NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. PRINCIPAL BUSINESS ACTIVITY AND BASIS OF PRESENTATION

PolarityTE, Inc. (together with its subsidiaries, the “Company”) is a clinical stage biotechnology company developing regenerative tissue products and biomaterials. The Company also operates a laboratory testing and clinical research business using equipment, personnel, and facilities it acquired to advance the development of regenerative tissue products.

The Company’s first regenerative tissue product is SkinTE. In July 2021, the Company submitted an investigational new drug application (“IND”) for SkinTE to the United States Food and Drug Administration (the “FDA”) through its subsidiary, PolarityTE MD, Inc. Prior to June 1, 2021, the Company sold SkinTE under Section 361 of the Public Health Service Act in 2020 and into 2021 and, after the Company’s decision to file an IND under Section 351 of that Act, under an enforcement discretion position stated by the FDA in a regenerative medicine policy framework to help facilitate regenerative medicine therapies. The FDA’s stated period of enforcement discretion ended May 31, 2021. Consequently, the Company terminated commercial sales of SkinTE on May 31, 2021, and ceased its SkinTE commercial operations, and has transitioned to a clinical stage company pursuing an IND for SkinTE. As a result, there are no revenues from commercial SkinTE sales after June 2021, and the Company has eliminated or reduced costs associated with commercial sale of SkinTE.

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 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, 2020, 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 year ended December 31, 2020, filed with the Securities and Exchange Commission on Form 10-K on March 30, 2021.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

Use of estimates. The preparation of financial statements in conformity with U.S. 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, the valuation of common stock warrant liabilities, and the impairment of property and equipment. Actual results could differ from those estimates.

Cash and cash equivalents. Cash equivalents consist of highly liquid investments with original maturities of three months or less from the date of purchase. As of September 30, 2021, the Company did not hold any cash equivalents.

Inventory. Inventory comprises raw materials, which are valued at the lower of cost or net realizable value, on a first-in, first-out basis. The Company evaluates the carrying value of its inventory on a regular basis, taking into account anticipated future sales compared with quantities on hand, and the remaining shelf life of goods on hand to record an inventory reserve. The Company recorded inventory charges of $0.7 million for the nine months ended September 30, 2021, of which $0.3 million and $0.4 million were recorded in research and development and cost of sales, respectively, within the accompanying consolidated statement of operations. No inventory reserve was recorded as of September 30, 2021, or December 31, 2020.

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 the condensed consolidated balance sheet in property and equipment and other current and long-term liabilities. The current 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 ASC 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 ASC 842 to leases with a term of 12 months or less for all classes of assets.

Revenue Recognition. Under ASC 606, 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 recorded product revenues primarily from the sale of SkinTE, its regenerative tissue product. When the Company marketed its SkinTE product, it was sold to healthcare providers (customers), primarily through direct sales representatives. Product revenues consisted of a single performance obligation that the Company satisfies at a point in time. In general, the Company recognized product revenue upon delivery to the customer.

In the contract services segment, the Company records service revenues from the sale of its preclinical 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. The Company believes that this method provides an appropriate measure of the transfer of services over the term of the performance obligation based on the remaining 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 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. As of September 30, 2021, and December 31, 2020, the Company had unbilled receivables of $0.5 million and $0.2 million, respectively, and deferred revenue of $0.3 million and $0.2 million, respectively. The unbilled receivables balance is included in consolidated accounts receivable. Revenue of $0.2 million was recognized during the nine months ended September 30, 2021, that was included in the deferred revenue balance as of December 31, 2020.

Research and Development Expenses. Costs incurred for research and development are expensed as incurred. Nonrefundable advance payments for goods or services 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 Clinical 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 agreements. Under certain change of control provisions, some warrants issued by the Company could require cash settlement which necessitates such warrants to be recorded as liabilities. Warrants classified as liabilities are remeasured each period until settled or until classified as equity.

Stock-Based Compensation. The Company measures all stock-based compensation to employees and non-employees using a fair value method and records such expense in general and administrative, research and development, and sales and marketing expenses. For stock options with graded vesting, the Company recognizes compensation expense over the service period for each separately vesting tranche of the award as though the award were in substance, multiple awards 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 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 commensurate with the expected term of the option. The volatility factor is determined based on the Company’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 to compensation expense over the vesting period of, generally, six months to three years.

