
Class						Outstanding May ~~13, 2022~~5, 2023
Common Stock, $0.0005 par value						~~15,485,900~~

17,182,841

ProPhase Labs, Inc. and Subsidiaries

TABLE OF CONTENTS


				PAGE
PART I. FINANCIAL INFORMATION

Item 1.			Financial Statements (Unaudited)	3

~~Item 1.~~			~~Financial Statements (Unaudited)~~	3

	Condensed Consolidated Balance Sheets as of March 31 ~~2022~~, 2023 and December 31, ~~2021~~202 2	3

			Condensed Consolidated Statements of Operations and Comprehensive ~~Loss~~Income (Loss) for the Three Months Ended March 31 ~~2022~~, 202 3 and ~~2021~~2022	45

			Condensed Consolidated Statements of Stockholders’ Equity for the Three Months Ended March 31 ~~2022~~, 202 3 and ~~2021~~2022	56

			Condensed Consolidated Statements of Cash Flows for the Three Months Ended ~~March~~Mar ch 31 ~~2022~~, 202 3 and ~~2021~~2022	6 7

			Notes to Condensed Consolidated Financial Statements	7 9

Item 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations	3323

Item 3.			Quantitative and Qualitative Disclosures about Market Risk	41 30

Item 4.			Controls and Procedures	41 31

PART II. OTHER INFORMATION

Item 1.			Legal Proceedings	42 32
~~Item 1A.~~			~~Risk Factors~~	43
Item 1A.			Risk Factors	32

Item 2.			Unregistered Sales of Equity Securities and Use of Proceeds	4332

Item 3.			Defaults Upon Senior Securities	4332

Item 4.			Mine Safety Disclosures	4332
~~Item 5.~~			~~Other Information~~	43
Item 6.5.			~~Exhibits~~Other Information	4332

~~Signatures~~Item 6.			44Exhibits	33

2
Signatures						34

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)


	March 31, 2023		December 31, 2022
	(Unaudited)
ASSETS
Current assets
Cash and cash equivalents	$	9,613	$	9,109

Marketable debt securities, available for sale	5,946		8,328

Accounts receivable, net	37,836		37,054
Inventory, net	4,311		3,976
Prepaid expenses and other current assets	3,573		2,366
Total current assets	61,279		60,833

Property, plant and equipment, net	8,891		7,288
Prepaid expenses, net of current portion	121		121
Operating lease right-of-use asset, net	3,974		4,059
Intangible assets, net	14,524		8,475
Goodwill	5,231		5,709
Deferred tax asset	191		—
Other assets	1,163		1,163
TOTAL ASSETS	$	95,374	$	87,648

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	4,866	$	5,905
Accrued diagnostic services	353		1,009
Accrued advertising and other allowances	151		99
Operating lease liabilities	298		301
Deferred revenue	2,841		2,499
Income tax payable	3,849		4,190
Other current liabilities	6,109		2,072
Total current liabilities	18,467		16,075

Non-current liabilities:
Deferred revenue, net of current portion	1,160		1,059
Deferred tax liability, net	—		224
Unsecured promissory notes, net of discount of $376 and $0	7,224		—
Unsecured convertible promissory notes, net	2,400		2,400
Operating lease liabilities, net of current portion	4,182		4,259
Due to sellers (see Note 3)	2,000		—
Total non-current liabilities	16,966		7,942

March 31, December 31,
March 31, December 31,
2022 2021
(Unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 25,807 $ 8,408
Restricted cash - 250
Marketable debt securities, available for sale 3,543 8,779
Marketable equity securities, at fair value - 76
Accounts receivable, net 36,694 37,708
Inventory, net 4,680 4,600
Prepaid expenses and other current assets 1,831 1,496
Total current assets 72,555 61,317

Property, plant and equipment, net 6,440 5,947
Prepaid expenses, net of current portion 251 460
Right-of-use asset, net 4,319 4,402
Intangible assets, net 10,143 10,852
Goodwill 5,709 5,709
Other assets 248 608
TOTAL ASSETS $ 99,665 $ 89,295

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable $ 8,204 $ 7,026
Accrued diagnostic services 1,012 1,890
Accrued advertising and other allowances 95 104
Lease liabilities 654 663
Deferred revenue 2,246 2,034
Income tax payable
4,285

1,312

Other current liabilities 3,274 2,495
Total current liabilities 19,770 15,524

Non-current liabilities:
Deferred revenue, net of current portion 858 905
Deferred tax liability 443 -
Note payable 18 44
Unsecured convertible promissory notes, net 7,997 9,996
Lease liabilities, net of current portion 4,134 4,198
Total non-current liabilities 13,450 15,143
Total liabilities 33,220 30,667

COMMITMENTS AND CONTINGENCIES - -

Stockholders’ equity
Preferred stock authorized 1,000,000, $0.0005 par value, 0 shares issued and outstanding - -
Common stock authorized 50,000,000, $0.0005 par value, 15,485,900 and 15,485,900 shares outstanding, respectively 16 16
Additional paid-in capital 105,634 104,552
Retained earnings 10,490 2,642
Treasury stock, at cost, 17,018,846 and 16,818,846 shares, respectively (49,557 ) (48,407 )
Accumulated other comprehensive loss (138 ) (175 )
Total stockholders’ equity 66,445 58,628
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 99,665 $ 89,295


Total liabilities	35,433		24,017

COMMITMENTS AND CONTINGENCIES

Stockholders’ equity
Preferred stock authorized 1,000,000, $0.0005 par value, no shares issued and outstanding	—		—
Common stock authorized 50,000,000, $0.0005 par value, 16,851,041 and 16,210,776 shares outstanding, respectively	17		16
Additional paid-in capital	111,482		109,138
Retained earnings	12,303		11,753
Treasury stock, at cost, 18,934,955 and 18,126,970 shares, respectively	(63,953)		(58,033)
Accumulated other comprehensive loss	92		757
Total stockholders’ equity	59,941		63,631
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	95,374	$	87,648

See accompanying notes to these condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations and ~~Other~~ Comprehensive ~~Loss~~

Income (Loss)

(in thousands, except per share amounts)

(unaudited)

March 31, 2022 March 31, 2021
For the three months ended
March 31, 2022 March 31, 2021
Revenues, net $ 47,531 $ 15,271
Cost of revenues 18,854 6,344
Gross profit 28,677 8,927

Operating expenses:
Diagnostic expenses 4,672 3,809
General and administration 7,824 3,782
Research and development 35 115
Total operating expenses 12,531 7,706
Income (loss) from operations 16,146 1,221

Interest income, net 73 87
Interest expense (233 ) (251 )
Change in fair value of investment securities (76 ) -
Income from operations before income taxes 15,910 1,057
Income tax expense (3,416 ) -
Income from operations after income taxes 12,494 1,057
Net income $ 12,494 $ 1,057

Other comprehensive loss:
Unrealized gain (loss) on marketable debt securities 37 (11 )
Total comprehensive income $ 12,531 $ 1,046

Earnings per share:
Basic $ 0.81 $ 0.07
Diluted $ 0.68 $ 0.06

Weighted average common shares outstanding:
Basic 15,486 14,563
Diluted 18,740 18,200


	For the three months ended
	March 31, 2023		March 31, 2022
Revenues, net	$	19,303	$	47,531
Cost of revenues	8,783		18,854
Gross profit	10,520		28,677

Operating expenses:
Diagnostic expenses	1,203		4,672
General and administration	8,298		7,824
Research and development	144		35
Total operating expenses	9,645		12,531
Income from operations	875		16,146

Interest income, net	11		73
Interest expense	(215)		(233)
Other income (loss)	(107)		(76)
Income from operations before income taxes	564		15,910
Income tax expense	14		3,416
Income from operations after income taxes	550		12,494
Net income	$	550	$	12,494

Other comprehensive (loss) income:
Unrealized loss on marketable debt securities	(665)		37
Total comprehensive (loss) income	$	(115)	$	12,531

Earnings per share:
Basic	$	0.03	$	0.81
Diluted	$	0.03	$	0.68

Weighted average common shares outstanding:
Basic	16,748		15,486
Diluted	18,061		18,740

See accompanying notes to these condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Statements of Stockholders’ Equity

(in thousands, except share data)

(unaudited)

Common Stock Shares Outstanding Par Value Additional Paid in Capital Retained Earnings Comprehensive Loss Treasury Stock Total
Common Stock Shares Outstanding Par Value Additional Paid in Capital Retained Earnings Comprehensive Loss Treasury Stock Total
Balance as of January 1, 2022 15,485,900 $ 16 $ 104,552 $ 2,642 $ (175 ) $ (48,407 ) $ 58,628
Issuance of common shares for debt conversion 200,000 - 600 - - - 600
Cash dividends - - - (4,646 ) - - (4,646 )
Repurchases of common shares (200,000 ) - - - - (1,150 ) (1,150 )
Unrealized loss on marketable debt securities - - - - 37 - 37
Stock-based compensation - - 482 - - - 482
Net income - - - 12,494 - - 12,494
Balance as of March 31, 2022 15,485,900 $ 16 $ 105,634 $ 10,490 $ (138 ) $ (49,557 ) $ 66,445

Common Stock Shares Outstanding Par Value Additional Paid in Capital Retained Earnings Comprehensive Loss Treasury Stock Total

Common Stock
Shares Outstanding,
Par Value Additional Paid in Capital Accumulated Deficit
Accumulated
Comprehensive Income (loss)
Treasury Stock Total
Balance as of January 1, 2021 11,604,253 $ 14 $ 61,674 $ (3,631 ) $ (11 ) $ (47,490 ) $ 10,556
Issuance of common stock and warrants for cash from public offering, net of $2,365 offering cost 3,000,000 2 35,133 - - - 35,135
Issuance of common stock and warrants for cash from private offering 550,000 - 5,500 - - - 5,500
Unrealized loss on marketable debt securities - - - - (11 ) - (11 )
Stock-based compensation - - 428 - - - 428
Net income - - - 1,057 - - 1,057
Balance as of March 31, 2021 15,154,253 $ 16 $ 102,735 $ (2,574 ) $ (22 ) $ (47,490 ) $ 52,665


