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.
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.
In addition, we have several national Broker, Distributor and Representative Agreements which provide for commission compensation based on sales performance.
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.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.
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 prescription pharmaceutical and 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, thesea new productsproduct(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.
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.
Should research or commercialization activity progress on certain formulations, resulting expenditures may require substantial financial support. The current sales levels of Cold-EEZE®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 that meet our long term goals and objectives.
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.
Our revenues are significantly concentrated in 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.
Although we have a broad range of retail customers that includes many large wholesalers, mass merchandisers and multiple outlet pharmacy and food chains, our five largest customers account for a significant percentage of our sales —– 61% and 56% and 48% of total sales for Fiscal 20092010 and 2008,2009, respectively. In addition, retail customers comprising the five largest accounts receivable balances represented 66%51% and 55%66% of total accounts receivable balances at December 31, 20092010 and 2008,2009, 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.
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.
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 Interim Chief Financial Officer, and certain managers and strategists within the Company. The loss of the services of any one of them could have a material adverse effect on us.
Certain raw material active ingredients used in connection with the Cold-EEZE®Cold-EEZE® product are purchased from a single unaffiliated supplier. Should the relationship terminate or the vendor become unable 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.
We continue to look for safe and reliable multiple-location sources for products and raw materials so that we can continue to obtain products and raw materials in the event of a disruption in our business relationship with any single manufacturer or supplier. While secondary sources have been identified for some of our manufacturing and raw materials needs, our inability to find alternative sources for some of our manufacturing and raw materials
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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 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 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.
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. We currently maintain product liability insurance in the amount of, and with a maximum payout of, $25 million. 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 its products.
We are involved in litigation including claims relating to certain of our Cold-EEZE®Cold-EEZE® products and other business matters 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’smanagement'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.
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Certain Officers, Directors, PSI Parent and former executives and their families own a substantial amount of our Common
Stock
As of March 24, 2010,1, 2011, our executive officers and directors, and PSI Parent beneficially owned approximately 9.1% and 9.8%, respectively, of our Common Stock and our former executives, Mr. Guy J. Quigley and Mr. Charles Phillips, and their immediate families beneficially owned, approximately 30.7%27.1% of our Common Stock. Mr. Quigley and Mr. Phillips also hold options granted under our 1997 Stock Option Plan to purchase an aggregate of 633,500 additional shares of our Common Stock at an average exercise price of $8.08 per share. 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, your ability to influence us through voting your shares may be limited or the market price of our Common Stock may be adversely affected.
Our stock price is volatile
The market price of our Common Stock has experienced significant volatility. There are several factors which could affect the price of our Common Stock, including some of which are announcements of technological innovations for new commercial products by us or our competitors, developments concerning propriety rights, new or revised governmental regulation or general conditions in the market for our products. Sales of a substantial number of shares by existing stockholders could also have an adverse effect on the market price of our Common Stock.
Future sales of shares of our Common Stock in the public market could adversely affect the trading price of
shares of the Common Stock and our ability to raise funds in new stock offerings
Future sales of substantial amounts of shares of our Common Stock in the public market, or the perception that such sales are likely to occur, could affect prevailing trading prices of our Common Stock. As of March
24, 2010,1, 2011, we had
14,484,38714,749,877 shares of Common Stock outstanding.
As of March 24, 20101, 2011 we also have outstanding options, which are fully vested, to purchase an aggregate of 1,487,750363,250 shares of our Common Stock at an average exercise price of $8.64$7.98 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. Some stockholders may believe such an offer to be in their best interest because it may include a premium over the market price of our Common Stock at the time. In addition, these provisions may assist current management in retaining its position and place it in a better position to resist changes which some stockholders may want to make if dissatisfied with the conduct of our business.
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 a standard form of indemnity agreement with each member of our Board of Directors, Mr. Karkus and Mr. Cuddihy. These agreements provide, among other things, that we will indemnify each director, Mr. Karkus and Mr. Cuddihy 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.
We have identified material weaknesses in our internal control environment for the period from April 1, 2009
through December 31, 2009
and Fiscal 2010
A material weakness is a control deficiency, or combination of deficiencies in internal control deficiencies,over financial reporting such that results inthere is a reasonable probabilitypossibility that a material misstatement of the financial statements will not be prevented or detected by our internal controls.on a timely basis. In relation to our Financial Statements for Fiscal 2009, in connection with its review of the Company’s internal control process over financial reporting, management identified as a consequence of certain events occurring during the second quarter of Fiscal 2009 the following material weaknesses in our internal control environment: (i)lack of management continuity due to changes in executive management and (ii) lack of documentation and/or the availability of documentation or records within our files of business transactions, contracts and/or evaluations conducted by the Company. Additionally, during a portion of Fiscal 2009, we also identified and initiated remediation program to address our lack of sufficient subject matter expertise in at least two of the following significant areas: (a) accounting for and the disclosure of complex transactions and (b) the selection, monitoring and evaluation of certain vendors that provided services to Pharma.
In relation to our Financial Statements for Fiscal 2010, during the third and fourth quarter, we implemented a new accounting and operating software and hardware platform (“ERP System”) to upgrade and integrate the company’s operations onto a common, state-of-the-art ERP System. The new ERP System is projected to provide management with improved data gathering, processing, retrieval and analysis on a more timely and cost effective basis than its prior methods and systems. The installation and transition period of the new ERP System was from June to December 2010.
However, during the transition period, certain personnel had significant access to and certain initial processing responsibilities within the ERP System as part of the installation, integration testing, launch, shakedown and training processes. Specifically, such personnel had access to certain processing functions within the various software applications whereby they could, enter, process, record and report transactions without our customary level of segregation of duties. Although there was significant oversight by management during the transition period, there were limited, appropriately trained staff available to provide adequate separation of duties during the transition period.
Following the identification of these material weaknesses, management took measures and plans to continue to take measures to remediate these weaknesses and deficiencies. However, the implementation of these measures may not fully address these weaknesses. A failure to correct these weaknesses or other control deficiencies or a failure to discover and address any other control deficiencies could result in inaccuracies in our consolidated financial statements and could impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis or could cause investors to lose confidence in our reported financial information, which could have a negative impact on our financial condition and stock price.
Item 1B. Unresolved Staff Comments
Not applicable.
| Item 1B. | Unresolved Staff Comments |
Not applicable.
Our corporate headquarters is located in Doylestown, Pennsylvania. We purchased this property
with an area ofin 1998. Our headquarters is approximately 13,000 square feet
and is comprised principally of office space and limited warehousing and storage
in November 1998.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. Effective in June 2009, we closed our 15,500 square foot Elizabethtown, Pennsylvania manufacturing location and consolidated our manufacturing operations in the Lebanon facility. At December 31,
2009,2010, the net value of the Elizabethtown facility in the amount of $138,000 is classified as an asset held for sale.
In February 2011, the Elizabethtown facility was sold and we derived net proceeds from the sale of approximately $166,000.
In addition to warehousing and storage capacity at the Lebanon facility, we also storestored certain inventory on a month-to-monthshort term basis as needed, at a number of additional warehouses with storage charges based upon the quantities of product being stored.an outside side warehouse. We believe that our existing facilities are adequate at this time.
Item 3. Legal Proceedings
THE QUIGLEY CORPORATION
(currently PROPHASE LABS, INC.) VS. JOHN C. GODFREY, ET AL.
This action was commenced by us in November 2004 in the Court of Common Pleas of Bucks County, Pennsylvania against John C. Godfrey, Nancy Jane Godfrey, and Godfrey Science and Design, Inc. for injunctive relief regarding the Cold-EEZE® trade name andCold-EEZE® trademark; injunctive relief relating to the Cold-EEZE®Cold-EEZE® formulations and manufacturing methods; injunctive relief for breach of the duty of loyalty, and declaratory judgment pending our payment of commissionsregarding various payments that the defendants assert are owing to defendants.them. Our complaint is based in part upon certain contracts with defendants whereby we obtained the Exclusive Representationexclusive right to manufacture and Distribution Agreementdistribute product pursuant to a basic patent and also obtained various consulting services (the "Agreements"). Subsequent to entering into the Agreements, the defendants took various actions that we believe were in breach of the Agreements. We instituted the action because of defendants' threats to deal with other parties and to use the Company’s Cold-EEZE® trademark and the Consulting Agreement (together the “Agreements”) between ustrade secrets that we developed during our manufacture of Cold-EEZE®. Both because of their breaches and the defendants. We haveexpiration of the basic patent, we terminated the Agreements due to the defendants’ alleged material breaches of the Agreements. Defendants have answered the complaint and asserted counterclaims against us seeking remediescounterclaims. They seek monetary damages and counter injunctive and declaratory relief relative to the Company's trademark and other intellectual property. The monetary relief sought by the defendants is based on their claim that they were not paid various amounts asserted to be due under the Agreements. This claim is estimated to be in excess of $5.0 million. We believe that the defendants’defendants' counterclaims are without merit and are vigorously defending those counterclaims and are prosecuting our action on the complaint.
Pre-trial discovery is
complete.ongoing. Defendants moved for partial summary judgment, and we filed a response and cross-motion for summary judgment. On August 21, 2008, the court denied both motions for summary judgment. The case has not been assigned to a trial calendar, although it is possible that the case will be listed for trial in
2010.2011.
At this time no prediction as to the outcome of this action can be made.
THE QUIGLEY CORPORATION
(currently PROPHASE LABS, INC.)VS. WACHOVIA INSURANCE SERVICES, INC. AND FIRST UNION
INSURANCE SERVICES AGENCY, INC.
We instituted a Writ of Summons against Wachovia Insurance Services, Inc. and First Union Insurance Services Agency, Inc. on December 8, 2005 in the Court of Common Pleas of Bucks County, Pennsylvania,.Pennsylvania. The purpose of this suit was to maintain an action and toll the statute of limitation against our insurance broker who failed to place excess limits coverage for us for the period from November 29, 2003 until April 6, 2004. As a result of the defendant’sdefendant's failure to place insurance and to notify us thereof, certain pending actions covered by our underlying insurance which are currently being defended by insurance counsel and the underlying insurance carrier may cause an exhaustion of the underlying insurance for the policy periods ending November 29, 2004 and November 29, 2005. Any case in which an alleged action arose relating to the use of Cold-EEZE®Cold-EEZE® Nasal Spray from November 29, 2003 to April 6, 2004 is not covered by excess insurance. Our claim against Wachovia Insurance Services, Inc. and First Union Insurance Services Agency, Inc. is for negligence and for equitable insurance for these claims based on our undertaking of certain attorneys’ fees and costs of settlement for claims that should have been covered by underlying insurance placed by Wachovia Insurance Services, Inc.
At this time no prediction can be made as to the outcome of any action against Wachovia Insurance Services, Inc. and First Union Insurance Services Agency, Inc.
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THOMAS A. SIMONIAN VS. THE QUIGLEY CORPORATION
(currently PROPHASE LABS, INC.)
On February 24, 2010, an action was commenced in the United States District Court for the Northern District of Illinois Eastern Division by Mr. Thomas Simonian against us for false patent marketing under 35 U.S.C. § 292. Mr. Simonian claims that our Cold-EEZE®Cold-EEZE® packaging references certain patents which have been expired since June 10, 2005 and August 3, 2007. On such information and belief, Mr. Simonian claims that the Company marks certain of its Cold-EEZE®Cold-EEZE® branded products with the expired patents with the intent to deceive the public and to gain a competitive advantage in the market. Mr. Simonian is seeking an award of monetary damages.
We are investigating this claim. At this time no prediction can be made as to the outcome of this case.
PUBLIC PATENT FOUNDATION, INC. VS. THE QUIGLEY CORPORATION
(currently PROPHASE LABS, INC.)
On February 24, 2010, an action was commenced in the United States District Court for the Southern District of New York by Public Patent Foundation, Inc. (“PPF”) against us for false patent marketing under 35 U.S.C. § 292. PPF claims that our Cold-EEZE®Cold-EEZE® packaging references certain patents which have been expired since June 10, 2005 and August 3, 2007. On such information and belief, PPF claims that the Company marks certain of its Cold-EEZE®Cold-EEZE® branded products with the expired patents with the intent to deceive the public and to gain a competitive advantage in the market. PPF is seeking an award of monetary damages.
We are investigating this claim. In the interim, we have filed a Motion to Dismiss for Failure to State a Claim which is currently pending before the court. At this time no prediction can be made as to the outcome of this case.
PROPHASE LABS, INC (formerly THE QUIGLEY CORPORATION) VS. GUY QUIGLEY, GARY QUIGLEY, SCANDA SYSTEMS LIMITED, SCANDA SYSTEMS LTD, CHILESHA HOLDINGS LTD, KEVIN BROGAN, INNERLIGHT HOLDINGS, INC., GEORGE LONGO, GRAHAM BRANDON, PACIFIC RIM PHARMACEUTICALS LTD AND JOHN DOE DEFENDANTS
On August 23, 2010, we initiated an action in the Court of Common Pleas for Bucks County, Pennsylvania. This action is against certain former officers and directors of the Company, including a shareholder that beneficially owns approximately 20.2% of our Common Stock, and against certain third parties (a “Complaint”). The Company has asserted claims arising from, among other things, a variety of transactions and payments previously made or entered into by the Company. All of the transactions and events that are the subject of the Complaint occurred prior to June 2009 and the installation of the current Board of Directors.
In the normal course of its 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.Item 4. Reserved
PART II
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Our Common Stock is currently traded on The NASDAQ Global Market under the trading symbol “QGLY.“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 20092010 and 2008,2009, as reported on The NASDAQ Global Market.
 | | | | | | | | |
| | 2009 | | 2008 |
| Quarter Ended | | High | | Low | | High | | Low |
| March 31, | | $ | 5.00 | | | $ | 3.86 | | | $ | 5.74 | | | $ | 4.17 | |
| June 30, | | $ | 6.70 | | | $ | 3.53 | | | $ | 5.85 | | | $ | 4.54 | |
| September 30, | | $ | 4.01 | | | $ | 1.58 | | | $ | 5.65 | | | $ | 4.58 | |
| December 31, | | $ | 2.50 | | | $ | 1.45 | | | $ | 5.39 | | | $ | 2.85 | |
| | | 2010 | | | 2009 | |
| Quarter Ended | | High | | | Low | | | High | | | Low | |
| | | | | | | | | | | | | |
| March 31, | | $ | 2.25 | | | $ | 1.90 | | | $ | 5.00 | | | $ | 3.86 | |
| June 30, | | $ | 2.24 | | | $ | 1.09 | | | $ | 6.70 | | | $ | 3.53 | |
| September 30, | | $ | 1.85 | | | $ | 0.80 | | | $ | 4.01 | | | $ | 1.58 | |
| December 31, | | $ | 1.52 | | | $ | 1.00 | | | $ | 2.50 | | | $ | 1.45 | |
As of March
24, 2010,1, 2011, there were approximately
275272 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.
