UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q10-Q/A

(Amendment No. 1)

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period endedSeptember 30, 2017March 31, 2018

OR

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to ______________

Commission file number0-21617

ProPhase Labs, Inc.

(Exact name of registrant as specified in its charter)

(215) 345-0919

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or shorter period that the registration was required to submit and post such files). Yes [X] No [  ]

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [  ] No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

ProPhase Labs, Inc. and Subsidiaries

TABLE OF CONTENTS

explanatory note

On August 10, 2018, the Company’s management, after consultation and discussions with EisnerAmper LLP, the Company’s independent registered public accounting firm, and the Audit Committee of the Board of Directors, concluded that the Company’s previously issued audited consolidated financial statements for the fiscal year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K for such period and unaudited condensed consolidated financial statements for the fiscal quarters ended March 31, 2017, June 30, 2017, September 30, 2017 and March 31, 2018 (collectively with the fiscal year ended December 31,2017, the “Restated and Revised Periods”) included in the Company’s Quarterly Reports on Form 10-Q for such periods should no longer be relied upon, and determined that these financial statements will be restated due to the identification of certain accounting errors related to income tax accounting.

The Company has determined that it miscalculated its income tax benefit by incorrectly utilizing certain net operating losses without taking into account the statutory limitation imposed by the State of Pennsylvania, which resulted in an overstatement of net income as discussed below. The Company also incorrectly determined the amount of income tax benefit allocable to continuing operations, which resulted in an overstatement of income from continuing operations, and an equal understatement of the gain on sale of discontinued operations, presented net of taxes, which had no impact on net income.

Based on its review, the Company has determined that its income tax expense was understated and its net income was overstated by approximately $1.2 million for the fiscal year ended December 31, 2017. Concurrently with the filing of this Form10-Q/A, the Company is filing an amendment on Form 10-K/A to its Annual Report on Form 10-K for the fiscal year ended December 31, 2017 to restate the audited consolidated financial statements included in the Form 10-K and amendments on Form 10-Q/A to its Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2017, June 30, 2017, September 30, 2017 and March 31, 2018 to correct the errors described above.

The corrections to the Restated and Revised Periods, which we refer to herein collectively as the “Restatement”, were prepared following an independent review by the Company.

Description of the Restatement

In completing our Federal and State income tax preparation review procedures for filing of the Federal and State income tax returns for the fiscal year ended December 31,2017 during the second quarter of fiscal 2018, the Company identified an error in the accounting treatment of state Net Operating Loss (NOL) limitations which resulted in the overstatement of income tax receivable of $0.5 million, the understatement of state income tax liability and expense of $0.7 million as of March 31, 2018 and a corresponding overstatement of retained earnings of $1.2 million as of March 31, 2018.

For additional information regarding the corrections to the financial statements in the Restated and Revised Periods, see Notes 2, 4 and 7 of the Condensed Consolidated Financial Statements included in Part I, Item 1, “Financial Statements”.

Internal Controls Over Financial Reporting

As a result of the Restatement, we also concluded that we had a material weakness related to our internal control over financial reporting. For more information regarding management’s assessment of internal control over financial reporting and disclosure controls and procedures, as well as the related remediation actions, refer to Item 4 “Controls and Procedures” in this Quarterly Report on Form 10-Q/A.

Items Amended by this Form 10-Q/A

This Form 10-Q/A amends and restates the entire contents of the original Form 10-Q. The portions of this Form 10-Q/A that have been revised to give effect to the Restatement and matters related thereto are as follows:

In addition, the Company’s Chief Executive Officer and Principal Accounting Officer have provided new certifications dated as of the date of this filing in connection with this Form 10-Q/A.

Except as described above, no other changes have been made to the Company’s Quarterly Report on Form 10-Q ended March 31, 2018 (the “Original Filing”). This Form 10-Q/A speaks as of the date of the Original Filing and does not reflect events that may have occurred after the date of the Original Filing or modify or update any disclosures that may have been affected by subsequent events.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)

See accompanying notes to condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations and Other Comprehensive Income

(in thousands, except per share amounts)

(unaudited)

See accompanying notes to condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Statement of Stockholders’ Equity

For the Nine Months Ended September 30, 2017

(in thousands, except share data)

(unaudited)

See accompanying notes to condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash FlowsOperations

(in thousands)thousands, except per share amounts)

(unaudited)

See accompanying notes to condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Statement of Stockholders’ Equity

(in thousands, except share data)

(unaudited)

See accompanying notes to condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 1 – Organization and Business

ProPhase Labs, Inc. (“we”, “us” or the “Company”) was initially organized as a corporation in Nevada in July 1989. Effective June 18, 2015, we changed our state of incorporation from the State of Nevada to the State of Delaware. We are a manufacturer, marketervertically integrated and distributor of a diversified range of health carebranding, marketing and cold remedy products that are offered to the general public. We are alsotechnology company engaged in the research, development, manufacture, distribution, marketing and developmentsale of potential over-the-counter (“OTC”) drugconsumer healthcare products, dietary supplements and natural base health products includingother remedies in the United States. This includes the development and marketing of dietary supplements personal care and cosmeceutical products. Onunder the TK Supplements^® brand.

In August 23, 2017, the Companywe formed a new wholly-owned subsidiary, ProPhase Digital Media, Inc. (a(“PDM”), a Delaware corporation), whichcorporation and wholly-owned subsidiary. Our objective is for PDM to become an independent full-service direct marketing agency. PDM’s first initiative will be responsible for marketingto market the dietary TK Supplements^®product line, but could also marketline. If successful, this may lead to the marketing of other companies’ products as well.consumer products.

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

We use a December 31 year-end for financial reporting purposes. References herein to “Fiscal 2018” shall mean the fiscal year ended December 31, 2018 and references to other “Fiscal” years shall mean the year, which ended on December 31 of the year indicated. The term “we”, “us” or the “Company” as used herein also refer, where appropriate, to the Company, together with its subsidiaries and consolidated variable interest entities unless the context otherwise requires.

Discontinued Operations

Prior to March 29, 2017, our flagship OTC drug brand was Cold-EEZE^® and our principal product was Cold-EEZE^®cold remedy zinc gluconate lozenges, proven in clinical studies to reduce the duration and severity of symptoms of the common cold.lozenges. In addition to Cold-EEZE^® cold remedy lozenges, we also marketed and distributed non-lozenge forms of our proprietary zinc gluconate formulation, (i) Cold-EEZE^® cold remedy QuickMelts^®, (ii) Cold-EEZE^®Gummies and (iii) Cold-EEZE^® cold remedy Oral Spray. Each of the Cold-EEZE^® QuickMelts^®and Gummies products are based on a proprietary zinc gluconate formulation in combination with certain (i) immune system support, (ii) energy, (iii) sleep and relaxation, and/or (iv) cold and flu symptom relieving active ingredients.

On January 6,Effective March 29, 2017, we signed an asset purchase agreement (as amended, the “Asset Purchase Agreement”), by and among the Company, Meda Consumer Healthcare Inc. (“MCH”) and Mylan Inc. (together with MCH, “Mylan”), for the sale of assets by us to Mylan (see Note 3). The sale of assets (i) was subject to stockholder approval and other customary closing conditions and (ii) consisted principally of the sale ofsold our intellectual property rights and other assets relatingrelated to our Cold-EEZE^®brand and product line, (collectively, referred to herein as the “Cold-EEZE^® Business”) to Mylan, including all then current and pipeline over-the-counter allergy, cold, flu, multi-symptom relief and immune support treatments for adults and children to the extent each is,was, or iswas intended to be, branded “Cold-EEZE^®”, and all private label versions thereof, including all formulations and derivatives thereof (collectively referred to as set forth in the Asset Purchase Agreement.

A special meeting of our stockholders was held on March 29, 2017 (the “Special Meeting”). At the Special Meeting, our stockholders approved the sale of assets and the transactions contemplated by the Asset Purchase Agreement. Effective March 29, 2017, we completed the sale of the Cold-EEZE“Cold-EEZE^®Business Business”) to Mylan.Mylan Consumer Healthcare Inc. (formerly known as Meda Consumer Healthcare Inc.) (“MCH”) and Mylan Inc. (together with MCH, “Mylan”). As a consequenceresult of the sale of the Cold-EEZE^®Business, for the three and nine months ended September 30,March 31, 2017, and 2016, we have classified as discontinued operations (i) all income and expenses attributable to the Cold-EEZE^® Business, (ii) the gain from the sale of the Cold-EEZE^® Business, (ii) all income and expenses attributable to the Cold-EEZE^®Business, and (iii) the income tax expense attributed to the sale of the Cold-EEZE^® Business (see Notes 3 and 6).Business. Excluded from the sale of the Cold-EEZE^®Business were our accounts receivable and inventory, and weinventory. We have also retained all liabilities associated with our Cold-EEZE^®Business operations arising prior to March 29, 2017.

