UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

For the fiscal year ended  December 31, 2013

OR

 

For the transition period from ______ to ______

 

Commission file number 01-21617

 

 

 

 

Registrant’s telephone number, including area code (215) 345-0919

 

Securities registered pursuant to Section 12(b) of the Act: 

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.      

Yes ¨    No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  

Yes ¨    No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x      No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).

Yes x      No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨  No x

 

The aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates was $15,803,329 as of June 30, 2013, based on the closing price of the common stock on The NASDAQ Global Market.

 

Number of shares of each of the registrant’s classes of securities outstanding on March 25, 2014

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Information set forth in Part III of this report is incorporated by reference to the registrant’s proxy statement for the 2014 annual meeting of stockholders.

 

 

 

TABLE OF CONTENTS

 

 

 

PART I

 

Forward-Looking Statements

 

This Annual Report on Form 10-K (“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 Report may contain forward-looking statements attributed 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 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 fund our operations including the cost and availability of capital and credit;

·

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 dependence on sales from our principal product, Cold-EEZEÒ Cold Remedy, and our ability to successfully develop and commercialize our 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 cough/cold 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 uncertain length and severity of the general financial and economic downturn, the timing and strength of an economic recovery, if any, 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 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;

·

Potential disruptions in our ability to manufacture our products or our access to raw materials;

·

Seasonal fluctuations in demand for our products;

	·	Our ability to attract, retain and motivate our key employees;
	·	The ability of Phusion Laboratories, LLC, a 50% owned joint venture, to successfully implement its business plan and strategy to develop and commercialize one or more non-prescription remedies using certain patented and proprietary technology; and

·

Other risks identified in this Report.

 

You should also consider carefully the statements under other sections of this Report, including the Risk Factors included in Item 1A, which 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 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.

 

 

 

Where You Can Find Other Information

 

ProPhase Labs, Inc. (“we”, “us” or the “Company”) files periodic and current reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). We make available on our website (www.ProPhaseLabs.com) free of charge our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to or exhibits included in those reports as soon as reasonably practical after we electronically file such materials with or furnish them to the SEC. Information appearing on our website is not part of this Annual Report on Form 10-K. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington D.C. 20549-1004. You may request copies of these documents, upon payment of a duplication fee, by writing the SEC at its principal office at 100 F Street, NE Room 1580, Washington, D.C. 20549-1004. In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements regarding issuers that file electronically with the SEC, including the Company.

 

 

 

We are a manufacturer, marketer and distributor of a diversified range of homeopathic and health products that are offered to the general public. We are also engaged in the research and development of potential over-the-counter (“OTC”) drug, natural base health products along with supplements, personal care and cosmeceutical products.

 

Our primary business is the manufacture, distribution, marketing and sale of OTC cold remedy products to consumers through national chain, regional, specialty and local retail stores. Our flagship brand is Cold-EEZE^Ò Cold Remedy and our principal product is Cold-EEZE^Ò zinc gluconate lozenges, proven in clinical studies to reduce the duration and severity of symptoms of the common cold by 42%. In addition to Cold-EEZE^® Cold Remedy lozenges, we market and distribute non-lozenge forms of our proprietary zinc gluconate formulation, (i) Cold-EEZE^® Cold Remedy QuickMelts^® and (ii) Cold-EEZE^® Cold Remedy Oral Spray. In Fiscal 2013, we expanded our Cold-EEZE^® Cold Remedy QuickMelts^® product line and began shipments to retailers in July 2013 two new products, Cold-EEZE^® Plus Immune Support QuickMelts^® and Cold-EEZE^® Plus Immune Support + Energy QuickMelts^®. Each of these new Cold-EEZE^® QuickMelts^® products are based on our proprietary zinc gluconate formulation in combination with certain immune system support and natural energy active ingredients. 

 

Cold-EEZE^Ò Cold Remedy is an established product in the health care and cold remedy market. For Fiscal 2013, 2012 and 2011, our revenues have come principally from our OTC cold remedy products. For Fiscal 2013 and 2012, our net sales for each period were related to markets in the United States.

 

We use a December 31 year-end for financial reporting purposes. References herein to the fiscal year ended December 31, 2013 shall be the term “Fiscal 2013” and references to other “Fiscal” years shall mean the year, which ended on December 31 of the year indicated.

 

We are a corporation organized in Nevada in July 1989. Our principal executive offices are located at 621 N. Shady Retreat Road, Doylestown, Pennsylvania 18901 and our telephone number is 215-345-0919. The terms, “we”, “us” and the “Company” refer to the Company together with its consolidated subsidiaries unless the context otherwise requires. 

 

 

Cold-EEZE^Ò Cold Remedy is one of our most popular OTC cold remedy products and its benefits are derived from its proprietary zinc gluconate formulation. Cold-EEZE^Ò Cold Remedy lozenges effectiveness has been substantiated in two double-blind clinical studies proving that Cold-EEZE^Ò Cold Remedy lozenges reduce the duration of the common cold by 42%. We acquired worldwide manufacturing and distribution rights to our lozenge formulation in 1992 and commenced national marketing in 1996. In addition to our lozenge product, the Cold-EEZE^Ò Cold Remedy proprietary zinc gluconate formulation is available in two additional cold remedy delivery forms, (i) a fast dissolving QuickMelt and (ii) an Oral Spray. The demand for our OTC cold remedy products is seasonal, where the third and fourth quarters of each year generally have the largest sales volume.

 

 

 

Our business operations are concentrated on the development, manufacturing, marketing and distribution of our proprietary Cold-EEZE^Ò Cold Remedy lozenge products and on the development of various product extensions. Our product line of OTC cold remedy products are reviewed regularly to identify new consumer opportunities and/or trends in flavor, convenience, packaging and delivery systems or forms to help improve market share for our products. Additionally, we are active in exploring new product technologies, applications, product line extensions and other new product opportunities consistent with our company and brand image, and our standard of proven consumer benefit and efficacy.

 

Manufacturing Facility 

Our wholly owned subsidiary, Pharmaloz Manufacturing, Inc. (“PMI”), produces our Cold-EEZE^® Cold Remedy lozenges and other lozenge products in addition to performing operational tasks such as warehousing and shipping. Our PMI facility is located in Lebanon, Pennsylvania. Additionally, our PMI facility is a United States Food and Drug Administration (“FDA”) registered facility that engages in contract manufacturing and distribution activities. PMI also produces and sells therapeutic lozenges to unaffiliated third party retail, wholesale and distribution outlets.

 

Joint Venture – Phusion Laboratories, LLC

On March 22, 2010, we, Phosphagenics Limited (“PSI Parent”), an Australian corporation, Phosphagenics Inc. (“PSI”), a Delaware corporation and subsidiary of PSI Parent, and Phusion Laboratories, LLC (the “Joint Venture”), a Delaware limited liability company, entered into a Limited Liability Company Agreement (the “LLC Agreement”) of the 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”).  TPM facilitates the delivery and depth of penetration of active molecules in pharmaceutical, nutraceutical, and other products. Pursuant to the LLC Agreement, we and PSI each own a 50% membership interest in the Joint Venture.

 

The Joint Venture is managed by a four-person Board of Managers, with two managers appointed by each member. The LLC Agreement contains other standard terms in such arrangements, including provisions relating to the governance of the Joint Venture, indemnification obligations of the Joint Venture, allocation of profits and losses, the distribution of funds to the members and restrictions on transfer of a member’s interest.

 

 

 

	- 4 -

 

 

Pursuant to the LLC Agreement, we and PSI each own a 50% membership interest in the Joint Venture. PSI Parent conducts and oversees much of the product development, formulation, testing and other research and development needed by the Joint Venture, and we will oversee much of the production, distribution, sales and marketing. The LLC Agreement provides that each member may be required, from time to time and subject to certain limitations, to make capital contributions to the Joint Venture to fund its operations, in accordance with agreed upon budgets for products to be developed. Specifically, we contributed in Fiscal 2010 $500,000 in cash as initial capital and we are committed to fund up to $2.0 million, subject to agreed upon budgets (which have not been established to date), toward the initial development and marketing costs of new products for the Joint Venture. The Joint Venture has not engaged in any financial transactions, other than organizational expenses and general market and initial product evaluation and analysis. At December 31, 2013, cash and equivalents includes $378,000 which is expected to be used by the Joint Venture to fund future product development initiatives currently under consideration by PSI Parent, PSI and us.

 

Our determination is that the Joint Venture qualifies as a VIE and that we are the primary beneficiary.  We have consolidated the Joint Venture financial statements beginning with the quarter ended March 31, 2010.  In Fiscal 2010, we recorded our $3.6 million payment representing the estimated fair value to acquire the product license as an intangible asset.   We currently estimate the expected remaining useful life of the product license to be approximately 13 years which we will begin amortizing the cost of intangible asset once product development and commercialization begins.  Thus far, the Joint Venture has not generated any revenues and its expenses, including organizational, marketing analysis and preliminary formulations have been absorbed by the respective Joint Venture members.  Furthermore, the liabilities and other obligations incurred, if any, by the Joint Venture is without recourse to us and do not create a claim on our general assets.

 

The product development effort of the Joint Venture is a multi-stage process that includes (i) market analysis and research, (ii) product formulation research and development, (iii) product evaluation, (iv) product commercialization, (v) production and distribution, and (vi) retail and consumer advertising and marketing. We conducted preliminary market analysis to identify market opportunities to develop differentiated, science-based, efficacious products that deliver results to consumers and we have worked with PSI and PSI Parent to provide initial formulations for certain identified OTC active ingredients. In December 2011, we initiated a study of these preliminary formulations to evaluate product attributes, performance and potential commercial viability. These initial studies were completed in Fiscal 2013. Our initial studies provided certain positive indications and additional studies will be required. Such additional studies have not yet been scheduled.

Products

 

OTC Cold-Remedy Products

In May 1992, we entered into an exclusive agreement for worldwide representation, manufacturing and marketing of a zinc gluconate formulation. This zinc gluconate formulation is the foundation of our brand; Cold-EEZE^® Cold Remedy products which are distributed principally in the United States. Cold-EEZE^® Cold Remedy is an OTC consumer product used to reduce the duration of the common cold. We have substantiated the effectiveness of Cold-EEZE^® Cold Remedy lozenges through a variety of studies. A randomized double-blind placebo-controlled study, conducted at Dartmouth College of Health Science, Hanover, New Hampshire, concluded that the lozenge formulation treatment, initiated within 48 hours of symptom onset, resulted in a significant reduction in the total duration of the common cold.

 

 

 

On May 22, 1992, “Zinc and the Common Cold, a Controlled Clinical Study,” was published in England in the Journal of International Medical Research, Volume 20, Number 3, Pages 234-246. According to this publication, (a) flavorings used in other zinc lozenge products (citrate, tartrate, separate, orotate, picolinate, mannitol or sorbitol) render the zinc inactive and unavailable to the patient’s nasal passages, mouth and throat where cold symptoms have to be treated, (b) this patented formulation delivers approximately 93% of the active zinc to the mucosal surfaces and (c) the patient has the same sequence of symptoms as in the absence of treatment but goes through the phases at an accelerated rate and with reduced symptom severity.

