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 manufacturing and marketing company with deep experience with OTC consumer healthcare products and dietary supplements.
We are engaged in the research, development, manufacture, distribution, marketing and sale of 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.
Our
wholly-owned subsidiary, Pharmaloz Manufacturing, Inc. (“PMI”), is a full service contract manufacturer and private
label developer of a broad range of non-GMO, organic and natural-based cough drops and lozenges and OTC drug and dietary supplement
products.
In
addition, we 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 2019” shall mean the fiscal
year ended December 31, 2019 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 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.
For
Fiscal 2019 and 2018, we incurred costs of $40,000 and $170,000, respectively, which was recorded as a loss on sale of
discontinued operations, net of taxes.
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 PlusTM
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 retailers and several
regional retailers.
Note
2 – Summary of Significant Accounting Policies
For
Fiscal 2019 and 2018, our revenues from continuing operations have come principally from our OTC healthcare and dietary supplement
contract manufacturing business and sales to retail customers of dietary supplement product.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 timing of acceptance of our TK Supplement® products in the marketplace,
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 timing of acceptance of our TK Supplements® products in the marketplace 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, 2019, we had working capital of approximately $9.0 million, including $0.9 million marketable securities available for sale.
We believe our current working capital at December 31, 2019 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.
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.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
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 1.65% - 3.09%, during Fiscal 2019. For Fiscal 2019 and 2018, we reported an unrealized gain of $22,000
and $54,000, respectively. We had an accumulated unrealized loss of $2,000 and $24,000 as of December 31, 2019 and 2018, 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, 2019
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Losses
|
|
|
Value
|
|
U.S
treasuries
|
|
$
|
125
|
|
|
$
|
-
|
|
|
$
|
125
|
|
Corporate
bonds
|
|
|
803
|
|
|
|
(2
|
)
|
|
|
801
|
|
|
|
$
|
928
|
|
|
$
|
(2
|
)
|
|
$
|
926
|
|
|
|
As
of December 31, 2018
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Losses
|
|
|
Value
|
|
U.S
treasuries
|
|
$
|
2,401
|
|
|
$
|
(3
|
)
|
|
$
|
2,398
|
|
Corporate
bonds
|
|
|
4,310
|
|
|
|
(21
|
)
|
|
|
4,289
|
|
|
|
$
|
6,711
|
|
|
$
|
(24
|
)
|
|
$
|
6,687
|
|
We
have determined that the unrealized losses are deemed to be temporary as of December 31, 2019. 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, 2019.
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. During 2019 and 2018, the
Company wrote off certain inventory previously recorded. At December 31, 2019 and 2018, the financial statements include non-cash
adjustments to reduce inventory for excess, obsolete or short-dated shelf-life inventory of $168,000 and $103,000, respectively.
The components of inventory are as follows (in thousands):
|
|
December
31,
|
|
|
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Raw
materials
|
|
$
|
1,024
|
|
|
$
|
1,374
|
|
Work
in process
|
|
|
299
|
|
|
|
371
|
|
Finished
goods
|
|
|
136
|
|
|
|
158
|
|
|
|
$
|
1,459
|
|
|
$
|
1,903
|
|
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.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2019, our cash and cash equivalents
balance was $0.4 million and our bank balance was $0.5 million. Of the total bank balance, $335,000 was covered by federal
depository insurance and $176,000 was uninsured at December 31, 2019.
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, 2019 and 2018.
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.
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.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2019
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Marketable
debt securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government obligations
|
|
$
|
-
|
|
|
$
|
125
|
|
|
$
|
-
|
|
|
$
|
125
|
|
Corporate
obligations
|
|
|
-
|
|
|
|
801
|
|
|
|
-
|
|
|
|
801
|
|
|
|
$
|
-
|
|
|
$
|
926
|
|
|
$
|
-
|
|
|
$
|
926
|
|
|
|
As
of December 31, 2018
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Marketable
debt securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government obligations
|
|
$
|
-
|
|
|
$
|
2,398
|
|
|
$
|
-
|
|
|
$
|
2,398
|
|
Corporate
obligations
|
|
|
-
|
|
|
|
4,289
|
|
|
|
-
|
|
|
|
4,289
|
|
|
|
$
|
-
|
|
|
$
|
6,687
|
|
|
$
|
-
|
|
|
$
|
6,687
|
|
There
were no transfers of marketable securities between Levels 1, 2 or 3 for the Fiscal 2019 and 2018.