	For the Three Months Ended March 31, 2023
	Common Stock Shares Outstanding	Par Value		Additional Paid in Capital		Retained Earnings		Treasury Stock		Accumulated Other Comprehensive Loss		Total
Balance as of January 1, 2023	16,210,776	$	16	$	109,138	$	11,753	$	(58,033)	$	757	$	63,631
Issuance of common stock in asset acquisition	100,000	1		999		—		—		—		1,000
Repurchase of common shares	(63,616)	—		—		—		(541)		—		(541)
Unrealized loss on marketable debt securities	—	—		—		—		—		(665)		(665)
Issuance of common stock upon stock options cashless exercise	603,881	—		—		—		—		—		—
Issuance of warrants with unsecured promissory note	—	—		398		—		—		—		398
Treasury shares repurchased to satisfy tax withholding obligations	—	—		—		—		(5,379)		—		(5,379)
Stock-based compensation	—	—		947		—		—		—		947
Net income	—	—		—		550		—		—		550
Balance as of March 31, 2023	16,851,041	$	17	$	111,482	$	12,303	$	(63,953)	$	92	$	59,941


	For the Three Months Ended March 31, 2022
	Common Stock Shares Outstanding	Par Value		Additional Paid in Capital		Retained Earnings		Treasury Stock		Accumulated Other Comprehensive Loss		Total
Balance as of January 1, 2022	15,485,000	$	16	$	104,552	$	2,642	$	(48,407)	$	(175)	$	58,628
Issuance of common shares for debt conversion	200,000	—		600		—		—		—		600
Cash dividends	—	—		—		(4,646)		—		—		(4,646)
Repurchase of common shares	(200,000)	—		—		—		(1,150)		—		(1,150)
Unrealized loss on marketable debt securities	—	—		—		—		—		37		37
Stock-based compensation	—	—		482		—		—		—		482
Net loss	—	—		—		12,494		—		—		12,494
Balance as of March 31, 2022	15,485,000	$	16	$	105,634	$	10,490	$	(49,557)	$	(138)	$	66,445

See accompanying notes to these condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)


	For the three months ended
	March 31, 2023		March 31, 2022
Cash flows from operating activities
Net income	$	550	$	12,494
Adjustments to reconcile net income to net cash provided by operating activities:
Realized loss on marketable debt securities	107		179
Depreciation and amortization	1,292		1,249
Accretion of debt discount	20		1
Amortization on operating lease right-of-use assets	85		83
Gain on sale of assets	—		(23)
Stock-based compensation expense	947		482
Change in fair value of investment securities	—		76
Accounts receivable allowances	(147)		(924)
Inventory valuation reserve	—		25
Bad debt expenses	230		—
Changes in operating assets and liabilities:
Accounts receivable	(864)		1,938
Inventory	(335)		(105)
Prepaid expenses and other current assets	(2,107)		(126)
Deferred tax asset	(96)		—
Other assets	—		360
Accounts payable and accrued expenses	(2,661)		1,178
Accrued diagnostic services	(656)		(878)
Accrued advertising and other allowances	52		—
Deferred revenue	443		165
Deferred tax liability	—		443
Operating lease liabilities	(80)		(73)
Income tax payable	(341)		2,973
Other current liabilities	4,037		770
Net cash provided by operating activities	476		20,287

Cash flows from investing activities
Business acquisitions, escrow received	478		—
Asset acquisition, net of cash acquired	(2,904)		—

Purchase of marketable securities	—		(206)
Proceeds from sale of marketable debt securities	1,291		5,300
Proceeds from dispositions of property and other assets, net	—		85
Capital expenditures	(517)		(1,095)
Net cash (used in) provided by investing activities	(1,652)		4,084

Cash flows from financing activities

Proceeds from issuance of secured note payable	7,600		—

~~(unaudited)~~

March 31, 2022 March 31, 2021
For the three months ended
March 31, 2022 March 31, 2021
Cash flows from operating activities
Net income $ 12,494 $ 1,057
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Realized loss on marketable debt securities 179 2
Depreciation and amortization 1,249 536
Amortization of debt discount 1 2
Amortization on right-of-use assets 83 85
Gain on sale of assets (23 ) -
Stock-based compensation expense 482 428
Change in fair value of investment securities 76 -
Accounts receivable allowances (924 ) -
Inventory valuation reserve 25 -
Changes in operating assets and liabilities:
Accounts receivable 1,938 (11,178 )
Inventory (105 ) (12,987 )
Prepaid and other assets (126 ) 2,243
Other assets 360 (8 )
Accounts payable and accrued expenses 1,178 4,009
Accrued diagnostic services (878 ) -
Deferred revenue 165 -
Deferred tax liability
443
-
Lease liabilities (73 ) 101
Income tax payable
2,973
-
Other liabilities 770 7,818
Net cash provided by (used in) operating activities 20,287 (7,892 )

Cash flows from investing activities
Issuance of secured promissory note receivable - (1,000 )
Purchase of marketable securities (206 ) (2,005 )
Proceeds from sale of marketable debt securities 5,300 100
Proceeds from dispositions of property and other assets 85 -
Capital expenditures (1,095 ) (3,927 )
Net cash provided by (used in) investing activities 4,084 (6,832 )

Cash flows from financing activities
Proceeds from issuance of common stock from public offering, net - 35,135
Proceeds from issuance of common stock and warrants from private offering - 5,500
Repayment of note payable (1,426 ) -
Repurchases of common shares (1,150 ) -
Payment of dividends (4,646 ) -
Net cash (used in) provided by financing activities (7,222 ) 40,635

Increase in cash, cash equivalents and restricted cash 17,149 25,911
Cash, cash equivalents and restricted cash, at the beginning of the period 8,658 6,816
Cash, cash equivalents and restricted cash, at the end of the period $ 25,807 $ 32,727

Supplemental disclosures:
Cash paid for income taxes $ - $ -
Interest payment on the promissory notes $ 241 $ 250

Supplemental disclosure of non-cash investing and financing activities:
Issuance of common shares for debt conversion $ 600 $ -
Net unrealized gain (loss), investments in marketable debt securities $ 37 $ (11 )


Repurchase of common stock for payment of statutory taxes due on cashless exercise of stock option	(5,379)		—
Repurchases of common shares	(541)		(1,150)
Repayment of note payable	—		(1,426)
Payment of dividends	—		(4,646)
Net cash provided by (used in) financing activities	1,680		(7,222)

Increase in cash, cash equivalents and restricted cash	504		17,149
Cash and cash equivalents, at the beginning of the period	9,109		8,658
Cash and cash equivalents, at the end of the period	$	9,613	$	25,807

Supplemental disclosures:
Cash paid for income taxes	$	1,500	$	—
Interest payment on the promissory notes	$	203	$	241

Supplemental disclosure of non-cash investing and financing activities:
Financed capital expenditures	$	1,623	$	—
Common stock issued in Asset Acquisition	$	1,000	$	—
Issuance of common shares for debt conversion	$	—	$	600
Net unrealized loss, investments in marketable debt securities	$	—	$	37

See accompanying notes to these condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

~~(unaudited)~~

Note 1 - Organization and Business

ProPhase Labs, Inc. (“ProPhase”, “we”, “us”, “our” or the “Company”) is a diversified company that offers a range of services including ~~diagnostic~~genomics testing, ~~genomics~~diagnostic testing and contract manufacturing. We ~~provide traditional CLIA molecular laboratory services, including SARS-CoV-2 (“COVID-19”) testing~~are also focused on licensing, developing and ~~seek to leverage our Clinical Laboratory Improvement Amendments (“CLIA”) accredited laboratory services to provide whole genome sequencing~~commercializing novel drugs, dietary supplements, compounds and research direct to consumers, while building a genomics database to be used for further research. In addition, we have deep experience with over-the-counter (“OTC”) consumer healthcare products and dietary supplements.diagnostics. We currently conduct our operations through two operating segments: diagnostic services and consumer products.

Until late ~~Fiscal~~fiscal year 2020, we were engaged primarily in the research, development, manufacture, distribution, marketing and sale of OTC consumer healthcare products and dietary supplements in the United States. However, commencing in December 2020, we also began offering COVID-19 and prepared to validate other Respiratory Pathogen Panel (RPP) molecular tests through our diagnostic services ~~business, and in~~business. In August 2021 we began offering personal genomics products and ~~services.~~

services and in July 2022 we began focusing on the licensing, development and commercialization of novel drugs, dietary supplements, compounds and diagnostics.

Our wholly owned subsidiary, ProPhase Diagnostics, Inc. (“ProPhase Diagnostics”), which was formed on October 9, 2020, offers a broad array of clinical diagnostic and testing services at its CLIA certified laboratories including ~~state-of-the-art~~ polymerase chain reaction (“PCR”) testing for COVID-19. Critical to COVID-19 testing, we provide fast turnaround times for results. We also offer rapid antigen ~~and antibody/immunity~~ testing for COVID-19. On October 23, 2020, we acquired Confucius Plaza Medical Laboratory Corp. (“CPM”), which included a non-operating but certified 4,000 square foot CLIA accredited laboratory located in Old Bridge, New Jersey. In December 2020, we expanded our diagnostic service business with the build-out of a second, larger CLIA accredited laboratory in Garden City, New York. Operations at this second facility commenced in January 2021.

On August 10, 2021, we acquired Nebula Genomics, Inc. (“Nebula”), a privately owned personal genomics company, through our new wholly owned subsidiary, ProPhase Precision Medicine, Inc. (“ProPhase Precision”) (see Note 3, Business Acquisitions). ProPhase Precision focuses on genomics ~~testing~~sequencing technologies, a comprehensive method for analyzing entire genomes, including the genes and chromosomes in DNA. The data obtained from genomic ~~testing~~sequencing can be used to help to identify inherited disorders and tendencies, help predict disease risk, help identify expected drug response, and characterize genetic mutations, including those that drive cancer progression.

Our wholly owned subsidiary, ProPhase BioPharma, Inc. (“PBIO”) was formed on June 28, 2022, for the licensing, development and commercialization of novel drugs, dietary supplements and compounds beginning with Equivir (dietary supplement) and Equivir G (Rx). In July 2022, PBIO announced a second licensing agreement for two small molecule PIM kinase inhibitors, Linebacker LB-1 and LB-2, with plans to pursue development and commercialization of LB-1 as a cancer co-therapy.

