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 vertically integrated and diversified branding, marketing and technology company engaged in the research, development,
manufacture, distribution, marketing and sale of over-the-counter (“OTC”) consumer healthcare products, dietary supplements
and other remedies 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 distributor
of a broad range of non-GMO, organic and/or natural-based cough drops and lozenges and OTC drug and dietary supplement products.
In
August 2017, we formed ProPhase Digital Media, Inc. (“PDM”), a Delaware corporation and wholly-owned subsidiary. Our
objective is for PDM to become an independent full-service direct marketing agency. PDM’s first initiative will be to market
the TK Supplements
®
product line. If successful, this may lead to the marketing of other companies’ consumer
products.
In
addition, we also continue to actively pursue acquisition opportunities for other companies, technologies and products within
and outside the consumer products industry.
We
use a December 31 year-end for financial reporting purposes. References herein to “Fiscal 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 and consolidated variable interest entities unless the context otherwise
requires.
Note
2 – Summary of Significant Accounting Policies
For
the three months ended March 31, 2019 and 2018, our revenues have come principally from OTC health care contract manufacturing
and sales to retail customers of dietary supplement products.
Basis
of Presentation
The
unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles
for interim financial statements and within 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 consolidated financial statements, including the notes thereto, appearing in our Annual Report on
Form 10-K for the fiscal year ended December 31, 2018. 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, 2019 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 dietary supplement products sold in the
United States. In addition, we are engaged in marketing activities for the TK Supplements
®
product line
of dietary supplements.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Our
sales are influenced by and subject to (i) the scope and timing of TK Supplements
®
product market acceptance,
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 quarters higher net sales from our
contract manufacturing services. Revenues are generally at their lowest levels in the second quarter, when customer demand
generally declines.
As
a consequence of the scope and timing of our TK Supplements
®
product market acceptance 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, 2019, we had working capital of approximately $13.3 million, including $4.2 million of marketable debt securities,
which are available for sale. We believe our current working capital at March 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 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, 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 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 1.23% - 3.25%, during the first quarter of Fiscal 2019. For the
three months ended March 31, 2019, we reported an unrealized gain of $15,000 and an accumulated unrealized loss 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):
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
|
|
As
of March 31, 2019
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Market
|
|
|
|
Cost
|
|
|
Losses
|
|
|
Value
|
|
U.S treasuries
|
|
$
|
430
|
|
|
$
|
(3
|
)
|
|
$
|
427
|
|
Corporate
bonds
|
|
|
3,808
|
|
|
|
(6
|
)
|
|
|
3,802
|
|
|
|
$
|
4,238
|
|
|
$
|
(9
|
)
|
|
$
|
4,229
|
|
|
|
As
of December 31, 2018
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Market
|
|
|
|
Cost
|
|
|
Losses
|
|
|
Value
|
|
U.S treasuries
|
|
$
|
2,401
|
|
|
$
|
(3
|
)
|
|
$
|
2,398
|
|
Corporate
bonds
|
|
|
4,310
|
|
|
|
(21
|
)
|
|
|
4,289
|
|
|
|
$
|
6,711
|
|
|
$
|
(24
|
)
|
|
$
|
6,687
|
|
We
have determined that the unrealized losses are deemed to be temporary as of March 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 March 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. At March 31, 2019,
after the 2019 write-off of certain inventory previously recorded, the financial statements include adjustments to reduce inventory
for excess, obsolete or short-dated shelf-life inventory of $372,000, inclusive of adjustments of $267,000 for product
samples of TK Supplements
®
products. At March 31, 2019, the inventory adjustment for excess, obsolete or short-dated
shelf-life inventory included $128,000 in finished goods and $244,000 in raw material and work in process. At December 31,
2018, the financial statements include adjustments to reduce inventory for excess, obsolete or short-dated shelf-life inventory
of $377,000, inclusive of an adjustment of $270,000 for product samples of TK Supplements
®
products. At December
31, 2018, the inventory adjustment for excess, obsolete or short-dated shelf-life inventory included $319,000 in finished goods
and $58,000 in raw material and work in process. The components of inventory are as follows (in thousands):
|
|
March
31, 2019
|
|
|
December
31, 2018
|
|
Raw materials
|
|
$
|
1,096
|
|
|
$
|
1,374
|
|
Work in process
|
|
|
243
|
|
|
|
371
|
|
Finished goods
|
|
|
272
|
|
|
|
158
|
|
|
|
$
|
1,611
|
|
|
$
|
1,903
|
|
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
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, 2019 and 2018 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 and other personal care products 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 debt 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, 2019, our cash and cash equivalents
balance was $2.5 million and our bank balance was $2.6 million. Of the total bank balance, $250,000 was covered by federal depository
insurance and $2.3 million was uninsured at March 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 March 31, 2019 and December 31, 2018.
