Notes to Condensed Consolidated Financial
Statements
(unaudited)
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 2020” shall mean the fiscal
year ended December 31, 2020 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.
Note
2 – Summary of Significant Accounting Policies
For
the three months ended March 31, 2020 and 2019, our revenues have come principally from our OTC healthcare and dietary supplement
contract manufacturing business and sales to retail customers of dietary supplement product.
Basis
of Presentation
The
unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles
for interim financial statements and the rules of the Securities and Exchange Commission (“SEC”) applicable to interim
financial statements, and therefore do not include all disclosures that might normally be required for financial statements prepared
in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The accompanying
unaudited condensed consolidated financial statements have been prepared by management without audit and should be read in conjunction
with our audited consolidated financial statements, including the notes thereto, appearing in our Annual Report on Form 10-K for
the fiscal year ended December 31, 2019. In the opinion of management, all adjustments necessary for a fair presentation of the
consolidated financial position, consolidated results of operations and consolidated cash flows, for the periods indicated, have
been made. The results of operations for the three months ended March 31, 2020 are not necessarily indicative of operating results
that may be achieved over the course of the full year.
Product
Innovation, Seasonality of the Business and Liquidity
Our
net sales are derived principally from our contract manufacturing of OTC healthcare and our dietary supplement products sold in
the United States. In addition, we are engaged in market activities for our TK Supplements® product line of dietary
supplements.
Our
sales are influenced by and subject to (i) the timing of acceptance of our TK Supplements® 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 March
31, 2020, we had working capital of approximately $8.4 million, including $0.8 million in marketable securities available for
sale. We believe our current working capital at March 31, 2020 is at an acceptable and adequate level to support our business
for at least the next twelve months.
ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial
Statements
(unaudited)
Based
on the Company’s current assessment, the Company does not expect any material impact on its long-term liquidity due to the
COVID-19 pandemic. However, the Company will continue to assess the effect of the pandemic on its operations. The extent to which
the COVID-19 pandemic will impact the Company’s business and operations will depend on future developments that are highly
uncertain and cannot be predicted with confidence at this time, such as the ultimate geographic spread of the disease, the duration
of the outbreak, the duration and effect of business disruptions and the short-term effects and ultimate effectiveness of the
travel restrictions, quarantines, social distancing requirements and business closures in the United States and other countries
to contain and treat the disease. While the potential economic impact caused by, and the duration of, COVID-19 may be difficult
to assess or predict, a widespread pandemic such as COVID-19 could result in significant disruption of global financial markets,
reducing the Company’s ability to access capital, which could in the future negatively affect the Company’s liquidity.
In addition, a recession or market correction resulting from the spread of COVID-19 could materially affect the Company’s
business and the value of its common stock.
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 its 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 a 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
Debt Securities
We
have classified our investments in marketable debt securities as available-for-sale and as a current asset. Our investments in
marketable debt 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 debt securities are recorded as interest income (expense). We initiated
short term investments in marketable debt securities, which carry maturity dates between one and three years from date of purchase
with interest rates of 1.875% - 2.750% during the first quarter of Fiscal 2020. For the three months ended March 31, 2020,
we reported unrealized gains of $11,000 and an accumulated unrealized income of $9,000. Unrealized gains and losses
are classified as other comprehensive income (loss) and the cost is determined on a specific identification basis. The following
is a summary of the components of our marketable debt securities and the underlying fair value input level tier hierarchy (see
long-lived assets below) (in thousands):
|
|
As of March 31, 2020
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Value
|
|
U.S. government obligations
|
|
$
|
829
|
|
|
$
|
11
|
|
|
$
|
840
|
|
|
|
As of December 31, 2019
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Losses
|
|
|
Value
|
|
U.S. government obligations
|
|
$
|
125
|
|
|
$
|
-
|
|
|
$
|
125
|
|
Corporate obligations
|
|
|
803
|
|
|
|
(2
|
)
|
|
|
801
|
|
|
|
$
|
928
|
|
|
$
|
(2
|
)
|
|
$
|
926
|
|
ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial
Statements
(unaudited)
We believe that the unrealized
gains or losses generally are the result of a change 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.
