# ProPhase Labs, Inc.: Form 10-Q for the period ended Sep 30, 2018

- Company: [ProPhase Labs, Inc.](/companies/prph.md) (CIK 868278)
- Form: 10-Q
- Filed: 2018-11-14
- Accepted by EDGAR: Nov 14, 2018, 19:04 ET
- Period: 2018-09-30
- Accession: 0001493152-18-015980
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/868278/000149315218015980/form10-q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/868278/000149315218015980/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2018-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2018-07-01 to 2018-09-30 | $2.4m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Revenue | 9 months, 2018-01-01 to 2018-09-30 | $9.0m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Cost of revenue | 3 months, 2018-07-01 to 2018-09-30 | $1.7m | us-gaap:CostOfGoodsAndServicesSold |
| Cost of revenue | 9 months, 2018-01-01 to 2018-09-30 | $5.6m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2018-07-01 to 2018-09-30 | $756.0k | us-gaap:GrossProfit |
| Gross profit | 9 months, 2018-01-01 to 2018-09-30 | $3.4m | us-gaap:GrossProfit |
| Research and development | 3 months, 2018-07-01 to 2018-09-30 | $144.0k | us-gaap:ResearchAndDevelopmentExpense |
| Research and development | 9 months, 2018-01-01 to 2018-09-30 | $319.0k | us-gaap:ResearchAndDevelopmentExpense |
| Operating income | 3 months, 2018-07-01 to 2018-09-30 | −$912.0k | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2018-01-01 to 2018-09-30 | −$1.2m | us-gaap:OperatingIncomeLoss |
| Net income | 3 months, 2018-07-01 to 2018-09-30 | −$1.1m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2018-01-01 to 2018-09-30 | −$1.3m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2018-07-01 to 2018-09-30 | −$0.09 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2018-01-01 to 2018-09-30 | −$0.11 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2018-07-01 to 2018-09-30 | −$0.09 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2018-01-01 to 2018-09-30 | −$0.11 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2018-07-01 to 2018-09-30 | 11,541 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2018-01-01 to 2018-09-30 | 11,344 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2018-01-01 to 2018-09-30 | −$1.3m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2018-01-01 to 2018-09-30 | $24.0k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2018-09-30 | $2.3m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2018-09-30 | $18.1m | us-gaap:AssetsCurrent |
| Total assets | at 2018-09-30 | $20.6m | us-gaap:Assets |
| Current liabilities | at 2018-09-30 | $876.0k | us-gaap:LiabilitiesCurrent |
| Shareholders' equity | at 2018-09-30 | $19.7m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 43,856 characters.

*The following discussion and analysis should be read in conjunction with our interim unaudited condensed financial statements and related notes included in this Quarterly Report on Form 10-Q (“Quarterly Report”) and the audited financial statements and notes thereto as of and for the year ended December 31, 2017 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K/A filed with the Securities and Exchange Commission (“SEC”) on August 20, 2018 (the “2017 Annual Report”). As used in this Quarterly Report, unless the context suggests otherwise, “we,” “us,” “our,” or “ProPhase” refer to ProPhase Labs, Inc. and its subsidiaries and consolidated variable interest entities, unless the context otherwise requires.*

### Forward-Looking Statements

This Quarterly Report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements. Many of these factors are beyond our ability to predict. Given the risks and uncertainties surrounding forward-looking statements, you should not place undue reliance on these statements. Forward-looking statements typically are identified by use of terms such as “anticipate”, “believe”, “plan”, “expect”, “intend”, “may”, “will”, “should”, “estimate”, “predict”, “potential”, “continue” and similar words although some forward-looking statements are expressed differently. This Quarterly Report may contain forward-looking statements attributable to third parties relating to their estimates regarding the growth of our markets. You are cautioned that such forward-looking statements are not guarantees of future performance and that all forward-looking statements address matters that involve risk and uncertainties, and there are many important risks, uncertainties and other factors that could cause our actual results, levels of activity, performance, achievements and prospects, as well as those of the markets we serve, to differ materially from the forward-looking statements contained in this Quarterly Report.