 

On July 15, 1996, results of a randomized double-blind placebo-controlled study on the common cold, which commenced at the Cleveland Clinic Foundation on October 3, 1994, were published. The study “Zinc Gluconate Lozenges for Treating the Common Cold” was completed and published in The Annals of Internal Medicine – Volume 125 Number 2. Using a 13.3mg lozenge (almost half the strength of the lozenge used in the Dartmouth study), the result still showed a 42% reduction in the duration of common cold symptoms.

 

In addition to Cold-EEZE^® Cold Remedy lozenges, we market and distribute non-lozenge forms of our proprietary zinc gluconate formulation, (i) Cold-EEZE^® Cold Remedy QuickMelts^® and (ii) Cold-EEZE^® Cold Remedy Oral Spray. Cold-EEZE^® Cold Remedy Oral Spray is a liquid form of our zinc gluconate formulation that is sprayed in the mouth. Cold-EEZE^® Cold Remedy QuickMelts^® are fast dissolving tablets that are taken orally.

 

The Cold-EEZE^® Cold Remedy QuickMelts^® product line is comprised of (i) Cold-EEZE^® Daytime/Nighttime QuickMelts^® (launched in Fiscal 2012) and (ii) Cold-EEZE^® Plus Immune Support QuickMelts^® and Cold-EEZE^® Plus Immune Support + Energy QuickMelts^® (each launched in Fiscal 2013). We also manufacture, market and distribute organic cough drops and a Vitamin C supplement (“Organix”) and perform contract manufacturing services of cough drop and other OTC cold remedy products for third parties.

 

Our business is subject to federal and state health and safety laws and regulations. Our OTC cold remedies are subject to regulations by various federal, state and local agencies, including the FDA. Additionally, Cold-EEZE^®, a homeopathic cold remedy, is subject to the Homeopathic Pharmacopoeia of the United States. See “Regulatory Matters” below for more information.

 

Patents, Trademarks, Royalty and Commission Agreements

 

We do not currently own patents for our OTC cold-remedy products. We maintain various trademarks for each of our products including Cold-EEZE^®, Kids-EEZE^®, QuickMelts^®, Organix Rx Complete^® and Organix Rx Defense^®.

 

We currently own various domestic and international patents covering certain product development initiatives principally developed under our Pharma subsidiary operations.  To date, we have not realized any meaningful levels of revenues from such patents and we have suspended in Fiscal 2009 any further commercialization efforts for various products under such patents.

 

Our Joint Venture has (i) an exclusive, royalty-free, world-wide (subject to certain limitations), paid-up license to exploit OTC drugs (and certain other products) that embody certain PSI Technology and (ii) a non-exclusive, royalty-free, world-wide (subject to certain limitations) paid-up license to exploit certain compounds that embody the PSI Technology for use in a product combining one or more of such compounds with an OTC drug or in a product that is part of a regimen that includes the application of an OTC drug.

 

Product Distribution and Customers

 

Our products are distributed through national chain, regional, specialty and local retail stores throughout the United States. Revenues for Fiscal 2013, 2012 and 2011 were $25.0 million, $22.4 million and $17.5 million, respectively. Walgreen Company (“Walgreens”), Wal-Mart Stores Inc (“Wal-Mart”) and CVS Caremark Corporation (“CVS”) accounted for approximately 20.4%, 14.3% and 11.6%, respectively, of our Fiscal 2013 revenues. Walgreens, Wal-Mart and CVS accounted for approximately 19.3%, 13.8% and 13.4%, respectively, of our Fiscal 2012 revenues. Walgreens, Wal-Mart, CVS and Rite-Aid Corp (“Rite Aid”) accounted for approximately 17%, 14%, 13% and 12%, respectively, of our Fiscal 2011 revenues. The loss of sales to any one or more of these large retail customers could have a material adverse effect on our business operations and financial condition.

 

In addition, we have entered into multiple broker, distributor and representative agreements with third parties which provide for commission compensation based on sales performance.

 

 

 

Research and Development

 

We have historically invested significantly in research and development activities. Our research and development costs for Fiscal 2013, 2012 and 2011 were $824,000, $1.3 million and $1.1 million respectively.

 

During Fiscal 2013, 2012 and 2011, our research and development initiatives have been principally focused on product line development and/or line extensions for OTC cold remedy products under the Cold-EEZE^® brand. In addition, our Joint Venture is at its early stage of development where product and market research has been initiated and new product initiatives are being evaluated and prioritized for future development and commercialization utilizing the licensed PSI Technology. Through the Joint Venture, PSI Parent will conduct and oversee much of the product development, formulation, testing and other research and development needed by the Joint Venture, and we will oversee much of the production, distribution, sales and marketing. 

 

Currently, we fund our research and development costs with cash generated from operations. In addition to funding from operations, we may seek to raise capital through the issuance of securities or to other financing sources to support our research and development activities including new product technologies, applications, licensing, commercialization and other development opportunities, as well as acquisitions of new formulations, ingredients, applications and other products, including those products, if any, that may be developed through the Joint Venture. Any such funding through the issuance of our equity securities would result in the dilution of current stockholder ownership. Should research or commercialization activity progress on certain formulations, resulting expenditures may require substantial financial support and may necessitate the consideration of alternative approaches such as licensing, joint venture or partnership arrangements that meet our long term goals and objectives. Ultimately, should internal working capital be insufficient and external funding methods or other business arrangements become unattainable, it could result in the deferral or loss of future growth and development opportunities.

  

Regulatory Matters

 

We are subject to federal and state laws and regulations adopted for the health and safety of users of pharmaceutical and health care products. Our OTC cold remedy products are subject to regulation by various federal, state, and local agencies, including the FDA. In addition, our Cold-EEZE^® Cold Remedy products are subject to the standards established by the Homeopathic Pharmacopoeia of the United States. These regulatory authorities have broad powers, and we may be subject to regulatory and legislative changes that can affect the economics of the industry by requiring changes in operating practices or by influencing the demand for and the costs of manufacturing or distributing its products. Our Cold-EEZE^® Cold Remedy products are considered a homeopathic drug and are exempt from pre-approval requirements and other, but not all, FDA requirements. 

 

Many homeopathic drug products, including Cold-EEZE^Ò Cold Remedy products, are manufactured and distributed under FDA enforcement policies that provide criteria needed to market a homeopathic OTC drug product without FDA approval. We believe we meet those requirements, which include registration of our manufacturing facility, listing of the product in FDA’s product database, and packaging, labeling, and manufacturing homeopathic drugs in compliance with current good manufacturing practice (“cGMP”) regulations. Due to the unique nature of homeopathic drug products, some cGMP requirements are not applicable, including certain expiration dating, and testing and release for distribution. In addition, the FDA is currently not enforcing the requirement for a laboratory determination of identity and strength of each active ingredient prior to release for distribution, although this exemption is pending FDA review and we cannot assure that the exemption will be permanently implemented. We also cannot assure that the FDA will agree with our determination of compliance. If the FDA disagrees, the FDA could, upon inspection, issue a notice of violations, referred to as a form FDA-483, or issue a Warning Letter, or both. If we fail to take timely corrective actions to the satisfaction of FDA, the agency can initiate legal actions, such as seizure and injunction, which could include a recall order or the entry of a consent decree, or both. In addition, we could be subject to monetary penalties and even criminal prosecution for egregious conduct. We believe that we are in compliance with all such laws, regulations, and standards currently in effect including the Food, Drug, and Cosmetics Act as amended from time to time, and the standards established under the Homeopathic Pharmacopoeia of the United States.

 

Pre-clinical development, clinical trials, product manufacturing, labeling, marketing, distribution and licensing and/or acquisition of potential new products are also generally subject to federal and state regulation in the United States and other countries. Obtaining FDA and any other required regulatory approval for certain OTC products, or seeking the issuance of a final monograph from the FDA for certain OTC products, can require substantial resources and take several years. The length of this process depends on the type, complexity and novelty of the product and the nature of the disease or other indications to be treated. If we cannot obtain regulatory approval of, or final OTC monograph for, a new product(s) in a timely manner or if patents are not granted or are subsequently challenged, it could have a material adverse effect on our business and financial condition.

 

 

 

Competition

 

We compete with other suppliers of OTC cold remedy products. These suppliers range widely in size. Some of our competitors have significantly greater financial, technical or marketing resources than we do. Management believes that our Cold-EEZE^® Cold Remedy lozenge products, which have been clinically proven in two double-blind studies to reduce the severity of common cold symptoms, offer a significant advantage over many of our competitors in the OTC cold remedy market. We believe that our ability to compete depends on a number of factors, including product quality and price, availability, speed to market, consumer marketing, reliability, credit terms, brand name recognition, delivery time and post-sale service and support.

 

Employees

 

At December 31, 2013, we employed 50 full-time employees, the majority of which were employed at our manufacturing facility in a production function. The remaining employees were involved in an executive, sales, marketing or administrative capacity. None of our employees are covered by a collective bargaining agreement or are members of a union.

 

 Suppliers; Raw Materials

 

We derive our sales principally from our Cold-EEZE^Ò Cold Remedy zinc gluconate products which are available in various forms– lozenges, oral spray and QuickMelts^® – and various flavors for purchase by consumers at retail stores.  We also produce private label lozenge products for sale to certain retail customers.  Our zinc lozenge products are manufactured by us at our Lebanon, Pennsylvania facility.  The constituent raw materials and packaging used in the manufacture and presentation of these items are procured from various sources with additional suppliers having been identified in the event that alternatives are required.  While the absence of a current raw materials or packaging source may cause short term interruption, we expect that identified alternative sources would fill our needs in a short time and any transition period would be mitigated by adequate levels of finished product available for sale.  Certain products within our line of products such as Cold-EEZE^Ò Cold Remedy Oral Spray and Cold-EEZE^® Cold Remedy QuickMelts^® are manufactured for us by third party contract manufacturers and while currently purchased from single sources, we do not believe that there would be a material revenue risk to us if product availability was jeopardized.

 

 

Any of the following risks could materially affect our business, financial condition, or results of operations. These risks could also cause our actual results to differ materially from those indicated in the forward-looking statements contained herein and elsewhere. The risks described below are not the only risks facing us. Additional risks not currently known to us or those we currently deem to be immaterial may also materially and adversely affect our business, financial condition or results of operations.

 

Our business is subject to significant competitive pressures

The OTC healthcare product, pharmaceutical and consumer product industries are highly competitive. Many of our competitors have substantially greater capital resources, technical staffs, facilities, marketing resources, product development, distribution and experience than we do. Our competitors may have certain advantages, including the ability to allocate greater resources for new product development, marketing and other purposes.