In January 2023, the Company acquired exclusive rights to the BE-Smart Esophageal Pre-Cancer Diagnostic Screening Test and related intellectual property assets.

Our wholly owned subsidiary, Pharmaloz Manufacturing, Inc. (“PMI”), is a full-service contract manufacturer and private label developer of a broad range of non-GMO, organic and natural-based cough drops and lozenges and OTC drug and dietary supplement products.

We also develop and market dietary supplements under the TK Supplements® brand.

Note 2 - Summary of Significant Accounting Policies

Basis of Presentation

The unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial statements and 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 audited consolidated financial statements, including

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

the notes thereto, appearing in our Annual Report on Form 10-K for the fiscal year ended December 31, ~~2021.~~2022. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial position, consolidated results of operations and other comprehensive loss and consolidated cash flows, for the periods indicated, have been made. The results of operations for the three months ended March 31, ~~2022~~2023 are not necessarily indicative of operating results that may be achieved over the course of the full year.

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

~~Segments~~

~~In accordance with FASB ASC 280, “Segment Reporting” (“ASC 280”), the Company discloses financial and descriptive information about its reportable operating segments.~~

ASC 280 establishes standards for reporting information about operating segments in annual and interim financial statements and requires that companies report financial and descriptive information about their reportable segments based on a management approach. ASC 280 also establishes standards for related disclosures about products and services, geographic areas and major customers.

Operating segments are defined as components of an enterprise that engage in business activities for which separate financial information is available and is evaluated by the Chief Operating Decision Maker (“CODM”), which for the Company is its Chief Executive Officer, in deciding how to allocate resources and assess performance. We maintain two operating segments: diagnostic services (which includes our COVID-19 and other diagnostic testing services) and consumer products (which includes our contract manufacturing, retail customers and personal genomics products and services) (see Note 15 Segment Information).

~~Business and Liquidity Risks and Uncertainties~~

We launched our diagnostic service business in December 2020 and expanded in January 2021 with the opening of our Garden City, New York CLIA accredited laboratory. Our diagnostic service business is and will continue to be influenced by the level of demand for COVID-19 and other diagnostic testing, how long this demand persists, the prices we are able to receive for performing our testing services, our ability to collect payment or reimbursement for our testing services, as well as the availability of COVID-19 testing from other laboratories and the period of time for which we are able to serve as an authorized laboratory offering COVID-19 testing under various Emergency Use Authorizations.

While our revenues increased significantly for the year ended December 31, 2021 and the first quarter of fiscal 2022 as a result of the launch of our diagnostic services business, we will continue to be dependent on both government agency and insurance company reimbursement as well as the prevalence of COVID-19 associated strains.

In March 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), was enacted, providing for reimbursement to healthcare providers for COVID-19 tests provided to uninsured individuals, subject to continued available funding. Approximately 69~~% and~~ 57% of our diagnostic services revenue for the three months ended March 31, 2022 and 2021, respectively was generated from this program for the uninsured. On March 22, 2022, the Health Resources & Services Administration (HRSA) program stopped accepting claims for COVID-19 testing and treatment due to lack of sufficient funds. Despite requests from the Acting Director of the Office of Management and Budget and the White House Coordinator for COVID-19 Response for additional emergency funding for the uninsured program, emergency funding has not been allocated to the HRSA uninsured program as of the financial statement issuance date. We continue to perform testing for uninsured persons and are incurring the accompanying costs. However, as a result of the suspension of the HRSA uninsured program, we did not recognize any revenue related to COVID-19 testing that we performed for uninsured individuals from March 23, 2022 through March 31, 2022. If funding for the HRSA program is reinstituted in the future, we will submit eligible claims for reimbursement to HRSA and record the associated revenues. If the HRSA program remains unfunded and we are unable to submit claims for reimbursement, there could be a material adverse effect on our business and financial condition.

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

In addition, our diagnostic service business is subject to extensive federal, state, and local laws and regulations, all of which are subject to change, as well as laws and regulations governing the submission of claims for payment for our services, such as those relating to: coverage of our services under Medicare, Medicaid and other federal health care programs; the amounts that we may bill for our services; and the party to which we must submit claims. Also, reimbursement policies and requirements for some payers and procedures are ambiguous, which could lead to billing errors and related disputes. There can be no assurance that our efforts to offer and perform COVID-19 or other diagnostic testing will be successful in the future or that the revenue and operating profits from such business will increase or maintain their current level.

We acquired and commenced our personal genomics business in August 2021. This business is and will continue to be influenced by demand for our genetic testing products and services, our marketing and service capabilities, and our ability to comply with applicable regulatory requirements.

~~Our consumer sales are and will continue to be influenced by (i) the timing of acceptance of our TK Supplements~~^® consumer products in the marketplace, and (ii) fluctuations in the timing of purchase and the ultimate level of demand for the OTC healthcare and cold remedy products that we manufacture, which is largely a function of the timing, length and severity of each cold season. Generally, a cold season is defined as the period from September to March when the incidence of the common cold rises as a result of the change in weather and other factors. We generally experience in the first, third and fourth quarter higher levels of net revenues from our contract manufacturing business. Revenues are generally at their lowest levels in the second quarter when customer demand generally declines.

~~For the three months ended March 31, 2022, $20.3~~ ~~million was provided by operating activities. The Company had cash, cash equivalents and marketable securities of $29.4~~ million as of March 31, 2022. Based on management’s current business plans, the Company estimates it will have enough cash and liquidity to finance its operating requirements for at least 12 months from the date of filing these unaudited condensed consolidated financial statements. However, due to the nature of the diagnostic business and the Company’s focus thus far on COVID-19 testing, there are inherent uncertainties associated with managements’ business plan and cash flow projections, particularly if the Company is unable to grow its diagnostic testing business beyond COVID-19 testing services.

The Company’s future capital needs and the adequacy of its available funds will depend on the Company’s ability to achieve sustained profitability from its diagnostic services, the Company’s ability to successfully diversify its diagnostic services revenue streams and the Company’s ability to market and grow its personal genomics business. The Company may be required to raise additional funds through equity or debt securities offerings or strategic collaboration and/or licensing agreements in order to fund operations until it is able to generate enough revenues. Such financing may not be available on acceptable terms, or at all, and the Company’s failure to raise capital when needed could have a material adverse effect on its strategic objectives, results of operations and financial condition.

Use of Estimates

The preparation of condensed consolidated 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 condensed consolidated financial statements and reported amounts of revenues and expenses during the respective reporting periods. Examples include revenue recognition and the impact of the variable consideration of diagnostic test reimbursement rates, the provision for uncollectible receivables and billing errors, allowances, slow moving and/or dated inventory and associated provisions, the potential impairment of long-lived assets, stock based compensation valuations, income tax asset valuations and assumptions related to accrued advertising.

Our estimates and assumptions are based on historical experience, current trends and other factors that management believes to be relevant at the time the condensed consolidated financial statements are prepared. Management reviews the accounting policies, assumptions, estimates and judgments on a quarterly basis. Actual results could differ from those estimates.

~~Cash 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 securities.

~~Restricted Cash~~

~~Restricted cash as of December 31, 2021 includes approximately $250,000~~ held in escrow related to a potential purchase of an additional lab facility. The potential purchase was not consummated, and we are pursuing the return of the escrow, which is in dispute. As of March 31, 2022, we recognized an expense for this balance as the recovery of the funds was no longer considered probable.

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

~~Marketable Debt Securities~~

We have classified our investments in marketable debt securities as available-for-sale and as a current asset. Our investments in marketable debt securities are carried at fair value, with unrealized gains and as a separate component of stockholders’ equity. Realized gains and losses from our marketable debt securities are recorded as interest income (expense). These investments in marketable debt securities carry maturity dates between one and three years from date of purchase.

~~The following is a summary of the components of our marketable debt securities and the underlying fair value input level tier hierarchy (in thousands) (see fair value of financial instruments):~~

~~Summary of Components of Marketable Securities~~

As of March 31, 2022
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. government obligations $ 667 $ 123 $ (44 ) $ 746
Corporate obligations 2,839 - (42 ) 2,797
$ 3,506 $ 123 $ (86 ) $ 3,543

As of December 31, 2021
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. government obligations $ 650 $ 17 $ - $ 667
Corporate obligations 8,304 - (192 ) 8,112
$ 8,954 $ 17 $ (192 ) $ 8,779

~~Marketable Equity Securities~~

Marketable equity securities are recorded at fair value in the consolidated balance sheets. The change in fair value of marketable equity securities is recognized within other non-operating income, net in the consolidated statements of income.

~~On June 25, 2021, we were issued~~ ~~1,260,619~~ ~~common shares (the “Investment Shares”) as an interest payment under our note receivable (see Note 13, Consulting Agreement and Secured Promissory Note Receivable) with a fair value of $315,000~~ ~~at the time of issuance and a fair value of $76,000~~ ~~at December 31, 2021.~~ ~~The investment was classified as a Level 1 financial instrument. We recorded a $76,000~~ ~~decrease in fair value of investment securities within the statement of operations for the three months ended March 31, 2022.~~

~~Accounts Receivable, net~~

Accounts receivable consists primarily of amounts due from government agencies and healthcare insurers. Unbilled accounts receivable relates to the delivery of our diagnostic testing services for which the related billings will occur in a future period, after a patient’s insurance information has been validated, and represent amounts for which we have a right to receive payment. Unbilled accounts receivable is classified as accounts receivable on the consolidated balance sheet. We carry our accounts receivable at the amount of consideration for which we expect to be entitled less allowances. When estimating the allowances for our diagnostics business, the Company pools its receivables based on the following payer types: healthcare insurers and government payers. The Company principally estimates the allowances by pool based on historical collection experience, current economic conditions, government and healthcare insurer payment trends, and the period of time that the receivables have been outstanding. Should a payer’s reimbursement policy change or their credit quality deteriorate, the Company removes the payer from their respective pools and establishes allowances based on the individual risk characteristics of such payer.

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

~~Accounts are written off as uncollectible at the time we determine that collections are unlikely. Accounts receivable, net is comprised of the following (in thousands):~~

~~Schedule of Accounts Receivable Net~~

March 31, 2022 December 31, 2021
Trade accounts receivable $ 24,727 $ 18,520
Unbilled accounts receivable 14,944 23,089
Accounts receivable, gross 39,671 41,609
Less allowances (2,977 ) (3,901 )
Total accounts receivable $ 36,694 $ 37,708

~~Inventory, net~~

Inventory is valued at the lower of cost, determined on a first-in, first-out basis (“FIFO”), or net realizable value. Inventory items are analyzed to determine cost and the net realizable value and appropriate valuation adjustments are established.