Such risks and uncertainties include, but are not limited to:

|  |  |
| --- | --- |
| ● | The ability of our management to successfully implement our business plan and strategy; |
| ● | Our ability to compete effectively, including our ability to maintain and increase our markets and/or market share in the markets in which we do business; |
| ● | Our ability to fund our operations including the cost and availability of capital and credit; |
| ● | Our ability to grow our manufacturing business and operate it profitably; |
| ● | Potential disruptions in our ability to manufacture our products and those of others or our access to raw materials; |
| ● | Our ability to successfully develop and commercialize our existing products and new products; |
| ● | Changes in our retail and distribution customers strategic business plans including, but not limited to, (i) expansions, mergers, and/or consolidations, (ii) retail shelf space allocations for products within each outlet and in particular the healthcare category in which we compete, (iii) changes in their private label assortment and (iv) product selections, distribution allocation, merchandising programs and retail pricing of our products as well as competitive products; |
| ● | The general financial and economic uncertainty, fluctuations in consumer confidence and the strength of the United States economy, and their impacts on our business including demand for our products; |
|  | Our ability to protect our proprietary rights; |
| ● | Our continued ability to comply with regulations relating to our current products and those we manufacture for others, and any new products we develop, including our ability to effectively respond to changes in laws and regulations or the interpretation thereof including changing market rules and evolving federal, state and regional laws and regulations; |
| ● | Seasonal fluctuations in demand for the products we manufacture at our manufacturing facility; and |
| ● | Our ability to attract, retain and motivate our key employees. |

22

You should also consider carefully the statements we make under other sections of this Quarterly Report and in our 2017 Annual Report, as well as in other documents we file from time to time with the SEC, that address additional risks that could cause our actual results to differ from those set forth in any forward-looking statements. Our forward-looking statements speak only as the date of this Quarterly Report. We undertake no obligation to publicly update or review any forward-looking statements, whether as a result of new information, future developments or otherwise, except as required by law.

### General

ProPhase was initially organized in Nevada in July 1989. Effective June 18, 2015, we changed our state of incorporation from the State of Nevada to the State of Delaware. We are a vertically integrated and diversified branding, marketing and technology company with deep experience with OTC consumer healthcare products, dietary supplements and other remedies. We are engaged in the research, development, manufacture, distribution, marketing and sale of 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.

ProPhase Digital Media, Inc. (“PDM”), a wholly-owned subsidiary of ProPhase Labs, Inc., is an independent full-service direct marketing agency. PDM’s first initiative will be to market the TK Supplements® product line. If successful, this may lead to the marketing of other companies’ consumer products.

In addition, we also continue to actively pursue acquisition opportunities for other companies, technologies and products within and outside the consumer products industry.

### 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 Consumer Healthcare Inc. (formerly known as Meda Consumer Healthcare Inc.) (“MCH”) and Mylan Inc. (together with MCH, “Mylan”) pursuant to the terms of an Asset Purchase Agreement, dated January 6, 2017 (the “Asset Purchase Agreement”). As a consequence of the sale of the Cold-EEZE® Business, for the three and nine months ended September 30, 2017, we have classified as discontinued operations (i) all income and expenses attributable to the Cold-EEZE® Business, (ii) the gain from the sale of the Cold-EEZE® Business, and (iii) the income tax expense attributed to the sale of the Cold-EEZE® Business. Excluded from the sale of the Cold-EEZE® Business were our accounts receivable and inventory. We have also retained all liabilities associated with our Cold-EEZE® Business operations arising prior to March 29, 2017.

On May 31, 2018, we received notice from Mylan of a claim for $800,000 in losses against the escrow account established with Mylan in connection with our sale of the Cold-EEZE® Business. We resolved this claim pursuant to a settlement agreement, effective October 16, 2018, pursuant to which $160,000 of the funds held in escrow were released to Mylan (the “Mylan Settlement”). This expense is reflected in discontinued operations for the three and nine months ended September 30, 2018.

### Continuing Operations and Product Development

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 (see Note 8) 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 healthcare and dietary supplement 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 and pre-commercialization and market testing initiatives in the OTC dietary supplement category under the brand name of TK Supplements®. The TK Supplements® product line comprises three men’s health products: (i) Legendz XL® for sexual health, (ii) Triple Edge XL®, an energy booster plus testosterone support, and (iii) Super ProstaFlow PlusTM for prostate and urinary health. In addition to developing direct-to-consumer (“Direct Response”) marketing strategies for Legendz XL®, we are currently in distribution in a national chain drug retailer and several regional retailers.

