POLARITYTE, INC. - Quarter Report: 2013 July (Form 10-Q)

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 July 31, 2013

Commission File No. 000-51128

Majesco Entertainment Company

(Exact name of registrant as specified in its charter)

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 R 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 R 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):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R

As of September 4, 2013, there were 46,295,969 shares of the Registrant’s common stock outstanding.

MAJESCO ENTERTAINMENT COMPANY AND SUBSIDIARY

INDEX

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)

See accompanying notes to condensed consolidated financial statements

MAJESCO ENTERTAINMENT COMPANY AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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

See accompanying notes to condensed consolidated financial statements

MAJESCO ENTERTAINMENT COMPANY AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(Unaudited, in thousands)

See accompanying notes to condensed consolidated financial statements

MAJESCO ENTERTAINMENT COMPANY AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

See accompanying notes to condensed consolidated financial statements

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 casual-game 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, DSi, 3DS and Wii, Sony’s PlayStation 3, or PS3, Microsoft’s Xbox 360 and the personal computer, or PC, and, in some instances, distributes games for others. It also publishes and distributes 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.

The Company’s video game titles are targeted at various demographics at a range of price points. Due to the larger budget requirements for developing and marketing premium console titles for core gamers, the Company focuses on publishing casual games targeting casual-game 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 segment.

Geographic regions

Net revenues by geographic region were as follows:

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, 2012 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, 2012 filed with the Securities and Exchange Commission on Form 10-K on January 14, 2013.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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.

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).

The Company operates certain mobile games in which players can play for free and purchase virtual goods for use in the games. We recognize revenues from the sale of certain virtual goods as service revenues over the estimated period in which players use the goods in the game. We currently estimate these periods of use to be less than a year. We will 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 served. The Company has not earned significant revenue to date related to its mobile 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, the license term commences and all other recognition criteria are met, or as per-copy royalties are earned on sales of games. Revenue from the sale of game accessories to licensees is recognized upon shipment.

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 condensed consolidated balance sheets. Included in advances from customers and deferred revenue are $0 and $969 of deferred license revenue at July 31, 2013 and October 31, 2012, respectively. Included in advances from customers and deferred revenue are $0 and $3,366 of deferred revenue at July 31, 2013 and October 31, 2012, respectively, on sales of products to a distributor with a future street date. In connection with the deferred revenue from product sales, the Company had approximately $1,093 of deferred cost of sales – product included in prepaid expenses and other current assets at October 31, 2012, which amount is included in product costs in the nine months ended July 31, 2013.

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 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. As of July 31, 2013 and October 31, 2012, $500 of such costs were classified as non-current and included in other assets in the accompanying condensed consolidated balance sheets.

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-capitalized 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 general and administrative expenses. If the Company was required to write off capitalized software development costs and prepaid license fees, due to changes in market conditions or product acceptance, its results of operations could be materially adversely affected.

Costs of developing mobile games, including payments to third-party developers, are expensed as research and development expenses when the Company cannot reliably project that future net cash flows from developed games will exceed related development costs. Revenue from certain of these games is largely dependent on players’ purchases of virtual goods for use in the games. The Company has not earned significant revenue to date from the sale of virtual goods.

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.

(Loss) Income Per Share. Basic (loss) income per share of common stock is computed by dividing net (loss) income applicable to common stockholders by the weighted average number of shares of common stock outstanding for the period. Basic income (loss) per share excludes the impact of unvested shares of restricted stock issued as long term incentive awards to directors, officers and employees. Diluted income per share reflects the potential impact of common stock options, unvested shares of restricted stock and outstanding common stock purchase warrants that have a dilutive effect under the treasury stock method. Diluted (loss) per share excludes the potential impact of common stock options, unvested shares of restricted stock and outstanding common stock purchase warrants because their effect would be anti-dilutive, due to Company net losses or current market prices of shares of the Company’s stock.

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 and nine months ended July 31, 2013, sales of the Company’s Zumba Fitness games accounted for approximately 66% and 66% of net revenues, respectively, and for the three and nine months ended July 31, 2012, sales of the Company’s Zumba Fitness games accounted for approximately 79% and 79% of net revenues, respectively. We license the rights to publish these games from a third party and have rights to publish other Zumba Fitness games. If the new versions are not successful, this may have a significant impact on our results of operations and cash flows.

Recent Accounting Pronouncements.