 

We believe that our ability to compete depends on a number of factors, including product quality and price, availability, speed to market, consumer marketing, reliability, credit terms, brand name recognition, delivery time and post-sale service and support, and new and existing product innovation and commercialization. There can be no assurance that we will be able to compete successfully in the future. If we are unable to compete effectively, our earnings may be significantly negatively impacted.

 

 

 

Our long range business plan may not be successful

We have aligned our operations to focus principally in the research, development, manufacture, marketing and sale of OTC cold remedy and consumer products, natural based health products and other supplement and cosmeceutical products. In addition, we may seek to acquire from third parties or enter into other arrangements with respect to new formulations, ingredients, applications and other products developed by third parties who may be seeking our commercialization, marketing and distribution expertise.

 

There can be no assurance that we will be able to effectuate our business plan successfully or that our revenue growth will continue. In addition, we may not be successful in acquiring or otherwise entering into any new lines of business and, if we are successful in doing so, there can be no assurance that such new business will achieve profitability.

 

We will need to obtain additional capital to support long term product development and commercialization programs

Our ability to achieve and sustain operating profitability depends in large part on our ability to commence, execute and complete new and existing product innovation and commercialization, including the Joint Venture product development initiatives, and, if required, clinical programs to obtain regulatory approvals in the United States and elsewhere. We can give no assurance that we will be able to achieve such product innovation and commercialization, to obtain any required approvals or to achieve significant levels of sales.

 

The amount of capital that may be needed to complete product development initiatives will depend on many factors which may include but are not limited to (i) the cost involved in applying for and obtaining FDA, international regulatory or other technical approvals, (ii) whether we elect to establish partnering arrangements for development, sales, manufacturing and marketing of such products, (iii) the level of future sales of OTC cold remedy products, and expense levels for marketing efforts, (iv) whether we can establish and maintain strategic arrangements for development, sales, manufacturing and marketing of our products, and (v) whether any or all of the options for our Common Stock issued to employees of the Company are exercised and the timing and amount of these exercises. 

 

Should research or commercialization activity progress on certain formulations, resulting expenditures may require substantial financial support.  The current sales level of our OTC cold remedy products may not generate all the funds we anticipate will be needed to support future product acquisition or development.  Accordingly, in addition to funding from operations, we may in the short and long term seek to raise capital through the issuance of securities or to secure other financing sources to support our research, new product technologies, applications, licensing, commercialization and other development opportunities.  If we obtain such funding through the issuance of equity securities, it would result in the dilution of current stockholders’ ownership in the Company.  Any debt financing, if available, may include financial and other covenants that could restrict use of proceeds of such financing or impose other business and financial restrictions on us.  In addition, we may consider alternative approaches such as licensing, joint venture, or partnership arrangements to provide long term capital.   There can be no assurances that we will have access to the capital required to fun these aspects of our business on favorable terms or at all.

To the extent that we do not generate sufficient cash from operations, we may need to access our Equity Line to finance our growth. Recent volatility in the credit markets and the potential impact on the liquidity of major financial institutions may have an adverse effect on our ability to fund our business strategy through our Equity Line on terms that we believe to be reasonable, or at all.  Our Equity Line is limited and may not be sufficient to meet our capital requirements.

 

 

 

Our Equity Line with Dutchess may not be available to us if we elect to make a draw down

Pursuant to the Equity Line, Dutchess committed to purchase, subject to certain conditions, up to 2,500,000 shares of our Common Stock over a thirty-six month period.  Dutchess will not be obligated to purchase shares under the Equity Line unless certain conditions are met, which include, among others:  effectiveness of the registration statement; the continued listing of our stock on the NASDAQ Global Market; our compliance with our obligations under the purchase agreement and registration rights agreement entered into with Dutchess; the absence of injunctions or other governmental actions prohibiting the issuance of our Common Stock to Dutchess; the absence of violations of shareholder approval requirements with respect to such issuance of our common stock to Dutchess and the accuracy of representations and warranties made to Dutchess.  If we are unable to access funds through the Equity Line, we may be unable to access capital on favorable terms or at all.

 

Any draw downs under our Equity Line with Dutchess may result in dilution to our shareholders

If we sell shares to Dutchess under the equity line, it will have a dilutive effect on the holdings of our current shareholders, and may result in downward pressure on the price of our Common Stock.  If we draw down amounts under the equity line, we will issue shares to Dutchess at a discount of 5% from the average price of our Common Stock.  If we draw down amounts under the equity line when our share price is decreasing, we will need to issue more shares to raise the same amount than if our stock price was higher.  Issuances in the face of a declining share price will have an even greater dilutive effect than if our share price were stable or increasing, and may further decrease our share price.

 

We may not be able to commercialize new products through our Joint Venture

 

We face significant technological risks inherent in developing these products.  The Joint Venture may be subject to delays and/or ultimately unable to successfully implement its business plan and strategy to develop and commercialize one or more non-prescription remedies using certain patented and proprietary TPM^TM that exploit certain compounds that embody the TPM^TM for use in a product combining one or more of such compounds with an OTC drug.  The commercialization and ultimate product market acceptance is subject to, among other influences, consumer purchasing trends, demand for our OTC drug, health and wellness trends, regulatory factors, retail acceptance and overall economic and market conditions.  As a consequence, we may suspend or abandon some or all of our proposed new products before they become commercially viable which could have an adverse affect on our business.  Even if we develop and obtain approval of a new product, if we cannot successfully commercialize it in a timely manner, our business and financial condition may be materially adversely affected.

 

Instability and volatility in the financial markets could have a negative impact on our business, financial condition, results of operations and cash flows

In recent years, there has been substantial volatility in financial markets due at least in part to the global economic environment. In addition, there has been substantial uncertainty in the capital markets and access to financing is uncertain. Moreover, customer spending habits may be adversely affected by the current economic environment and prevailing high unemployment rates in the United States.  These conditions could have an adverse effect on our industry and business, including our access to funding sources, demand for our products and our customers’ ability to continue to purchase our products, which could have a material adverse effect on our financial condition, results of operations and cash flows.

 

To the extent that we do not generate sufficient cash from operations, we may need to issue equity or to incur indebtedness to finance our growth. Recent turmoil and volatility in the credit markets and the potential impact on 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, or at all.

 

 

	- 10 -

Commodity price increases will increase our operating costs and may negatively affect financial results

Commodity prices impact our business directly through the cost of raw materials used to make our products (such as corn syrup, sucrose and other commodities and ingredients) and the amount we pay to purchase packaging for our products (such as paper, board and plastic). Commodities such as these are susceptible to price volatility caused by conditions outside of our control, including fluctuations in commodities markets, currency fluctuations, availability of supply, weather, consumer demand and changes in governmental agricultural programs. Increases in the price of our commodities and other raw materials would negatively impact our gross margins and/or our sales volume if we were unable to offset such increases through increases in our selling price, changes in product mix or cost reduction/productivity enhancement efforts.

 

The sales of our primary product fluctuates by season and from Cold Season to Cold Season

Our sales are derived principally from our OTC cold remedy products. A significant portion of our business is highly seasonal, which causes major variations in operating results from quarter to quarter. The third and fourth quarters generally represent the largest sales volume for our OTC cold remedy products. In addition, our sales are influenced by and subject to fluctuations in the timing of purchase and the ultimate level of demand for our products which are a function of the timing, length and severity of each cold season. Generally, a Cold Season is defined as the period of September to March when the incidence of the common cold rises as a consequence of the change in weather and other factors.

 

There can be no assurance that we will be able to manage our working capital needs and inventory to meet the fluctuating demand for these products. Failure to accurately predict and respond to consumer demand may result in the production of excess inventory which may be expensive to store or which we may be required to dispose if such excess inventory remains unsold. Conversely, if products achieve greater success than anticipated for any given quarter, this may result in insufficient inventory to meet customer demand. If we do not manage our working capital needs and inventory, our business and financial condition may be materially adversely affected.

 

Our performance may fluctuate when our retail customers are affected simultaneously by the same economic, regulatory or health and wellness factors

Our revenues are significantly concentrated in our OTC cold remedy products. Our retail customers are subject to fluctuations of business based upon consumer purchasing trends, demand for cold remedy products and overall economic and market conditions. Consequently, many retailers will likely be influenced at the same time by similar economic conditions, regulatory factors or health and wellness trends, which can affect the level of demand for our products. It is reasonable to expect that, if one retailer reduces or delays its purchasing in response to a general economic, regulatory or health and wellness factor, other retailers may also decide to reduce or delay their purchasing at approximately the same time. Accordingly, our sales are subject to fluctuations as a result of such factors.

 

We have a concentration of sales to and accounts receivable from several large retail customers

Although we have a broad range of retail customers that includes many national chain, regional, specialty and local retail stores, our five largest customers account for a significant percentage of our sales, approximately 57% of total revenues for each of Fiscal 2013 and 2012, respectively. In addition, retail customers comprising the five largest accounts receivable balances represented 68% and 65% of total accounts receivable balances at December 31, 2013 and 2012, respectively. We extend credit to retail customers based upon an evaluation of their financial condition and credit history, and collateral is not generally required. If one or more of these large retail customers cannot pay, the write-off of their accounts receivable could have a material adverse effect on our operations and financial condition. The loss of sales to any one or more of these large retail customers would also have a material adverse effect on our financial condition, results of operations and cash flows.

 

Retail customer’s strategic business plans may negatively influence the distribution of our products to consumer.

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 cough/cold 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 could affect the consumer sales of our products and could result in a material adverse effect to our business and financial condition.

 

 

 

Our future success depends on the continued sales of our principal product

For Fiscal 2013 and 2012, our cold remedy products, principally Cold-EEZE^® Cold Remedy, represented approximately 94% and 95%, respectively, of our total sales. Accordingly, we depend on the continued acceptance of Cold-EEZE^® Cold Remedy products by our customers. Our investments in and strategies used for our brand marketing are critical to achieve brand awareness with current consumers, educate potential new consumers and convert potential consumers into customers. However, there can be no assurance that Cold-EEZE^® Cold Remedy products will continue to receive, maintain or increase market acceptance. The inability to successfully commercialize Cold-EEZE^® Cold Remedy products in the future and/or expand its product line, for any reason, would have a material adverse effect on our financial condition, prospects and ability to continue operations.

 

Our products and potential new products are or may be subject to extensive governmental regulation

Our business is regulated by various agencies of the states and localities where our products are sold. Governmental regulations in foreign countries where we plan to commence or expand sales may prevent or delay entry into a market or prevent or delay the introduction, or require the reformulation of certain of our products. In addition, no prediction can be made as to whether new domestic or foreign legislation regulating our activities will be enacted. Any new legislation could have a material adverse effect on our business, financial condition and operations. Non-compliance with any applicable requirements may subject us or the manufacturers of our products to agency action, including warning letters, fines, product recalls, seizures and injunctions.

 

The manufacturing, processing, formulation, packaging, labeling and advertising of our cold remedy products are subject to regulation by several federal agencies, including (i) the FDA, (ii) the Federal Trade Commission (“FTC”), (iii) the Consumer Product Safety Commission, (iv) the United States Department of Agriculture, (v) the United States Postal Service, (vi) the United States Environmental Protection Agency and (vii) the United States Occupational Safety and Health Administration.