~~At March 31, 2022 and December 31, 2021, the components of inventory are as follows (in thousands):~~

~~Schedule of Components of Inventory~~

March 31, December 31,
2022 2021
Diagnostic services testing material $ 3,103 $ 2,989
Raw materials 1,238 1,514
Work in process 476 260
Finished goods 322 272
Inventory $ 5,139 $ 5,035
Inventory valuation reserve (459 ) (435 )
Inventory, net $ 4,680 $ 4,600

~~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 including lab equipment - three to seven years; computer equipment and software - three to five years; and furniture and fixtures - five years.

~~Concentration of Financial Risks~~

Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash investments, marketable debt securities, and 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 March 31, 2022, our cash and cash equivalents and restricted cash balance was $25.8~~ ~~million. Of the total bank balance, $0.9~~ ~~million was covered by federal depository insurance and $24.9~~ ~~million was uninsured at March 31, 2022.~~

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

Accounts receivable subject us to credit risk concentrations from time-to-time. We extend credit to our consumer healthcare product customers based upon an evaluation of the customer’s financial condition and credit history and generally do not require collateral. Our diagnostic services receivable credit risk is based on payer reimbursement experience, which includes government agencies and healthcare insurers, the period the receivables have been outstanding and the historical collection rates. The collectability of the diagnostic services receivables is also directly linked to the quality of our billing processes, which depends on information provided to the payors and meeting their requirements for reimbursement.

~~Leases~~

At the inception of an arrangement, we determine whether the arrangement is or contains a lease based on the unique facts and circumstances present in the arrangement. Most leases with a term greater than one year are recognized on the balance sheet as right-of-use assets and short-term and long-term lease liabilities, as applicable. We have elected not to recognize on the balance sheet leases with terms of 12 months or less. We typically only include an initial lease term in its assessment of a lease arrangement. Options to renew a lease are not included in our assessment unless there is reasonable certainty that we will renew.

Operating lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease payments over the expected remaining lease term. Certain adjustments to the right-of-use asset may be required for items such as incentives received. The interest rate implicit in our leases is typically not readily determinable. As a result, we utilize our incremental borrowing rate, which reflects the fixed rate at which we could borrow on a collateralized basis the amount of the lease payments in the same currency, for a similar term and in a similar economic environment (see Note 12, Leases).

~~The components of a lease should be allocated between lease components (~~~~e.g~~~~., land, building, etc.) and non-lease components (~~~~e.g~~., common area maintenance, consumables, etc.). The fixed and in-substance fixed contract consideration (including any consideration related to non-components) must be allocated based on the respective relative fair values to the lease components and non-lease components.

~~Goodwill and Intangible Assets~~

Goodwill represents the excess of the fair value of the consideration transferred over the fair value of the underlying identifiable assets and liabilities acquired in a business combination. Goodwill and intangible assets deemed to have an indefinite life are not amortized, but instead are assessed for impairment annually. Additionally, if an event or change in circumstances occurs that would more likely than not reduce the fair value of the reporting unit below its carrying value, we would evaluate goodwill at that time.

In testing for goodwill impairment, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, we conclude that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is not required. If we conclude otherwise, we are required to perform the two-step impairment test. The goodwill impairment test is performed at the reporting unit level by comparing the estimated fair value of a reporting unit with its respective carrying value. If the estimated fair value exceeds the carrying value, goodwill at the reporting unit level is not impaired. If the estimated fair value is less than the carrying value, an impairment charge will be recorded to reduce the reporting unit to fair value.

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

Intangible assets deemed to have finite lives are amortized on a straight-line basis over their estimated useful lives, where the useful life is the period over which the asset is expected to contribute directly, or indirectly, to our future cash flows.

Fair Value of Financial Instruments

We measure assets and liabilities at fair value based on expected exit price as defined by the authoritative guidance on fair value measurements, which represents the amount that would be received on the sale date of an asset or paid to transfer a liability, as the case may be, in an orderly transaction between market participants. As such, fair value may be based on assumptions that market participants would use in pricing an asset or liability. The authoritative guidance on fair value measurements establishes a consistent framework for measuring fair value on either a recurring or nonrecurring basis whereby inputs, used in valuation techniques, are assigned a hierarchical level.

The following are the hierarchical levels of inputs to measure fair value:

•

Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

	●	~~Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.~~

	●	Level 2: Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the assets or liabilities; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

	●	Level 3: Unobservable inputs reflecting the Company’s assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.

•

Level 2: Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the assets or liabilities; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

•Level 3: Unobservable inputs reflecting the Company’s assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.

The carrying amounts of our financial assets and liabilities, such as cash, accounts receivable, accounts payable, and unsecured note payable, approximate their fair values because of the short-term nature of these instruments.

We account for our marketable securities at fair value, with the net unrealized gains or losses of marketable debt securities reported as a component of accumulated other comprehensive income or loss and marketable equity securities

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

change in fair value reported on the condensed consolidated ~~statement~~statements of ~~operations.~~operation and comprehensive income (loss). The components of marketable securities are as follows (in thousands):

~~Schedule of Fair Value of Financial Instruments~~

As of March 31, 2022
Level 1 Level 2 Level 3 Total
U.S. government obligations $ - $ 746 $ - $ 746
Corporate obligations - 2,797 - 2,797
$ - $ 3,543 $ - $ 3,543


	As of March 31, 2023
	Level 1		Level 2		Level 3		Total
U.S. government obligations	$	—	$	1,451	$	—	$	1,451
Corporate obligations	4,395		100		—		4,495
	$	4,395	$	1,551	$	—	$	5,946

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

As of December 31, 2021
Level 1 Level 2 Level 3 Total
U.S. government obligations $ - $ 667 $ - $ 667
Corporate obligations - 8,112 - 8,112
Marketable equity securities 76 - - 76
$ 76 $ 8,779 $ - $ 8,855


	As of December 31, 2022
	Level 1		Level 2		Level 3		Total
U.S. government obligations	$	—	$	1,478	$	—	$	1,478
Corporate obligations	5,496		1,354		—		6,850
Marketable equity securities	—		—		—		—
	$	5,496	$	2,832	$	—	$	8,328

There were no transfers of marketable debt securities between Levels 1, 2 or 3 for the three months ended March 31, ~~2022~~2023 and ~~2021.~~

2022.

Goodwill

During the three months ended March 31, 2023, the Company received $0.5 million in connection with terms from an escrow agreement from the purchase of Nebula. The receipt of this escrow payment reduced the excess consideration paid for Nebula and was recorded as a reduction of the Goodwill at the time of receipt.

Revenue Recognition

~~We recognize~~

The Company recognizes revenues in accordance with FASB Accounting Standards Codification ("ASC") 606, Revenues from Contracts with Customers. The Company recognizes revenue that represents the transfer of promised goods or services to customers at an amount that reflects the consideration that is expected to be received in exchange for those goods or services. ~~We recognize~~The Company recognizes revenue when performance obligations with our customers have been satisfied. At contract inception, we evaluate the contract to determine if revenue should be recognized 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.

~~Contract with Customers and Performance Obligations~~

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. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Sales from product shipments to contract manufacturing and retailer customers are recognized at the time ownership is transferred to the customer. Revenue from diagnostic services is recognized when the results are made available to the customer. Revenue from our personal genomics business is recognized when the genetic testing results are provided to the customer. For subscription services associated with our genomic testing, we recognize revenue ratably over the term of the subscription.

~~Transaction Price~~

For contract manufacturing and retail customers, the transaction price is fixed based upon either (i) the terms of a combined master agreement and each related purchase order, or (ii) if there is no master agreement, the price per 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.

Revenue from retail customers is reduced for trade promotions, estimated sales returns and other allowances in the same period as the related sales are recorded. No such allowance is applicable to our contract manufacturing customers. We estimate 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.

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

We do not accept returns from our contract manufacturing customers. Our return policy for retail 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 during which product may be returned. All requests for product returns must be submitted to us for pre-approval. We will not accept return requests pertaining to customer inventory “Overstocking” or “Resets”. We will accept return requests only for products in their 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.

For our diagnostic services business, a revenue transaction is initiated when we receive a requisition order to perform a diagnostic test. The information provided on the requisition form is used to determine the party that will be billed for the testing performed and the expected reimbursement. We provide diagnostic services to a range of customers. In many cases, the customer that orders our services is not responsible for paying for these services. Depending on the billing arrangement and applicable law, the payer may be the patient or a third party, such as a health plan, Medicare or Medicaid program and other government reimbursement programs. We bill the providers at standard price and take into consideration negotiated discounts and anticipated reimbursement remittance adjustments based on the payer portfolio, when revenue is recorded. We use the most expected value method to estimate the transaction price for reimbursements that vary from the listed contract price.

For our personal genomics business, a revenue transaction is initiated by a DNA test kit sale direct to the consumer sales via our website or through online retailers. The kit sales and subscriptions are billed at a standard price and take into consideration any discounts when revenue is recorded.

~~Recognize Revenue When the Company Satisfies a Performance Obligation~~

Recognition for contract manufacturing and retail customers is satisfied at a point in time when the goods are shipped to the customer as (i) we have 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.

For diagnostic services, recognition occurs at the point in time that the results are made available to the customer, which is when the customer benefits from the information contained in the results and obtains control.

