Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
1 – Organization and Business
ProPhase
Labs, Inc. (“we”, “us” or the “Company”) was initially organized 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 manufacturer,
marketer and distributor of a diversified range of homeopathic and health care products that are offered to the general public.
We are also engaged in the research and development of potential over-the-counter (“OTC”) drug, natural base health
products along with supplement, personal care and cosmeceutical products.
Our
primary business is the manufacture, distribution, marketing and sale of OTC health care and cold remedy products to consumers
through national chain, regional, specialty and local retail stores. Our flagship brand is Cold-EEZE
®
and our
principal product is Cold-EEZE
®
cold remedy zinc gluconate lozenges, proven in clinical studies to reduce the
duration and severity of symptoms of the common cold. In addition to Cold-EEZE
®
cold remedy lozenges, we market
and distribute non-lozenge forms of our proprietary zinc gluconate formulation, (i) Cold-EEZE
®
cold remedy QuickMelts
®
and (ii) Cold-EEZE
®
cold remedy Oral Spray. Each of our Cold-EEZE
®
QuickMelts
®
products are based on our proprietary zinc gluconate formulation in combination with certain (i) immune system support,
(ii) energy, (iii) sleep and relaxation, and/or (iv) cold and flu symptom relieving active ingredients.
In
Fiscal 2015, we introduced three new Cold-EEZE
®
product line extensions: (i) a Cold-EEZE
®
Multi-Symptom
Relief for Cold and Flu lozenge, (ii) a Cold-EEZE
®
Daytime and Nighttime Multi-Symptom Relief in liquid form for
each of adults and children, and (iii) Cold-EEZE
®
Natural Allergy Relief caplets for indoor and outdoor allergies.
Shipments for these three new Cold-EEZE
®
product line extensions began in the third quarter of Fiscal 2015. In
Fiscal 2016, we expanded our Cold-EEZE
®
product line further to include (i) Cold-EEZE
®
Gummies
Multi-Symptom Relief for Cold and Flu and (ii) Cold-EEZE
®
Nighttime Multi-Symptom Relief for Cold and Flu QuickMelts
®
.
Shipments began for these two new products during the third quarter of Fiscal 2016.
We
also perform contract manufacturing services of lozenge-based products for third parties. For the three and six months ended June
30, 2016 and 2015, our revenues from operations have come principally from our OTC health care and cold remedy products.
We
use a December 31 year-end for financial reporting purposes. References herein to “Fiscal 2016” shall mean the fiscal
year ended December 31, 2016 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
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 year ended December 31, 2015.
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 and six months ended June 30, 2016 are not necessarily indicative of operating results that may be achieved over
the course of the full year.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
2 – Summary of Significant Accounting Policies – continued
Seasonality
of the Business
Our
net sales are derived principally from our OTC heath care and cold remedy products. Currently, our sales are influenced by and
subject to fluctuations in the timing of purchase and the ultimate level of demand for our products which are a function of the
timing, length and severity of each cold season. Generally, a cold season is defined as the period of 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 third and fourth quarter higher levels of net sales along with a corresponding increase in marketing and advertising expenditures
designed to promote our products during the cold season. Revenues and related marketing costs are generally at their lowest levels
in the second quarter when consumer demand generally declines. We track health and wellness trends and develop retail promotional
strategies to align our production scheduling, inventory management and marketing programs to optimize consumer purchases.
For
the three and six months ended June 30, 2016 and 2015, our net sales were principally related to domestic markets.
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
and intangible assets, impairment of property and equipment and intangible assets, income tax valuations and assumptions related
to accrued advertising. When providing for the appropriate sales returns, allowances, cash discounts and cooperative incentive
promotion costs (“Sales Allowances”), we apply a uniform and consistent method for making certain assumptions for
estimating these provisions. These estimates and assumptions are based on historical experience, current trends and other factors
that management believes to be relevant at the time the financial statements are prepared. Management reviews the accounting policies,
assumptions, estimates and judgments on a quarterly basis. Actual results could differ from those estimates.