 

In addition to OTC and prescription drug products, the FDA regulates the safety, manufacturing, labeling and distribution of dietary supplements, including vitamins, minerals and herbs, food additives, food supplements, over-the-counter and prescription drugs and cosmetics. The FTC also has overlapping jurisdiction with the FDA to regulate the promotion and advertising of vitamins, over-the-counter drugs, cosmetics and foods. In addition, our cold remedy products are homeopathic remedies which are subject to standards established by the Homeopathic Pharmacopoeia of the United States (“HPUS”). HPUS sets the standards for source, composition and preparation of homeopathic remedies which are officially recognized under the Federal Food, Drug and Cosmetics Act, as amended.

 

Preclinical development, clinical trials, product manufacturing, labeling, distribution and marketing of potential new products are also subject to federal and state regulation in the United States and other countries. Clinical trials and product marketing and manufacturing are subject to the rigorous review and approval processes of the FDA and foreign regulatory authorities. To obtain approval of a new drug product, a company must demonstrate through adequate and well-controlled clinical trials that the drug product is safe and effective for its intended use. Obtaining FDA and other required regulatory approvals is lengthy and expensive. Typically, obtaining regulatory approval for pharmaceutical products requires substantial resources and takes several years. The length of this process depends on the type, complexity and novelty of the product and the nature of the disease or other indication to be treated. Preclinical studies must comply with FDA regulations. Clinical trials must also comply with FDA regulations to ensure safety of the human subjects in the trial and may require large numbers of test subjects, complex protocols and possibly lengthy follow-up periods. Consequently, satisfaction of government regulations may take several years: may cause delays in introducing potential new products for considerable periods of time and may require imposing costly procedures upon our activities. If regulatory approval of new products is not obtained in a timely manner or not at all, we could be materially adversely affected. Even if regulatory approval of new products is obtained, such approval may impose limitations on the indicated uses for which the products may be marketed which could also materially adversely affect our business, financial condition and future operations.

 

We have experienced net losses for each of the seven of the past eight fiscal years. In Fiscal 2013 we realized net income of $405,000. There can be no assurance that our strategic focus will result in any revenue growth or that we will be successful in initiating or acquiring any new lines of business, or that any such new lines of business will achieve profitability. As of December 31, 2013, we had working capital of approximately $6.7 million which we believe is an acceptable and adequate level of working capital to support our business. Our ability to fund working capital needs will depend on our ability to generate cash in the future.

 

 

 

Our ability to use our net operating loss carryforwards to offset future taxable income may be subject to certain limitations

In general, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to use its pre-change net operating loss carryforwards, or NOLs, to offset future taxable income. Future changes in our stock ownership, some of which are outside of our control, could result in an ownership change under Section 382 of the Code. Furthermore, our ability to use NOLs of companies that we may acquire in the future may be subject to limitations. For these reasons, we may not be able to use a material portion of the NOLs reflected on our balance sheet, even if we attain profitability.

 

Our success is dependent on key personnel

Our success depends, in part, upon the continued service of key personnel, such as Mr. Ted Karkus, Chairman and Chief Executive Officer, Mr. Robert V. Cuddihy, Jr., Chief Operating Officer and Chief Financial Officer, and certain managers and strategists within the Company. If we are unable to attract and retain such personnel, the loss of the services of any one of them could have a material adverse effect on us.

 

In order to be successful, we must retain and motivate executives and other key employees, including those in managerial, technical, marketing and health product positions. In particular, our product generation efforts depend on hiring and retaining qualified health and science professionals. Competition for skilled employees who can perform the services that we require is intense and hiring, training, motivating, retaining and managing employees with the skills required is time-consuming and expensive. If we are not be able to hire sufficient professional staff to support our operations, or to train, motivate, retain and manage the employees we do hire, it could have a material adverse effect on our business operations or financial results.

 

We are dependent on our manufacturing facility and suppliers for certain of our cold remedy products

Our manufacturing, warehousing and distribution center is located in Lebanon, Pennsylvania. In the event of a disruption of this facility, we would need to outsource to third parties, at least temporarily, our manufacturing, warehousing and distribution requirements. While such secondary sources have been identified for our products, if we are unable to find other sources or there were a delay in the ramp-up for the production and distribution operations for some of our products, it could have a material adverse effect on our operations.

 

Certain raw material active ingredients used in connection with the Cold-EEZE^® products are purchased from a single unaffiliated supplier. Should the relationship terminate or the vendor become unable to supply material, we believe that current contingency plans would prevent such termination from materially affecting our operations, although there may be delays in production of our products until an acceptable replacement supplier is located.

 

Our inability to find alternative sources for some of our manufacturing and raw materials may have a material adverse effect on our operations and financial condition. In addition, the terms on which manufacturers and suppliers will make products and raw materials available to us could have a material effect on our success.

 

The manufacturing of OTC products and dietary supplements is subject to applicable current good manufacturing practice (“cGMP”) regulations and FDA inspections. We believe we are in substantial compliance with material provisions of the applicable cGMP regulations. Contract manufacturers are also subject to these same requirements and we require such compliance in our contractual relationships with such manufacturers. However, we cannot assure that the FDA will agree with our determination of compliance. If the FDA disagrees, it could, upon inspection of our facility, issue a notice of violations, referred to as a form FDA-483, or issue a Warning Letter, or both. If the FDA concludes that there is an imminent public health threat or if we fail to take timely corrective actions to the satisfaction of the FDA, the agency can initiate legal actions, such as seizure and injunction, which could include a recall order or the entry of a consent decree, or both. In addition, we could be subject to monetary penalties and even criminal prosecution for egregious conduct. The FDA could initiate similar legal actions against the contract manufacturer if it concludes its facility is not in compliance, which would affect the availability of our products. While secondary sources have been identified for our products, our inability to find other sources or a delay in the ramp-up for the production and distribution operations for some of its products may have a material adverse effect on our operations.

 

 

	- 13 -

 

We are uncertain as to whether we can protect our proprietary rights

The strength of our patent position and proprietary formulations and compounds may be important to our long-term success. We currently own numerous U.S. and foreign patents in connection with potential products; however there can be no assurance that these patents and proprietary formulations and compounds will effectively protect our products from duplication by others. In addition, we may not be able to afford the expense of any litigation which may be necessary to enforce our rights under any of the patents. Furthermore, there can be no assurance that third parties will not obtain access to or independently develop our technologies, know-how, ideas, concepts and documentation, which could have a material adverse effect on our financial condition.

 

Although we believe that current and future products do not and will not infringe upon the patents or violate the proprietary rights of others, if any of our current or future products do infringe upon the patents or proprietary rights of others, we may have to modify the products or obtain an additional license for the manufacture and/or sale of such products. We could also be prohibited from selling the infringing products. If we were found to infringe on the proprietary rights of others, it is uncertain whether we would be able to take corrective actions in a timely manner, upon acceptable terms and conditions, or at all, and the failure to do so could have a material adverse effect upon our business, financial condition and operations.

 

Our existing products and potential new products expose us to potential product liability claims

Our business results in exposure to an inherent risk of potential product liability claims, including claims for serious bodily injury or death caused by the sales of our existing products and the products which are being developed. These claims could lead to substantial damage awards. While we currently maintain product liability insurance, a successful claim brought against us in excess of, or outside of, existing insurance coverage could have a material adverse effect on our results of operations and financial condition. Claims against us, regardless of their merit or eventual outcome, may also have a material adverse effect on the consumer demand for our products.

 

We are involved in litigation matters and are a defendant in a stockholder derivative lawsuit filed by our former CEO

We are, from time-to-time, subject to various legal proceedings and claims, either asserted or unasserted. Any such claims, whether with or without merit, can be time-consuming and expensive to defend and can divert management's attention and resources. While management believes that we have adequate insurance coverage and, if applicable, accrued loss contingencies for all known matters, there is no assurance that the outcome of all current or future litigation will not have a material adverse effect on us.

 

A purported derivative lawsuit was filed against us, our officers and directors, as described under "Part I, Item 3, Legal Proceedings". We believe the lawsuit is without merit and we intend to engage in a vigorous defense of such litigation. If we are not successful in our defense of this litigation, we could be forced to make significant payments to or other settlements with our stockholders and their lawyers, and such payments or settlement arrangements could have a material adverse effect on our business, operating results or financial condition. Regardless of the outcome, the litigation could result in substantial costs and significant adverse impact on our reputation and divert management's attention and resources, which could have a material adverse effect on our business, operating results or financial condition. We also have certain obligations to indemnify our officers and directors and to advance expenses to such officers and directors. Although we have purchased liability insurance for our directors and officers, if our insurance carriers should deny coverage, or if the indemnification costs exceed the insurance coverage, we may be forced to bear some or all of these indemnification costs directly, which could be substantial and may have an adverse effect on our business, financial condition, results of operations and cash flows. If the cost of our liability insurance increases significantly, or if this insurance becomes unavailable, we may not be able to maintain or increase our levels of insurance coverage for our directors and officers, which could make it difficult to attract or retain qualified directors and officers.

 

In May 2012, we received an expression of interest and a non-binding proposal to be acquired by Matrixx, a competitor of Cold-EEZE^®. In September 2012, Matrixx purchased for $200,000 a three year option to acquire 1,453,427 shares of our Common Stock for $1.40 per share from Guy J. Quigley, our former Chairman and Chief Executive Officer. Matrixx also acquired from Mr. Quigley a voting proxy to vote the shares subject to the option.

 

In October 2012, we received a revised non-binding proposal, on essentially the same terms as Matrixx's earlier offer, except that in the latest proposal Matrixx raised the proposed price by $0.20 per share. At a meeting held on October 24, 2012, our board of directors unanimously rejected the October 2012 Matrixx proposal after careful consideration and consultation with its advisors. On February 5, 2013, Matrixx informed us that it has withdrawn its unsolicited offer to acquire us.

 

 

 

Matrixx continues to hold its voting proxy and an option to purchase shares from Guy Quigley.  The Matrixx option to purchase shares expires in September 2015.  Circumstances may occur in which the interests of Matrixx could be in conflict with the interests of other shareholders. Accordingly, Matrixx’s ability to influence us through voting their shares may affect our other shareholders or the market price of our Common Stock may be adversely affected.

 

Certain Officers, Directors and former executives and their families own a substantial amount of our Common Stock

As of March 25, 2014, our executive officers and directors beneficially owned approximately 18.6% of our Common Stock and Mr. Guy J. Quigley, Mr. Quigley’s spouse and Matrixx beneficially owned, approximately 17.4% of our Common Stock. These individuals have significant influence over the outcome of all matters submitted to stockholders for approval, including the election of directors. Consequently, they exercise substantial influence over all major decisions including major corporate actions such as mergers and other business combinations transactions which could result in or prevent a change of control of the Company. Circumstances may occur in which the interests of these shareholders could be in conflict with the interests of other shareholders. Accordingly, a stockholder’s ability to influence us through voting their shares may be limited or the market price of our Common Stock may be adversely affected.

