NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1 – ORGANIZATION AND BUSINESS
ProPhase
Labs, Inc. (“we”, “us” or the “Company”) was initially organized as a corporation in Nevada
in July 1989. Effective June 18, 2015, we changed our state of incorporation from the State of Nevada to the State of Delaware.
We are a vertically integrated and diversified branding, marketing and technology company engaged in the research, development,
manufacture, distribution, marketing and sale of over-the-counter (“OTC”) consumer healthcare products, dietary supplements
and other remedies in the United States. This includes the development and marketing of dietary supplements under the TK Supplements
®
brand.
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.
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 in this Annual Report to “Fiscal 2017” shall
mean the fiscal year ended December 31, 2017 and references to other “Fiscal” years shall mean the year, which ended
on December 31 of the year indicated. The term “we”, “us” or the “Company” as used herein
also refer, where appropriate, to the Company, together with its subsidiaries unless the context otherwise requires.
Discontinued
Operations
Prior
to March 29, 2017, our flagship OTC drug brand was Cold-EEZE
®
and our principal product was Cold-EEZE
®
cold remedy zinc gluconate lozenges. In addition to Cold-EEZE
®
cold remedy lozenges, we also marketed and
distributed non-lozenge forms of our proprietary zinc gluconate formulation, (i) Cold-EEZE
®
cold remedy QuickMelts
®
,
(ii) Cold-EEZE
®
Gummies and (iii) Cold-EEZE
®
cold remedy Oral Spray.
Effective
March 29, 2017, we sold our intellectual property rights and other assets related to our Cold-EEZE
®
brand and
product line, including all then current and pipeline over-the-counter allergy, cold, flu, multi-symptom relief and immune support
treatments for adults and children to the extent each was, or was intended to be, branded “Cold-EEZE
®
”,
including all formulations and derivatives thereof (collectively referred to as the “Cold-EEZE
®
Business”)
to Mylan. As a consequence of the sale of the Cold-EEZE
®
Business, for Fiscal 2017, 2016 and 2015, we have classified
as discontinued operations (i) all income and expenses attributable to the Cold-EEZE
®
Business, (ii) the gain
from the sale of the Cold-EEZE
®
Business, and (iii) the income tax expense attributed to the sale of the Cold-EEZE
®
Business. Excluded from the sale of the Cold-EEZE
®
Business were our accounts receivable and inventory.
We have also retained all liabilities associated with our Cold-EEZE
®
Business operations arising prior to March
29, 2017.
Continuing
Operations
We
continue to own and operate our manufacturing facility and manufacturing business in Lebanon, Pennsylvania, and our headquarters
in Doylestown, Pennsylvania. As part of the sale of the Cold-EEZE
®
Business, we entered into a manufacturing agreement
with Mylan and our wholly-owned subsidiary, Pharmaloz Manufacturing, Inc. (“PMI”), to supply various Cold-EEZE
®
lozenge products to Mylan. In addition to the production services we provide to Mylan under the manufacturing agreement,
we produce OTC drug and dietary supplement lozenges and other products for other third-party customers in addition to performing
operational tasks such as warehousing, customer order processing and shipping.
We
are also pursuing a series of new product development, pre-commercialization and market testing initiatives in the OTC dietary
supplement category. Initial OTC dietary supplement product development activities were completed in the fourth quarter of Fiscal
2015 under the brand name of TK Supplements
®
. The TK Supplements
®
product line comprises of three
men’s health products: (i) Legendz XL
®
for sexual health, (ii) Triple Edge XL
®
, an energy
booster plus testosterone support, and (iii) Super ProstaFlow+
TM
for prostate and urinary health. In addition to developing
direct-to-consumer (“Direct Response”) marketing strategies for Legendz XL
®
, we received initial product
acceptance and shipped into a national chain drug retailer and to several regional retailers during the Fiscal 2017.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
2 – RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
The Company determined
that when calculating its income tax provision related to the gain on sale of discontinued operations, it incorrectly utilized
available net operating losses without considering the statutory limitations imposed by the state of Pennsylvania, and that it
incorrectly allocated the amount of income tax benefit resulting from the reversal of certain valuation allowances to continuing
operations, which resulted in an overstatement of income the tax benefit from continuing operations and an understatement of the
gain on sale of discontinued operations, which is presented net of taxes. In the process of this determination, the Company determined
that such information existed at December 31, 2017 which affected the income tax benefit/ provision from continuing and discontinued
operations reported in the year ended December 31, 2017. The Company concluded that the impact of applying corrections for these
errors and misstatements on the consolidated financial statements as of and for the year ended December 31, 2017 is material.
As a result, the Company is restating its consolidated financial statements as of and for the year ended December 31, 2017. See
below for a reconciliation of the previously reported amounts to the restated amounts.
The
table below sets forth the consolidated balance sheet, including the balances as originally reported, adjustments and the as restated
balances (in thousands):
|
|
As
of December 31, 2017
|
|
|
|
As
originally reported
|
|
|
Adjustments
|
|
|
As
restated
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax receivable
|
|
$
|
502
|
|
|
$
|
(502
|
)
|
|
$
|
-
|
|
Total
current assets
|
|
|
28,919
|
|
|
|
(502
|
)
|
|
|
28,417
|
|
Total
assets
|
|
$
|
34,161
|
|
|
$
|
(502
|
)
|
|
$
|
33,659
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
current liabilities
|
|
$
|
310
|
|
|
$
|
740
|
|
|
$
|
1,050
|
|
Total
current liabilities
|
|
|
1,072
|
|
|
|
740
|
|
|
|
1,812
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained
earnings
|
|
|
22,144
|
|
|
|
(1,242
|
)
|
|
|
20,902
|
|
Total
stockholders’ equity
|
|
|
33,089
|
|
|
|
(1,242
|
)
|
|
|
31,847
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
34,161
|
|
|
$
|
(502
|
)
|
|
$
|
33,659
|
|
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
2 – RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS - (continued)
The
table below sets for the consolidated statements of operations, including the balances as originally reported, adjustments, and
the as restated amounts (in thousands):
|
|
For
the year ended December 31, 2017
|
|
|
|
As
originally reported
|
|
|
Adjustments
|
|
|
As
restated
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax benefit from continuing operations
|
|
$
|
17,990
|
|
|
$
|
(16,569
|
)
|
|
$
|
1,421
|
|
Income
(loss) from continuing operations
|
|
|
14,327
|
|
|
|
(16,569
|
)
|
|
|
(2,242
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain
on sale of discontinued operations, net of taxes
|
|
|
26,974
|
|
|
|
15,327
|
|
|
|
42,301
|
|
Income
from discontinued operations
|
|
|
27,504
|
|
|
|
15,327
|
|
|
|
42,831
|
|
Net
income
|
|
|
41,831
|
|
|
|
(1,242
|
)
|
|
|
40,589
|
|
Total
comprehensive income
|
|
|
41,753
|
|
|
|
(1,242
|
)
|
|
|
40,511
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations
|
|
$
|
0.92
|
|
|
$
|
(1.06
|
)
|
|
$
|
(0.14
|
)
|
Income
from discontinued operations
|
|
|
1.77
|
|
|
|
0.99
|
|
|
|
2.75
|
|
Net
income
|
|
$
|
2.69
|
|
|
$
|
(0.08
|
)
|
|
$
|
2.61
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations
|
|
$
|
0.92
|
|
|
$
|
(1.07
|
)
|
|
$
|
(0.14
|
)
|
Income
from discontinued operations
|
|
|
1.75
|
|
|
|
0.98
|
|
|
|
2.73
|
|
Net
income
|
|
$
|
2.67
|
|
|
$
|
(0.09
|
)
|
|
$
|
2.59
|
|
The
table below sets forth the consolidated statements of cash flows from operating activities, including the balances as originally
reported, adjustments and the as restated balances (in thousands):
|
|
For
the year ended December 31, 2017
|
|
|
|
As
originally reported
|
|
|
Adjustments
|
|
|
As
restated
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
41,831
|
|
|
$
|
(1,242
|
)
|
|
$
|
40,589
|
|
Gain
on sale of assets, net of taxes
|
|
|
(26,974
|
)
|
|
|
(15,327
|
)
|
|
|
(42,301
|
)
|
Income
tax benefit
|
|
|
(17,990
|
)
|
|
|
16,569
|
|
|
|
(1,421
|
)
|
Income
tax receivable
|
|
|
(502
|
)
|
|
|
502
|
|
|
|
-
|
|
Income
taxes payable
|
|
|
(848
|
)
|
|
|
(502
|
)
|
|
|
(1,350
|
)
|
Net
cash used in operating activities
|
|
$
|
(2,838
|
)
|
|
$
|
-
|
|
|
$
|
(2,838
|
)
|
The
restatement had no impact on cash flows from investing activities or financing activities or net increase in cash.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
For
Fiscal 2017, 2016 and 2015, our revenues from continuing operations have come principally from our OTC healthcare products.
