NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
1 – Organization and Business
ProPhase
Labs, Inc. (“we”, “us” or the “Company”) was initially organized as a corporation in Nevada
in July 1989. Effective June 18, 2015, we changed our state of incorporation from the State of Nevada to the State of Delaware.
We are a vertically integrated and diversified branding, marketing and technology company engaged in the research, development,
manufacture, distribution, marketing and sale of over-the-counter (“OTC”) consumer healthcare products and
dietary supplements in the United States. This includes the development and marketing of dietary supplements under the TK Supplements
®
brand.
ProPhase
Digital Media, Inc. (“PDM”), a wholly-owned subsidiary of ProPhase Labs, Inc., is an independent full-service direct
marketing agency. PDM’s first initiative will be to market the TK Supplements
®
product line. If successful,
this may lead to the marketing of other companies’ consumer products.
In
addition, we also continue to actively pursue acquisition opportunities for other companies, technologies and products within
and outside the consumer products industry.
We
use a December 31 year-end for financial reporting purposes. References herein to “Fiscal 2018” shall mean
the fiscal year ended December 31, 2018 and references to other “fiscal” years shall mean the year,
which ended on December 31 of the year indicated. The term “we”, “us” or the “Company” as
used herein also refer, where appropriate, to the Company, together with its subsidiaries and consolidated variable interest entities
unless the context otherwise requires.
Discontinued
Operations
Prior
to March 29, 2017, our flagship OTC drug brand was Cold-EEZE
®
and our principal product was Cold-EEZE
®
cold remedy zinc gluconate lozenges. In addition to Cold-EEZE
®
cold remedy lozenges, we also marketed and
distributed non-lozenge forms of the proprietary zinc gluconate formulation, (i) Cold-EEZE
®
cold remedy
QuickMelts
®
, (ii) Cold-EEZE
®
Gummies and (iii) Cold-EEZE
®
cold remedy oral spray.
Effective
March 29, 2017, we sold our intellectual property rights and other assets related to our Cold-EEZE
®
brand and product
line, including all then current and pipeline over-the-counter allergy, cold, flu, multi-symptom relief and immune support treatments
for adults and children to the extent each was, or was intended to be, branded “Cold-EEZE
®
”, including
all formulations and derivatives thereof (collectively referred to as the “Cold-EEZE
®
Business”) to
Mylan Consumer Healthcare Inc. (formerly known as Meda Consumer Healthcare Inc.) (“MCH”) and Mylan Inc. (together
with MCH, “Mylan”). As a result of the sale of the Cold-EEZE
®
Business, for Fiscal 2017, we
have classified as discontinued operations (i) all income and expenses attributable to the Cold-EEZE
®
Business,
(ii) the gain from the sale of the Cold-EEZE
®
Business, and (iii) the income tax expense attributed to the sale
of the Cold-EEZE
®
Business. Excluded from the sale of the Cold-EEZE
®
Business were our accounts
receivable and inventory. We have also retained all liabilities associated with our Cold-EEZE
®
Business operations
arising prior to March 29, 2017.
Continuing
Operations
We
continue to own and operate our manufacturing facility and manufacturing business in Lebanon, Pennsylvania, and our headquarters
in Doylestown, Pennsylvania. As part of the sale of the Cold-EEZE
®
Business, we entered into a manufacturing agreement
with Mylan and our wholly-owned subsidiary, Pharmaloz Manufacturing, Inc. (“PMI”), to supply various Cold-EEZE
®
lozenge products to Mylan. In addition to the production services we provide to Mylan under the manufacturing agreement,
we also produce OTC healthcare and dietary supplement products for other third-party customers in addition to performing
operational tasks such as warehousing and shipping.
We
are also engaged in development and distribution of a product line of OTC dietary supplements under the brand name of TK Supplements
®
.
The TK Supplements
®
product line comprises three men’s health products: (i) Legendz XL
®
for
sexual health, (ii) Triple Edge XL
®
, an energy booster plus testosterone support, and (iii) Super ProstaFlow Plus
TM
for prostate and urinary health. In addition to developing direct-to-consumer (“Direct Response”) marketing
strategies for Legendz XL
®
, we are currently in distribution in a national chain drug retailer and several regional
retailers.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
2 – Summary of Significant Accounting Policies
For
Fiscal 2018 and 2017, our revenues from continuing operations have come principally from our OTC healthcare contract manufacturing
business and sales to retail customers of dietary supplement product.
Basis
of Presentation
The
consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions
and balances have been eliminated.
Discontinued
Operations Carve Out and ProPhase Allocations
For
Fiscal 2018 and 2017, results from operations for the Cold-EEZE
®
Business are classified as discontinued
operations. The carve out of the discontinued operations (i) were prepared in accordance with the SEC’s carve out rules
under Staff Accounting Bulletin (“SAB”) Topic 1B1 and (ii) are derived from identifying and carving out the specific
assets, liabilities, net sales, cost of sales, operating expenses and interest expense associated with the Cold-EEZE
®
Business’s operations. Administrative and overhead expenses, including personnel expenses and bonuses, and research
and development overhead expenses incurred by us (for which the discontinued operation benefits from such resources) are allocated
to discontinued operations based upon the percentage of the Cold-EEZE
®
Business’s net sales to our consolidated
net sales. For Fiscal 2018 and 2017, we allocated (i) $0 and $348,000, respectively, of administrative expenses, $0 and
$1.7 million, respectively of sales and marketing expenses and (iii) $0 and $52,000, respectively, of research and development
expenses, to discontinued operations in the accompanying statements of operations.
Product
Innovation, Seasonality of the Business and Liquidity
Our
net sales are derived principally from our contract manufacturing of OTC healthcare and dietary supplement products sold in the
United States. In addition, we are engaged in market activities for the TK Supplements
®
product line of dietary
supplements.
Our
sales are influenced by and subject to (i) the scope and timing of TK Supplement
®
product market testing and the
ultimate market launch, and (ii) fluctuations in the timing of purchase and the ultimate level of demand for the OTC healthcare
and cold remedy products that we manufacture for others, which are a function of the timing, length and severity of each cold
season. Generally, a cold season is defined as the period from September to March when the incidence of the common cold
rises as a consequence of the change in weather and other factors. We generally experience in the first, third and fourth quarter
higher levels of net sales from our contract manufacturing of OTC healthcare and cold remedy products. Revenues are generally
at their lowest levels in the second quarter when customer demand generally declines.
As
a consequence of the scope and timing of our TK Supplements
®
product market testing and the ultimate market launch
and the seasonality of our business, we realize variations in operating results and demand for working capital from quarter to
quarter. As of December 31, 2018, we had working capital of approximately $14.0 million, including $6.7 million marketable
securities available for sale. We believe our current working capital at December 31, 2018 is at an acceptable and adequate level
to support our business for at least the next twelve months.
Use
of Estimates
The
preparation of financial statements and the accompanying notes thereto, in conformity with generally accepted accounting principles
in the United States of America (“GAAP”), requires management to make estimates and assumptions that affect reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements
and reported amounts of revenues and expenses during the respective reporting periods. Examples include the provision for bad
debt, sales returns and allowances, inventory obsolescence, useful lives of property and equipment, impairment of property and
equipment, income tax valuations and assumptions related to accrued advertising. When providing for the appropriate sales returns,
allowances, cash discounts and cooperative incentive promotion costs (“Sales Allowances”), we apply a uniform and
consistent method for making certain assumptions for estimating these provisions. These estimates and assumptions are based on
historical experience, current trends and other factors that management believes to be relevant at the time the financial statements
are prepared. Management reviews the accounting policies, assumptions, estimates and judgments on a quarterly basis. Actual results
could differ from those estimates.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Cash
and Cash Equivalents
We
consider all highly liquid investments with an initial maturity of three months or less at the time of purchase to be cash equivalents.
Cash equivalents include cash on hand and monies invested in money market funds. The carrying amount approximates the fair market
value due to the short-term maturity of these investments.