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 March 31, 2020 and March
31, 2019, the financial statements include non-cash adjustments to adjust inventory for excess, obsolete or short-dated shelf-life
inventory by $12,000 and $10,000 respectively. The components of inventory are as follows (in thousands):
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Raw materials
|
|
$
|
993
|
|
|
$
|
1,024
|
|
Work in process
|
|
|
463
|
|
|
|
299
|
|
Finished goods
|
|
|
247
|
|
|
|
136
|
|
|
|
$
|
1,703
|
|
|
$
|
1,459
|
|
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. We have reviewed our property, plant and equipment for the three months
ended March 31, 2020 and 2019 and concluded there were no impairments or changes in useful lives.
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 March 31, 2020, our cash and cash equivalents
balance was $0.7 million and our bank balance was $0.8 million. Of the total bank balance, $0.3 million was covered by federal
depository insurance and $0.5 million was uninsured at March 31, 2020.
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 March 31, 2020 and December 31, 2019.
ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial
Statements
(unaudited)
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 of Financial Instruments
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.
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, with the net unrealized
gains or losses reported as a component of accumulated other comprehensive income or loss. The components of marketable debt securities
are as follows (in thousands):
|
|
As of March 31, 2020
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Marketable debt securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government obligations
|
|
$
|
-
|
|
|
$
|
840
|
|
|
$
|
-
|
|
|
$
|
840
|
|
|
|
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
|
|
There
were no transfers of marketable debt securities between Levels 1, 2 or 3 for the three months ended March 31, 2020.
Revenue
Recognition
We recognize revenue
that represents 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, evaluate the contract to determine if revenue should be recognized
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.
ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial
Statements
(unaudited)
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 $1.7 million and $0.2 million,
respectively, for the three months ended March 31, 2020 and $2.1 million and $0.2 million, respectively, for the three months
ended March 31, 2019. 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.
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 the Company and the R&D services are invoiced at the
time the performance is completed.
The
Company does 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 sales to 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 from our contract manufacturing customers. 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 products must 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.
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.
Accrued
advertising and other allowances from continuing operations as of March 31, 2020 included (i) $46,000 for estimated returns which
is reported as a liability and (ii) $22,000 for cooperative and incentive promotion costs which is also reported as a liability.
Accrued advertising and other allowances from discontinued operations as of March 31, 2020 included (i) $134,000 for estimated
returns, which is reported as a reduction to account receivables, and (ii) $69,000 for cooperative incentive promotion costs,
which is reported as accrued advertising and other allowances under current liabilities. As of December 31, 2019, accrued advertising
and other allowances from continuing operations included (i) $37,000 for estimated returns which is reported as a liability and
(ii) $92,000 for cooperative and incentive promotion costs which is also reported as a liability. 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.
ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial
Statements
(unaudited)
As
of March 31, 2020, we have deferred revenue of $205,000 in relation to Research and Development (“R&D”) stability
and release testing programs. As of December 31, 2019, deferred revenue was $214,000. 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 expected by recognition period (in thousands):
|
|
Deferred Revenue
|
|
|
|
March 31, 2020
|
|
|
December 31, 2019
|
|
Recognition Period
|
|
|
|
|
|
|
|
|
0-12 Months
|
|
$
|
93
|
|
|
$
|
104
|
|
13-24 Months
|
|
|
33
|
|
|
|
49
|
|
Over 24 Months
|
|
|
79
|
|
|
|
61
|
|
Total
|
|
$
|
205
|
|
|
$
|
214
|
|
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 the three months ended March 31, 2020 and 2019
(in thousands):
|
|
For the Three Months Ended
|
|
Revenue by Customer Type
|
|
March 31, 2020
|
|
|
March 31, 2019
|
|
Contract manufacturing
|
|
$
|
1,723
|
|
|
$
|
2,124
|
|
Retail and others
|
|
|
165
|
|
|
|
194
|
|
Total revenue
|
|
$
|
1,888
|
|
|
$
|
2,318
|
|
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 the three months ended
March 31, 2020 and 2019 were $47,000 and $27,000, 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.
ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial
Statements
(unaudited)
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. For the three months
ended March 31, 2020 and 2019, we charged to operations $198,000 and $196,000, respectively, for share-based compensation expense
for the aggregate fair value of stock grants issued and vested stock options earned.
Research
and Development
R&D
costs are charged to operations in the period incurred R&D costs incurred for the three months ended March 31, 2020 and 2019
from continuing operations were $59,000 and $94,000, 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.
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
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.
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.
ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial
Statements
(unaudited)
Note
3 – Property, Plant and Equipment
The
components of property and equipment are as follows (in thousands):
|
|
March 31,
|
|
|
December 31,
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
Estimated Useful Life
|
Land
|
|
$
|
504
|
|
|
$
|
504
|
|
|
|
Building improvements
|
|
|
3,113
|
|
|
|
3,113
|
|
|
10-39 years
|
Machinery
|
|
|
4,376
|
|
|
|
4,285
|
|
|
3-7 years
|
Computer equipment
|
|
|
458
|
|
|
|
472
|
|
|
3-5 years
|
Furniture and fixtures
|
|
|
207
|
|
|
|
207
|
|
|
5 years
|
|
|
|
8,658
|
|
|
|
8,581
|
|
|
|
Less: accumulated depreciation
|
|
|
(6,295
|
)
|
|
|
(6,251
|
)
|
|
|
Total property, plant and equipment, net
|
|
$
|
2,363
|
|
|
$
|
2,329
|
|
|
|
Depreciation
expense incurred for the three months ended March 31, 2020 and 2019 was $82,000 and $101,000, respectively. During the three months
ended March 31, 2020, we wrote off fully depreciated assets and accumulated depreciation totaling $38,000.
Note
4 – Transactions Affecting Stockholders’ Equity
Our
authorized capital stock consists of 50 million shares of Common Stock, $0.0005 par value, and one million shares of preferred
stock, $0.0005 par value (“Preferred Stock”).
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 March 31, 2020 and December 31, 2019, no shares of Preferred Stock
have been issued.
Common Stock Dividend
On December 24,
2018, the Board declared a special cash dividend of $0.25 per share on the Company’s Common Stock resulting in $2.9
million payable on January 24, 2019 to holders of record of the Company’s Common Stock on January 10, 2019. On January
24, 2019, the Company paid an aggregate of $2.9 million to the Company’s stockholders entitled to receive such
dividend.
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
the three months ended March 31, 2020, 8,346 shares of Common Stock were granted to our directors under the 2010 Directors’
Plan. We recorded $17,000 of director fees during the three months ended March 31, 2020 in connection with these grants, which
represented the fair value of the shares calculated based on the average closing price of the Company’s shares of Common
Stock for the last five trading days of the quarter in which the Board fee was earned.
During
the three months ended March 31, 2019, 7,166 shares of Common Stock were granted to our directors under the 2010 Directors’
Plan. We recorded $23,000 of director fees during the three months ended March 31, 2019 in connection with these grants, which
represented the fair value of the shares calculated based on the average closing price of the Company’s shares of Common
Stock for the last five trading days of the quarter in which the Board fee was earned.
At
March 31, 2020, there were 350,440 shares of Common Stock that may be issued pursuant to the terms of the 2010 Directors’
Plan.
ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial
Statements
(unaudited)
The
2010 Equity Compensation Plan
On
May 5, 2010, our stockholders approved the 2010 Equity Compensation Plan, which was 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.
No
options were granted under the 2010 Plan for the three months ended March 31, 2020 and 2019. In addition, no stock options were
exercised during the three months ended March 31, 2020 and 2019.
As
of March 31, 2020, there were 782,000 options outstanding and 528,659 options available to be issued pursuant to the terms of
the 2010 Plan. We will recognize approximately $350,000 of share-based compensation expense over a weighted average period of
1.8 years.
The
2018 Stock Incentive Plan
On
April 12, 2018, our stockholders approved the 2018 Stock Incentive Plan (the “2018 Stock Plan”). At April 12,
2018, all 2.3 million shares available for issuance under the 2018 Stock Plan have been granted in the form of stock options at
an initial exercise price of $3.00 per share, which is exercisable in 36 monthly installments to Ted Karkus (the “CEO
Option”), our Chief Executive Officer and no stock options have been exercised under the 2018 Stock Plan.
The 2018 Plan
requires certain proportionate adjustments to be made to the stock options granted under the 2018 Stock 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 the Company’s 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 the Company’s
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 Company’s stockholders. We will
recognize approximately $447,000 of share-based compensation expense over a weighted average period of 0.9 years.
The
following table summarizes stock options activity during the three months ended March 31, 2020 for both the 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, 2020
|
|
|
3,082
|
|
|
$
|
1.67
|
|
|
|
3.7
|
|
|
$
|
1,085
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited/expired
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding as of March 31, 2020
|
|
|
3,082
|
|
|
$
|
1.67
|
|
|
|
3.4
|
|
|
$
|
900
|
|
Options vested and exercisable
|
|
|
1,848
|
|
|
$
|
1.58
|
|
|
|
3.1
|
|
|
$
|
626
|
|
Note
5 – 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 the
three months ended March 31, 2020 and 2019 were $16,000 and $21,000, respectively.