Basis
of Presentation
The
consolidated financial statements (“Financial Statements”) include the accounts of the Company and its wholly -owned
subsidiaries. All intercompany transactions and balances have been eliminated.
Discontinued
Operations Carve Out and ProPhase Allocations
For
Fiscal 2017, 2016 and 2015, results from operations for our Cold-EEZE
®
Business are classified as discontinued
operations. The carve out of the discontinued operations (i) were prepared in accordance with the SEC’s carve out rules
under Staff Accounting Bulletin (“SAB”) Topic 1B1 and (ii) are derived from identifying and carving out the specific
assets, liabilities, net sales, cost of sales, operating expenses and interest expense associated with the Cold-EEZE
®
Business’s operations. Administrative and overhead expenses, including personnel expenses and bonuses, and research
and development overhead expenses incurred by us (for which the discontinued operation benefits from such resources) are allocated
to discontinued operations based upon the percentage of the Cold-EEZE
®
Business’s net sales to our consolidated
net sales. For Fiscal 2017, 2016 and 2015, we allocated (i) $348,000, $2.3 million and $4.7 million, respectively, of administrative
expenses, $1.7 million, $5.4 million and $7.4 million, respectively of sales and marketing expenses and (iii) $52,000, $218,000
and $738,000, respectively, of research and development expenses, to discontinued operations in the accompanying statements of
operations.
Product
Innovation, Seasonality of the Business and Liquidity
Our
net sales are derived principally from our contract manufacturing of OTC heathcare and dietary supplement products sold in the
United States. In addition, we are engaged in early stage commercialization and market testing activities for the TK Supplements
®
product line of dietary supplements.
Our
sales are influenced by and subject to (i) the scope and timing of TK Supplement
®
product market testing and the
ultimate market launch, and (ii) fluctuations in the timing of purchase and the ultimate level of demand for the OTC healthcare
and cold remedy products that we manufacture for others, which are a function of the timing, length and severity of each cold
season. Generally, a cold season is defined as the period 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 first, third and fourth quarter higher
levels of net sales from our contract manufacturing of OTC healthcare and cold remedy products. Revenues are generally at their
lowest levels in the second quarter when customer demand generally declines.
As
a consequence of the scope and timing of our TK Supplements
®
product market testing and the ultimate market launch
and the seasonality of our business, we realize variations in operating results and demand for working capital from quarter to
quarter. As of December 31, 2017, we had working capital of approximately $26.7 million, including $18.8 million marketable securities
available for sale. We believe our current working capital at December 31, 2017 is at an acceptable and adequate level to support
our business for at least the next twelve months ending March 31, 2019.
Use
of Estimates
The
preparation of financial statements and the accompanying notes thereto, in conformity with generally accepted accounting principles
in the United States of America (“GAAP”), requires management to make estimates and assumptions that affect reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements
and reported amounts of revenues and expenses during the respective reporting periods. Examples include the provision for bad
debt, sales returns and allowances, inventory obsolescence, useful lives of property and equipment, impairment of property and
equipment, income tax valuations and assumptions related to accrued advertising. When providing for the appropriate sales returns,
allowances, cash discounts and cooperative incentive promotion costs (“Sales Allowances”), we apply a uniform and
consistent method for making certain assumptions for estimating these provisions. These estimates and assumptions are based on
historical experience, current trends and other factors that management believes to be relevant at the time the financial statements
are prepared. Management reviews the accounting policies, assumptions, estimates and judgments on a quarterly basis. Actual results
could differ from those estimates.
Cash
Equivalents
We
consider all highly liquid investments with an initial maturity of three months or less at the time of purchase to be cash equivalents.
Cash equivalents include cash on hand and monies invested in money market funds. The carrying amount approximates the fair market
value due to the short-term maturity of these investments.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
Marketable
Securities
We
have classified our investments in marketable securities as available-for-sale and as a current asset. Our investments in marketable
securities are carried at fair value, with unrealized gains and losses included as a separate component of stockholders’
equity. Realized gains and losses from our marketable securities recorded as other income (expense). During Fiscal 2017, we initiated
short-term investments in marketable securities. At December 31, 2017, $16.0 million of our investments in marketable securities
carried maturity dates under one year from date of purchase with interest rates of 0.87% - 3.12% and $2.8 million carry maturity
dates between one and two years with interest rates of 1.97% - 2.31%. For Fiscal 2017, we reported an unrealized loss of $78,000.
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 securities and the underlying fair value input level tier
hierarchy (see long-lived assets below) (in thousands):
|
|
As
of December 31, 2017
|
|
|
|
Input
|
|
|
Amortizied
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Market
|
|
|
|
Level
|
|
|
cost
|
|
|
gain
|
|
|
loss
|
|
|
Value
|
|
U.S.
government obligations
|
|
|
Level
2
|
|
|
$
|
1,744
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,744
|
|
Corporate
obligations
|
|
|
Level
2
|
|
|
|
16,943
|
|
|
|
-
|
|
|
|
(78
|
)
|
|
|
17,021
|
|
|
|
|
|
|
|
$
|
18,687
|
|
|
$
|
-
|
|
|
$
|
(78
|
)
|
|
$
|
18,765
|
|
Inventory
Inventory
is valued at the lower of cost, determined on a first-in, first-out basis (FIFO), or net realizable value. Inventory items are
analyzed to determine cost and the net realizable value and appropriate valuation adjustments are established. At December 31,
2017, the financial statements include adjustments to reduce inventory for excess, obsolete or short-dated shelf-life inventory
of $1.1 million, inclusive of adjustments of (i) $541,000 for product samples of TK Supplements
®
products. At December
31, 2016, the financial statements include adjustments to reduce inventory for excess, obsolete or short-dated shelf-life inventory
of $1.6 million, inclusive of adjustments of (i) $383,000 for product samples of TK Supplements
®
products and (ii)
$606,000 for Cold-EEZE
®
Division products. The components of inventory are as follows (in thousands):
|
|
December
31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Raw
materials
|
|
$
|
1,269
|
|
|
$
|
1,404
|
|
Work
in process
|
|
|
245
|
|
|
|
466
|
|
Finished
goods
|
|
|
17
|
|
|
|
866
|
|
|
|
$
|
1,531
|
|
|
$
|
2,736
|
|
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.
The depreciation expense is computed in accordance with the estimated asset lives (see Note 5).
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 requirements associated with the development of
OTC and other personal care products in order to continue to compete on a national and/or international level.
Our
business is subject to federal and state laws and regulations adopted for the health and safety of users of our products. The
manufacturing and distribution of OTC healthcare and dietary supplement products are subject to regulations by various federal,
state and local agencies, including the Food and Drug Administration (“FDA”) and, as applicable, the Homeopathic Pharmacopoeia
of the United States.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
Financial
instruments that potentially subject us to significant concentrations of credit risk consist principally of cash investments,
marketable securities and trade accounts receivable. Our marketable securities are fixed income investments which are highly liquid
and can be readily purchased or sold through established markets.
We
maintain cash and cash equivalents with certain major financial institutions. As of December 31, 2017, our cash and cash equivalents
were $3.2 million and our bank balance was $3.3 million. Of the total bank balance, $500,000 was covered by federal depository
insurance and $2.8 million was uninsured.
Trade
accounts receivable potentially subject us to credit concentrations from time-to-time as a consequence of the timing, payment
pattern and ultimate purchase volumes or shipping schedules with our customers. We extend credit to our customers based upon an
evaluation of the customer’s financial condition and credit history and generally we do not require collateral. Our customers
include consumer products companies and large national chain, regional, specialty and local retail stores. These credit concentrations
may impact our overall exposure to credit risk, either positively or negatively, in that our customers may be similarly affected
by changes in economic, regulatory or other conditions that may impact the timing and collectability of amounts due to us. As
a consequence of an evaluation of our customer’s financial condition, payment patterns, balance due to us and other factors,
we did not offset our account receivable with an allowance for bad debt at December 31, 2017 and 2016, respectively.