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 years ended December 31, 2019 and 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 $9.0 million and $0.9 million,
respectively, for Fiscal 2019 and $12.6 million and $0.5 million, respectively, for Fiscal 2018. 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 & 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, 2019 and 2018, we included a provision for sales allowances from continuing operations of $0 and $1,000, respectively,
which are reported as a reduction to account receivables. Additionally, accrued advertising and other allowances from continuing
operations as of December 31, 2019 included (i) $37,000 for estimated returns which is reported as a liability and (ii) $92,000
for corporative and incentive promotion costs which is also reported as a liability. In addition, accrued advertising and
other allowances from discontinued operations as of December 31, 2019 included (i) $132,000 for estimated returns, which
is reported as a reduction to account receivables, and (ii) $76,000 for cooperative incentive promotion costs, which is reported
as accrued advertising and other allowances under current liabilities. As of December 31, 2018, accrued advertising and other
allowances from discontinued operations included (i) $181,000 for estimated future sales 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, 2019, we have deferred revenue of $214,000 in relation to Research and Development (“R&D”) stability
and release testing programs. As of December 31, 2018, deferred revenue was $206,000. 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
|
|
$
|
104
|
|
13-24
Months
|
|
|
49
|
|
Over
24 Months
|
|
|
61
|
|
Total
|
|
$
|
214
|
|
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
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.
The
following table disaggregates the Company’s revenue by revenue source for Fiscal 2019 and 2018 (in thousands):
|
|
For
the Years Ended
|
|
Revenue
by Customer Type
|
|
December
31, 2019
|
|
|
December
31, 2018
|
|
Contract
manufacturing
|
|
$
|
8,974
|
|
|
$
|
12,633
|
|
Retail
and others
|
|
|
902
|
|
|
|
493
|
|
Total
revenue
|
|
$
|
9,876
|
|
|
$
|
13,126
|
|
Practical
Expedients Elected
We
have elected the following practical expedients in applying ASC 606 across all revenue relationships.
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 2019 and 2018
were $443,000 and $264,000, 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. We account for forfeitures as they occur.
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 5). 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 2019 and 2018 (i) from continuing operations
were $332,000 and $398,000, 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.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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
In
February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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. We 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. The
adoption of this standard did not have a material impact on our consolidated financial statements.
In June 2018, the FASB
issued ASU 2018-07 “Improvements to Nonemployee Share-Based Payment Accounting”, which simplifies the accounting for
share-based payments granted to nonemployees for goods and services. Under the ASU, most of the guidance on such payments to nonemployees
would be aligned with the requirements for share-based payments granted to employees. The amendments are effective for fiscal
years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption
is permitted, but not earlier than an entity’s adoption date of Topic 606. We adopted this standard on January 1, 2019.
The adoption of this standard did not have a material impact on our consolidated financial statements.
Recently
Issued Accounting Standards, Not Yet Adopted
In
September 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326). The ASU sets forth a “current
expected credit loss” (CECL) model which requires the Company to measure all expected credit losses for financial instruments
held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces
the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized
cost and applies to some off-balance sheet credit exposures. In February 2020, the FASB issued ASU 2020-02, Financial Instruments
- Credit Losses (Topic 326), which amends the effective date of the original pronouncement for smaller reporting companies. ASU
2016-13 and its amendments will be effective for the Company for interim and annual periods in fiscal years beginning after December
15, 2022. The Company is currently assessing the impact of the adoption of this ASU on its financial statements.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
In
December 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU
2019-12”), which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain
exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application.
This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020,
with early adoption permitted. The Company is currently evaluating the impact of this standard on its consolidated financial statements
and related disclosures.
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.
For
Fiscal 2019 and 2018, we incurred costs of $40,000 and $170,000, respectively, which was recorded as a loss on sale of
discontinued operations, net of taxes.