Comprehensive Income — In February 2013, the FASB issued an update to ASC 220, Comprehensive Income. The update to ASC 220 establishes standards for the reporting and presentation of reclassifications out of accumulated other comprehensive income. The update became effective for the Company on February 1, 2013. Adoption of the update did not have a material impact on the Company’s financial position, results of operations, and cash flows.

Fair Value — In July 2013, the FASB issued an update to ASC 740, Income Taxes. The update provides guidance on 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 will become effective for the Company on November 1, 2014. The Company is currently evaluating the potential impact of the update on its financial position, results of operations, and cash flows.

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.

The Company had outstanding warrants that may have required settlement by transferring assets under certain change of control circumstances and were classified as liabilities in the Company’s condensed 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, which had a fair value of $0, expired in March 2013.

Assumptions used to determine the fair value of the warrants through the date of their expiration were:

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 and nine months ended July 31, 2013 and 2012 is presented below:

The carrying value of accounts receivable, accounts payable and accrued expenses, due from/to factor, and advances from customers are reasonable estimates of their fair values because of their short-term maturity.

4. DUE FROM (TO) FACTOR, NET

Due from (to) factor consists of the following:

Outstanding accounts receivable sold to the factor as of July 31, 2013 and October 31, 2012 for which the Company retained credit risk amounted to $191 and $387, respectively. As of July 31, 2013 and October 31, 2012, there were no allowances for uncollectible accounts. Allowances include provisions for customer payments and incentives deductible in future periods.

5. ACCOUNTS AND OTHER RECEIVABLES, NET

Accounts and other receivables, net, consist of the following:

6. INVENTORIES

Inventories consist of the following:

7. PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses consist of the following:

8. PROPERTY AND EQUIPMENT, NET

Property and equipment, net, consist of the following:

9. ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consist of the following:

10.  STOCKHOLDERS’ EQUITY

Common stock warrants and units

The following table sets forth the number shares of common stock purchasable under outstanding stock purchase warrants at July 31, 2013 and October 31, 2012:

In the nine months ended July 31, 2012, 20,000 warrants were exercised on a cashless basis for 12,320 shares. In the three and nine months ended July 31, 2013, 16,500 and 1,126,501 warrants, respectively, expired. There were no other changes to the status of the Company’s outstanding warrants and units in the three and nine months ended July 31, 2013 or 2012.

11. STOCK BASED COMPENSATION ARRANGEMENTS

The Company issued 65,277 and 230,962 shares of restricted stock during the three and nine months ended July 31, 2013, respectively, and cancelled 0 and 246,547 shares of restricted stock, respectively. The Company issued 39,419 and 71,933 shares of restricted stock during the three and nine months ended July 31, 2012, respectively, and cancelled 0 and 0 shares of restricted stock during the three and nine months ended July 31, 2012, respectively. The Company values shares of restricted stock at fair value as of the grant date.

The Company issued 250,000 and 1,101,061 stock options during the three and nine months ended July 31, 2013, respectively, and cancelled 0 and 16,069 of stock options, respectively. Options for 851,061 shares issued during the nine months ended July 31, 2013 have an exercise price of $0.77 per share and a seven-year term and vest in one year. The aggregate grant-date fair value of the options was $400, based on an estimated four-year life, expected volatility of 84.8%, an interest rate of 0.6% and a 0% dividend yield. Options for 250,000 shares issued during the three and nine months ended July 31, 2013 have an exercise price of $0.59 per share and a seven-year term and vest over two years, subject to performance conditions. The aggregate grant-date fair value of the options was $88, based on an estimated four-year life, expected volatility of 79.0%, an interest rate of 1.0% and a 0% dividend yield. As of July 31, 2013, the Company determined that achievement of the performance conditions was not probable and, accordingly, no related compensation expense was recorded. The Company issued 0 and 0 stock options during the three and nine months ended July 31, 2012, respectively and cancelled 0 and 0 of stock options, respectively.

Stock-based compensation amounted to $352 and $1,017 in the three and nine months ended July 31, 2013, respectively and $438 and $1,301 in the three and nine months ended July 31, 2012, respectively.

12. INCOME TAXES

The tax provision reflected in the accompanying condensed consolidated statements of operations represents alternative minimum taxes and certain state taxes. The federal and state income tax provisions recorded by the Company for the three and nine months ended July 31, 2012 reflect the use of available net operating loss (“NOL”) carryforwards to offset taxable income. NOL carryforwards available for income tax purposes at July 31, 2013 amounted to approximately $73,000 for federal income taxes, $19,000 for certain state income taxes and $5,000 for United Kingdom income taxes. Due to the Company’s history of losses, a valuation allowance sufficient to fully offset NOLs 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.