During
Fiscal 2017, 2016 and 2015, effectively all of our net revenues were related to domestic markets and were principally generated
from the sale of our contract manufacturing of OTC healthcare and dietary supplement products.
Raw
materials used in the production of the products are available from numerous sources. Certain raw material active ingredients
are purchased from a single unaffiliated supplier. Should the relationship terminate or the vendor become unable to supply material,
we believe that the current contingency plans would prevent a termination from materially affecting our operations. However, if
the relationship was terminated, there may be delays in production of our products until an acceptable replacement supplier is
located.
Long-lived
Assets
We
review the carrying value and useful lives 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 or the period over which they should be depreciated has
changed. 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, marketable securities, accounts receivable, assets held for sale, accounts payable, accrued expenses and
notes payable are reflected in the Consolidated Financial Statements at carrying value which approximates fair value. We account
for our marketable securities at fair value pursuant to Accounting Standards Codification, or ASC, 820-10, with the net unrealized
gains or losses reported as a component of accumulated other comprehensive income or loss.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
|
|
As
of December 31, 2017
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Marketable
securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government obligations
|
|
$
|
-
|
|
|
$
|
1,744
|
|
|
$
|
-
|
|
|
$
|
1,744
|
|
Corporate
obligations
|
|
|
-
|
|
|
|
17,021
|
|
|
|
-
|
|
|
|
17,021
|
|
|
|
$
|
-
|
|
|
$
|
18,765
|
|
|
$
|
-
|
|
|
$
|
18,765
|
|
Revenue
Recognition
We
generate sales principally through two types of customers, contract manufacturing customers 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 $9.7 million and $201,000 for Fiscal 2017, $4.1 million and $67,000
for Fiscal 2016 and $2.4 million and $86,000 for Fiscal 2015, respectively. (see Notes 9 and 13 for discussion of a significant
contract manufacturing agreement and sales concentration). 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.
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 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 December 31, 2017 and 2016, we included a provision for sales allowances from continuing operations of $2,000 and zero, respectively.
Additionally, at December 31, 2017 accrued advertising and other allowances from discontinued operations $480,000 for estimated
future sales returns and $200,000 for cooperative incentive promotion costs. As of December 31, 2016, accrued advertising and
other allowances included $1.2 million for estimated future sales returns and $1.5 million for cooperative incentive promotion
costs.
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.
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 media advertising, presented as part of sales and marketing expense; cooperative incentive promotions and coupon
program expenses, which are accounted for as part of net sales; and free product, which is accounted for as part of cost of sales.
Advertising and incentive promotion expenses incurred (i) from continuing operations for Fiscal 2017, 2016 and 2015 were $45,000,
$717,000 and $1,000, respectively, and (ii) attributed to and classified as discontinued operations were $2.8 million, $7.5 million
and $6.9 million, respectively. Included in prepaid expenses and other current assets was $143,000 and $263,000 at December 31,
2017 and 2016, respectively, relating to prepaid advertising and promotion expenses.
Share-Based
Compensation
We
recognize all share-based payments to employees and directors, including grants of stock options, as compensation expense in the
financial statements based on their fair values. Fair values of stock options are determined through the use of the Black-Scholes
option pricing model. The compensation cost is recognized as an expense over the requisite service period of the award, which
usually coincides with the vesting period.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
Stock
and stock options for purchase of our common stock $0.005 per 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 7). Stock options are exercisable
during a period determined by us, but in no event later than ten years from the date granted. In Fiscal 2017, 2016 and 2015, we
charged to operations $78,000, $1,000 and $135,000, respectively, for share-based compensation expense for the aggregate fair
value of stock and 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 incurred for Fiscal 2017,
2016 and 2015 (i) from continuing operations were $431,000, $358,000 and $340,000, respectively, and (ii) attributed to and classified
as discontinued operations of $52,000, $218,000 and $738,000, respectively. Research and development costs are principally related
to personnel expenses and new product development initiatives and costs associated with our OTC healthcare 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 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 net current and non-current deferred tax asset is being
provided (see Note 9).
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.
The
major jurisdictions for which we file income tax returns are the United States and the state of Pennsylvania.
Recently
Issued Accounting Standards
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 2014-09, “Revenue from Contracts with Customers”, on revenue recognition. 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. We will adopt the provisions of the new standard in the first quarter of 2018. We have determined the following
pertaining to the impact of adopting ASU 2014-09:
|
●
|
Contract
Manufacturing — we have concluded that the standard will not have a material impact on revenue recognition. We determined
that contracts herein meet the definition of a contract under the new standard, through which the combined duties and responsibilities
to provide manufacturing services for customers within each contract will be considered one single performance obligations
under ASC 606. Thus, the allocation of contract consideration to separate performance obligations is not applicable. The transaction
price in each contract is fixed, as the consideration is based upon the manufacturing price from each related purchase order.
We determined that we will continue recognizing revenue at a point in time as the goods are shipped.
|
|
|
|
|
●
|
Contract
Costs — we have concluded that no incremental costs are incurred to obtain the contracts. Additionally, we have determined
that costs incurred to fulfill customer contracts would not require capitalization because these costs do not generate or
enhance our resources that will be used in satisfying performance obligations in the future. We have determine that the impact
on our retail revenues will not be material.
|
|
|
|
|
●
|
Transition
Method —we will be adopting ASU 2014-09 using the modified retrospective approach.
|
In
addition, the remaining significant implementation matters to be addressed prior to fully adopting ASU 2014-09 include finalizing
updates to our (i) business processes, (ii) systems and (iii) controls to comply with ASU 2014-09. We expect to complete its assessment
of the full financial impact of ASU 2014-09 before filing our Quarterly Report on Form 10-Q for the three months ended March 31,
2018 which will include the required financial reporting disclosures under ASC 2014-09.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
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 do not intend to early
adopt and are currently assessing the impact of this update, but preliminarily believe that its adoption will not have a material
impact on our consolidated financial statements.
In
June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments—Credit Losses.” The standard modifies the
impairment model for most financial assets, including trade accounts receivables and loans, and will require the use of an “expected
loss” model for instruments measured at amortized cost. Under this model, entities will be required to estimate the lifetime
expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting
in a net presentation of the amount expected to be collected on the financial asset. The effective date of the standard is for
fiscal years beginning after December 15, 2019 with early adoption permitted. We are currently evaluating the impact of adoption
of this update on our consolidated financial statements.
In
August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash
Payments”
.
The new standard attempts to reduce diversity in practice in how cash receipts and cash payments are presented
and classified in the statement of cash flows. ASU No. 2016-15 provides guidance on eight specific cash flow issues. The new guidance
will be effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. We will adopt
ASU 2016-15 in the first quarter of Fiscal 2018 and do not expect it to have a material impact on our consolidated financial statements.
In
October 2016, the FASB issued ASU No. 2016-16, “Income Taxes: Intra-Entity Transfers of Assets Other than Inventory”.
The new standard requires entities should recognize the income tax consequences of an asset other than inventory when the asset
transfer occurs. The new guidance will be effective for fiscal years beginning after December 15, 2017 and requires a modified
retrospective adoption through a cumulative effect adjustment directly to retained earnings as of the beginning of the period
of adoption. We will adopt ASU 2016-16 in the first quarter of Fiscal 2018 and do not expect it to have a material impact on our
consolidated financial statements.
In
February 2018, the FASB issued ASU No. 2018-02 “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive
Income”. ASU 2018-02 allows for a reclassification from accumulated other comprehensive income or loss to retained earnings
or accumulated deficit for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (“TCJA”). ASU 2018-02
also requires certain related disclosures. ASU 2018-02 is effective for annual periods, and interim periods within those annual
periods, beginning after December 15, 2018 and should be applied either in the period of adoption or retrospectively to each period
in which the effect of the change in the U.S. federal corporate income tax rate in the TCJA is recognized. Early adoption is permitted.
We are currently evaluating the impact of ASU 2018-02 on our consolidated financial statements, but do not believe it will have
a material effect on our financial position or results of operations.