Net Loss Per Share. Basic net 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. Gains on warrant liabilities are only considered dilutive when the average market price of the common stock during the period exceeds the exercise price of the warrants. All common stock warrants issued participate on a one-for-one basis with common stock in the distribution of dividends, if and when declared by the Board of Directors, on the Company’s common stock. For purposes of computing earnings per share (EPS), these warrants are considered to participate with common stock in earnings of the Company. Therefore, the Company calculates basic and diluted EPS using the two-class method. Under the two-class method, net income for the period is allocated between common stockholders and participating securities according to dividends declared and participation rights in undistributed earnings. No income was allocated to the warrants for the three and nine months ended September 30, 2021 as results of operations were a loss for each period and the warrant holders are not required to absorb losses. The Company has issued pre-funded warrants from time to time at an exercise price of $0.001 per share. The shares of common stock into which the pre-funded warrants may be exercised are considered outstanding for the purposes of computing earnings per share because the shares may be issued for little or no consideration, are fully vested, and are exercisable after the original issuance date.

Impairment of Long-Lived Assets. The Company reviews long-lived assets, including property and equipment, and intangible assets 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.

Goodwill. Under accounting guidelines, goodwill is not amortized, but must be tested for impairment annually, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below the carrying amount. The Company reviews goodwill for impairment annually and whenever events or changes indicate that the carrying value of an asset may not be recoverable. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of significant assets or products. Application of these impairment tests requires significant judgment. There were no goodwill impairments recorded during the nine months ended September 30, 2021 and 2020.

Offering Costs. The Company capitalizes direct and incremental costs (i.e., consisting of legal, accounting, and other fees and costs) associated with equity financings until such financings are consummated, at which time such costs are recorded in additional paid-in capital against the gross proceeds of the equity financings. If the related equity financing is abandoned, the previously deferred offering costs will be charged to expense in the period in which the offering is abandoned.

Recent Accounting Pronouncements

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.

In August 2020, the FASB issued ASU No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity (ASU 2020-06). ASU 2020-06 simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts in an entity’s own equity. Those instruments that do not have a separately recognized embedded conversion feature will no longer recognize a debt issuance discount related to such a conversion feature and would recognize less interest expense on a periodic basis. It also removes from ASC 815-40-25-10 certain conditions for equity classification and amends certain guidance in ASC Topic 260 on the computation of EPS for convertible instruments and contracts in an entity’s own equity. An entity can use either a full or modified retrospective approach to adopt the ASU’s guidance. As a smaller reporting company, the Company is required to adopt this ASU for the fiscal year beginning January 1, 2024, with early adoption permitted for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The Company is currently assessing the impact and timing of adoption of this ASU.

In May 2021, the FASB issued ASU No. 2021-04, Earnings Per Share (Topic 260), Debt— Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging— Contracts in Entity’s Own Equity (Subtopic 815-40) (ASU 2021-04). ASU 2021-04 updates current accounting guidance for modifications or exchanges of freestanding equity-classified written call options that remain equity-classified after modification or exchange as an exchange of the original instrument for a new instrument. The ASU specifies that the effects of modifications or exchanges of freestanding equity-classified written call options that remain equity after modification or exchange should be recognized depending on the substance of the transaction, whether it be a financing transaction to raise equity (topic 340), to raise or modify debt (topic 470 and 835), or other modifications or exchanges. If the modification or exchange does not fall under topics 340, 470, or 835, an entity may be required to account for the effects of such modifications or exchanges as dividends which should adjust net income (or loss) in the basic EPS calculation. The Company is required to apply the amendments within this ASU prospectively to modifications or exchanges occurring on or after the effective date of the amendment. The Company plans to adopt this ASU on January 1, 2022. The Company does not expect the adoption of the new guidance to have a significant impact on its consolidated financial statements and related disclosures.

Recently Adopted Accounting Pronouncements

In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes, which simplifies the accounting for income taxes by removing certain exceptions to the current guidance, and improving the consistent application of and simplification of other areas of the guidance. The Company adopted this standard prospectively on January 1, 2021. The adoption of this ASU did not have a material impact on the Company’s condensed consolidated financial statements and related disclosures.