Continuing Operations

We continue to own and operate our manufacturing facility and manufacturing business in Lebanon, Pennsylvania, and our headquarters in Doylestown, Pennsylvania. As part of the sale of the Cold-EEZE^® Business, we entered into a manufacturing agreement (see Note 7)9) with Mylan and our wholly-owned subsidiary, Pharmaloz Manufacturing, Inc. (“PMI”), to supply various Cold-EEZE^®lozenge products to Mylan. In addition to the production services we provide to Mylan under the manufacturing agreement, we produce OTC drughealthcare and dietary supplement lozenges and other products for other third partythird-party customers in addition to performing operational tasks such as warehousing, customer order processing and shipping.

We are also pursuing a series of new product development and pre-commercialization and market testing initiatives in the OTC dietary supplement category. Initial OTC dietary supplement product development activities were completed in the fourth quarter of Fiscal 2015 under the brand name of TK Supplements^®. The TK Supplements^® product line comprises of three men’s health products: (i) Legendz XL^® for sexual health, (ii) Triple Edge XL^®, a dailyan energy booster plus testosterone support, and (iii) Super ProstaFlow Plus^TM for prostate and urinary health. In addition to developing direct-to-consumer (“Direct Response”) marketing strategies offor Legendz XL^®, we received initial product acceptance and shipped into a national chain drug retailer and to several regional retailers during the Fiscal 2017.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 12 – Organization and Business – continuedRestatement of Previously Issued Financial Statements

We useThe Company determined that when calculating its 2017 income tax provision related to the gain on sale of discontinued operations, it incorrectly utilized available net operating losses without considering the statutory limitations imposed by the state of Pennsylvania, and that it incorrectly allocated the amount of income tax benefit resulting from the reversal of certain valuation allowances to continuing operations, which resulted in an overstatement of income the tax benefit from continuing operations and an understatement of the gain on sale of discontinued operations, which is presented net of taxes. In the process of this determination, the Company determined that such information existed at March 31, 2018 which affected certain balance sheet accounts and retained earnings as a December 31 year-end for financial reporting purposes. References herein to “Fiscal 2017” shall meancarryover effect from the fiscal year ended December 31, 20172017. The Company concluded that the impact of applying corrections for these errors and references to other “Fiscal” years shall meanmisstatements on the year, whichconsolidated financial statements as of March 31, 2018 is material. As a result, the Company is restating its consolidated financial statements as of and for the three months ended on DecemberMarch 31, 2018. See below for a reconciliation of the year indicated. The term “we”, “us” or the “Company” as used herein also refer, where appropriate,previously reported amounts to the Company, together with its subsidiaries unlessrestated amounts.

The table below sets forth the context otherwise requires.condensed consolidated balance sheet, including the balances as originally reported, adjustments and the as restated balances (in thousands):

Note 23 – Summary of Significant Accounting Policies

For the three months ended March 31, 2018 and 2017, our revenues from continuing operations have come principally from contract manufacturing OTC health care and dietary supplement products for third parties, including Mylan.

Basis of Presentation

The unaudited condensed consolidated financial statementshave been prepared in accordance with generally accepted accounting principles for interim financial statements and within the rules of the Securities and Exchange Commission (“SEC”) applicable to interim financial statements and therefore do not include all disclosures that might normally be required for financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The accompanying unaudited condensed consolidated financial statements have been prepared by management without audit and should be read in conjunction with our consolidated financial statements, including the notes thereto, appearing in our Annual Report on Form 10-K10-K/A for Fiscal 2016.the fiscal year ended December 31, 2017. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial position, consolidated results of operations and consolidated cash flows, for the periods indicated, have been made.The results of operations for the three and nine months ended September 30, 2017March 31, 2018 are not necessarily indicative of operating results that may be achieved over the course of the full year.Historical financial statements have been reclassified to conform to the current period presentation, principally reflecting the sale of Cold-EEZE^® Business as discontinued operations.

Discontinued Operations Carve Out and ProPhase Allocations

For the three and nine months ended September 30,March 31, 2017, and 2016, results from operations for our Cold-EEZE^® Business are classified as discontinued operations The carve out of the discontinued operations (i) were prepared in accordance with the SEC’s carve out rules under Staff Accounting Bulletin (“SAB”) Topic 1B1 and (ii) are derived from identifying and carving out the specific assets, liabilities, net sales, cost of sales, operating expenses and interest expense associated with the Cold-EEZE^® Business’s operations. General administrative and overhead expenses, including personnel expenses and bonuses, and research and development overhead expenses incurred by us (for which the discontinued operation benefits from such resources) are allocated to discontinued operations based upon the percentage of the Cold-EEZE^® Business’s net sales to our consolidated net sales. For the three months ended September 30,March 31, 2017, and 2016, we allocated (i) zero and $406,000, respectively,$348,000 of administrative expenses and (ii) zero and $77,000, respectively, of research and development expenses, to discontinued operations in the accompanying condensed statements of operations. For the nine months ended September 30, 2017 and 2016, we allocated (i) $348,000 and $1.1 million respectively, of administrative expenses and (ii) $52,000 and $172,000, respectively, of research and development expenses, to discontinued operations in the accompanying condensed statements of operations (see Note 3)4). There were no discontinued operations for the three months ended March 31, 2018.

Product Innovation, Seasonality of the Business and Liquidity

Our net sales are derived principally from our contract manufacturing of OTC heath carehealthcare and cold remedydietary supplements products sold in the United StatesStates. In addition, we are engaged in early stage commercialization and market testing activities for the TK Supplements^®product line of America.dietary supplements.

Our net sales are derived principally from our contract manufacturing and retail customers in the United States. In addition, we are engaged in early stage commercialization and market testing activities for the TK Supplements® product line of dietary supplements. Our sales are influenced by and subject to (i) the scope and timing of TK Supplement^® product market testing and the ultimate market launch, and (ii) fluctuations in the timing of purchase and the ultimate level of demand for our contract manufactured OTC healthcare and dietary supplement products which are a function of the timing, length and severity of each cold season. Generally, a cold season is defined as the period of September to March when the incidence of the common cold rises as a consequence of the change in weather and other factors. We generally experience in the first, third and fourth quarter higher levels of net sales. Revenues are generally at their lowest levels in the second quarter when customer demand generally declines.

ForAs a consequence of the threescope and nine months ended September 30,timing of our TK Supplements^® product market testing and the ultimate market launch and the seasonality of our business, we realize variations in operating results and demand for working capital from quarter to quarter. As of March 31, 2018, we had working capital of approximately $29.2 million, including $18.3 million marketable securities available for sale. We believe our current working capital at March 31, 2017 is at an acceptable and 2016,adequate level to support our net sales were principally related to domestic markets.

ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)

Note 2 – Summary of Significant Accounting Policies – continuedbusiness for at least the next twelve months.

Use of Estimates

The preparation of financial statements and the accompanying notes thereto, in conformity with GAAP, requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the respective reporting periods. Examples include the provision for bad debt, sales returns and allowances, inventory obsolescence, useful lives of property and equipment and intangible assets, impairment of property and equipment and intangible assets, income tax valuations and assumptions related to accrued advertising. When providing for the appropriate sales returns, allowances, cash discounts and cooperative incentive promotion costs, 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.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 3 – Summary of Significant Accounting Policies – continued

Cash and Cash Equivalents

We consider all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Cash equivalents include cash on hand and monies invested in money market funds. The carrying amount approximates the fair market value due to the short-term maturity of these investments.

Marketable Securities

We have classified our investments in marketable securities as available-for-sale and as a current asset. Our investments in marketable securities are carried at fair value, with unrealized gains and losses included as a separate component of stockholders’ equity. Realized gains and losses from our marketable securities are recorded as other income (expense). We initiated short term investments in marketable securities, which carry maturity dates underbetween one yearand three years from date of purchase with interest rates of 0.87%1.87% - 1.56%2.96%, during the thirdfirst quarter of Fiscal 2017.2018. For those three and nine months ended September 30, 2017,March 31, 2018, we reported an unrealized loss of $35,000.$43,000 and an accumulated unrealized loss of $121,000. Unrealized gains and losses are classified as other comprehensive income (loss) and the cost is determined on a specific identification basis. The following is a summary of the components of our marketable securities and the underlying fair value input level tier hierarchy (see long-lived assets below) (in thousands):

Inventory Valuation

Inventory is valued at the lower of cost, determined on a first-in, first-out basis (FIFO), or market.net realizable value. Inventory items are analyzed to determine cost and the marketnet realizable value and appropriate valuation adjustments are established.established. At September 30, 2017 and DecemberMarch 31, 2016,2018, after the 2018 write-off of certain inventory previously recorded, the financial statements include adjustments to reduce inventory for excess, obsolete or obsoleteshort-dated shelf-life inventory of $1.5$558,000, inclusive of adjustments of $149,000 for product samples of TK Supplements^® products. At December 31, 2017, the financial statements include adjustments to reduce inventory for excess, obsolete or short-dated shelf-life inventory of $1.1 million, and $1.6 million, respectively.inclusive of an adjustment of $541,000 for product samples of TK Supplements^® products. The components of inventory are as follows (in thousands):

The components of inventory are as follows (in thousands):

ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)

Note 2 – Summary of Significant Accounting Policies – continued

Property, Plant and Equipment

Property, plant and equipment are recorded at cost. We use the straight-line method in computing depreciation for financial reporting purposes. Depreciation expense is computed in accordance with the following ranges of estimated asset lives: building and improvements – ten to thirty-nine years; machinery and equipment – three to seven years; computer equipment and software – three to five years; and furniture and fixtures – five years.