In addition to our outstanding Common Stock, there were reserved for issuance
1,487,750363,250 shares of our Common Stock underlying outstanding unexercised and vested options as of December 31,
20092010 at the price-per-share stated and expire on the date indicated, as follows:
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Description | | | | Number | | Exercise Price | | Expiration Date | | | | Number | | Exercise Price | | Expiration Date |
| Option Plan | | | * | | | | 70,000 | | | $ | 0.81 | | | | May 2010 | | | | * | | | | 48,000 | | | $ | 8.11 | | | | October 2010 | |
| Option Plan | | | * | | | | 20,000 | | | $ | 0.81 | | | | June 2010 | | | | * | | | | 83,500 | | | $ | 8.11 | | | | October 2013 | |
| Option Plan | | | * | | | | 500 | | | $ | 0.81 | | | | December 2010 | | | | * | | | | 5,000 | | | $ | 9.50 | | | | March 2010 | |
| Option Plan | | | * | | | | 60,000 | | | $ | 1.26 | | | | May 2010 | | | | * | | | | 45,000 | | | $ | 9.50 | | | | May 2010 | |
| Option Plan | | | * | | | | 25,000 | | | $ | 1.26 | | | | June 2010 | | | | * | | | | 169,500 | | | $ | 9.50 | | | | June 2010 | |
| Option Plan | | | * | | | | 13,500 | | | $ | 1.26 | | | | December 2011 | | | | * | | | | 42,000 | | | $ | 9.50 | | | | October 2010 | |
| Option Plan | | | * | | | | 7,000 | | | $ | 5.19 | | | | March 2010 | | | | * | | | | 95,000 | | | $ | 9.50 | | | | October 2014 | |
| Option Plan | | | * | | | | 42,000 | | | $ | 5.19 | | | | May 2010 | | | | * | | | | 3,000 | | | $ | 13.80 | | | | March 2010 | |
| Option Plan | | | * | | | | 117,000 | | | $ | 5.19 | | | | June 2010 | | | | * | | | | 2,500 | | | $ | 13.80 | | | | April 2010 | |
| Option Plan | | | * | | | | 15,000 | | | $ | 5.19 | | | | October 2010 | | | | * | | | | 80,000 | | | $ | 13.80 | | | | May 2010 | |
| Option Plan | | | * | | | | 50,250 | | | $ | 5.19 | | | | July 2012 | | | | * | | | | 213,500 | | | $ | 13.80 | | | | June 2010 | |
| Option Plan | | | * | | | | 8,000 | | | $ | 8.11 | | | | March 2010 | | | | * | | | | 30,000 | | | $ | 13.80 | | | | October 2010 | |
| Option Plan | | | * | | | | 45,000 | | | $ | 8.11 | | | | May 2010 | | | | * | | | | 75,500 | | | $ | 13.80 | | | | December 2015 | |
| Option Plan | | | * | | | | 122,000 | | | $ | 8.11 | | | | June 2010 | | | | * | | | | | | | | | | | | | |
| Subtotal | | | | | | | 595,250 | | | | | | | | Subtotal | | | | | | | | 892,500 | | | | | | | | | |
| | | | | | | | | | | | | | | | Grand Total Options | | | | | | | | 1,487,750 | | | | | | | | | |
TABLE OF CONTENTS
| Description | | | Number | | | Exercise Price | | Expiration Date | | | Number | | | Exercise Price | | Expiration Date |
| Option Plan | * | | | 45,500 | | | $ | 1.00 | | December 2017 | * | | | 6,000 | | | $ | 8.11 | | January 2012 |
| Option Plan | * | | | 10,000 | | | $ | 1.26 | | December 2011 | * | | | 32,000 | | | $ | 8.11 | | October 2013 |
| Option Plan | * | | | 1,000 | | | $ | 1.26 | | May 2011 | * | | | 10,000 | | | $ | 9.50 | | May 2011 |
| Option Plan | * | | | 2,500 | | | $ | 1.26 | | June 2011 | * | | | 22,500 | | | $ | 9.50 | | June 2011 |
| Option Plan | * | | | 7,500 | | | $ | 5.19 | | May 2011 | * | | | 10,000 | | | $ | 9.50 | | October 2011 |
| Option Plan | * | | | 13,000 | | | $ | 5.19 | | June 2011 | * | | | 6,000 | | | $ | 9.50 | | November 2011 |
| Option Plan | * | | | 4,000 | | | $ | 5.19 | | October 2011 | * | | | 6,000 | | | $ | 9.50 | | January 2012 |
| Option Plan | * | | | 1,000 | | | $ | 5.19 | | November 2011 | * | | | 40,500 | | | $ | 9.50 | | October 2014 |
| Option Plan | * | | | 5,000 | | | $ | 5.19 | | January 2012 | * | | | 4,000 | | | $ | 13.80 | | May 2011 |
| Option Plan | * | | | 19,750 | | | $ | 5.19 | | July 2012 | * | | | 17,500 | | | $ | 13.80 | | June 2011 |
| Option Plan | * | | | 12,000 | | | $ | 8.11 | | May 2011 | * | | | 15,000 | | | $ | 13.80 | | October 2011 |
| Option Plan | * | | | 20,500 | | | $ | 8.11 | | June 2011 | * | | | 2,500 | | | $ | 13.80 | | November 2011 |
| Option Plan | * | | | 8,000 | | | $ | 8.11 | | October 2011 | * | | | 10,000 | | | $ | 13.80 | | January 2012 |
| Option Plan | * | | | 5,000 | | | $ | 8.11 | | November 2011 | * | | | 26,500 | | | $ | 13.80 | | December 2015 |
| | | | | | | | | | | | | | | | | | | | | |
| Subtotal | | | | 154,750 | | | | Subtotal | | | | 208,500 | | | | | | |
| | | | | | | | | Grand Total Options | | | | 363,250 | | | | | | |
Securities Authorized Under Equity Compensation
The following table sets forth certain information regarding stock option and warrant grants made to employees, directors and consultants:
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
| | | | | | |
| Plan Category | | Number of
Securities to be
Issued Upon
Exercise of
Outstanding
Options & Warrants
(A) | | Weighted
Average
Exercise Price
of Outstanding
Options &
Warrants
(B) | | Number of Securities
Remaining Available for
Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column A)
(C) |
| Equity Plans Approved by Security Holders(1) | | | 1,487,750 | | | $ | 8.64 | | | | — | |
| (1) | An incentive stock option plan was instituted in Fiscal 1997, (the “1997 Option Plan”) and approved by the stockholders in Fiscal 1998. Options pursuant to the 1997 Option Plan have been granted to directors, executive officers and employees. At December 31, 2009, we are precluded from issuing any additional options or grants in the future under the 1997 Option Plan pursuant to the terms of the plan document. Options previously granted may continue to be available for exercise at any time prior to such options’ respective expiration dates. |
| Plan Category | | Number of Securities to be Issued Upon Exercise of Outstanding Options & Warrants (A) | | | Weighted Average Exercise Price of Outstanding Options & Warrants (B) | | | Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column A) ( C ) | |
| | | | | | | | | | |
Equity Plans Approved by Security Holders (1,2,3) | | | 1,299,750 | | | $ | 2.99 | | | | 1,000,375 | |
(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 Option Plan have been granted to directors, executive officers and employees. At December 31, 2010, we are precluded from issuing any additional options or grants in the future under the 1997 Option Plan pursuant to the terms of the plan document. Options previously granted may continue to be 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. The 2010 Equity Compensation Plan provides that the total number of shares of Common Stock that may be issued is equal to 900,000 shares plus up to 900,000 shares that are authorized for issuance but unissued under the 1997 Plan, an aggregate of 1.8 million shares. The 1997 Plan expired on December 2, 2007 and no additional awards may be made; however, as of March 31, 2010, there remained 1,449,750 shares subject to vested options that were authorized for issuance (the “Issued Options”) but were unissued under the 1997 Plan. As of December 31, 2010, 1,039,500 of the Issued Options under the 1997 Plan expired unexercised or were terminated (the “Expired Options”). As a consequence, these shares are deemed and remain unissued which up to a maximum of 900,000 shares become available for issuance under the 2010 Equity Compensation Plan and the remaining 139,500 options were deemed cancelled.
All of the Company’s employees, including employees who are officers or members of the Board are eligible to participate in the 2010 Equity Compensation Plan. Consultants and advisors who perform services for the Company are also eligible to participate in the 2010 Equity Compensation Plan. At December 31, 2010, we have granted 982,000 stock options, subject to vesting, under the 2010 Equity Compensation Plan and have charged to operations $42,000 for compensation expense for the fair value of the vested portion of the stock options as of December 31, 2010 (see Note 8 to Notes to Consolidated Financial Statements).
(3) On May 5, 2010, our shareholders approved the 2010 Directors’ Equity Compensation Plan. A primary purpose of the 2010 Directors’ Equity Compensation Plan is to provide us with the ability to pay all or a portion of the fees of Directors in restricted stock instead of cash. The 2010 Directors’ Equity Compensation Plan provides that the total number of shares of Common Stock that may be issued under the 2010 Directors’ Equity Compensation Plan is equal to 250,000. As of December 31, 2010, we granted 67,625 shares of our Common Stock valued at $90,000 for director compensation. At December 31, 2010, there are 182,375 shares of Common Stock that may be issued pursuant to the 2010 Directors Equity Compensation Plan.
Other Stock Issuances
Pursuant to the terms of Mr. Cuddihy’s employment agreement, which has a three year term, Mr. Cuddihy will receivereceives 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 the Company’s shares for the last five (5) trading days of the quarter in which the shares are earned. Mr.Mr Cuddihy earned 4,418 shares and 6,586 shares for the quarters ended September 30, 2009 and December 31, 2009, respectively. Wewas issued an aggregate of 11,00435,075 shares for Fiscal 2010 pursuant to the terms of the employment agreement.
Pursuant to the Original License Agreement with PSI Parent, we issued 1,440,000 shares of Common Stock having an aggregate value of approximately $2.6 million to Mr. Cuddihy on February 24, 2010.PSI Parent. This issuance of the PSI Shares was in part the consideration paid for (i) an exclusive, royalty-free, world-wide (subject to certain limitations), paid-up license to exploit OTC drugs (and certain other products) that embody certain of PSI Parent’s 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.
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,
2010, 2009, 2008, 2007
2006 and
2005.2006. 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, |
| | | 2009 | | 2008 | | 2007 | | 2006 | | 2005 |
Statement of Income Data:
| | | | | | | | | | | | | | | | | | | | |
| Net sales | | $ | 19,816 | | | $ | 20,507 | | | $ | 28,241 | | | $ | 26,850 | | | $ | 33,185 | |
| Gross profit | | $ | 11,569 | | | $ | 11,413 | | | $ | 18,556 | | | $ | 17,545 | | | $ | 21,301 | |
| Income (loss) – continuing operations | | $ | (3,842 | ) | | $ | (6,409 | ) | | $ | (1,856 | ) | | $ | (547 | ) | | $ | 2,339 | |
| Income (loss) – discontinued operations(1) | | | — | | | | 875 | | | | (602 | ) | | | (1,201 | ) | | | 878 | |
| Net income (loss) | | $ | (3,842 | ) | | $ | (5,534 | ) | | $ | (2,458 | ) | | $ | (1,748 | ) | | $ | 3,217 | |
Basic earnings (loss) per share:
| | | | | | | | | | | | | | | | | | | | |
| Continuing operations | | $ | (0.30 | ) | | $ | (0.50 | ) | | $ | (0.14 | ) | | $ | (0.04 | ) | | $ | 0.20 | |
| Discontinued operations | | | — | | | | 0.07 | | | | (0.05 | ) | | | (0.10 | ) | | | 0.08 | |
| Net income (loss) | | $ | (0.30 | ) | | $ | (0.43 | ) | | $ | (0.19 | ) | | $ | (0.14 | ) | | $ | 0.28 | |
Diluted earnings (loss) per share:
| | | | | | | | | | | | | | | | | | | | |
| Continuing operations | | $ | (0.30 | ) | | $ | (0.50 | ) | | $ | (0.14 | ) | | $ | (0.04 | ) | | $ | 0.17 | |
| Discontinued operations | | | — | | | | 0.07 | | | | (0.05 | ) | | | (0.10 | ) | | | 0.07 | |
| Net income (loss) | | $ | (0.30 | ) | | $ | (0.43 | ) | | $ | (0.19 | ) | | $ | (0.14 | ) | | $ | 0.24 | |
Weighted average shares outstanding:
| | | | | | | | | | | | | | | | | | | | |
| Basic | | | 12,963 | | | | 12,878 | | | | 12,729 | | | | 12,245 | | | | 11,661 | |
| Diluted | | | 12,963 | | | | 12,878 | | | | 12,729 | | | | 12,245 | | | | 13,299 | |
| | | | | | | | | | |
| | As of December 31, |
| | | 2009 | | 2008 | | 2007 | | 2006 | | 2005 |
Balance Sheet Data:
| | | | | | | | | | | | | | | | | | | | |
| Working capital | | $ | 11,475 | | | $ | 14,071 | | | $ | 18,578 | | | $ | 20,541 | | | $ | 20,682 | |
| Total assets | | $ | 19,817 | | | $ | 24,369 | | | $ | 33,502 | | | $ | 34,845 | | | $ | 35,976 | |
| Debt | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 1,464 | |
| Stockholders’ equity | | $ | 14,059 | | | $ | 17,774 | | | $ | 23,244 | | | $ | 25,529 | | | $ | 25,320 | |
| (1) | On February 29, 2008, we sold Darius to InnerLight Holdings, Inc. (see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and Note 3 to the Financial Statements). The sale of this segment has been treated as discontinued operations and all periods presented have been reclassified. |
| | | Year Ended December 31, | |
| | | 2010 | | | 2009 | | | 2008 | | | 2007 | | | 2006 | |
| Statement of Income Data: | | | | | | | | | | | | | | | |
| Net sales | | $ | 14,502 | | | $ | 19,816 | | | $ | 20,507 | | | $ | 28,241 | | | $ | 26,850 | |
| Gross profit | | $ | 8,830 | | | $ | 11,569 | | | $ | 11,413 | | | $ | 18,556 | | | $ | 17,545 | |
| Loss - continuing operations | | $ | (3,501 | ) | | $ | (3,842 | ) | | $ | (6,409 | ) | | $ | (1,856 | ) | | $ | (547 | ) |
Income (loss) - discontinued operations (1) | | | - | | | | - | | | | 875 | | | | (602 | ) | | | (1,201 | ) |
| Net loss | | $ | (3,501 | ) | | $ | (3,842 | ) | | $ | (5,534 | ) | | $ | (2,458 | ) | | $ | (1,748 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Basic earnings (loss) per share: | | | | | | | | | | | | | | | | | | | | |
| Continuing operations | | $ | (0.25 | ) | | $ | (0.30 | ) | | $ | (0.50 | ) | | $ | (0.14 | ) | | $ | (0.04 | ) |
| Discontinued operations | | | - | | | | - | | | | 0.07 | | | | (0.05 | ) | | | (0.10 | ) |
| Net loss | | $ | (0.25 | ) | | $ | (0.30 | ) | | $ | (0.43 | ) | | $ | (0.19 | ) | | $ | (0.14 | ) |
| Diluted earnings (loss) per share: | | | | | | | | | | | | | | | | | | | | |
| Continuing operations | | $ | (0.25 | ) | | $ | (0.30 | ) | | $ | (0.50 | ) | | $ | (0.14 | ) | | $ | (0.04 | ) |
| Discontinued operations | | | - | | | | - | | | | 0.07 | | | | (0.05 | ) | | | (0.10 | ) |
| Net loss | | $ | (0.25 | ) | | $ | (0.30 | ) | | $ | (0.43 | ) | | $ | (0.19 | ) | | $ | (0.14 | ) |
| Weighted average shares outstanding: | | | | | | | | | | | | | | | | | | | | |
| Basic | | | 14,285 | | | | 12,963 | | | | 12,878 | | | | 12,729 | | | | 12,245 | |
| Diluted | | | 14,285 | | | | 12,963 | | | | 12,878 | | | | 12,729 | | | | 12,245 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | As of December 31, | |
| | | 2010 | | | 2009 | | | 2008 | | | 2007 | | | 2006 | |
| Balance Sheet Data: | | | | | | | | | | | | | | | | | | | | |
| Working capital | | $ | 7,521 | | | $ | 11,475 | | | $ | 14,071 | | | $ | 18,578 | | | $ | 20,541 | |
| Total assets | | $ | 21,695 | | | $ | 21,330 | | | $ | 24,369 | | | $ | 33,502 | | | $ | 34,845 | |
| Stockholders’ equity | | $ | 13,460 | | | $ | 14,059 | | | $ | 17,774 | | | $ | 23,244 | | | $ | 25,529 | |
(1) On February 29, 2008, we sold Darius to InnerLight Holdings, Inc. (see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and Note 14 to the Financial Statements). The sale of this segment has been treated as discontinued operations and all periods presented have been reclassified.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Our Business.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 base health products along with supplements and cosmeceuticals for human and veterinary use.products.
Our primary business is currently the manufacture, distribution, marketing and sale of OTCover-the-counter (“OTC”) cold remedy products to consumers through national chain, regional, specialty and local retail stores. One of our principal products is Cold-EEZE®Cold-EEZEÒ, a zinc gluconate glycine product proven in clinical studies to reduce the duration and severity of the common cold symptoms by nearly half. Cold-EEZE®Cold-EEZEÒ is an established product in the health care and cold remedy market. For Fiscal 2010, 2009 2008 and 2007,2008, our revenues from continuing operations have come principally from our cold remedy products.Strategic Review. Prior to Fiscal 2009, we were organized into three business segments: (i) cold remedy, (ii) contract manufacturing and (iii) ethical pharmaceutical. We historically managed each of our segments separately as a consequence of different marketing, manufacturing and/or research and development strategies. However, as a consequence of our strategic review, as described below, completed in the fourth quarter of Fiscal 2009, we realigned our operations to focus principally on the research, development, manufacture, marketing and sale of OTC cold remedy and consumer products, natural base health products and other supplements and cosmeceuticals for human and veterinary use. As a consequence of this strategic review, as of December 31, 2009, we are engaged principally in the OTC/Personal Care marketplace segment.
Our strategic review included a review and evaluation of (i) evolving market conditions of OTC cold remedy opportunities in conjunction with our current product offerings, (ii) manufacturing and distribution operations and capacity, (iii) product line financial performance criterion, current returns on investment and marketing strategy, (iv) current research and development initiatives and (v) opportunities to develop prescription pharmaceutical and new OTC products. We determined as a result of this review to curtail further investment in certain of our wholly owned subsidiary’s, Quigley Pharma, Inc. (“Pharma”), existing products under development in light of our view concerning market opportunities, regulatory pathways, the need for further robust and consistent preclinical and clinical testing and continued requirements in the areas of commercial formulation and development. However, we continue to engage in research and development activities that we determine are appropriate as discussed below.