Long-lived
Assets
We
review our 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. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Fair
Value of Financial Instruments
Cash and cash equivalents,
marketable debt securities, accounts receivable, accounts payable, and accrued expenses are reflected in the Condensed
Consolidated Financial Statements at carrying value which approximates fair value. We account for our marketable debt securities
at fair value pursuant to GAAP, with the net unrealized gains or losses reported as a component of accumulated other comprehensive
income or loss.
|
|
As
of March 31, 2019
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Marketable debt securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government obligations
|
|
$
|
-
|
|
|
$
|
427
|
|
|
$
|
-
|
|
|
$
|
427
|
|
Corporate
obligations
|
|
|
-
|
|
|
|
3,802
|
|
|
|
-
|
|
|
|
3,802
|
|
|
|
$
|
-
|
|
|
$
|
4,229
|
|
|
$
|
-
|
|
|
$
|
4,229
|
|
|
|
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 debt securities between Levels 1, 2 or 3 for the three months ended March 31, 2019 and
December 31, 2018.
Revenue
Recognition
We
account for revenue in accordance with ASC Topic 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. The Company recognizes revenue when its performance obligations with its customers have been satisfied. At
contract inception, the Company determines if a contract is within the scope of Topic 606 and then evaluates 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. 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 contract manufacturing and retail customers was $2.1 million and $0.2 million, respectively, for the three months ended March
31, 2019 and $3.3 million and $77,000, respectively, for the three months ended March 31, 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.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
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 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.
Consistent
with Company practice prior to the adoption of ASC 606, 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 retail customers are satisfied at a point in time when the goods are shipped
to the customer as (i) the Company has 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.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Under
ASC 606, we continue to recognize contract manufacturing and retail customers at a point in time as the Company has an enforceable
right to payment for goods as products are shipped to customers.
As
of March 31, 2019 and December 31, 2018, we included a provision for sales allowances from operations of $4,000 and $1,000, respectively,
which are reported as a reduction to account receivables. Additionally, accrued advertising and other allowances from discontinued
operations as of March 31, 2019 included (i) $154,000 for estimated returns, which is reported as a reduction to account
receivables, and (ii) $78,000 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 March 31, 2019, we have deferred revenue of $119,000 in relation to Research and Development (“R&D”) stability
and release testing programs. 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
|
|
$
|
97,123
|
|
13-24 Months
|
|
|
22,220
|
|
Total
|
|
$
|
119,343
|
|
Disaggregation
of Revenue
We
disaggregate revenue from contracts with customers into two categories: contract manufacturing and retail customers. The Company
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, 2019 and 2018
(in thousands):
|
|
For
the Three Months ended
|
|
Revenue by Customer
Type
|
|
March
31, 2019
|
|
|
March
31, 2018
|
|
Contract manufacturing
|
|
$
|
2,124
|
|
|
$
|
3,330
|
|
Retail and
others
|
|
|
194
|
|
|
|
77
|
|
Total revenue
|
|
$
|
2,318
|
|
|
$
|
3,407
|
|
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.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Shipping
and Handling Activities
We
account for shipping and handling activities we perform after a customer obtains control of the good 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 incurred for the three months ended March 31, 2019 and 2018 were
$27,000 and $5,000, respectively.
Stock-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 4). Stock options are
exercisable during a period determined by us, but in no event later than seven years from the date granted.
Research
and Development
Research
and development costs are charged to operations in the period incurred. Research and development costs incurred for the three
months ended March 31, 2019 and 2018 were $94,000 and $87,000, respectively. Research and development 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. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
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 condensed consolidated financial statements.
In
August 2018, the SEC adopted SEC Final Rule Release No. 33-10532, Disclosure Update and Simplification, which amended certain
disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded
the disclosure requirements regarding stockholders’ equity for interim financial statements. Under the amendments, a description
of the changes in each caption of stockholders’ equity presented in the balance sheet must be provided in a note or separate statement.