For genomic services, we satisfy our product performance obligation at a point in time when the genetic testing results are provided to the customer. For subscriptions services associated with its genomic testing, we satisfy our performance obligation ratably over the subscription period. If the customer does not return the test kit, services cannot be completed by us, potentially resulting in unexercised rights (“breakage”) revenue, including lifetime subscription services. We estimate breakage for the portion of test kits not expected to be returned using an analysis of historical data and consider other factors that could influence customer test kit return behavior. When breakage revenue is recognized on a kit, we recognize breakage on any associated subscription services ratably over the term of the subscription. The Company recognized breakage revenue from aggregate unreturned test kits and subscriptions of $~~0.4~~ ~~million for the three months ended March 31, 2022.~~

~~Contract Balances~~

Deferred revenues primarily consist of amounts that have been billed to or received from customers in advance of revenue recognition and prepayments received from customers in advance of services performed for the R&D work. ~~As of March 31, 2022 and December 31, 2021, we have deferred revenue of $3.1~~ ~~million and $2.9~~ ~~million, respectively. Our new personal genomics business comprised $2.9~~million of the deferred revenue as of March 31, 2022. The deferred revenue balance within the personal genomics business is comprised of kits to be sequenced and subscription services, which have an average life between 12 ~~and~~ 36 ~~months. The remainder of deferred revenue relates to research and development (“R&D”) stability and release testing programs recognized as contract manufacturing revenue.~~

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

~~The following table disaggregates our deferred revenue by recognition period (in thousands):~~

~~Schedule of Deferred Revenue~~

March 31, December 31,
2022 2021
Recognition Period
0-12 Months $ 2,246 $ 2,034
13-24 Months 598 530
Over 24 Months 260 375
Total $ 3,104 $ 2,939

~~Disaggregation of Revenue~~

We disaggregate revenue from contracts with customers into four categories: diagnostic services, contract manufacturing, retail and others, and genomic products and services. We 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 the three months ended March 31, 2022 and 2021 (in thousands):~~

~~Schedule of Disaggregation by Revenue~~

For the three months ended
Revenue by Customer Type March 31, 2022 March 31, 2021
Diagnostic services $ 44,913 $ 12,738
Contract manufacturing 1,154 1,908
Retail and others 546 625
Genomic products and services 918 -
Total revenue, net $ 47,531 $ 15,271

~~Customer Consideration~~

The Company makes payments to certain diagnostic services customers for distinct services that approximate the fair value for those services. Such services include specimen collection, the collection and delivery of insurance and patient information necessary for billing and collection, and logistics services. Consideration associated with specimen collection services is classified in cost of revenues and the remaining costs are classified as diagnostic expenses within operating expenses in the accompanying statement of operations.

~~Sales Tax Exclusion from the Transaction Price~~

We exclude 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~~

~~We account for shipping and handling activities that we perform as activities to fulfill the promise to transfer the good.~~

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

~~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 general and administrative expense, (ii) cooperative incentive promotions and coupon program expenses, which are accounted for as part of net revenue, and (iii) free product, which is accounted for as part of cost of revenues. Advertising and incentive promotion expenses incurred for the three months ended March 31, 2022 and 2021 were $~~60,000~~ ~~and $168,000, respectively.~~

~~Stock-Based Compensation~~

The Company accounts for stock-based compensation in accordance with FASB ASC 718, “Compensation - Stock Compensation.” Under the fair value recognition provision of the ASC, stock-based compensation cost is estimated at the grant date based on the fair value of the award. The Company estimates the fair value of stock options and warrants granted using the Black-Scholes-Merton option pricing model and stock grants at their closing reported market value. We recognize all stock-based payments to employees and directors, including grants of stock options, as compensation expense in the condensed consolidated financial statements based on their grant date fair values. The grant date 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. We account for forfeitures as they occur.

Stock and stock options to purchase our common stock have been granted to employees pursuant to the terms of certain agreements and stock option plans (see Note 7, Stockholders’ Equity). Stock options are exercisable during a period determined by us, but in no event later than seven years from the date granted.

~~Research and Development (“R&D”)~~

~~R&D costs are charged to operations in the period incurred. R&D costs incurred for the three months ended March 31, 2022 and 2021 were $35,000and $115,000~~, respectively. R&D costs are principally related to personnel expenses and new product development initiatives and costs associated with our OTC health care products, dietary supplements and validation costs in association with the diagnostic services business.

Income Taxes

The Company recognizes deferred tax liabilities and assets based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities, using enacted tax rates in effect in the years the differences are expected to reverse.

The provision for, or benefit from, income taxes includes deferred taxes resulting from the temporary differences in income for financial and tax purposes using the liability method. Future realization of deferred income tax assets requires sufficient taxable income within the carryback, carryforward period available under tax law. We evaluate, on a quarterly basis whether, based on all available evidence, it is probable that the deferred income tax assets are realizable. Valuation allowances are established when it is more likely than not that the tax benefit of the deferred tax asset will not be

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

realized. The evaluation, as prescribed by ASC ~~740- 10,~~740-10, “Income Taxes,” includes the consideration of all available evidence, both positive and negative, regarding historical operating results including recent years with reported losses, the estimated timing of future reversals of existing taxable temporary differences, estimated future taxable income exclusive of reversing temporary differences and carryforwards, and potential tax planning strategies which may be employed to prevent an operating loss or tax credit carryforward from expiring unused.

The Company accounts for uncertainties in income taxes under the provisions of FASB ASC 740-10-05 (the “Subtopic”). The Subtopic clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. The Subtopic prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Subtopic provides guidance on the de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

Recently Issued Accounting Standards, Adopted

On January 1, 2023, the accounting for convertible debt instruments and convertible preferred stock by removing the existing guidance that requires entities to account for beneficial conversion features and cash conversion features in equity, separately from the host convertible debt or preferred stock. The guidance in ASC 470-20 applies to convertible instruments for which the embedded conversion features are not required to be bifurcated from the host contract and accounted for as derivatives. In addition, the amendments revise the scope exception from derivative accounting in ASC 815-40 for freestanding financial instruments and embedded features that are both indexed to the issuer’s own stock and classified in stockholders’ equity, by removing certain criteria required for equity classification. These amendments are expected to result in more freestanding financial instruments qualifying for equity classification (and, therefore, not accounted for as derivatives), as well as fewer embedded features requiring separate accounting from the host contract. The amendments in ASU 2020-06 further revise the guidance in ASC 260, ~~Earnings Per Share~~, to require entities to calculate diluted earnings per share (EPS) for convertible instruments by using the if-converted method. In addition, entities must presume share settlement for purposes of calculating diluted EPS when an instrument may be settled in cash or shares. The amendments in ASU 2020-06 are effective for public entities, excluding smaller reporting companies, for fiscal years beginning after December 15, 2021. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020. The adoption of ASU 2020-06 did not have a material impact on the Company’s condensed consolidated financial statements or disclosures.

In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40). This ASU reduces diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (for example, warrants) that remain equity classified after modification or exchange. This ASU provides guidance for a modification or an exchange of a freestanding equity-classified written call option that is not within the scope of another Topic. It specifically addresses: (1) how an entity should treat a modification of the terms or conditions or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange; (2) how an entity should measure the effect of a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange; and (3) how an entity should recognize the effect of a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange. This ASU will be effective for all entities for fiscal years beginning after December 15, 2021. An entity should apply the amendments prospectively to modifications or exchanges occurring on or after the effective date of the amendments. Early adoption is permitted, including adoption in an interim period. The adoption of ASU 2021-04 did not have a material impact on the Company’s condensed consolidated financial statements or disclosures.

~~Recently Issued Accounting Standards, Not Yet Adopted~~

~~In September 2016, the FASB issued~~Company adopted ASU 2016-13, ~~Financial~~“Financial Instruments - Credit Losses (Topic 326)~~. The~~ : Measurement of Credit Losses on Financial Instruments” (“ASU ~~sets forth a “current~~2016-13”) ASU 2016-13 requires an impairment model (known as the current expected credit ~~loss” (CECL) model which requires~~loss (“CECL”) model) that is based on expected losses rather than incurred losses. Under the ~~Company to measure all~~new guidance, each reporting entity should estimate an allowance for expected credit losses, ~~for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts.~~which is intended to result in more timely recognition of losses. This model replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost, accounts receivable and available for sale debt securities and applies to some off-balance sheet credit exposures. In February 2020, the FASB issued ASU 2020-02, Financial Instruments - Credit Losses (Topic 326), which amends the effective date of the original pronouncement for smaller reporting companies. ASU 2016-13 and its amendments will be effective for the Company for interim and annual periods in fiscal years beginning after December 15, 2022. ~~We are currently assessing the impact of the~~The adoption of ~~this~~ ASU 2016-13 did not have a material impact on ~~our~~the Company's consolidated financial statements.

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

Note 3 - Asset Acquisition

~~Business Acquisition~~

Stella Diagnostics - Asset Purchase Agreement

~~Nebula Acquisition~~

On ~~August 10, 2021 (the “Effective Date”),~~December 15, 2022, the Company ~~and its wholly owned subsidiary, ProPhase Precision,~~ entered into ~~and closed a Stock~~an Asset Purchase Agreement (the ~~“Nebula Stock~~“Stella Purchase Agreement”), with ~~Nebula, each of~~Stella Diagnostics Inc. (“Stella”) and Stella DX, LLC (“Stella DX” and, together with Stella, the ~~stockholders of Nebula (the “Seller Parties”~~“Stella Sellers”), ~~and Kamal Obbad, as Seller Party Representative. Pursuant~~pursuant to which, on January 3, 2023, the ~~terms of the Nebula Stock Purchase Agreement, ProPhase Precision acquired~~Company purchased all of the assets, rights and interests of the Stella Sellers and their affiliates pertaining to the Stella Sellers’ BE-Smart Esophageal Pre-Cancer Diagnostic Screening Test and certain clinical assets, including all intellectual property rights (the “Stella Purchased Assets”).

As consideration for the Stella Purchased Assets, at closing, the Company (i) paid to the Stella Sellers $3.5 million in cash, minus (a) the Secured Note Amount of $0.5 million, (b) the Liability Payoff Amount of $1.6 million and (c) the Promissory Note Payoff Amount of $0.4 million, and (ii) issued ~~and outstanding~~to Stella DX 100,000 shares of common stock, ~~of Nebula from the Seller Parties, for an aggregate purchase price of approximately $14.3~~ ~~million, subject to post-closing adjustments (the “Nebula Acquisition”). A portion of the purchase price equal to $3.6~~ million was paid in shares of the Company’s common stock to certain Seller Parties and noteholders of Nebula, based on their election to receive shares of the Company’s common stock in lieu of cash, which shares were valued at a pricepar value $0.0005 per share, of $~~7.46, which is equal to~~ the ~~average closing price~~Company at a value of $10.00 per share. Total consideration paid was $4.6 million. The Secured Note Amount of $0.5 million and the Promissory Note Payoff of $0.4 million were paid in 2022. The balance of the ~~Company’s common stock on Nasdaq for the five trading days preceding the signing of the Nebula Stock Purchase Agreement. A portion of the purchase price equal to $1,080,000~~ ~~(the “Escrow Amount”) is being held in escrow by Citibank, N.A. (the “Escrow Agent”) until~~ ~~February 23, 2023~~(“Escrow Termination Date”), pursuant to the terms and conditions of an escrow agreement entered into with the Escrow Agent, as security for the indemnification obligations of the Seller Parties. At the Escrow Termination Date, the remaining amount, if any, of the Escrow Amount, less any amount reasonably necessary to pay any claim with respect to which a notice of claim has been timely and properly given, will be delivered to the Seller Parties, as applicable.