13. (LOSS) INCOME PER SHARE

The table below provides a reconciliation of basic and diluted average shares outstanding used in computing (loss) income per share, after applying the treasury stock method.

Options, warrants and restricted shares to acquire 3,604,544 and 3,802,465 shares of common stock were not included in the calculation of diluted (loss) income per common share for the three and nine months ended July 31, 2013, respectively, as the effect of their inclusion would be anti-dilutive due to the Company’s net loss in the periods. Options, warrants and restricted shares to acquire 4,172,951 and 1,845,473 shares of common stock were not included in the calculation of diluted earnings per common share for the three and nine months ended July 31, 2012, respectively, as the effect of their inclusion would be anti-dilutive due to the Company’s net loss in the periods.

14. COMMITMENTS AND CONTINGENCIES

Infringement claims

On July 1, 2011, a complaint for patent infringement was filed in the United States District Court for the District of Delaware by Impulse Technology Ltd. against Microsoft Corporation and certain other game publisher defendants that have released games for Microsoft’s Kinect for Xbox 360, including the Company. The complaint alleged infringement relating to Microsoft’s Xbox Kinect hardware, and correspondingly, the Company’s Zumba Fitness, Zumba Fitness Rush, Hulk Hogan’s Main Event and Jillian Michaels Fitness Adventure games for Xbox 360, of Impulse’s patents for certain motion tracking technology. The Company entered into a settlement agreement resolving the dispute with Impulse on April 23, 2013 and the Company was dismissed from the case with prejudice against Impulse on May 16, 2013. The settlement did not have a material effect on the Company’s consolidated financial position, cash flows or results of operations.

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, the Company at times may be a party to claims and suits in the ordinary course of business. The Company records 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 Intelligent Verification Systems, LLC 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, 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 its 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 July 31, 2013, commitments under development agreements amounted to $6,011.

15. WORKFORCE REDUCTION

On January 8, 2013, we implemented a realignment of our workforce to reduce certain fixed costs and provide for a more flexible variable cost based model using outside subcontractors in the production of our games. The realignment included a reduction in workforce of approximately 40 employees, including 14 employees related to the closure of our studio in Massachusetts, which focused on social games for Facebook, 14 game-testing personnel in our New Jersey facility, and other marketing and support personnel. A portion of the affected game-testing workforce was converted to seasonal employees. Employees directly affected by the restructuring plan received notification during the three months ended January 31, 2013.

The Company recorded the following charges in the three and nine months ended July 31, 2013:

Changes in the Company’s accrued liabilities for workforce reduction costs in the three and nine months ended July 31, 2013 were as follows:

16. RELATED PARTIES

The Company currently has an agreement with Morris Sutton, the Company’s former Chief Executive Officer and father of the Company’s Chief Executive Officer, under which he provides services as a consultant. The agreement provides for a monthly retainer of $13. Under this arrangement, fees totaled $38 and $113 in the three and nine months ended July 31, 2013, respectively, and $38 and $113 in the three and nine months ended July 31, 2012, respectively.

The Company purchases a portion of its Zumba belt accessories from a second supplier, on terms equivalent to those of its primary supplier. Morris Sutton and another relative of Jesse Sutton, the Company’s Chief Executive Officer, earned compensation from the supplier of approximately $39 and $98 in the three and nine months ended July 31, 2013, respectively, and $0 and $446 in the three and nine months ended July 31, 2012, respectively, based on the value of the Company’s purchases.

The Company also has an agreement with a member of its board of directors to provide specified strategic consulting services, in addition to his services as a board member, on a month-to-month basis at a monthly rate of $10. Under this arrangement, fees totaled $30 and $90 in the three and nine months ended July 31, 2013, respectively, and $30 and $90 in the three and nine months ended July 31, 2012, respectively.

17. SUBSEQUENT EVENT

Acquisition Transaction

On August 6, 2013, the Company formed GMS Entertainment Limited (“GMS Entertainment”) with a shareholder of Orid Media to pursue online casino gaming. GMS Entertainment is a company limited by shares and incorporated in the Isle of Man and is owned 50% by the Company. In connection with the formation of GMS Entertainment and subject to completion of the asset purchase agreement described below, the Company agreed to invest $3,500,000 in cash and an additional $1,000,000 contingent on the financial performance of GMS Entertainment, to be used for the acquisition of the assets and for working capital purposes.