Management continues to assess our entire business operations, including but not limited to our (i) fundamental market and operations strategies, (ii) product development methodologies and current product development initiatives and focus, (iii) product line and brand marketing, (iv) consumer and retailer relationships, and (v) current internal and external operational resources and needs. During Fiscal 2009, management made initial progress in cost control and fundamental marketing initiatives in an effort to reduce overhead expenses while marketing our existing products. However, management believes we will need to continue our restructuring activities well into Fiscal 2010 and will make meaningful investments therein in order to (i) build greater consumer awareness for our products, (ii) properly formulate new products, (iii) develop effective product launch strategies, (iv) seek to reduce the effects of the significant seasonality of the current business with new product development initiatives for potential launch in Fiscal 2011/2012 and (v) operate our business more efficiently.
Research and Development. We have invested significantly in research and development activities. Our current research and development activity is specifically targeted to potential natural base health products, including, compounds QR-333 (potential topical symptomatic relief of diabetic peripheral neuropathy); QR-440 (potential relief of inflammation and joint pain); and QR-448 (potential anti-infective against infectious bronchitis in poultry). In addition, we may seek to acquire (or enter into other arrangements regarding) new formulations, ingredients, applications and other products developed by third parties who may be seeking our commercialization, marketing and distribution expertise. We are currently undergoing limited research and development activity in compliance with regulatory requirements and are evaluating various new product technologies, applications, licensing, commercialization and other development opportunities. We are in the initial stages of what may be a lengthy process to develop our patent applications into or acquire rights for commercial products.
Joint Venture. – Phusion Laboratories, LLC
On March 22, 2010, the Company, 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 TMTPM™ 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.
In connection with the LLC Agreement, PSI Parent granted to us, pursuant to the terms of a License Agreement, dated March 22, 2010 (the “Original License Agreement”), (i) an exclusive, royalty-free, world-wide (subject to certain limitations), paid-up license to exploit OTC drugs (and certain other products) that embody certain of PSI Parent’s TPM-related patents and related know-how (collectively, the “PSI Technology”) and (ii) a non-exclusive, royalty-free, world-wide (subject to certain limitations) paid-up license to exploit certain compounds that embody the PSI Technology for use in a product combining one or more of such compounds with an OTC drug or in a product that is part of a regimen that includes the application of an OTC drug.
Proxy Contest.
Pursuant to the Original License Agreement, we issued 1,440,000 shares of our $0.0005 par value common stock (“Common Stock”) having an aggregate value of approximately $2.6 million to PSI Parent (such shares, the “PSI Shares”), and made a one-time payment to PSI Parent of $1.0 million. In April 2009,accordance with a Contribution Agreement, dated March 22, 2010 (the “Contribution Agreement”), by and among us, PSI Parent, PSI, and the Karkus Group filedJoint Venture, we transferred, conveyed and assigned to the Joint Venture all of our rights, title and interest in, to and under the Original License Agreement, and the Joint Venture assumed, and undertook to pay, discharge and perform when due, all of our liabilities and obligations under and arising pursuant to the Original License Agreement (such actions, collectively, the “Assignment and Assumption”).
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, in Fiscal 2010 we contributed $500,000 of initial capital. In addition, we are committed to fund up to $2.0 million, subject to agreed upon budgets (which have not yet been formally established), toward the
SEC a preliminary Proxy Statement proposing an alternative slateinitial development and marketing costs of
director nomineesnew products for the
CompanyJoint Venture. In Fiscal 2010, the newly formed Joint Venture incurred a loss of $77,000. The Joint Venture has not engaged in any financial transactions, other than certain organizational expenses and general market and product analysis, as formal operations are not expected to commence until Fiscal 2011. At December 31, 2010, cash and equivalents includes $425,000 related to the
slate nominatedJoint Venture which is expected to be used by the
Company’s incumbent BoardJoint Venture to fund future product development initiatives currently under consideration by PSI Parent, PSI and us. As of
Directors Incumbent BoardDecember 31, 2010, we have not established a formal commercialization program timeline for
vote atany specific OTC drug covered under the
2009 Annual Meeting. The Karkus Group proposedproduct license and we do not project that any OTC drug products will be available for shipment within the
Alternative Ballot because they believed it was time for a change in the Company. As the Alternative Ballot indicated, among other matters, over the prior three years the Company’s management had delivered declining revenues, declining gross and net profits (increasing net losses), declining stockholders’ equity and declining stock price, with excessive compensation paid to the Company’s management and their family members.On June 12, 2009, Mr. Guy Quigley, then Chairman, President and Chief Executive Officer of the Company, resigned his positions with the Company. Mr. Quigley’s resignation had been preceded by the resignation of Mr. Charles Phillips, formerly the Executive Vice President and Chief Operating Officer of the Company, effective May 29, 2009.
Additionally on June 12, 2009, following the seating of the newly elected Board of Directors, Mr. Karkus was elected Chairman of the Board of Directors and the Board elected members to its Audit Committee, Compensation Committee, and Corporate Governance and Nominating Committee. Mr. Karkus was appointed as our interim Chief Executive Officer effective June 18, 2009 and effective July 15, 2009, the Board appointed (i) Mr. Karkus as our permanent Chief Executive Officer and (ii) Mr. Robert V. Cuddihy, Jr. as our Executive Vice President and Chief Operating Officer. Effective October 21, 2009, Mr. Cuddihy also was named our interim Chief Financial Officer.
As a consequence of the Proxy Contest between the Incumbent Ballot and the Alternative Ballot, for Fiscal 2009 we charged to operations approximately $2.5 million in costs associated with the proxy solicitation and related litigation.
Manufacturing Facility Consolidation. Our wholly owned subsidiary, QMI, produces our Cold-EEZE® and other lozenge products along with performing such operational tasks as warehousing and shipping our Cold-EEZE® and other cold remedy products. Additionally, QMI maintains a FDA approved facility that engages in contract manufacturing and distribution activities of lozenge-based products for unaffiliated third parties. QMI also produces and sells therapeutic lozenges to wholesale and distribution outlets. On February 2, 2009, we announced its intention to close QMI’s production facility in Elizabethtown, Pennsylvania and consolidate our manufacturing operations at our Lebanon, Pennsylvania facility. Effective in June 2009, the Elizabethtown facility was closed. QMI’s Lebanon facility continues production and distribution of our Cold-EEZE® brand and other cold remedy products.
Research and Development. On April 30, 2009, we announced preliminary results that the Diabetic Peripheral Neuropathy Phase IIb clinical study demonstrated a significant improvement in two key measures of distal sensory nerve function in the group treated with its investigational new drug, QR-333. The compound was applied topically to the feet of subjects suffering from painful diabetic neuropathy and over the course of 12
next twelve months. Critical Accounting Estimates
TABLE OF CONTENTS
weeks, significantly improved both maximal conduction velocity and compound sensory amplitude in the sural nerve. The mean improvement in nerve conduction velocity exceeded the change considered by thought leaders to be “clinically meaningful” in clinical studies. The sural nerve carries sensation from the feet and its pathology is the fundamental cause of foot pain and ultimately foot ulcers and amputation in some diabetic subjects.
On July 22, 2009, we announced the final results from our Phase IIb double-blind, placebo-controlled, study of topical compound QR-333 for the treatment of symptomatic diabetic peripheral neuropathy. The study was completed with fewer than expected evaluable patients with the final and comprehensive conclusions revealing that (i) the compound is safe and well tolerated, and (ii) there were nominal trends, but no statistical differences, between active and placebo groups for the primary and secondary endpoints measuring efficacy by (a) the reduction of pain, (b) symptomatic improvements, (c) improved quality of life and (d) improved sleep.
However, we are encouraged by the positive, clinical and statistically significant improvement for efficacy in sural nerve conduction velocity and amplitude unexpectedly found in a sub-set of the patient population. This data may indicate the potential benefit of this compound as a disease modifying agent which, if validated through additional clinical trials, potentially broadens the therapeutic market opportunity. Additional clinical work would be required and future study considerations might include, a longer duration period to improve patient compliance as well as an assessment of sural nerve function and measures of distal nerve sensory thresholds in the feet to provide more detail to the potential for disease modification. There can be no assurance that we will undertake additional clinical studies or that the results of any such studies would lead to a marketable product that can achieve regulatory approvals.
A preliminary analysis of the lack of adequate primary and secondary end point data indicates that the results may have been attributed to fewer than expected evaluable patients due to a shortage of drug and a high number of patients terminated early due to a lack of compliance with application and usage protocols.
All required end of study regulatory and reporting documentation and procedures will be completed. We will continue to consider licensing, partnering or collaborative relationship opportunities to further the development and potential commercialization of the QR-333 candidate and other formulations.
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.
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®Cold-EEZEÒ, has been clinically proven to reduce the severity and duration of common cold symptoms. Accordingly, 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®, we market and distribute Kids-EEZE® Chest Relief, Kids-EEZE® Cough Cold and Kids-EEZE® Allergy children OTC cold remedies (“Kids-EEZE® Products”). We added new products to our OTC Personal Care marketplace segmentintroduced Kids-EEZE® Chest Relief in Fiscal 20072008 and expanded the product line to include Kids-EEZE® Cough Cold and Kids-EEZE® Allergy in Fiscal 2008 such as ISC-10 Immune, Organix Organic Cough2010. We also manufacturer, market and Sore Throat Dropsdistribute an organic cough drop and Kids-EEZE® Chest Relief.a Vitamin C supplement (“Organix”). Each of these newthe Kids-EEZE® Products and Organix® products do carry shelf-life expiration dates for which we aggregate such new product market experience data and updatesupdate its 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, the monitoring of current occurrences, developments by customer, market conditions and any other occurrences that could affect the expected provisions relative to net sales for the period presented are also performed.
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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 item 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.
We classify product returns into principally three categories, (i) non-routine returns, (ii) obsolete product and (iii) product mix realignment by certain of our customers. “Non-routine” returns are defined as product returned to us as a consequence of unanticipated circumstances principally due to (i) retail store closings or (ii) unexpected poor retail sell through to consumers causing us to discontinue the product. “Obsolete” returns are defined as product returned to us as a consequence of product shelf-life “use by” expiration date. “Product“Product mix realignment” returns are defined as product returned to us due to initiatives by the trade to discontinue purchasing certain of our products. Product mix realignment returns are generally nominal and are frequently related to discontinued or soon to be discontinued products. Our return policy accommodates returns for (i) discontinued products, (ii) store closings and (iii) products that have reached or exceeded designated expiration date. The following is a summary of the change in the return provision for the years ended December 31, 2010 and 2009 (in thousands):
| | | Amount | |
| Return provision at December 31, 2008 | | $ | 1,427 | |
| Net change in the return provision Fiscal 2009 | | | 86 | |
| Return provision at December 31, 2009 | | | 1,513 | |
| Net change in the return provision Fiscal 2010 | | | 33 | |
| Return provision at December 31, 2010 | | $ | 1,546 | |
For Fiscal 2010, 2009 and 2008,
(in thousands): | | |
| | Amount |
| Return provision at December 31, 2007 | | $ | 296 | |
| Net change in the return provision Fiscal 2008 | | | 1,131 | |
| Return provision at December 31, 2008 | | | 1,427 | |
| Net change in the return provision Fiscal 2009 | | | 86 | |
| Return provision at December 31, 2009 | | $ | 1,513 | |
For Fiscal 2009, 2008 and 2007, net sales of products with limited shelf-life and expiration dates were $617,000, $311,000 and $265,000, and $2.4 million, respectively.
For Fiscal
2008,2010, the return provision increased by
$1.1 million to $1.4 million.$33,000. The increase in the return provision was principally due to (i) a charge of
$552,000 attributable to products which were discontinued during Fiscal 2008 as a consequence of both return criterion of (a) poor retail sell through to consumers (non-routine returns) and (b) the decreasing shelf-life of the products as expiration dates came due (obsolete returns), (ii) a charge of $209,000 due principally to discontinued product flavors (non-routine returns), (iii) a charge of $165,000 for product returns attributable to store closings (non-routine returns), (iv) a charge of $102,000$815,000, including $462,000 for products with shelf-life expiration dates (obsolete returns)
offset by (ii) net returns of $782,000 associated principally with Fiscal 2009 and
(v) a charge of $103,000 as a consequence of an increase in product returns experiencedFiscal 2010 received and processed during
the period.Fiscal 2010.
For Fiscal 2009, the return provision increased by $86,000 to $1.5 million. The increase in the return provision was principally due to (i) a charge of $827,000 for products with shelf-life expiration dates (obsolete returns) offset by
(iii)(ii) net returns associated with Fiscal 2008 and Fiscal 2009 received and processed during Fiscal 2009 of $741,000 as a consequence of an increase in product returns experienced during the period. We continue to experience higher than expected return provisions as a consequence of excess inventories at retail for new products launched in Fiscal 2008 that carried limited shelf lives.
A one percent deviation for these sales allowance provisions for the Fiscal 2010, 2009 2008 and 20072008 would affect net sales by approximately $188,000, $261,000 $276,000 and $348,000,$276,000, respectively. A one percent deviation for cooperative incentive promotions reserve provisions for the years ended December 31, 2010, 2009 2008 and 20072008 could affect net sales by approximately $182,000, $245,000 and $252,000, and $323,000, respectively.
As of December 31, 2009,2010, we have net operating loss carry-forwards of approximately $25.7$28.7 million for federal purposes that will expire beginning in fiscal 2020 through 2029.2030. Additionally, there are net operating loss carry-forwards of $20.3$19.9 million for state purposes that will expire beginning in fiscalFiscal 2018 through 2029.2030. Until sufficient taxable income to offset the temporary timing differences attributable to operations, the tax deductions attributable to option, warrant and stock activities and alternative minimum tax credits of $26,000 are assured, a valuation allowance equaling the total deferred tax asset is being provided. ManagementAs a consequence of the accumulated losses of the Company, management believes that this allowance is required due to the uncertainty of realizing these tax benefits in the future. The uncertainty arises largely due to substantial research and development costs.
Seasonality of the Business
Our net sales are derived principally from itsour OTC cold remedy products. Currently,As a consequence, 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 (defined below). 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 (“Cold Season”) when the incidence of the common cold rises as a consequence of the change in weather and other factors. We generally experience in the fourth quarter higher levels of net sales along with a corresponding increase in marketing and advertising expenditures designed to promote its products during the cold season. Revenues and related marketing costs are generally at its lowest levels in the second quarter when consumer demand generally declines. We track health and wellness trends and develop retail promotional strategies to align its production scheduling, inventory management and marketing programs to optimize consumer purchases.
Results of Operations
Fiscal 2010 compared with Fiscal 2009
Net sales for Fiscal 2010 were $14.5 million as compared to $19.8 million for Fiscal 2009. Net sales decreased $5.3 million in Fiscal 2010 as compared to Fiscal 2009. The decline in net sales is principally due (i) an acceleration in Fiscal 2009 of our retail customer purchases and stocking for the 2009-2010 Cold Season into the fourth quarter of Fiscal 2009 which skewed net sales for that cold season, (ii) a decrease by our retail customers purchases in the fourth quarter of Fiscal 2010 in an effort to better align their purchases and inventory levels with the projected timing of the incidence levels of upper respiratory disorders during the 2010-2011 Cold Season, (iii) a decrease associated with our retail customers reducing the number, timing and value of our promotional and/or display programs as a consequence of, among other influences, (a) limited space availability, (b) allocation of more promotional space to private label brands and/or other products and (c) a general reduction in off-shelf, price promotion opportunities for the 2010-2011 Cold Season. In addition, our net sales of our contract manufacturing operations decreased $911,000 in Fiscal 2010 to $594,000 as compared to $1.5 million in Fiscal 2009 due to (i) the decline in candy product sales as a consequence of the closure of the Elizabethtown manufacturing facility in June 2009 and (ii) fluctuations in contract manufacturing orders from non-related third party entities to produce lozenge-based products.
Data suggests that the highest incidence of upper respiratory disorders for the 2009-2010 Cold Season occurred in the fourth quarter of Fiscal 2009 and were at significantly lower levels during the first, second and third quarters of Fiscal 2010 when compared to the 2008-2009 and prior Cold Seasons. As a consequence, there was a reduced consumer demand at retail and therefore a corresponding reduction in retailer purchases and stocking during Fiscal 2010 as compared to Fiscal 2009. Furthermore, a significant increase in the incidence of upper respiratory disorders for the 2010-2011 Cold Season was not observed until late in the fourth quarter in Fiscal 2010. Our flagship product, Cold-EEZE® continues to compete for market share with new products entering the category and many retailer initiatives to reduce the number of products it carries on shelf within the cold and flu remedy category. We are continuing to support Cold-EEZE® as a clinically proven cold remedy product through in-store promotion, media advertising and coupon programs.
