zumba World Party and Zumba Kids during our first quarter of fiscal 2014. Comparatively, we released Zumba Core during the fourth quarter of fiscal 2012. Therefore, launch sales of Zumba Core of approximately $11 million, which include initial retailer stock-up, were included in the fourth quarter of fiscal 2012, while launch revenue for Zumba World Party and Zumba Kids was included in the first quarter of 2014, affecting comparability. Net revenues in the European market decreased to approximately $3.0 million from $6.1 million during the same period a year ago. Overall Zumba sales accounted for 72% of our net revenues during the three months ended January 31, 2014, compared to 67% in the prior-year period.
 
 
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The following table sets forth our net revenues by platform:
 
 
 
Three months ended January31,
 
 
 
2014
 
%
 
 
2013
 
%
 
 
 
(thousands)
 
 
 
 
(thousands)
 
 
 
Nintendo Wii/WiiU
 
$
9,355
 
43
%
 
$
12,584
 
54
%
Microsoft Xbox 360/Xbox One
 
 
8,346
 
38
%
 
 
5,594
 
24
%
Nintendo DS/3DS
 
 
2,584
 
12
%
 
 
4,740
 
20
%
Sony Playstation 3
 
 
892
 
4
%
 
 
172
 
1
%
Accessories and other
 
 
757
 
3
%
 
 
382
 
1
%
TOTAL
 
$
21,934
 
100
%
 
$
23,472
 
100
%
 
Gross Profit. Gross profit for the three months ended January 31, 2014 was $3.4 million compared to a gross profit of $7.2 million in the same period last year. The decrease in gross profit was primarily attributable to a lower gross profit as a percentage of sales when compared to the same period last year. Gross profit as a percentage of net sales was 15% for the three months ended January 31, 2014, compared to 30% for the three months ended January 31, 2013. The decrease in gross profit as a percentage of sales primarily reflects higher development and licensing costs of our current-period Zumba releases when compared to prior releases. We incur fixed development and licensing fees to develop a game sequel. These costs are amortized over expected sales of the related product. Therefore, when the expected sales volume decreases for a particular title, amortized development and licensing costs increase as a percentage of revenue. We also developed our latest sequel, Zumba World Party, for both current gen, and next gen console platforms. This resulted in a higher development expense relative to our previous titles.
 
Product Research and Development Expenses. Research and development expenses were $1.2 million for the three months ended January 31, 2014, compared to $2.1 million of expenses for the same period in 2013. The decrease reflects the effects of the January 2013 workforce reduction, including the closing of our social games studio, and decreased spending on other development projects.
 
Selling and Marketing Expenses. Total selling and marketing expenses were approximately $4.1 million for the three months ended January 31, 2014, comparable to $3.7 million for the three months ended January 31, 2013.  Each period included holiday-season advertising expenses for Zumba releases.  The increase was primarily due to marketing activities related to the Company’s mobile game releases in the current-year period.
 
General and Administrative Expenses. For the three-month period ended January 31, 2014, general and administrative expenses amounted to $2.1 million, compared to $2.3 million for the three months ended January 31, 2013.  Lower costs of cash compensation costs and consulting and professional fees were partially offset by higher share-based compensation charges.
 
Operating loss. Operating loss for the three months ended January 31, 2014 was approximately $4.1 million, compared to an operating loss of $2.0 million in the comparable period in 2013, primarily reflecting lower gross profits on sales in fiscal 2014.
 
Change in Fair Value of Warrant Liability. Prior to March 2013, we had outstanding warrants that were recorded at fair value as liabilities and remeasured on a quarterly basis.  We recorded a nominal gain for the three months ended January 31, 2013, reflecting a decrease in the fair value of the warrants.
 
Income Taxes. In the three months ended January 31, 2014 and 2013, our income tax expense was not significant, representing primarily minimum state income taxes.
 
Liquidity and Capital Resources
 
As of January 31, 2014, our cash and cash equivalents balance was $12.3 million and funds available to us under our factoring and purchase order financing agreements were $3.6 million and $10.0 million, respectively. We expect continued fluctuations in the use and availability of cash due to the seasonality of our business, timing of receivables collections and working capital needs necessary to finance our business.  Capitalized software and development costs and license fees amount to $2.1 million as of January 31, 2014, primarily reflecting unamortized costs incurred in the development of games to be sold in future periods.  We will incur additional costs to complete games currently in development and purchase initial inventory.
 