3. LIQUIDITY AND NEED FOR ADDITIONAL CAPITAL

The Company has experienced recurring losses and cash outflows from operating activities. As of September 30, 2021, the Company had an accumulated deficit of $499.8 million. As of September 30, 2021, the Company had cash and cash equivalents of $27.4 million. The Company has been funded historically through sales of equity and debt.

On January 14, 2021, the Company completed a registered direct offering of 6,670,000 shares of its common stock, par value $0.001 per share, pre-funded warrants to purchase up to 2,420,910 shares of common stock and accompanying common warrants to purchase up to 9,090,910 shares of common stock. Each share of common stock and pre-funded warrant were sold together with a common warrant. The combined offering price of each common share and accompanying common warrant was $1.100 and for each pre-funded warrant and accompanying common warrant was $1.099. The pre-funded warrants had an exercise price of $0.001 each and were exercised in full in January 2021. Each common warrant is exercisable for one share of the Company’s common stock at an exercise price of $1.20 per share. The warrants are immediately exercisable and will expire five years from the date of issuance. The holder of the warrants may not exercise any portion of the warrants to the extent that the holder would own more than 4.99% of the outstanding common stock immediately after exercise, which percentage may be changed at the holder’s election to a lower percentage at any time or to a higher percentage not to exceed 9.99% upon 61 days’ notice to the Company. The Company also issued to designees of the placement agent for the registered direct offering, warrants to purchase up to 6.0% of the aggregate number of common stock shares and pre-funded warrants sold in the offering (or warrants to purchase up to 545,455 shares of common stock). The placement agent warrants have substantially the same terms as the common warrants, except that the placement agent warrants have an exercise price equal to 125% of the purchase price per share (or $1.375 per share). The Company received net proceeds of $9.2 million in connection with the offering, after deducting placement agent fees and related offering expenses.

On January 22, 2021, the Company entered into a letter agreement with the holder of warrants to purchase 10,688,043 shares of common stock at an exercise price of $0.624 per share that were issued to the holder in the registered direct offering that closed on December 23, 2020. Under the letter agreement the holder agreed to exercise the 10,688,043 warrants in full and the Company agreed to issue and sell to the holder new common warrants to purchase up to 8,016,033 shares of the Company’s common stock, par value $0.001 per share, at a price of $0.125. Each new warrant is exercisable for one share of common stock at an exercise price of $1.20 per share. The new warrants are immediately exercisable and will expire five years from the date of issuance. The holder of the warrants may not exercise any portion of the warrants to the extent that the holder would own more than 4.99% of the outstanding common stock immediately after exercise, which percentage may be changed at the holder’s election to a lower percentage at any time or to a higher percentage not to exceed 9.99% upon 61 days’ notice to the Company. The Company also issued to designees of the placement agent for the registered direct offering in December 2020, warrants to purchase 6.0% of the aggregate number of new warrants issued under the letter agreement (or warrants to purchase up to 480,962 shares of common stock). The placement agent warrants have substantially the same terms as the new warrants. The Company received net proceeds of $6.7 million from the exercise of the existing warrants and $0.9 million from the sale of the newly issued warrants, after deducting placement agent fees and related offering expenses. The offering closed on January 25, 2021.

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’s significant operating losses raise substantial doubt regarding the Company’s ability to continue as a going concern for at least one year from the date of issuance of these condensed consolidated financial statements. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts of liabilities that might result from the outcome of this uncertainty. The Company is a clinical stage biotechnology company that has historically incurred losses and negative cash flows. Consequently, the future success of the Company depends on its ability to attract additional capital and, ultimately, on its ability to successfully complete the regulatory approval process for its product, SkinTE, and develop future profitable operations. 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.

4. FAIR VALUE

In accordance with ASC 820, Fair Value Measurements and Disclosures, financial instruments were measured at fair value using a three-level hierarchy which maximizes use of observable inputs and minimizes use of unobservable inputs:

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.