NOTE
4 – DISCONTINUED OPERATIONS, SALE OF COLD-EEZE
®
BUSINESS
Effective
March 29, 2017, we completed the sale of the Cold-EEZE
®
Business to Mylan. As a consequence of the sale of the
Cold-EEZE
®
Business, for Fiscal 2017, 2016 and 2015, we have classified as discontinued operations (i) the gain
from the sale of the Cold-EEZE
®
Business, (ii) all gains and losses attributable to the Cold-EEZE
®
Business operations and (iii) the income tax expense attributed to the sale of the Cold-EEZE
®
Business (see Note
9). Excluded from the sale of the Cold-EEZE
®
Business were our accounts receivable and inventory, and we also retained
all liabilities associated with our Cold-EEZE
®
Business operations arising prior to March 29, 2017.
Pursuant
to the Asset Purchase Agreement, we also agreed to a one-time sale to Mylan of certain non-lozenge-based Cold-EEZE
®
inventory. At December 31, 2017, we have classified as assets held for sale approximately $22,000 of such inventory, which approximates
our cost. At December 31, 2016, the balance sheet impact of discontinued operations was deemed not material, as such, no reclassifications
for discontinued operations have been presented.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
4 – DISCONTINUED OPERATIONS, SALE OF COLD-EEZE
®
BUSINESS - (continued)
Pursuant
to the Asset Purchase Agreement, we entered into a transition service arrangement with Mylan, for which we earned $150,000 in
transition service fees through December 31, 2017. Pursuant to this arrangement, we (i) received, processed, fulfilled, and shipped
customer orders, and billed such customers for these shipments on behalf of Mylan from March 30, 2017 to June 30, 2017, (ii) processed
certain sales allowances, returns and other customer promotional deductions, and (iii) paid certain Cold-EEZE
®
Business expenses which are to be reimbursed by Mylan. For Fiscal 2017, the $150,000 transition service fees earned are recorded
as a component of other income (expense).
The
net proceeds received from the sale of the Cold-EEZE
®
Business were as follows (in thousands):
|
|
Amount
|
|
|
|
(as
restated)
|
|
Gross
consideration from the sale of the Cold-EEZE
®
Business
|
|
$
|
50,000
|
|
Closing
and transaction costs
|
|
|
(4,175
|
)
|
Net
proceeds from sale of the Cold-EEZE
®
Business
|
|
|
45,825
|
|
Book
value of assets sold
|
|
|
(13
|
)
|
Gain
on sale of the Cold-EEZE
®
Business before income taxes
|
|
|
45,812
|
|
Income
tax expense
|
|
|
(3,511
|
)
|
Gain
on sale of the Cold-EEZE
®
Business after income taxes
|
|
$
|
42,301
|
|
|
|
|
|
|
Net
proceeds:
|
|
|
|
|
Cash
paid at closing, net of closing and transaction costs
|
|
$
|
43,145
|
|
Proceeds
due on sale of assets, cash held in escrow
|
|
|
5,000
|
|
|
|
$
|
48,145
|
|
For
Fiscal 2017, we incurred $4.2 million in closing and transaction costs associated with the sale of the Cold-EEZE
®
Business which were comprised of (i) transaction fees and related closing costs of $1.9 million and (ii) performance bonuses,
contract termination compensation and severance payments to certain employees associated with the sale of the Cold-EEZE
®
Business of $2.3 million. The compensation committee of our board of directors approved these compensation arrangements.
These compensation and termination payments were paid by us in April 2017.
The
following table sets forth the condensed operating results of our discontinued operations for Fiscal 2017, 2016 & 2015, respectively,
(in thousands):
|
|
Year
Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Net
sales
|
|
$
|
4,687
|
|
|
$
|
16,808
|
|
|
$
|
18,087
|
|
Cost
of sales
|
|
|
2,036
|
|
|
|
7,738
|
|
|
|
6,741
|
|
Sales
and marketing
|
|
|
1,720
|
|
|
|
5,385
|
|
|
|
7,395
|
|
Administration
|
|
|
350
|
|
|
|
2,329
|
|
|
|
4,719
|
|
Research
and development
|
|
|
51
|
|
|
|
218
|
|
|
|
738
|
|
Income
(loss) from discontinued operations
|
|
$
|
530
|
|
|
$
|
1,138
|
|
|
$
|
(1,506
|
)
|
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
5 – PROPERTY, PLANT AND EQUIPMENT
The
components of property and equipment are as follows (in thousands):
|
|
December
31,
|
|
|
|
|
|
2017
|
|
|
2016
|
|
|
Estimated
Useful Life
|
|
|
|
|
|
|
|
|
|
Land
|
|
$
|
504
|
|
|
$
|
504
|
|
|
|
Buildings
and improvements
|
|
|
3,059
|
|
|
|
3,016
|
|
|
10
- 39 years
|
Machinery
and equipment
|
|
|
4,099
|
|
|
|
4,274
|
|
|
3
- 7 years
|
Computer
equipment and software
|
|
|
355
|
|
|
|
319
|
|
|
3
- 5 years
|
Furniture
and fixtures
|
|
|
196
|
|
|
|
196
|
|
|
5
years
|
|
|
|
8,213
|
|
|
|
8,309
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
Accumulated depreciation
|
|
|
5,471
|
|
|
|
5,134
|
|
|
|
|
|
$
|
2,742
|
|
|
$
|
3,175
|
|
|
|
Depreciation
expense incurred for Fiscal 2017, 2016 and 2015 (i) from continuing operations were $315,000, $347,000 and $288,000, respectively,
and (ii) attributed to and classified as discontinued operations of $22,000, $79,000 and $80,000, respectively.
NOTE
6 – 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, with 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 were recorded as a reduction of the Notes, and the origination costs were charged to interest expense over
the term of the loan. The Warrants had an exercise term equal to three years and were 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 was charged
to interest expense over the term of the loan (see Note 7).
The
Notes bore interest at the rate of 12% per annum, payable semi-annually and the principal was due and payable on June 15, 2017.
The Notes could be pre-paid at any time prior to maturity without penalty. The effective interest, inclusive of the Warrants and
loan origination costs, was 14.3% per annum. For Fiscal 2017, 2016 and 2015, we charged to other income (expense) $54,000, $187,000
and $11,000, respectively, in connection with the Notes.
On
March 29, 2017, in connection with the sale of the Cold-EEZE
®
Business, we paid in full the remaining principal
and accrued interest due under the Notes, in the total amount of $1.5 million. Of the $1.5 million paid to the Investors, $69,000
was netted against the aggregate exercise price of the Warrants, which were simultaneously exercised by the Investors.
In
connection with the issuance of the Notes, the Company entered into a security agreement with John E. Ligums, Jr., as collateral
agent for the Investors (the “Security Agreement”), to secure the timely payment and performance in full of the Company’s
obligations under the Notes. Under the Security Agreement, we granted to the collateral agent, for the benefit of the Investors
a lien upon and security interest in the property and assets listed as collateral in the Security Agreement, including without
limitation, all of our personal property, inventory, equipment, general intangibles, cash and cash equivalents, and proceeds.
In connection with the payoff of the Notes, the Security Agreement was terminated.
At
December 31, 2016, the $1.5 million Notes are reported net of $10,000 of the unamortized interest for the loan origination costs
and unamortized interest for the Warrants. At December 31, 2016, other current liabilities included $9,000 for accrued interest
under the terms of the Notes.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
6 – SECURED PROMISSORY NOTES AND OTHER OBLIGATIONS- (continued)
The
offers and sales of the Notes and Warrants were made without registration under the Securities Act, or the securities laws of
certain states, in reliance on the exemptions provided by Section 4(a)(2) of the Securities Act and Regulation D under the Securities
Act and in reliance on similar exemptions under applicable state laws.
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. Pursuant to the terms of the Godfrey Settlement Agreement,
we paid the Godfreys $2.1 million in December 2012 and we paid four additional annual payments of $100,000 due each December of
Fiscal 2013, 2014, 2015 and 2016. Each annual payment in the amount of $100,000 accrued interest at the per annum rate of 3.25%.
The annual installment of $103,000 and $107,000, inclusive of accrued interest, were paid in Fiscal 2016 and 2015, respectively.
The Fiscal 2016 installment was the final required payment under the Godfrey Settlement Agreement. Under the Godfrey Settlement
Agreement, the Godfreys assigned, transferred and conveyed to us all of their right, title, and interest in U.S. Trademark Registration
No. 1,838,542 for the trademark Cold-EEZE
®
, among other intellectual property associated with such trademark, which
as discussed in Note 4 and Note 10 was sold to Mylan in 2017.
NOTE
7 – STOCKHOLDERS’ EQUITY AND STOCK COMPENSATION
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
The
Preferred Stock authorized under our certificate of incorporation may be issued from time to time in one or more series. As of
December 31, 2017, 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 to our capital structure or the
terms of our capital stock.