Cost of sales decreased $2.5 million for Fiscal 2010 to $5.7 million as compared to $8.2 million for Fiscal 2009. The decrease in cost of sales is principally due to (i) lower revenues from period to period, offset by (ii) an improvement in gross margin. We realized gross margins of 60.9% for Fiscal 2010 as compared to 58.4% in Fiscal 2009, an improvement of 2.5%. Our improved gross margin reflects the net effect of (i) the elimination of the production and facility overhead expenses attributable to the closing of the Elizabethtown manufacturing facility, (ii) improved production margins of the OTC cold remedy segment, (iii) improved overhead cost management at our Lebanon production and distribution facility, offset by (iv) an adverse impact of a reduction to net sales to absorb fixed production overhead expenses at our manufacturing facility and (v) increased product promotion with retailers to support the launch of our new products. Gross margins are influenced by fluctuations in quarter-to-quarter production volume, fixed production costs and related overhead absorption, 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 2010 increased $724,000, or 14.9%, to $5.6 million as compared to $4.9 million for Fiscal 2009. The increase in sales and marketing expense for Fiscal 2010 as compared to Fiscal 2009 was principally due to the net effect of (i) the implementation of more cost effective and targeted marketing programs, (ii) improved timing of marketing campaigns to better match the timing and product demand of the 2010-2011 Cold Season, (iii) the discontinuation of certain ineffective marketing programs, offset by (iv) an increase in traditional media purchases in print, digital, out-of-home and television, and (v) an increase in marketing research and development costs associated with the development of new product packaging for our Cold-EEZE® and Kids-EEZE® product lines introduced during the 2010-2011 Cold Season.
General and administrative (“G&A”) expenses for Fiscal 2010 were $6.0 million as compared to $9.3 million in Fiscal 2009. The decrease in G&A expense of $3.3 million for Fiscal 2010 as compared to Fiscal 2009 was primarily due to the net effects of (i) a decrease in stock promotion costs of $2.3 million, principally related to the Board of Directors proxy contest in Fiscal 2009 and (ii) a decrease in professional fees and other expenses of $601,000 and (iii) a decrease of $606,000 in personnel expenses.
Research and development costs for Fiscal 2010 and 2009 were $794,000 and $1.3 million, respectively. The decrease of $514,000 in research and development costs for Fiscal 2010 as compared to Fiscal 2009 was due to a decline in the scope, timing and amount of research and development activity from period to period. In Fiscal 2009 and as a result of a strategic review, we determined to curtail and now have discontinued further investment in certain of our wholly owned subsidiary’s, Pharma, products then under development. This was determined in light of our view concerning market opportunities, regulatory pathways, the need for further robust and consistent preclinical and clinical testing and continued requirements in the areas of commercial formulation and development. However, 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.
Interest and other income for Fiscal 2010 was $53,000 as compared to $9,000 for Fiscal 2009. The increase of $44,000 for Fiscal 2010 as compared to Fiscal 2009 was principally the result of the allocation of funds into interest bearing accounts.
As noted above, we have net operating loss carry-forwards for both federal and certain states. For Fiscal 2010, we had a current tax benefit of $40,000 as a consequence of a carry back of an alternative minimum tax net operating loss to a prior period.
As a consequence of the effects of the above, the net loss for Fiscal 2010, was $3.5 million, or ($.25) per share, as compared to a net loss of $3.8 million, or ($0.30) per share, for Fiscal 2009.
Fiscal 2009 compared with Fiscal 2008
Net sales for Fiscal 2009 were $19.8 million as compared to $20.5 million for 2008, reflecting a decrease ofFiscal 2008. Net sales decreased $691,000 or 3.4%.in Fiscal 2009 as compared to Fiscal 2008. The decline in net sales is due to the net effect of (i) an increase in net sales of OTC cold remedy product, principally Cold-EEZE®,products, of $124,000, offset by (ii) a decrease of net sales of contract manufacturing product of $815,000 which declined to $1.5 million for Fiscal 2009 as compared to $2.3 million for Fiscal 2008. The decline in contract manufacturing product sales is principally a result of the closure of the Elizabethtown manufacturing facility and the elimination of certain low margin products. Net sales of OTC cold remedy products have remained stable over the past two Fiscal years as the cold and flu seasons have indicated comparable levels of the incidence of colds by consumers. Our flagship product, Cold-EEZE®Cold-EEZE® continues to compete for market share with new products entering the category and many retailer initiatives to reduce the number of products it carries on shelf within the cold and flu remedy category. We are continuing to support Cold-EEZE®Cold-EEZE® as a clinically proven cold remedy product through in-store promotion, media advertising and coupon programs.
Cost of sales decreased $847,000 for Fiscal 2009 to $8.2 million as compared to $9.1 million for Fiscal 2008. The decrease in cost of sales is principally due to (i) lower revenues from period to period and (ii) an improvement in gross margin. We realized gross margins of 58.4% for Fiscal 2009 as compared to 55.7% in Fiscal 2008, an improvement of 2.7%. The 2.7% increase in the gross margin was principally due to the net effect of (i) the elimination of the production and facility overhead expenses attributable to the closing of the Elizabethtown manufacturing facility, (ii) improved production margins of the
OTC cold remedy products, offset by (iii) an adverse impact to net sales as a consequence of the inventory reduction programs maintained by our larger retail customers. Gross margins are influenced by fluctuations in quarter-to-quarter production volume, fixed production costs and related overhead absorption, and the timing of shipments to customers which are factors of the seasonality of our sales activities and products.
Selling,
Sales and marketing expense for Fiscal 2009 decreased $1.1 million, or 18.6%, to $4.9 million as compared to $6.0 million for Fiscal 2008. The decrease in sales and administrative (“SG&A”)marketing expense for Fiscal 2009 as compared to Fiscal 2008 was principally due to as we implemented more efficient in-store, digital and consumer-based marketing initiatives versus print and radio advertising programs launched in Fiscal 2008.
G&A expenses for Fiscal 2009 were $14.2$9.3 million as compared to $13.9$7.9 million in Fiscal 2008. The increase in SGG&A expense of $295,000$1.4 million for Fiscal 2009 as compared to Fiscal 2008 was primarily due to the net effects of (i) an increase in stock promotion costs of $2.3 million, principally related to the Proxy ContestBoard of Directors proxy contest and (ii) an increase in professional fees and other expenses of $256,000, offset by, (iii) a decrease in advertising costs of $1.2 million as we implemented more efficient in-store, digital and consumer-based marketing initiatives versus print and radio advertising programs launched in Fiscal 2008 and (iv) a decrease of $1.2 million in personnel costs principally due to a decrease in executive salaries, bonuses and head count.
Research and development costs for Fiscal 2009 and 2008 were $1.3 million and $4.2 million, respectively. The decrease in research and development expenditure of $2.9 million in was principally the result of (i) decreased Pharma study costs of $2.6 million and (ii) a reduction in personnel costs of $223,000. The decreased spending for the Fiscal 2009 as compared to Fiscal 2008 was principally due to (i) the completion of the Phase IIb study for QR-333 Diabetic Peripheral Neuropathy in November 2008 and (ii) a subsequent slowdown in related Fiscal 2009 spending pending the availability of the final results of the study. In addition, we strategically determined to curtail
and ultimately suspend further investment certain of Pharma’s
then existing products under development in light of our view concerning market opportunities, regulatory pathways, the need for further robust and consistent preclinical and clinical testing and continued requirements in the areas of commercial formulation and development.
As noted above, we have net operating loss carry-forwards for both federal and certain states. However, effective December 31, 2009, we elected to conform our tax reporting year, historically a fiscal period ending September 30, to our financial reporting period ending December 31. As a consequence, we will file a full period tax return for the fiscal year ended September 30, 2009 with the Internal Revenue Service (“IRS”) and will also file with the IRS a “short period return” for the three months ended December 31, 2009 in compliance with the election. For Fiscal 2009, we had a current tax benefit of $26,000 for certain federal and state alternative minimum income taxes incurred for the “short period return”, inclusive of an alternative minimum tax refund due us of $110,000 as a consequence of a carry back of an alternative minimum tax net operating loss to a prior period. In future fiscal periods, our tax and financial reporting periods will be the same, the period ending December 31.
Fiscal 2008 compared with Fiscal 2007
Net sales for Fiscal 2008 were $20.5 million compared to $28.2 million for Fiscal 2007, a decrease of $7.7 million or 27.4%, principally due to lower cold remedy product sales. The sales of cold remedy products decreased in Fiscal 2008 by $7.5 million, or 29.3%, as compared to Fiscal 2007. This decrease may be attributable to certain customer reviews of inventory levels and product mix carried particularly in light of declining market and economic conditions, including higher than normal product returns. The cough cold retail category in general, and the Company in particular, was adversely affected in Fiscal 2008 by a reduction in the incidence of colds by consumers as compared to prior years.
Cost of sales decreased $591,000 for Fiscal 2008 to $9.1 million as compared to $9.7 million for Fiscal 2007. The decrease in cost of sales was principally due to (i) lower revenues from period to period, offset by (ii) a decline in gross margin. We realized gross margins of 55.7% for Fiscal 2008 as compared to 65.7% in Fiscal 2007, a decrease of 10.0%. The 10.0% decrease in the gross margin was principally due to (i) an increase in product returns, expired shelf-life and obsolete product of 5.4%, (ii) an impairment charge of $300,000 related to our closure plans for the Elizabethtown manufacturing facility and (iii) declining production volumes and reduced margins realized from certain contract manufacturing products. Certain of these contract manufacturing products were discontinued in Fiscal 2009 as
As a consequence of the
closureeffects of the
Elizabethtown manufacturing facility. Gross margins are influenced by fluctuations in quarter-to-quarter production volume, fixed production costs and related overhead absorption, andabove, the
timing of shipments to customers which are factors of the seasonality of our sales activities and products.SG&A expensenet loss for Fiscal 2008 were $13.92009, was $3.8 million, or ($.30) per share, as compared to $14.6a net loss of $5.5 million, in Fiscal 2007. The decrease in SG&A expense of $721,000 was principally due to the net effects of (i) increased outside advertising, marketing and promotional costs of $1.5 million, primarily due to increased media advertising, offset by (ii) a decrease of $252,000 for sales brokerage and commission costs due to the lower net sales in Fiscal 2008, (iii) a decrease of $1.1 million in personnel costs principally due to a decrease in general payroll and bonus costs; (iv) a decrease of $455,000 in legal costs as a consequence of lower litigation and legal services required during Fiscal 2008 as compared to Fiscal 2007 and (v) a decrease of $173,000 in stock promotion.
Research and development costsor ($0.43) per share, for Fiscal 2008 and 2007 were $4.2 million and $6.5 million, respectively. Principally, the decrease in research and development expenditure was the result of decreased Pharma study costs of approximately $2.2 million in Fiscal 2008.
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On February 29, 2008, we sold our wholly owned subsidiary, Darius, our former health and wellness segment, to InnerLight. On February 29, 2008, Mr. Kevin P. Brogan, the then president of Darius was a significant shareholder of InnerLight. In addition, Mr. Gary Quigley, then an employee and stockholder of the Company and also the brother of Mr. Guy Quigley, our then Chairman, President and Chief Executive Officer (as well as a shareholder), became a significant shareholder of InnerLight either before or shortly after the sale of Darius. Mr. Gary Quigley was also a principal of Scandasystems, which entered into an agreement to receive royalties from InnerLight. The results and balances associated with Darius are presented as discontinued operations in the condensed consolidated statements of operations.
The terms of the sale agreement include a cash purchase price of $1.0 million by InnerLight for the stock of Darius and its subsidiaries without guarantees, warranties or indemnifications. We recorded a gain on the disposal of Darius of $736,000, as a result of sales proceeds of $1.0 million less residual investment of $5,000 and net assets of Darius of $259,000 on the date of sale.
Sales attributable to Darius from January 1, 2008 until date of disposal on February 29, 2008 and for Fiscal 2007 were $2.2 million and $11.3 million, respectively. Net income (loss) from January 1, 2008 until date of disposal on February 29, 2008, and for Fiscal 2007 were $139,000 and ($602,000), respectively. Financial results from operations of Darius are presented as discontinued operations in our Financial Statements.
Liquidity and Capital Resources
Our aggregate cash and cash equivalents as of December 31,
20092010 were
$12.8$8.2 million compared to
$11.9$12.8 million at December 31,
2008.2009. Our working capital was
$11.5$7.5 million and
$14.1$11.5 million as of December 31,
20092010 and December 31,
2008,2009, respectively. Changes in working capital for Fiscal
20092010 were principally due to
the net effect of (i) cash
generated fromused in operations of
$445,000, inclusive$3.5 million, (ii) capital expenditures of
$2.5$153,000, (iii) the cash payment of $1.0 million
of costs incurred as a consequence ofto acquire the
Proxy Contest, (ii) netproduct license in connection with the Joint Venture, offset by, (iv) proceeds of
$480,000 realized principally from the sale of fixed assets relating to the closure of the Elizabethtown manufacturing facility in June 2009, (iii) proceeds of $127,000$133,000 from the exercise of stock
options, offset by (iv) capital expenditures of $208,000.options. Significant factors impacting working capital for Fiscal
20092010 included (i)
a decreasean increase in accounts receivable and inventory balances,
andoffset by, (ii)
a decreasean increase in other
operating assetsaccrued advertising and
liabilities.other allowances.
Management believes that its strategy to maintain Cold-EEZE®Cold-EEZEÒ as a recognized brand name, its broader range of products, its adequate manufacturing capacity, together with its current working capital, should provide an internal source of capital to fund normal business operations. Our operations support the current research and development expenditures related to new products. In addition to the funding from operations, we may in the short and long term raise capital through the issuance of securities or secure other financing sources to support such product development research, new product acquisitions or a venture investment or acquisition. Such funding through the issuance of equity securities would result in the dilution of current stockholders’ ownership in the Company. Should our product development initiatives progress on certain formulations, additional development expenditures may require substantial financial support and may necessitate the consideration of alternative approaches such as licensing, joint venture, or partnership arrangements that we determine will 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 would likely result in the deferral or abandonment of future development relative to current and prospective product development initiatives and formulations.
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, and(iv) further investment in our Joint Venture, (iv) venture investments or acquisitions and/or (v) support current operations. DuringSince late Fiscal 2009,2008, there has been substantial volatility and a decline in the capital and financial
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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 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,
20092010 consist of the following:
| | | | | | | | |
| Year | | Employment
Contracts | | Advertising | | Product and
Other
Purchases | | Total |
| 2010 | | $ | 1,075 | | | $ | 235 | | | $ | 660 | | | $ | 1,970 | |
| 2011 | | | 1,075 | | | | — | | | | — | | | | 1,075 | |
| 2012 | | | 582 | | | | — | | | | — | | | | 582 | |
| 2013 | | | — | | | | — | | | | — | | | | — | |
| 2014 | | | — | | | | — | | | | — | | | | — | |
| Total | | $ | 2,732 | | | $ | 235 | | | $ | 660 | | | $ | 3,627 | |
| Year | | Employment Contracts | | | Advertising (1) | | | Total | |
| 2011 | | $ | 1,075 | | | $ | 1,206 | | | $ | 2,281 | |
| 2012 | | | 582 | | | | - | | | | 582 | |
| 2013 | | | | | | | - | | | | - | |
| 2014 | | | - | | | | - | | | | - | |
| 2015 | | | - | | | | - | | | | - | |
| Total | | $ | 1,657 | | | $ | 1,206 | | | $ | 2,863 | |
(1) Additional advertising costs are expected to be incurred during Fiscal 2011.
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. Consequently, 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.
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.
Effect of Recent Accounting Pronouncements
Effective July 2009, we adopted the “FASB Accounting Standards Codification” and the Hierarchy of Generally Accepted Accounting Principles (ASC-105). This standard establishes only two levels of U.S. generally accepted accounting principles (“GAAP”), authoritative and nonauthoritative. The Financial Accounting Standard Board (“FASB”) Accounting Standards Codification (the “Codification”) became the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literature not included in the Codification became nonauthoritative. We began using the new guidelines and numbering system prescribed by the Codification when referring to GAAP for the three months and nine months ended September 30, 2009. As the Codification was not intended to change or alter existing GAAP, it did not have any impact on our consolidated financial statements.
In February 2008, the FASB issued an accounting standard update that delayed the effective date of fair value measurements accounting for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008. These include goodwill and other non-amortizable intangible assets. We adopted this accounting standard update effective January 1, 2009. The adoption of this update to non-financial assets and liabilities, as codified in ASC-820, has not had a significant impact on our consolidated financial position, results of operations or cash flows.
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In November 2008, the SEC issued for comment a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS)(“IFRS”). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (IASB)(“IASB”). Under the proposed roadmap, we could be required in fiscal 2014 to prepare financial statements in accordance with IFRS. The SEC will make a determination in 2011 regarding the mandatory adoption of IFRS. We are currently assessing the impact that this potential change would have on our consolidated financial statements and we will continue to monitor the development of the potential implementation of IFRS.