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):

The following table presents the change in fair value of the liability classified common stock warrants for the nine months ended September 30, 2021 (in thousands):

The following table presents the change in fair value of the liability classified common stock warrants for the nine months ended September 30, 2020 (in thousands):

The Company uses the Monte Carlo simulation model to determine the fair value of the liability classified warrants. Input assumptions used to measure the fair value of these freestanding instruments during the nine months ended September 30, 2021, are as follows:

Input assumptions used to measure the fair value of these freestanding instruments during the nine months ended September 30, 2020, are as follows:

5. PROPERTY AND EQUIPMENT, NET

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

The Company sold SkinTE under Section 361 of the Public Health Service Act in 2020 and into 2021 and, after the Company’s decision to file an IND under Section 351 of that Act, under an enforcement discretion position stated by the FDA in a regenerative medicine policy framework to help facilitate regenerative medicine therapies. The FDA’s stated period of enforcement discretion ended May 31, 2021. Consequently, the Company terminated commercial sales of SkinTE on May 31, 2021, and ceased its SkinTE commercial operations. As a result, there are no revenues from commercial SkinTE sales after June 1, 2021, and the Company has eliminated or reduced costs associated with commercial sale of SkinTE. At March 31, 2021, approximately $3.0 million of total property and equipment was related to commercial SkinTE operations, of which approximately $2.5 million was repurposed by the Company primarily as research and development equipment. The Company evaluated the future use of its commercial property and equipment and recorded an impairment charge of approximately $0.4 million during the first quarter of 2021. The impairment charges occurred within the Company’s regenerative medicine business segment and are included in restructuring and other charges within the accompanying consolidated statement of operations for the nine months ended September 30, 2021. There was no impairment charge recorded during the third quarter of 2021. See Note 13.

Depreciation and amortization expense for property and equipment, including assets acquired under financing leases was as follows (in thousands):

6. LEASES

The Company leases facilities and certain equipment under noncancelable leases that expire at various dates through June 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.

Operating Leases

On December 27, 2017, the Company entered into a commercial lease agreement with Adcomp LLC, a Utah limited liability company, pursuant to which the Company leased approximately 178,528 rentable square feet of warehouse, manufacturing, office, and lab space in Salt Lake City, Utah from the landlord. The initial term of the lease is five years, and it expires on November 30, 2022. The Company has a one-time option to renew for an additional five years. The initial base rent under this lease is $98,190 per month ($0.55 per sq. ft.) for the first year of the initial lease term and increases 3.0% per annum thereafter. Because the rate implicit in the lease is not readily determinable, the Company has used an incremental borrowing rate of 10% to determine the present value of the lease payments.

In April 2019, the Company entered into an operating lease to obtain 6,307 square feet of manufacturing, laboratory, and office space. The original term of the lease expired in April 2024 and required monthly lease payments subject to annual increases. During the third quarter of 2020, the Company initiated a business analysis to determine the long-term strategy of the remote facility and cost to remain operational. During the fourth quarter of fiscal year 2020, it was determined that the Company would cease operations and vacate the facility. As a result, the Company determined that the approved plan to vacate the lease represented a triggering event requiring the long-lived assets attributable to the disposal group be assessed for impairment. Given the facts and circumstances, the Company determined that the carrying value of the related assets of the disposal group were not recoverable. As a result, the carrying values were reduced to $0 as of December 31, 2020. During the second quarter of 2021, the Company terminated the lease effective June 30, 2021. The Company recorded a net gain on termination of $0.3 million which was included in restructuring and other charges on the condensed consolidated statement of operations.

Financing Leases

In November 2018 and April 2019, the Company entered into financing leases primarily for laboratory equipment used in research and development activities. The financing leases have remaining terms that range from 6 to 31 months as of September 30, 2021, and include options to purchase equipment at the end of the lease. Because the rate implicit in the lease is not readily determinable, the Company has used an incremental borrowing rate of approximately 10% to determine the present value of the lease payments for these leases.

As of September 30, 2021, the maturities of operating and finance lease liabilities were as follows (in thousands):

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

Operating leases

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

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

As of September 30, 2021, and December 31, 2020, the weighted average remaining lease term for operating leases was 1.2 and 2.1 years, respectively, and the weighted average discount rate used for operating leases was 10.01% and 9.75%, respectively. As of September 30, 2021, and December 31, 2020, the weighted average remaining lease term for finance leases was 2.1 and 2.6 years, respectively, and the weighted average discount rate used for finance leases was 9.78% for both periods.