Our
primary product, Cold-EEZE
®
cold remedy lozenges, utilizes a proprietary zinc gluconate formulation which has
been clinically proven to reduce the severity and duration of common cold symptoms. Factors considered in estimating the appropriate
sales returns and allowances for this product include it being (i) a unique product with limited competitors, (ii) competitively
priced, (iii) promoted, (iv) unaffected for remaining shelf-life as there is no product expiration date and (v) monitored for
inventory levels at major customers and third-party consumption data. In addition to Cold-EEZE
®
cold remedy lozenges,
we market and distribute a variety of Cold-EEZE
®
cold remedy QuickMelts
®
, a Cold-EEZE
®
cold remedy Oral Spray, a Cold-EEZE
®
Natural Allergy Relief caplets, a Cold-EEZE
®
Daytime
and Nighttime Multi-Symptom Relief in a liquid form and our new Cold-EEZE
®
Gummies Multi-Symptom Relief for Cold
and Flu. We also manufacture, market and distribute an organic cough drop and a Vitamin C supplement. Each of the Cold-EEZE
®
cold remedy Oral Spray, QuickMelts
®
and Gummies products, Cold-EEZE
®®
Natural Allergy Relief
caplets, Cold-EEZE
®
liquid forms and organic lozenge products carry shelf-life expiration dates for which we aggregate
such new product market experience data and update our sales returns and allowances estimates accordingly. Sales allowances estimates
are tracked at the specific customer and product line levels and are tested on an annual historical basis, and reviewed quarterly.
Additionally, we monitor current developments by customer, market conditions and any other
occurrences that could affect the expected provisions relative to net sales for the period presented.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
2 – Summary of Significant Accounting Policies – continued
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.
Inventory
Valuation
Inventory
is valued at the lower of cost, determined on a first-in, first-out basis (FIFO), or market. Inventory items are analyzed to determine
cost and the market value and appropriate valuation adjustments are established. At June 30, 2016 and December 31, 2015, the financial
statements include adjustments to reduce inventory for excess or obsolete inventory of $531,000 and $501,000, respectively. The
components of inventory are as follows (in thousands):
|
|
June
30, 2016
|
|
|
December
31, 2015
|
|
|
|
|
|
|
|
|
Raw
materials
|
|
$
|
1,528
|
|
|
$
|
1,303
|
|
Work
in process
|
|
|
246
|
|
|
|
530
|
|
Finished
goods
|
|
|
2,575
|
|
|
|
2,498
|
|
|
|
$
|
4,349
|
|
|
$
|
4,331
|
|
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 software - three years; and furniture and fixtures
– five years.
Concentration
of Risks
Future
revenues, costs, margins, and profits will continue to be influenced by our ability to maintain our manufacturing availability
and capacity together with our marketing and distribution capabilities and the regulatory requirements associated with the development
of OTC 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. Our
OTC health care and cold remedy 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 and
trade accounts receivable.
We
maintain cash and cash equivalents with certain major financial institutions. As of June 30, 2016, our cash balance was $1.1 million
and our bank balance was $1.1 million. Of the total bank balance, $396,000 was covered by federal depository insurance and $745,000
was uninsured at June 30, 2016.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
2 – Summary of Significant Accounting Policies – continued
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 broad
range of customers includes many 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 offset our account receivable with an allowance for bad debt of $61,000 and zero, respectively, at June 30, 2016 and December
31, 2015.
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.
Fair
Value of Financial Instruments
Cash
and cash equivalents, accounts receivable, accounts payable, accrued expenses and notes payable are reflected in the Condensed
Consolidated Financial Statements at carrying value which approximates fair value.
Revenue
Recognition
Sales
are recognized at the time ownership is transferred to the customer. Revenue is reduced for trade promotions, estimated sales
returns, cash discounts and other allowances in the same period as the related sales are recorded. 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)
Note
2 – Summary of Significant Accounting Policies – continued
Our
return policy 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 only accept return requests for product 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.