Concentration of Risks

Future revenues, costs, margins and profits will continue to be influenced by our ability to maintain our manufacturing availability and capacity together with our marketing and distribution capabilities and the regulatory requirements associated with the development of OTC and other personal care products in order to compete on a national level and/or international level.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 3 – Summary of Significant Accounting Policies – continued

Our business is subject to federal and state laws and regulations adopted for the health and safety of users of our products. OurThe manufacturing and distribution of OTC health carehealthcare and dietary supplement products are subject to regulations by various federal, state and local agencies, including the Food and Drug Administration (“FDA”) and, as applicable, the Homeopathic Pharmacopoeia of the United States.

Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash investments, marketable securities, and trade accounts receivable. Our marketable securities are fixed income investments which are highly liquid and can be readily purchased or sold through established markets.

We maintain cash and cash equivalents with certain major financial institutions. As of September 30, 2017,March 31, 2018, our cash and cash equivalents balance was $3.9$3.4 million and our bank balance was $3.6 million. Of the total bank balance, $500,000 was covered by federal depository insurance and $3.1 million was uninsured at September 30, 2017.March 31, 2018.

Trade accounts receivable potentially subject us to credit concentrations from time-to-time as a consequence of the timing, payment pattern and ultimate purchase volumes or shipping schedules with our customers. We extend credit to our customers based upon an evaluation of the customer’s financial condition and credit history and generally we do not require collateral. Our customers include consumer products companies and large national chain, regional, specialty and local retail stores. These credit concentrations may impact our overall exposure to credit risk, either positively or negatively, in that our customers may be similarly affected by changes in economic, regulatory or other conditions that may impact the timing and collectability of amounts due to us. As a consequence of an evaluation of our customer’s financial condition, payment patterns, balance due to us and other factors, we did not offset our account receivable with an allowance for bad debt at September 30, 2017March 31, 2018 and December 31, 2016.2017.

Long-lived Assets

We review our carrying value of our long-lived assets with definite lives whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. When indicators of impairment exist, we determine whether the estimated undiscounted sum of the future cash flows of such assets is less than their carrying amounts. If less, an impairment loss is recognized in the amount, if any, by which the carrying amount of such assets exceeds their respective fair values. The determination of fair value is based on quoted market prices in active markets, if available, or independent appraisals; sales price negotiations; or projected future cash flows discounted at a rate determined by management to be commensurate with our business risk. The estimation of fair value utilizing discounted forecasted cash flows includes significant judgments regarding assumptions of revenue, operating and marketing costs; selling and administrative expenses; interest rates; property and equipment additions and retirements; industry competition; and general economic and business conditions, among other factors.

Fair value is based on the prices that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, a three-tier fair value hierarchy prioritizes the inputs used to measure fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)

Note 2 – Summary of Significant Accounting Policies – continued

Fair Value of Financial Instruments

Cash and cash equivalents, marketable securities, accounts receivable, assets held for sale, accounts payable, and accrued expenses and notes payable are reflected in the Condensed Consolidated Financial Statements at carrying value which approximates fair value. We account for our marketable securities at fair value pursuant to Accounting Standards Codification, or ASC, 820-10, with the net unrealized gains or losses reported as a component of accumulated other comprehensive income or loss.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 3 – Summary of Significant Accounting Policies – continued

Revenue Recognition

We account for revenue in accordance with ASC Topic 606, which requires revenue recognized to represent the transfer of promised goods or services to customers at an amount that reflects the consideration which is expected to be received in exchange for those goods or services. The Company recognizes revenue when its performance obligations with its customers have been satisfied. At contract inception, the Company determines if a contract is within the scope of Topic 606 and then evaluates the contract using the following five steps: (1) identify the contract with the customer; (2) identify the performance obligations; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance obligation.

We have not made any significant changes to judgments in applying ASC 606 during the three months ended March 31, 2018.

Performance Obligations

We generate sales principally through two types of customers, contract manufacturing customers and retail customers. Sales from product shipments to contract manufacturing and retailer customercustomers are recognized at the time ownership is transferred to the customer. Net sales from contract manufacturing and retail customers was $3.3 million and $77,000, respectively, for the three months ended March 31, 2018 and $727,000 and $42,000, respectively, for the three months ended March 31, 2017. Revenue from retailer customers is reduced for trade promotions, estimated sales returns, cash discounts and other allowances in the same period as the related sales are recorded. No such allowance is applicable to our contract manufacturing customers. We make estimates of potential future product returns and other allowances related to current period revenue. We analyze historical returns, current trends, and changes in customer and consumer demand when evaluating the adequacy of the sales returns and other allowances.

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The combined duties and responsibilities within each contract will be considered one single performance obligation under ASC 606 as these items would not be separately identifiable from each other promise in the contract and we provide a significant service of integrating the duties with other promises in the contracts.

Transaction Price

The transaction price is fixed based upon either (i) a combined Master Agreement and each related purchase order, or (ii) if there is no Master Agreement, the price per the individual purchase order received from each customer. The customers are invoiced at an agreed upon contractual price for each unit ordered and delivered by the Company.

Consistent with Company practice prior to the adoption of ASC 606, the Company does not collect sales tax or other similar taxes from customers. As such, there is no effect on the measurement of the transaction price.

Recognize Revenue When the Company Satisfies a Performance Obligation

Performance obligations related to contract manufacturing and retail customers are satisfied at a point in time when the goods are shipped to the customer as (i) the Company has transferred control of the assets to the customers upon shipping, and (ii) the customer obtains title and assumes the risks and rewards of ownership after the goods are shipped.

The Company does not accept returns in the contract manufacturing revenue stream. Our return policy for retailer customers accommodates returns for (i) discontinued products, (ii) store closings and (iii) products that have reached or exceeded their designated expiration date. We do not impose a period of time within which product may be returned. All requests for product returns must be submitted to us for pre-approval. The main components of our returns policy are: (i) we will accept returns that are due to damaged product that is un-saleable and such return request activity falls within an acceptable range, (ii) we will accept returns for products that have reached or exceeded designated expiration dates and (iii) we will accept returns in the event that we discontinue a product provided that the customer will have the right to return only such items that it purchased directly from us. We will not accept return requests pertaining to customer inventory “Overstocking” or “Resets”. We will only accept return requests for productonly products 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.

PursuantProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 3 – Summary of Significant Accounting Policies – continued

Under ASC 606, the terms of the Asset Purchase Agreement, we are responsible for andCompany will continue to accept product returns ofrecognize contract manufacturing and retail customers at a point in time as the Cold-EEZE^®BusinessCompany has an enforceable right to payment for productgoods as products are shipped prior to March 30, 2017. Additionally, pursuant to the terms of the Asset Purchase Agreement, we allocated and, in June 2017, issued a credit to Mylan in the aggregate amount of $400,000 for future sales returns and allowances relating to certain product returns that were sold by us prior to March 30, 2017.customers.

As of September 30, 2017March 31, 2018 and December 31, 2016,2017, we included a provision for sales allowances from continuing operations of zero$14,000 and $108,000,$2,000, respectively. Additionally, accrued advertising and other allowances from discontinued operations as of September 30, 2017March 31, 2018 included (i) $902,000$452,000 for estimated future sales returns and (ii) $371,000$200,000 for cooperative incentive promotion costs. As of December 31, 2016,2017, accrued advertising and other allowances from discontinued operations included (i) $1.2 million$480,000 for estimated future sales returns and (ii) $1.5 million$200,000 for cooperative incentive promotion costs.

OneAs of ourMarch 31, we have deferred revenue in relation to Research & Development stability and release testing programs.

Disaggregation of Revenue

We disaggregate revenue from contracts with customers accountedinto two categories: contract manufacturing and retail customers. The Company determined that disaggregating revenue into these categories achieves the disclosure objective to depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.

The following table disaggregates the Company’s revenue by revenue source for 50.7% of our revenues in the ninethree months ended September 30, 2017, compared to one customer accounted for 68.3% of our revenues in Fiscal 2016. March 31, 2018 (in thousands):

Practical Expedients Elected

The Company has elected the following practical expedients in applying ASC 606 across all each revenue stream:

Sales Tax Exclusion from the Transaction Price

The Company excludes from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by the Company from the customer.