 

 

 

 

 

As of March 25, 2014, there are outstanding options, which are fully vested, to purchase an aggregate of 753,250 shares of our Common Stock at an average exercise price of $1.92 per share. If these options are exercised, and the holders of these options were to attempt to sell a substantial amount of their holdings at once, the market price of our Common Stock would likely decline. Moreover, the perceived risk of this potential dilution could cause stockholders to attempt to sell their shares and investors to “short” our stock, a practice in which an investor sells shares that he or she does not own at prevailing market prices, hoping to purchase shares later at a lower price to cover the sale. As each of these events would cause the number of shares of Common Stock being offered for sale to increase, our Common Stock’s market price would likely further decline. All of these events could combine to make it very difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.

 

 

We do not intend to pay cash dividends in the foreseeable future

We have not paid cash dividends on our Common Stock since our inception. Our intention is to retain earnings, if any, for use in the business and we do not anticipate paying any cash dividends to stockholders in the foreseeable future.

 

Our Articles of Incorporation and By-laws contain certain provisions that may be barriers to a takeover

Our Articles of Incorporation and By-laws contain certain provisions which may deter, discourage, or make it difficult for another person or entity to gain control of the Company through a tender offer, merger, proxy contest or similar transaction or series of transactions.  These provisions may deter a future tender offer or other takeover attempt which could include a premium over the market price of our Common Stock at the time.  Such provisions could depress the trading price of our Common Stock

We have agreed to indemnify our Officers and Directors from liability

In accordance with sections 78.7502 and 78.751 of the Nevada General Corporation Law our Articles of Incorporation provide that we will indemnify any person who is or was made a party to, or is or was threatened to be made a party to, any pending, completed, or threatened action, suit or proceeding because he or she is or was a director, officer, employee or agent of the Company or is or was serving at the Company’s request as a director, officer, employee or agent of any corporation, partnership, joint venture, trust or other enterprise. These provisions permit us to advance expenses to an indemnified party in connection with defending any such proceeding, upon receipt of an undertaking by the indemnified party to repay those amounts if it is later determined that the party is not entitled to indemnification. In August 2009, we entered into indemnity agreements with each member of our board of directors and Mr. Cuddihy. These agreements provide, among other things, that we will indemnify each officer and director in the event they become a party or otherwise a participant in any action or proceeding on account of their service as a director or officer of the Company (or service for another corporation or entity in any capacity at the request of the Company) to the fullest extent permitted by applicable law. These indemnity provisions may reduce the likelihood of derivative litigation against directors and officers and discourage or deter stockholders from suing directors or officers for breaches of their duties to the Company, even though such an action, if successful, might otherwise benefit the Company or its stockholders. In addition, to the extent that we expend funds to indemnify directors and officers, funds will be unavailable for operational purposes.

 

 

 

 

Not applicable.

 

 

Our corporate headquarters is located in Doylestown, Pennsylvania.  We purchased this property in 1998.  Our headquarters is approximately 13,000 square feet and is comprised of office space and a storage area.  Our principal manufacturing facility is located in Lebanon, Pennsylvania.  The facility was purchased in October 2004.  The facility has a total area of approximately 57,500 square feet, comprised of manufacturing, warehousing and office space.   We believe that our existing facilities are adequate at this time and do not anticipate the need for additional facilities in the foreseeable future.

 

Item 3.                     Legal Proceedings

GUY QUIGLEY VS. TED KARKUS, ROBERT V. CUDDIHY, JR., MARK BURNETT, MARK LEVENTHAL, MARK FRANK, LOUIS GLECKEL, MD, JAMES McCUBBIN AND PROPHASE LABS, INC. AS A NOMINAL DEFENDANT

We were named as a nominal defendant in a purported derivative complaint filed on February 2, 2012 by stockholder and former director and Chief Executive Officer Guy Quigley in the Court of Common Pleas of Philadelphia County, Pennsylvania (No. 111200409). The complaint also names as a defendant each of our directors and executive officers. Among other things, the suit alleges various breaches of fiduciary and other duties, and seeks recovery of unspecified damages and other relief. Prior to filing this complaint, the plaintiff applied to the same court for permission to take pre-complaint discovery on the basis that the plaintiff required such discovery in order to assert claims. The court denied the plaintiff's request. We believe the lawsuit is without merit and intend to vigorously defend against it. On April 5, 2013, the court entered an order allowing limited pre-trial discovery limited to demand futility and plaintiff adequacy issues, which was completed by July 12, 2013. We filed a motion to dismiss on July 26, 2013 on demand futility and plaintiff adequacy issues. On August 26, 2013 the court heard oral arguments regarding the Company’s motion for summary judgment and dismissal with prejudice.  The court stayed any additional discovery until the court rules on our motion to dismiss with and our motion is currently pending with the court. At this time, no prediction as to the outcome of this action can be made.

 

As noted above, we previously commenced litigation against the plaintiff, Guy Quigley, and other parties in August 2010 in the Bucks County Court of Common Pleas, Pennsylvania (No. 2010-08227). The August 2010 action remains pending.

 

 

 

 

East Bay Management, Inc., Ted Karkus and John Doe 1 were named as defendants in a purported complaint filed on June 10, 2013 by Gary Quigley, the brother of our stockholder and former director and Chief Executive Officer Guy Quigley, in the Court of Common Pleas of Philadelphia County, Pennsylvania (No. 2013-04393). The suit alleges five causes of action against the defendants, including the Company’s Chief Executive Officer, for (i) fraud, (ii) conversion, (iii) unjust enrichment, (iv) conspiracy and (v) piercing the corporate veil.  On July 10, 2013, Mr. Karkus removed the case to the United States District Court for Eastern Pennsylvania.  On August 16, 2013, Mr. Karkus filed a Motion to Dismiss for Failure to State a Claim.  Mr. Gary Quigley responded to the motion to dismiss.   On January 7, 2014, the court heard oral arguments regarding the motion to dismiss.  The court stayed any additional discovery until the court rules on the motion to dismiss and the motion is currently pending with the court.  At this time, no prediction as to the outcome of this action can be made.

 

On January 15, 2014, our Board of Directors, without the presence of Ted Karkus, voted to indemnify Mr. Karkus and pay the expenses incurred by him in connection with this legal matter.  This action has been and will continue to be vigorously defended by Mr. Karkus, who denies any wrongdoing.

 

East Bay Management, Inc., Ted Karkus, Scott Strady and John Doe were named as defendants in a purported complaint filed on August 9, 2013 by the Estate of Josephine Quigley, the mother of our stockholder and former director and Chief Executive Officer Guy Quigley, and Kariba Holdings Limited (see Kariba Compliant above) in the Court of Common Pleas of Philadelphia County, Pennsylvania (No. 2013-006131). Guy Quigley, our stockholder, former director and Chief Executive Officer of the Company, filed this suite as Executor of the Estate of Josephine Quigley and as a representative of Kariba Holdings.  The suit alleges five causes of action against the defendants, including the Company’s Chief Executive Officer, for (i) fraud, (ii) conversion, (iii) unjust enrichment, (iv) conspiracy and (v) piercing the corporate veil.  On September 23, 2013, Mr. Karkus removed the case to the United States District Court for Eastern Pennsylvania.  On September 23, 2013, Mr. Karkus filed a Motion to Dismiss for Failure to State a Claim.  The Estate of Josephine Quigley and Kariba Holdings Limited responded to the motion to dismiss. On January 7, 2014, the court heard oral arguments regarding the motion to dismiss.  The court stayed any additional discovery until the court rules on the motion to dismiss and the motion is currently pending with the court.  At this time, no prediction as to the outcome of this action can be made.

 

On January 15, 2014, our Board of Directors, without the presence of Ted Karkus, voted to indemnify Mr. Karkus and pay the expenses incurred by him in connection with this legal matter.  This action has been and will continue to be vigorously defended by Mr. Karkus, who denies any wrongdoing.

 

 

Other Litigation

In the normal course of our business, we are named as defendant in legal proceedings. It is our policy to vigorously defend litigation and/or enter into settlements of claims where management deems appropriate.

 

 

Not applicable.

 

 

 

PART II

 

 

Market Information

 

Our Common Stock is currently traded on The NASDAQ Global Market under the trading symbol “PRPH.” The price set forth in the following table represents the high and low bid prices for our Common Stock for each quarter of the Fiscal 2013 and 2012, as reported on The NASDAQ Global Market.

 

Common Stock

 

		2013						2012
Quarter Ended		High			Low			High			Low
March 31,		$	2.25		$	1.40		$	1.22		$	0.90
June 30,		$	1.72		$	1.42		$	1.14		$	0.65
September 30,		$	2.25		$	1.42		$	1.44		$	1.00
December 31,		$	2.31		$	1.52		$	1.68		$	1.24

 

Holders

As of March 17, 2014, there were approximately 249 holders of record of our Common Stock, including brokerage firms, clearing houses, and/or depository firms holding the Company’s securities for their respective clients. The exact number of beneficial owners of our securities is not known but exceeds 400.

 

Dividends

We have not declared, nor paid any cash dividends on our Common Stock since our Company’s inception. At this time, we intend to retain our earnings to finance future growth and maintain liquidity. Future cash dividends, if any, will be at the discretion of our Board of Directors and will depend upon, among other things, our future operations and earnings, capital requirements, general financial condition, contractual and financing restrictions and such other factors as our Board of Directors may deem relevant.

 

Warrants and Options

In addition to our outstanding Common Stock, there were reserved for issuance 753,250 shares of our Common Stock underlying outstanding unexercised and vested options as of December 31, 2013 at the price-per-share stated and expiration date indicated, as follows:

 

Description		Number of  Options		Exercise  Price			Expiration Date
Option Plan		40,500		$	9.50		October 26, 2014
Option Plan		26,500		$	13.80		December 11, 2015
Option Plan		590,000		$	1.00		December 14, 2017
Option Plan		25,000		$	1.08		May 28, 2018
Option Plan		10,000		$	0.87		November 5, 2018
Option Plan		50,000		$	1.17		December 18, 2018
Option Plan		7,500		$	1.36		December 20, 2019
Option Plan		3,750		$	1.48		April 9, 2020
Total		753,250

 

 

 

Securities Authorized Under Equity Compensation

 

The following table sets forth certain information regarding stock option and warrant grants made to employees, directors and consultants:

 

 

 

(1)  An incentive stock option plan was instituted in Fiscal 1997 (the “1997 Plan”) and approved by the stockholders in Fiscal 1998. Options pursuant to the 1997 Plan have been granted to directors, executive officers and employees. At December 31, 2013, we are precluded from issuing any additional options or grants in the future under the 1997 Plan pursuant to the terms of the plan document. An aggregate of 67,000 stock options previously granted pursuant to the terms of the 1997 Plan remain available for exercise at any time prior to such options’ respective expiration dates.