The description must include a reconciliation of the beginning balance to the ending balance of each period for which a statement
of comprehensive income is required to be filed. The condensed consolidated financial statements included in this Quarterly
Report include a reconciliation of the beginning balance to the ending balance of stockholders’ equity for each period in
which a statement of operations and comprehensive income (loss) is provided.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Recently
Issued Accounting Standards, Not Yet Adopted
In
June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments—Credit Losses.” The standard modifies the
impairment model for most financial assets, including trade accounts receivables and loans, and will require the use of an “expected
loss” model for instruments measured at amortized cost. Under this model, entities will be required to estimate the lifetime
expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting
in a net presentation of the amount expected to be collected on the financial asset. The effective date of the standard is for
fiscal years beginning after December 15, 2019 with early adoption permitted. We are currently evaluating the potential
impact of the adoption of this update on our consolidated financial statements.
Note
3 – Property, Plant and Equipment
The
components of property and equipment are as follows (in thousands):
|
|
March
31, 2019
|
|
|
December
31, 2018
|
|
|
Estimated
Useful Life
|
Land
|
|
$
|
504
|
|
|
$
|
504
|
|
|
|
Building improvements
|
|
|
3,107
|
|
|
|
3,059
|
|
|
10-39 years
|
Machinery
|
|
|
4,126
|
|
|
|
4,126
|
|
|
3-7 years
|
Computer equipment
|
|
|
457
|
|
|
|
457
|
|
|
3-5 years
|
Furniture
and fixtures
|
|
|
207
|
|
|
|
207
|
|
|
5 years
|
|
|
|
8,401
|
|
|
|
8,353
|
|
|
|
Less: accumulated
depreciation
|
|
|
(5,955
|
)
|
|
|
(5,854
|
)
|
|
|
Total property,
plant and equipment, net
|
|
$
|
2,446
|
|
|
$
|
2,499
|
|
|
|
Depreciation
expense incurred for the three months ended March 31, 2019 and 2018 was $101,000 and $95,000, respectively.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
4 – Transactions Affecting Stockholders’ Equity
Our
authorized capital stock consists of 50 million shares of Common Stock, $0.0005 par value (“Common Stock”)
and 1 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, 2019, no shares of Preferred Stock have been issued. Our board of directors has 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 amend from time to time our certificate of incorporation and bylaws 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.
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, we made cash payment of $2.9 million.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
The
2010 Directors’ Equity Compensation Plan
On
May 5, 2010, our stockholders approved the 2010 Directors’ Equity Compensation Plan which, was has been subsequently amended
and restated by our stockholders (the “2010 Directors’ Plan”). A primary purpose of the 2010 Directors’
Plan is to provide us with the ability to pay all or a portion of the fees of directors in restricted stock instead of cash. The
2010 Directors’ Plan provides that the total number of shares of Common Stock that may be issued under the 2010 Directors’
Plan is equal to 675,000 shares.
During 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 first five trading days of the quarter in which the Board
fee was earned. No shares were granted during the three months ended March 31, 2018.
As
of
March 31, 2019, there
were 375,694 shares of Common Stock that may be issued pursuant to the terms of the 2010 Directors’ Plan.
The
2010 Equity Compensation Plan
On
May 5, 2010, our stockholders approved the 2010 Equity Compensation Plan, which has been subsequently amended and restated by
our stockholders (the “2010 Plan”). The 2010 Plan provides that the total number of shares of Common Stock that may
be issued under the 2010 Plan is 3.9 million shares. No options were granted under the 2010 Plan for the three months ended March
31, 2019 or 2018. In addition, no stock options were exercised during the three months ended March 31, 2019 or
2018. As of March 31, 2019, there were 649,500 options outstanding and 661,159 options available to be issued pursuant
to the terms of the 2010 Plan.
We will recognize approximately $440,372 over that 2.5 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. As of September 30,
2018, all 2.3 million shares have been granted in the form of stock options to Ted Karkus (the “CEO Option”), our
Chief Executive Officer and no stock options have been exercised under the 2018 Stock Plan. We use the Black-Scholes option pricing
model to determine the fair value of the stock options 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 $965,481 over that
1.9 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 June 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.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
The
following table summarizes stock options activities during the three months ended March 31, 2019 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, 2019
|
|
|
2,980
|
|
|
$
|
1.82
|
|
|
|
4.8
|
|
|
$
|
3,235
|
|
Forfeited
|
|
|
(30
|
)
|
|
|
2.35
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding as of March 31,
2019
|
|
|
2,950
|
|
|
$
|
1.87
|
|
|
|
4.2
|
|
|
$
|
3,396
|
|
Options vested and exercisable
|
|
|
858
|
|
|
$
|
1.88
|
|
|
|
3.9
|
|
|
$
|
1,079
|
|
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 during
the three months ended March 31, 2019 and 2018 were $21,000 and $22,000, respectively.