In connection with the Nebula Acquisition, ProPhase Precision entered into an employment agreement with Kamal Obbad, the Chief Executive Officer of Nebula, on the Effective Date, pursuant to which Mr. Obbad serves as Senior Vice President, Director of Sales and Marketing of ProPhase Precision. As a condition to the employment agreement, Mr. Obbadconsideration was ~~awarded a stock option to purchase~~ ~~250,000~~ ~~shares of Company common stock~~paid at ~~an exercise price equal to $7.67~~ ~~per share, the~~ closing ~~price of the Company common stock on the Effective Date (see Note 7, Stockholders’ Equity).~~

~~Based on the valuation, the total consideration of $12.7~~ ~~million, which is net of $1.6~~ ~~million in cash acquired, has been allocated to assets acquired and liabilities assumed based on their respective fair values as follows (in thousands):~~

~~Schedule of Assets Acquired and Liabilities Assumed~~

Account Amount
Short term investments $ 1,800
Accounts receivable 171
Inventory 133
Prepaid and other current assets 379
Definite-lived intangible assets 10,990
Total assets acquired 13,473
Accounts payable (805 )
Accrued expenses and other current liabilities (43 )
Deferred revenue (2,391 )
Note payable (81 )
Deferred tax liability (1,925 )
Total liabilities assumed (5,245 )
Net identifiable assets acquired 8,228
Goodwill 4,446
Total consideration, net of cash acquired (1) $ 12,674

~~(1)~~

~~Net of $1.6~~ ~~million cash acquired.~~

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

Goodwill represents the excess of the purchase price over the net identifiable tangible and intangible assets acquired. The Company believes the goodwill related to the acquisition was a result of the expected synergies to be realized from combining operations and is not deductible for income tax purposes. The preliminary purchase price allocation is adjusted, as necessary, up to one year after the acquisition closing date if management obtains more information regarding asset valuations and liabilities assumed.

~~The intangible assets identified in conjunction with the Nebula Acquisition are as follows (in thousands):~~

~~Schedule of Intangible Assets Acquisition~~

Gross Carrying Value Estimated Useful Life (in years)
Trade names $ 5,550 15
Proprietary intellectual property 4,260 5
Customer relationships 1,180 1
Total $ 10,990

~~Note 4 –~~ ~~Goodwill and Acquired Intangible Assets~~

~~Goodwill~~

~~There were no changes in goodwill for~~during the three months ended March 31, ~~2022.~~

2023.

In addition to the consideration paid at closing, the Company will issue shares of common stock valued at $2.0 million (the “Milestone Stock”) to the Stella Sellers upon a Commercialization Event (as defined in the Stella Purchase Agreement). The Milestone Stock was recorded at closing as a non-current liability at its fair value of $2.0 million and will be marked to market until settlement through other income or expense in the consolidated statements of operations. Also, the Company is required to pay to the Stella Sellers for each of the seven calendar years during the seven year period commencing on the first day of the calendar year following the date of the Commercialization Event, a non-refundable, non-creditable royalty of 5% of the Adjusted Gross Margin (as defined in the Stella Purchase Agreement) for such Annual Period.

The asset purchase does not qualify as a business combination under FASB ASC 805,

Business Combinations, and has therefore been accounted for as an asset acquisition. In connection with the Stella Purchased Assets, the Company incurred $0.2 million in transaction costs, which were capitalized into the purchase price of the Stella Purchased Assets. The total purchase price for the Stella Purchased Assets was $6.8 million, which was allocated to the proprietary technology intangible asset acquired. The Company is amortizing the acquired intangible asset on a straight-line basis over its estimated useful life of five years.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 4 - Intangible Assets, Net

During the three months ended March 31, 2023, the Company acquired intangible assets of $6.8 million included with proprietary intellectual property, in connection with the acquisition of the Stella Purchased Assets. See Note 3.

Intangible assets as of March 31, ~~2022~~2023 and December 31, ~~2021~~2022 consisted of the following (in thousands):

~~Schedule of Intangible Assets~~

March 31,
2022

December 31,
2021

Estimated Useful
Life (in years)
Trade names $ 5,550 $ 5,550 15
Proprietary intellectual property 4,260 4,260 5
Customer relationships 1,180 1,180 1
CLIA license 1,307 1,307 3
Total intangible assets, gross 12,297 12,297
Less: accumulated amortization (2,154 ) (1,445 )
Total intangible assets, net $ 10,143 $ 10,852


	March 31, 2023		December 31, 2022		Estimated Useful Life (in years)
Trade names	$	5,550	$	5,550	15
Proprietary intellectual property	11,063		4,260		5
Customer relationships	1,180		1,180		1
CLIA license	1,307		1,307		3
	19,100		12,297
Less: accumulated amortization	(4,576)		(3,822)
Total intangible assets, net	$	14,524	$	8,475

Amortization expense for acquired intangible assets was $~~709,000~~ $754,000 and $~~109,000~~ $709,000 during the three months ended March 31, ~~2022~~2023 and ~~2021,~~2022, respectively. The estimated future amortization expense of acquired intangible assets as of March 31, ~~2022~~2023 is as follows (in thousands):

~~Schedule of Estimated Future Amortization Expense of Acquired Intangible Assets~~

Remaining periods ended December 31, 2022 $ 1,669
Year ended December 31, 2023 1,585
Year ended December 31, 2024 1,222
Year ended December 31, 2025 1,222
Year ended December 31, 2026 890
Thereafter 3,555
Total intangible assets, net $ 10,143


Remaining periods in the year ended December 31, 2023	$	2,191
Year ended December 31, 2024	2,583
Year ended December 31, 2025	2,583
Year ended December 31, 2026	2,251
Year ended December 31, 2027	1,731
Thereafter	3,185
	$	14,524

Note 5 - ~~Property, Plant and Equipment~~

~~The components of property, plant and equipment are as follows (in thousands):~~

~~Schedule of Property, Plant and Equipment~~

March 31,
2022

December 31,
2021
Estimated Useful Life
Land $ 352 $ 352
Building improvements 1,729 1,729 10-39 years
Machinery 4,740 4,740 3-7 years
Lab equipment 4,936 4,330 3-7 years
Computer equipment 1,589 1,211 3-5 years
Furniture and fixtures 468 468 5 years
Property, Plant and Equipment, Gross 13,814 12,830
Less: accumulated depreciation (7,374 ) (6,883 )
Total property, plant and equipment, net $ 6,440 $ 5,947

~~Depreciation expense incurred for the three months ended March 31, 2022 and 2021 was $491,000~~ ~~and $428,000, respectively.~~

~~Note 6 -Unsecured Convertible~~-Unsecured Promissory Notes Payable

2023 Unsecured Promissory Note Payable

On January 26, 2023, the Company issued an unsecured promissory note (the “2023 Note”) and guaranty for an aggregate principal amount of $7.6 million. The 2023 Note is due and payable on January 27, 2026, the third anniversary of the date on which the 2023 Note was funded (the “Closing Date”), and accrues interest at a rate of 10% per year from the Closing Date, payable on a quarterly basis, until the 2023 Note is repaid in full. The Company has the right to prepay the 2023 Note at any time after the Closing Date and prior to the maturity date without premium or penalty upon providing seven days’ written notice to the note holder. Repayment of the 2023 Note has been guaranteed by the Company’s wholly-owned subsidiary, Pharmaloz Manufacturing, Inc. In addition to the 2023 Note, the Company issued warrants to purchase 76,000 shares of the Company's common stock at an exercise price of $9.00 for a term of 5 year, vesting immediately. The warrants were valued at $400,000 fair value,using the Black-Scholes option pricing model to calculate the grant date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 81.5%, risk free interest rate of 3.62% and expected warrant life of 5 years. The relative fair value of the warrant was $380,000 and was recorded as a discount to the note payable in accordance with FASB ASC 835-30-25, Recognition, and is being accreted over the term of the note payable for financial statement purposes. As of March 31, 2023, the unpaid principal balance of the 2023 Note was $7.2 million, net of debt discount of $0.4 million.

2020 Unsecured Convertible Notes Payable

On September 15, 2020,~~, we~~ the Company issued two unsecured, partially convertible, promissory notes (the “September 2020 Notes”) for an aggregate principal amount of $10 $10 million to two investors (collectively, the “Lenders”).

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

On February 28, 2022, wethe Company entered into a letter agreement (the “Letter Agreement”) with one of the Lenders providing for the payoff of its September 2020 Note in the principal amount of $~~2,000,000~~.

$2,000,000.

Pursuant to the terms of the Letter Agreement, (i) the Lender converted $~~600,000~~$600,000 of the principal amount due to him under his September 2020 Note into 200,000 shares of Company common stock (the “Conversion Shares”) at a price of $~~3.00~~$3.00 per share as provided for under the terms of the September 2020 Note (the “Conversion”), (ii) the Company paid to the Lender $~~1,440,548~~$1,440,548 in cash, representing $~~1,400,000~~$1,400,000 of the remaining principal under the September 2020 Note following the Conversion plus $~~40,548~~$40,548 in accrued and outstanding interest under the September 2020 Note, and (iii) the Company repurchased the Conversion Shares at a price of $~~5.75~~$5.75 per share for an aggregate amount of $~~1,150,000~~$1,150,000 (for a total aggregate payment to the Lender of $~~2,590,548~~)$2,590,548).