Marketable
Securities
We
have classified our investments in marketable securities as available-for-sale and as a current asset. Our investments in marketable
securities are carried at fair value, with unrealized gains and losses included as a separate component of stockholders’
equity. Realized gains and losses from our marketable securities are recorded as other interest income (expense). We initiated
short term investments in marketable securities, which carry maturity dates between one and three years from date of purchase
with interest rates of 2.39% - 3.67%, during Fiscal 2018. For Fiscal 2018 and 2017, we reported an unrealized gain
of $54,000 and unrealized loss of $78,000, respectively. We had an accumulated unrealized loss of $24,000 and $78,000 as of December
31, 2018 and 2017, respectively. Unrealized gains and losses are classified as other comprehensive income (loss) and cost is determined
on a specific identification basis. The following is a summary of the components of our marketable securities and the underlying
fair value input level tier hierarchy (see long-lived assets below) (in thousands):
|
|
As
of December 31, 2018
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Market
|
|
|
|
Cost
|
|
|
Losses
|
|
|
Value
|
|
U.S treasuries
|
|
$
|
2,401
|
|
|
$
|
(3
|
)
|
|
$
|
2,398
|
|
Corporate bonds
|
|
|
4,310
|
|
|
|
(21
|
)
|
|
|
4,289
|
|
|
|
$
|
6,711
|
|
|
$
|
(24
|
)
|
|
$
|
6,687
|
|
|
|
As
of December 31, 2017
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Market
|
|
|
|
Cost
|
|
|
Losses
|
|
|
Value
|
|
U.S treasuries
|
|
$
|
1,744
|
|
|
$
|
-
|
|
|
$
|
1,744
|
|
Corporate bonds
|
|
|
17,099
|
|
|
|
(78
|
)
|
|
|
17,021
|
|
|
|
$
|
18,843
|
|
|
$
|
(78
|
)
|
|
$
|
18,765
|
|
We
have determined that the unrealized losses are deemed to be temporary as of December 31, 2018. We believe that the unrealized
losses generally are the result of increases in the risk premiums required by market participants rather than an adverse change
in cash flows or a fundamental weakness in the credit quality of the issuer or underlying assets. We have the ability and intent
to hold these investments until a recovery of fair value, which may be maturity. We do not consider the investment in corporate
bonds to be other-than-temporarily impaired at December 31, 2018.
Inventory
Inventory
is valued at the lower of cost, determined on a first-in, first-out basis (FIFO), or net realizable value. Inventory items are
analyzed to determine cost and the net realizable value and appropriate valuation adjustments are established. At December 31,
2018, after the 2018 write-off of certain inventory previously reserved, the financial statements include adjustments to
reduce inventory for excess, obsolete or short-dated shelf-life inventory of $377,000, inclusive of adjustments of $270,000 for
product samples of TK Supplements
®
products. At December 31, 2017, the financial statements include adjustments
to reduce inventory for excess, obsolete or short-dated shelf-life inventory of $1.1 million, inclusive of an adjustment of $541,000
for product samples of TK Supplements
®
products. The components of inventory are as follows (in thousands):
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Raw materials
|
|
$
|
1,374
|
|
|
$
|
1,269
|
|
Work in process
|
|
|
371
|
|
|
|
245
|
|
Finished goods
|
|
|
158
|
|
|
|
17
|
|
|
|
$
|
1,903
|
|
|
$
|
1,531
|
|
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Property,
Plant and Equipment
Property,
plant and equipment are recorded at cost. We use the straight-line method in computing depreciation for financial reporting purposes.
Depreciation expense is computed in accordance with the following ranges of estimated asset lives: building and improvements
– ten to thirty-nine years; machinery and equipment – three to seven years; computer equipment and software –
three to five years; and furniture and fixtures – five years.
Concentration
of Risks
Future
revenues, costs, margins and profits will continue to be influenced by our ability to maintain our manufacturing availability
and capacity together with our marketing and distribution capabilities and the regulatory requirements associated with the development
of OTC consumer healthcare products, dietary supplements and other remedies in order to compete on a national level and/or international
level.
Our
business is subject to federal and state laws and regulations adopted for the health and safety of users of our products. The
manufacturing and distribution of OTC healthcare and dietary supplement products are subject to regulations by various federal,
state and local agencies, including the Food and Drug Administration (“FDA”) and, as applicable, the Homeopathic Pharmacopoeia
of the United States.
Financial
instruments that potentially subject us to significant concentrations of credit risk consist principally of cash investments,
marketable securities, and trade accounts receivable. Our marketable securities are fixed income investments, which are highly
liquid and can be readily purchased or sold through established markets.
We
maintain cash and cash equivalents with certain major financial institutions. As of December 31, 2018, our cash and cash equivalents
balance was $1.6 million and our bank balance was $1.6 million. Of the total bank balance, $250,000 was covered
by federal depository insurance and $1.4 million was uninsured at December 31, 2018.
Trade
accounts receivable potentially subject us to credit concentrations from time-to-time as a consequence of the timing, payment
pattern and ultimate purchase volumes or shipping schedules with our customers. We extend credit to our customers based upon an
evaluation of the customer’s financial condition and credit history and generally we do not require collateral. Our customers
include consumer products companies and large national chain, regional, specialty and local retail stores. These credit concentrations
may impact our overall exposure to credit risk, either positively or negatively, in that our customers may be similarly affected
by changes in economic, regulatory or other conditions that may impact the timing and collectability of amounts due to us. As
a consequence of an evaluation of our customer’s financial condition, payment patterns, balance due to us and other factors,
we did not offset our account receivable with an allowance for bad debt at December 31, 2018 and 2017.
Long-lived
Assets
We
review the carrying value of our long-lived assets with definite lives whenever events or changes in circumstances indicate
that the carrying amount of the assets may not be recoverable. When indicators of impairment exist, we determine whether the estimated
undiscounted sum of the future cash flows of such assets is less than their carrying amounts. If less, an impairment loss is recognized
in the amount, if any, by which the carrying amount of such assets exceeds their respective fair values. The determination of
fair value is based on quoted market prices in active markets, if available, or independent appraisals; sales price negotiations;
or projected future cash flows discounted at a rate determined by management to be commensurate with our business risk. The estimation
of fair value utilizing discounted forecasted cash flows includes significant judgments regarding assumptions of revenue, operating
and marketing costs; selling and administrative expenses; interest rates; property and equipment additions and retirements; industry
competition; and general economic and business conditions, among other factors.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Fair
value is based on the prices that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements,
a three-tier fair value hierarchy prioritizes the inputs used to measure fair value. These tiers include: Level 1, defined as
observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets
that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data
exists, therefore requiring an entity to develop its own assumptions.
Fair
Value of Financial Instruments
Cash
and cash equivalents, marketable securities, accounts receivable, assets held for sale, accounts payable, and accrued expenses
are reflected in the consolidated financial statements at carrying value which approximates fair value. We
account for our marketable securities at fair value pursuant to Accounting Standards Codification, or ASC, 820-10, with the net
unrealized gains or losses reported as a component of accumulated other comprehensive income or loss.
|
|
As
of December 31, 2018
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Marketable securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government obligations
|
|
$
|
-
|
|
|
$
|
2,398
|
|
|
$
|
-
|
|
|
$
|
2,398
|
|
Corporate
obligations
|
|
|
-
|
|
|
|
4,289
|
|
|
|
-
|
|
|
|
4,289
|
|
|
|
$
|
-
|
|
|
$
|
6,687
|
|
|
$
|
-
|
|
|
$
|
6,687
|
|
|
|
As
of December 31, 2017
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Marketable securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government obligations
|
|
$
|
-
|
|
|
$
|
1,744
|
|
|
$
|
-
|
|
|
$
|
1,744
|
|
Corporate
obligations
|
|
|
-
|
|
|
|
17,021
|
|
|
|
-
|
|
|
|
17,021
|
|
|
|
$
|
-
|
|
|
$
|
18,765
|
|
|
$
|
-
|
|
|
$
|
18,765
|
|
There
were no transfers of marketable securities between Levels 1, 2 or 3 for the Fiscal 2018 and 2017.
Revenue
Recognition
We
account for revenue in accordance with ASC 606, which requires revenue recognized to represent the transfer of promised goods
or services to customers at an amount that reflects the consideration which is expected to be received in exchange for those goods
or services. We recognize revenue when performance obligations with our customers have been satisfied. At contract inception,
we determine if a contract is within the scope of ASC Topic 606 and then evaluate the contract using the following five steps:
(1) identify the contract with the customer; (2) identify the performance obligations; (3) determine the transaction price; (4)
allocate the transaction price to the performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance
obligation.
We
adopted ASC 606 as of January 1, 2018 using the modified retrospective method. For the year ended December 31, 2018, there
were no changes to our opening balances upon the adoption of ASC 606 and the amounts which would have been reported under the
standards in effect prior to adoption.