7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES

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

8. OTHER CURRENT LIABILITIES

The following table presents the major components of other current liabilities (in thousands):

The short-term financing balance is related to a financing arrangement entered into during the nine months ended September 30, 2021 to fund an insurance contract. Under the financing arrangement, the amounts will be repaid in nine equal monthly installments, with an interest rate of 3.85%.

9. STOCK-BASED COMPENSATION

2020, 2019 and 2017 Equity Incentive Plans

2020 Plan

On October 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 7,191,917 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. The 2020 Plan provides that effective on January 1 of each year the number of shares of common stock reserved and available for issuance under the 2020 Plan shall be cumulatively increased by the lesser of 4% of the number of shares of common stock issued and outstanding on the immediately preceding December 31 or such lesser number of shares as determined by the 2020 plan administrator. As of September 30, 2021, the Company had 1,265,210 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. As of September 30, 2021, the Company had 49,097 shares available for future issuances under the 2019 Plan.

2017 Plan

On December 1, 2016, the Company’s 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 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. As of September 30, 2021, the Company had 211,134 shares available for future issuances under the 2017 Plan.

A summary of the Company’s employee and non-employee stock option activity for the nine months ended September 30, 2021, is presented below:

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.

Restricted Stock

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

Stock-Based Compensation Expense

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

10. SALE OF COMMON STOCK, WARRANTS AND PRE-FUNDED WARRANTS

On January 14, 2021, the Company completed a registered direct offering of 6,670,000 shares of its common stock, par value $0.001 per share, pre-funded warrants to purchase up to 2,420,910 shares of common stock and accompanying common warrants to purchase up to 9,090,910 shares of common stock. Each share of common stock and pre-funded warrant was sold together with a warrant. The combined offering price of each common stock share and accompanying warrant was $1.10 and for each pre-funded warrant and accompanying warrant was $1.099. The pre-funded warrants had an exercise price of $0.001 each and were exercised in full in January 2021. Each warrant is exercisable for one share of the Company’s common stock at an exercise price of $1.20 per share. The warrants are immediately exercisable and will expire five years from the date of issuance. The holder of the warrants may not exercise any portion of the warrants to the extent that the holder would own more than 4.99% of the outstanding common stock immediately after exercise, which percentage may be changed at the holder’s election to a lower percentage at any time or to a higher percentage not to exceed 9.99% upon 61 days’ notice to the Company. The Company also issued to designees of the placement agent warrants to purchase 6.0% of the aggregate number of common stock shares and pre-funded warrants sold in the offering (or warrants to purchase up to 545,455 shares of common stock). The placement agent warrants have substantially the same terms as the warrants, except that the placement agent warrants have an exercise price equal to 125% of the purchase price per share (or $1.375 per share). The net proceeds to the Company from the offering were $9.2 million, after direct offering expenses of $0.8 million payable by the Company.

As the common stock warrants and placement agent common stock warrants could each require cash settlement in certain scenarios, the common stock warrants and placement agent common stock warrants were classified as liabilities upon issuance and were initially recorded at estimated fair values of $8.1 million and $0.5 million, respectively. Since the pre-funded warrants did not contain the same cash settlement provision, these warrants were classified as a component of stockholders’ equity within additional paid-in-capital. The pre-funded warrants were equity classified because they met characteristics of the equity classification criteria. The total proceeds from the offering were first allocated to the liability classified warrants, based on their estimated fair values, with the residual $1.4 million allocated to the common stock and pre-funded common stock warrants in equity. Issuance costs allocated to the equity classified pre-funded common stock warrants and common stock of $0.1 million were recorded as a reduction to additional paid-in capital. Issuance costs allocated to the liability classified warrants of $0.7 million were recorded as an expense. The Company measured the fair value of the accompanying common warrants and placement agent warrants using the Monte Carlo simulation model at issuance and again at September 30, 2021, using the following inputs:

Accompanying common warrants:

Placement agent warrants:

On January 22, 2021, the Company entered into a letter agreement with the holder of warrants to purchase 10,688,043 shares of common stock at an exercise price of $0.624 per share that were issued to the holder in the registered direct offering that closed on December 23, 2020. Under the letter agreement the holder agreed to exercise the 10,688,043 warrants in full and the Company agreed to issue and sell to the holder common warrants to purchase up to 8,016,033 shares of the Company’s common stock, par value $0.001 per share, at a price of $0.125. Each warrant is exercisable for one share of Common Stock at an exercise price of $1.20 per share. The warrants are immediately exercisable and will expire five years from the date of issuance. A holder may not exercise any portion of the warrants to the extent that the holder would own more than 4.99% of the outstanding common stock immediately after exercise, which percentage may be changed at the holder’s election to a lower percentage at any time or to a higher percentage not to exceed 9.99% upon 61 days’ notice to the Company. The Company also issued to designees of the placement agent, warrants to purchase 6.0% of the aggregate number of common stock shares and pre-funded warrants sold in the offering (or warrants to purchase up to 480,962 shares of common stock). The placement agent warrants have substantially the same terms as the new warrants. The 10,688,043 warrants issued on December 23, 2020, were exercised on January 22, 2021, and closing of the offering occurred on January 25, 2021. The Company received gross proceeds of approximately $6.7 million from the exercise of the existing warrants and gross proceeds of approximately $1.0 million from the sale of the new warrants.

Immediately prior to the exercise of the existing 10,688,043 liability classified common stock warrants, a remeasurement loss of $3.6 million was recorded. The Company measured the fair value of the common stock warrants using the Monte Carlo simulation model on January 22, 2021, using the following inputs:

As the new common stock warrants and placement agent common stock warrants could each require cash settlement in certain scenarios, the new common stock warrants and placement agent common stock warrants were classified as liabilities upon issuance and were initially recorded at estimated fair values of $5.8 million and $0.4 million, respectively. Cash issuance costs of $0.1 million were recorded as an expense. The Company measured the fair value of the accompanying common stock warrants and placement agent common stock warrants using the Monte Carlo simulation model at issuance and again at September 30, 2021, using the following inputs:

Accompanying new common stock warrants:

Placement agent warrants:

The following table summarizes warrant activity for the nine months ended September 30, 2021.

On March 30, 2021, the Company entered into a sales agreement with Cantor Fitzgerald & Co. to sell shares of common stock having aggregate sales proceeds of up to $50.0 million, from time to time, through an “at the market” equity offering program under which Cantor Fitzgerald & Co. will act as sales agent. As of September 30, 2021, no common stock had been sold.

Pursuant to an Equity Purchase Agreement dated as of December 5, 2019 (the “Purchase Agreement”) that the Company entered into with Keystone Capital Partners, LLC (“Keystone”), Keystone agreed to purchase up to $25.0 million of shares of our common stock, subject to certain limitations, at our direction from time to time during the 36-month term of the Purchase Agreement. In anticipation of the “at the market” equity offering program described above, the Company provided notice to Keystone of its decision to terminate the Purchase Agreement, which was effective on March 26, 2021.

11. NET LOSS PER SHARE ATTRIBUTABLE TO COMMON STOCKHOLDERS

The following tables present reconciliations for the numerators and denominators of basic and diluted net loss per share:

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

12. DEBT

PPP Loan

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. On October 15, 2020, the Borrower applied to the Lender for forgiveness of the PPP loan in its entirety based on the Borrower’s use of the PPP loan for payroll costs, rent, and utilities. In June of 2021, the Company received notice of forgiveness of the PPP loan in whole and the Lender was paid by the SBA, including all accrued unpaid interest. The Company recorded the forgiveness of $3.6 million of principal and accrued interest, which were included in gain on extinguishment of debt on the condensed consolidated statement of operations for the nine months ended September 30, 2021.

On September 17, 2021, the Company received notice from the Lender that the SBA is continuing to review the PPP Loan. As part of this review, the SBA requested documents that the Company is required to maintain but may not have been required to submit with its application for the PPP Loan. These documents included an affiliation worksheet showing the relationship between the Company and PTE-MD and affiliated subsidiaries, documents showing the use of the PPP Loan proceeds, documents showing the calculation of the loan amount requested in the Company’s loan application, federal tax returns, and documents showing employee compensation information. The Company submitted the documents to the SBA through the Lender on September 28, 2021.