Our current plan is to fund our operations through product sales and existing cash balances from which we expect to have sufficient funds for the next twelve months.  However, our operating results may vary significantly from period to period and we have incurred operating losses.  We believe that sales of video game software for casual games operating on dedicated handheld and console platforms have declined industry-wide for the past two years due to the late lifecycle of existing generation gaming platforms and the introduction of competing platforms such as mobile gaming. The newly introduced next generation console platforms have not yet demonstrated a large base of users in the casual and fitness game segments from which we have derived the majority of our revenues. Therefore, we do not currently plan to develop a new Zumba Fitness console game during 2014. Rather we will promote our existing next gen title, Zumba World Party, as the installed hardware base develops. As our Zumba Fitness titles accounted for a significant portion of our revenues over the past three years, we expect our revenues will decline in 2014. As a result, we expect to incur a net operating loss in 2014 and have factored this into our planning. We may be required to modify our plan, or seek outside sources of financing, and/or equity sales, if our operating plan and sales targets are not met. There can be no assurance that such funds will be available on acceptable terms, if at all. In the event that we are unable to negotiate alternative financing, or negotiate terms that are acceptable to us, we may be forced to modify our business plan materially, including making reductions in game development and other expenditures. Additionally, we are dependent on our purchase order financing and account receivable factoring agreement to finance our working capital needs, including the purchase of inventory. If the current level of financing was reduced or we fail to meet our operational objectives, it could create a material adverse change in the business.
 
 
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Factoring and Purchase Order Financing.
 
We factor our receivables. Under our factoring agreement, we have the ability to take cash advances against accounts receivable and inventory of up to $30.0 million, and the availability of up to $2.0 million in letters of credit. The factor, in its sole discretion, can reduce the availability of financing at any time. We had no outstanding advances against accounts receivable under our factoring agreement at January 31, 2014.  We also utilize financing to provide funding for the manufacture of our products. Under an agreement with a finance company, we have up to $10.0 million of availability for letters of credit and purchase order financing. In connection with these arrangements, the finance company and the factor have a security interest in substantially all of our assets. We had no outstanding advances for purchase order financing at January 31, 2014.
 
Under the terms of our factoring agreement, we sell our accounts receivable to the factor. The factor, in its sole discretion, determines whether or not it will accept the credit risk associated with a receivable. If the factor does not accept the credit risk on a receivable, we may sell the accounts receivable to the factor while retaining the credit risk. In both cases we surrender all rights and control over the receivable to the factor. However, in cases where we retain the credit risk, the amount can be charged back to us in the case of non-payment by the customer. The factor is required to remit payments to us for the accounts receivable purchased from us, provided the customer does not have a valid dispute related to the invoice. The amount remitted to us by the factor equals the invoiced amount, adjusted for allowances and discounts we have provided to the customer, less factor charges of 0.45 to 0.5% of the invoiced amount.
 
In addition, we may request that the factor provide us with cash advances based on our accounts receivable and inventory. The factor may either accept or reject our request for advances at its discretion. Generally, the factor allowed us to take advances in an amount equal to 70% of net accounts receivable, plus 60% of our inventory balance, up to a maximum of $2.5 million of our inventory balance. Occasionally, the factor allows us to take advances in excess of these amounts for short-term working capital needs. These excess amounts are typically repaid within a 30-day period. At January 31, 2014, we had no excess advances outstanding.
 
Amounts to be paid to us by the factor for any accounts receivable are offset by any amounts previously advanced by the factor. The interest rate is prime plus 1.5%, annually, subject to a 5.5% floor. In certain circumstances, an additional 1.0% annually is charged for advances against inventory.
 
Manufacturers require us to present a letter of credit, or pay cash in advance, in order to manufacture the products required under a purchase order. We utilize letters of credit either from a finance company or our factor. The finance company charges 1.5% of the purchase order amount for each transaction for 30 days, plus administrative fees. Our factor provides purchase order financing at a cost of 0.5% of the purchase order amount for each transaction for 30 days. Additional charges are incurred if letters of credit remain outstanding in excess of the original time period and/or the financing company is not paid at the time the products are received. When our liquidity position allows, we will pay cash in advance instead of utilizing purchase order financing. This results in reduced financing and administrative fees associated with purchase order financing.
 