As with any new product launch, we anticipate losses from the TK Supplements® products as we optimize our retail and direct response strategy.

Product Innovation, Seasonality of the Business and Liquidity

Our net sales are derived principally from our contract manufacturing of OTC healthcare and dietary supplements products 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 (i) by market acceptance of our TK Supplement® products and (ii) by the ultimate level of demand for our contract manufactured OTC healthcare and dietary supplement products which are a function of the timing, length and severity of each cold season. Generally, a cold season is defined as the period of September to March when the incidence of the common cold rises as a consequence of the change in weather and other factors.

As a consequence of the scope and timing of our TK Supplements® product market launch and the seasonality of our contract manufacturing OTC business, we realize variations in operating results and demand for working capital from quarter to quarter. As of September 30, 2018, we had working capital of approximately $17.2 million, including $6.9 million marketable securities available for sale. We believe our current working capital at September 30, 2018 is at an acceptable and adequate level to support our business for at least the next twelve months.

### Financial Condition and Results of Operations

### Results from Continuing Operations for the Three Months Ended September 30, 2018

### as Compared to the Three Months Ended September 30, 2017

For the three months ended September 30, 2018, net sales were $2.4 million as compared to $3.0 million for the three months ended September 30, 2017. The decrease in net sales from period to period was principally due to a decrease in contract manufacturing net sales.

Cost of sales for the three months ended September 30, 2018 were $1.7 million as compared to $2.6 million for the three months ended September 30, 2017. For the three months ended September 30, 2018 and 2017, we realized a gross margin of 31.0% and 14.2%, respectively. The increase of 16.8% in gross margin from the prior period is principally due to (i) better cost management on raw materials, (ii) an increase in the absorption of fixed production costs and (iii) improved streamlining of our manufacturing processes from period to period.

Sales and marketing expense for the three months ended September 30, 2018 was $395,000 as compared to $150,000 for the three months ended September 30, 2017. The increase of $245,000 in sales and marketing expense was principally due to the development costs associated with launching TK Supplements product lines.

Administration expenses for the three months ended September 30, 2018 was $1.1 million as compared to $1.1 million or the three months ended September 30, 2017.

Research and development costs during the three months ended September 30, 2018 was $144,000, as compared to $60,000 for the three months ended September 30, 2017. The increase of $84,000 in research and development costs for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017 was due principally to the timing of product research expenses in the current period.

Interest income for the three months ended September 30, 2018 and 2017 was $15,000 and $125,000, respectively. The decrease in interest income for the three months ended September 30, 2018 as compared to September 30, 2017 was principally due a lower balance in our investment account available to earn interest.

For the three months ended September 30, 2018, we charged $160,000 to the loss on sale of the discontinued operations resulting from the Mylan Settlement and for the three months ended September 30, 2017, we charged to discontinued operations $3.5 million for estimated federal and state income taxes arising from the sale of the Cold-EEZE® Business and we realized an income tax benefit from continuing operations of $1.0 million as a consequence of the utilization of the federal and state net operating losses.

For the three months ended September 30, 2017, results from operations for our Cold-EEZE® Business are classified as discontinued operations. The carve out of the discontinued operations 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 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 the three months ended September 30, 2017, there were no costs incurred related to discontinued operations.

As a consequence of the effects of the above, the net loss from continuing operations for the three months ended September 30, 2018 was $897,000, or ($0.08) per share, as compared to net loss of $472,000, or ($0.03) per share, for the three months ended September 30, 2017. Net loss from discontinued operations for the three months ended September 30, 2018 was $160,000, or ($0.01), compared to $305,000, or (0.02) per share, for the three months ended September 30, 2017.

### Financial Condition and Results of Operations

### Results from Continuing Operations for the Nine Months Ended September 30, 2018

### as Compared to the Nine Months Ended September 30, 2017

For the nine months ended September 30, 2018, net sales were $9.0 million as compared to $5.7 million for the nine months ended September 30, 2017. The increase in net sales from period to period was principally due to the treatment of the discontinued operations for the Cold-EEZE® Business in the prior period and an increase in contract manufacturing net sales.