Note
4 – Property, Plant and Equipment
The
components of property and equipment are as follows (in thousands):
|
|
December
31,
|
|
|
December
31,
|
|
|
|
|
|
2019
|
|
|
2018
|
|
|
Estimated
Useful Life
|
Land
|
|
$
|
504
|
|
|
$
|
504
|
|
|
|
Building
improvements
|
|
|
3,113
|
|
|
|
3,059
|
|
|
10-39 years
|
Machinery
|
|
|
4,285
|
|
|
|
4,126
|
|
|
3-7 years
|
Computer
equipment
|
|
|
472
|
|
|
|
457
|
|
|
3-5 years
|
Furniture
and fixtures
|
|
|
207
|
|
|
|
207
|
|
|
5
years
|
|
|
|
8,581
|
|
|
|
8,353
|
|
|
|
Less:
accumulated depreciation
|
|
|
(6,252
|
)
|
|
|
(5,854
|
)
|
|
|
Total
property, plant and equipment, net
|
|
$
|
2,328
|
|
|
$
|
2,499
|
|
|
|
Depreciation
expense incurred for Fiscal 2019 and 2018 from continuing operations were $398,000 and $383,000, respectively.
Note
5 – 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, 2019, 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.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 Dividends
On
May 7, 2018, the Board declared a special cash dividend of $1.00 per share on the Company’s common stock to holders of record
on May 21, 2018, resulting in the payment of $11.7 million to stockholders on June 5, 2018.
On
December 24, 2018, the Board declared a special cash dividend of $0.25 per share on the Company’s common stock to holders
of record on January 10, 2019, resulting in the payment of $2.9 million to stockholders on January 24, 2019.
On
November 20, 2019, the Board declared a special cash dividend of $0.25 per share on the Company’s common stock to holders
of record on December 3, 2019, resulting in the payment of $2.9 million to stockholders on December 12, 2019.
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 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 2019 and 2018, 24,074 shares and 14,948 shares, respectively, were granted to our directors under the 2010 Directors’
Plan. We recorded $62,000 and $45,000 of director fees during Fiscal 2019 and Fiscal 2018, respectively, in connection with these
grants.
At
December 31, 2019, there were 358,786 shares of Common Stock that may be issued pursuant to the terms of the 2010 Directors’
Plan.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
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 2019, the Company granted 200,000 stock options at an exercise price of $2.01, the closing price of the Company’s
common stock on the date of grant, to certain employees. The stock options will vest in four equal annual installments beginning
on the date of grant.
During
Fiscal 2018, the company 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, to employees pursuant to the terms of the 2010 Plan. 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.
During
Fiscal 2018 there were 490,000 options exercised, including 250,000 shares that were exercised pursuant to a cashless exercise.
We derived $337,500 from the exercise of options in 2018. No options were exercised under the 2010 Plan during Fiscal 2019.
At
December 31, 2019, there were 782,000 stock options outstanding and 528,659 options available to be issued pursuant to the terms
of the 2010 Plan. We will recognize approximately $401,000 of share-based compensation expense over a weighted average
period of 2.1 years.
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 April 12,
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. We will recognize approximately $577,000 of share-based
compensation expense over a weighted average period of 1.2 years.
The
2018 Plan requires certain proportionate adjustments to be made to the 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)
in order to maintain parity. 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 September 5, 2018, the date the special $1.00 special cash dividend was paid to stockholders.
The exercise price of the CEO Option was further reduced from $2.00 to $1.75 per share, effective as of January 24, 2019, the
date the $0.25 special cash dividend was paid to stockholders. The exercise price of the CEO Option was further reduced from $1.75
to $1.50 per share, effective as of December 12, 2019, the date another $0.25 special cash dividend was paid to stockholders.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
following table summarizes stock options activities during Fiscal 2019 and 2018 for both 2010 Plan and 2018 Stock Plan
(in thousands, except per share data). All outstanding options are expected to vest.
|
|
Number of Shares
|
|
|
Weighted Average Exercise
Price
|
|
|
Weighted Average Remaining
Contractual Life (in years)
|
|
|
Total Intrinsic Value
|
|
Outstanding as of January 1, 2018
|
|
|
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
|
|
Granted
|
|
|
200
|
|
|
|
2.01
|
|
|
|
6.9
|
|
|
|
|
|
Forfeited/expired
|
|
|
(98
|
)
|
|
|
2.81
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding as of December 31, 2019
|
|
|
3,082
|
|
|
$
|
1.67
|
|
|
|
3.7
|
|
|
$
|
1,085
|
|
Options vested and exercisable
|
|
|
1,656
|
|
|
$
|
1.59
|
|
|
|
3.4
|
|
|
$
|
665
|
|
The
following table summarizes weighted average assumptions used in determining the fair value of the stock options at the date of
grant during Fiscal 2019 and 2018:
|
|
For
the Years Ended
|
|
|
|
December
31, 2019
|
|
|
December
31, 2018
|
|
Exercise
price
|
|
$
|
2.01
|
|
|
$
|
2.52
|
|
Expected
term in years
|
|
|
4.5
|
|
|
|
4.5
|
|
Expected
volatility (annual)
|
|
|
42
|
%
|
|
|
40
|
%
|
Risk-free
interest rate
|
|
|
2
|
%
|
|
|
2
|
%
|
Expected dividend
yield (per share)
|
|
|
0
|
%
|
|
|
0
|
%
|
The
fair value of the stock options at the time of the grant in Fiscal 2019 and 2018 was $148,000 and $1.8 million, respectively.