13. RESTRUCTURING AND OTHER CHARGES

As discussed in Note 5, the Company decided to file an IND in the second half of 2021, cease commercial sales of SkinTE by May 31, 2021, and wind down its SkinTE commercial operations. As a result, management approved several actions as part of a restructuring plan. Costs associated with the restructuring plan were included in restructuring and other charges on the condensed consolidated statement of operations.

The Company evaluated the future use of its commercial property and equipment and recorded an impairment charge of approximately $0.4 million for the three months ended March 31, 2021. No property and equipment impairment charges were recorded during the three months ended June 30, 2021 or the three months ended September 30, 2021. The Company recognized $0.2 million and $0.4 million of expense related to employee severance and benefit arrangements for the three and nine month periods ended September 30, 2021. Remaining severance costs will be paid by the end of the fourth quarter of 2021. The Company also recognized incremental expense of $0.2 million for the nine month period ended September 30, 2021 related to the remeasurement of employee stock options that were modified due to restructuring. Lastly, during the second quarter of 2021 and effective June 30, 2021, the Company terminated a lease which included manufacturing, laboratory, and office space. The Company recorded a net gain on termination of $0.3 million which was included in restructuring and other charges on the condensed consolidated statement of operations during the second quarter of 2021.

14. COMMITMENTS AND CONTINGENCIES

Commitments

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 provided that Arches would perform specimen testing services for customers referred by Co-Diagnostics to Arches. Co-Diagnostics would arrange all logistics for delivering specimens to Arches for COVID-19 testing for those customers of Co-Diagnostics electing to use the service. Arches would bill Co-Diagnostics for the testing services and Co-Diagnostics would manage all customer billing. The Rental Agreement for LGC Genomics Oktopure Extraction Machine between Arches and Co-Diagnostics provided that Co-Diagnostics would make available to Arches the Oktopure high throughput extraction machine that Arches will use to perform COVID-19 testing. The term of the rental agreement was 12 months and required Arches to use Co-Diagnostics tests exclusively in the machine. In the second quarter of 2021, the rental agreement was amended to remove the minimum monthly purchase obligation of reagents and was replaced by a $3,300 monthly rental fee. The COVID-19 Laboratory Services Agreement could be canceled by the Company at any time by providing 60 days written notice, and the Rental Agreement could be canceled at any time by written notice given within 60 days after termination of the Laboratory Services Agreement. On May 27, 2021, the Company gave written notice to Co-Diagnostics of termination of the COVID-19 Laboratory Services Agreement, so the last day of that agreement was July 26, 2021, and no longer in effect on July 27, 2021. On July 27, 2021, the Company gave written notice to Co-Diagnostics of termination of the Rental Agreement, so the last day of that agreement was July 29, 2021.

On June 25, 2021, the Company entered into a statement of work with a contract research organization to provide services for a proposed clinical trial described as a multi-center, prospective, randomized controlled trial evaluating the effects of SkinTE in the treatment of full-thickness diabetic foot ulcers at a cost of approximately $5.1 million consisting of $3.1 million of service fees and $2.0 million of estimated costs. In July 2021 the Company prepaid 10% of the total cost recited in the work order, or $0.5 million, which will be applied to payment of the final invoice under the work order. Over the approximately three-year term of the clinical trial the service provider shall submit to the Company for payment invoices on a monthly basis for units of work stated in the work order that are completed and billable expenses incurred. During the three-month period ended September 30, 2021, the Company received invoices for work performed and expenses incurred totalling $0.2 million. Either party may terminate the agreement without cause on 60 days’ notice to the other party.