GMS Entertainment entered into an asset purchase agreement to acquire substantially all of the assets of Orid Media, a designer and developer of online casino games, including all of the outstanding share capital of its wholly-owned subsidiary Pariplay. Under the agreement, GMS Entertainment will purchase the assets for $2,500,000, plus an additional $1,000,000 contingent on the financial performance of GMS Entertainment. The agreement is subject to certain conditions, including approval from the IOM Commission with respect to a gambling license held by Pariplay.

Common Stock Purchase Agreement

On August 2, 2013, the Company entered into a common stock purchase agreement with an investor, and investor in Orid Media, with respect to a registered direct offer and sale by the Company of 3,333,333 shares of the Company’s common stock at an offering price of $.60 per share. The agreement may be rescinded in the event the acquisition transaction above is not completed.

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, 2012 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 and Wii, Sony’s PlayStation 3, or PS3, Microsoft’s Xbox 360 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.

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.

Income Taxes.  Income taxes consists of our provision/(benefit) for income taxes. Utilization of our net operating loss (“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. In fiscal 2012 and 2013, we recorded certain alternative minimum taxes and state taxes and, in fiscal 2012, reversed our valuation allowance to the extent of our NOL used.

Seasonality and Variations in Interim Quarterly Results

Our quarterly net revenues, gross profit, and operating (loss) income 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).

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.

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 currently estimate these periods of use to be less than a year. We will 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.

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. As of July 31, 2013, the net carrying value of our licenses and capitalized software development costs was $7.8 million, including $0.5 million classified as noncurrent and included in other assets in the accompanying condensed consolidated financial statements. If we were required to write off licenses or capitalized software development costs, due to changes in market conditions or product acceptance, our results of operations could be materially adversely affected.

License fees and milestone payments made to our third party developers are typically considered non-refundable advances against the total compensation they can earn based upon the sales performance of the products. Any additional royalty or other compensation earned beyond the milestone payments is expensed to cost of sales as incurred.

We expense as research and development costs associated with the development of mobile and social games when we cannot reliably project that future net cash flows from developed games will exceed related development costs. These games have not earned significant revenues to date and we are continuing to evaluate alternatives for future development and monetization.

Inventory.  Inventory is stated at the lower of cost or market. Cost is determined by the first-in, first-out method. We estimate the net realizable value of slow-moving inventory on a title-by-title basis and charge the excess of cost over net realizable value to cost of sales. Some of our inventory items are packaged with accessories, such as basketballs for our NBA Baller Beats game, belts for our Zumba games and dolls for our Babysitting Mama game. The purchase of these accessories involves longer lead times and minimum purchase amounts, which 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 July 31, 2013 versus three months ended July 31, 2012

Net Revenues. Net revenues for the three months ended July 31, 2013 decreased approximately 56% to $4.0 million from $9.1 million in the comparable quarter last year. The decrease was primarily due to declines in sales of our Zumba products for the Nintendo Wii and Microsoft XBOX. The decline in sales is attributable to lower sales for the third release in the Zumba franchise compared to prior releases and declining sales for console games overall, particularly for the Nintendo Wii. Net revenues in the European market decreased to approximately $0.4 million from $2.0 million during the same period a year ago. Overall Zumba sales accounted for 66% of our net revenues during the three months ended July 31, 2013, compared to 79% in the prior-year period.

The following table sets forth our net revenues by platform:

Gross Profit. Gross profit for the three months ended July 31, 2013 was $1.2 million compared to a gross profit of $3.5 million in the same period last year. The decrease in gross profit was primarily attributable to decreased net revenues for the three months ended July 31, 2013, as discussed above. Gross profit as a percentage of net sales was 31% for the three months ended July 31, 2013, compared to 38% for the three months ended July 31, 2012. The decrease in gross profit as a percentage of sales primarily reflects lower average selling prices compared to the three months ended July 31, 2012 and a lower percentage of total revenue from royalties in Europe.

Product Research and Development Expenses. Research and development expenses were $1.4 million for the three months ended July 31, 2013, compared to $1.9 million of expenses for the same period in 2012. Lower internal development expenses, including the effects of the January 2013 closing of our social games studio, were partially offset by outsourced development costs for mobile games in the current-year period.