Note
6 – Other Current Liabilities
The
following table sets forth the components of other current liabilities at March 31, 2020 and December 31, 2019, respectively,
(in thousands):
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Accrued expenses
|
|
$
|
122
|
|
|
$
|
218
|
|
Accrued benefits
|
|
|
14
|
|
|
|
25
|
|
Accrued payroll
|
|
|
88
|
|
|
|
57
|
|
Accrued vacation
|
|
|
20
|
|
|
|
5
|
|
Sales tax payable
|
|
|
1
|
|
|
|
-
|
|
Deferred revenue
|
|
|
93
|
|
|
|
104
|
|
Total other current liabilities
|
|
$
|
338
|
|
|
$
|
409
|
|
ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial
Statements
(unaudited)
Note
7– 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 was required to 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 elected to assume
the defense of these claims on behalf of Mylan, which we disputed and vigorously contested. Although we believe
these claims are without merit, we have negotiated a settlement with the plaintiffs.
As
described in Part I, Item 1, Note 10 “Subsequent Events,” on May 4, 2020, the final pending claim against the Company’s
escrow account with Mylan was resolved and, as a consequence, the Escrow Agent released all funds from the escrow account to the
Company on May 7, 2020, in the amount of $4.8 million.
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.
ProPhase Labs, Inc.
and Subsidiaries
Notes to Condensed Consolidated Financial
Statements
(unaudited)
Future
Obligations:
We
have estimated future minimum obligations for an executive’s employment agreement over the next five years, including the
remainder of Fiscal 2020, as follows (in thousands):
|
|
Employment
|
|
|
|
Contracts
|
|
2020
|
|
$
|
94
|
|
2021
|
|
|
595
|
|
2022
|
|
|
675
|
|
2023
|
|
|
675
|
|
2024
|
|
|
675
|
|
Total
|
|
$
|
2,714
|
|
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, an action was filed 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
8 – 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 March 31,
2020 and 2019 were 3,082,000 and 2,950,000, respectively.
For
the three months ended March 31, 2020, dilutive loss per share were the same as basic earnings per share due to the exclusion
of Common Stock in the form of stock options (“Common Stock Equivalents”), which in a net loss position would have
an anti-dilutive effect on loss per share. For the three months ended March 31, 2020, there were 3,082,000 potential dilutive
Common Stock Equivalents that were excluded from the loss per share computation as a consequence of their anti-dilutive effect.
For the three months ended March 31, 2019, there were 2,950,000 potential dilutive Common Stock Equivalents that were excluded
from the loss per share computation as a consequence of their anti-dilutive effect.
Note
9 – Significant Customers
Revenue
for the three months ended March 31, 2020 and 2019 was $1.9 million and $2.3 million, respectively. Three third-party contract
manufacturing customers accounted for 48.6% and 18% and 17.3%, respectively, of our revenue from continuing operations for the
three months ended March 31, 2020. Three third-party contract manufacturing customers accounted for 45.7%, 23.9% and 12.3%, respectively,
of our revenue from continuing operations for the three months ended March 31, 2019. 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. Four customers represented 49%, 18%, 12%, and 11%
of our total trade receivable balances at March 31, 2020 and three customers represented 70%, 14% and 11% of our total trade receivable
balances at December 31, 2019.
Note
10 – Subsequent Event
Settlement
and Release of Escrow Receivable
On
May 4, 2020, the final pending claim against the Company’s escrow account with Mylan was resolved and, as a consequence,
the Escrow Agent released all funds from the escrow account to the Company on May 7, 2020, in the amount of $4.8 million.
Receipt
of Loan under the Paycheck Protection Program
On
May 3, 2020, the Company entered into a promissory note and agreement (the “Note”) with Wells Fargo, N.A. for an aggregate
principal amount of $295,250 (the “Loan”), pursuant to the Paycheck Protection Program under the recently enacted
Coronavirus Aid, Relief, and Economic Security Act.
The
Loan matures two years from the disbursement date and bears interest at a rate of 1.000% per annum, with the first six months
of interest deferred. Principal and interest are payable monthly commencing six months after the disbursement date and may be
prepaid by the Company at any time prior to maturity with no prepayment penalties. We did not provide any collateral or guarantees
for the Loan, not did we pay any facility charge to obtain the Loan.