Shipping and Handling Activities

The Company accounts for shipping and handling activities it performs after a customer obtains control of the good as activities to fulfill the promise to transfer the good.

Advertising and Incentive Promotions

Advertising and incentive promotion costs are expensed within the period in which they are utilized. Advertising and incentive promotion expense is comprised of (i) media advertising, presented as part of sales and marketing expense, (ii) cooperative incentive promotions and coupon program expenses, which are accounted for as part of net sales, and (iii) free product, which is accounted for as part of cost of sales. Advertising and incentive promotion expenses incurred (i) from continuing operations for the three months ended September 30,March 31, 2018 and 2017 were $5,000 and 2016 were $22,000 and $46,000,$32,000, respectively, and (ii) attributed to and classified as discontinued operations were zero and $1.1 million, respectively. Advertising and incentive promotion expenses incurred (i) from continuing operations for the nine months ended September 30, 2017 and 2016 were $78,000 and $385,000, respectively, and (ii) attributed to and classified as discontinued operations were $2.8 million and $4.5$2.6 million, respectively. Included in prepaid expenses and other current assets was $10,000$160,000 and $263,000$143,000 at September 30, 2017March 31, 2018 and December 31, 2016,2017, respectively, relating to prepaid advertising and promotion expenses.

Shipping and Handling

Product sales may 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.

ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)

Note 2 – Summary of Significant Accounting Policies – continued

Stock-Based Compensation

We recognize all share-based payments to employees and directors, including grants of stock options, as compensation expense in the financial statements based on their fair values. Fair values of stock options are determined through the use of the Black-Scholes option pricing model. The compensation cost is recognized as an expense over the requisite service period of the award, which usually coincides with the vesting period.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 3 – Summary of Significant Accounting Policies – continued

Stock and stock options for the purchase of our common stock, $0.0005 par value (“Common Stock”), have been granted to both employees and non-employees pursuant to the terms of certain agreements and stock option plans (see Note 5)6). Stock options are exercisable during a period determined by us, but in no event later than ten years from the date granted. For the three months ended September 30, 2017 and 2016, we charged to operations $28,000 and zero, respectively, for share-based compensation expense for the aggregate fair value of stock grants issued and vested stock options earned. For the nine months ended September 30, 2017 and 2016, we charged to operations $46,000 and $1,000, respectively, for share-based compensation expense for the aggregate fair value of stock grants issued and vested stock options earned.

Research and Development

Research and development costs are charged to operations in the period incurred. Research and development costs incurred for the three months ended September 30,March 31, 2018 and 2017 and 2016 (i) from continuing operations were $60,000$87,000 and $43,000,$34,000, respectively, and (ii) attributed to and classified as discontinued operations ofwere zero and $77,000, respectively. Research and development costs incurred for the nine months ended September 30, 2017 and 2016 (i) from continuing operations were $318,000 and $202,000, respectively, and (ii) attributed to and classified as discontinued operations of $52,000, and $172,000, respectively. Research and development costs are principally related to personnel expenses and new product development initiatives and costs associated with our OTC health care products.

Income Taxes

We utilize the asset and liability approach which requires the recognition of deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns. In estimating future tax consequences, we generally consider all expected future events other than enactments of changes in the tax law or rates. Until we have sufficient taxable income to offset the temporary timing differences attributable to operations and the tax deductions attributable to option, warrant and stock activities are assured, a full valuation allowance equaling the total deferred tax asset is being provided (see Notes 34 and 6)7).

We utilize a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than fifty percent likely of being realized upon ultimate settlement. Any interest or penalties related to income taxes will be recorded as interest or administrative expense, respectively.

As a result of our continuing tax losses, we have recorded a full valuation allowance against a net deferred tax asset. Additionally, we have not recorded a liability for unrecognized tax benefits.

Recently IssuedAdopted Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers”, on revenue recognition. The new standard provides for a single five-step model to be applied to all revenue contracts with customers as well as requires additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Companies have an option to use either a retrospective approach or cumulative effect adjustment approach to implement the standard. This ASU,We adopted the new standard as amended, is effectiveof January 1, 2018, using the modified retrospective method. See the Revenue Recognition section within the Summary of Significant Accounting Policies in Note 3 for fiscal yearsfurther details on the impact to our consolidated financial statements upon adoption and interim periods within those years beginning after December 15, 2017. We plan to adopt the provisionspractical expedients elected. The implementation of the new revenue recognition standard did not have a material impact on our consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18 “Statement of Cash Flows: Restricted Cash” which requires a statement of cash flows to explain the change during a period in the first quartertotal cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Under the new standard, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown in the statement of cash flows. ASU 2016-18 was effective for us as of January 1, 2018. We have not generally had restricted cash or restricted cash equivalents, and there is no restricted cash on the balance sheet as of March 31, 2018. The Company is utilizing a comprehensive approach to access the impactadoption of the guidance our revenue. Additionally, the Company is evaluating the impact of the new guidance on disclosures, as well as the impact on controls to support the recognition. We do not believe that its adoption willthis update did not have a material impact on our consolidated financial statements.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 2 – SummaryIn August 2016, the FASB issued ASU No. 2016-15, “Statement of SignificantCash Flows: Classification of Certain Cash Receipts and Cash Payments.” The new standard attempts to reduce diversity in practice in how cash receipts and cash payments are presented and classified in the statement of cash flows. ASU No. 2016-15 provides guidance on eight specific cash flow issues, none of which currently apply to us. The new guidance was effective for us in the first quarter of 2018. The adoption of ASU 2016-15 did not have a material impact on the Company’s financial statements.

In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes: Intra-Entity Transfers of Assets Other than Inventory.” The new standard requires entities to recognize the income tax consequences of an asset other than inventory when the asset transfer occurs. The new guidance was effective for us in the first quarter of 2018. The adoption of ASU 2016-15 did not have a material impact on the Company’s financial statements.

Recently Issued Accounting Policies – continuedStandards

In February 2016, the FASB issued ASU No. 2016-02 “Leases”.“Leases.” The new standard will require most leases to be recognized on the balance sheet which will increase reported assets and liabilities. Lessor accounting remains substantially similar to current guidance. The new standard is effective for annual and interim periods in fiscal years beginning after December 15, 2018, which for us is the first quarter of fiscal 2019 and mandates a modified retrospective transition method. We do not intend to early adopt and are currently assessing the impact of this update, but preliminarily believe that its adoption will not have a material impact on our consolidated financial statements.

In April 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting”. The new standard simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. We adopted the standard in January 2017 with no material impact on our consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments—Credit Losses.” The standard modifies the impairment model for most financial assets, including trade accounts receivables and loans, and will require the use of an “expected loss” model for instruments measured at amortized cost. Under this model, entities will be required to estimate the lifetime expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset. The effective date of the standard is for fiscal years beginning after December 15, 2019 with early adoption permitted. We are currently evaluating the impact of adoption of this update will have on our consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments”. The new standard attempts to reduce diversity in practice in how cash receipts and cash payments are presented and classified in the statement of cash flows. ASU No. 2016-15 provides guidance on eight specific cash flow issues. The new guidance will be effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. Early adoption is permitted including adoption in an interim period. We do not intend to early adopt and we are currently assessing the impact adoption of this update will have on our consolidated financial statements.

In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes: Intra-Entity Transfers of Assets Other than Inventory”. The new standard requires entities should recognize the income tax consequences of an asset other than inventory when the asset transfer occurs. The new guidance will be effective for fiscal years beginning after December 15, 2017 and requires a modified retrospective adoption through a cumulative effect adjustment directly to retained earnings as of the beginning of the period of adoption. We are currently evaluating the impact adoption of this update will have on our consolidated financial statements.

Note 34 – Discontinued Operations, Sale of the Cold-EEZE^® Business

At the Special Meeting held on March 29, 2017, our stockholders approved the sale of the Cold-EEZE^® Business and the transactions contemplated by the Asset Purchase Agreement. Effective March 29, 2017, we completed the sale of the Cold-EEZE^®Business to Mylan.

As a consequence of the sale of the Cold-EEZE^® Business, for the three and nine months ended September 30,March 31, 2017, and 2016, we have classified as discontinued operations (i) the gain from the sale of the Cold-EEZE^® Business, (ii) all gains and losses attributable to the Cold-EEZE^® Business operations and (iii) the income tax expense attributed to the sale of the Cold-EEZE^®Business (see Note 6)7). Excluded from the sale of the Cold-EEZE^®Business were our accounts receivable and inventory, and we also retained all liabilities associated with our Cold-EEZE^®Business operations arising prior to March 29, 2017.