As
of June 30, 2016 and December 31, 2015, we included a provision for (i) sales allowances of $22,000 and $83,000, respectively,
and an allowance for bad debt of $61,000 as of June 30, 2016, which each are reported as a reduction to account receivables. Additionally,
accrued advertising and other allowances as of June 30, 2016 included (i) $1.4 million for estimated future sales returns and
(ii) $393,000 for cooperative incentive promotion costs. As of December 31, 2015, accrued advertising and other allowances included
(i) $1.4 million for estimated future sales returns and (ii) $786,000 for cooperative incentive promotion costs.
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 June 30, 2016 and 2015 were
$694,000 and $442,000, respectively. Advertising and incentive promotion expenses incurred for the six months ended June 30, 2016
and 2015 were $3.8 million and $3.6 million, respectively. Included in prepaid expenses and other current assets was $149,000
and $854,000 at June 30, 2016 and December 31, 2015, respectively, relating to prepaid advertising and promotion expenses.
Shipping
and Handling
Product
sales carry shipping and handling charges to the purchaser, included as part of the invoiced price, which is classified as revenue.
In all cases, costs related to this revenue are recorded in cost of sales.
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.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
2 – Summary of Significant Accounting Policies – continued
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 3). 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 June 30, 2016 and 2015, we charged to operations zero and $34,000, respectively, for share-based compensation expense for
the aggregate fair value of stock grants issued and vested stock options earned. For the six months ended June 30, 2016 and 2015,
we charged to operations $1,000 and $68,000, respectively, for share-based compensation expense for the aggregate fair value of
stock grants issued and vested stock options earned.
Research
and Development
Research
and development costs are charged to operations in the period incurred. Research and development costs for the three months ended
June 30, 2016 and 2015 were $169,000 and $272,000, respectively. Research and development costs for the six months ended June
30, 2016 and 2015 were $255,000 and $480,000, respectively. Research and development costs are principally related to new product
development initiatives and costs associated with our OTC health care and cold remedy products.
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 we have 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 (see Note
4).
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 continuing tax losses, we have recorded a full valuation allowance against a net deferred tax asset. Additionally,
we have not recorded a liability for unrecognized tax benefits.
Recently
Issued Accounting Standards
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts
with Customers”, on revenue recognition. The new standard provides for a single five-step model to be applied to all revenue
contracts with customers as well as requires additional financial statement disclosures that will enable users to understand the
nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Companies have an option to use
either a retrospective approach or cumulative effect adjustment approach to implement the standard. As amended by ASU No. 2015-14
issued in August 2015, this ASU is effective for fiscal years and interim periods within those years beginning after December
15, 2017, with early adoption permitted. We are currently assessing the impact of this update, and believe that its adoption will
not have a material impact on our consolidated financial statements.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
2 – Summary of Significant Accounting Policies – continued
In
August 2014, the FASB issued ASU No. 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as
a Going Concern”.
The amendments in this update state that in connection with preparing financial statements for
each annual and interim reporting period, an entity’s management should evaluate whether there are conditions or events
that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that
the financial statements are issued (or within one year after the date that the financial statements are available to be issued,
when applicable). The amendments in this update are effective for the annual reporting period beginning after December 15, 2016
and for annual periods and interim periods thereafter. Early application is permitted. The adoption of ASU 2014-15 is not expected
to have a material impact on our consolidated financial statements.
In
July 2015, the FASB issued ASU No. 2015-11 “Simplifying the Measurement of Inventory” which requires an entity to
measure inventory balances at the lower of cost and net realizable value. Net realizable value is the estimated selling prices
in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent
measurement is unchanged for inventory measured using LIFO or the retail inventory method. The amendments in this update are effective
for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. We are currently
assessing the impact of this update, and believe that its adoption on January 1, 2017 will not have a material impact on our consolidated
financial statements.