For Fiscal 2019 and 2018, we charged to operations $682,000 and $590,000, respectively, for share-based compensation expense for
the aggregate fair value of the vested stock options earned.
Note
6 – 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
2019 and 2018 were $84,000 and $90,000, respectively.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
7 – Income Taxes
The
components of the provision (benefit) for income taxes, in the consolidated statements of operations are as follows (in thousands):
|
|
Year Ended
|
|
|
Year Ended
|
|
|
|
12/31/2019
|
|
|
12/31/2018
|
|
Continuing Operations
|
|
|
|
|
|
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
-
|
|
|
|
103
|
|
|
|
|
-
|
|
|
|
103
|
|
Deferred:
|
|
|
|
|
|
|
|
|
Federal
|
|
|
-
|
|
|
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
Income taxes from Continuing Operations
|
|
|
-
|
|
|
|
103
|
|
|
|
|
|
|
|
|
|
|
Discontinued Operations
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
|
|
|
-
|
|
|
|
-
|
|
Deferred
|
|
|
|
|
|
|
|
|
Federal
|
|
|
-
|
|
|
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
Income taxes from Discontinued Operations
|
|
|
-
|
|
|
|
-
|
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
-
|
|
|
|
$
103
|
|
PROPHASE
LABS, INC & 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):
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
Statutory
rate - federal
|
|
$
|
(660
|
)
|
|
$
|
(341
|
)
|
State
taxes, net of federal benefit
|
|
|
(7
|
)
|
|
|
306
|
|
Permanent
differences and other
|
|
|
145
|
|
|
|
243
|
|
Income
tax from continuing operation before valuation allowance
|
|
|
(522
|
)
|
|
|
208
|
|
|
|
|
|
|
|
|
|
|
Change
in valuation allowance
|
|
|
(522
|
)
|
|
|
(105
|
)
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
|
-
|
|
|
|
103
|
|
Total
|
|
$
|
-
|
|
|
$
|
103
|
|
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,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
Net
operating loss and capital loss carryforward
|
|
$
|
4,605
|
|
|
$
|
4,081
|
|
Depreciation
|
|
|
(93
|
)
|
|
|
(109
|
)
|
Other
|
|
|
198
|
|
|
|
216
|
|
Valuation
allowance
|
|
|
(4,710
|
)
|
|
|
(4,188
|
)
|
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.
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, 2019, there is a valuation allowance of $4.7 million. As of December 31, 2019, the Company has state NOL carryforwards of
$1.1 million, which begin to expire in 2024 and federal NOL carryforwards of $3.5 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 may be carried
forward for 20 years and begins to expire in 2032. The remaining amount of $0.9 million federal NOL generated in years 2018 and
2019 may be carried forward indefinitely and its utilization is limited to 80% of taxable income.
We
file a consolidated federal income tax return and separate company state returns as well as combined state returns where applicable.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
8 – Other Current Liabilities
The
following table sets forth the components of other current liabilities at December 31, 2019 and 2018, respectively (in thousands):
|
|
December
31,
|
|
|
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Accrued
expenses
|
|
$
|
218
|
|
|
$
|
167
|
|
Accrued
benefits
|
|
|
25
|
|
|
|
23
|
|
Accrued
payroll
|
|
|
57
|
|
|
|
195
|
|
Accrued
vacation
|
|
|
5
|
|
|
|
66
|
|
Sales
tax payable
|
|
|
-
|
|
|
|
3
|
|
Income
taxes payable
|
|
|
-
|
|
|
|
106
|
|
Deferred
revenue
|
|
|
104
|
|
|
|
206
|
|
Total
other current liabilities
|
|
$
|
409
|
|
|
$
|
766
|
|
Note
9 – Commitments and Contingencies
Escrow
Receivable
We
have indemnification obligations to Mylan Consumer Healthcare Inc. (formerly known as Meda Consumer Healthcare Inc.) (“MCH”)
and Mylan Inc. (together with MCH, “Mylan”) under the asset purchase agreement pursuant to which we sold the Cold-EEZE®
business to Mylan, 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, which was March 29, 2017, 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
(i.e., 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.