Cost of sales for the nine months ended September 30, 2018 were $5.6 million as compared to $5.1 million for the nine months ended September 30, 2017. For the nine months ended September 30, 2018 and 2017, we realized a gross margin of 38.1% and 11.5%, respectively. The increase of 26.6% in gross margin from the prior period is principally due to (i) treatment of the discontinued operations for the Cold-EEZE® Business in the prior period (ii) an increase in the absorption of fixed production costs, and (iii) improved streamlining of our manufacturing processes from period to period.

Sales and marketing expense for the nine months ended September 30, 2018 was $802,000 as compared to $486,000 for the nine months ended September 30, 2017. The increase of $316,000 in sales and marketing expense was principally due to treatment of the discontinued operations for the Cold-EEZE® Business in the prior period and the development costs associated with launching TK Supplements product lines.

Administration expenses for the nine months ended September 30, 2018 was $3.5 million as compared to $3.5 million for the nine months ended September 30, 2017.

Research and development costs during the nine months ended September 30, 2018 were $319,000, as compared to $318,000 for the nine months ended September 30, 2017.

Interest income (expense), net for the nine months ended September 30, 2018 and 2017 was $115,000 and $222,000, respectively. The decrease in interest income (expense) was the result of the net effects of interest income of $125,000 earned on our investment account offset by interest expense of $54,000 incurred pursuant to the terms of the secured promissory notes.

Other income for the nine months ended September 30, 2018 and 2017 was zero and $150,000, respectively. The decrease in other income was due to the transition services fees earned in 2017 pursuant to the terms of the transition services agreement with Mylan, which fees were not payable in 2018.

For the nine months ended September 30, 2017, we charged to discontinued operations $3.4 million for estimated federal and state income taxes arising from the sale of the Cold-EEZE® Business and we realized an income tax benefit from continuing operations of $1.3 million as a consequence of the utilization of the federal and state net operating losses. There were no discontinued operations during the nine months ended September 30, 2018.

For the nine months ended September 30, 2017, results from operations for our Cold-EEZE® Business are classified as discontinued operations. The carve out of the discontinued operations 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 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 the nine months ended September 30, 2017, we allocated (i) $348,000 to administrative operating expenses, included in Administration and (ii) $52,000 to research and development operating expenses, in the accompanying statement of operations. As a consequence of the sale of the Cold-EEZE® Business, we recorded a gain on the sale of the assets of $42.4 million, net of $3.4 million of income tax.

As a consequence of the effects of the above, the net loss from continuing operations for the nine months ended September 30, 2018 was $1.1 million, or ($0.10) per share as compared to net loss of $2.1 million, or ($0.13) for the nine months ended September 30, 2017. Net loss from discontinued operations for the nine months ended September 30, 2018 was $160,000, or ($0.01) per share, compared to net gain from discontinued operations of $42.9 million, or $2.58 per share, at September 30, 2017. Net loss for the nine months ended September 30, 2018 was $1.3 million, or ($0.11) per share as compared to $40.8 million, or $2.45 per share for the nine months ended September 30, 2017.

### Liquidity and Capital Resources

Our aggregate cash and cash equivalents and including marketable securities, as of September 30, 2018, were $9.1 million compared to $21.9 million at December 31, 2017. The decrease of $12.8 million in our cash and securities balance for the nine months ended September 30, 2018 was principally due the $11.7 million payment of a $1.00 special cash dividend in June 2018 and cash used in operating activities

#### Amended and Restated Employment Agreement with Ted Karkus

On February 16, 2018, our board of directors approved the Amended and Restated 2015 Executive Employment Agreement with Ted Karkus, our Chief Executive Officer (the “Amended Employment Agreement”), which became effective February 23, 2018 and which received stockholder approval at a special meeting of stockholders held on 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 his previous employment agreement (the “Prior Employment Agreement”) (i.e., not less than $675,000 per annum) to a base salary of $125,000 per annum (the “Term Base Salary”) through February 22, 2021. Unless otherwise determined by the mutual agreement of the Company and Mr. Karkus, on February 22, 2021 and thereafter, Mr. Karkus’ 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 awarded Mr. Karkus a stock option to purchase 2,300,000 shares of our Common Stock at an exercise price of $3.00 per share on February 23, 2018 (the “CEO Option”).The CEO 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 CEO Option is be exercisable for a five year term commencing on the date of grant. The CEO Option was granted pursuant to the 2018 Stock Plan, which was also adopted and approved by our board of directors on February 16, 2018. The 2018 Plan, like the Amended Employment Agreement, received stockholder approval at a special meeting of stockholders held on April 12, 2018 at which time the options were considered granted. The 2018 Plan authorizes the issuance of up to 2,300,000 shares pursuant to stock options granted under the 2018 Plan, all of which were issued to Mr. Karkus as part of the CEO Option.