In
February 2016, the FASB issued ASU No. 2016-02 “Leases”. The new standard will require most leases to be recognized
on the balance sheet which will increase reported assets and liabilities. Lessor accounting remains substantially similar to current
guidance. The new standard is effective for annual and interim periods in fiscal years beginning after December 15, 2018, which
for us is the first quarter of fiscal 2019 and mandates a modified retrospective transition method. We are currently assessing
the impact of this update, and believe that its adoption will not have a material impact on our consolidated financial statements.
In
April 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. The new standard simplifies
several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures,
and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU No. 2016-09 is effective
for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted
for financial statements that have not already been issued. We are currently assessing the impact that this ASU will have on our
consolidated financial position, results of operations and cash flows.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
3 – Secured Promissory Notes and Other Obligations
Secured
Promissory Notes
On
December 11, 2015, we executed two Subscription Agreements (the “Subscription Agreements”) with the investors named
therein (the “Investors”) providing for the purchase of 12% Secured Promissory Notes – Series A (“Notes”)
in the aggregate principal amount of up to $3.0 million and warrants to purchase shares of our Common Stock (the “Warrants”).
Notes
in the amount of $1.5 million and 51,000 Warrants, at an exercise price of $1.35 per share, which was equal to the closing price
of our Common Stock on the date of investment, were issued by the Company and its wholly-owned subsidiaries Pharmaloz Manufacturing,
Inc. and Quigley Pharma, Inc. (collectively, the “Obligors”) and funded on December 11, 2015. We incurred loan origination
costs of $22,000 which was recorded as a reduction of the Notes and the origination costs are charged to interest expense over
the term of the loan. The Warrants have an exercise term equal to three years and are exercisable commencing on the date of issuance.
The fair value of the Warrants at the date of grant was $14,000 which is recorded as a reduction of the Notes and is charged to
interest expense over the term of the loan. At June 30, 2016, the $1.5 million Notes are reported net of $22,000 of the unamortized
interest for the loan origination costs and unamortized interest for the Warrants. At June 30, 2016, other current liabilities
include $7,000 for accrued interest under the terms of the Notes.
The
Notes are secured by substantially all of our tangible and intangible assets. The Notes bear interest at the rate of 12% per annum,
payable semi-annually and the principal is due and payable on June 15, 2017. The Notes may be pre-paid at any time prior to maturity
without penalty. The effective interest, inclusive of the Warrant and loan origination costs, is 14.3% per annum. For the six
months ended June 30, 2016, we charged to interest expense $105,000 in connection with the Notes.
In
connection with the issuance of the Notes, we entered into a security agreement with John E. Ligums, Jr. (an Investor and a shareholder
in the Company), as collateral agent for the Investors (the “Security Agreement”) to secure the timely payment and
performance in full of the Obligors’ obligations pursuant to the Notes. Under the Security Agreement, the Obligors grant
to the Collateral Agent, for the benefit of the Investors a lien upon and security interest in the property and assets listed
as collateral in the Security Agreement, including without limitation, all of the Obligors’ personal property, inventory,
equipment, general intangibles, cash and cash equivalents, and proceeds.
Godfrey
Settlement Agreement
In
November 2004, we commenced an action against John C. Godfrey, Nancy Jane Godfrey, and Godfrey Science and Design, Inc. (together
the “Godfreys”) for injunctive relief regarding the ownership of the Cold-EEZE
®
trademark. The Godfreys
subsequently asserted against us counterclaims and sought monetary damages and injunctive and declaratory relief relative to the
Cold-EEZE
®
trademark and other intellectual property.