Stockholder
Rights Plan
On
September 8, 1998, our Board of Directors declared a dividend distribution of Common Stock Purchase Rights (each individually,
a “Right” and collectively, the “Rights”) payable to the stockholders of record on September 25, 1998,
thereby creating a Stockholder Rights Plan (the “Rights Agreement”). The Rights Agreement was subsequently amended
effective each of (i) May 23, 2008, (ii) August 18, 2009, (iii) June 2014 and (iv) January 6, 2017. The Rights Agreement, as amended
and restated, provides that each Right entitles the stockholder of record to purchase from the Company that number of common shares
of Common Stock having a combined market value equal to two times the Rights exercise price of $45. The Rights are not exercisable
until the distribution date, which will be the earlier of a public announcement that a person or group of affiliated or associated
persons has acquired 15% or more of the outstanding common shares of Common Stock, or the announcement of an intention by a similarly
constituted party to make a tender or exchange offer resulting in the ownership of 15% or more of the outstanding common shares
of Common Stock (such person, the “acquirer”). The Rights Agreement, as amended and restated, allows for an exemption
for Ted Karkus, our Chairman and Chief Executive Officer, to acquire up to 20% of our Common Stock without our Board of Directors
declaring a dividend distribution.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
7 – STOCKHOLDERS’ EQUITY AND STOCK COMPENSATION - (continued)
The
dividend has the effect of giving the stockholder a 50% discount on the share’s current market value for exercising such
right. In the event of a cashless exercise of the Right, and the acquirer has acquired less than 50% beneficial ownership of the
Company, a stockholder may exchange one Right for one common share of the Company. The Rights Agreement, as amended and restated,
includes a provision pursuant to which our Board of Directors may exempt from the provisions of the Rights Agreement an offer
for all outstanding shares of our Common Stock that the directors determine to be fair and not inadequate and to otherwise be
in the best interests of the Company and its stockholders, after receiving advice from one or more investment banking firms. The
expiration date of the Rights Agreement, as amended, is June 18, 2024.
On
February 16, 2018, our board of directors, approved the termination of the Rights Agreement effective February 20, 2018. As a
consequence of the termination of the Rights Agreement, all of the Rights distributed to our stockholders expired on February
20, 2018.
2015
Equity Line of Credit
On
July 30, 2015, we entered into an equity line of credit agreement (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. 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.
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 is 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 has 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 a particular put.
During such time, we are entitled to deliver another draw down notice. In addition, Dutchess is not 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.
During
the period from August 21, 2015 through December 31, 2015, we sold an aggregate of 750,000 shares of our Common Stock to Dutchess
under and pursuant to the 2015 Equity Line and we derived net proceeds of $1.0 million. 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 December 31, 2017 we have 2,450,000 shares of our Common Stock available for
sale to Dutchess, at our discretion, under the terms of the 2015 Equity Line and covered pursuant to a registration statement.
The 2015 Equity Line is scheduled to expire in July 2018.
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 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. At December 31, 2017, there were 979,500 options
outstanding under the 2010 Equity Compensation Plan (see
“Stock Options”
below).
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
7 – STOCKHOLDERS’ EQUITY AND STOCK COMPENSATION - (continued)
Stock
Options and Warrants Fair Value
All
of our employees, including employees who are officers or members of the Board are eligible to participate in the 2010 Plan. Consultants
and advisors who perform services for us are also eligible to participate in the 2010 Plan. For Fiscal 2017, we granted 625,000
options under the 2010 Plan. For Fiscal 2016 and 2015, there were no options granted under the 2010 Plan. For Fiscal 2015, we
issued 51,000 Warrants pursuant to the terms of the Subscription Agreements for the Notes. For Fiscal 2017 and 2016, there were
no warrants issued. Presented below is a summary of the terms of the grant of options and Warrants:
|
|
Year
Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Number of options granted
|
|
|
625,000
|
|
|
|
-
|
|
|
|
-
|
|
Number of Warrants granted
|
|
|
-
|
|
|
|
-
|
|
|
|
51,000
|
|
Vesting period
|
|
|
3-4
years
|
|
|
|
-
|
|
|
|
none
|
|
Maximum term of option or Warrants from
date of grant
|
|
|
7
years
|
|
|
|
-
|
|
|
|
3
years
|
|
Weighted average exercise price per share
|
|
$
|
2.01
|
|
|
|
-
|
|
|
$
|
1.35
|
|
Weighted average fair value per share of options and
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants granted
during the year
|
|
$
|
0.76
|
|
|
|
-
|
|
|
$
|
0.26
|
|
We
used the Black-Scholes option pricing model during Fiscal 2017 and 2015 to determine the fair value of the stock options and Warrants
at the date of grant. Based upon our limited historical experience, we determined the expected term of the stock option grants
to be a range between 2.5 to 6.5 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.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
7 – STOCKHOLDERS’ EQUITY AND STOCK COMPENSATION - (continued)
Presented
below is a summary of assumptions used in determining the fair value of the stock options and Warrants at the date of grant:
|
|
Year
Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Expected option or Warrant life
|
|
|
4.5
- 4.75 years
|
|
|
|
-
|
|
|
|
3
years
|
|
Weighted average risk free rate
|
|
|
1.62%
- 1.81
|
%
|
|
|
-
|
|
|
|
0.88
|
%
|
Dividend yield
|
|
|
0
|
%
|
|
|
-
|
|
|
|
0
|
%
|
Expected volatility
|
|
|
38.59%
- 44.51
|
%
|
|
|
-
|
|
|
|
26.42
|
%
|
The
fair value of the stock options and Warrants at the time of the grant in Fiscal 2017 and 2015 was $476,000 and $14,000, respectively.
For Fiscal 2015, the Warrants granted were not subject to a vesting period. For Fiscal 2017, 2016 and 2015, we charged to operations
$78,000, $1,000 and $135,000, respectively, for share-based compensation expense for the aggregate fair value of the vested stock
options earned.
Stock
Options
At
December 31, 2017, 360,750 of the options granted under the 2010 Equity Compensation Plan were vested and 618,750 were non-vested.
At December 31, 2017, there are 121,159 options available for grant to purchase shares of Common Stock that may be issued pursuant
to the terms of the 2010 Plan.
A
summary of the status of our stock options granted pursuant the 2010 Plan as of December 31, 2017, 2016 and 2015 and changes during
the years then ended is presented below (in thousands, except per share data):
|
|
Year
Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
Weighted
Average
|
|
|
|
|
|
Weighted
Average
|
|
|
|
|
|
Weighted
Average
|
|
|
|
Shares
|
|
|
Exercise
Price
|
|
|
Shares
|
|
|
Exercise
Price
|
|
|
Shares
|
|
|
Exercise
Price
|
|
Options
outstanding - beginning of year
|
|
|
1,699
|
|
|
$
|
1.20
|
|
|
|
1,713
|
|
|
$
|
1.21
|
|
|
|
1,740
|
|
|
$
|
1.40
|
|
Granted
|
|
|
625
|
|
|
|
2.01
|
|
|
|
-
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
(1,332
|
)
|
|
|
1.11
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
Cancelled
|
|
|
(13
|
)
|
|
|
1.00
|
|
|
|
(14
|
)
|
|
|
1.44
|
|
|
|
(27
|
)
|
|
|
13.50
|
|
Options
outstanding - end of year
|
|
|
979
|
|
|
$
|
1.81
|
|
|
|
1,699
|
|
|
$
|
1.20
|
|
|
|
1,713
|
|
|
$
|
1.21
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
granted and subject to future vesting
|
|
|
618
|
|
|
$
|
2.01
|
|
|
|
-
|
|
|
$
|
-
|
|
|
|
4
|
|
|
$
|
1.48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable,
at end of year
|
|
|
361
|
|
|
|
|
|
|
|
1,699
|
|
|
|
|
|
|
|
1,709
|
|
|
|
|
|
Available
for grant
|
|
|
121
|
|
|
|
|
|
|
|
734
|
|
|
|
|
|
|
|
20
|
|
|
|
|
|
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
7 – STOCKHOLDERS’ EQUITY AND STOCK COMPENSATION - (continued)
The
following table summarizes information about stock options outstanding and stock options exercisable at December 31, 2017 (in
thousands, except remaining life and per share data):
|
|
Options
Outstanding and Exercisable
|
|
Range
of
Exercise Prices
|
|
Number
Outstanding
|
|
|
Weighted
Average Remaining Contractual Life
|
|
|
Weighted
Average Exercise Price Per Share
|
|
$1.17 - $1.36
|
|
|
90
|
|
|
|
1.13
|
|
|
$
|
1.20
|
|
$1.36 - $1.65
|
|
|
265
|
|
|
|
2.23
|
|
|
$
|
1.57
|
|
$2.00 - $2.15
|
|
|
6
|
|
|
|
6.75
|
|
|
$
|
2.15
|
|
Total
|
|
|
361
|
|
|
|
|
|
|
$
|
1.49
|
|
The
aggregate intrinsic value of (i) options outstanding, (ii) options outstanding and expected to vest in the future and (iii) options
outstanding and exercisable at December 31, 2017 was $347,000, $102,000 and $245,000, respectively.