Pursuant to the Assetterms of the asset purchase agreement entered into with Mylan on January 6, 2017 (the “Asset Purchase Agreement,Agreement”), we also agreed to a one-time sale to Mylanof certain non-lozenge-based Cold-EEZE^® inventory. At September 30, 2017, we have classified as assets heldinventory for saleapproximately$22,000 of such inventory, $699,000, which approximates our cost. At March 31, 2017, we classified in our balance sheet this inventory as an asset held for sale, discontinued operations. Additionally, pursuant to the terms of the Asset Purchase Agreement, we allocated and agreed to pay Mylan an aggregate of $400,000 for future sales returns and allowances arising from certain product returns that were sold by us prior to March 30, 2017. At March 31, 2017, we classified in our balance sheet this liability as an accrued sales allowances, discontinued operations. At December 31, 2016, the2017, we classified $22,000 of assets held for sale in our balance sheet impact of discontinued operations was deemed not material, as such, no reclassifications for discontinued operations have been presented.sheet.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 34 – Discontinued Operations, Sale of the Cold-EEZE^® Business –- continued

Pursuant to the Asset Purchase Agreement, we entered into a 90 day transition service arrangement with Mylan, for which we earned $150,000 in transition service fees through September 30, 2017. Pursuant to this arrangement, we (i) received, processed, fulfilled, and shipped customer orders, and billed such customers for these shipments on behalf of Mylan from March 30, 2017 to June 30, 2017, (ii) processed certain sales allowances, returns and other customer promotional deductions, and (iii) paid certain Cold-EEZE^®Business expenses which are to be reimbursed by Mylan. At September 30, 2017, we have a balance due to Mylan of $319,000 which is comprised of (i) net billings to Mylan’s customers for product shipments, less sales and other allowances, of $1.0 million (ii) return allocation of $400,000 for future sales returns and allowances (see Note 2), offset by (iii) $1.5 million for product shipments and transition service fee due from Mylan and (iv) $240,000 for the reimbursement of certain Cold-EEZE^®Business expenses we paid on behalf of Mylan. For the nine months ended September 30, 2017, the $150,000 transition service fees earned are recorded as a component of other income (expense).

The net proceeds received from the sale of the Cold-EEZE^® Business were as follows (in thousands):

For the nine months ended September 30,Fiscal 2017, we incurred $4.2 million in closing and transaction costs associated with the sale of the Cold-EEZE^® Business which were comprised of (i) transaction fees and related closing costs of $1.9 million and (ii) performance bonuses, contract termination compensation and severance payments to certain employees associated with the sale of the Cold-EEZE^®Business of $2.3 million. The compensation committee of our board of directors approved these compensation arrangements. These compensation and termination payments were paid by us in April 2017.

The following table sets forth the condensed operating results of our discontinued operations for the three and nine months ended September 30,March 31, 2017, and 2016, respectively, (in thousands):

ProPhase Labs, Inc. and Subsidiaries
NotesThere was no activity related to Condensed Consolidated Financial Statements
(unaudited)discontinued operations for the three months ended March 31, 2018.

Note 45 – Secured Promissory Notes and Other Obligations

Secured Promissory Notes

On December 11, 2015, we executed two Subscription Agreementssubscription agreements (the “Subscription Agreements”) with the investors named therein (the “Investors”) providing for the purchase of 12% Secured Promissory Notes – Series A (“Notes”) in the aggregate principal amount of up to $3.0 million and warrants to purchase shares of our Common Stock (the “Warrants”).

Notes in the amount of $1.5 million and 51,000 Warrants, at an exercise price of $1.35 per share, which was equal to the closing price of our Common Stock on the date of investment, were issued by the Company and its wholly-owned subsidiaries, PMI and Quigley Pharma, Inc. (collectively, the “Obligors”), and funded on December 11, 2015. We incurred loan origination costs of $22,000 which werewas recorded as a reduction of the Notes and the origination costs wereare charged to other income (expense)interest expense over the term of the loan. The Warrants hadhave an exercise term equal to three years and wereare exercisable commencing on the date of issuance. The fair value of the Warrants at the date of grant was $14,000 which wasis recorded as a reduction of the Notes and is charged to other income (expense)interest expense over the term of the loan.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 5 – Secured Promissory Notes and Other Obligations - continued

The Notes bore interest at the rate of 12% per annum, payable semi-annually and the principal was due and payablepaid on June 15, 2017. The Notes could be pre-paid at any time prior to maturity without penalty. The effective interest, inclusive of the WarrantWarrants and loan origination costs, was 14.3% per annum. For the ninethree months ended September 30,March 31, 2018 and 2017, and 2016, we charged to other income (expense)interest expense zero and $54,000, and $105,000, respectively, in connection with the Notes.

On March 29, 2017, in connection with the sale of the Cold-EEZE^® Business, we paid in full the remaining principal and accrued interest due under the Notes, in the total amount of $1,553,000, due under the Notes. Of the $1,553,000 paid to the Investors, $69,000 was netted against the aggregate exercise price of the Warrants, which were simultaneously being exercised by the Investors.

In connection with the issuance of the Notes, the Company entered into a security agreement with John E. Ligums, Jr., as collateral agent for the Investors (the “Security Agreement”), to secure the timely payment and performance in full of the Company’s obligations under the Notes. Under the Security Agreement, we granted to the collateral agent, for the benefit of the Investors a lien upon and security interest in the property and assets listed as collateral in the Security Agreement, including without limitation, all of our personal property, inventory, equipment, general intangibles, cash and cash equivalents, and proceeds. In connection with the payoff of the Notes, the Security Agreement was terminated.

Note 56 – Transactions Affecting Stockholders’ Equity

Our authorized capital stock consists of 50 million shares of Common Stock and 1 million shares of preferred stock, $.0005 par value (“Preferred Stock”).

Preferred Stock

On June 16, 2015, our stockholders approved the change to our state of incorporation from the State of Nevada to the State of Delaware pursuant to a plan of conversion (the “Conversion Plan”) and the filing of a certificate of incorporation in the State of Delaware. The Preferred Stock authorized under our certificate of incorporation may be issued from time to time in one or more series. As of September 30, 2017,March 31, 2018, no shares of Preferred Stock have been issued. Our board of directors has the full authority permitted by law to establish, without further stockholder approval, one or more series of Preferred Stock and the number of shares constituting each such series and to fix by resolution voting powers, preferences and relative, participating, optional and other special rights of each series of Preferred Stock, and the qualifications, limitations or restrictions thereof, if any. Subject to the limitation on the total number of shares of Preferred Stock that we have authority to issue under our certificate of incorporation, the board of directors is also authorized to increase or decrease the number of shares of any series, subsequent to the issue of that series, but not below the number of shares of such series then-outstanding. In case the number of shares of any series is so decreased, the shares constituting such decrease will resume the status that they had prior to the adoption of the resolution originally fixing the number of shares of such series. We may amend from time to time our certificate of incorporation and bylaws to increase the number of authorized shares of Preferred Stock or Common Stock or to make other changes or additions to our capital structure or the terms of our capital stock.

ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)

Note 5 – Transactions Affecting Stockholders’ Equity – continued

Stockholder Rights Plan

On September 8, 1998, our Board of Directors declared a dividend distribution of Common Stock Purchase Rights (each individually, a “Right” and collectively, the “Rights”) payable to our stockholders of record on September 25, 1998, thereby creating a Stockholder Rights Plan (the “Rights Agreement”). The Plan was subsequently amended effective each of (i) May 23, 2008, (ii) August 18, 2009, (iii) June 18, 2014 and (iv) January 6, 2017. The Rights Agreement, as amended and restated, provides that each Right entitles the stockholder of record to purchase from the Company that number of shares of Common Stock having a combined market value equal to two times the Rights exercise price of $45. The Rights are not exercisable until the distribution date, which will be the earlier of a public announcement that a person or group of affiliated or associated persons has acquired 15% or more of the outstanding shares of Common Stock, or the announcement of an intention by a similarly constituted party to make a tender or exchange offer resulting in the ownership of 15% or more of the outstanding shares of Common Stock (such person, the “acquirer”). The Rights Agreement allows for an exemption for Ted Karkus, the Company’s Chairman and Chief Executive Officer, to acquire up to 20% of our Common Stock without our Board of Directors declaring a dividend distribution.

The dividend has the effect of diluting the acquirer by giving our other stockholders a 50% discount on our Common Stock’s current market value for exercising the Rights. In the event of a cashless exercise of the Right and the acquirer has acquired less than 50% beneficial ownership of the Company, a stockholder may exchange one Right for one share of Common Stock of the Company. The Rights Agreement, as amended, includes a provision pursuant to which our Board of Directors may exempt from the provisions of the Rights Agreement an offer for all outstanding shares of our Common Stock that the Board of Directors determines to be fair and not inadequate and to otherwise be in the best interests of the Company and its stockholders, after receiving advice from one or more investment banking firms. The expiration date of the Rights Agreement, as amended, is June 18, 2024.