Advances from Customers. On a case by case basis, distributors and other customers have agreed to provide us with cash advances on their orders. These advances are then applied against future sales to these customers. In exchange for these advances, we offer these customers beneficial pricing or other considerations.
 
Commitments and Contingencies.
 
On September 20, 2012, a complaint for patent infringement was filed in the United States District Court for the Eastern District of Virginia by Intelligent Verification Systems, LLC against Microsoft Corporation and the Company.  The complaint alleges that Kinect and certain Kinect games, including Zumba Fitness Rush, infringe the plaintiff’s patents relating to biometric facial recognition and facial expression recognition technology.  Intelligent Verification Systems is seeking injunctive relief and monetary damages in an unspecified amount for the alleged infringement. The Company intends, in conjunction with Microsoft, to defend itself against the claim. The Company cannot currently estimate a potential range of loss if the claim against the Company is successful.
 
In addition to the items above, we at times may be a party to claims and suits in the ordinary course of business.  We record a liability when it is both probable that a liability has been incurred and the amount of the loss or range of loss can be reasonably estimated. We have not recorded a liability with respect to the Intelligent Verification Systems, LLC matter above.  While we believe that we have valid defenses with respect to the legal matter pending and intends to vigorously defend the matter, given the uncertainty surrounding litigation and our inability to assess the likelihood of a favorable or unfavorable outcome, it is possible that the resolution of the matter could have a material adverse effect on our consolidated financial position, cash flows or results of operations.
 
 
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Commitments under development agreements amounted to $1.5 million at January 31, 2014. In addition, certain agreements provide for minimum commitments for marketing support.
 
Off-Balance Sheet Arrangements
 
As of January 31, 2014, we had no off-balance sheet arrangements.
 
Inflation
 
Our management currently believes that inflation has not had, and does not currently have, a material impact on continuing operations.
 
Cash Flows
 
Cash and cash equivalents were $12.3 million as of January 31, 2014 compared to $13.4 million at October 31, 2013 and $26.8 million at January 31, 2013. Working capital as of January 31, 2014 was $11.6 million compared to $15.7 million at October 31, 2013.  Changes in cash and working capital balances reflected operating results, as well as significant seasonal factors. Total cash and cash equivalents, plus advances available to us under our factoring agreement were $15.9 million and $18.2 million at January 31, 2014 and October 31, 2013, respectively.
 
Operating Cash Flows. Our principal operating source of cash is sales of our interactive entertainment products. Our principal operating uses of cash are for payments associated with third-party developers of our software, costs incurred to manufacture, sell and market our video games and general and administrative expenses.
 
For the three months ended January 31, 2014, we generated approximately $1.0 million in cash flow from operating activities, compared to $8.8 million in the same period last year. In addition to an increase in our net loss in the current period, cash collections from sales of the preceding quarters decreased, reflecting a decline in sales to $10.0 in the fourth fiscal quarter of 2013 from $26.6 million in the fourth quarter of fiscal 2012. 
 
Investing Cash Flows. Cash used in investing activities in the three months ended January 31, 2014 amounted to $0.3 million, compared to less than $0.1 million in the three months ended January 31, 2013, primarily reflecting the purchase of website assets.
 
Financing Cash Flows. Net cash used in financing activities for the three months ended January 31, 2014 reflected cash used to reduce outstanding borrowings under our purchase order financing agreement for seasonal inventory.  We had no outstanding borrowings at October 31, 2012 and, accordingly, there were no net cash outflows for repayments in the three months ended January 31, 2013.
 
 
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Item 3. Quantitative and Qualitative Disclosure about Market Risk
 
Not applicable.
 
Item 4. Controls and Procedures
 
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures, as defined in the Securities Exchange Act of 1934 Rule 13a-15(e) and 15d-15(e), as of the end of the period covered by this report.
 
In designing and evaluating our disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
 
While we believe our disclosure controls and procedures and our internal control over financial reporting are adequate, no system of controls can prevent errors and fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. 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 our Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur. Controls can also be circumvented by individual acts of some people, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with its policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
 
Subject to the limitations above, management believes that the condensed 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.
 