On
December 20, 2012, we and the Godfreys, including the Estate of Nancy Jane Godfrey, entered into a Settlement Agreement and Mutual
General Release (the “Godfrey Settlement Agreement”), pursuant to which we resolved all disputes, including claims
asserted by us and counterclaims asserted against us in the action. At each of June 30, 2016 and December 31, 2015, other current
liabilities include $100,000, inclusive of accrued interest at the annual rate of 3.25%, for final installment payment due in
December 2016 pursuant to the terms of the Godfrey Settlement Agreement.
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 and 1 million shares of preferred stock, $.0005 par value
(“Preferred Stock”).
Preferred
Stock
On
June 16, 2015, our shareholders approved the change our state of incorporation from the State of Nevada to the State of Delaware
pursuant to a plan of conversion (“Conversion Plan”) and the filing of a certificate of incorporation in the State
of Delaware. The Preferred Stock authorized under our certificate of incorporation may be issued from time to time in one or more
series. As of June 30, 2016, 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 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.
Stockholder
Rights Plan
On
September 8, 1998, our Board of Directors declared a dividend distribution of Common Stock Purchase Rights (each individually,
a “Right” and collectively, the “Rights”) payable to the stockholders of record on September 25, 1998,
thereby creating a Stockholder Rights Plan (the “Rights Agreement”). The Plan was subsequently amended effective each
of (i) May 23, 2008, (ii) August 18, 2009 and (iii) June 18, 2014. The Rights Agreement, as amended and restated, provides that
each Right entitles the stockholder of record to purchase from the Company that number of shares of Common Stock having a combined
market value equal to two times the Rights exercise price of $45. The Rights are not exercisable until the distribution date,
which will be the earlier of a public announcement that a person or group of affiliated or associated persons has acquired 15%
or more of the outstanding shares of Common Stock, or the announcement of an intention by a similarly constituted party to make
a tender or exchange offer resulting in the ownership of 15% or more of the outstanding shares of Common Stock (such person, the
“acquirer”). The Rights Agreement allows for an exemption for Ted Karkus, the Company’s Chairman and Chief Executive
Officer, to acquire up to 20% of our Common Stock without our Board of Directors declaring a dividend distribution.
The
dividend has the effect of diluting the acquirer by giving our other stockholders a 50% discount on our Common Stock’s current
market value for exercising the Rights. In the event of a cashless exercise of the Right and the acquirer has acquired less than
50% beneficial ownership of the Company, a stockholder may exchange one Right for one share of Common Stock of the Company. The
Rights Agreement, as amended, includes a provision pursuant to which our Board of Directors may exempt from the provisions of
the Rights Agreement an offer for all outstanding shares of our Common Stock that the directors determine to be fair and not inadequate
and to otherwise be in the best interests of the Company and its stockholders, after receiving advice from one or more investment
banking firms. The expiration date of the Rights Agreement, as amended, is June 18, 2024.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
4 – Transactions Affecting Stockholders’ Equity – continued
Equity
Line of Credit
On
July 30, 2015, we entered into a new equity line of credit agreement (such arrangement, the “2015 Equity Line”) with
Dutchess Opportunity Fund II, LP (“Dutchess”). Pursuant to the 2015 Equity Line, Dutchess committed to purchase, subject
to certain restrictions and conditions, up to 3,200,000 shares of our Common Stock, over a period of 36 months from the effectiveness
of the registration statement registering the resale of shares purchased by Dutchess pursuant to the Investment Agreement.
We
may, at our discretion, draw on the 2015 Equity Line from time to time, as and when we determine appropriate in accordance with
the terms and conditions of the 2015 Equity Line. The maximum number of shares that we are entitled to put to Dutchess in any
one draw down notice shall not exceed 500,000 shares with a purchase price calculated in accordance with the 2015 Equity Line.
We may deliver a notice for a subsequent put from time to time, following the one day pricing period for the prior put.