Stock
Option Exercises
There
were 1,332,000 stock options exercised in Fiscal 2017 and we derived net proceeds of $1.5 million. The intrinsic value of the
options exercised in Fiscal 2017 was $1.5 million. There were no stock options exercised in Fiscal 2016 or 2015.
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 (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 425,000 shares. We did not grant shares to Directors in Fiscal 2017, 2016 or 2015 for director compensation.
At December 31, 2017, there are 147,808 shares of Common Stock that may be issued pursuant to the terms of the 2010 Directors’
Equity Compensation Plan.
Treasury
Stock - Stock Purchase Agreements
On
June 12, 2017 we entered into a Stock Purchase Agreement with each of Mark S. Leventhal, a former director of the Company, and
certain other persons and entities associated and/or affiliated with Mr. Leventhal (the “Leventhal Holders”), pursuant
to which we purchased all 1,061,980 shares of our Common Stock then held by the Leventhal Holders, representing an approximate
6.2% aggregate ownership interest (based on 17.2 million shares of common stock outstanding as of June 12, 2017). Upon consummation
of the transactions, the Leventhal Holders ceased to hold any direct or indirect ownership interest in the Company.
Pursuant
to the terms of the Stock Purchase Agreements, the total consideration paid by us to the Leventhal Holders for their shares was
$1,858,465, which amount was equal to the product of (i) $1.75 multiplied by (ii) the number of shares purchased.
Treasury
Stock – Tender Offers
In
Fiscal 2017, we announce two discrete tender offers to purchase our Common Stock in each of August 2017 and November 2017.
On
August 25, 2017, we announced a tender offer to purchase up to 4.0 million shares of our Common Stock at a price of $2.30 per
share (the “August 2017 Tender Offer”). The number of shares proposed to be purchased in the August 2017 Tender Offer
represented approximately 24.7% of approximately 16.2 million shares our Common Stock issued and outstanding as of August 21,
2017. The last reported sale price of our Common Stock on August 15, 2017, the last full trading day before we announced the Tender
Offer, was $2.13 per share.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
7 – STOCKHOLDERS’ EQUITY AND STOCK COMPENSATION - (continued)
The
August 2017 Tender Offer expired on September 25, 2017. Subject to the terms of the August 2017 Tender Offer, we accepted for
purchase 4,323,335 shares of our Common Stock, including all “odd lots” validly tendered, at a purchase price of $2.30
per share, for an aggregate purchase price of approximately $9.9 million. Based on the final tabulation by American Stock Transfer
& Trust Company, the Depositary for the August 2017 Tender Offer, 5,910,327 shares of our Common Stock were properly tendered
and not withdrawn. We were informed by the Depositary that, after giving effect to the priority for an aggregate amount of approximately
9,338 “odd lot” shares, the final proration factor for the remaining tendered shares is approximately 73%. Prior to
the August 2017 Tender Offer, an investor, BML Investment Partners, L.P. (“BLM”), owned 2,322,627 shares, or 13.6%,
of our outstanding Common Stock. Pursuant to the terms of the Tender Offer, BML tendered and sold 1,695,305 shares of our Common
Stock. In addition, Ted Karkus, our Chairman of the Board and Chief Executive Officer, Robert V. Cuddihy, Jr., our then Chief
Operating Officer and Chief Financial Officer, and one of our directors tendered and sold 364,954, 358,621 and 4,379 shares of
Common Stock, respectively.
On
November 20, 2017, we announced a tender offer to purchase up to 1.7 million shares of our Common Stock at a price of $2.30 per
share (the “November 2017 Tender Offer”). The number of shares proposed to be purchased in the November 2017 Tender
Offer represented approximately 13.7% of approximately 12.4 million shares our Common Stock issued and outstanding as of November
14, 2017. The last reported sale price of our Common Stock on November 9, 2017, the last full trading day before we announced
the Tender Offer, was $2.13 per share.
The
November 2017 Tender Offer expired on December 18, 2017. Subject to the terms of the November 2017 Tender Offer, we accepted for
purchase 1,948,569 shares of our Common Stock, including all “odd lots” validly tendered, at a purchase price of $2.30
per share, for an aggregate purchase price of approximately $4.5 million. Based on the final tabulation by the Depositary for
the November 2017 Tender Offer, 2,072,280 shares of our Common Stock were properly tendered and not withdrawn. We were informed
by the Depositary that, after giving effect to the priority for an aggregate amount of approximately 8,401 “odd lot”
shares, the final proration factor for the remaining tendered shares is approximately 94%. Pursuant to the terms of the Tender
Offer, Mr. Karkus sold 424,789 shares of Common Stock. Subsequent to the completion of the November 2017 Tender Offer, Mr. Karkus
exercised 600,000 outstanding options. As a consequence of Mr. Karkus’s exercise of his options at an exercise price of
$1.00 per share, we derived net proceeds of $600,000.
NOTE
8 – DEFINED CONTRIBUTION PLANS
We
maintain the ProPhase Labs, Inc. 401(k) Savings and Retirement Plan, a defined contribution plan for our employees. Our contributions
to the plan are based on the amount of the employee plan contributions and compensation. Our contributions to the plan in Fiscal
2017, 2016 and 2015 were $120,000, $121,000 and $134,000, respectively. For Fiscal 2017. 2016 and 2015, we charged (i) to continuing
operations $104,000, $62,000 and $59,000, respectively and (ii) to discontinue operations $16,000, $59,000 and $75,000 respectively,
for our plan contribution.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
9 – INCOME TAXES
The
components of the provision (benefit) for income taxes, in the consolidated statements of operations are as follows (in thousands):
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
|
(as
restated)
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
(1,245
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
$
|
(176
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
|
(1,421
|
)
|
|
|
-
|
|
|
|
-
|
|
Deferred
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
15,412
|
|
|
|
(936
|
)
|
|
|
(1,403
|
)
|
State
|
|
|
682
|
|
|
|
(66
|
)
|
|
|
(73
|
)
|
|
|
|
16,094
|
|
|
|
(1,002
|
)
|
|
|
(1,476
|
)
|
Total
|
|
$
|
14,673
|
|
|
$
|
(1,002
|
)
|
|
$
|
(1,476
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes from
continuing operations before valuation allowance
|
|
$
|
14,673
|
|
|
$
|
(1,002
|
)
|
|
$
|
(1,476
|
)
|
Change in valuation
allowance
|
|
|
(16,094
|
)
|
|
|
1,002
|
|
|
|
1,476
|
|
Income
tax benefit
|
|
|
(1,421
|
)
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
(1,421
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discontinued Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
1,245
|
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
2,266
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
3,511
|
|
|
|
-
|
|
|
|
-
|
|
Deferred
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
3,511
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes from discontinued operations
before valuation allowance
|
|
$
|
3,511
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Change in valuation
allowance
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Income
tax expense
|
|
|
3,511
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
3,511
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,090
|
|
|
$
|
-
|
|
|
$
|
-
|
|
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
9 – INCOME TAXES - (continued)
A
reconciliation of the statutory federal income tax expense (benefit) to the effective tax is as follows (in thousands):
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
(as
restated)
|
|
|
|
|
|
|
|
Statutory rate - federal
|
|
$
|
14,512
|
|
|
$
|
(975
|
)
|
|
$
|
(1,224
|
)
|
State taxes, net of federal benefit
|
|
|
2,061
|
|
|
|
(41
|
)
|
|
|
(305
|
)
|
Rate Change
|
|
|
1,804
|
|
|
|
|
|
|
|
|
|
Permanent differences
and other
|
|
|
(193
|
)
|
|
|
14
|
|
|
|
53
|
|
Income tax from
continuing operation before valuation allowance
|
|
|
18,184
|
|
|
|
(1,002
|
)
|
|
|
(1,476
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in valuation
allowance
|
|
|
(16,094
|
)
|
|
|
1,002
|
|
|
|
1,476
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
|
2,090
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
2,090
|
|
|
$
|
-
|
|
|
$
|
-
|
|
The
tax effects of the primary “temporary differences” between values recorded for assets and liabilities for financial
reporting purposes and values utilized for measurement in accordance with tax laws giving rise to our deferred tax assets are
as follows (in thousands):
|
|
Year
Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
(as
restated)
|
|
|
|
|
|
|
|
Net operating loss and capital
loss carryforward
|
|
$
|
3,595
|
|
|
$
|
18,019
|
|
|
$
|
16,921
|
|
Consulting-royalty costs
|
|
|
-
|
|
|
|
-
|
|
|
|
(8
|
)
|
Trademark
|
|
|
21
|
|
|
|
576
|
|
|
|
671
|
|
Investment in Phusion
|
|
|
33
|
|
|
|
938
|
|
|
|
1,103
|
|
Depreciation
|
|
|
41
|
|
|
|
(304
|
)
|
|
|
(103
|
)
|
Other
|
|
|
604
|
|
|
|
1,159
|
|
|
|
802
|
|
Valuation allowance
|
|
|
(4,294
|
)
|
|
|
(20,388
|
)
|
|
|
(19,386
|
)
|
Total
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
A valuation allowance
for all of our net deferred tax assets has been provided as we are unable to determine, at this time, that the generation of future
taxable income against which the net operating loss (“NOL”) carryforwards could be used can be predicted to be more
likely than not. The net change in the valuation allowance for Fiscal 2017, 2016 and 2015 was ($16.1) million, $1.0 million and
$1.6 million, respectively. Certain exercises of options and warrants, and restricted stock issued for services that became unrestricted
resulted in reductions to taxes currently payable and a corresponding increase to additional-paid-in-capital for prior years.