On May 7, 2018, the Compensation Committee of the board of directors, as required by the terms of the 2018 Stock Plan, adjusted the terms of the CEO Option, such that the exercise price of the CEO Option was reduced from $3.00 per share to $2.00 per share, effective as of June 5, 2018, the date of the special $1.00 cash dividend was paid to the stockholders in order to maintain parity.

#### Asset Purchase Agreement with Mylan

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, which was March 29, 2017, other than certain fundamental representations which survive until the expiration of the applicable statute of limitations. There is a limited indemnification cap with respect to a majority of the Company’s indemnification obligations under the Asset Purchase Agreement with the exception of claims for actual fraud, the breach of any fundamental representations and certain other items, which have a larger indemnification cap (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 (the “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 18th 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. As descripted below, in August 2018, Mylan asserted an indemnification claim against us, for a yet to be determined amount. Accordingly, the first distribution was not released to us on September 29, 2018 and remains subject to resolution of this claim.

On May 31, 2018, we received notice of a claim for $800,000 in losses against the escrow amount. We have resolved this claim pursuant to the settlement agreement effective October 16, 2018, pursuant to which $160,000 of the funds held in escrow were released to Mylan. This expense is reflected in discontinued operations for the three and nine months ended September 30, 2018.

On August 2, 2018, we received notice of an indemnification claim from Mylan in relation to product advertising claims brought against Mylan on certain Cold-EEZE® products. Pursuant to the terms of the Asset Purchase Agreement, we have elected to assume the defense of these claims on behalf of Mylan. We dispute these product advertising claims and intend to vigorously contest such claims. While we believe this claim is without merit, in the event that this or any other indemnity claim is successful, however, we may be required to pay Mylan such amounts out of escrow fund, pursuant to the indemnification provisions of the Asset Purchase Agreement which may reduce the amount we ultimately collect from escrow or could even require us to return a portion of the net proceeds received from the sale of the Cold-EEZE® Business if the escrow funds are insufficient to cover the losses. Management expects to collect the full remaining escrow balance.

#### General

As of September 30, 2018, we had working capital of approximately $17.2 million. We believe our current working capital is an acceptable and adequate level of working capital to support our business for at least the next twelve months.

On June 25, 2018, we filed a shelf registration statement with the SEC, which was declared effective on July 5, 2018. The shelf registration statement allows us to issue, from time to time, at prices and on terms to be determined at or prior to the time of an offering, up to $75 million of any combination of an indeterminate number of shares of common stock, preferred stock, warrants and units, subject to certain limitations for so long as our public float is less than $75 million.

Management is not aware of any other trends, events or uncertainties that have or are reasonably likely to have a material negative impact upon our (i) short-term or long-term liquidity, or (ii) net sales or income from continuing operations. Any challenge to our patent or trademark rights could have a material adverse effect on our future; however, we are not aware of any condition that would make such an event probable. Our business is subject to seasonal variations thereby impacting our liquidity and working capital during the course of our fiscal year.

To the extent that we do not generate sufficient cash from operations, our cash balances will decline. We may also use our cash to explore and/or acquire new product technologies, applications, product line extensions, new contract manufacturing applications and other new product opportunities. In the event that our available cash is insufficient to support such initiatives, we may need to incur indebtedness or issue Common Stock to finance plans for growth. Volatility in the credit markets and the liquidity of major financial institutions may have an adverse effect on our ability to fund our business strategy through borrowings, under either existing or newly created instruments in the public or private markets on terms that we believe to be reasonable, if at all.