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

The September 2020 Note that remains outstanding as of March 31, ~~2022~~2023 is due and payable on September 15, 2023 and accrues interest at a rate of 10%10% per year from the closing date, payable on a quarterly basis, until the September 2020 Note is repaid in full. ~~We have~~At March 31, 2023 and 2022, the right to prepay the outstanding September 2020 Note at any time after the 13-month anniversary of the initial issuance date after providing written notice to the Lender and may prepay the September 2020 Note prior to such time with the consent of the Lender. The Lender has the right, at any time, and from time to time, on and after the 13-month anniversary of the initial issuance date to convert up to an aggregate~~of $3.0~~ ~~million~~unpaid balance of the September 2020 ~~Note into common stock of the Company at a conversion price of $3.00~~ ~~per share. Repayment of the September 2020 Note has been guaranteed by our wholly owned subsidiary, PMI.~~

~~The September 2020 Note contains customary events of default. If a default occurs~~Notes was $2.4 million and is not cured within the applicable cure period or is not waived, any outstanding obligations under the September 2020 Note may be accelerated. The September 2020 Note also contain certain restrictive covenants which, among other things, restrict our ability to create, incur, assume or permit to exist, directly or indirectly, any lien (other than certain permitted liens described in the September 2020 Note) securing any indebtedness of the Company, and prohibits us from distributing or reinvesting the proceeds from any divestment of assets (other than in the ordinary course) without the prior approval of the Lender.

$8.0 million, respectively.

For the three months ended March 31, ~~2022~~2023 and ~~2021, we incurred $233,000~~ ~~and $251,000, respectively, in~~2022, interest expense, ~~related to the September 2020 Notes.~~

including accretion of debt discount was $215,000 and $233,000, respectively.

Note 76 - Stockholders’ Equity

Our authorized capital stock consists of 50 million shares of common stock, $~~0.0005~~$0.0005 par value, and ~~1000000~~one million shares of preferred stock, $~~0.0005~~$0.0005 par value.

Preferred Stock

The preferred stock authorized under our certificate of incorporation may be issued from time to time in one or more series. As of March 31, ~~2022~~2023 and December 31, ~~2021,~~ 02022, no shares of preferred stock have been issued.

Common Stock Dividends

No dividends have been declared during the three months ended March 31, 2023.

On February 14, 2022, the board of directors of the Company declared a special cash dividend of $~~0.30~~$0.30 per share on the Company’s common stock, paid on March 10, 2022, in the amount of $~~4.6~~$4.6 million to holders of record of the Company’s common stock on March 1, 2022.

Common Stock

Stock Repurchase Program

On March 15, 2023, the Company announced that its board of directors had approved a new stock repurchase program. Under the stock repurchase program, the Company is authorized to repurchase up to $6.0 million of its outstanding shares of common stock from time to time, over a six-month period. The number of shares to be repurchased and the timing of the repurchases, if any, will depend on a number of factors, including, but not limited to, price, trading volume and general market conditions, along with the Company’s working capital requirements and general business conditions. The board of directors will re-evaluate the program from time to time and may authorize adjustments to its terms

Following the Commencement Date (as defined in the stock repurchase agreement), and for a period of six months thereafter, repurchases may be made through open market transactions (based on prevailing market prices), privately negotiated transactions, block trades, or any combination thereof, in accordance with applicable federal securities laws, including Rule 10b-18 of the Securities Exchange Act of 1934, as amended.

There were 63,616 shares repurchased under this new program during the three months ended March 31, 2023.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

~~Common Stock~~

~~Stock Repurchase Program~~

On September 8, 2021, the board of directors (the “Board”) approved a stock repurchase program under which the Company was authorized to repurchase up to $~~6.0~~ $6.0 million of its outstanding shares of common stock from time to time, over a six-month period.

This stock repurchase program expired on March 30, 2022. During the three months ended March 31, 2022, the Company did not make any common shares repurchase under ~~the~~this stock repurchase program.

The 2022 Directors’ Equity Compensation Plan

On May 19, 2022, the stockholders of the Company approved the 2022 Directors’ Equity Compensation Plan (the “2022 Directors’ Plan”) at the 2022 Annual Meeting of Stockholders of the Company (the “2022 Annual Meeting”). The 2022 Directors’ Plan amended and restated the Company’s Amended and Restated 2010 Directors’ Equity Compensation Plan and provided for an increase in the number of shares reserved for issuance under the plan by 300,000 shares and for the adjustment of the per share exercise price of stock ~~repurchase program expired on~~options granted under the 2022 Plan in the event of any change in the outstanding shares of common stock of the Company as a result of, among other things, any distribution or special dividend to stockholders of shares, cash or other property (other than regular cash dividends).

As of March ~~30, 2022.~~

31, 2023, there were 180,000 shares of common stock available to be issued under the 2022 Directors’ Plan. There were no options issued under this plan during the three months ended March 31, 2023.

The 2010 Directors’ Equity Compensation Plan

On May 20, 2021, the stockholders of the Company approved the Amended and Restated 2010 Directors’ Equity Compensation Plan (the “Amended 2010 Directors’ Plan”) at the 2021 Annual Meeting of Stockholders of the Company (the “2021 Annual Meeting”). The Amended 2010 Directors’ Plan ~~authorizes~~authorized the issuance of up to 775,000 shares of common stock.

At This plan was amended and restated on April 11, 2022 (to become the 2022 Directors' Plan), subject to stockholder approval, which was obtained at the 2022 Annual Meeting.

During the three months ended March 31, 2022, there were ~~425,126~~no stock options issued under the Amended 2010 Directors’ Plan.

The 2022 Equity Compensation Plan

On May 19, 2022, the stockholders of the Company approved the 2022 Equity Compensation Plan (the “2022 Plan”) at the 2022 Annual Meeting. The 2022 Plan amended and restated the Company’s Amended and Restated 2010 Equity Compensation Plan and provided for an increase in the number of shares reserved for issuance under the plan by 1,000,000 shares and for the adjustment of the per share exercise price of stock options granted under the 2022 Plan in the event of any change in the outstanding ~~and~~shares of common stock of the Company as a result of, among other things, any distribution or special dividend to stockholders of shares, cash or other property (other than regular cash dividends).

As of March 31, 2023, there were no803,285 shares of common stock available to be issued under the ~~Amended 2010 Directors’~~2022 Plan.

During the three months ended March 31, 2023, there were 205,000 issued under the 2022 Plan.

The 2010 Equity Compensation Plan

On May 20, 2021, the stockholders of the Company approved the Amended and Restated 2010 Equity Compensation Plan (the “Amended 2010 Plan”) at the 2021 Annual Meeting. The Amended 2010 Plan ~~authorizes~~authorized the issuance of up to 4,900,000 shares of common stock.

~~As of December 31, 2021~~ This plan was amended and restated on April 11, 2022 (to become the 2022 Plan), subject to stockholder approval, which was obtained at the 2022 Annual Meeting.

During the three months ended March 31, 2022, there were ~~2,014,874~~no stock options ~~outstanding and~~ ~~295,785stock options available to be~~ issued under the Amended 2010 Plan. ~~We will recognize an aggregate of approximately $1,684,000~~ ~~of remaining share-based compensation expense related to outstanding stock options over a weighted average period of~~ ~~2.8~~ ~~years.~~

The 2018 Stock Incentive Plan

On April 12, 2018, ~~our~~the Company's stockholders approved the 2018 Stock Incentive Plan (the “2018 Stock Plan”). The 2018 Stock Plan provides for the grant of incentive stock options to eligible employees of the Company, and for the grant of non-statutory stock options to eligible employees, directors and consultants. The 2018 Stock Plan provides that the total number of shares that may be issued pursuant to the 2018 Stock Plan is 2,300,000 shares. At April 12, 2018, all

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

2,300,000 shares ~~have~~had been granted in the form of stock options to Ted Karkus (the “CEO Option”), our Chief Executive Officer. ~~To date, no stock options have been exercised under the 2018 Stock Plan. No share based compensation expense will be recognized in forward periods related to the 2018 Stock Plan.~~

The 2018 Stock Plan ~~requires~~required certain proportionate adjustments to be made to the stock options granted under the 2018 Stock Plan upon the occurrence of certain events, including a special distribution (whether in the form of cash, shares, other securities, or other property) in order to maintain parity. Accordingly, the Compensation Committee of the board of directors, as required by the terms of the 2018 Stock Plan, adjusted the ~~terms~~exercise price of the CEO Option ~~such that~~in connection with each special cash dividend paid by the Company proportionately to the amount of the dividend paid. The final exercise price of the CEO Option was ~~reduced from $3.00~~$0.60 per share ~~to $2.00~~ ~~per share, effective as of September 5, 2018,~~after the ~~date the special $1.00~~latest special cash dividend ~~was~~ paid ~~to stockholders. The exercise price of the CEO Option was further reduced from $2.00~~ ~~to $1.75~~ ~~per share, effective as of January 24, 2019, the date the $0.25~~ ~~special cash dividend was paid to stockholders. The exercise price of the CEO Option was further reduced from $1.75~~ ~~to $1.50~~ ~~per share, effective as of December 12, 2019, the date another $0.25 special cash dividend was paid to stockholders. The exercise price of the CEO Option was further reduced from $1.50~~ ~~to $1.20~~ ~~per share, effective as of~~on June 3, ~~2021,~~2022.

During the ~~date another $0.30~~ ~~special cash dividend was paid~~three months ended March 31, 2023 and 2022, 1,100,000 and 0 stock options were exercised under the 2018 Stock Plan. No share based compensation expense will be recognized in forward periods related to ~~Company’s stockholders. The exercise price of~~ the ~~CEO Option was further reduced from $1.20~~ ~~to $0.90~~ ~~per share, effective as of March 10, 2022, the date another $0.30~~ ~~special cash dividend was paid to Company’s stockholders.~~

2018 Stock Plan.

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

Inducement Option ~~Award~~

~~As part~~Awards

There were no issuances of ~~Nebula Acquisition,~~inducements awards during the Company issued a non-qualified stock option to Kamal Obbad, the Chief Executive Officer of Nebula, as an inducement to his employment with the Company (the “Inducement Award”). The Inducement Award entitles Mr. Obbad to purchase up to ~~250,000~~ ~~shares of the Company’s common stock at an exercise price of $7.67~~ per share, the closing price of the Company’s common stock on the closing date of the Nebula Acquisition. The Inducement Award was granted to Mr. Obbad on the closing date of the Nebula Acquisition. The Inducement Award vested 25~~% on the grant date~~three months ended March 31, 2023 and ~~will vest~~ 25% per year for the next three years subject to Mr. Obbad’s continued employment with the Company. The Inducement Award expires on the seventh anniversary of the grant date. Any portion of the Inducement Award that does not vest and become exercisable will be forfeited for no consideration. The grant date fair value of the Inducement Award was approximately $~~1,128,000~~.