The
purchase price shall be set at ninety-five percent (95%) of the volume weighted average price (VWAP) of the Common Stock during
the one trading day immediately following our put notice. We have the right to withdraw all or any portion of any put, except
that portion of the put that has already been sold to a third party, including any portion of a put that is below the minimum
acceptable price set forth on the put notice, before the closing. In the event Dutchess receives more than a five percent (5%)
return on the net sales for a specific put, Dutchess must remit such excess proceeds to us; however, in the event Dutchess receives
less than a five percent (5%) return on the net sales for a specific put, Dutchess will have the right to deduct from the proceeds
of the put amount on the applicable closing date so Dutchess’s return will equal five percent (5%).
There
are put restrictions applied on days between the draw down notice date and the closing date with respect to that particular put.
During such time, we are entitled to deliver another draw down notice. In addition, Dutchess will not be obligated to purchase
shares if Dutchess’ total number of shares beneficially held at that time would exceed 4.99% of the number of shares of
Common Stock as determined in accordance with Rule 13d-1(j) of the Securities Exchange Act of 1934, as amended. In addition, we
are not permitted to draw on the facility unless there is an effective registration statement to cover the resale of the shares.
Pursuant
to the terms of the 2015 Equity Line, we are obligated to file one or more registrations statements with the SEC to register the
resale by Dutchess of the shares of Common Stock issued or issuable under the 2015 Equity Line. In addition, we are obligated
to use all commercially reasonable efforts to have the registration statement declared effective by the SEC within 90 days after
the registration statement is filed. On August 4, 2015, we filed a registration statement for the underlying shares of the 2015
Equity Line with the SEC and the registration statement was declared effective by the SEC on August 21, 2015.
The
sales of the shares under the 2015 Equity Line were deemed to be exempt from registration under the Securities Act of 1933, as
amended in reliance upon Section 4(2) (or Regulation D promulgated thereunder). At June 30, 2016, we have 2,450,000 shares of
our Common Stock available for sale, at our discretion, under the terms of the 2015 Equity Line and covered pursuant to a registration
statement.
During
the three months ended June 30, 2015, we sold an aggregate of 438,480 shares of our Common Stock to Dutchess under and pursuant
to a previous equity line of credit agreement (such arrangement, the “2014 Equity Line”) with Dutchess and we derived
net proceeds of $524,000. The sales of the shares under the 2014 Equity Line were deemed to be exempt from registration under
the Securities Act of 1933, as amended in reliance upon Section 4(a)(2) (or Regulation D promulgated thereunder). The 2014 Equity
Line was terminated by the Company in July 2015 (see 2015 Equity Line above).
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
4 – Transactions Affecting Stockholders’ Equity – continued
The
2010 Equity Compensation Plan
On
May 5, 2010, our stockholders approved the 2010 Equity Compensation Plan which was subsequently amended, restated and approved
by stockholders on April 24, 2011, and further amended and approved by stockholders on May 6, 2013, and further amended and approved
by stockholders on May 24, 2016 (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 equal to 3.2 million shares, including 900,000 shares that are authorized for
issuance but unissued under a 1997 incentive stock option plan and 700,000 shares added to the 2010 Plan effective May 24, 2016.
No options were granted under the 2010 Plan for the six months ended June 30, 2016 or 2015. There were no stock options exercised
for the six months ended June 30, 2016 or 2015. At June 30, 2016, there were 1,706,500 options outstanding under the 2010 Plan
and 726,159 options available to be issued pursuant to the terms of the 2010 Plan.
The
2010 Directors’ Equity Compensation Plan
On
May 5, 2010, our stockholders approved the 2010 Directors’ Equity Compensation Plan which was subsequently amended and approved
by stockholders on May 6, 2013. A primary purpose of the 2010 Directors’ Equity Compensation 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’ Equity
Compensation Plan provides that the total number of shares of Common Stock that may be issued under the 2010 Directors’
Equity Compensation Plan is equal to 425,000. For the six months ended June 30, 2016 or 2015, no shares were granted to directors.
At June 30, 2016, there were 147,808 shares of Common Stock that may be issued pursuant to the terms of the 2010 Directors’
Equity Compensation Plan.