Performance
Obligations
We
generate sales principally through two types of customers, contract manufacturing and retail customers. Sales from product shipments
to contract manufacturing and retailer customers are recognized at the time ownership is transferred to the customer. Net sales
from OTC healthcare contract manufacturing and retail dietary supplement product customers were $12.6 million and $0.5 million,
respectively, for Fiscal 2018 and $9.7 million and $0.2 million, respectively, for Fiscal 2017. Revenue from retailer
customers is reduced for trade promotions, estimated sales returns, cash discounts and other allowances in the same period as
the related sales are recorded. No such allowance is applicable to our contract manufacturing customers. We make estimates of
potential future product returns and other allowances related to current period revenue. We analyze historical returns, current
trends, and changes in customer and consumer demand when evaluating the adequacy of the sales returns and other allowances.
A
performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account
in accordance with ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and
recognized as revenue when, or as, the performance obligation is satisfied. The combined duties and responsibilities within each
contract will be considered one single performance obligation under ASC 606 as these items would not be separately identifiable
from each other promise in the contract and we provide a significant service of integrating the duties with other promises in
the contracts.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Transaction
Price
The
transaction price is fixed based upon either (i) a combined Master Agreement and each related purchase order, or (ii) if there
is no Master Agreement, the price per the individual purchase order received from each customer. The customers are invoiced at
an agreed upon contractual price for each unit ordered and delivered by us.
Consistent
with Company practice prior to the adoption of ASC 606, we do not collect sales tax or other similar taxes from customers. As
such, there is no effect on the measurement of the transaction price.
Recognize
Revenue When the Company Satisfies a Performance Obligation
Performance
obligations related to contract manufacturing and retail customers are satisfied at a point in time when the goods are shipped
to the customer as (i) we have transferred control of the assets to the customers upon shipping, and (ii) the customer obtains
title and assumes the risks and rewards of ownership after the goods are shipped.
We
do not accept returns in the contract manufacturing revenue stream. Our return policy for retailer customers accommodates returns
for (i) discontinued products, (ii) store closings and (iii) products that have reached or exceeded their designated expiration
date. We do not impose a period of time within which product may be returned. All requests for product returns must be submitted
to us for pre-approval. The main components of our returns policy are: (i) we will accept returns that are due to damaged product
that is un-saleable and such return request activity falls within an acceptable range, (ii) we will accept returns for products
that have reached or exceeded designated expiration dates and (iii) we will accept returns in the event that we discontinue a
product provided that the customer will have the right to return only such items that it purchased directly from us. We will not
accept return requests pertaining to customer inventory “Overstocking” or “Resets”. We will accept return
requests for only products in its intended package configuration. We reserve the right to terminate shipment of product to customers
who have made unauthorized deductions contrary to our return policy or pursue other methods of reimbursement. We compensate the
customer for authorized returns by means of a credit applied to amounts owed or to be owed and in the case of discontinued product
only, also by way of an exchange. We do not have any significant product exchange history.
Under
ASC 606, we continue to recognize revenue from contract manufacturing and retail customers at a point in time as
we have an enforceable right to payment for goods as products are shipped to customers.
As
of December 31, 2018 and 2017, we included a provision for sales allowances from continuing operations of $1,000 and $2,000, respectively,
which are reported as a reduction to account receivables. Additionally, accrued advertising and other allowances from discontinued
operations as of December 31, 2018 included (i) 181,000 for estimated returns which is reported as a reduction to account
receivables and (ii) $88,000 for cooperative incentive promotion costs, which is reported as accrued advertising and other
allowances under current liabilities. As of December 31, 2017, accrued advertising and other allowances from discontinued
operations included (i) $480,000 for estimated future sales returns which is reported as a reduction to account receivables
and (ii) $200,000 for cooperative incentive promotion costs which is reported as accrued advertising and other allowances
under current liabilities.
As
of December 31, 2018, we have deferred revenue of $206,000 in relation to Research and Development (“R&D”) stability
and release testing programs. No revenue was deferred as of December 31, 2017. Deferred revenues primarily consist of amounts
that have been billed to or received from customers in advance of revenue recognition and prepayments received from customers
in advance for implementation, maintenance and other services, as well as initial subscription fees. We recognize deferred revenues
as revenues when the services are performed and the corresponding revenue recognition criteria are met. Customer prepayments are
generally applied against invoices issued to customers when services are performed and billed.
The
following table disaggregates the Company’s deferred revenue by recognition period (in thousands):
Recognition Period
|
|
Deferred
Revenue
|
|
0-12 Months
|
|
$
|
184
|
|
13-24 Months
|
|
|
22
|
|
Total
|
|
$
|
206
|
|
Disaggregation
of Revenue
We
disaggregate revenue from contracts with customers into two categories: contract manufacturing and retail customers. We determined
that disaggregating revenue into these categories achieves the disclosure objective to depict how the nature, amount, timing and
uncertainty of revenue and cash flows are affected by economic factors.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
following table disaggregates the Company’s revenue by revenue source for Fiscal 2018 and 2017 (in thousands):
|
|
For
the Years Ended
|
|
Revenue by Customer
Type
|
|
December
31, 2018
|
|
|
December
31, 2017
|
|
Contract manufacturing
|
|
$
|
12,633
|
|
|
$
|
9,666
|
|
Retail and others
|
|
|
493
|
|
|
|
201
|
|
Total revenue
|
|
$
|
13,126
|
|
|
$
|
9,867
|
|
Practical
Expedients Elected
We
have elected the following practical expedients in applying ASC 606 across all revenue stream:
Sales
Tax Exclusion from the Transaction Price
We
exclude from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on
and concurrent with a specific revenue-producing transaction and collected by the Company from the customer.
Shipping
and Handling Activities
We
account for shipping and handling activities that we perform as activities to fulfill the promise to transfer the good.
Advertising
and Incentive Promotions
Advertising
and incentive promotion costs are expensed within the period in which they are utilized. Advertising and incentive promotion expense
is comprised of (i) media advertising, presented as part of sales and marketing expense, (ii) cooperative incentive promotions
and coupon program expenses, which are accounted for as part of net sales, and (iii) free product, which is accounted for as part
of cost of sales. Advertising and incentive promotion expenses (i) incurred from continuing operations for Fiscal 2018
and 2017 were $264,000 and $45,000, respectively, and (ii) attributed to and classified as discontinued operations for
Fiscal 2018 and 2017 were $0 and $2.8 million, respectively.
Share-Based
Compensation
We
recognize all share-based payments to employees and directors, including grants of stock options, as compensation expense in the
financial statements based on their fair values. Fair values of stock options are determined through the use of the Black-Scholes
option pricing model. The compensation cost is recognized as an expense over the requisite service period of the award, which
usually coincides with the vesting period.
Stock
and stock options for the purchase of our common stock, $0.0005 par value (“Common Stock”), have been granted to both
employees and non-employees pursuant to the terms of certain agreements and stock option plans (see Note 6). Stock options
are exercisable during a period determined by us, but in no event later than ten years from the date granted.
Research
and Development
R&D
costs are charged to operations in the period incurred R&D costs incurred for Fiscal 2018 and 2017 (i) from
continuing operations were $398,000 and $431,000, respectively, and (ii) attributed to and classified as discontinued operations
were $0 and $52,000, respectively. R&D costs are principally related to personnel expenses and new product development
initiatives and costs associated with our OTC health care products, dietary supplements and other remedies.
Income
Taxes
We
utilize the asset and liability approach which requires the recognition of deferred tax assets and liabilities for the
future tax consequences of events that have been recognized in our financial statements or tax returns. In estimating future tax
consequences, we generally consider all expected future events other than enactments of changes in the tax law or rates. Until
sufficient taxable income to offset the temporary timing differences attributable to operations and the tax deductions attributable
to option, warrant and stock activities are assured, a valuation allowance equaling the total deferred tax asset is being
provided.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
We
utilize a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position
for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position
will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure
the tax benefit as the largest amount which is more than fifty percent likely of being realized upon ultimate settlement. Any
interest or penalties related to income taxes will be recorded as interest or administrative expense, respectively.
As
a result of our losses from continuing operations, we have recorded a full valuation allowance against a net deferred
tax asset. Additionally, we have not recorded a liability for unrecognized tax benefit.
Recently
Adopted Accounting Standards, Not Yet Adopted
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 2014-09, “Revenue from Contracts with Customers” on revenue recognition. See the Revenue Recognition section within
the Summary of Significant Accounting Policies in Note 2 for further details on the impact to our consolidated financial statements
upon adoption and practical expedients elected. The implementation of the new revenue recognition standard did not have a material
impact on our consolidated financial statements.