2015 Equity Line of Credit

On July 30, 2015, we entered into a new equity line of credit agreement (such arrangement, the “2015 Equity Line”) with Dutchess Opportunity Fund II, LP (“Dutchess”). Pursuant to the 2015 Equity Line, Dutchess committed to purchase, subject to certain restrictions and conditions, up to 3,200,000 shares of our Common Stock, over a period of 36 months from the effectiveness of the registration statement registering the resale of shares purchased by Dutchess pursuant to the Investment Agreement.

We may, at our discretion, draw on the 2015 Equity Line from time to time, as and when we determine appropriate in accordance with the terms and conditions of the 2015 Equity Line. The maximum number of shares that we are entitled to put to Dutchess in any one draw down notice shall not exceed 500,000 shares with a purchase price calculated in accordance with the terms of the 2015 Equity Line. We may deliver a notice for a subsequent put from time to time, following the one day pricing period for the prior put.

The purchase price shall beis set at ninety-five percent (95%) of the volume weighted average price (VWAP) of the Common Stock during the one trading day immediately following our put notice. We have the right to withdraw all or any portion of any put, except that portion of the put that has already been sold to a third party, including any portion of a put that is below the minimum acceptable price set forth on the put notice, before the closing. In the event Dutchess receives more than a five percent (5%) return on the net sales for a specific put, Dutchess must remit such excess proceeds to us; however, in the event Dutchess receives less than a five percent (5%) return on the net sales for a specific put, Dutchess will havehas the right to deduct from the proceeds of the put amount on the applicable closing date so Dutchess’s return will equal five percent (5%).

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 6 – Transactions Affecting Stockholders’ Equity – continued

There are put restrictions applied on days between the draw down notice date and the closing date with respect to that particular put. During such time, we are entitled to deliver another draw down notice. In addition, Dutchess willis not be obligated to purchase shares if Dutchess’ total number of shares beneficially held at that time would exceed 4.99% of the number of shares of Common Stock as determined in accordance with Rule 13d-1(j) of the Securities Exchange Act of 1934, as amended. In addition, we are not permitted to draw on the facility unless there is an effective registration statement to cover the resale of the shares.

ProPhase Labs, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)

Note 5 – Transactions Affecting Stockholders’ Equity – continued

Pursuant to the terms of the 2015 Equity Line, we are obligated to file one or more registration statements with the SEC to register the resale by Dutchess of the shares of Common Stock issued or issuable under the 2015 Equity Line. In addition, we are obligated to use all commercially reasonable efforts to have the registration statement declared effective by the SEC within 90 days after the registration statement is filed. On August 4, 2015, we filed a registration statement for the underlying shares of the 2015 Equity Line with the SEC and the registration statement was declared effective by the SEC on August 21, 2015.

At September 30, 2017,March 31, 2018, we have 2,450,000 shares of our Common Stock available for sale, at our discretion, under the terms of our 2015 Equity Line and covered pursuant to an effective registration statement. The 2015 Equity Line is scheduled to expire in July 2018.

The 2010 Equity Compensation Plan

On May 5, 2010, our stockholders approved the 2010 Equity Compensation Plan, which was subsequently amended, restated and approved by our stockholders on April 24, 2011, and further amended and approved by our stockholders on May 6, 2013 and May 24, 2016 (the “2010 Plan”). The 2010 Plan provides that the total number of shares of Common Stock that may be issued under the 2010 Plan is equal to 3.2 million shares, including 900,000 shares that are authorized for issuance but unissued under a 1997 incentive stock option plan and 700,000 shares added to the 2010 Plan effective May 24, 2016.

For During the ninethree months ended September 30, 2017,March 31, 2018, we granted 30,000 options, exercisable at $2.35 per share and subject to employeesvesting over a three-year term, to consultant to acquire our Common Stock pursuant to the terms of the 2010 Plan and aggregate of 625,000 options of which (i) 25,000 options are exercisable at $2.15 per share that vest over three years and (ii) 600,000 options are exercisable at $2.00 per share that vest over four years. The assumptions used in determining the fair value of the 25,000 stock options granted in the third quarter of Fiscal 2017 were (i) expected option life of 4.5 years, (ii) weighted average risk rate of 1.62%, (iii) dividend yield of 0% and (iv) expected volatility of 38.59%. The assumptions used in determining the fair value of the 600,000 stock options granted in the second quarter of Fiscal 2017 were (i) expected option life of 4.75 years, (ii) weighted average risk rate of 1.81%, (iii) dividend yield of 0% and (iv) expected volatility of 44.51%.Plan. No options were granted under the 2010 Plan for the three months and nine months ended September 30, 2016.

For the three months and nine months ended September 30, 2017, stock options of 592,000 and 682,000, respectively, were exercised pursuant to the 2010 Plan and we derived net proceeds of $752,000 and $854,000, respectively. For the nine months ended September 30, 2016, thereMarch 31, 2017. There were no stock options exercised.exercised for the three months ended March 31, 2018 and 2017. At September 30, 2017,March 31, 2018, there were 1,642,0001,009,500 options outstanding under the 2010 Plan and 108,65991,159 options available to be issued pursuant to the terms of the 2010 Plan.

The 2010 Directors’ Equity Compensation Plan

On May 5, 2010, our stockholders approved the 2010 Directors’ Equity Compensation Plan which, was subsequently amended and approved by stockholders on May 6, 2013.2013 (the “2010 Directors’ 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 425,000. For the ninethree months ended September 30,March 31, 2018 and 2017, and 2016, no shares were granted to our directors.directors under the 2010 Directors’ Plan. At September 30, 2017,March 31, 2018, there were 147,808 shares of Common Stock that may be issued pursuant to the terms of the 2010 Directors’ Equity Compensation Plan.

TreasuryThe 2018 Stock Incentive Plan

Stock Purchase Agreements

On JuneApril 12, 2017 we entered into a2018, our stockholders approved the 2018 Stock Purchase Agreement with eachIncentive Plan (the “2018 Stock Plan”). The 2018 Stock Plan provides for the grant of Mark S. Leventhal, a former directorincentive stock options to eligible employees of the Company, and certain other personsfor the grant of nonstatutory stock options to eligible employees, directors and entities associated and/or affiliated with Mr. Leventhal (the “Leventhal Holders”), pursuant to which we purchased all 1,061,980 shares of our Common Stock then held by the Leventhal Holders, representing an approximate 6.2% aggregate ownership interest (based on 17.2 million shares of common stock outstanding as of June 12, 2017). Upon consummationconsultants. The purpose of the transactions,2018 Stock Plan is to advance the Leventhal Holders ceasedinterests of the Company and its stockholders by providing an incentive to hold any direct or indirect ownership interest inattract, retain, and reward persons performing services for the Company.

PursuantCompany and by motivating such persons to contribute to the termsgrowth and profitability of the Company. The 2018 Stock Purchase Agreements,Plan provides that the total consideration paid by us to the Leventhal Holders for their shares was $1,858,465, which amount was equal to the product of (i) $1.75 multiplied by (ii) the number of shares purchased.

ProPhase Labs, Inc. and Subsidiaries
Notesthat may be issued pursuant to Condensed Consolidated Financial Statements
(unaudited)options under the 2018 Stock Plan is equal to 2.3 million shares. At March 31, 2018, no options were yet exercisable, as the stockholders had not yet approved the 2018 Stock Plan.

Note 5 – Transactions Affecting Stockholders’ Equity – continued

Tender Offer

On August 25, 2017, we announced a tender offer to purchase up to 4.0 million shares of our Common Stock at a price of $2.30 per share (the “Tender Offer”). The number of shares proposed to be purchased in the tender offer represented approximately 24.7% of the approximately 16.2 million shares of our Common Stock issued and outstanding as of August 21, 2017. The last reported sale price of our Common Stock on August 15, 2017, the last full trading day before we announced the Tender Offer, was $2.13 per share.

The Tender Offer expired on September 25, 2017. Subject to the terms of the Tender Offer, we accepted for purchase 4,323,335 shares of our Common Stock, including all “odd lots” validly tendered, at a purchase price of $2.30 per share, for an aggregate purchase price of approximately $9.9 million. Based on the final tabulation by American Stock Transfer & Trust Company, the Depositary for the Tender Offer, 5,910,327 shares of our Common Stock were properly tendered and not withdrawn. We were informed by the Depositary that, after giving effect to the priority for an aggregate amount of approximately 9,338 “odd lot” shares, the final proration factor for the remaining tendered shares is approximately 73%. Prior to the Tender Offer, an investor, BML Investment Partners, L.P. (“BLM”), owned 2,322,627 shares, or 13.6%, of our outstanding Common Stock. Pursuant to the terms of the Tender Offer, BML tendered and sold 1,695,305 shares of our Common Stock. In addition, Ted Karkus, our Chairman of the Board and Chief Executive Officer, Robert V. Cuddihy, Jr., our then Chief Operating Officer and Chief Financial Officer, and one of our directors tendered and sold 364,954, 358,621 and 4,379 shares of Common Stock, respectively.