 

(2)  On May 5, 2010, our shareholders approved the 2010 Equity Compensation Plan, which was subsequently amended, restated and approved by shareholders on April 24, 2011 and further amended and approved by our shareholders on May 6, 2013 (the “2010 Plan”). The 2010 Plan provides that the total number of shares of Common Stock that may be issued is equal to 1.6 million shares plus up to 900,000 shares that were authorized for issuance but unissued under the 1997 Plan, an aggregate of 2.5 million shares. 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. At December 31, 2013, we have outstanding 1,570,500 stock options, subject to vesting, under the 2010 Plan. For the year ended December 31, 2013, we charged to operations $160,000 for compensation expense for the fair value of the vested portion of the stock options (see Note 6 to Notes to Consolidated Financial Statements). At December 31, 2013, there are 262,159 shares of Common Stock that may be issued in the future pursuant to the 2010 Plan.

 

(3)  On May 5, 2010, our shareholders approved the 2010 Directors’ Equity Compensation Plan which was subsequently amended and approved by our shareholders on May 6, 2013. The 2010 Directors’ Equity Compensation Plan provides that the total number of shares of Common Stock that may be issued under the 2010 Directors’ Equity Compensation Plan is equal to 425,000. For the year ended December 31, 2013, 16,470 shares of our Common Stock were granted. At December 31, 2013, there are 176,135 shares of Common Stock that may be issued pursuant to the 2010 Directors Equity Compensation Plan.

 

Equity Line of Credit

 

 

 

 

 

 

Pursuant to the terms of Mr. Cuddihy’s prior employment agreement dated August 19, 2009, Mr. Cuddihy received an annual grant of shares of Common Stock equal to $50,000, payable quarterly, promptly following the close of each quarter. The value of the shares is calculated based on the average closing price of our shares for the last five (5) trading days of the quarter in which the shares are earned. For the year ended December 31, 2012, Mr. Cuddihy was issued an aggregate of 10,757 shares earned in Fiscal 2011 pursuant to the terms of his employment agreement.

 

 

 

 

The following table sets forth the selected financial data appearing in or derived from our consolidated financial statements for and at the end of the years ended December 31, 2013, 2012, 2011 2010 and 2009. The selected financial data should be read in conjunction with the consolidated financial statements appearing elsewhere herein, and with Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations (in thousands, except per share amounts):

 

		Year Ended December 31,
		2013			2012			2011			2010			2009
Statement of Income Data:
Net sales		$	25,032		$	22,406		$	17,453		$	14,502		$	19,816
Gross profit		$	16,671		$	14,252		$	11,282		$	8,830		$	11,569
Income (loss) from operations		$	405		$	(1,091)		$	(2,710)		$	(3,501)		$	(3,842)
Net income (loss)		$	405		$	(1,091)		$	(2,710)		$	(3,501)		$	(3,842)
Basic income (loss) per share		$	0.03		$	(0.07)		$	(0.18)		$	(0.25)		$	(0.30)
Diluted income (loss) per share		$	0.03		$	(0.07)		$	(0.18)		$	(0.25)		$	(0.30)
Weighted average shares outstanding:
Basic			15,839			14,843			14,817			14,285			12,963
Diluted			16,276			14,843			14,817			14,285			12,963

 

		As of December 31,
		2013			2012			2011			2010			2009
Balance Sheet Data:
Working capital		$	6,655		$	5,809		$	5,342		$	7,521		$	11,475
Total assets		$	17,420		$	16,661		$	19,079		$	21,695		$	21,330
Other long term obligations		$	200		$	300		$	-		$	-		$	-
Stockholders’ equity		$	12,596		$	11,451		$	11,226		$	13,460		$	14,059

 

 

 

 

Our Business.  We are a manufacturer, marketer and distributor of a diversified range of homeopathic and health products that are offered to the general public.  We are also engaged in the research and development of potential natural based health products along with supplement and cosmeceutical products. 

 

Our primary business is the manufacture, distribution, marketing and sale of over-the-counter (“OTC”) cold remedy products to consumers through national chain, regional, specialty and local retail stores.  One flagship brand is Cold-EEZE^Ò  Cold Remedy and our principal product is Cold-EEZE^Ò Cold Remedy zinc gluconate lozenges, proven in clinical studies to reduce the duration of the common cold by 42%.  Cold-EEZE^Ò Cold Remedy is an established product in the health care and cold remedy market.  For Fiscal 2013, 2012 and 2011, our revenues from continuing operations have come principally from our OTC cold remedy products.

 

Recent Events

Revenue Growth

We have implemented a business and marketing strategy designed to deliver results to our stockholders over the long term.  This multi-phase strategy was implemented during the 2010-2011 Cold Season.  Generally, a cold season is defined as the period of September to March (“Cold Season”) when the incidence of the common cold rises as a consequence of the change in weather and other factors.  

 

Our strategic initiatives include preserving the Cold-EEZE^® Cold Remedy brand, repositioning the Cold-EEZE^® Cold Remedy brand for growth and then leveraging the Cold-EEZE^® Cold Remedy brand.  We believe that by investing in our Cold-EEZE^® Cold Remedy brand, we are building our distribution platform and pipeline.  We have made important investments in new product development, consumer and healthcare professional education and consumer and retail-based marketing.  Each of these strategic components, when aggregated, have led to securing increased shelf space with our retailers and have provided us with the opportunity to introduce new and improved products, including the national launch of two additional cold remedy products for the 2013-2014 Cold Season: Cold-EEZE^® Cold Remedy Plus Immune Support QuickMelts^® and Cold-EEZE^® Cold Remedy Plus Immune Support + Energy QuickMelts^®.

 

Through our strategic initiatives, we have grown our net sales and generated net income for Fiscal 2013. Our net sales increased 11.7% in Fiscal 2013 as compared to net sales in Fiscal 2012.  In addition, we generated net income of $405,000, or $0.03 per share, in Fiscal 2013 as compared to a net loss of $1.1 million, or ($0.07) per share, for Fiscal 2012.  Our net sales growth is incremental to the net sales growth of 28.4% achieved in Fiscal 2012 as compared to Fiscal 2011.  We have increased our net sales an aggregate of 43.4% in Fiscal 2013 as compared to Fiscal 2011 and we have returned to profitability.

 

On March 22, 2010, we, Phosphagenics Limited (“PSI Parent”), an Australian corporation, Phosphagenics Inc. (“PSI”), a Delaware corporation and subsidiary of PSI Parent, and Phusion Laboratories, LLC (the “Joint Venture”), a Delaware limited liability company, entered into a Limited Liability Company Agreement (the “LLC Agreement”) of the 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”).  TPM facilitates the delivery and depth of penetration of active molecules in pharmaceutical, nutraceutical, and other products. Pursuant to the LLC Agreement, we and PSI each own a 50% membership interest in the Joint Venture. 

 

 

 

Income Taxes

 

As of December 31, 2013, we have net operating loss carry-forwards of approximately $34.7 million for federal purposes that will expire beginning in Fiscal 2020 through 2032.  Additionally, there are net operating loss carry-forwards of $20.1 million for state purposes that will expire beginning in Fiscal 2018 through 2032.  Until sufficient taxable income to offset the temporary timing differences attributable to operations, and the tax deductions attributable to option, warrant and stock activities are assured, a valuation allowance equaling the total deferred tax asset is being provided.  As a consequence of the accumulated losses of the Company, we believe that this allowance is required due to the uncertainty of realizing these tax benefits in the future.

 

Seasonality of the Business

 

Our sales are derived principally from our OTC cold remedy products.  A significant portion of our business is highly seasonal, which causes major variations in operating results from quarter to quarter.  The third and fourth quarters generally represent the largest sales volume for our OTC cold remedy products with a corresponding increase in marketing and advertising expenditures designed to promote our products during the Cold Season.  In addition, our sales are influenced by and subject to fluctuations in the timing of purchase and the ultimate level of demand for our products which are a function of the timing, length and severity of each cold season.  We track health and wellness trends and develop retail promotional strategies to align our production scheduling, inventory management and marketing programs to optimize consumer purchases. 

 

Results of Operations

 

Fiscal 2013 compared with Fiscal 2012

Net sales for Fiscal 2013 increased $2.6 million, or 11.7%, to $25.0 million as compared to $22.4 million for Fiscal 2012.  The increase in net sales is principally due to (i) an increase in our retail customers’ purchases in the first and fourth quarter of Fiscal 2013, as compared to the same periods in Fiscal 2012, in an effort by retailers to maintain adequate shelf and warehouse stock during peak seasonal demand to meet an increase in consumer demand at retail of our OTC cold remedy products, (ii) sales of our Cold-EEZE^® Cold Remedy Daytime/Nighttime QuickMelts^®, launched in July 2012 and Cold-EEZE^® Cold Remedy Oral Spray initially launched in August 2011, and (iii) sales of our Cold-EEZE^® Cold Remedy Plus Immune Support + Energy QuickMelts^® and Cold-EEZE^® Cold Remedy Plus Immune Support QuickMelts^® launched in July 2013.  In addition, net sales of our contract manufacturing operations increased $568,000 in Fiscal 2013 to $1.8 million as compared to $1.3 million in Fiscal 2012 due to fluctuations in contract manufacturing orders from non-related third party entities to produce lozenge-based products. 

 

Industry data is suggesting that the incidence of upper respiratory disorders for Fiscal 2013 were on average comparable to the incidence levels in Fiscal 2012.  However, within each fiscal period, the incidence of upper respiratory disorders trended significantly higher the first quarter of Fiscal 2013, an increase of approximately 13%, as compared to first quarter of Fiscal 2012, where as the fourth quarter of Fiscal 2013 trended down approximately 11% as compared to the fourth quarter of Fiscal 2012.  Although the average incidence of upper respiratory disorders, on average remained stable from year to year, we believe that we have increased our net sales through, among other initiatives, increased investments in our sales, marketing, advertising, consumer communication and promotion of our flagship brand, Cold-EEZE^® Cold Remedy.   In addition, we support our Cold-EEZE^® Cold Remedy products through traditional techniques such as in-store promotion, media advertising and other programs.  We compete for market share with new products entering the category and face retailer initiatives that attempt to reduce the number of products they carry on shelf within the cold and flu category. 

 

Cost of sales increased $207,000 for Fiscal 2013 to $8.4 million as compared to $8.2 million for Fiscal 2012.  The increase in cost of sales is principally due to our increased sales from period to period. We realized gross margins of 66.6% for Fiscal 2013, as compared to 63.6% in Fiscal 2012, an increase of 3.0%. The increase of 3.0% in gross margin is principally due to fluctuations in our product mix shipped from period to period and the improved absorption of fixed production costs.  Gross margins are principally influenced by fluctuations in quarter-to-quarter production volume, fixed production costs and related overhead absorption, raw ingredient costs, inventory mark to market write-downs, if any, retail cooperative incentive promotion and the timing of shipments to customers which are factors of the seasonality of our sales activities and products. 