Note
5 – Income Taxes
As
of December 31, 2015, we have net operating loss carry-forwards of approximately $44.5 million for federal purposes that will
expire beginning in Fiscal 2020 through 2034. Additionally, there are net operating loss carry-forwards of $21.9 million for state
purposes that will expire beginning in Fiscal 2020 through 2034. 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. As a consequence of the accumulated losses of the
Company, we believe that this allowance is required due to the uncertainty of realizing these tax benefits in the future.
Note
6 – Joint Venture
On
March 22, 2010, we, Phosphagenics Limited (“PSI Parent”), an Australian corporation, Phosphagenics Inc. (“PSI”),
a Delaware corporation and subsidiary of PSI Parent, and Phusion Laboratories, LLC (“Phusion”), a Delaware limited
liability company, entered into a Limited Liability Company Agreement (the “LLC Agreement”) of Phusion and additional
related agreements for the purpose of developing and commercializing, for worldwide distribution and sale, a wide range of non-prescription
remedies using PSI Parent’s proprietary patented TPM™ technology (“TPM”). TPM facilitates the delivery
and depth of penetration of active molecules in pharmaceutical, nutraceutical, and other products. Pursuant to the LLC Agreement,
we and PSI each own a 50% membership interest in the Phusion joint venture. Phusion qualifies as a variable interest entity and
we have consolidated Phusion in our financial statements.
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
6 – Joint Venture – continued
In
connection with the LLC Agreement, PSI Parent granted to us, pursuant to the terms of a License Agreement, dated March 22, 2010
(the “Original License Agreement”), (i) an exclusive, royalty-free, world-wide (subject to certain limitations), paid-up
license to exploit OTC drugs and certain other products that embody certain of PSI Parent’s TPM-related patents and related
know-how (collectively, the “PSI Technology”) and (ii) a non-exclusive, royalty-free, world-wide (subject to certain
limitations), paid-up license to exploit certain compounds that embody the PSI Technology for use in a product combining one or
more of such compounds with an OTC drug or in a product that is part of a regimen that includes the application of an OTC drug.
On
October 17, 2014, we initiated a demand for arbitration with the American Arbitration Association, case number 01-14-0001-7373.
The Phosphagenics Entities (defined below) have made counter claims of breaches against the Company and Phusion (see Note 7).
At June 30, 2016, cash and cash equivalents includes $366,000 which is available to be used by Phusion to fund future product
development initiatives.
Note
7– Commitments and Contingencies
PROPHASE
LABS, INC. PROPHASE LABS, INC. FOR THE BENEFIT OF PHUSION LABORATORIES, LLC vs. Phosphagenics, Inc., Phosphagenics, LTD and Phusion
Laboratories, LLC as a nominal defendant
On
October 17, 2014, we initiated a demand for arbitration with the American Arbitration Association, case number 01-14-0001-7373.
This demand for arbitration pertains to our Phusion joint venture and the matter is against Phosphagenics, Inc. and Phosphagenics
LTD (collectively known as the “Phosphagenics Entities”). We have raised certain claims based upon the Phosphagenics
Entities’ alleged breach of a certain amended and restated license agreement for the exploitation of certain intellectual
property and, separately, breach of the Phusion joint venture operating agreement as between the Company and the Phosphagenics
Entities. The Phosphagenics Entities have made counter claims of breaches against the Company and Phusion. The arbitration hearing
was held during December 2015 and January 2016 and the evidentiary hearing is now concluded. Each of the parties submitted to
the arbitrator their post-hearing briefs on or before March 15, 2016. At this time while no prediction as to the outcome of this
action can be made, we anticipate an arbitral ruling will likely be rendered in or about September 2016 and we do not expect a
material adverse outcome.