Note 67 – Income Taxes

At December 31, 2016,2017, there were $47.1are $12.2 million in net operating loss carryforwards, subject to applicable limitations, available to us for federal purposes whichthat will expire beginning for the year ended December 31, 20202032 through 2036. Additionally, there were $22.1$13.8 million in net operating loss carryforwards, subject to limitations, available to us for state purposes which will expire beginning for the year ended December 31, 20202019 through 2036.2037.

Based upon preliminary estimates, we believe that a significant portion of our income tax liability of $19.5 million arising from our taxable gain for federal and state income tax purposes from the sale of the Cold-EEZE^® Business will be offset to the extent of our current year losses from operations, the write-off for tax purposes of the tax-basis of the Cold-EEZE^®Business and the available net operating loss carryforwards at the federal and state levels. However, for state income tax purposes, based upon the available state net operating loss carryforwards and corresponding limitations, we estimate a net income tax expense arising from the sale of the Cold-EEZE^® Business of $1.3 million.

Utilization of net operating loss carryforwards may be subject to limitations as set forth in Section 382 of the Internal Revenue Code (“Section 382”). Based on our preliminary Section 382 analysis, we do not believe that our current net operating loss carryforwards are subject to these limitations as of September 30, 2017.March 31, 2018. However, until we complete a final Section 382 analysis upon filing of our 20172018 income tax return, there can be no assurances that our preliminary analysis is accurate or complete. Should we identify any limitations upon the completion of our final Section 382 analysis, the impact could be material to our consolidated financial statements and that we could incur additional income tax expense arising from the sale of the Cold-EEZE^® Business.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

For the ninethree months ended September 30,March 31, 2017, we charged to discontinued operations $19.5$2.5 million for estimated federal and state income taxes arising from the sale of the Cold-EEZE^® Business and we have realized an income tax benefit from continuing operations of $18.1$0.5 million as a consequence of the utilization of the federal and state net operating losses.

Subsequent to the income tax effects arising from the sale of the Cold-EEZE^® Business, we will continue to have net operating loss carry-forwards for federal income tax purposes. Until sufficient taxable income to offset the temporary timing differences attributable to operations, and the tax deductions attributable to option, warrant and stock activities are assured, a valuation allowance equaling the total deferred tax asset is being provided. As a consequence of the accumulated losses of the Company, we believe that this allowance is required due to the uncertainty of realizing these tax benefits in the future.

On December 22, 2017, the President of the United States signed into law legislation that is commonly referred to as the Tax Cuts and Jobs Act (the “TCJA”). This legislation reduced the U.S. corporate tax rate from the existing graduated rate of 15-35% to a flat 21% for tax years beginning after December 31, 2017. As a result of the enacted law, we were required to revalue our deferred tax assets and liabilities existing as of December 31, 2017 from the graduated 15-35% federal rate in effect through the end of 2017, to the new flat 21% rate. This revaluation resulted in a reduction to our deferred tax asset of $1.6 million. This amount was offset by a corresponding reduction to our valuation allowance. The other provisions of the TCJA did not have a material impact on our December 31, 2017 consolidated financial statements. Estimates used to prepare our income tax expense are based on our initial analysis of the TCJA. Given the complexity of the TCJA, anticipated guidance from the U.S. Treasury regarding implementation of the TCJA, and the potential for additional guidance from the Securities and Exchange Commission and the FASB related to the TCJA, these estimates may be adjusted during Fiscal 2018 to reflect any such guidance provided.

Note 8 – Other Accrued Liabilities

The following table sets forth the components of other current liabilities at March 31, 2018 and December 31, 2017, respectively, (in thousands):

Note 7–9– Commitments and Contingencies

Escrow Receivable

We have indemnification obligations to Mylan under the Asset Purchase Agreement that may require us to make future payments to Mylan and other related persons for any damages incurred by Mylan or such related persons as a result of any breaches of our representations, warranties, covenants or agreements contained in the Asset Purchase Agreement, or arising from the Retained Liabilities (as such term is defined in the Asset Purchase Agreement) or certain third party claims specified in the Asset Purchase Agreement. Generally, our representations and warranties survive for a period of 24 months from the closing date, other than certain fundamental representations which survive until the expiration of the applicable statute of limitations. There is a limited indemnification cap with respect to a majority of the Company’s indemnification obligations under the Asset Purchase Agreement with the exception of claims for actual fraud, the breach of any fundamental representations and certain other items, which have a larger indemnification cap (e.g., the purchase price).

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 9– Commitments and Contingencies - continued

Pursuant to the terms of the Asset Purchase Agreement, we, Mylan, and an escrow agent entered into an Escrow Agreement at closing, pursuant to which Mylan deposited $5 million of the aggregate purchase price for the Cold-EEZE^® Business into an escrow account established with the Escrow Agent in order to satisfy, in whole or in part, certain of our indemnity obligations under the Asset Purchase Agreement. If, on the 18^thmonth anniversary of the closing date, there are funds remaining in the escrow account, then the escrow account will be reduced by the difference, if a positive number, of (i) $2.5 million minus (ii) the aggregate amount of all escrow claims asserted by Mylan prior to this date that have either been paid out of the escrow account or are pending as of such date, and, within two business days of such date, the Escrow Agent will disburse such difference, if a positive number, to us. Within two business days of the second anniversary of the closing date, the Escrow Agent will release any funds remaining in the escrow account to us minus any amounts being reserved for escrow claims asserted by Mylan prior to such date. Upon the resolution of any pending escrow claims, the Escrow Agent will, within two business days of receipt of joint instructions or a final order from a court (as described in the Escrow Agreement) disburse such reserved amount to the parties entitled to such funds.

Management does not believe that we will be subject to indemnity claims contemplated by the Asset Purchase Agreement. However, in the event that such a claim is made, and if successful, we would be required to pay Mylan pursuant to the indemnification provisions of the Asset Purchase Agreement which may reduce the amount we ultimately collect from escrow or could even require us to return a portion of the net proceeds received from the sale of the Cold-EEZE^® Division.Business.

Manufacturing Agreement

In connection with the Asset Purchase Agreement, the Company and its wholly-owned subsidiary, PMI, entered into a Manufacturing Agreement (the “Manufacturing Agreement”) with Mylan. Pursuant to the terms of the Manufacturing Agreement, Mylan (or an affiliate or designee) will purchasepurchased the inventory of the Company’s Cold-EEZE^® brand and product line, and PMI will manufacture certain products for Mylan, as described in the Manufacturing Agreement, at prices that reflect current market conditions for such products and include an agreed upon mark-up on our costs. Unless terminated sooner by the parties, the Manufacturing Agreement will remain in effect until March 29, 2022. Thereafter, the Manufacturing Agreement may be renewed by Mylan for up to five successive one yearone-year periods by providing notice of its intent to renew not less than 90 days prior to the expiration of the then-current term.

Transition ServicesEmployment Agreement

On February 16, 2018, our board of directors approved the Amended and Restated 2015 Executive Employment Agreement with Ted Karkus, our Chief Executive Officer (the “Amended Employment Agreement”), which became effective February 23, 2018, and was approved by stockholders at a special meeting of stockholders held April 12, 2018. Pursuant to the terms of the Amended Employment Agreement, Mr. Karkus voluntarily agreed to reduce his base salary from the rate set forth in the 2015 Employment Agreement (i.e.,not less than $675,000 per annum) to a base salary of $125,000 per annum (the “Term Base Salary”) through February 22, 2021. Unless otherwise determined by the mutual agreement of the Company and Mr. Karkus, on February 22, 2021 and thereafter, Mr. Karkus’ salary will increase from the Term Base Salary to not less than $675,000 per annum.