In
November 2016, the FASB issued ASU No. 2016-18 “Statement of Cash Flows: Restricted Cash” which requires a statement
of cash flows to explain the change during a period in the total cash, cash equivalents, and amounts generally described as restricted
cash or restricted cash equivalents. Under the new standard, amounts generally described as restricted cash and restricted cash
equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total
amounts shown in the statement of cash flows. ASU 2016-18 was effective for us as of January 1, 2018. We have not generally had
restricted cash or restricted cash equivalents, and there is no restricted cash on the balance sheet as of December 31,
2018 and 2017. The adoption of this update did not have a material impact on our consolidated financial statements.
In
August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash
Payments.” The new standard attempts to reduce diversity in practice in how cash receipts and cash payments are presented
and classified in the statement of cash flows. ASU No. 2016-15 provides guidance on eight specific cash flow issues, none of which
currently apply to us. The new guidance was effective for us in the first quarter of 2018. The adoption of ASU 2016-15 did not
have a material impact on our financial statements.
In
October 2016, the FASB issued ASU No. 2016-16, “Income Taxes: Intra-Entity Transfers of Assets Other than Inventory.”
The new standard requires entities to recognize the income tax consequences of an asset other than inventory when the asset
transfer occurs. The new guidance was effective for us in the first quarter of 2018. The adoption of ASU 2016-15 did not have
a material impact on our financial statements.
Recently
Issued Accounting Standards
In
June 2018, the FASB issued ASU 2018-07 intended to reduce cost and complexity and to improve financial reporting for nonemployee
share-based payments. Currently, the accounting requirements for nonemployee and employee share-based payment transactions are
significantly different. This ASU expands the scope of Topic 718, Compensation-Stock Compensation (which currently only includes
share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently,
the accounting for share-based payments to nonemployees and employees will be substantially aligned. This ASU supersedes Subtopic
505-50, Equity-Equity-Based Payments to Nonemployees. The amendments in this ASU are effective for public companies for fiscal
years beginning after December 15, 2018, with early adoption permitted. We are currently evaluating the impact of this new
standard on our consolidated financial statements.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
In
February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) in order to increase transparency and comparability among organizations
by, among other provisions, recognizing lease assets and lease liabilities on the balance sheet for those leases classified as
operating leases under previous GAAP. For public companies, ASU 2016-02 is effective for fiscal years beginning after December
15, 2018 (including interim periods within those periods) using a modified retrospective approach and early adoption is permitted.
In transition, entities may also elect a package of practical expedients that must be applied in its entirety to all leases commencing
before the adoption date, unless the lease is modified, and permits entities to not reassess (a) the existence of a lease, (b)
lease classification or (c) determination of initial direct costs, as of the adoption date, which effectively allows entities
to carryforward accounting conclusions under previous GAAP. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted
Improvements, which provides entities an optional transition method to apply the guidance under Topic 842 as of the adoption date,
rather than as of the earliest period presented. The Company adopted Topic 842 on January 1, 2019, using the optional transition
method to apply the new guidance as of January 1, 2019, rather than as of the earliest period presented, and elected the package
of practical expedients described above. We do not expect the new accounting guidance to have a material impact on our
consolidated financial statements.
In
June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments—Credit Losses.” The standard modifies the
impairment model for most financial assets, including trade accounts receivables and loans, and will require the use of an “expected
loss” model for instruments measured at amortized cost. Under this model, entities will be required to estimate the lifetime
expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting
in a net presentation of the amount expected to be collected on the financial asset. The effective date of the standard is for
fiscal years beginning after December 15, 2019 with early adoption permitted. We are currently evaluating the impact of
adoption of this update on our consolidated financial statements.
In
August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820), – Disclosure Framework – Changes
to the Disclosure Requirements for Fair Value Measurement,” which makes a number of changes meant to add, modify or remove
certain disclosure requirements associated with the movement amongst or hierarchy associated with Level 1, Level 2 and Level 3
fair value measurements. This guidance is effective for fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2019. Early adoption is permitted upon issuance of the update. We do not expect the adoption of this
guidance to have a material impact on our consolidated financial statements.
In
August 2018, the SEC adopted SEC Final Rule Release No. 33-10532, Disclosure Update and Simplification, which amended certain
disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded
the disclosure requirements regarding stockholders’ equity for interim financial statements. Under the amendments, a description
of the changes in each caption of stockholders’ equity presented in the balance sheet must be provided in a note or separate
statement. The description must include a reconciliation of the beginning balance to the ending balance of each period for which
a statement of comprehensive income is required to be filed. Our first presentation of changes in stockholders’ equity will
be included in our Form 10-Q for the quarter ended March 31, 2019.
Note
3 – Discontinued Operations, Sale of the Cold-EEZE
®
Business
Effective
March 29, 2017, we completed the sale of the Cold-EEZE
®
Business to Mylan. As a consequence of the sale of the
Cold-EEZE
®
Business, for Fiscal 2017, we have classified as discontinued operations (i) the gain from the
sale of the Cold-EEZE
®
Business, (ii) all gains and losses attributable to the Cold-EEZE
®
Business
operations and (iii) the income tax expense attributed to the sale of the Cold-EEZE
®
Business (see Note 9). Excluded
from the sale of the Cold-EEZE
®
Business were our accounts receivable and inventory, and we also retained all liabilities
associated with our Cold-EEZE
®
Business operations arising prior to March 29, 2017.
Pursuant
to the asset purchase agreement, we also agreed to a one-time sale to Mylan
of
certain non-lozenge-based Cold-EEZE
®
inventory. At December 31, 2017, we have classified as assets held for sale
approximately
$22,000 of such inventory, which approximates our cost.
Pursuant
to the asset purchase agreement, we entered into a transition service arrangement with Mylan, for which we earned $150,000
in transition service fees through December 31, 2017. Pursuant to this arrangement, we (i) received, processed, fulfilled, and
shipped customer orders, and billed such customers for these shipments on behalf of Mylan from March 30, 2017 to June 30, 2017,
(ii) processed certain sales allowances, returns and other customer promotional deductions, and (iii) paid certain Cold-EEZE
®
Business expenses which are to be reimbursed by Mylan. For Fiscal 2017, the $150,000 transition service fees earned
were recorded as a component of other income (expense).
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
net proceeds received from the sale of the Cold-EEZE
®
Business were as follows (in thousands):
|
|
Amount
|
|
Gross
consideration from the sale of the Cold-EEZE
®
Business
|
|
$
|
50,000
|
|
Closing
and transaction costs
|
|
|
(4,175
|
)
|
Net
proceeds from sale of the Cold-EEZE
®
Business
|
|
|
45,825
|
|
Book
value of assets sold
|
|
|
(13
|
)
|
Gain
on sale of the Cold-EEZE
®
Business before income taxes
|
|
|
45,812
|
|
Income
tax expense
|
|
|
(3,511
|
)
|
Gain
on sale of the Cold-EEZE
®
Business after income taxes
|
|
$
|
42,301
|
|
|
|
|
|
|
Net
proceeds:
|
|
|
|
|
Cash
paid at closing, net of closing and transaction costs
|
|
$
|
43,145
|
|
Proceeds
due on sale of assets, cash held in escrow
|
|
|
5,000
|
|
|
|
$
|
48,145
|
|
For
Fiscal 2017, we incurred $4.2 million in closing and transaction costs associated with the sale of the Cold-EEZE
®
Business which were comprised of (i) transaction fees and related closing costs of $1.9 million and (ii) performance bonuses,
contract termination compensation and severance payments to certain employees associated with the sale of the Cold-EEZE
®
Business of $2.3 million. The compensation committee of our board of directors approved these compensation arrangements.
These compensation and termination payments were paid by us in April 2017.
The
following table sets forth the operating results of our discontinued operations for Fiscal 2018 and 2017, respectively,
(in thousands):
|
|
For
the Years ended
|
|
|
|
December
31, 2018
|
|
|
December
31, 2017
|
|
Net
sales
|
|
$
|
-
|
|
|
$
|
4,687
|
|
Cost
of sales
|
|
|
-
|
|
|
|
2,037
|
|
Sales
and marketing
|
|
|
-
|
|
|
|
1,720
|
|
Administration
|
|
|
-
|
|
|
|
348
|
|
Research
and development
|
|
|
-
|
|
|
|
52
|
|
Income
from discontinued operations
|
|
$
|
-
|
|
|
$
|
530
|
|
For
Fiscal 2018, we incurred costs of $170,000 which was charged against the gain on sale of discontinued assets,
net of taxes.