Effective January
In June 2009, we adopted a newthe Financial Accounting Standards Board (“FASB”) modified the accounting standard update regarding business combinations. As codified under ASC-805, this update requires an entityrelated to recognizeconsolidation. This standard, as modified, intends to improve financial reporting by enterprises involved with variable interest entities. This standard, as modified, addresses the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair valueeffects on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred; that restructuring costs generally be expensed in periods subsequentcertain provisions relating to the acquisition date; and that changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognizedConsolidation of Variable Interest Entities, as a componentresult of provision for taxes. In addition, acquired in-process researchthe elimination of the qualifying special-purpose entity concept in the accounting standard related to transfers and development is capitalized as an intangible assetservicing, and amortized over its estimated useful life. Withconstituent concerns about the adoptionapplication of certain key provisions of this accounting standard, update, any tax related adjustments associated with acquisitions that closed prior to January 1, 2009 will be recorded through income tax expense, whereas the previous accounting treatment would require any adjustment to be recognized through the purchase price. This accounting standard update applies prospectively to business combinations forincluding those in which the acquisition dateaccounting and disclosures under the standard do not always provide timely and useful information about an enterprise’s involvement in a variable interest entity. This standard, as modified, is on or aftereffective as of the beginning of theeach reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The adoption of the consolidation standard, as modified, did not have a material effect on our consolidated financial statements.
In October 2009, the FASB issued Accounting Standards Update No. 2009-13, "Multiple-Deliverable Revenue Arrangements" ("ASU No. 2009-13"). ASU No. 2009-13 amends guidance included within ASC Topic 605-25 to require an entity to use an estimated selling price when vendor specific objective evidence or acceptable third party evidence does not exist for any products or services included in a multiple element arrangement. The arrangement consideration should be allocated among the products and services based upon their relative selling prices, thus eliminating the use of the residual method of allocation. ASU No. 2009-13 also requires expanded qualitative and quantitative disclosures regarding significant judgments made and changes in applying this guidance. ASU No. 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after DecemberJune 15, 2008. The2010. Early adoption of these accounting updates hasand retrospective application are also permitted. We elected to adopt ASU No. 2009-13 early and the adoption did not hadhave a significant impactmaterial effect on our consolidated financial position, resultsstatements.
In January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair Value Measurements”. ASU 2010-06 amends ASU 820 to require a number of operationsadditional disclosures regarding fair value measurements. The amended guidance requires entities to disclose the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers, the reasons for any transfers in or cash flows.Effective Januaryout of Level 3, and information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis. This ASU also clarifies the requirement for entities to disclose information about both the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements as well as the level of disaggregation required for each class of asset and liability disclosed. The amended Level 1 and 2 guidance is effective for interim and annual financial periods beginning after December 15, 2009 we adopted an accounting standard which establishes accountingwhile the amended Level 3 guidance is effective for interim and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary, as codified in ASC-810. This accounting standard states that accounting and reporting for minority interests are to be recharacterized as noncontrolling interests and classified as a component of equity. The calculation of earnings per share continues to be based on income amounts attributable to the parent.annual financial periods beginning after December 15, 2010. The adoption of these accounting updates hasASU 2010-06 did not hadhave a significant impactmaterial effect on our consolidated financial position, results of operations or cash flows.
Effective January 2009, we adopted an accounting standard update regarding the determination of the useful life of intangible assets. As codified in ASC-350, this update amends the factors considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under intangibles accounting. It also requires a consistent approach between the useful life of a recognized intangible asset under prior business combination accounting and the period of expected cash flows used to measure the fair value of an asset under the new business combinations accounting (as currently codified under ASC-850). The update also requires enhanced disclosures when an intangible asset’s expected future cash flows are affected by an entity’s intent and/or ability to renew or extend the arrangement. The adoption of these accounting updates has not had a significant impact on our consolidated financial position, results of operations or cash flows.
Effective January 2009, we adopted a new accounting standard update from the Emerging Issues Task Force (“EITF”) consensus regarding the accounting of defensive intangible assets. This update, as codified in ASC-350, clarifies accounting for defensive intangible assets subsequent to initial measurement. It applies to acquired intangible assets which an entity has no intention of actively using, or intends to discontinue use of, the intangible asset but holds it to prevent others from obtaining access to it (i.e. a defensive intangible asset). Under this update, a consensus was reached that an acquired defensive asset should be accounted for as a separate unit of accounting (i.e. an asset separate from other assets of the acquirer); and the useful life assigned to an acquired defensive asset should be based on the period during which the asset would diminish in value. The adoption of this accounting update has not had a significant impact on our consolidated financial position, results of operations or cash flows.
Effective April 2009, we adopted a new accounting standard for subsequent events, as codified in ASC-855. The update modifies the names of the two types of subsequent events either as recognized subsequent events (previously referred to in practice as Type I subsequent events) or non-recognized subsequent events (previously
statements.
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referred to in practice as Type II subsequent events). In addition, the standard modifies the definition of subsequent events to refer to events or transactions that occur after the balance sheet date, but before the financial statements are issued (for public entities) or available to be issued (for nonpublic entities). It also requires the disclosure of the date through which subsequent events have been evaluated. The update did not result in significant changes in the practice of subsequent event disclosures, and therefore the adoption has not had a significant impact on our consolidated financial position, results of operations or cash flows. As a consequence of the adoption of ASC-855, we have evaluated and disclosed subsequent events relating to the year ended December 31, 2009 in our Financial Statements.
Effective April 2009, we adopted three accounting standard updates which were intended to provide additional application guidance and enhanced disclosures regarding fair value measurements and impairments of securities. They also provide additional guidelines for estimating fair value in accordance with fair value accounting. The first update, as codified in ASC-820 (formerly FASB Staff Positions (“FSP”) No.157-4,Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly), provides additional guidelines for estimating fair value in accordance with fair value accounting. The second accounting update, as codified in ASC-320 (formerly FSP No. 115-2,Recognition and Presentation of Other-Than-Temporary Impairments), changes accounting requirements for other-than-temporary-impairment (OTTI) for debt securities by replacing the current requirement that a holder have the positive intent and ability to hold an impaired security to recovery in order to conclude an impairment was temporary with a requirement that an entity conclude it does not intend to sell an impaired security and it will not be required to sell the security before the recovery of its amortized cost basis. The third accounting update, as codified in ASC-825 (formerly Accounting Principles Board (“APB”) Opinion No. 28-1,Interim Disclosures about Fair Value of Financial Instruments), increases the frequency of fair value disclosures. These updates were effective for fiscal years and interim periods ended after June 15, 2009. The adoption of these accounting updates has not had a significant impact on our consolidated financial position, results of operations or cash flows.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
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.
Item 8. Financial Statements and Supplementary Data
| Item 8. | Financial Statements and Supplementary Data |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of
The Quigley CorporationProPhase Labs, Inc.
We have audited the accompanying consolidated balance sheetssheet of The Quigley CorporationProPhase Labs, Inc. and Subsidiaries (the “Company”) as of December 31, 2009 and 2008,2010 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three yearsyear ended December 31, 2009.2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit 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 audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated 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, 2010 and the consolidated results of their operations and their cash flows for the year ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
/S/ EisnerAmper LLP
Edison, New Jersey
March 15, 2011
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 sheet of ProPhase Labs, Inc. and Subsidiaries (the “Company” and formerly The Quigley Corporation) as of December 31, 2009 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two years ended December 31, 2009. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated 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 audit 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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
consolidated financial statements referred to above present fairly, in all material respects, the
consolidated financial position of
The Quigley CorporationProPhase Labs, Inc. and Subsidiaries as of December 31, 2009 and
2008, and the
consolidated results of
itstheir operations and
itstheir cash flows for each of the
threetwo years ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America.
/S/ Amper, Politziner & Mattia, LLP
Edison, New Jersey
March 24, 2010
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
| | | | |
| | December 31, |
| | | 2009 | | 2008 |
ASSETS
| | | | | | | | |
| Cash and cash equivalents (Note 2) | | $ | 12,801 | | | $ | 11,957 | |
| Accounts receivable, net of doubtful accounts of $23 and $131, respectively (Note 2) | | | 2,086 | | | | 4,524 | |
| Inventory, net (Note 2) | | | 1,405 | | | | 3,001 | |
| Prepaid expenses and other current assets | | | 803 | | | | 1,184 | |
| Assets held for sale (Notes 2 and 4) | | | 138 | | | | — | |
| Total current assets | | | 17,233 | | | | 20,666 | |
| Property, plant and equipment, net of accumulated depreciation of $3,155 and $4,870, respectively (Note 4) | | | 2,572 | | | | 3,668 | |
| Other assets | | | 12 | | | | 35 | |
| | | $ | 19,817 | | | $ | 24,369 | |
LIABILITIES AND STOCKHOLDERS' EQUITY
| | | | | | | | |
LIABILITIES
| | | | | | | | |
| Accounts payable | | $ | 482 | | | $ | 694 | |
| Accrued royalties and sales commissions (Note 5) | | | 3,787 | | | | 3,792 | |
| Accrued advertising | | | 731 | | | | 1,306 | |
| Other current liabilities | | | 758 | | | | 803 | |
| Total current liabilities | | | 5,758 | | | | 6,595 | |
COMMITMENTS AND CONTINGENCIES (Note 7)
| | | | | | | | |
STOCKHOLDERS' EQUITY
| | | | | | | | |
| Common Stock, $.0005 par value; authorized 50,000,000; Issued: 17,679,436 and 17,554,436 shares, respectively (Note 8) | | | 9 | | | | 9 | |
| Additional paid-in-capital | | | 37,726 | | | | 37,599 | |
| Retained earnings | | | 1,512 | | | | 5,354 | |
| Treasury stock, at cost, 4,646,053 and 4,646,053 shares, respectively | | | (25,188 | ) | | | (25,188 | ) |
| | | | 14,059 | | | | 17,774 | |
| | | $ | 19,817 | | | $ | 24,369 | |
| | | December 31, | |
| | | 2010 | | | 2009 | |
| ASSETS | | | | | | |
| Cash and cash equivalents (Note 2) | | $ | 8,232 | | | $ | 12,801 | |
| Accounts receivable, net of allowance for doubtful accounts of $13 and $23, respectively (Note 2) | | | 4,821 | | | | 3,599 | |
| Inventory, net (Note 2) | | | 1,682 | | | | 1,405 | |
| Prepaid expenses and other current assets | | | 883 | | | | 803 | |
| Assets held for sale (Notes 2 and 4) | | | 138 | | | | 138 | |
| Total current assets | | | 15,756 | | | | 18,746 | |
| | | | | | | | | |
| Intangible asset, licensed technology (Note 3) | | | 3,577 | | | | - | |
| | | | | | | | | |
| Property, plant and equipment, net of accumulated depreciation of $3,389 and $3,155, respectively (Note 4) | | | 2,362 | | | | 2,572 | |
| Other assets | | | - | | | | 12 | |
| | | $ | 21,695 | | | $ | 21,330 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | |
| LIABILITIES | | | | | | | | |
| Accounts payable | | $ | 489 | | | $ | 708 | |
| Accrued royalties and sales commissions (Note 5) | | | 3,665 | | | | 3,681 | |
| Accrued advertising and other allowances | | | 3,524 | | | | 2,124 | |
| Other current liabilities | | | 557 | | | | 758 | |
| Total current liabilities | | | 8,235 | | | | 7,271 | |
| | | | | | | | | |
| COMMITMENTS AND CONTINGENCIES (Note 7) | | | | | | | | |
| | | | | | | | | |
| STOCKHOLDERS' EQUITY | | | | | | | | |
| Common Stock, $.0005 par value; authorized 50,000,000;Issued: 19,353,672 and 17,679,436 shares, respectively (Note 8) | | | 10 | | | | 9 | |
| Additional paid-in-capital | | | 40,627 | | | | 37,726 | |
| Retained earnings (accumulated deficit) | | | (1,989 | ) | | | 1,512 | |
| Treasury stock, at cost, 4,646,053 and 4,646,053 shares, respectively | | | (25,188 | ) | | | (25,188 | ) |
| | | | 13,460 | | | | 14,059 | |
| | | $ | 21,695 | | | $ | 21,330 | |
See accompanying notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
| | | | | | |
| | Year Ended December 31, |
| | | 2009 | | 2008 | | 2007 |
| Net sales (Notes 2 and 15) | | $ | 19,816 | | | $ | 20,507 | | | $ | 28,241 | |
| Cost of sales (Note 2) | | | 8,247 | | | | 9,094 | | | | 9,685 | |
| Gross profit | | | 11,569 | | | | 11,413 | | | | 18,556 | |
Operating expenses:
| | | | | | | | | | | | |
| Sales and marketing | | | 4,852 | | | | 5,958 | | | | 4,995 | |
| Administration | | | 9,344 | | | | 7,943 | | | | 9,627 | |
| Research and development (Note 2) | | | 1,308 | | | | 4,241 | | | | 6,482 | |
| Total operating expense | | | 15,504 | | | | 18,142 | | | | 21,104 | |
| Loss from operations | | | (3,935 | ) | | | (6,729 | ) | | | (2,548 | ) |
Other income (expense)
| | | | | | | | | | | | |
| Interest income | | | 9 | | | | 320 | | | | 692 | |
| Total other income | | | 9 | | | | 320 | | | | 692 | |
| Loss from continuing operations before taxes | | | (3,926 | ) | | | (6,409 | ) | | | (1,856 | ) |
| Income tax expense (benefit) (Note 10) | | | (84 | ) | | | — | | | | — | |
| Loss from continuing operations | | | (3,842 | ) | | | (6,409 | ) | | | (1,856 | ) |
Discontinued operations (Note 3)
| | | | | | | | | | | | |
| Gain on disposal of health and wellness operations | | | — | | | | 736 | | | | — | |
| Income (loss) from discontinued operations | | | — | | | | 139 | | | | (602 | ) |
| Net loss | | $ | (3,842 | ) | | $ | (5,534 | ) | | $ | (2,458 | ) |
Earnings (loss) per common share:
| | | | | | | | | | | | |
| Loss from continuing operations | | $ | (0.30 | ) | | $ | (0.50 | ) | | $ | (0.14 | ) |
| Income (loss) from discontinued operations | | | — | | | | 0.07 | | | | (0.05 | ) |
| Net loss | | $ | (0.30 | ) | | $ | (0.43 | ) | | $ | (0.19 | ) |
Diluted earnings (loss) per common share:
| | | | | | | | | | | | |
| Loss from continuing operations | | $ | (0.30 | ) | | $ | (0.50 | ) | | $ | (0.14 | ) |
| Income (loss) from discontinued operations | | | — | | | | 0.07 | | | | (0.05 | ) |
| Net loss | | $ | (0.30 | ) | | $ | (0.43 | ) | | $ | (0.19 | ) |
Weighted average common shares outstanding:
| | | | | | | | | | | | |
| Basic | | | 12,963 | | | | 12,878 | | | | 12,729 | |
| Diluted | | | 12,963 | | | | 12,878 | | | | 12,729 | |