We
have estimated future minimum obligations over the next five years, including the remainder of Fiscal 2016, as follows (in thousands):
Fiscal
Year
|
|
|
Employment
Contracts
|
|
|
Godfrey
Settlement
Agreement
|
|
|
Note
|
|
|
Total
|
|
2016
|
|
|
|
512
|
|
|
|
100
|
|
|
|
-
|
|
|
|
612
|
|
2017
|
|
|
|
1,025
|
|
|
|
-
|
|
|
|
1,500
|
|
|
|
2,525
|
|
2018
|
|
|
|
512
|
|
|
|
-
|
|
|
|
-
|
|
|
|
512
|
|
2019
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
2020
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
|
$
|
2,049
|
|
|
$
|
100
|
|
|
$
|
1,500
|
|
|
$
|
3,649
|
|
ProPhase
Labs, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
8 – Earnings (Loss) Per Share
Basic
earnings (loss) per share is computed by dividing net income or loss attributable to common stockholders by the weighted-average
number of shares of our Common Stock outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution
that could occur if securities or other contracts to issue Common Stock were exercised or converted into Common Stock or resulted
in the issuance of Common Stock that shared in the earnings of the entity. Diluted earnings (loss) per share also utilize the
treasury stock method which prescribes a theoretical buy-back of shares from the theoretical proceeds of all options and warrants
outstanding during the period. Options and warrants outstanding to acquire shares of our Common Stock at June 30, 2016 and 2015
were 1,706,500 and 1,739,500, respectively.
For
the three and six months ended June 30, 2016 and 2015, dilutive earnings (loss) per share is the same as basic earnings per share
due to (i) the inclusion of Common Stock, in the form of stock options and warrants (“Common Stock Equivalents”),
would have an anti-dilutive effect on the loss per share or (ii) there were no Common Stock Equivalents for the respective period.
For the three months ended June 30, 2016 and 2015, there were 276,165 and 274,594 Common Stock Equivalents, respectively, which
were in the money, that were excluded from the earnings (loss) per share computation as a consequence of their anti-dilutive effect.
For the six months ended June 30, 2016 and 2015, there were 244,112 and 314,342 Common Stock Equivalents, respectively, which
were in the money, that were excluded from the earnings (loss) per share computation as a consequence of their anti-dilutive effect.
A
reconciliation of the applicable numerators and denominators of the income statement periods presented, as reflected in the results
of continuing operations, is as follows (in thousands, except per share amounts):
|
|
Three
Months Ended
|
|
|
Three
Months Ended
|
|
|
Six
Months Ended
|
|
|
Six
Months Ended
|
|
|
|
June
30, 2016
|
|
|
June
30, 2015
|
|
|
June
30, 2016
|
|
|
June
30, 2015
|
|
|
|
Loss
|
|
|
Shares
|
|
|
EPS
|
|
|
Loss
|
|
|
Shares
|
|
|
EPS
|
|
|
Loss
|
|
|
Shares
|
|
|
EPS
|
|
|
Loss
|
|
|
Shares
|
|
|
EPS
|
|
Basic
loss per share
|
|
$
|
(1,127
|
)
|
|
|
17,081
|
|
|
$
|
(0.06
|
)
|
|
$
|
(1,566
|
)
|
|
|
16,020
|
|
|
$
|
(0.10
|
)
|
|
$
|
(2,463
|
)
|
|
|
17,081
|
|
|
$
|
(0.14
|
)
|
|
$
|
(2,946
|
)
|
|
|
15,956
|
|
|
$
|
(0.18
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dilutives:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
loss per share
|
|
$
|
(1,127
|
)
|
|
|
17,081
|
|
|
$
|
(0.06
|
)
|
|
$
|
(1,566
|
)
|
|
|
16,020
|
|
|
$
|
(0.10
|
)
|
|
$
|
(2,463
|
)
|
|
|
17,081
|
|
|
$
|
(0.14
|
)
|
|
$
|
(2,946
|
)
|
|
|
15,956
|
|
|
$
|
(0.18
|
)
|
ProPhase
Labs, Inc. and Subsidiaries