In connection withconsideration of Mr. Karkus’ voluntary reduction in salary, our board of directors granted Mr. Karkus a stock option to purchase 2,300,000 shares of our Common Stock at an exercise price of $3.00 per share on February 23, 2018 (the “Executive Stock Option”). The Executive Stock Option will vest and be exercisable in 35 equal monthly installments of 63,888 shares and one monthly installment of 63,290 shares, subject to his continued employment, and subject to accelerated vesting in the Asset Purchaseevent Mr. Karkus’s employment is terminated for any reason other than by us for Cause or by Mr. Karkus without Good Reason (as such terms are defined in the Amended Employment Agreement). The Executive Stock Option is be exercisable for a five year term commencing on the date of grant. The Executive Stock Option was granted pursuant to the 2018 Stock Plan, which was also adopted and approved by our board of directors on February 16, 2018. The 2018 Plan, like the Amended Employment Agreement, we entered intoreceived stockholder approval at a transition services agreement with Mylanspecial meeting of stockholders held on April 12, 2018. The 2018 Plan authorizes the issuance of up to provide litigation support, insurance coverage, supply chain, customer support, finance, accounting, commercial advertising and packaging services, quality control, IT and research and development services2,300,000 shares pursuant to Mylan for time periods ranging from twostock options granted under the 2018 Plan, all of which were issued to nine months fromMr. Karkus as part of the closing date. We will continue to incur certain operating costs during the transition period to support Mylan.Executive Stock Option.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 7– Commitments and Contingencies – continued

Future Obligations:

We have estimated future minimum obligations over the next five years, including the remainder of Fiscal 2017,2018, as follows (in thousands):

Other Commitments:

On September 27, 2017, we entered into an Employment Agreement Termination and Release Agreement with Robert V. Cuddihy, Jr., our former Chief Financial Officer (the “Termination Agreement”). The Termination Agreement provides that Mr. Cuddihy’s employment agreement will terminate effective September 30, 2017, and that on the expiration of the seven day revocation period from the date Mr. Cuddihy signs the Termination Agreement, and subject to his not having revoked the Termination Agreement prior to that time, we would pay Mr. Cuddihy a one-time lump sum payment of $55,000 by October 15, 2017. The Termination Agreement contains a general release of claims in favor of us and other customary provisions. The one-time payment to Mr. Cuddihy was paid on October 20, 2017.

Note 810 – Earnings (Loss) Per Share

Basic earnings (loss) per share for continuing and discontinued operations are computed by dividing respective net income or loss attributable to common stockholders by the weighted-average number of shares of our Common Stock outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue Common Stock were exercised or converted into Common Stock or resulted in the issuance of Common Stock that shared in the earnings of the entity. Diluted earnings (loss) per share also utilize the treasury stock method which prescribes a theoretical buy-back of shares from the theoretical proceeds of all options and warrants outstanding during the period. Options and warrants outstanding to acquire shares of our Common Stock at September 30,March 31, 2018 and 2017 were 1,009,500 and 2016 were 1,642,000 and 1,706,500,1,699,000, respectively.

For the three months ended September 30,March 31, 2018 and 2017, there were 282,867 and 689,909 common stock equivalents which were in the money, respectively, that were included in the fully diluted earnings per share computation. For the three months ended March 31, 2017, dilutive earnings (loss)loss per share from continuing operations is the same as basic earningsloss per share due to (i) the inclusion of Common Stock, in the form of stock options and warrants, (“Common Stock Equivalents”), would have an anti-dilutive effect on the loss per share or (ii) there were no Common Stock Equivalentsfrom continuing operations.

Note 11 – Significant Customers

Revenue from continuing operations for the respective period. For the three months ended September 30,March 31, 2018 and March 31, 2017 there were 504,170 Common Stock Equivalents which were inwas $3.4 million and $771,000, respectively. Two third-party contract manufacturing customers accounted for 48.2% and 33.2%, respectively, of our revenue from continuing operations for the money, that were excludedthree months ended March 31, 2018. Two third-party contract manufacturing customers accounted for 56.4% and 19.9%, respectively, of our revenues from continuing operations for the earnings (loss) per share computationthree months ended March 31, 2017. The loss of sales to either of these large third-party contract manufacturing customers could have a material adverse effect on our business operations and financial condition.

We are subject to account receivable credit concentrations from time-to-time as a consequence of their anti-dilutive effect. For the nine months ended September 30,timing, payment pattern and ultimate purchase volumes or shipping schedules with our customers. These concentrations may impact our overall exposure to credit risk, either positively or negatively, in that our customers may be similarly affected by changes in economic, regulatory or other conditions that may impact the timing and collectability of amounts due to us. Two customers represented 56% and 35% and one customer represented 84% of our total trade receivable balances at March 31, 2018 and December 31, 2017, there were 456,728 Common Stock Equivalents which were inrespectively. Management believes that the money, that were included in the fully diluted earnings per share computation.provision for possible losses on uncollectible accounts receivable is adequate for our credit loss exposure. The allowance for doubtful accounts was zero for both March 31, 2018 and December 31, 2017.

ForNote 12 - Subsequent Events

On February 16, 2018, our board of directors approved the three months ended September 30, 2016 there were 519,162 CommonAmended and Restated 2015 Executive Employment Agreement with the CEO (the “Employment Agreement”), which became effective February 23, 2018. However, the Employment Agreement required approval by the requisite vote of stockholders at a special meeting of the stockholders that was held on April 12, 2018 (the “Special Meeting”). At the Special Meeting, shareholders voted to approve the Employment Agreement.

On February 16, 2018, the board of directors approved the 2018 Stock EquivalentsIncentive Plan, which were inrequired stockholder approval by the money, that were included inrequisite vote of stockholders received at the fully diluted earningsSpecial Meeting on April 12, 2018. The 2018 Stock Incentive Plan provides for the grant of incentive stock options to eligible employees of the Company, and for the grant of nonstatutory stock options to eligible employees, directors and consultants. At the Special Meeting, shareholders voted to approve the 2018 Stock Plan.

On April 12, 2018, our board of directors approved the amended and restatement of our 2010 Plan, which, if approved by our stockholders at our annual meeting on May 23, 2018, will (i) increase the number of shares reserved for issuance under the 2010 Plan by 700,000 shares from 3.2 million shares to 3.9 million shares, and (ii) allow our board of directors to grant restricted stock awards and restricted stock units.

On April 12, 2018, our board of directors approved the amendment and restatement of our 2010 Directors’ Plan, which, if approved by our stockholders at the Company’s annual meeting on May 23, 2018, will (i) increase the number of shares reserved for issuance under the 2010 Directors’ Plan by 250,000 shares from 425,000 shares to 675,000 shares, and (ii) allow our board of directors to grant restricted stock awards and restricted stock units.

On May 7, 2018, our board of directors declared a special cash dividend of $1.00 per share computation. For the nine months ended September 30, 2016, for continuing operations dilutive earnings (loss) per share isshare. On the same date, the Compensation Committee of the board of directors approved an adjustment to the stock option granted to Mr. Karkus on February 23, 2018, as basic earnings per share due to (i)permitted under the inclusion of CommonCompany’s 2018 Stock in the form of stock options and warrants (“Common Stock Equivalents”), would have an anti-dilutive effect on the loss per share or (ii) there were no Common Stock Equivalents for the respective period. For the nine months ended September 30, 2016, there were 342,248, Common Stock Equivalents which were in the money, that were excluded from the earnings (loss) per share computationPlan, as a consequence of their anti-dilutive effect.the special cash dividend. The board of directors has adjusted the terms of the Executive Stock Option, such that the exercise price of the Executive Stock Option will be reduced from $3.00 per share to $2.00 per share, effective as of June 5, 2018, the date the special cash dividend is to be paid and subject to such dividend payment being made.

Note 9 – Subsequent Event

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis should be read in conjunction with our interim unaudited condensed financial statements and related notes included in this Quarterly Report on Form 10-Q10-Q/A (“Quarterly Report”) which has been restated as discussed in Note 2 in the condensed consolidated financial statements and the audited financial statements and notes thereto as of and for the year ended December 31, 20162017 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K10-K/A filed with the Securities and Exchange Commission (“SEC”) on February 24, 2017August 20, 2018 (the “2016“2017 Annual Report”). As used in this Quarterly Report, unless the context suggests otherwise, “we,” “us,” “our,” or “ProPhase” refer to ProPhase Labs, Inc. and its subsidiaries and consolidated variable interest entities, unless the context otherwise requires.

Restatement and revision of the consolidated financial

GeneralAs discussed in the Explanatory Note, this Amendment to Form 10-Q/A (this Amendment), amends and restates the Company’s consolidated financial statements and related disclosures in Part I, Item 2. “Financial Statements” as of and for the three months ended March 31, 2018 to reflect the correction of certain errors discussed in Note 2Restatement of Previously Issued Financial Statements. Accordingly, the Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth below reflects the effects of these restatements and revisions.

Forward-Looking Statements

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

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

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

General

ProPhase was initially organized in Nevada in July 1989. Effective June 18, 2015, we changed our state of incorporation from the State of Nevada to the State of Delaware. We are a manufacturer, marketervertically integrated and distributor of a diversified range of health carebranding, marketing and technology company with deep experience with OTC consumer healthcare products, dietary supplements and cold remedy products that are offered to the general public.other remedies. We are also engaged in the research, development, manufacture, distribution, marketing and sale of OTC consumer healthcare products, dietary supplements and other remedies in the United States. This includes the development and marketing of potential over-the-counterdietary supplements under the TK Supplements^®brand.

In August 2017, we formed ProPhase Digital Media Inc. (“OTC”PDM”) drug, a Delaware corporation and natural base health products including supplements, personal care and cosmeceuticalwholly-owned subsidiary. Our objective is for PDM to become an independent full-service direct marketing agency. PDM’s first initiative will be to market the TK Supplements® product line. If successful, this may lead to the marketing of other companies’ consumer products.