| | | Year Ended December 31, | |
| | | 2010 | | | 2009 | | | 2008 | |
| | | | | | | | | | |
| Net sales (Notes 2 and 12) | | $ | 14,502 | | | $ | 19,816 | | | $ | 20,507 | |
| | | | | | | | | | | | | |
| Cost of sales (Note 2) | | | 5,672 | | | | 8,247 | | | | 9,094 | |
| | | | | | | | | | | | | |
| Gross profit | | | 8,830 | | | | 11,569 | | | | 11,413 | |
| | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | |
| Sales and marketing | | | 5,576 | | | | 4,852 | | | | 5,958 | |
| Administrative | | | 6,054 | | | | 9,344 | | | | 7,943 | |
| Research and development (Note 2) | | | 794 | | | | 1,308 | | | | 4,241 | |
| Total operating expense | | | 12,424 | | | | 15,504 | | | | 18,142 | |
| | | | | | | | | | | | | |
| Loss from operations | | | (3,594 | ) | | | (3,935 | ) | | | (6,729 | ) |
| | | | | | | | | | | | | |
| Interest income | | | 53 | | | | 9 | | | | 320 | |
| | | | | | | | | | | | | |
| Loss from continuing operations before taxes | | | (3,541 | ) | | | (3,926 | ) | | | (6,409 | ) |
| | | | | | | | | | | | | |
Income tax expense (benefit) (Note 10) | | | (40 | ) | | | (84 | ) | | | - | |
| | | | | | | | | | | | | |
| Loss from continuing operations | | | (3,501 | ) | | | (3,842 | ) | | | (6,409 | ) |
| | | | | | | | | | | | | |
| Discontinued operations (Note 14): | | | | | | | | | | | | |
| Gain on disposal of health and wellness operations | | | - | | | | - | | | | 736 | |
| Income from discontinued operations | | | - | | | | - | | | | 139 | |
| | | | | | | | | | | | | |
| Net loss | | $ | (3,501 | ) | | $ | (3,842 | ) | | $ | (5,534 | ) |
| | | | | | | | | | | | | |
Basic earnings (loss) per share: | | | | | | | | | | | | |
| Loss from continuing operations | | $ | (0.25 | ) | | $ | (0.30 | ) | | $ | (0.50 | ) |
| Income from discontinued operations | | | - | | | | - | | | | 0.07 | |
| Net loss | | $ | (0.25 | ) | | $ | (0.30 | ) | | $ | (0.43 | ) |
| | | | | | | | | | | | | |
| Diluted earnings (loss) per share: | | | | | | | | | | | | |
| Loss from continuing operations | | $ | (0.25 | ) | | $ | (0.30 | ) | | $ | (0.50 | ) |
| Income from discontinued operations | | | - | | | | - | | | | 0.07 | |
| Net loss | | $ | (0.25 | ) | | $ | (0.30 | ) | | $ | (0.43 | ) |
| | | | | | | | | | | | | |
| Weighted average common shares outstanding: | | | | | | | | | | | | |
| Basic | | | 14,285 | | | | 12,963 | | | | 12,878 | |
| Diluted | | | 14,285 | | | | 12,963 | | | | 12,878 | |
See accompanying notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share data)
| | | | | | | | | | | | |
| | Common
Stock Shares | | Par
Value | | Additional
Pain-In
Capital | | Retained
Earnings
(Deficit) | | Treasury
Stock | | Total |
| Balance at December 31, 2006 | | | 12,684,633 | | | $ | 9 | | | $ | 37,362 | | | $ | 13,346 | | | $ | (25,188 | ) | | $ | 25,529 | |
| Net loss | | | | | | | | | | | | | | | (2,458 | ) | | | | | | | (2,458 | ) |
| Proceeds from exercise of stock options | | | 168,500 | | | | | | | | 173 | | | | | | | | | | | | 173 | |
| Tax benefits from exercise of stock options | | | | | | | | | | | 154 | | | | | | | | | | | | 154 | |
| Tax benefit allowance | | | | | | | | | | | (154 | ) | | | | | | | | | | | (154 | ) |
| Balance at December 31, 2007 | | | 12,853,133 | | | | 9 | | | | 37,535 | | | | 10,888 | | | | (25,188 | ) | | | 23,244 | |
| Net loss | | | | | | | | | | | | | | | (5,534 | ) | | | | | | | (5,534 | ) |
| Proceeds from exercise of stock options | | | 55,250 | | | | | | | | 64 | | | | | | | | | | | | 64 | |
| Tax benefits from exercise of stock options | | | | | | | | | | | 68 | | | | | | | | | | | | 68 | |
| Tax benefit allowance | | | | | | | | | | | (68 | ) | | | | | | | | | | | (68 | ) |
| Balance at December 31, 2008 | | | 12,908,383 | | | | 9 | | | | 37,599 | | | | 5,354 | | | | (25,188 | ) | | | 17,774 | |
| Net loss | | | | | | | | | | | | | | | (3,842 | ) | | | | | | | (3,842 | ) |
| Proceeds from exercise of stock options | | | 125,000 | | | | | | | | 127 | | | | | | | | | | | | 127 | |
| Tax benefits from exercise of stock options | | | | | | | | | | | 88 | | | | | | | | | | | | 88 | |
| Tax benefit allowance | | | | | | | | | | | (88 | ) | | | | | | | | | | | (88 | ) |
| Balance at December 31, 2009 | | | 13,033,383 | | | $ | 9 | | | $ | 37,726 | | | $ | 1,512 | | | $ | (25,188 | ) | | $ | 14,059 | |
| | | | | | | | | | | | Retained | | | | | | | |
| | | | | | | | | Additional | | | Earnings | | | | | | | |
| | | Common Stock | | | Par | | | Paid-In | | | (Accumulated | | | Treasury | | | | |
| | | Shares | | | Value | | | Capital | | | Deficit) | | | Stock | | | Total | |
| Balance at December 31, 2007 | | | 12,853,133 | | | $ | 9 | | | $ | 37,535 | | | $ | 10,888 | | | $ | (25,188 | ) | | $ | 23,244 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | | | | | | | | | | | | | (5,534 | ) | | | | | | | (5,534 | ) |
| Proceeds from exercise of stock options | | | 55,250 | | | | | | | | 64 | | | | | | | | | | | | 64 | |
| Tax benefits from exercise of stock options | | | | | | | | | | | 68 | | | | | | | | | | | | 68 | |
| Tax benefit allowance | | | | | | | | | | | (68 | ) | | | | | | | | | | | (68 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2008 | | | 12,908,383 | | | | 9 | | | | 37,599 | | | | 5,354 | | | | (25,188 | ) | | | 17,774 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | | | | | | | | | | | | | (3,842 | ) | | | | | | | (3,842 | ) |
| Proceeds from exercise of stock options | | | 125,000 | | | | | | | | 127 | | | | | | | | | | | | 127 | |
| Tax benefits from exercise of stock options | | | | | | | | | | | 88 | | | | | | | | | | | | 88 | |
| Tax benefit allowance | | | | | | | | | | | (88 | ) | | | | | | | | | | | (88 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2009 | | | 13,033,383 | | | | 9 | | | | 37,726 | | | | 1,512 | | | | (25,188 | ) | | | 14,059 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | | | | | | | | | | | | | (3,501 | ) | | | | | | | (3,501 | ) |
| Proceeds from exercise of stock options | | | 130,500 | | | | | | | | 133 | | | | | | | | | | | | 133 | |
| Common Stock Issued to Phosphangenics Limited pursuant to an Exclusive License Agreement (Note 3) | | | 1,440,000 | | | | 1 | | | | 2,576 | | | | | | | | | | | | 2,577 | |
| Common stock granted pursuant to an employment agreement | | | 36,111 | | | | | | | | 60 | | | | | | | | | | | | 60 | |
| Common stock granted pursuant to a compensation agreement | | | 67,625 | | | | | | | | 90 | | | | | | | | | | | | 90 | |
| Share-based compensation expense | | | | | | | | | | | 42 | | | | | | | | | | | | 42 | |
| Tax benefits from exercise of stock options | | | | | | | | | | | 42 | | | | | | | | | | | | 42 | |
| Tax benefit allowance | | | | | | | | | | | (42 | ) | | | | | | | | | | | (42 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2010 | | | 14,707,619 | | | $ | 10 | | | $ | 40,627 | | | $ | (1,989 | ) | | $ | (25,188 | ) | | $ | 13,460 | |
See accompanying notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | | | | |
| | Year Ended December 31, |
| | | 2009 | | 2008 | | 2007 |
Cash flows from operating activities:
| | | | | | | | | | | | |
| Net loss | | $ | (3,842 | ) | | $ | (5,534 | ) | | $ | (2,458 | ) |
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
| | | | | | | | | | | | |
| Impairment charge | | | 74 | | | | 100 | | | | — | |
| Depreciation and amortization | | | 522 | | | | 745 | | | | 996 | |
| Gain on disposal of health and wellness operations | | | | | | | (736 | ) | | | — | |
| Loss on the sales of fixed assets | | | 104 | | | | 17 | | | | 20 | |
| Sales allowance and provision for bad debts | | | (47 | ) | | | 1,283 | | | | (298 | ) |
| Inventory valuation provision | | | 633 | | | | 832 | | | | 438 | |
(Increase) decrease in assets and liabilities:
| | | | | | | | | | | | |
| Accounts receivable | | | 2,485 | | | | 778 | | | | 182 | |
| Inventory | | | 963 | | | | 323 | | | | (987 | ) |
| Prepaid expenses and other current assets | | | 381 | | | | (353 | ) | | | (48 | ) |
| Other assets | | | 9 | | | | 53 | | | | 83 | |
| Accounts payable | | | (212 | ) | | | 311 | | | | (348 | ) |
| Accrued royalties and sales commissions | | | (5 | ) | | | 41 | | | | 328 | |
| Accrued advertising | | | (575 | ) | | | (63 | ) | | | (770 | ) |
| Other current liabilities | | | (45 | ) | | | (1,847 | ) | | | 1,551 | |
| Net cash provided by (used in) operating activities | | | 445 | | | | (4,050 | ) | | | (1,311 | ) |
Cash flows from investing activities:
| | | | | | | | | | | | |
| Proceeds for the sale of health and wellness operations | | | — | | | | 1,000 | | | | — | |
| Capital expenditures | | | (208 | ) | | | (200 | ) | | | (533 | ) |
| Proceeds from the sale of fixed assets | | | 480 | | | | 10 | | | | — | |
| Net cash flows provided by (used in) investing activities | | | 272 | | | | 810 | | | | (533 | ) |
Cash flows from financing activities:
| | | | | | | | | | | | |
| Stock options and warrants exercised | | | 127 | | | | 64 | | | | 173 | |
| Net cash provided by financing activities | | | 127 | | | | 64 | | | | 173 | |
| Net increase (decrease) in cash and cash equivalents | | | 844 | | | | (3,176 | ) | | | (1,671 | ) |
| Cash and cash equivalents at beginning of period | | | 11,957 | | | | 15,133 | | | | 17,757 | |
| Less: cash and cash equivalents of discontinued operations at end of period reported as a component assets of discontinued operations | | | — | | | | — | | | | (953 | ) |
| Cash and cash equivalents at end of period | | $ | 12,801 | | | $ | 11,957 | | | $ | 15,133 | |
Supplemental disclosures of cash flow information:
| | | | | | | | | | | | |
| Interest | | $ | — | | | $ | — | | | $ | — | |
| Taxes | | $ | 43 | | | $ | — | | | $ | — | |
| | | Year Ended December 31, | |
| | | 2010 | | | 2009 | | | 2008 | |
| Cash flows from operating activities: | | | | | | | | | |
| Net loss | | $ | (3,501 | ) | | $ | (3,842 | ) | | $ | (5,534 | ) |
| Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | | | | | | | | | | | | |
| Impairment charge | | | - | | | | 74 | | | | 100 | |
| Depreciation and amortization | | | 363 | | | | 522 | | | | 745 | |
| Share-based compensation expense | | | 192 | | | | - | | | | - | |
| Gain on disposal of health and wellness operations | | | - | | | | - | | | | (736 | ) |
| Loss on the sales of fixed assets | | | - | | | | 104 | | | | 17 | |
| Sales discounts and provision for bad debts | | | (33 | ) | | | (133 | ) | | | (376 | ) |
| Inventory valuation provision | | | (728 | ) | | | 633 | | | | 832 | |
| Changes in operating assets and liabilities: | | | | | | | | | | | | |
| Accounts receivable | | | (1,189 | ) | | | 2,485 | | | | 1,366 | |
| Inventory | | | 451 | | | | 963 | | | | 323 | |
| Prepaid expenses and other current assets | | | (80 | ) | | | 381 | | | | (353 | ) |
| Other assets | | | 12 | | | | 9 | | | | 53 | |
| Accounts payable | | | (219 | ) | | | (109 | ) | | | 434 | |
| Accrued royalties and sales commissions | | | (16 | ) | | | (38 | ) | | | (32 | ) |
| Accrued advertising and other allowance | | | 1,400 | | | | (559 | ) | | | 956 | |
| Other current liabilities | | | (201 | ) | | | (45 | ) | | | (1,845 | ) |
| Net cash provided by (used in) operating activities | | | (3,549 | ) | | | 445 | | | | (4,050 | ) |
| | | | | | | | | | | | | |
| Cash flows from investing activities: | | | | | | | | | | | | |
| Proceeds from the sale of health and wellness operations | | | - | | | | - | | | | 1,000 | |
| Capital expenditures | | | (153 | ) | | | (208 | ) | | | (200 | ) |
| Acquisition of product license | | | (1,000 | ) | | | | | | | | |
| Proceeds from the sale of fixed assets | | | - | | | | 480 | | | | 10 | |
| Net cash flows provided by (used in) investing activities | | | (1,153 | ) | | | 272 | | | | 810 | |
| | | | | | | | | | | | | |
| Cash flows from financing activities: | | | | | | | | | | | | |
| Proceeds from the exercise of stock options | | | 133 | | | | 127 | | | | 64 | |
| Net cash provided by financing activities | | | 133 | | | | 127 | | | | 64 | |
| | | | | | | | | | | | | |
| Net increase (decrease) in cash and cash equivalents | | | (4,569 | ) | | | 844 | | | | (3,176 | ) |
| | | | | | | | | | | | | |
| Cash and cash equivalents at beginning of year | | | 12,801 | | | | 11,957 | | | | 15,133 | |
| | | | | | | | | | | | | |
| Cash and cash equivalents at end of year | | $ | 8,232 | | | $ | 12,801 | | | $ | 11,957 | |
| | | | | | | | | | | | | |
| Supplemental disclosures of cash flow information: | | | | | | | | | | | | |
| Income taxes paid | | $ | 34 | | | $ | 43 | | | $ | - | |
| | | | | | | | | | | | | |
| Common stock issued to Phosphagenics Limited pursuant to a product license agreement | | $ | 2,577 | | | $ | - | | | $ | - | |
See accompanying notes to consolidated financial statements
PROPHASE LABS, INC. AND SUBSIDIARIES
NOTE 1
—– ORGANIZATION AND BUSINESS
The Quigley Corporation
ProPhase Labs, Inc (“we”, “us” or the “Company”), organized under the laws of the State of Nevada, is 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
cosmeceuticals for human and veterinary use.cosmeceutical products.
Our primary business is currently the manufacture, distribution, marketing and sale of over-the-counter (“OTC”)OTC cold remedy products to consumers through national chain, regional, specialty and local retail stores. One of our principal products is Cold-EEZE®Cold-EEZEÒ, a zinc gluconate glycine product proven in clinical studies to reduce the duration and severity of the common cold symptoms by nearly half. Cold-EEZE®Cold-EEZEÒ is an established product in the health care and cold remedy market. For Fiscal 2010, Fiscal 2009 and Fiscal 2008 and Fiscal 2007 (as each is defined below), our revenues from continuing operations have come principally from our cold remedy products.Prior to Fiscal 2009, we were organized into three business segments: (i) cold remedy, (ii) contract manufacturing and (iii) ethical pharmaceutical. We historically managed each of our segments separately as a consequence of different marketing, manufacturing and/or research and development strategies. Following a strategic review, as described further below, completed in the fourth quarter of Fiscal 2009, we realigned our operations to focus principally in the research, development, manufacture, marketing and sale of OTC cold remedy products.
On March 22, 2010, the Company, Phosphagenics Limited (“PSI Parent”), an Australian corporation, Phosphagenics Inc. (“PSI”), a Delaware corporation and
consumer products, natural base health productssubsidiary 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
supplementsproducts. Pursuant to the LLC Agreement, we and
cosmeceuticals for human and veterinary use. AsPSI each own a
consequence of our strategic review, as of December 31, 2009, we are engaged principally50% membership interest in the
OTC/Personal Care marketplace segment.Our strategic review included a review and evaluationJoint Venture (see Note 3).
On May 5, 2010, our shareholders approved, among other corporate matters, the Board of
(i) evolving market conditions for OTC cold remedy opportunities in respect ofDirectors’ proposal to change our
current product offerings, (ii) our manufacturing and distribution operations and capacity, (iii) product line financial performance criteria current returns on investment and marketing strategy, (iv) current research and development initiatives and (v) opportunitiesname to
develop prescription pharmaceutical and new OTC products. As a result of our strategic review, management determined that it is in our best interests to focus primarily on the OTC/Personal Care marketplace, which may include but is not limited to our Cold-EEZE® and Kids-EEZE® brands, as well as other homeopathic, dietary supplement, cosmetic, cosmeceutical, first aid, functional food and beverage products. We also determined to curtail further investment in certain products under development by our wholly owned subsidiary,ProPhase Labs, Inc. from The Quigley
Pharma, Inc. (“Pharma”), in light of our view concerning market opportunities, regulatory pathways, the need for further robust and consistent preclinical and clinical testing and continued requirements in the areas of commercial formulation and development.Corporation.
We use a December 31 year-end for financial reporting purposes. References herein to the fiscal year ended December 31, 20092010 shall be the term “Fiscal 2009”2010” and references to other “Fiscal” years shall mean the year, which ended on December 31 of the year indicated. Our consolidated balance sheet at December 31, 2009 and our consolidated statement of cash flows for Fiscal 2009 and 2008 have been reclassified to conform with our Fiscal 2010 presentation. The term the “we”, “us”“us: or the “Company” as used herein also refer, where appropriate, to the Company, together with its subsidiaries unless the context otherwise requires.
NOTE 2 —– SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements (“Financial Statements”) include the accounts of the Company and its wholly-owned subsidiaries.wholly owned subsidiaries and its Joint Venture, a variable interest entity (see Note 3). All intercompany transactions and balances have been eliminated. Effective March 31, 2004, the financial statements include consolidated variable interest entities (“VIEs”) of which we are the primary beneficiary (see Note 13).