In addition, certain tax benefits for option and warrant exercises totaling $6.5 million are deferred and will be credited to
additional-paid-in-capital, and not income tax expense, if the NOL’s attributable to these exercises are utilized. The net
operating loss carry-forwards currently approximate $12.2 million for federal purposes will expire beginning in Fiscal 2020 through
2036. Additionally, there are net operating loss carry-forwards of $13.8 million for state purposes that will expire beginning
in Fiscal 2019 through 2037. Included in other current liabilities on the December 31, 2017 consolidated balance sheet is $0.7
million of income taxes payable.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
9 – INCOME TAXES - (continued)
On
December 22, 2017, the President of the United States signed into law legislation that is commonly referred to as the Tax Cuts
and Jobs Act (“The TCJA”). This legislation reduced the U.S. corporate tax rate from the existing graduated rate of
15-35% to a flat 21% for tax years beginning after December 31, 2017. As a result of the enacted law, we were required to revalue
our deferred tax assets and liabilities existing as of December 31, 2017 from the graduated 15-35% federal rate in effect through
the end of 2017, to the new flat 21% rate. This revaluation resulted in a reduction to our deferred tax asset of $1.8 million.
This amount was offset by a corresponding reduction to our valuation allowance. The other provisions of the TCJA did not have
a material impact on our December 31, 2017 consolidated financial statements. Estimates used to prepare our income tax expense
are based on our initial analysis of the TCJA. Given the complexity of the TCJA, anticipated guidance from the U.S. Treasury regarding
implementation of the TCJA, and the potential for additional guidance from the Securities and Exchange Commission and the FASB
related to the TCJA, these estimates may be adjusted during Fiscal 2018 to reflect any such guidance provided.
NOTE
10 – COMMITMENTS AND CONTINGENCIES
Escrow
Receivable
We
have indemnification obligations to Mylan under the Asset Purchase Agreement that may require us to make future payments to Mylan
and other related persons for any damages incurred by Mylan or such related persons as a result of any breaches of our representations,
warranties, covenants or agreements contained in the Asset Purchase Agreement, or arising from the Retained Liabilities (as such
term is defined in the Asset Purchase Agreement) or certain third party claims specified in the Asset Purchase Agreement. Generally,
our representations and warranties survive for a period of 24 months from the closing date, other than certain fundamental representations
which survive until the expiration of the applicable statute of limitations. There is a limited indemnification cap with respect
to a majority of the Company’s indemnification obligations under the Asset Purchase Agreement with the exception of claims
for actual fraud, the breach of any fundamental representations and certain other items, which have a larger indemnification cap
(e.g., the purchase price).
Pursuant
to the terms of the Asset Purchase Agreement, we, Mylan, and an escrow agent entered into an Escrow Agreement at closing, pursuant
to which Mylan deposited $5 million of the aggregate purchase price for the Cold-EEZE
®
Business into an escrow
account established with the Escrow Agent in order to satisfy, in whole or in part, certain of our indemnity obligations under
the Asset Purchase Agreement. If, on the 18
th
month anniversary of the closing date, 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. Within two business days of the second anniversary of the closing date, 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.
Management
does not believe that we will be subject to indemnity claims contemplated by the Asset Purchase Agreement. However, in the event
that such a claim is made, and if successful, we would be required to pay Mylan 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
®
Division.
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) will purchased the inventory of the Company’s Cold-EEZE
®
brand and product line and PMI will
manufactures certain products for Mylan, as described in the Manufacturing Agreement, at prices that reflect current market conditions
for such products and include an agreed upon mark-up on our costs. Unless terminated sooner by the parties, the Manufacturing
Agreement will remain in effect until March 29, 2022. Thereafter, the Manufacturing Agreement may be renewed by Mylan for up to
five successive one year periods by providing notice of its intent to renew not less than 90 days prior to the expiration of the
then-current term.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
10 – COMMITMENTS AND CONTINGENCIES - (continued)
Employment
Agreements
On
January 14, 2015, we entered into new employment agreements, effective as of January 1, 2015, with Mr. Karkus and Mr. Cuddihy,
our former Chief Operating Officer and Chief Financial Officer. These January 2015 employment agreements superseded the 2012 Employment
Agreements that had been scheduled to terminate on July 15, 2015. On May 29, 2015 we entered into amended and restated employment
agreements with each of Mr. Karkus and Mr. Cuddihy (the “2015 Employment Agreements”). The 2015 Employment Agreements
superseded the employment agreements of Messrs. Karkus and Cuddihy, dated January 1, 2015. The 2015 Employment Agreements were
approved by our Compensation Committee.
Under
his 2015 Employment Agreement, Mr. Karkus agreed to an annual base salary of $675,000 as Chief Executive Officer. Mr. Karkus was
eligible to receive an annual increase in base salary and could be awarded a bonus in the sole discretion of the Compensation
Committee. He was also entitled to receive regular benefits routinely provided to other senior executives of the Company. In the
event of a termination by the Company of the employment of Mr. Karkus without cause or due to a voluntary resignation by Mr. Karkus
with Good Reason (as defined in his 2015 Employment Agreement), Mr. Karkus was entitled to receive 1.5 times his base salary (“Mr.
Karkus Severance”), with one-half of such amount to be paid as a lump sum severance payment in cash and the remaining one-half
paid in 12 equal consecutive, monthly installments commencing on the first business day of the month following the effective date
of the termination. In addition, all of the stock options and/or restricted stock then held by Mr. Karkus would automatically
vest concurrently upon such termination of employment, regardless of any prior existing vesting schedules. If Mr. Karkus’
employment was terminated without cause or leaves with Good Reason in contemplation of (or within 24 months following) a change
in control of the Company, then, in lieu of the Mr. Karkus Severance payment described above, Mr. Karkus would instead receive
a one-time severance payment in cash equal to the greater of (i) $1.5 million, and (ii) 199 percent of his average annual total
Form W-2 compensation for the three calendar years immediately preceding the date of termination.
Under
his 2015 Employment Agreement, Mr. Cuddihy agreed to an annual base salary of $350,000 as Chief Financial Officer and Chief Operating
Officer. Mr. Cuddihy was eligible to receive an annual increase in base salary and could be awarded a bonus in the sole discretion
of the Compensation Committee. He was also entitled to regular benefits routinely provided to other senior executives of the Company.