Note
4 – Property, Plant and Equipment
The
components of property and equipment are as follows (in thousands):
|
|
December
31,
|
|
|
December
31,
|
|
|
|
|
|
2018
|
|
|
2017
|
|
|
Estimated
Useful Life
|
Land
|
|
$
|
504
|
|
|
$
|
504
|
|
|
|
Leasehold
improvements
|
|
|
3,059
|
|
|
|
3,059
|
|
|
10-39
years
|
Machinery
|
|
|
4,126
|
|
|
|
4,099
|
|
|
3-7
years
|
Computer
equipment
|
|
|
457
|
|
|
|
355
|
|
|
3-5
years
|
Furniture
and fixtures
|
|
|
207
|
|
|
|
197
|
|
|
5
years
|
|
|
|
8,353
|
|
|
|
8,213
|
|
|
|
Less:
accumulated depreciation
|
|
|
(5,854
|
)
|
|
|
(5,471
|
)
|
|
|
Total
property, plant and equipment, net
|
|
$
|
2,499
|
|
|
$
|
2,742
|
|
|
|
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Depreciation
expense incurred for Fiscal 2018 and 2017 (i) from continuing operations were $383,000 and $315,000, respectively, and
(ii) attributed to and classified as discontinued operations of $0 and $22,000, respectively.
Note
5 – Secured Promissory Notes and Other Obligations
Secured
Promissory Notes
On
March 29, 2017, in connection with the sale of the Cold-EEZE
®
Business, we paid in full the remaining principal
and accrued interest due under certain 12% Secured Promissory Notes – Series A that were issued in December 2015 (the
“Notes”), in the total amount of $1.5 million. Of the $1.5 million paid to the Investors of the Notes (the
“Investors”), $69,000 was netted against the aggregate exercise price of the warrants held by these
Investors, which were simultaneously exercised by the Investors.
In
connection with the issuance of the Notes, the Company entered into a security agreement with John E. Ligums, Jr., as collateral
agent for the Investors (the “Security Agreement”), to secure the timely payment and performance in full of the Company’s
obligations under the Notes. Under the Security Agreement, we granted to the collateral agent, for the benefit of the Investors
a lien upon and security interest in the property and assets listed as collateral in the Security Agreement, including without
limitation, all of our personal property, inventory, equipment, general intangibles, cash and cash equivalents, and proceeds.
In connection with the payoff of the Notes, the Security Agreement was terminated.
Note
6 – Transactions Affecting Stockholders’ Equity
Our
authorized capital stock consists of 50 million shares of Common Stock and one million shares of preferred stock, $0.0005
par value (“Preferred Stock”) per share.
Preferred
Stock
The
Preferred Stock authorized under our certificate of incorporation may be issued from time to time in one or more series. As of
December 31, 2018, no shares of Preferred Stock have been issued. Our board of directors have the full authority permitted by
law to establish, without further stockholder approval, one or more series of Preferred Stock and the number of shares constituting
each such series and to fix by resolution voting powers, preferences and relative, participating, optional and other special rights
of each series of Preferred Stock, and the qualifications, limitations or restrictions thereof, if any. Subject to the limitation
on the total number of shares of Preferred Stock that we have authority to issue under our certificate of incorporation, the board
of directors is also authorized to increase or decrease the number of shares of any series, subsequent to the issue of that series,
but not below the number of shares of such series then-outstanding. In case the number of shares of any series is so decreased,
the shares constituting such decrease will resume the status that they had prior to the adoption of the resolution originally
fixing the number of shares of such series. We may, subject to any required stockholder approval amend from time to time our certificate
of incorporation to increase the number of authorized shares of Preferred Stock or Common Stock or to make other changes or additions
to our capital structure or the terms of our capital stock.
Stockholder
Rights Plan
On
September 8, 1998, our Board of Directors declared a dividend distribution of Common Stock Purchase Rights (each individually,
a “Right” and collectively, the “Rights”) payable to the stockholders of record on September 25, 1998,
thereby creating a Stockholder Rights Plan (the “Rights Agreement”). The Rights Agreement was subsequently amended
effective each of (i) May 23, 2008, (ii) August 18, 2009, (iii) June 2014 and (iv) January 6, 2017. The Rights Agreement, as amended
and restated, provides that each Right entitles the stockholder of record to purchase from the Company that number of common shares
of Common Stock having a combined market value equal to two times the Rights exercise price of $45. The Rights are not exercisable
until the distribution date, which will be the earlier of a public announcement that a person or group of affiliated or associated
persons has acquired 15% or more of the outstanding common shares of Common Stock, or the announcement of an intention by a similarly
constituted party to make a tender or exchange offer resulting in the ownership of 15% or more of the outstanding common shares
of Common Stock (such person, the “acquirer”). The Rights Agreement, as amended and restated, allows for an exemption
for Ted Karkus, our Chairman and Chief Executive Officer, to acquire up to 20% of our Common Stock without our Board of Directors
declaring a dividend distribution.
The
dividend has the effect of giving the stockholder a 50% discount on the share’s current market value for exercising such
right. In the event of a cashless exercise of the Right, and the acquirer has acquired less than 50% beneficial ownership of the
Company, a stockholder may exchange one Right for one common share of the Company. The Rights Agreement, as amended and restated,
includes a provision pursuant to which our Board of Directors may exempt from the provisions of the Rights Agreement an offer
for all outstanding shares of our Common Stock that the directors determine to be fair and not inadequate and to otherwise be
in the best interests of the Company and its stockholders, after receiving advice from one or more investment banking firms. The
expiration date of the Rights Agreement, as amended, is June 18, 2024.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
On
February 16, 2018, our board of directors, approved the termination of the Rights Agreement effective February 20, 2018. As a
consequence of the termination of the Rights Agreement, all of the Rights distributed to our stockholders expired on February
20, 2018.
2015
Equity Line of Credit
On
July 30, 2015, we entered into an equity line of credit agreement (the “2015 Equity Line”) with Dutchess Opportunity
Fund II, LP (“Dutchess”). Pursuant to the 2015 Equity Line, Dutchess committed to purchase, subject to certain restrictions
and conditions, up to 3,200,000 shares of our Common Stock, over a period of 36 months from the effectiveness of the registration
statement registering the resale of shares purchased by Dutchess pursuant to the investment agreement. The
2015 Equity Line of Credit expired in July 2018.
Common
Stock Dividend
On
May 7, 2018, the Board declared a special cash dividend of $1.00 per share on the Company’s common stock, $11.7 million
payable on June 5, 2018 to holders of record of the Company’s common stock on May 21, 2018.
On
December 24, 2018, the Board declared a special cash dividend of $0.25 per share on the Company’s common stock, $2.9 million
payable on January 24, 2019 to holders of record of the Company’s common stock on January 10, 2019.
The
Company recorded $2.9 million dividend payable as of December 31, 2018.
The
2010 Directors’ Equity Compensation Plan
On
May 5, 2010, our stockholders approved the 2010 Directors’ Equity Compensation Plan which, was has been subsequently amended
and restated by our stockholders (the “2010 Directors’ Plan”). A primary purpose of the 2010 Directors’
Plan is to provide us with the ability to pay all or a portion of the fees of directors in restricted stock instead of cash. The
2010 Directors’ Plan provides that the total number of shares of Common Stock that may be issued under the 2010 Directors’
Plan is equal to 675,000 shares.
During
Fiscal 2018 and 2017, 14,948 shares and zero shares, respectively, were granted to our directors under the 2010 Directors’
Plan. We recorded $45,000 of director fees during Fiscal 2018 in connection with these grants.
At
December 31, 2018, there were 382,860 shares of Common Stock that may be issued pursuant to the terms of the 2010 Directors’
Plan.
The
2010 Equity Compensation Plan
On
May 5, 2010, our stockholders approved the 2010 Equity Compensation Plan, which has been subsequently amended and restated by
our stockholders (the “2010 Plan”). The 2010 Plan provides that the total number of shares of Common Stock that may
be issued under the 2010 Plan is 3.9 million shares.
During
Fiscal 2018, we granted 30,000 options, exercisable at $2.35 per share and subject to vesting over a three-year term, to
a consultant pursuant to the terms of the 2010 Plan and we granted 160,000 options to employees, exercisable at $3.18 per share
and subject to vesting over four years. During Fiscal 2017, we granted, 600,000 options to employees, exercisable at
$2.00 per share and subject to vesting over a four-year term. We use the Black-Scholes option pricing model to determine the fair
value of the stock options at the date of grant. Options to non-employees are valued at initial issuance, then revalued at
each reporting date until the date the options vest and at which point the final fair value is determined. Based upon our
limited historical experience, we determined the expected term of the stock option grants to be 4.5 – 4.75 years,
calculated using the “simplified” method in accordance with the SEC Staff Accounting Bulletin 110. We use the “simplified”
method since our historical data does not provide a reasonable basis upon which to estimate expected term. Presented below is
a summary of the terms of the grant of options.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
During
Fiscal 2018 and 2017, there were 490,000 and 1,332,000 options exercised, respectively, and we derived $337,500 and
$1.5 million from the exercise of options in 2018 and 2017, respectively. We had 250,000 shares that were exercised
in Fiscal 2018 pursuant to a cashless exercise. At December 31, 2018, there were 679,500 stock options outstanding
under the 2010 Plan.