The
terms of the Escrow Agreement provide that if, as of September 29, 2018, there were funds remaining in the escrow account, then
the escrow account would 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 had either been paid out of the escrow account or were pending
as of such date, and, within two business days of such date, the Escrow Agent would 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 would then, 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
distributions were not released to us on September 29, 2018 or March 29, 2019.
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.
On
August 2, 2018, we received notice of an indemnification claim from Mylan in relation to certain product advertising claims brought
against Mylan related to certain Cold-EEZE® products. Pursuant to the terms of the asset purchase agreement, we
have elected to assume the defense of these claims on behalf of Mylan. We dispute these product advertising claims and intend
to vigorously contest such claims. While we believe these claims are without
merit, we are currently negotiating a settlement of these claims. We expect to collect the remaining escrow balance within the
next three months, net of an immaterial settlement amount. In the event we are unable to reach a reasonable settlement agreement,
however, and the remaining escrow funds are insufficient to cover the losses asserted under these claims or the legal fees associated
with defending these claims, we may be required to pay amounts in excess of what is remaining in the escrow account, which could
have an adverse impact on our operations.
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
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
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.
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 5, as required by the terms of the 2018 Stock Plan, in order to maintain parity, the Compensation Committee
of the board of directors adjusted the exercise price of the CEO Option on May 7, 2018, 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, from $2.00 to $1.75 per share, effective as of January 24, 2019, the date the special $0.25 cash dividend was paid,
and from $1.75 to $1.50 per share, effective as of December 12, 2019, the date another 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 as of December 31, 2019, as follows (in thousands):
|
|
Employment
|
|
|
|
Contracts
|
|
2020
|
|
$
|
125
|
|
2021
|
|
|
595
|
|
2022
|
|
|
675
|
|
2023
|
|
|
675
|
|
2024
|
|
|
675
|
|
Total
|
|
$
|
2,745
|
|
PROPHASE
LABS, INC & SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
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.
On
November 12, 2019, Craig Cunningham filed an action in the United States District Court for the Eastern District of Texas against
TK Supplements, Inc., one of our wholly-owned subsidiaries (“TK Sub”), asserting two class claims and alleging that,
by sending plaintiff text messages to his cellular telephone number without his prior express consent and notwithstanding its
listing on the Do No Call Registry, TK Sub violated the Telephone Consumer Protection Act, 47 U.S.C. § 227(b)(3)(B) and 47
U.S.C. § 227(c)(5). Plaintiff seeks to represent a class of (i) all residents within the United States to whom TK Sub or
its agents sent text messages to the person’s cellular telephone number in the past four years and (ii) all residents within
the United States to whom TK Sub or its agents placed two or more telemarketing phone calls to the person’s residential
telephone number that was listed on the Do Not Call Registry in the past four years. On January 8, 2020, TK Supplements filed
its Answer and Defenses to the Complaint. We intend to defend this matter vigorously.
Note
10 – Loss Per Share
Basic
loss per share for continuing and discontinued operations are computed by dividing the respective net loss attributable to common
stockholders by the weighted-average number of shares of our Common Stock outstanding for the period. Diluted 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 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, 2019 and 2018 were 3,082,000 and 2,980,000, respectively.
For
Fiscal 2019 and 2018, dilutive 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 2019, there were 3,082,000 that were excluded from the loss per share computation as a consequence
of their anti-dilutive effect. For Fiscal 2018, there were 2,980,000 that were excluded from the loss per share computation as
a consequence of their anti-dilutive effect.
Note
11 – Significant Customers
Revenue
from continuing operations for Fiscal 2019 and 2018 was $9.9 million and $13.1 million, respectively. Three third-party contract
manufacturing customers accounted for 36.5%, 30.5% and 11.1%, respectively, of Fiscal 2019 revenues from continuing operations.
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. 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. Three of our customers represented 70%,
14% and 11% of our total trade receivable balances at December 31, 2019 and one customer represented 82% of our total trade
receivable balances at December 31, 2018.