 

 

 

 Sales and marketing expense for Fiscal 2013 increased $592,000 to $9.5 million as compared to $8.9 million for Fiscal 2012.  The increase in sales and marketing expense for Fiscal 2013 as compared to Fiscal 2012 was principally due to an increase in advertising expenditures as we expanded the scope and timing of our media and product promotion advertising campaigns from period to period. We continue to make significant, strategic marketing investments in an effort to build and grow the sales of our OTC cold remedy products. 

 

General and administrative (“G&A”) expenses decreased $234,000 for Fiscal 2013 to $5.9 million as compared to $6.1 million in Fiscal 2012.  The decrease in G&A expense for Fiscal 2013 as compared to Fiscal 2012 was primarily due to a decrease in personnel expenses and professional fees.

 

Research and development costs for Fiscal 2013 and 2012 were $824,000 and $1.3 million, respectively. The decrease of $477,000 in research and development costs for Fiscal 2013 as compared to Fiscal 2012 was principally due a decrease in the scope, timing, cost and amount of research and development activity from period to period.  In February 2013, we introduced to the retail trade two new products, Cold-EEZE^® Cold Remedy Plus Immune Support + Energy QuickMelts^® and Cold-EEZE^® Cold Remedy Plus Immune Support QuickMelts^® which began shipping to our retailer customers in July 2013.  Additionally, we continue to engage in other research and development activities that we determine are appropriate and we may increase our research and development activities in future periods.

 

In Fiscal 2012 as a result of the Settlement Agreement, we realized $1.0 million benefit as a consequence of a reduction of the previously recorded accrued royalties and commission obligation of $3.5 million.  Under the 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.

 

Interest and other income for Fiscal 2013 was $2,000 as compared to $7,000 for Fiscal 2012.  The decrease of $5,000 for Fiscal 2013 as compared to Fiscal 2012 was principally the result of decreased bank balances during Fiscal 2013 and lower interest rates.  Interest expense for Fiscal 2013 was $13,000 as compared to zero for Fiscal 2012 as a consequence of interest paid pursuant to the terms of the Settlement Agreement consummated in December 2012.

 

As noted above, we have net operating loss carry-forwards for both federal and certain states.  As a consequence of these loss carry-forwards, we did not incur income tax expense for Fiscal 2013 or Fiscal 2012.

 

As a consequence of the effects of the above, the net income for Fiscal 2013, was $405,000, or $0.03 per share, as compared to a net loss of $1.1 million, or ($0.07) per share, for Fiscal 2012.

 

Fiscal 2012 compared with Fiscal 2011

Net sales for Fiscal 2012 increased $4.9 million, or 28.4%, to $22.4 million as compared to $17.5 million for Fiscal 2011.  The increase in net sales is principally due to (i) an increase in our retail customers’ purchases in the first and fourth quarter of Fiscal 2012, as compared to the same periods in Fiscal 2011, in an effort by those retailers to maintain adequate shelf and warehouse stock during peak seasonal demand to meet an increase in consumer demand at retail of our OTC cold remedy products, (ii) sales of our Cold-EEZE^® Cold Remedy Daytime/Nighttime QuickMelts^®, a new product launched in July 2012 and Cold-EEZE^® Cold Remedy Oral Spray initially launched in August 2011 and expanded its distribution in Fiscal 2012.  In addition, our net sales of our contract manufacturing operations increased $455,000 in Fiscal 2012 to $1.3 million as compared to $856,000 in Fiscal 2011 due to fluctuations in contract manufacturing orders from non-related third party entities to produce lozenge-based products. 

 

Industry data is suggesting that the incidence of upper respiratory disorders for Fiscal 2012 were on average 3% below the incidence levels in Fiscal 2011.  Although the average incidence of upper respiratory declined during Fiscal 2012, we believe that we have increased our net sales through, among other initiatives, increased investments in our sales, marketing, advertising, consumer communication and promotion of our flagship brand, Cold-EEZE^® Cold Remedy    In addition, we support our Cold-EEZE^® Cold Remedy products through traditional techniques such as in-store promotion, media advertising and other programs.  We compete for market share with new products entering the category and face retailer initiatives that attempt to reduce the number of products they carry on shelf within the cold and flu category. 

 

 

 

Cost of sales increased $2.0 million for Fiscal 2012 to $8.2 million as compared to $6.2 million for Fiscal 2011.  The increase in cost of sales is principally due to our increased sales from period to period. We realized gross margins of 63.6% for Fiscal 2012, as compared to 64.6% in Fiscal 2011, a decrease of 1.0%.  Our gross margin reflects the net effect of (i) an increase in the absorption rate of fixed production overhead costs as a percentage of revenues as a consequence of increased shipments to retailers, offset by (ii) an increase in raw ingredient and packaging costs and (iii) an increase in retail merchandising and promotions.  Gross margins are principally influenced by fluctuations in quarter-to-quarter and year-to-year production volume, fixed production costs and related overhead absorption, raw ingredient costs, inventory mark to market write-downs, if any, and the timing of shipments to customers which are factors of the seasonality of our sales activities and products. 

 

Sales and marketing expense for Fiscal 2012 increased $1.0 million to $8.9 million as compared to $7.9 million for Fiscal 2011.  The increase in sales and marketing expense for Fiscal 2012 as compared to Fiscal 2011 was principally due to an increase in advertising expenditures as we expanded the scope and timing of our media and product promotion advertising campaigns from period to period as we continue to make significant, strategic marketing investments in an effort to build and grow the sales of our OTC cold remedy products. 

 

General and administrative (“G&A”) expenses increased $1.1 million for Fiscal 2012 to $6.1 million as compared to $5.0 million in Fiscal 2011.  The increase in G&A expense for Fiscal 2012 as compared to Fiscal 2011 was primarily due to an increase in personnel expenses and professional fees.

 

Research and development costs for Fiscal 2012 and 2011 were $1.3 million and $1.1 million, respectively. The increase of $200,000 in research and development costs for Fiscal 2012 as compared to Fiscal 2011 was principally due to an increase in personnel expenses and an increase in the scope, timing and amount of research and development activity from period to period.  In February 2012, we introduced to the retail trade an offering of a new product, Cold-EEZE^® Cold Remedy Daytime/Nighttime QuickMelts^®.  The Cold-EEZE^® Cold Remedy Daytime/Nighttime QuickMelts^® began shipping to retailers in July 2012.  Additionally, we continue to engage in other research and development activities that we determine are appropriate and we may increase our research and development activities in future periods as a consequence of the Joint Venture.

 

Under the 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.  As a result of the Settlement Agreement, we realized $1.0 million benefit as a consequence of a reduction of the previously recorded accrued royalties and commission obligation of $3.5 million.

 

Interest and other income for Fiscal 2012 was $7,000 as compared to $28,000 for Fiscal 2011.  The decrease of $21,000 for Fiscal 2012 as compared to Fiscal 2011 was principally the result of decreased bank balances and lower interest rates.

 

As noted above, we have net operating loss carry-forwards for both federal and certain states.  As a consequence of these loss carry-forwards and our loss realized during Fiscal 2012, we did not incur income tax expense for Fiscal 2012 or Fiscal 2011.

 

As a consequence of the effects of the above, the net loss for Fiscal 2012, was $1.1 million, or ($0.07) per share, as compared to a net loss of $2.7 million, or ($0.18) per share, for Fiscal 2011.

 

Liquidity and Capital Resources

 

Our aggregate cash and cash equivalents as of December 31, 2013 were $1.6 million as compared to $572,000 at December 31, 2012.  Our working capital was $6.7 million and $5.8 million as of December 31, 2013 and December 31, 2012, respectively.  Changes in working capital for Fiscal 2013 were principally due to the net effect of (i) cash provided by operations of $1.1 million comprised principally of net income of $405,000 and a decrease in prepaid expenses of $886,000, (ii) net proceeds of $471,000 derived from the sale of our Common Stock and the exercise of stock options offset by, (iii) capital expenditures of $442,000 and (iv) the installment payment of $100,000 pursuant to the terms of the Settlement Agreement. 

 

 

 

 

 

 

Pursuant to the LLC Agreement, we and PSI each own a 50% membership interest in the Joint Venture.  PSI Parent will conduct and oversee much of the product development, formulation, testing and other research and development needed by the Joint Venture, and we will oversee much of the production, distribution, sales and marketing.  The LLC Agreement provides that each member may be required, from time to time and subject to certain limitations, to make capital contributions to the Joint Venture to fund its operations, in accordance with agreed upon budgets for products to be developed.  Specifically, we contributed in Fiscal 2010 $500,000 in cash as initial capital and we are committed to fund up to $2.0 million, subject to agreed upon budgets (which have not been established to date), toward the initial development and marketing costs of new products for the Joint Venture.  The newly formed Joint Venture has not engaged in any financial transactions, other than organizational expenses and general market and initial product evaluation and analysis.  At December 31, 2013, cash and equivalents includes $378,000 which is expected to be used by the Joint Venture to fund future product development initiatives currently under consideration by PSI Parent, PSI and us.

 

Management is not aware of any 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 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 liquidity and working capital during the course of our fiscal year.

 

Management believes that cash generated from operations, along with its current cash balances, will be sufficient to finance working capital and capital expenditure requirements for at least the next twelve months.  However, in the longer term, as previously discussed, we may require additional capital to support, among other items, (i) new product introductions, (ii) expansion of our product marketing and promotion activities, (iii) additional research development activities, (iv) further investment in our Joint Venture, (iv) venture investments or acquisitions and/or (v) support current operations.  Since late Fiscal 2008, there has been substantial volatility and a decline in the capital and financial markets due at least in part to the constricted global economic environment resulting in substantial uncertainty and access to financing is uncertain. Moreover, consumer and as a consequence, customer spending habits may be adversely affected by the current economic crisis.  These conditions could have an adverse effect on our industry and business, including our financial condition, results of operations and cash flows. 

 

To the extent that we do not generate sufficient cash from operations, we may need to incur indebtedness to finance plans for growth.  Recent turmoil and stagnation in the credit markets and the potential impact on 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. 

 

Our future contractual obligations and commitments at December 31, 2013 consist of the following (in thousands):

 

		Employment			Settlement
Year		Contracts			Agreement			Total
2014		$	1,025		$	100		$	1,125
2015			555			100			655
2016						100			100
2017			-						-
2018			-			-			-
Total		$	1,580		$	300		$	1,880

 

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.

 

 

	- 28 -

 

Impact of Inflation

 

We are subject to normal inflationary trends and anticipate that any increased costs would be passed on to our customers.  Inflation has not had a material effect on our business.