The
2018 Stock Incentive Plan
On
April 12, 2018, our stockholders approved the 2018 Stock Incentive Plan (the “2018 Stock Plan”). The 2018 Stock Plan
provides for the grant of incentive stock options to eligible employees of the Company, and for the grant of nonstatutory stock
options to eligible employees, directors and consultants. The purpose of the 2018 Stock Plan is to advance the interests of the
Company and its stockholders by providing an incentive to attract, retain, and reward persons performing services for the Company
and by motivating such persons to contribute to the growth and profitability of the Company. The 2018 Stock Plan provides that
the total number of shares that may be issued pursuant to the 2018 Stock Plan is 2.3 million shares. At September 30, 2018, all
2.3 million shares have been granted in the form of stock options to Ted Karkus (the “CEO Option”), our Chief
Executive Officer and no stock options have been exercised under the 2018 Stock Plan. We use the Black-Scholes option pricing
model to determine the fair value of the stock options and Warrants at the date of grant. Based upon our limited historical experience,
we determined the expected term of the stock option grants to be 4.5 years, calculated using the “simplified” method
in accordance with the SEC Staff Accounting Bulletin 110. We use the “simplified” method since our historical data
does not provide a reasonable basis upon which to estimate expected term.
The
2018 Plan requires certain proportionate adjustments to be made to stock options granted under the 2018 Plan upon the occurrence
of certain events, including a special distribution (whether in the form of cash, shares, other securities, or other property).
Accordingly, the Compensation Committee of the board of directors, as required by the terms of the 2018 Stock Plan, adjusted the
terms of the CEO Option, such that the exercise price of the CEO Option was reduced from $3.00 per share to $2.00 per share, effective
as of June 5, 2018, the date the special $1.00 cash dividend was paid to stockholders. Pursuant to the terms of the
CEO Option, the exercise price of the CEO Option was reduced from $2.00 to $1.75 per share, effective as of January 24, 2019,
the date the special cash dividend was paid in order to maintain parity.
The
following table summarizes stock options activities during Fiscal 2018 and 2017 for both 2010 Plan and 2018 Stock Plan
(in thousands, except per share data):
|
|
Number
of Shares
|
|
|
Weighted
Average Exercise Price
|
|
|
Weighted
Average Remaining Contractual Life (in years)
|
|
|
Total
Intrinsic Value
|
|
Outstanding as of January 1, 2017
|
|
|
669
|
|
|
$
|
1.52
|
|
|
|
3.2
|
|
|
$
|
324
|
|
Granted
|
|
|
625
|
|
|
|
2.01
|
|
|
|
6.3
|
|
|
|
-
|
|
Exercised
|
|
|
(315
|
)
|
|
|
1.55
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding as of December 31, 2017
|
|
|
980
|
|
|
|
1.82
|
|
|
|
4.8
|
|
|
|
52
|
|
Granted
|
|
|
2,490
|
|
|
|
2.08
|
|
|
|
4.3
|
|
|
|
-
|
|
Exercised
|
|
|
(490
|
)
|
|
|
1.64
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding as of December 31,
2018
|
|
|
2,980
|
|
|
$
|
1.82
|
|
|
|
4.8
|
|
|
$
|
3,235
|
|
Options vested and exercisable
|
|
|
673
|
|
|
$
|
2.00
|
|
|
|
4.1
|
|
|
$
|
777
|
|
The
following table summarizes weighted average assumptions used in determining the fair value of the stock options at the date of
grant during Fiscal 2018 and 2017:
|
|
For
the Years Ended
|
|
|
|
December
31, 2018
|
|
|
December
31, 2017
|
|
Exercise price
|
|
$
|
2.52
|
|
|
$
|
2.01
|
|
Expected term in years
|
|
|
4.5
|
|
|
|
4.6
|
|
Expected volatility (annual)
|
|
|
40
|
%
|
|
|
42
|
%
|
Risk-free interest rate
|
|
|
2
|
%
|
|
|
2
|
%
|
Expected dividend yield (per share)
|
|
|
0
|
%
|
|
|
0
|
%
|
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
fair value of the stock options at the time of the grant in Fiscal 2018 and 2017 was $1.8 million and $476,000, respectively.
For Fiscal 2018 and 2017, we charged to operations $590,000 and $78,000, respectively, for share-based compensation expense
for the aggregate fair value of the vested stock options earned.
Treasury
Stock - Stock Purchase Agreements
On
June 12, 2017 we entered into a stock purchase agreement with each of Mark S. Leventhal, a former director
of the Company, and certain other persons and entities associated and/or affiliated with Mr. Leventhal (the “Leventhal Holders”),
pursuant to which we purchased all 1,061,980 shares of our Common Stock then held by the Leventhal Holders, representing an approximate
6.2% aggregate ownership interest (based on 17.2 million shares of common stock outstanding as of June 12, 2017). Upon consummation
of the transactions, the Leventhal Holders ceased to hold any direct or indirect ownership interest in the Company.
Pursuant
to the terms of the stock purchase agreements, the total consideration paid by us to the Leventhal Holders
for their shares was $1,858,465, which amount was equal to the product of (i) $1.75 multiplied by (ii) the number of shares purchased.
Treasury
Stock – Tender Offers
In
Fiscal 2017, we announced two discrete tender offers to purchase our Common Stock in each of August 2017 and November
2017.
On
August 25, 2017, we announced a tender offer to purchase up to 4.0 million shares of our Common Stock at a price of $2.30 per
share (the “August 2017 Tender Offer”). The number of shares proposed to be purchased in the August 2017 Tender Offer
represented approximately 24.7% of approximately 16.2 million shares our Common Stock issued and outstanding as of August 21,
2017. The last reported sale price of our Common Stock on August 15, 2017, the last full trading day before we announced the Tender
Offer, was $2.13 per share.
The
August 2017 Tender Offer expired on September 25, 2017. Subject to the terms of the August 2017 Tender Offer, we accepted for
purchase 4,323,335 shares of our Common Stock at a purchase price of $2.30 per share, for an aggregate purchase price of approximately
$9.9 million. Based on the final tabulation, 5,910,327 shares of our Common Stock were properly tendered and not withdrawn. Prior
to the August 2017 Tender Offer, an investor, BML Investment Partners, L.P. (“BLM”), owned 2,322,627 shares, or 13.6%,
of our outstanding Common Stock. Pursuant to the terms of the Tender Offer, BML tendered and sold 1,695,305 shares of our
Common Stock. In addition, Ted Karkus, our Chairman of the Board and Chief Executive Officer, Robert V. Cuddihy, Jr., our then
Chief Operating Officer and Chief Financial Officer, and one of our directors tendered and sold 364,954, 358,621 and 4,379 shares
of Common Stock, respectively.
On
November 20, 2017, we announced a tender offer to purchase up to 1.7 million shares of our Common Stock at a price of $2.30 per
share (the “November 2017 Tender Offer”). The number of shares proposed to be purchased in the November 2017 Tender
Offer represented approximately 13.7% of approximately 12.4 million shares our Common Stock issued and outstanding as of November
14, 2017. The last reported sale price of our Common Stock on November 9, 2017, the last full trading day before we announced
the Tender Offer, was $2.13 per share.
The
November 2017 Tender Offer expired on December 18, 2017. Subject to the terms of the November 2017 Tender Offer, we accepted for
purchase 1,948,569 shares of our Common Stock, at a purchase price of $2.30 per share, for an aggregate purchase price of approximately
$4.5 million. Based on the final tabulation, 2,072,280 shares of our Common Stock were properly tendered and not withdrawn. Pursuant
to the terms of the Tender Offer, Mr. Karkus sold 424,789 shares of Common Stock. Subsequent to the completion of the November
2017 Tender Offer, Mr. Karkus exercised 600,000 outstanding options. As a consequence of Mr. Karkus’s exercise of his options
at an exercise price of $1.00 per share, we derived net proceeds of $600,000.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
7 – Defined Contribution Plans
We
maintain the ProPhase Labs, Inc. 401(k) Savings and Retirement Plan, a defined contribution plan for our employees. Our contributions
to the plan are based on the amount of the employee plan contributions and compensation. Our contributions to the plan in Fiscal
2018 and 2017 were $90,000 and $120,000, respectively. For Fiscal 2018 and 2017, we charged (i) to continuing operations
$90,000 and $104,000, respectively and (ii) to discontinued operations $0 and $16,000, respectively, for our plan
contribution.