Note
6 – Other Accrued Liabilities
The
following table sets forth the components of other current liabilities at March 31, 2019 and December 31, 2018, respectively,
(in thousands):
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Accrued expenses
|
|
$
|
108
|
|
|
$
|
167
|
|
Accrued benefits
|
|
|
58
|
|
|
|
24
|
|
Accrued payroll
|
|
|
56
|
|
|
|
195
|
|
Accrued vacation
|
|
|
62
|
|
|
|
66
|
|
Sales tax payable
|
|
|
105
|
|
|
|
3
|
|
Income taxes payable
|
|
|
3
|
|
|
|
106
|
|
Deferred revenue
|
|
|
119
|
|
|
|
206
|
|
Total
other current liabilities
|
|
$
|
511
|
|
|
$
|
766
|
|
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 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 are funds remaining in the escrow account, then
the escrow account will be reduced by the difference, if a positive number, of (i) $2.5 million minus (ii) the aggregate amount
of all escrow claims asserted by Mylan prior to this date that have either been paid out of the escrow account or are pending
as of such date, and, within two business days of such date, the Escrow Agent will disburse such difference, if a positive number,
to us. In addition, within two business days of March 29, 2019, the Escrow Agent will release any funds remaining in the escrow
account to us minus any amounts being reserved for escrow claims asserted by Mylan prior to such date. Upon the resolution of
any pending escrow claims, the Escrow Agent will, within two business days of receipt of joint instructions or a final order from
a court (as described in the Escrow Agreement) disburse such reserved amount to the parties entitled to such funds. As described
below, in August 2018, Mylan asserted an indemnification claim against us, for a yet to be determined amount. Accordingly, the
distributions was 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, in the event that these or any other indemnity
claims are successful, we may be required to pay Mylan such amounts out of the escrow fund, pursuant to the indemnification provisions
of the asset purchase agreement, which may reduce the amount we ultimately collect from escrow or could even require us to return
a portion of the net proceeds received from the sale of the Cold-EEZE
®
Business if the escrow funds are insufficient
to cover the losses. Management expects to collect the full remaining escrow balance within the next twelve months, net of an
immaterial reserve representative of our best estimate of the cost to adjudicate this matter.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
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.
Future
Obligations:
We
have estimated future minimum obligations over the next five years, including the remainder of Fiscal 2019, as follows (in thousands):
|
|
Employment
|
|
|
|
Contracts
|
|
2019
|
|
$
|
94
|
|
2020
|
|
|
125
|
|
2021
|
|
|
595
|
|
2022
|
|
|
675
|
|
2023
|
|
|
675
|
|
Total
|
|
$
|
2,164
|
|
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
8 – Earnings (Loss) Per Share
Basic
earnings (loss) per share for continuing operations are computed by dividing the respective net income or loss attributable to
common stockholders by the weighted-average number of shares of our Common Stock outstanding for the period. Diluted earnings
(loss) per share reflects the potential dilution that could occur if securities or other contracts to issue Common Stock were
exercised or converted into Common Stock or resulted in the issuance of Common Stock that shared in the earnings of the entity.
Diluted earnings (loss) per share also utilize the treasury stock method, which prescribes a theoretical buy-back of shares
from the theoretical proceeds of all options and warrants outstanding during the period. Options outstanding to acquire shares
of our Common Stock at March 31, 2019 and December 31, 2018 were 2,950,000 and 2,980,000, respectively.
For
the three months ended March 31, 2019, dilutive earnings (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, 2019, there were 2,950,000
potential dilutive Common Stock Equivalents that were excluded from the earnings (loss) per share computation as a
consequence of their anti-dilutive effect. For the three months ended March 31, 2018, there were 282,867 Common Stock Equivalents
that were in the money that were included in the fully diluted earnings per share computation and 2,300,000 options was excluded
from the calculation.
Note
9 – Significant Customers
Revenue
for the three months ended March 31, 2019 and 2018 was $2.3 million and $3.4 million, respectively. Three third-party contract
manufacturing customers accounted for 45.7%, 23.9% and 12.3%, respectively, of our revenue for the three months
ended March 31, 2019. Two third-party contract manufacturing customers accounted for 48.2% and 33.2%, respectively, of our revenues
for the three months ended March 31, 2018. The loss of sales to either 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. Two customers represented 35% and 23% of
our total trade receivable balances at March 31, 2019 and 82% of our total trade receivable balances at December 31, 2018, respectively.