 

Critical Accounting 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 Consolidated Financial Statements included under Item 8 of this Part II.   However, certain accounting policies are deemed “critical”, as they require management’s highest degree of judgment, estimates and assumptions.  These accounting estimates and disclosures have been discussed with the Audit Committee of our Board of Directors.  A discussion of our critical accounting policies, 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 Allowances 

When providing for the appropriate sales returns, allowances, cash discounts and cooperative incentive promotion costs (“Sales Allowances”), we apply a uniform and consistent method for making certain assumptions for estimating these provisions.  These estimates and assumptions are based on historical experience, current trends and other factors that management believes to be relevant at the time the financial statements are prepared.  Management reviews the accounting policies, assumptions, estimates and judgments on a quarterly basis.  Actual results could differ from those estimates.

 

Our primary product, Cold-EEZE^Ò Cold Remedy lozenges, utilizes a proprietary zinc gluconate formulation which has been clinically proven to reduce the severity and duration of common cold symptoms.  Factors considered in estimating the appropriate sales returns and allowances for this product include it being (i) a unique product with limited competitors, (ii) competitively priced, (iii) promoted, (iv) unaffected for remaining shelf-life as there is no product expiration date and (v) monitored for inventory levels at major customers and third-party consumption data.  In addition to Cold-EEZE^® Cold Remedy lozenges, we market and distribute a variety of Cold-EEZE^® Cold Remedy QuickMelts^® and a Cold-EEZE^® Cold Remedy Oral Spray.  We also manufacture, market and distribute an organic cough drop and a Vitamin C supplement (“Organix^®”).  Each of the Cold-EEZE^® Cold Remedy Oral Spray and QuickMelts^® products, and Organix^® products carry shelf-life expiration dates for which we aggregate such new product market experience data and update our sales returns and allowances estimates accordingly.  Sales allowances estimates are tracked at the specific customer and product line levels and are tested on an annual historical basis, and reviewed quarterly. Additionally, we monitor current developments by customer, market conditions and any other occurrences that could affect the expected provisions relative to net sales for the period presented.

 

Our return policy accommodates returns for (i) discontinued products, (ii) store closings and (iii) products that have reached or exceeded their designated expiration date.  We do not impose a period of time within which product may be returned.  All requests for product returns must be submitted to us for pre-approval.  The main components of our returns policy are: (i) we will accept returns that are due to damaged product that is un-saleable and such return request activity fall 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.

 

 

	- 29 -

 

 

		Amount
Return provision at December 31, 2011		$	1,667
Net change in the return provision Fiscal 2012			(375)
Return provision at December 31, 2012			1,292
Net change in the return provision Fiscal 2013			227
Return provision at December 31, 2013		$	1,519

For Fiscal 2013, the return provision increased by $227,000. The increase in the return provision was principally due to (i) a charge of $1.4 million, including $534,000 for products with shelf-life expiration dates (obsolete returns), offset by (ii) net returns of $1.2 million associated principally with Fiscal 2013 and Fiscal 2012 received and processed during Fiscal 2013.

For Fiscal 2012, the return provision decreased by $375,000. The decrease in the return provision was principally due to (i) a charge of $1.1 million, including $631,000 for products with shelf-life expiration dates (obsolete returns), offset by (ii) net returns of $1.4 million associated principally with Fiscal 2012 and Fiscal 2011 received and processed during Fiscal 2012.

Effect of Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-05, “Comprehensive Income (ASU Topic 220): Presentation of Comprehensive Income,” (“ASU 2011-05”) which amends current comprehensive income guidance. This accounting update eliminates the option to present the components of other comprehensive income as part of the statement of shareholders’ equity. Instead, comprehensive income must be presented in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. ASU 2011-05 was effective for fiscal periods beginning after December 15, 2011 with early adoption permitted. In December 2011, the FASB issued ASU 2011-12 “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” This accounting update stated that the specific requirement to present items that are reclassified from other comprehensive income to net income alongside their respective components of net income and other comprehensive income will be deferred.  In February 2013, the FASB issued ASU 2013-02 “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”. This accounting update requires companies to present the effects on the line items of net income of significant reclassifications out of accumulated other comprehensive income if the amount being reclassified is required under U.S. generally accepted accounting principles to be reclassified in its entirety to net income in the same reporting period.  ASU 2013-02 is effective prospectively for fiscal years beginning after December 15, 2012. The adoption of ASU 2013-02 did not have a material impact on our consolidated financial position, results of operations or cash flows.

 

 

	- 30 -

 

In July 2013, the FASB issued Accounting Standards Update No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (“ASU 2013-11”).  ASU 2013-11 amends Accounting Standards Codification 740, “Income Taxes,” to require that in certain cases, an unrecognized tax benefit, or portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward when such items exist in the same taxing jurisdiction. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date, and retrospective application is permitted. We are currently evaluating the impact, if any this update will have on our financial statements.

  

 

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.

 

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

ProPhase Labs, Inc.

 

We have audited the accompanying consolidated balance sheets of ProPhase Labs, Inc. and Subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2013.  The financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion. 

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ProPhase Labs, Inc. and Subsidiaries as of December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America.

 

/S/ EisnerAmper LLP

 

Iselin, New Jersey

March 27, 2014

 

 

PROPHASE LABS, INC AND SUBSIDARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

 

		December 31,
		2013			2012
ASSETS
Cash and cash equivalents (Note 2)		$	1,638		$	572
Accounts receivable, net (Note 2)			5,319			5,409
Inventory (Note 2)			2,521			2,051
Prepaid expenses and other current assets (Note 2)			1,801			2,687
Total current assets			11,279			10,719
Property, plant and equipment, net of accumulated depreciation     of $4,064 and $3,860, respectively (Note 3)			2,564			2,365
Intangible asset, licensed technology (Note 8)			3,577			3,577
		$	17,420		$	16,661
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Accounts payable		$	1,011		$	1,296
Accrued advertising and other allowances (Note 2)			2,847			2,760
Other current liabilities (Note 4)			766			854
Total current liabilities			4,624			4,910
Other long term obligation (Note 5)			200			300
Total long term liabilities			200			300
COMMITMENTS AND CONTINGENCIES (Note 5)			-			-
STOCKHOLDERS' EQUITY
Common stock, $.0005 par value; authorized 50,000,000;     issued: 21,437,059 and 21,056,115 shares, respectively (Note 6)			11			11
Additional paid-in-capital			43,607			42,867
Accumulated deficit			(5,385)			(5,790)
Treasury stock, at cost, 5,336,053 and 5,336,053 shares,     respectively (Note 6)			(25,637)			(25,637)
			12,596			11,451
		$	17,420		$	16,661

 

See accompanying notes to consolidated financial statements

 

 

	- 33 -

PROPHASE LABS, INC & SUBSIDARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

		Year Ended December 31,
		2013			2012			2011
Net sales (Notes 2 and 11)		$	25,032		$	22,406		$	17,453
Cost of sales (Note 2)			8,361			8,154			6,171
Gross profit			16,671			14,252			11,282
Operating expenses:
Sales and marketing			9,538			8,946			7,904
Administrative			5,893			6,127			5,028
Research and development (Note 2)			824			1,301			1,088
Settlement benefit (Note 5)			-			(1,024)			-
Total operating expense			16,255			15,350			14,020
Income (loss) from operations			416			(1,098)			(2,738)
Interest income			2			7			28
Interest expense			(13)			-			-
Income (loss) from operations before taxes			405			(1,091)			(2,710)
Income tax (benefit) (Note 9)			-			-			-
Net income (loss)		$	405		$	(1,091)		$	(2,710)
Basic income (loss) per share:
Net income (loss)		$	0.03		$	(0.07)		$	(0.18)
Diluted income (loss) per share:
Net income (loss)		$	0.03		$	(0.07)		$	(0.18)
Weighted average common shares outstanding:
Basic			15,839			14,843			14,817
Diluted			16,276			14,843			14,817

 

See accompanying notes to consolidated financial statements

 

 

 

PROPHASE LABS, INC & SUBSIDARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except share data)

 

							Additional			Retained
		Common Stock		Par			Paid-In			Earnings			Treasury
		Shares		Value			Capital			(Deficit)			Stock			Total
Balance at December 31, 2010		14,707,619			10			40,627			(1,989)			(25,188)			13,460
Net loss											(2,710)						(2,710)
Share-based compensation expense								131									131
Common stock granted pursuant to an     employment agreement		341,254						294									294
Common stock granted pursuant to a     compensation plan		466,710						500									500
Treasury stock purchase (Note 8)		(690,000)												(449)			(449)
Balance at December 31, 2011		14,825,583			10			41,552			(4,699)			(25,637)			11,226
Net loss											(1,091)						(1,091)
Share-based compensation expense								153									153
Common stock granted pursuant to an     employment agreement		10,757						93									93
Common stock issued (Note 6)		883,722			1			1,069									1,070
Balance at December 31, 2012		15,720,062			11			42,867			(5,790)			(25,637)			11,451
Net income											405						405
Proceeds from exercise of stock options		25,000						27									27
Share-based compensation expense								160									160
Common stock granted pursuant to a     compensation plan		66,470						109									109
Common stock issued (Note 6)		289,474			-			444									444
Balance at December 31, 2013		16,101,006		$	11		$	43,607		$	(5,385)		$	(25,637)		$	12,596

 

See accompanying notes to consolidated financial statements

 

 

PROPHASE LABS, INC & SUBSIDARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

		Year Ended December 31,
		2013			2012			2011
Cash flows from operating activities:
Net income (loss)		$	405		$	(1,091)		$	(2,710)
Adjustments to reconcile net loss to net cash provided by (used in)    operating activities:
Depreciation and amortization			243			252			355
Gain on the sale of fixed assets			-			-			(28)
Reduction of payment obligation, settlement benefit			-			(1,024)			-
Share-based compensation expense			269			246			631
Changes in operating assets and liabilities:
Accounts receivable			90			(2,190)			1,602
Inventory			(470)			637			(1,006)
Prepaid expenses and other assets			886			(940)			(864)
Accounts payable			(285)			411			396
Accrued advertising and other allowances			87			(199)			(565)
Accrued royalties and commissions			-			(2,100)			-
Other operating assets and liabilities, net			(88)			269			81
Net cash provided by (used in) operating activities			1,137			(5,729)			(2,108)
Cash flows from investing activities:
Capital expenditures			(442)			(310)			(300)
Proceeds from the sale of fixed assets			-			-			166
Net cash flows used in investing activities			(442)			(310)			(134)
Cash flows from financing activities:
Proceeds from the exercise of stock options			27			-			-
Proceeds from issuance of common stock			444			1,070			-
Payment of long term obligation			(100)			-			-
Purchase of treasury stock			-			-			(449)
Net cash provided by (used in) financing activities			371			1,070			(449)
Net increase (decrease) in cash and cash equivalents			1,066			(4,969)			(2,691)
Cash and cash equivalents at beginning of year			572			5,541			8,232
Cash and cash equivalents at end of year		$	1,638		$	572		$	5,541
Supplemental disclosures of cash flow information:
Income taxes paid		$	-		$	-		$	-
Interest paid		$	13		$	-		$	-
Common stock issued, in lieu of cash, as payment of accrued compensation		$	-		$	-		$	294