Note
8 – Income Taxes
The
components of the provision (benefit) for income taxes, in the consolidated statements of operations are as follows (in thousands):
|
|
2018
|
|
|
2017
|
|
Current
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
(1,245
|
)
|
State
|
|
|
103
|
|
|
|
(176
|
)
|
|
|
|
103
|
|
|
|
(1,421
|
)
|
Deferred
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(86
|
)
|
|
|
15,412
|
|
State
|
|
|
225
|
|
|
|
682
|
|
|
|
|
139
|
|
|
|
16,094
|
|
Total
|
|
$
|
242
|
|
|
$
|
14,673
|
|
|
|
|
|
|
|
|
|
|
Income taxes from
continuing operations before valuation allowance
|
|
$
|
242
|
|
|
$
|
14,673
|
|
Change in
valuation allowance
|
|
|
(139
|
)
|
|
|
(16,094
|
)
|
Income
tax provision (benefit)
|
|
|
103
|
|
|
|
(1,421
|
)
|
Total
|
|
$
|
103
|
|
|
$
|
(1,421
|
)
|
|
|
|
|
|
|
|
|
|
Discontinued Operations
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
1,245
|
|
State
|
|
|
-
|
|
|
|
2,266
|
|
|
|
|
-
|
|
|
|
3,511
|
|
Deferred
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(34
|
)
|
|
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
|
|
|
(34
|
)
|
|
|
-
|
|
Total
|
|
$
|
(34
|
)
|
|
$
|
3,511
|
|
|
|
|
|
|
|
|
|
|
Income taxes from discontinued operations
before valuation allowance
|
|
$
|
(34
|
)
|
|
$
|
3,511
|
|
Change in
valuation allowance
|
|
|
34
|
|
|
|
-
|
|
Income
tax expense
|
|
|
-
|
|
|
|
3,511
|
|
Total
|
|
$
|
-
|
|
|
$
|
3,511
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
103
|
|
|
$
|
2,090
|
|
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
A
reconciliation of the statutory federal income tax expense (benefit) to the effective tax is as follows (in thousands):
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Statutory
rate - federal
|
|
$
|
(341
|
)
|
|
$
|
14,512
|
|
State
taxes, net of federal benefit
|
|
|
306
|
|
|
|
2,061
|
|
Rate
Change
|
|
|
-
|
|
|
|
1,804
|
|
Permanent
differences and other
|
|
|
243
|
|
|
|
(193
|
)
|
Income
tax from continuing operation before valuation allowance
|
|
|
208
|
|
|
|
18,184
|
|
|
|
|
|
|
|
|
|
|
Change
in valuation allowance
|
|
|
(105
|
)
|
|
|
(16,094
|
)
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
|
103
|
|
|
|
2,090
|
|
Total
|
|
$
|
103
|
|
|
$
|
2,090
|
|
The
tax effects of the primary “temporary differences” between values recorded for assets and liabilities for financial
reporting purposes and values utilized for measurement in accordance with tax laws giving rise to our deferred tax assets are
as follows (in thousands):
|
|
Year
Ended December 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Net
operating loss and capital loss carryforward
|
|
$
|
4,081
|
|
|
$
|
3,595
|
|
Consulting-royalty
costs
|
|
|
-
|
|
|
|
-
|
|
Trademark
|
|
|
-
|
|
|
|
21
|
|
Investment
in Phusion
|
|
|
-
|
|
|
|
33
|
|
Depreciation
|
|
|
(109
|
)
|
|
|
41
|
|
Other
|
|
|
216
|
|
|
|
604
|
|
Valuation
allowance
|
|
|
(4,188
|
)
|
|
|
(4,294
|
)
|
Total
|
|
$
|
-
|
|
|
$
|
-
|
|
We
recognize tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax bases, and for net operating loss carryforwards. Management
evaluated the deferred tax assets for recoverability using a consistent approach that considers the relative impact of negative
and positive evidence, including historical profitability and projections of future reversals of temporary differences and future
taxable income. We are required to establish a valuation allowance for deferred tax assets if management determines, based on
available evidence at the time the determination is made, that it is not more likely than not that some portion or all of the
deferred tax assets will be realized.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
A
valuation allowance for all of our net deferred tax assets has been provided as we are unable to determine, at this time, that
the generation of future taxable income against which the net operating losses (“NOL”) carryforwards could be used
is more likely than not. As a result of ongoing losses from continuing operations the Company has concluded that it is more likely
than not that it will not realize all of its deferred tax assets relating to federal and state filing jurisdictions. As of December
31, 2018, there is a valuation allowance of $4.2 million. As of December 31, 2018, the Company has state NOL carryforwards of
$1.1 million which begin to expire in 2023 and a federal NOL carryforwards of $3.0 million. The amount of the federal NOL generated
prior to the 2017 legislation commonly referred to as the Tax Cuts and Jobs Act (“TCJA”) of $2.6 million can be carried
forward for 20 years and begins to expire in 2032. The remaining amount of $0.4 million federal NOL generated in year 2018 can
be carried forward indefinitely.
We
file a consolidated federal income tax return and separate company state returns as well as combined sta
t
e
returns where applicable.
Note
9 – Other Current Liabilities
The
following table sets forth the components of other current liabilities at December 31, 2018 and 2017, respectively, (in thousands):
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Accrued Expenses
|
|
$
|
167
|
|
|
$
|
66
|
|
Accrued Benefits
|
|
|
24
|
|
|
|
15
|
|
Accrued Payroll
|
|
|
195
|
|
|
|
79
|
|
Accrued Vacation
|
|
|
66
|
|
|
|
88
|
|
Sales tax payable
|
|
|
3
|
|
|
|
3
|
|
Income taxes payable
|
|
|
106
|
|
|
|
740
|
|
Deferred revenue
|
|
|
206
|
|
|
|
-
|
|
Due to Mylan
and affiliates
|
|
|
-
|
|
|
|
59
|
|
Total
other current liabilities
|
|
$
|
766
|
|
|
$
|
1,050
|
|
Note
10 – Commitments and Contingencies
Escrow
Receivable
We
have indemnification obligations to Mylan under the asset purchase agreement that may require us to make future payments
to Mylan and other related persons for any damages incurred by Mylan or such related persons as a result of any breaches of our
representations, warranties, covenants or agreements contained in the asset purchase agreement, or arising from the Retained
Liabilities (as such term is defined in the asset purchase agreement) or certain third party claims specified in the asset
purchase agreement. Generally, our representations and warranties survive for a period of 24 months from the closing date,
other than certain fundamental representations which survive until the expiration of the applicable statute of limitations. There
is a limited indemnification cap with respect to a majority of the Company’s indemnification obligations under the asset
purchase agreement with the exception of claims for actual fraud, the breach of any fundamental representations and certain
other items, which have a larger indemnification cap (e.g., the purchase price).
Pursuant
to the terms of the asset purchase agreement, we, Mylan, and an escrow agent entered into an Escrow Agreement at closing,
pursuant to which Mylan deposited $5 million of the aggregate purchase price for the Cold-EEZE
®
Business into an
escrow account established with the Escrow Agent in order to satisfy, in whole or in part, certain of our indemnity obligations
under the asset purchase agreement.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
terms of the Escrow Agreement provide that if, as of September 29, 2018, there are funds remaining in the escrow account, then
the escrow account will be reduced by the difference, if a positive number, of (i) $2.5 million minus (ii) the aggregate amount
of all escrow claims asserted by Mylan prior to this date that have either been paid out of the escrow account or are pending
as of such date, and, within two business days of such date, the Escrow Agent will disburse such difference, if a positive number,
to us. In addition, within two business days of March 29, 2019, the Escrow Agent will release any funds remaining in the escrow
account to us minus any amounts being reserved for escrow claims asserted by Mylan prior to such date. Upon the resolution of
any pending escrow claims, the Escrow Agent will, within two business days of receipt of joint instructions or a final order from
a court (as described in the Escrow Agreement) disburse such reserved amount to the parties entitled to such funds. As described
below, in August 2018, Mylan asserted an indemnification claim against us, for a yet to be determined amount. Accordingly, the
first distribution was not released to us on September 29, 2018 and remains subject to resolution of this claim.