Legal Proceedings

On September 24, 2021, a class action complaint alleging violations of the Federal securities laws was filed in the United States District Court, District of Utah, by Marc Richfield against the Company and two present officers and one former officer of the Company, Case No. 2:21-cv-00561-DAO (the “Complaint”). The Complaint alleges 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(b) and 20(a) of the Securities and Exchange Act of 1934, as amended, and Rule 10b-5 adopted thereunder. Specifically, the Complaint alleges that the defendants misrepresented or failed to disclose that: (i) the IND for the Company’s product, SkinTE, filed with the FDA was deficient with respect to certain chemistry, manufacturing, and control items; (ii) as a result, it was unlikely that the FDA would approve the IND in its current form; (iii) accordingly, the Company had materially overstated the likelihood that the SkinTE IND would obtain FDA approval; and (iv) as a result, the public statements regarding the IND were materially false and misleading. At this early stage of the proceedings the Company has not yet filed any pleading responding to the complaint and is unable to make any prediction regarding the outcome of the litigation.

In the ordinary course of business, the 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 stated above, at September 30, 2021, the Company was not party to any legal or arbitration proceedings that may have significant effects on its financial position or results of operations. No 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 the Company’s is either a party adverse to the Company or its subsidiaries or has a material interest adverse to the Company or its subsidiaries.

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 in cash on October 1, 2019 and an additional $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. As of September 30, 2021, the Company has no remaining liability related to future cash payments under the agreement. The fair value of the restricted stock units was $0.8 million and was fully expensed upon Dr. Lough’s termination.

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. The annual lease rate is $60 per square foot. Initially the Company will occupy and pay 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 it elects 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. The Company is using 1,099 square feet, and Cohen LLC is using approximately 3,648 square feet as of September 30, 2021. The monthly lease payment for 4,747 square feet is $23,737. Of this amount $18,243 is allocated pro rata to Cohen, LLC based on square footage occupied. Additional lease charges for operating expenses and taxes are allocated under the sublease based on the ratio of rent paid by the Company and Cohen LLC to total rent. Once the space is fully occupied, the Company will reduce the overall annual lease rate for the Cohen LLC space to $58.60 per square foot. However, the Company has yet to fully occupy the 7,250 square feet covered by the office lease and the lease expires at the end of October 2021. The Company recognized $55,000 and $52,000 of sublease income for the three months ended September 30, 2021 and 2020, respectively, and $165,000 and $184,000 for the nine months ended September 30, 2021 and 2020, respectively. The sublease income is included in other income, net in the statement of operations. As of September 30, 2021, and December 31, 2020, there were no amounts due from the related party under this agreement.

16. SEGMENT REPORTING

Reportable segments are presented in a manner consistent with the internal reporting provided to the chief operating decision maker (CODM), the Chief Executive Officer of the Company.

The CODM allocates resources to and assesses the performance of each segment using information about its revenue and operating income (loss). These measures are presented in the following tables (in thousands).

17. SUBSEQUENT EVENTS

The Company planned to vacate the rental space in the building located at 40 West 57th Street in New York City when the office lease described in Note 15, above, was scheduled to expire on October 31, 2021. Cohen LLC wished to remain in the space, so the Company assigned the lease for the space to Cohen LLC under an agreement that relieved the Company of any further liability under the lease, made Cohen LLC the tenant under the lease, and provided for Cohen LLC’s month-to-month tenancy after October 31, 2021. The landlord consented to the assignment and was a party to the agreement.

On October 25, 2021, a stockholder derivative complaint alleging violations of the Federal securities laws was filed in the United States District Court, District of Utah, by Steven Battams against the Company, each member of the Board of directors, and two officers of the Company, Case No. 2:21-cv-00632-DBB (the “Stockholder Derivative Complaint”). The Stockholder Derivative Complaint alleges 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(b) and 20(a) of the Securities and Exchange Act of 1934, as amended, and Rule 10b-5 adopted thereunder. Specifically, the Stockholder Derivative Complaint alleges that the defendants misrepresented or failed to disclose that: (i) the IND for the Company’s product, SkinTE, filed with the FDA was deficient with respect to certain chemistry, manufacturing, and control items; (ii) as a result, it was unlikely that the FDA would approve the IND in its current form; (iii) accordingly, the Company had materially overstated the likelihood that the SkinTE IND would obtain FDA approval; and (iv) as a result, the public statements regarding the IND were materially false and misleading. At this early stage of the proceedings the Company has not yet filed any pleading responding to the complaint and is unable to make any prediction regarding the outcome of the litigation.