### Off-Balance Sheet Arrangements

It is not our usual business practice to enter into off-balance sheet arrangements such as guarantees on loans and financial commitments and retained interests in assets transferred to an unconsolidated entity for securitization purposes. We have no off-balance sheet arrangements that have, or are reasonably likely to have, a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

### Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Our significant accounting policies are described in Note 2 of the Notes to Condensed Consolidated Financial Statements included under Item 1 of this Part I of this Quarterly Report. However, certain accounting policies are deemed “critical”, as they require management’s highest degree of judgment, estimates and assumptions. These accounting policies, estimates, and disclosures have been discussed with Audit Committee of our Board of Directors. A discussion of our critical accounting policies and estimates, the judgments and uncertainties affecting their application and the likelihood that materially different amounts would be reported under different conditions or using different assumptions are as follows:

#### Revenue Recognition – Sales Allowance

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.

Under ASC 606, the Company shall continue to recognize contract manufacturing and retail customers at a point in time as the Company has an enforceable right to payment for goods as products are shipped to customers.

Pursuant to the Asset Purchase Agreement, we are responsible for and continue to accept product returns of the Cold-EEZE® Business for product shipped prior to March 30, 2017. Additionally, pursuant to the terms of the Asset Purchase Agreement, we allocated and agreed to pay Mylan an aggregate of $400,000 for future a sales returns and allowances arising from certain product returns that were sold by us prior to March 30, 2017.

As of September 30, 2018 and December 31, 2017, we included a provision for sales allowances from continuing operations of $1,000 and $2,000, respectively. Additionally, accrued advertising and other allowances from discontinued operations as of September 30, 2018, included (i) $260,000 for estimated returns and $88,000 for cooperative incentive promotion costs. As of December 31, 2017, accrued advertising and other allowances from discontinued operations included (i) $480,000 for estimated future sales returns and (ii) $200,000 for cooperative incentive promotion costs.

As of September 30, 2018, we have deferred revenue of $57,000 in relation to R&D stability and release testing programs.

#### Income Taxes

Accounting for income taxes requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. These deferred taxes are measured by applying the provisions of tax laws in effect at the balance sheet date, including the impact of the Tax Cuts and Jobs Act enacted on December 22, 2017 (the “TCJA”). The TCJA made broad and significant changes to the U.S. Tax Code that affects the year ended December 31, 2017, including, but not limited to, a change in the federal rate from 35% to 21%, effective January 1, 2018.

The Company recognizes in income the effect of a change in tax rates on deferred tax assets and liabilities in the period that includes the TCJA enactment date. 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.

### Recently Adopted 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 adopted the new standard as of January 1, 2018, using the modified retrospective method. See the Revenue Recognition section within the Summary of Significant Accounting Policies in Note 2 for further details on the impact to the our consolidated financial statements upon adoption and practical expedients elected. The implementation of the new revenue recognition standard did not have a material impact on our consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18 “Statement of Cash Flows: Restricted Cash” which requires a statement of cash flows to explain the change during a period in the total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Under the new standard, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown in the statement of cash flows. ASU 2016-18 was effective for us as of January 1, 2018. We have not generally had restricted cash or restricted cash equivalents, and there is no restricted cash on the balance sheet as of June 30, 2018. The adoption of this update did not have a material impact 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, none of which currently apply to us. The new guidance was effective for us in the first quarter of 2018. The adoption of ASU 2016-15 did not have a material impact on our 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 to recognize the income tax consequences of an asset other than inventory when the asset transfer occurs. The new guidance was effective for us in the first quarter of 2018. The adoption of ASU 2016-15 did not have a material impact on our financial statements.