Seasonality of the Business
Our net sales are derived principally from our cold remedy products. Currently, our sales are influenced by and subject to fluctuations in the timing of purchase and the ultimate level of demand for our products which are a function of the timing, length and severity of each cold season. Generally, a cold season is defined as the period of September to March when the incidence of the common cold rises as a consequence of the change in weather and other factors. We generally experience in the third and fourth quarter higher levels of net sales along with a
TABLE OF CONTENTS
THE QUIGLEY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (continued)
corresponding increase in marketing and advertising expenditures designed to promote its products during the cold season. Revenues and related marketing costs are generally at their lowest levels in the second quarter when consumer demand generally declines. We track health and wellness trends and develop retail promotional strategies to align our production scheduling, inventory management and marketing programs to optimize consumer purchases.
PROPHASE LABS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The preparation of the Financial Statements and the accompanying notes thereto, in conformity with generally accepted accounting principles in the United States (“GAAP”), requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the respective reporting periods. Examples include the provision for bad debt, sales returns and allowances, inventory obsolescence, useful lives of property and equipment and intangible assets, impairment of property and equipment and intangible assets, income tax valuations and assumptions related to accrued advertising. When providing for the appropriate sales returns, allowances, cash discounts and cooperative incentive promotion costs (“Sales Allowances”), we apply a uniform and consistent method for making certain assumptions for estimating these provisions. These estimates and assumptions are based on historical experience, current trends and other factors that management believes to be relevant at the time the financial statements are prepared. Management reviews the accounting policies, assumptions, estimates and judgments on a quarterly basis. Actual results could differ from those estimates.
Our primary product, Cold-EEZE®Cold-EEZEÒ, utilizes a proprietary zinc formulation which has been clinically proven to reduce the severity and duration of common cold symptoms. Accordingly, 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. We addedmarket certain new products to our OTC Personal Care marketplace segment in Fiscal 2007 and Fiscal 2008 such as ISC-10 Immune,(i) Organix Organic Cough and Sore Throat Drops and Kids-EEZE®(ii) three unique Kids-EEZEÒ products, Chest Relief.Relief, Cough Cold and Allergy. Each of these new products do carry shelf-life expiration dates for which we aggregate such new product market experience data and updatesupdate 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, the monitoring of current occurrences, developments by customer, market conditions and any other occurrences that could affect the expected provisions relative to net sales for the period presented are also performed.
We consider all highly liquid investments with an initial maturity of three months or less at the time of purchase to be cash equivalents. Cash equivalents include cash on hand and monies invested in money market funds. The carrying amount approximates the fair market value due to the short-term maturity of these investments.
Inventory is valued at the lower of cost, determined on a first-in, first-out basis (FIFO), or market. Inventory items are analyzed to determine cost and the market value and appropriate valuation reserves are established. At December 31, 20092010 and 2008,2009, the Financial Statements include an allowance for excess or obsolete inventory of $1.8$1.1 million and $1.2$1.8 million, respectively. At December 31, 20092010 and 2008,2009, inventory included raw material, work in progress and packaging amounts of $610,000$742,000 and $975,000,$610,000, respectively, and finished goods of $940,000 and $795,000, and $2.0 million, respectively.
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THE QUIGLEY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (continued)
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. We use a combination of straight-line and accelerated methods in computing depreciation for financial reporting purposes. The annual provision for depreciation has been computed in accordance with the estimated asset lives.
Future revenues, costs, margins and profits will continue to be influenced by our ability to maintain our manufacturing availability and capacity together with our marketing and distribution capabilities and the requirements associated with the development of OTC Personal Care products in order to continue to compete on a national and/or international level.
Our business is subject to federal and state laws and regulations adopted for the health and safety of users of our products. Cold-EEZE® is a homeopathicOur OTC cold remedy that isproducts are subject to regulations by various federal, state and local agencies, including the Food and Drug Administration (“FDA”) and, as applicable, the Homeopathic Pharmacopoeia of the United States.
PROPHASE LABS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash investments and trade accounts receivable.
We maintain cash and cash equivalents with
severalcertain major financial institutions. As of December 31,
2009,2010, our cash
was $8.2 million and
our bank balance was
$12.8$8.7 million. Of the total bank balance,
$7.7 million$708,000 was covered by federal depository insurance and
$5.1$8.0 million was uninsured.
Trade accounts receivable potentially subjects us to credit risk. We extend credit to our customers based upon an evaluation of the customer’s financial condition and credit history and generally we do not require collateral. Our broad range of customers includes many large wholesalers, mass merchandisers and multi-outlet pharmacy and chain drug store (see Note
15)12). During Fiscal
2010, 2009
2008 and
2007,2008, effectively all of our revenues were related to domestic markets.
Our revenues are principally generated from the sale of the cold remedy products which approximated
92%96%,
89%92% and
91%89% of total revenues for Fiscal
2010, 2009
2008 and
2007,2008, respectively. 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 the OTC cold remedy products.
Raw materials used in the production of the products are available from numerous sources. Certain raw material active ingredients used in connection with the Cold-EEZE®Cold-EEZE® product are purchased from a single unaffiliated supplier. Should the relationship terminate or the vendor become unable supply material, we believe that the current contingency plans would prevent a termination from materially affecting our operations. However, if the relationship was terminated, there may be delays in production of our products until an acceptable replacement supplier is located.
We review our long-lived assets for impairment on an exception basis whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through future undiscounted cash flows. In Fiscal 2009 and 2008, we recognized impairment charges of $74,000 and $100,000, respectively, principally for the land and building assets of our Elizabethtown manufacturing. As of December 31, 2009,2010, the Elizabethtown land and building assets are reported as an asset held for sale at fair value, less the cost of disposal. In February 2011, the Elizabethtown facility was sold and we derived net proceeds from the sale of approximately $166,000.
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THE QUIGLEY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (continued)
Revenue Recognition
Sales are recognized at the time ownership is transferred to the customer. Revenue is reduced for trade promotions, estimated sales returns, cash discounts and other allowances in the same period as the related sales are recorded. We make estimates of potential future product returns and other allowances related to current period revenue. We analyze historical returns, current trends, and changes in customer and consumer demand when evaluating the adequacy of the sales returns and other allowances.
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.
PROPHASE LABS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
As of
December 31, 2010 and December 31, 2009, we included a provision for sales allowances of
$1.5 million for future sales returns$106,000 and $127,000,
for other allowancesrespectively, which
isare reported as a reduction to
accounts receivable. As of December 31, 2008, we included a provision for sales allowances of $1.4 million for future sales returns and $154,000 for other allowances which is reported as a reduction to accounts receivable. Additionally, current liabilities as of December 31, 2009 and December 31, 2008 include $586,000 and $1.1 million, respectively, for cooperative incentive promotion costs.account receivables. We also included an estimate of the uncollectability of our accounts receivable as an allowance for doubtful accounts of
$23,000$13,000 and
$131,000$23,000 as of December 31,
2010 and 2009,
respectively. Additionally, accrued advertising and
other allowances as of December 31,
2008, respectively.Cost2010 include $1.5 million for estimated future sales returns, $1.2 million for cooperative incentive promotion costs and $828,000 for certain other advertising and marketing promotions. As of Sales
Pursuant to certain contract terms, we charged to cost ofDecember 31, 2009 accrued advertising and other allowances include $1.5 million for estimated future sales certain contingent royaltyreturns and consulting payments, calculated based upon net sales collected by us, to the then patent holders and the developers of the zinc gluconate glycine product formulation use in Cold-EEZE® (see Notes 5 and 7). The last remaining agreements expired in Fiscal 2007. We charged to cost of sales $293,000 in Fiscal 2007.
$586,000 for cooperative incentive promotion costs.
Product sales carry shipping and handling charges to the purchaser, included as part of the invoiced price, which is classified as revenue. In all cases, costs related to this revenue are recorded in cost of sales.
We recognize all share-based payments to employees and directors, including grants of stock options, as compensation expense in the financial statements based on their fair values. Fair values of stock options are determined through the use of the Black-Scholes option pricing model. The compensation cost is recognized as an expense over the requisite service period of the award, which usually coincides with the vesting period.
Stock options and warrants for purchase of our common stock, $0.0005 par value, (“Common Stock”) have been granted to both employees and non-employees sincepursuant to the date we became publicly traded.terms of certain agreements and stock option plans (see Note 8). Options and warrants are exercisable during a period determined by us, but in no event later than ten years from the date granted. NoIn Fiscal 2010, we charged to operations $192,000 in share-based compensation expense for the aggregate fair value of the stock grants and vested stock options were granted to employees and non-employees inissued during the year. There was no share-based compensation expense for Fiscal 2009 2008 or 2007.
2008.
Variable Interest Entity
The Joint Venture, of which we own a 50% membership interest effective March 22, 2010, qualifies as a variable interest entities (“VIE”) and we have consolidated the Joint Venture beginning with the quarter ended March 31, 2010 (see Note 3).
Advertising and Incentive Promotions
Advertising and incentive promotion costs are expensed within the period in which they are utilized. Advertising and incentive promotion expense is comprised of media advertising, presented as part of sales and marketing expense; co-operativecooperative incentive promotions and coupon program expenses, which are accounted for as part of net sales; and free product, which is accounted for as part of cost of sales. Advertising and incentive promotion costs incurred for Fiscal 2010, 2009 and 2008 and 2007 were $6.9 million, $5.8 million, and $7.7 million, and $7.3 million,
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THE QUIGLEY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (continued)
respectively. Included in prepaid expenses and other current assets was $170,000$189,000 and $242,000$170,000 at December 31, 20092010 and 2008,2009, respectively, relating to prepaid advertising and promotion expenses.
Research and development costs are charged to operations in the period incurred. Expenditures for Fiscal 2010, 2009 and 2008 and 2007 were $794,000, $1.3 million and $4.2 million, and $6.5 million, respectively. Principally,For Fiscal 2010, research and development costs are related principally to Pharma’s study activities, new product development initiatives and costs associated with Cold-EEZE®.
OTC cold remedy products. For Fiscal 2009 and 2008, research and development costs are related principally to the Pharma’s study activities; such studies and initiatives are no longer actively being commercialized.
We utilize the asset and liability approach which requires the recognition of deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns. In estimating future tax consequences, we generally consider all expected future events other than enactments of changes in the tax law or rates. Until sufficient taxable income to offset the temporary timing differences attributable to operations and the tax deductions attributable to option, warrant and stock activities are assured, a valuation allowance equaling the total
net current and non-current deferred tax asset is being provided (see Note 10).
PROPHASE LABS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
We utilize a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than fifty percent likely of being realized upon ultimate settlement.
Any interest or penalties related to uncertain tax positions will be recorded as interest or administrative expense, respectively.
As a result of our continuing tax losses, we have recorded a full valuation allowance against a net deferred tax asset, except for an alternative minimum tax credit carryforward in the amount of
$110,000.$51,000. Additionally, we have not recorded a liability for unrecognized tax benefits
for at December 31,
20092010 or
2008.2009.
The major jurisdiction for which we file income tax returns is the United States. The Internal Revenue Service (“IRS”) has examined our tax year ended September 30, 2005 and has made no changes to the filed tax returns. The tax years 2006 and forward remain open to examination by the IRS. The tax years 2004 and forward remain open to examination by the various state taxing authorities to which we are subject.
Effective December 31, 2009, we elected to conform our tax reporting year, historically a fiscal period ending September 30, to our financial reporting period ending December 31. As a consequence, we will filefiled a full period tax return for the fiscal year ended September 30, 2009 with the IRS and will also filefiled with the IRS a “short period return” for the three months ended December 31, 2009 in compliance with the election. In future fiscal periods, our tax and financial reporting periods will be the same, the period ending December 31.
Fair Value of Financial Instruments
Cash and cash equivalents, accounts receivable and accounts payable are reflected in the Financial Statements at carrying value which approximates fair value because of the short-term maturity of these instruments. Determination of the fair value of related party payables, if any, is not practicable due to their related party nature.
Recently Issued Accounting Standards
Effective July 2009, we adopted the “FASB Accounting Standards Codification” and the Hierarchy of Generally Accepted Accounting Principles (ASC-105). This standard establishes only two levels of U.S. generally accepted accounting principles (“GAAP”), authoritative and nonauthoritative. The Financial Accounting Standard Board (“FASB”) Accounting Standards Codification (the “Codification”) became the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literature not included in the Codification became nonauthoritative. We began using the new guidelines and numbering system
TABLE OF CONTENTS
THE QUIGLEY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (continued)
prescribed by the Codification when referring to GAAP for the three months and nine months ended September 30, 2009. As the Codification was not intended to change or alter existing GAAP, it did not have any impact on our consolidated financial statements.
In February 2008, the FASB issued an accounting standard update that delayed the effective date of fair value measurements accounting for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008. These include goodwill and other non-amortizable intangible assets. We adopted this accounting standard update effective January 1, 2009. The adoption of this update to non-financial assets and liabilities, as codified in ASC-820, has not had a significant impact on our consolidated financial position, results of operations or cash flows.
In November 2008, the SEC issued for comment a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS)(“IFRS”). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (IASB)(“IASB”). Under the proposed roadmap, we could be required in fiscal 2014 to prepare financial statements in accordance with IFRS. The SEC will make a determination in 2011 regarding the mandatory adoption of IFRS. We are currently assessing the impact that this potential change would have on our consolidated financial statements and we will continue to monitor the development of the potential implementation of IFRS.
Effective January
In June 2009,
we adopted a newthe Financial Accounting Standards Board (“FASB”) modified the accounting standard
update regarding business combinations. As codified under ASC-805, this update requires an entityrelated to
recognizeconsolidation. This standard, as modified, intends to improve financial reporting by enterprises involved with variable interest entities. This standard, as modified, addresses the
assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair valueeffects on
the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred; that restructuring costs generally be expensed in periods subsequentcertain provisions relating to the
acquisition date; and that changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognizedConsolidation of Variable Interest Entities, as a
componentresult of
provision for taxes. In addition, acquired in-process researchthe elimination of the qualifying special-purpose entity concept in the accounting standard related to transfers and
development is capitalized as an intangible assetservicing, and
amortized over its estimated useful life. Withconstituent concerns about the
adoptionapplication of certain key provisions of this
accounting standard,
update, any tax related adjustments associated with acquisitions that closed prior to January 1, 2009 will be recorded through income tax expense, whereas the previous accounting treatment would require any adjustment to be recognized through the purchase price. This accounting standard update applies prospectively to business combinations forincluding those in which the
acquisition dateaccounting and disclosures under the standard do not always provide timely and useful information about an enterprise’s involvement in a variable interest entity. This standard, as modified, is
on or aftereffective as of the beginning of
theeach reporting entity’s first annual reporting period
beginning on orthat begins after
DecemberNovember 15,
2008.2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The adoption of
these accounting updates hasthe consolidation standard, as modified, did not
hadhave a
significant impactmaterial effect on our consolidated financial
position, results of operations or cash flows.Effective January 2009, we adopted an accounting standard which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary, as codified in ASC-810. This accounting standard states that accounting and reporting for minority interests are to be recharacterized as noncontrolling interests and classified as a component of equity. The calculation of earnings per share continues to be based on income amounts attributable to the parent. The adoption of these accounting updates has not had a significant impact on our consolidated financial position, results of operations or cash flows.
Effective January 2009, we adopted an accounting standard update regarding the determination of the useful life of intangible assets. As codified in ASC-350, this update amends the factors considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under intangibles accounting. It also requires a consistent approach between the useful life of a recognized intangible asset under prior business combination accounting and the period of expected cash flows used to measure the fair value of an asset under the new business combinations accounting (as currently codified under ASC-850). The update also requires enhanced disclosures when an intangible asset’s expected future cash flows are affected by an entity’s intent and/or ability to renew or extend the arrangement. The adoption of these accounting updates has not had a significant impact on our consolidated financial position, results of operations or cash flows.
statements.
PROPHASE LABS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2
—– SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
– (continued)Effective January(CONTINUED)
In October 2009, we adopted a new accounting standard update from the Emerging Issues Task Force (“EITF”FASB issued Accounting Standards Update No. 2009-13, "Multiple-Deliverable Revenue Arrangements" ("ASU No. 2009-13") consensus regarding the accounting of defensive intangible assets. This update, as codified in ASC-350, clarifies accounting for defensive intangible assets subsequent. ASU No. 2009-13 amends guidance included within ASC Topic 605-25 to initial measurement. It applies to acquired intangible assets whichrequire an entity has no intention of actively using,to use an estimated selling price when vendor specific objective evidence or intends to discontinueacceptable third party evidence does not exist for any products or services included in a multiple element arrangement. The arrangement consideration should be allocated among the products and services based upon their relative selling prices, thus eliminating the use of the intangible asset but holds itresidual method of allocation. ASU No. 2009-13 also requires expanded qualitative and quantitative disclosures regarding significant judgments made and changes in applying this guidance. ASU No. 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption and retrospective application are also permitted. We elected to prevent others from obtaining access to it (i.e. a defensive intangible asset). Under this update, a consensus was reached that an acquired defensive asset should be accounted for as a separate unit of accounting (i.e., an asset separate from other assets of the acquirer);adopt ASU No. 2009-13 early and the useful life assigned to an acquired defensive asset should be based on the period during which the asset would diminish in value. The adoption of this accounting update hasdid not hadhave a significant impactmaterial effect on our consolidated financial position, resultsstatements.