On
August 2, 2018, we received notice of an indemnification claim from Mylan in relation to product advertising claims brought against
Mylan on certain Cold-EEZE
®
products.
While we believe this claim is without merit, in the event that this or any other indemnity claim is successful, we may be required
to pay Mylan such amounts from the escrow fund, pursuant to the indemnification provisions of the asset purchase agreement
which may reduce the amount we ultimately collect from escrow or could even require us to return a portion of the net proceeds
received from the sale of the Cold-EEZE
®
Business if the escrow funds
are insufficient to cover the losses. Management expects to collect the full remaining escrow balance within the next twelve
months, net of an immaterial reserve representative of our best estimate of the cost to adjudicate this matter.
On
May 31, 2018, we received notice of a claim for $800,000 in losses against the escrow amount. We resolved this claim pursuant
to a settlement agreement, effective October 16, 2018, pursuant to which $160,000 of the funds held in escrow were released to
Mylan. This expense is reflected in discontinued operations in the third quarter of 2018.
Manufacturing
Agreement
In
connection with the asset purchase agreement, the Company and its wholly-owned subsidiary, PMI, entered into a Manufacturing
Agreement (the “Manufacturing Agreement”) with Mylan. Pursuant to the terms of the Manufacturing Agreement, Mylan
(or an affiliate or designee) purchased the inventory of the Company’s Cold-EEZE
®
brand and product line,
and PMI will manufacture certain products for Mylan, as described in the Manufacturing Agreement, at prices that reflect current
market conditions for such products and include an agreed upon mark-up on our costs. Unless terminated sooner by the parties,
the Manufacturing Agreement will remain in effect until March 29, 2022. Thereafter, the Manufacturing Agreement may be renewed
by Mylan for up to five successive one-year periods by providing notice of its intent to renew not less than 90 days prior to
the expiration of the then-current term.
Employment
Agreements
On
April 17, 2017, we entered into an Employment Agreement Termination and Release Agreement (the “April 2017 Termination Agreement”)
with Mr. Cuddihy our former Chief Financial Officer. The April 2017 Termination Agreement terminated Mr. Cuddihy’s
prior employment agreement with us, and established new terms of Mr. Cuddihy’s employment with the Company. The April 2017
Termination Agreement was entered into in light of our recent successful sale of the Cold-EEZE
®
Business. The April
2017 Termination Agreement provided, among other things, that Mr. Cuddihy would remain employed by the Company on an at-will basis;
he would relinquish his rights under the 2015 Employment Agreement, including his rights to separation payments, in consideration
for the Company remitting to him a $675,000 termination payment (the “Termination Payment); and he would reduce his annual
base salary to $250,000 effective July 1, 2017.
On
September 27, 2017, we entered into another Employment Agreement Termination and Release Agreement with Mr. Cuddihy (the “September
2017 Termination Agreement”). Pursuant to the terms of the September 2017 Termination Agreement, Mr. Cuddihy’s 2015
Employment Agreement terminated effective September 30, 2017 and we paid Mr. Cuddihy a one-time lump sum payment of $55,000 on
October 20, 2017. The September 2017 Termination Agreement contains a general release of claims in favor of us and other customary
provisions.
On
February 16, 2018, our board of directors approved the Amended and Restated 2015 Executive Employment Agreement with Ted Karkus,
our Chief Executive Officer (the “Amended Employment Agreement”), which became effective February 23, 2018, and was
approved by stockholders at a special meeting of stockholders held on April 12, 2018. Pursuant to the terms of the Amended
Employment Agreement, Mr. Karkus voluntarily agreed to reduce his base salary from the rate set forth in his prior employment
agreement (
i.e.,
not less than $675,000 per annum) to a base salary of $125,000 per annum (the “Term Base Salary”)
through February 22, 2021. Unless otherwise determined by the mutual agreement of the Company and Mr. Karkus, on February 22,
2021 and thereafter, Mr. Karkus’s salary will increase from the Term Base Salary to not less than $675,000 per annum.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
In
consideration of Mr. Karkus’s voluntary reduction in salary, our board of directors awarded Mr. Karkus a stock option
to purchase 2,300,000 shares of our Common Stock at an exercise price of $3.00 per share on February 23, 2018. The CEO Option
will vest and be exercisable in 35 equal monthly installments of 63,888 options and one monthly installment of 63,290 options,
subject to his continued employment, and subject to accelerated vesting in the event Mr. Karkus’s employment is terminated
for any reason other than by us for Cause or by Mr. Karkus without Good Reason (as such terms are defined in the Amended Employment
Agreement). The CEO Option is be exercisable for a five year term commencing on the date of grant. The CEO Option was granted
pursuant to the 2018 Stock Plan, which was also adopted and approved by our board of directors on February 16, 2018. The 2018
Plan, like the Amended Employment Agreement, received stockholder approval at a special meeting of stockholders held on April
12, 2018 at which time the CEO Option were considered granted for accounting purposes. The 2018 Plan authorizes
the issuance of up to 2,300,000 shares pursuant to stock options granted under the 2018 Plan, all of which were issued to Mr.
Karkus as part of the CEO Option.
As
discussed further in Note 6, on May 7, 2018, the Compensation Committee of the board of directors, as required by the terms
of the 2018 Stock Plan in order to maintain parity, adjusted the terms of the CEO Option, such that the exercise price
of the CEO Option was reduced from $3.00 per share to $2.00 per share, effective as of June 5, 2018, the date of the special $1.00
cash dividend was paid in order to maintain parity, and from $2.00 to $1.75 per share, effective as of January 24, 2019, the
date of the special $0.25 cash dividend was paid in order to maintain parity.
Future
Obligations
We
have estimated future minimum obligations over the next five years, including the remainder of Fiscal 2018, as follows
(in thousands):
|
|
Employment
|
|
|
|
Contracts
|
|
2019
|
|
$
|
125
|
|
2020
|
|
|
125
|
|
2021
|
|
|
595
|
|
2022
|
|
|
675
|
|
2023
|
|
|
675
|
|
Total
|
|
$
|
2,195
|
|
Other
Litigation
In
the normal course of our business, we are named as a defendant in legal proceedings. It is our policy to vigorously defend litigation
and/or enter into settlements of claims where management deems appropriate.
Note
11 – Earnings (Loss) Per Share
Basic
earnings (loss) per share for continuing and discontinued operations are computed by dividing the respective net income or loss
attributable to common stockholders by the weighted-average number of shares of our Common Stock outstanding for the period. Diluted
earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue Common Stock
were exercised or converted into Common Stock or resulted in the issuance of Common Stock that shared in the earnings of the entity.
Diluted earnings (loss) per share also utilize the treasury stock method which prescribes a theoretical buy-back of shares from
the theoretical proceeds of all options and warrants outstanding during the period. Options and warrants outstanding to acquire
shares of our Common Stock at December 31, 2018 and 2017 were 2,980,000 and 979,500, respectively.
For
Fiscal 2018, dilutive earnings (loss) per share were the same as basic earnings per share due to the inclusion of Common
Stock in the form of stock options and warrants (“Common Stock Equivalents”), when in a net loss position would have
an anti-dilutive effect on loss per share. For Fiscal 2018, there were 923,006 that were excluded from the earnings (loss)
per share computation as a consequence of their anti-dilutive effect. For Fiscal 2017 there were 954,500 Common Stock Equivalents
that were in the money and there were 130,966 Common Stock Equivalents which were included in the fully diluted earnings
per share computation.
Note
12 – Significant Customers
Revenue
from continuing operations for Fiscal 2018 and 2017 was $13.1 million and $9.9 million, respectively. Three third-party
contract manufacturing customers accounted for 45.7%, 31.1% and 10.9%, respectively, of our revenue from continuing operations
for Fiscal 2018. Three third-party contract manufacturing customers accounted for 61.7%, 16.1% and 11.1%, respectively,
of our revenues from continuing operations for Fiscal 2017. The loss of sales to any of these large third-party
contract manufacturing customers could have a material adverse effect on our business operations and financial condition.
We
are subject to account receivable credit concentrations from time-to-time as a consequence of the timing, payment pattern and
ultimate purchase volumes or shipping schedules with our customers. These concentrations may impact our overall exposure to credit
risk, either positively or negatively, in that our customers may be similarly affected by changes in economic, regulatory or other
conditions that may impact the timing and collectability of amounts due to us. One customer represented 82% of our total trade
receivable balances at December 31, 2018 and one customer represented 84% of our total trade receivable balances at December 31,
2017, respectively.