### Recently Issued Accounting Standards

In June 2018, the FASB issued Accounting Standards Update (ASU) 2018-07 intended to reduce cost and complexity and to improve financial reporting for nonemployee share-based payments. Currently, the accounting requirements for nonemployee and employee share-based payment transactions are significantly different. This ASU expands the scope of Topic 718, Compensation-Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. This ASU supersedes Subtopic 505-50, Equity-Equity-Based Payments to Nonemployees. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2018, with early adoption permitted. We are currently evaluating the impact of this new standard on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”) which supersedes ASC Topic 840, *Leases*. ASU 2016-02 requires lessees to recognize a right-of-use asset and a lease liability on their balance sheets for all the leases with terms greater than twelve months. Based on certain criteria, leases will be classified as either financing or operating, with classification affecting the pattern of expense recognition in the income statement. For leases with a term of twelve months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. In July 2018, the FASB issued ASU No. 2018-11, “Leases (Topic 842): Targeted Improvements” that allows entities to apply the provisions of the new standard at the effective date (e.g. January 1, 2019), as opposed to the earliest period presented under the modified retrospective transition approach (January 1, 2017) and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The modified retrospective approach includes a number of optional practical expedients primarily focused on leases that commenced before the effective date of Topic 842, including continuing to account for leases that commence before the effective date in accordance with previous guidance, unless the lease is modified. We currently expect that most of our operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon its adoption of Topic 842, which will increase the total assets and total liabilities that we report relative to such amounts prior to adoption.

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 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820), – Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement,” which makes a number of changes meant to add, modify or remove certain disclosure requirements associated with the movement amongst or hierarchy associated with Level 1, Level 2 and Level 3 fair value measurements. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted upon issuance of the update. We do not expect the adoption of this guidance to have a material impact on its condensed consolidated Financial Statements.

In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed. This final rule is effective on November 5, 2018. Pursuant to an interpretation from SEC staff which indicated it would not object if filers did not implement this new release until periods beginning on or after the effective date, we will not implement this change until our quarterly report on Form 10-Q for the period ended March 31, 2019.

## Market risk

As filed, 1,425 characters.

Like virtually all commercial enterprises, we can be exposed to the risk (“market risk”) that the cash flows to be received or paid relating to certain financial instruments could change as a result of changes in interest rate, exchange rates, commodity prices, equity prices and other market changes.

Our operations are not subject to risks of material foreign currency fluctuations, nor do we use derivative financial instruments in our investment practices. We place our marketable investments in instruments that meet high credit quality standards. We do not expect material losses with respect to our investment portfolio or excessive exposure to market risks associated with interest rates. The impact on our results of one percentage point change in short-term interest rates would not have a material impact on our future earnings, fair value, or cash flows related to investments in cash equivalents or interest-earning marketable securities.

Current economic conditions may cause a decline in business and consumer spending which could adversely affect our business and financial performance including the collection of accounts receivables, realization of inventory and recoverability of assets. In addition, our business and financial performance may be adversely affected by current and future economic conditions, including a reduction in the availability of credit, financial market volatility and recession.

## Controls and procedures

As filed, 3,945 characters.

### Disclosure controls and procedures

We maintain “disclosure controls and procedures,” as that term is defined in Rule 13a-15(e), promulgated by the SEC pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurances that the objectives of the control system will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. However, our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives.

Our management, under the supervision and with the participation of the principal executive officer and principal accounting and financial officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Based on this evaluation, our principal executive officer and principal accounting and financial officer concluded that as of September 30, 2018, our disclosure controls and procedures continue to be not effective due to a material weakness identified in our internal control over financial reporting for the June 30, 2018 period.

A material weakness is a deficiency or a combination of control deficiencies in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

Following the filing of our original 2017 Form 10-K and during the financial statement close process for the quarter ended June 30, 2018 in connection with the preparation of our 2017 Federal and State income tax returns, management identified a material weakness that existed as of at December 31, 2017, primarily related to our lack of adequate controls over the accounting for recording of income tax expense and the allocation of income tax expense/ benefit between continuing and discontinued operations.

### Remediation Plan for Material Weakness in Internal Control over Financial Reporting

Beginning in August 2018, the Company’s management began implementing certain remediation measures to address the above-described material weakness and enhance the Company’s internal control over financial reporting. Management is making progress on its remediation plan which includes (i) reviewing our income tax processes and controls, (ii) evaluating the sufficiency of our income tax accounting experts and (iii) implementing management oversight with respect to the review of income tax reporting and disclosures. These measures will be implemented during the fourth quarter of Fiscal 2018.

### Changes in internal control over financial reporting

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 131 characters.

There have been no material changes to the risks described in Item 1A. Risk Factors of the 2017 Annual Report filed on Form 10-K/A.

Filed Nov 14, 2018.
Source: SEC EDGAR, the filing index for accession 0001493152-18-015980. Last ingested by Listed: Oct 24, 2026, 14:58 ET. No prices; not investment advice.