Selling and Marketing Expenses. Total selling and marketing expenses were approximately $1.0 million for the three months ended July 31, 2013, compared to $2.7 million for the three months ended July 31, 2012. The decrease was primarily due to prelaunch marketing activities related to the Company’s NBA Baller Beats game and media advertising related to Zumba incurred in the prior-year period. Commissions and other costs were also lower due to lesser sales volumes.

General and Administrative Expenses. For the three-month period ended July 31, 2013, general and administrative expenses amounted to $2.4 million, comparable to the prior-year period. Increases in costs of consulting and professional fees, including fees incurred for the establishment of a joint venture for online casino gaming, as discussed in Note 17 to the accompanying condensed consolidated financial statements, generally offset lower stock compensation costs and charges for uncollectible accounts.

Operating (Loss) Income. Operating loss for the three months ended July 31, 2013 was approximately $3.6 million, compared to an operating loss of $3.6 million in the comparable period in 2012, as the effects of lower sales and gross profits were offset by lower marketing spending for Zumba and other operating expenses.

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 gain of $0.6 million for the three months ended July 31, 2012, reflecting a decrease in the fair value of the warrants. There was no corresponding gain or loss recorded in the three months ended July 31, 2013, following the warrants’ expiration in March 2013.

Income Taxes. In the three months ended July 31, 2013 and 2012, our income tax expense was not significant, representing primarily minimum state income taxes.

Nine months ended July 31, 2013 versus nine months ended July 31, 2012

Net Revenues. Net revenues for the nine months ended July 31, 2013 decreased approximately 65% to $37.2 million from $105.7 million in the comparable period last year. The decrease was primarily due to lower sales of our Zumba Fitness products and lower revenues from games for the Microsoft Kinect and Nintendo 3DS due primarily to a smaller slate of new releases in the current-year period for these platforms. The decline in Zumba sales was due to lower sales for the third release in the franchise compared to prior releases, the timing of our newly released titles, and a lower demand for our Zumba products for the Nintendo Wii. Our results for the nine months ended July 31, 2012 include revenues from the launch of new Zumba titles for both the Nintendo Wii and Microsoft Kinect for the Xbox 360. Comparatively, we had no launch revenues for Zumba in our results for the same period in fiscal 2013 as our Zumba titles were released in the previous year. Additionally, sales of Zumba games for the Wii were significantly less than in the prior year overall. Software sales for all video games for the Nintendo Wii have declined significantly, reflecting the end of life of the Wii platform. Net revenues in the European market decreased to approximately $8.0 million from $25.2 million during the same period a year ago, also reflecting Zumba-release timing. Overall Zumba sales accounted for 66% of our net revenues during the period, compared to 79% in the prior year.

Gross Profit. Gross profit for the nine months ended July 31, 2013 was $11.4 million compared to a gross profit of $38.7 million in the same quarter last year. The decrease in gross profit was primarily attributable to decreased net revenues for the nine months ended July 31, 2013, as discussed above. Gross profit as a percentage of net sales was 31% for the nine months ended July 31, 2013, compared to 37% for the nine months ended July 31, 2012. The decrease in gross profit as a percentage of sales primarily reflects lower average selling prices and higher development and license fees in the current period and changes in product mix between the periods, including the higher percentage of total sales from Zumba in the prior-year period.

Product Research and Development Expenses. Research and development expenses were $4.9 million for the nine months ended July 31, 2013, compared to $5.9 million of expenses for the same period in 2012. Lower internal development expenses, including the effects of our January 2013 headcount reduction, were partially offset by increased third-party development costs of mobile games in the current-year period.

Selling and Marketing Expenses. Total selling and marketing expenses were approximately $6.2 million for the nine months ended July 31, 2013, compared to $16.4 million for the nine months ended July 31, 2012. The decrease was primarily due to decreased media advertising related to Zumba, marketing activities for NBA Baller Beats and other new releases. Commissions and other costs were also lower due to lesser sales volumes and our January 2013 headcount reduction.

General and Administrative Expenses. For the nine-month period ended July 31, 2013, general and administrative expenses decreased to $6.8 million from $8.1 million in the comparable prior-year period. The decrease primarily reflected lower compensation costs, including stock compensation and other administrative expenses. The prior year period also included charges for uncollectible accounts receivable.