In January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair Value Measurements”. ASU 2010-06 amends ASU 820 to require a number of operations or cash flows.Effective April 2009, we adopted a new accounting standard for subsequent events, as codified in ASC-855.additional disclosures regarding fair value measurements. The update modifiesamended guidance requires entities to disclose the namesamounts of significant transfers between Level 1 and Level 2 of the two typesfair value hierarchy and the reasons for these transfers, the reasons for any transfers in or out of subsequent events eitherLevel 3, and information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis. This ASU also clarifies the requirement for entities to disclose information about both the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements as recognized subsequent events (previously referred to in practicewell as Type I subsequent events) or non-recognized subsequent events (previously referred to in practice as Type II subsequent events). In addition, the standard modifieslevel of disaggregation required for each class of asset and liability disclosed. The amended Level 1 and 2 guidance is effective for interim and annual financial periods beginning after December 15, 2009 while the definitionamended Level 3 guidance is effective for interim and annual financial periods beginning after December 15, 2010. The adoption of subsequent events to refer to events or transactions that occur after the balance sheet date, but before the financial statements are issued (for public entities) or available to be issued (for nonpublic entities). It also requires the disclosure of the date through which subsequent events have been evaluated. The updateASU 2010-06 did not result in significant changes in the practice of subsequent event disclosures, and therefore the adoption has not hadhave a significant impactmaterial effect on our consolidated financial position, resultsstatements.
NOTE 3 – INVESTMENT IN PHUSION LABORATORIES, LLC.
On March 22, 2010, the Company, PSI Parent, an Australian corporation, PSI, a Delaware corporation and subsidiary of operations or cash flows. AsPSI Parent, and the Joint Venture, a consequenceDelaware limited liability company, entered into the LLC Agreement of the adoptionJoint Venture and additional related agreements for the purpose of ASC-855, we have evaluateddeveloping and disclosed subsequent events relatingcommercializing, for worldwide distribution and sale, a wide range of non-prescription remedies using PSI Parent’s proprietary patented TPM. TPM facilitates the delivery and depth of penetration of active molecules in pharmaceutical, nutraceutical and other products.
In connection with the LLC Agreement, PSI Parent granted to us, pursuant to the year ended December 31, 2009terms of a License Agreement, dated March 22, 2010 (the “Original License Agreement”), (i) an exclusive, royalty-free, world-wide (subject to certain limitations), paid-up license to exploit OTC drugs and certain other products that embody certain of PSI Parent’s TPM-related patents and related know-how (collectively, the “PSI Technology”) and (ii) a non-exclusive, royalty-free, world-wide (subject to certain limitations), paid-up license to exploit certain compounds that embody the PSI Technology for use in a product combining one or more of such compounds with an OTC drug or in a product that is part of a regimen that includes the application of an OTC drug.
Pursuant to the Original License Agreement, we issued 1,440,000 shares of our
Financial Statements.Effective April 2009,Common Stock having an aggregate value of approximately $2.6 million to PSI Parent (such shares, the “PSI Shares”), and made a one-time payment to PSI Parent of $1.0 million. PSI Parent has agreed, pursuant to a Share Transfer Restriction Agreement, dated March 22, 2010 (the “Share Transfer Restriction Agreement”), between us and PSI Parent, that, with certain exceptions, it will not sell or otherwise dispose of any of the PSI Shares prior to June 1, 2012. The PSI Shares were issued pursuant to an exemption from registration under the Securities Act, by virtue of Section 4(2) of the Securities Act and by virtue of Rule 506 of Regulation D under the Securities Act. Such sale and issuance did not involve any public offering and was made without general solicitation or advertising. Additionally, PSI Parent represented to us, among other things, that PSI Parent is not a US Person (as defined in Regulation S under the Securities Act), that PSI Parent is an accredited investor with access to all relevant information necessary to evaluate its investment and that the PSI Shares were being acquired for investment purposes only.
PROPHASE LABS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 – INVESTMENT IN PHUSION LABORATORIES, LLC. (CONTINUED)
In accordance with a Contribution Agreement, dated March 22, 2010 (the “Contribution Agreement”), by and among us, PSI Parent, PSI, and the Joint Venture, we adopted three accounting standard updatestransferred, conveyed and assigned to the Joint Venture all of our rights, title and interest in, to and under the Original License Agreement, and the Joint Venture assumed, and undertook to pay, discharge and perform when due, all of our liabilities and obligations under and arising pursuant to the Original License Agreement (such actions, collectively, the “Assignment and Assumption”).
Pursuant to the Contribution Agreement and in order to reflect the Assignment and Assumption, we, PSI Parent and the Joint Venture entered into an Amended and Restated License Agreement, dated March 22, 2010 (the “Amended License Agreement”), which were intendedamends and restates the Original License Agreement to provide additional application guidancereflect that the Joint Venture is the licensee thereunder and enhanced disclosures regarding fair value measurementswhich otherwise contains substantially the same terms as the Original License Agreement. The Joint Venture has the right to grant one or more sub-licenses of the rights granted under the Amended License Agreement to one or more third parties for reasonable consideration in any part of the applicable territory. The Amended License Agreement provides that PSI Parent shall not, directly or through third parties, exploit the covered intellectual property during the term thereof, subject to certain limitations. The Amended License Agreement will remain in effect until the expiration of the last to expire of the patents included within the PSI Technology or any extensions thereof. Either party may terminate the Amended License Agreement upon written notice to the other party in the event of certain events involving bankruptcy or insolvency. The Amended License Agreement also contains, among other things, provisions concerning the treatment of confidential information, the ownership of intellectual property and impairmentsindemnification obligations.
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 securities. They also provide additional guidelines for estimating fair valuethe 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 fair value accounting. The first update,agreed upon budgets for products to be developed. Specifically, we contributed $500,000 in cash as codified in ASC-820 (formerly FASB Staff Positions (“FSP”) No.157-4,Determining Fair Value Wheninitial capital. In addition, we are committed to fund up to $2.0 million, subject to agreed upon budgets (which have not yet been established), toward the Volumeinitial development and Levelmarketing costs of Activitynew products for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly), provides additional guidelines for estimating fair value in accordance with fair value accounting.Joint Venture. The second accounting update, as codified in ASC-320 (formerly FSP No. 115-2,Recognition and Presentation of Other-Than-Temporary Impairments), changes accounting requirements for other-than-temporary-impairment (OTTI) for debt securities by replacing the current requirement that a holder have the positive intent and ability to hold an impaired security to recovery in order to conclude an impairment was temporary with a requirement that an entity conclude it does not intend to sell an impaired security and it will not be required to sell the security before the recovery of its amortized cost basis. The third accounting update, as codified in ASC-825 (formerly Accounting Principles Board (“APB”) Opinion No. 28-1,Interim Disclosures about Fair Value of Financial Instruments), increases the frequency of fair value disclosures. These updates were effective for fiscal years and interim periods ended after June 15, 2009. The adoption of these accounting updatesnewly formed Joint Venture has not hadengaged in any financial transactions, other than organizational expenses and general market and product analysis. Formal operations are not expected to commence until Fiscal 2011. At December 31, 2010, cash and equivalents includes $425,000 related to the Joint Venture 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.
The Joint Venture is managed by a
significant impact on our consolidated financial position, resultsfour-person Board of
operations or cash flows.NOTE 3 — DISCONTINUED OPERATIONS
On February 29, 2008, we sold our wholly owned subsidiary, Darius International, Inc. (“Darius”), the former health and wellness segment, to InnerLight Holdings, Inc. (“InnerLight”). On February 29, 2008, Mr. Kevin P. Brogan, the then presidentManagers, with two managers appointed by each member. The initial Board of Darius was a significant shareholderManagers is comprised of InnerLight. In addition, Mr. Gary Quigley, then an employee and stockholderfour representatives, two representatives from each of the Company and alsoPSI Parent. The initial Company representatives on the brotherBoard of Managers are Mr. Guy Quigley,Ted Karkus and Mr. Robert Cuddihy. Mr. Karkus, on our then Chairman, Presidentbehalf, and ChiefMr. Harry Rosen, on behalf of PSI, are the Co-Chief Executive Officer (as wellOfficers of the Joint Venture. The LLC Agreement contains other normally found terms in such arrangements, including provisions relating to 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.
Our initial determination is that the Joint Venture qualifies as a shareholder), becameVIE and that we are the primary beneficiary. As a significant shareholderconsequence, we have consolidated the Joint Venture financial statements beginning with the quarter ended March 31, 2010. For Fiscal 2010, the newly formed Joint Venture has not engaged in any financial transactions, other than certain organizational expenses and general market and product analysis, as formal operations are not expected to commence until Fiscal 2011. 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. At December 31, 2010, we have recorded the $3.6 million payment representing the estimated fair value to acquire the product license as an intangible asset. We currently estimate the expected useful life of InnerLight either before or shortly after the saleproduct license to be approximately 12 years which we will begin amortizing the cost of Darius. Mr. Gary Quigley was alsointangible asset once production commercialization is completed with PSI Parent and the OTC drug products begin to ship to our retail customers. As of December 31, 2010, we have not established a principalformal commercialization program timeline for any specific OTC drug covered under the product license and we do not project that any OTC drug products will be available for shipment within the next twelve months.
PROPHASE LABS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 — DISCONTINUED OPERATIONS – (continued)
of Scandasystems, Ltd. (“Scandasystems”) (see Note 12), which entered into an agreement to receive royalties from InnerLight. The results and balances associated with Darius are presented as discontinued operations in the consolidated statements of operations.
We formed Darius in 2000 to market health and wellness products. The terms of the sale agreement include a cash purchase price of $1.0 million by InnerLight for the stock of Darius and its subsidiaries without guarantees, warranties or indemnifications. We recorded a gain on the disposal of Darius of $736,000, as a result of sales proceeds of $1.0 million less residual investment of $5,000 and net assets of Darius of $259,000 on the date of sale.
Sales attributable to Darius from January 1, 2008 until date of disposal on February 29, 2008 and for Fiscal 2007 were $2.2 million and $11.3 million, respectively. Net income (loss) from January 1, 2008 until date of disposal on February 29, 2008, and for Fiscal 2007 were $139,000 and ($602,000), respectively, Financial results from operations of Darius are presented as discontinued operations in the consolidated statements of operations and cash flows.
NOTE 4
—– PROPERTY, PLANT AND EQUIPMENT
The components of property and equipment are as follows (in thousands):
| | | | | | |
| | December 31, | | Estimated Useful Life |
| | | 2009 | | 2008 |
| Land | | $ | 504 | | | $ | 539 | | | | | |
| Buildings and improvements | | | 2,281 | | | | 2,692 | | | | 20 – 39 years | |
| Machinery and equipment | | | 2,535 | | | | 4,933 | | | | 5 – 7 years | |
| Computer software | | | 215 | | | | 135 | | | | 3 years | |
| Furniture and fixtures | | | 192 | | | | 239 | | | | 5 years | |
| | | | 5,727 | | | | 8,538 | | | | | |
| Less: Accumulated depreciation | | | 3,155 | | | | 4,870 | | | | | |
| | | $ | 2,572 | | | $ | 3,668 | | | | | |
On February 2, 2009, we announced our intention to close our production facility in Elizabethtown, Pennsylvania and consolidate our manufacturing operations at our Lebanon, Pennsylvania facility. Effective in June 2009, the Elizabethtown facility was closed. As of December 31, 2009, the Elizabethtown land and building assets are reported as an asset held for sale.
| | | December 31, | | |
| | | 2010 | | | 2009 | | Estimated Useful Life |
| | | | | | | | |
| Land | | $ | 504 | | | $ | 504 | | |
| Buildings and improvements | | | 2,281 | | | | 2,281 | | 20 - 39 years |
| Machinery and equipment | | | 2,592 | | | | 2,535 | | 3 - 7 years |
| Computer software | | | 192 | | | | 215 | | 3 years |
| Furniture and fixtures | | | 182 | | | | 192 | | 5 years |
| | | | 5,751 | | | | 5,727 | | |
| | | | | | | | | | |
| Less: Accumulated depreciation | | | 3,389 | | | | 3,155 | | |
| | | $ | 2,362 | | | $ | 2,572 | | |
Depreciation expense for Fiscal 2010, 2009 and 2008 was $363,000, $522,000, and 2007 was $522,000, $745,000, and $996,000, respectively. In addition, we charged to operations $60,000 and $100,000We disposed of certain automobiles in Fiscal 2009 and 2008 representing impairment costswith an aggregate net book value of $114,000. The automobiles were purchased by certain fixed assetsformer executive officers at our then book value of the Elizabethtown, Pennsylvania, manufacturing facility.
automobiles.
NOTE 5
—– PATENT RIGHTS AND RELATED ROYALTY COMMITMENTS
We have maintained a separate representation and distribution agreement relating to the development of the zinc gluconate glycine product formulation. In return for exclusive worldwide distribution rights, we agreed to pay the developer a 3% royalty and a 2% consulting fee based on sales collected, less certain deductions, throughout the term of this agreement, which expired May 2007. However, we and the developer are in litigation (see Note 7) and as such no potential offset for these fees from such litigation has been recorded. In Fiscal 2007, the final year of the agreement, we charged to operations $293,000 for royalty and consulting fees. The amount accrued for this expense at each of December 31, 20092010 and 20082009 was $3.5 million.
TABLE OF CONTENTS
THE QUIGLEY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 —– OTHER CURRENT LIABILITIES
At December 31, 20092010 and 2008,2009, other current liabilities include $386,000$483,000 and $215,000,$386,000, respectively, related to accrued compensation.
NOTE 7
—– COMMITMENTS AND CONTINGENCIES
Certain operating leases for office and warehouse space maintained by us resulted in rent expense for the Fiscal
2010, 2009
and 2008
of $11,000, $44,000 and
2007 of $44,000, $53,000,
and $68,000, respectively. We have approximate future obligations over the next five years as follows (in thousands):
| | | | | | | | |
| Year | | Employment
Contracts | | Advertising(1) | | Product and
Other
Purchases | | Total |
| 2010 | | $ | 1,075 | | | $ | 235 | | | $ | 660 | | | $ | 1,970 | |
| 2011 | | | 1,075 | | | | — | | | | — | | | | 1,075 | |
| 2012 | | | 582 | | | | — | | | | — | | | | 582 | |
| 2013 | | | — | | | | — | | | | — | | | | — | |
| 2014 | | | — | | | | — | | | | — | | | | — | |
| Total | | $ | 2,732 | | | $ | 235 | | | $ | 660 | | | $ | 3,627 | |
| (1) | | Year | | Employment Contracts | | | Advertising(1) | | | Total | | | 2011 | | $ | 1,075 | | | $ | 1,206 | | | $ | 2,281 | | | 2012 | | | 582 | | | | - | | | | 582 | | | 2013 | | | - | | | | - | | | | - | | | 2014 | | | - | | | | - | | | | - | | | 2015 | | | - | | | | - | | | | - | | | Total | | $ | 1,657 | | | $ | 1,206 | | | $ | 2,863 | |
(1) Additional advertising and research and development costs are expected to be incurred during Fiscal 2010. |
In July 2008, we entered into an agreement with a vendor to purchase a minimum order of product, initially over a three year period, incorporating a patented, proprietary delivery system. This agreement was amended, first in July 2009 and further amended in February 2010 resulting in, but not limited to, (i) a reduction in the (a) term of agreement and (b) purchase commitment, and (ii) reformulation of the flavor of the product. In addition, a new agreement was entered into in February of 2010 for the development of two new products. The aggregate purchase commitment under the term of these agreements, as amended, was $660,000 at December 31, 2009.
On July 2, 2008, we entered into an agreement with Dr. Richard Rosenbloom, the then Executive Vice President and Chief Operating Officer of Pharma, whereby we agreed to compensate Dr. Rosenbloom for assigning, to us, the entire right, title and interest in and to Dr. Rosenbloom’s concepts and/or inventions (“Inventions”) made prior to the date he became an employee of the Company. In consideration of, and as full compensation for, the covenants made in the agreement, we agreed to pay Dr. Rosenbloom compensation in the amount of five percent (5%) of net sales collected, less certain deductions, of royalty bearing products developed as a consequence of the Inventions. Effective October 22, 2009, the employment of Dr. Rosenbloom was terminated when the position of Executive Vice President of Pharma was eliminated. In November 2009, we and Dr. Rosenbloom entered into an Assignment and Release Agreement which, among other matters, provided for (i) the payment of $120,000 to Dr. Rosenbloom which was charged to operations inbe incurred during Fiscal 2009 and (ii) Dr. Rosenbloom waived and released (a) any and all claims, rights, title or interest in the Inventions, including, but not limited to, any ownership interest in the Inventions and (b) claims for any future royalty compensation.
2011.