Based on the evaluation of the effectiveness of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) were effective at a reasonable assurance level.
 
There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.
 
 
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PART II. OTHER INFORMATION
 
Item 1. Legal Proceedings
 
None.
 
Item 1A. Risk Factors
 
We may not be able to maintain our listing on the Nasdaq Capital Market.
 
Our common stock currently trades on the Nasdaq Capital Market, referred to herein as Nasdaq. This market has continued listing requirements that we must continue to maintain to avoid delisting. The standards include, among others, a minimum bid price requirement of $1.00 per share and any of: (i) a minimum stockholders’ equity of $2.5 million; (ii) a market value of listed securities of $35 million; or (iii) net income from continuing operations of $500,000 in the most recently completed fiscal year or in the two of the last three fiscal years. Our results of operations and our fluctuating stock price directly impact our ability to satisfy these listing standards. In the event we are unable to maintain these listing standards, we may be subject to delisting.
 
On March 1, 2013, we received a letter from Nasdaq notifying us that for the 30 consecutive trading days preceding the date of the letter, the bid price of our common stock had closed below the $1.00 per share minimum required for continued inclusion on the Nasdaq Capital Market pursuant to Nasdaq Marketplace Rule 5550(a)(2).
 
The letter also stated that, in accordance with Nasdaq Marketplace Rule 5810(c)(3)(A), we will be provided 180 calendar days, or until August 28, 2013, to regain compliance with the minimum bid price requirement. On August 29, 2013, we were notified by Nasdaq that the Company had been provided an additional 180 calendar day grace period, or until February 24, 2014. Compliance is achieved if the bid price per share of our common stock closes at $1.00 per share or greater for a minimum of ten consecutive trading days prior to February 24, 2014.
 
As we did not achieve compliance within the required period, the Nasdaq staff issued written notification that the Company’s securities are subject to delisting. Upon receipt of such notification, we appealed the Nasdaq staff delisting determination to a Nasdaq Listing Qualifications Panel in order to present to the panel our intended plan of compliance, which includes a reverse stock split in order to increase our bid price above the minimum amount in order to attempt to regain compliance. If the panel does not accept our plan  for compliance, or we fail to regain compliance, we could be delisted.
 
A delisting from Nasdaq would result in our common stock being eligible for listing on the Over-The-Counter Bulletin Board (the “OTCBB”). The OTCBB is generally considered to be a less efficient system than markets such as Nasdaq or other national exchanges because of lower trading volumes, transaction delays and reduced security analyst and news media coverage. These factors could contribute to lower prices and larger spreads in the bid and ask prices for our common stock. Additionally, trading of our common stock on the OTCBB may make us less desirable to institutional investors and may, therefore, limit our future equity funding options and could negatively affect the liquidity of our stock.
 
A description of other risks associated with our business, financial condition, and results of operations is set forth in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended October 31, 2013. These factors continue to be meaningful for your evaluation of the Company and we urge you to review and consider the risk factors presented in the Form 10-K.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
None.
 
Item 3. Defaults Upon Senior Securities
 
None.
 
Item 4. Mine Safety Disclosures
 
Not applicable.
 
Item 5. Other Information
 
None.
 
 
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Item 6. Exhibits
 
31.1*
 
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2*
 
Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32*
 
Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101.INS#
 
XBRL Instance Document.
 
 
 
101.SCH#
 
XBRL Schema Document.
 
 
 
101.CAL#
 
XBRL Calculation Linkbase Document.
 
 
 
101.DEF#
 
XBRL Definition Linkbase Document.
 
 
 
101.LAB#
 
XBRL Label Linkbase Document.
 
 
 
101.PRE#
 
XBRL Presentation Linkbase Document.
 
* Filed herewith.
 
# In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this quarterly report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act of 1933 or the Securities Exchange Act of 1934, except as shall be expressly set forth by specific reference in such filing.
 
SIGNATURE
 
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.
 
MAJESCO ENTERTAINMENT COMPANY
 
/s/ Jesse Sutton
 
Jesse Sutton
 
Chief Executive Officer
 
Date: March 12, 2014
 
 
 
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