Workforce Reduction. Workforce reduction costs amounted to $0.8 million in the nine months ended July 31, 2013. There were no such costs in the prior-year period. On January 8, 2013, we implemented a realignment of our workforce to reduce certain fixed costs and provide for a more flexible variable cost based model using outside subcontractors in the production of our games. The realignment included a reduction in workforce of approximately 40 employees. Workforce reduction costs consisted primarily of severance costs.

Loss on Impairment of Capitalized Software Development Costs and License Fees – Cancelled Games. For the nine-month period ended July 31, 2013, loss on impairment of capitalized software development costs and license fees – cancelled games, amounted to $0.2 million compared to $1.2 million in the prior-year period. Our games in development are subject to periodic reviews to assess game design and changing market conditions. When 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 a game, we cancel the game, and record a charge to operating expenses for the carrying amount of the game. In fiscal 2013, we reduced the number of console-game development projects initiated.

Operating (Loss) Income. Operating loss for the nine months ended July 31, 2013 was approximately $7.8 million, compared to operating income of $6.7 million in the comparable period in 2012, primarily as a result of decreased revenues and gross profits discussed above and our January 2013 workforce reduction offset by lower advertising costs and impairment losses.

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 gain of $1.6 million for the nine months ended July 31, 2012, reflecting a decrease in the fair value of the warrants. In the nine months ended July 31, 2013, the warrants expired and the change in the fair value of the warrant liability was not significant.

Income Taxes. In the nine months ended July 31, 2013 and 2012, our income tax expense was not significant, representing primarily minimum state income taxes.

Liquidity and Capital Resources

As of July 31, 2013, our cash and cash equivalents balance was $18.8 million and funds available to us under our factoring and purchase order financing agreements were $1.4 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 $7.8 million as of July 31, 2013, primarily reflecting costs incurred in the first nine months of the fiscal year in the development of games expected to be released in our next two fiscal quarters for the holiday season. We will incur additional costs prior to release to complete development of the games 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. Industry-wide sales of video game software have declined 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. Based on these factors, we expect to experience declining sales and an operating loss for fiscal 2013 and have reflected these expectations in our operating plan. 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.

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 July 31, 2013. 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 July 31, 2013.

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 July 31, 2013, 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 July 1, 2011, a complaint for patent infringement was filed in the United States District Court for the District of Delaware by Impulse Technology Ltd. against Microsoft Corporation and certain other game publisher defendants that have released games for Microsoft’s Kinect for Xbox 360, including the Company. The complaint alleged infringement relating to Microsoft’s Xbox Kinect hardware, and correspondingly, the Company’s Zumba Fitness, Zumba Fitness Rush, Hulk Hogan’s Main Event and Jillian Michaels Fitness Adventure games for Xbox 360, of Impulse’s patents for certain motion tracking technology. The Company entered into a settlement agreement resolving the dispute with Impulse on April 23, 2013 and the Company was dismissed from the case with prejudice against Impulse on May 16, 2013. The settlement did not have a material effect on the Company’s consolidated financial position, cash flows or results of operations.

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.

Commitments under development agreements amounted to $6.0 million at July 31, 2013. In addition, certain agreements provide for minimum commitments for marketing support.

Off-Balance Sheet Arrangements

As of July 31, 2013, 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 $18.8 million as of July 31, 2013 compared to $18.0 million at October 31, 2012 and $27.3 million at July 31, 2012. Working capital as of July 31, 2013 was $20.8 million compared to $27.7 million at October 31, 2012. 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 $20.2 million and $31.3 million at July 31, 2013 and October 31, 2012, 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 nine months ended July 31, 2013, we generated approximately $1.1 million in cash flow from operating activities, compared to $15.1 million in the same period last year. The decrease reflects our net loss in the current period, compared to net income in the prior-year period. In addition, both periods were significantly affected by working capital changes. In the current-year period operating losses were offset by the collection of receivables from prior-year sales. In 2012, operating income included the effects of amortizing prior-period license and development costs.

Investing Cash Flows. Cash used in investing activities in the nine months ended July 31, 2013 amounted to $0.2 million, compared to $0.2 million in the nine months ended July 31, 2012.

Financing Cash Flows. Net cash used in financing activities for the nine months ended July 31, 2012 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 nine months ended July 31, 2013.

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.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

A description of the 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, 2012. 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. There have been no material changes to these risks other than as may have been disclosed in our quarterly reports filed subsequent to our 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.

Item 6. Exhibits

* 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.