In the event of a termination by the Company of the employment of Mr. Cuddihy without cause or due to a voluntary resignation
by Mr. Cuddihy with Good Reason (as defined in his 2015 Employment Agreement), Mr. Cuddihy was entitled to receive 1.5 times his
base salary (“Mr. Cuddihy Severance”), with one-half of such amount to be paid as a lump sum severance payment in
cash.
On
April 17, 2017, we entered into an Employment Agreement Termination and Release Agreement (the “April 2017 Termination Agreement”)
with Mr. Cuddihy. The April 2017 Termination Agreement terminated Mr. Cuddihy’s prior employment agreement with us, and
established new terms of Mr. Cuddihy’s employment with the Company. The April 2017 Termination Agreement was entered into
in light of our recent successful sale of the Cold-EEZE
®
Business. The April 2017 Termination Agreement provided,
among other things, that Mr. Cuddihy would remain employed by the Company on an at-will basis; he would relinquish his rights
under the 2015 Employment Agreement, including his rights to separation payments, in consideration for the Company remitting to
him a $675,000 termination payment (the “Termination Payment); and he would reduce his annual base salary to $250,000 effective
July 1, 2017.
On
September 27, 2017, we entered into another Employment Agreement Termination and Release Agreement with Mr. Cuddihy (the “September
2017 Termination Agreement”). Pursuant to the terms of the September 2017 Termination Agreement, Mr. Cuddihy’s 2015
Employment Agreement terminated effective September 30, 2017 and we paid Mr. Cuddihy a one-time lump sum payment of $55,000 on
October 20, 2017. The September 2017 Termination Agreement contains a general release of claims in favor of us and other customary
provisions.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
10 – COMMITMENTS AND CONTINGENCIES - (continued)
Future
Obligations
At
December 31, 2017, we have approximate future obligations over the next five years as follows (in thousands):
Year
|
|
Employment
Agreements
|
|
2018
|
|
$
|
675
|
|
2019
|
|
|
169
|
|
2020
|
|
|
-
|
|
2021
|
|
|
-
|
|
2022
|
|
|
-
|
|
Total
|
|
$
|
844
|
|
Other
Litigation
In
the normal course of our business, we are named as a defendant in legal proceedings. It is our policy to vigorously defend litigation
and/or enter into settlements of claims where management deems appropriate.
NOTE
11 – 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, a Delaware limited liability company, entered into a Limited
Liability Company Agreement (the “LLC Agreement”) of the Phusion joint venture 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”). Pursuant to the LLC Agreement, we and
PSI each owned a 50% membership interest in the Phusion joint venture.
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,
against PSI Parent and PSI (collectively known as the (“Phosphagenics Entitles”)), relating to our Phusion joint venture.
In
November 2016, the arbitration case was resolved and concluded. The arbitrator rejected all of the counterclaims asserted by Phosphagenics
that ProPhase pay damages to Phosphagenics. The arbitrator also awarded to ProPhase recovery of approximately $350,000 (net of
the payment of certain wind down expenses) that had been invested in the Phusion joint venture entity; terminated the intellectual
property license that had been granted to Phusion from Phosphagenics; and directed the wind down and termination of Phusion Laboratories
LLC, the joint venture entity.
Phusion
a variable interest entity (“VIE)” and its financial statements are consolidated with the Company’s financial
statements for each period presented. As a consequence of Phusion qualifying as a VIE, the $350,000 award was effected through
the transfer of cash from the Phusion bank account to the Company’s solely controlled bank account and no gain or loss is
realized as a result of the award. The steps to wind down and terminate Phusion Laboratories LLC, the joint venture entity, were
initiated in December 2016 and completed in the first half of Fiscal 2017. The operations of the Phusion VIE were not material
to any of Fiscal 2017, 2016 or 2015.
PROPHASE
LABS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
12 – EARNINGS PER SHARE
Basic
earnings per share (“EPS”) excludes dilution and is computed by dividing income available to common stockholders by
the weighted-average number of common shares outstanding for the period. Diluted EPS 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 (“Common Stock Equivalents”) that shared in the earnings of the entity. Diluted EPS also
utilizes 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. Since there are options and Warrants outstanding, fluctuations in the actual market
price can have a variety of results for each period presented.
For
Fiscal 2017, diluted loss per share from continuing operations is the same as basic earnings per share due to the inclusion of
Common Stock, in the form of stock options and warrants, would have an anti-dilutive effect on the loss per share. For Fiscal
2017, there were 954,500 Common Stock Equivalents which were in the money that were included in the fully diluted earnings per
share from discontinued operations and net income computation. For Fiscal 2016 and 2015, diluted earnings per share is the same
as basic earnings per share due to the inclusion of Common Stock, in the form of stock options and warrants, would have an anti-dilutive
effect on the loss per share. For Fiscal 2016 and 2015, there were Common Stock Equivalents in the amount of 430,636 and 337,186,
respectively, which were in-the-money that were excluded in the earnings per share computation due to their dilutive effect. In
addition, for Fiscal 2016 and 2015, there were Common Stock Equivalents in the amount of 403,000 and 420,500, respectively, which
were out-of-the-money (the exercise price of the stock option was greater than the average market price for the period), that
were excluded in the earnings per share computation due to their dilutive effect.
NOTE
13 – SIGNIFICANT CUSTOMERS
Revenues
from continuing operations for Fiscal 2017, 2016 and 2015 were $9.9 million, $4.2 million and $2.5 million, respectively. Three
third-party contract manufacturing customers accounted for 61.7%, 16.1% and 11.1%, respectively, of our Fiscal 2017 revenues from
continuing operations. Three third-party contract customers accounted for approximately 66.6%, 14.7% and 10.3%, respectively,
of our Fiscal 2016 revenues from continuing operations. Two third-party contract customers accounted for approximately 60.0% and
24.5%, respectively, of our Fiscal 2015 revenues from continuing operations. The loss of sales to any one or more of these large
retail or third-party contract manufacturing customers could have a material adverse effect on our business operations and financial
condition.
We
are subject to account receivable credit concentrations from time-to-time as a consequence of the timing, payment pattern and
ultimate purchase volumes or shipping schedules with our customers. These concentrations may impact our overall exposure to credit
risk, either positively or negatively, in that our customers may be similarly affected by changes in economic, regulatory or other
conditions that may impact the timing and collectability of amounts due to us. One customer represented 84% and one customer represented
22% of our total trade receivable balances at December 31, 2017 and 2016, respectively. Management believes that the provision
for possible losses on uncollectible accounts receivable is adequate for our credit loss exposure. The allowance for doubtful
accounts was zero for both December 31, 2017 and 2016.
NOTE
14 – SUBSEQUENT EVENT
On
February 16, 2018, our board of directors approved the Amended and Restated 2015 Executive Employment Agreement with Ted Karkus,
our Chief Executive Officer (the “Amended Employment Agreement”), which became effective February 23, 2018, subject
to stockholder approval at a special meeting of stockholder to be held April 12, 2018. Pursuant to the terms of the Amended Employment
Agreement, Mr. Karkus has voluntarily agreed to reduce his base salary from the rate set forth in the 2015 Employment Agreement
(
i.e.,
not less than $675,000 per annum) to a base salary of $125,000 per annum (the “Term Base Salary”) through
February 22, 2021. Unless otherwise determined by the mutual agreement of the Company and Mr. Karkus, on February 22, 2021 and
thereafter, Mr. Karkus’ salary will increase from the Term Base Salary to not less than $675,000 per annum.
In
consideration of Mr. Karkus’ voluntary reduction in salary, our board of directors granted Mr. Karkus a stock option to
purchase 2,300,000 shares of our common stock at an exercise price of $3.00 per share on February 23, 2018 (the “Executive
Stock Option”). The Executive Stock Option will vest and be exercisable in 35 equal monthly installments of 63,888 shares
and one monthly installment of 63,290 shares, subject to his continued employment, and subject to accelerated vesting in the event
Mr. Karkus’s employment is terminated for any reason other than by us for Cause or by Mr. Karkus without Good Reason (as
such terms are defined in the Amended Employment Agreement). The Executive Stock Option will be exercisable for a five year term
commencing on the date of grant. The Executive Stock Option will be granted pursuant to the 2018 Stock Incentive Plan (the “2018
Plan”), which was also adopted and approved by our board of directors on February 16, 2018. The 2018 Plan, like the Amended
Employment Agreement, is subject to the stockholder approval. The 2018 Plan authorizes the issuance of up to 2,300,000 shares
pursuant to stock options granted under the 2018 Plan.