~~During the year ended December 31, 2021, we issued an inducement award to a non-employee to purchase up to~~ ~~100,000~~ ~~shares of the Company’s common stock at an exercise price of $5.76, the closing price of the common stock on the date of grant. The award vests in four equal installments from the date of grant. The award expires on the seventh anniversary of the grant date.~~

2022.

All inducement awards have been granted outside of the Company’s equity compensation plans.

Summary of all option grants

During the three months ended March 31, 2023, the Company granted options to purchase 205,000 shares of the Company’s common stock to various employees and consultants. The options grant date fair value was valued at $0.9 million, using the Black-Scholes option pricing model to calculate the grant-date fair value of the options with the following assumptions: no dividend yield, expected volatility of 80.9%, risk free interest rate of 3.78% and expected warrant life of 4.25 years. The fair value of stock options for employees are expensed over the vesting term in accordance with the terms of the related stock option agreements and are expensed over the terms of the consulting agreement for consultants.

The following table summarizes stock ~~options~~option activity during the three months ended March 31, ~~2022 for the Amended 2010 Plan, the Amended 2010 Directors’ Plan, the 2018 Stock Plan and the Inducement Awards~~2023, (in thousands, except per share data).

~~Schedule~~


	Number of Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)	Total Intrinsic Value
Outstanding as of January 1, 2023	3,952	$	5.36	4.0	$	20,379
Granted	205	6.84		7.0	—
Cashless exercised	(1,348)	0.99		—	—
Forfeited	(38)	2.64		—	—
Outstanding as of March 31, 2023	2,771	$	7.49	5.2	$	3,939
Options vested and exercisable	1,661	$	6.84	4.9	$	3,172

The aggregate intrinsic value is calculated as the difference between the exercise price of ~~Stock Options Activity~~

Number of Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Life
(in years) Total Intrinsic Value
Outstanding as of January 1, 2022 5,110 $ 3.27 3.4 $ 20,820
Forfeited (20 ) 8.99 - -
Outstanding as of March 31, 2022 5,090 $ 3.11 3.2 $ 20,767
Options vested and exercisable 4,069 $ 2.41 2.4 $ 19,398

Asthe underlying options and the closing stock price of $7.62 for the Company’s common stock on March 31, ~~2022, there were~~ ~~5,090,000~~ 2023.

During the three months ended March 31, 2023 certain holders of stock options ~~outstanding and~~ ~~295,785~~ elected to exercise their stock options ~~available~~pursuant to a cashless exercise provision resulting in the net issuance of 603,881 shares of common stock and the return of 744,369 shares to the Company. The Company also made a cash payment of approximately $5.4 million to

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

repurchase 603,881 shares of treasury stock to satisfy tax withholding obligations related to the cashless exercise of these stock options.

Stock Warrants

On January 12, 2023, the Company issued warrants to an advisory firm to purchase 50,000 shares of the Company's common stock at an exercise price of $10.00 for a term of 5 years, vesting immediately. The warrants were valued at 0.3 million fair value,using the Black-Scholes option pricing model to calculate the grant date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 80.9%, risk free interest rate of 3.53% and expected warrant life of 5 years. These warrants will be ~~issued.~~expensed over the 1 year term of the engagement which ends on December 31, 2023.

On January 27, 2023, the Company issued five year warrants to purchase 76,000 shares of the Company's common stock with the unsecured promissory note (see Note 5).

The following table summarizes warrant activity during the three months ended March 31, 2023 (in thousands, except per share data):


	Number of Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)
Outstanding as of January 1, 2023	855	$	8.23	1.9
Granted	126	9.39		4.8
Outstanding as of March 31, 2023	981	$	8.38	1.2
Warrants vested and exercisable	981	$	8.38	1.2

We recognized $0.9 million and $0.5 million of share-based compensation expense during the three months ended March 31, 2023 and 2022, respectively. We will recognize an aggregate of approximately $~~2,746,000~~ $4.7 million of remaining share-based compensation expense related to outstanding stock options over a weighted average period of ~~2.8~~ 3.9 years.

~~Stock Warrants~~

~~The following table summarizes warrant activity during the three months ended March 31, 2022 (in thousands, except per share data):~~

~~Summary of Warrant Activity~~

Number of Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Life
(in years)
Outstanding as of January 1, 2022 855 $ 8.23 1.9
Warrants granted - - -
Outstanding as of March 31, 2022 855 $ 8.23 1.6
Warrants vested and exercisable 855 $ 8.23 1.6

We ~~recognized $~~0 ~~and $105,000~~ ~~of share-based compensation expense during the three months ended March 31, 2022 and 2021, respectively.~~

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

Note ~~8 -~~ ~~Defined Contribution Plans~~

We maintain the ProPhase Labs, Inc. 401(k) Savings and Retirement Plan, a defined contribution plan for our employees. Our contributions to the plan are based on the amount of the employee plan contributions and compensation. Our contributions to the plan in the three months ended March 31, 2022 and 2021 were $~~52,000~~ ~~and $13,000, respectively.~~

~~Note 9~~7 – Income Taxes

We recognize tax assets and liabilities for ~~the~~ future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for net operating loss carryforwards. Management evaluated the deferred tax assets for recoverability using a consistent approach that considers the relative impact of negative and positive evidence, including historical profitability and projections of future reversals of temporary differences and future taxable income. We are required to establish a valuation allowance for deferred tax assets if management determines, based on available evidence at the time the determination is made, that it is not more likely than not that some portion or all of the deferred tax assets will be realized. As of March 31, ~~2022~~2023 the Company has net deferred tax liabilities for federal and combined states jurisdictions compared to net deferred tax assets with a full valuation allowance as of December 31, ~~2021.~~2022. The decrease in deferred tax assets with a corresponding decrease in valuation allowance against those assets as of March 31, ~~2022~~2023 is primarily due to utilization of net operating losses. The Company has net deferred tax assets in other states jurisdictions where we maintain a full valuation allowance. Judgment is required to estimate forecasted future taxable income, which may be impacted by future business developments, actual results, tax initiatives, legislative, and other economic factors. The Company will continue to monitor income levels and potential changes to its operating and tax model, and other legislative or global developments in its determination.

The Company’s effective tax rate for the three months ended March 31, ~~2022~~2023 is ~~21.47~~%1.69% and it is primarily driven by federal tax at 21%21%, state taxes at ~~7.1~~%10.13%, offset by permanent differences, the R&D credit and ~~a decrease in the valuation allowance for federal and combined states jurisdictions. The total~~state deferred tax ~~expense for the three months ended March 31, 2022 is $3.4~~ ~~million and it mostly relates to current federal and combined state taxes.~~

benefits.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

~~Note 10 -~~ ~~Other Current Liabilities~~

~~The following table sets forth the components of other current liabilities at March 31, 2022 and December 31, 2021, respectively (in thousands):~~

~~Schedule of Other Current Liabilities~~

March 31, December 31,
2022 2021
Accrued commissions $ 1,294 $ 1,283
Accrued payroll 50 514
Accrued expenses 356 300
Accrued returns 246 338
Accrued benefits and vacation 50 60
Accrued insurance reimbursement
1,278

-

Total other current liabilities $ 3,274 $ 2,495

Note ~~11 -~~ 8 – Commitments and Contingencies

Manufacturing Agreement

The Company and its wholly owned subsidiary, PMI, entered into a manufacturing agreement (the “Manufacturing Agreement”) with Mylan Consumer Healthcare Inc. (formerly known as Meda Consumer Healthcare Inc.) (“MCH”) and Mylan Inc. (together with MCH, “Mylan” in connection with the asset purchase agreement we entered into with Mylan in 2017. Pursuant to the terms of the Manufacturing Agreement, Mylan (or an affiliate or designee) purchased the inventory of the Company’s Cold-EEZE® brand and product line, and PMI agreed to 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. On May 1, 2021, the Manufacturing Agreement was assigned by Mylan to Nurya Brands, Inc. (“Nurya”) in connection with Nurya’s acquisitions of certain assets from Mylan, including the Cold-EEZE® brand and product line. Unless terminated sooner by the parties, the Manufacturing Agreement ~~will~~was to remain in effect until March 29, 2023. Thereafter, the Manufacturing Agreement ~~may~~could be renewed by Nurya for up to four successive one-year periods by providing notice of its intent to renew not less than 90 days prior to the expiration of the then-current term.

On November 15, 2022, the Company was notified by Nurya of its election to renew the Manufacturing agreement for one year. As a result, the Manufacturing Agreement will remain in effect until March 29, 2024.

License Agreements

Linebacker LB1 and LB2

On July 19, 2022, the Company through its wholly-owned subsidiary ProPhase BioPharma entered into a License Agreement (the “License Agreement”) with Global BioLife, Inc. (the “Licensor”), with an effective date of July 18, 2022 (the “Linebacker Effective Date”), pursuant to which it acquired from Licensor a worldwide exclusive right and license under certain patents identified in the License Agreement (the “Licensed Patents”) and know-how (collectively, the “Licensed IP”) to exploit any compound covered by the Licensed Patents (the “Licensed Compound”), including Linebacker LB1 and LB2, and any product comprising or containing a Licensed Compound (“Licensed Products”) in the treatment of cancer, inflammatory diseases or symptoms, memory-related syndromes, diseases or symptoms including dementia and Alzheimer’s Disease (the “Field”). Under the terms of the License Agreement, the Licensor reserves the right, solely for itself and for GRDG Sciences, LLC (“GRDG”) to use the Licensed Compound and Licensed IP solely for research purposes inside the Field and for any purpose outside the Field.

Under the terms of License Agreement, the Company

is required to pay to Licensor a one-time upfront license fee of $50,000 within 10 days of the Linebacker Effective Date and must pay an additional $900,000 following the achievement of a first Phase 3 study which may be required by FDA for the first Licensed Product and an additional $1 million upon the receipt of regulatory approval of a New Drug Application (NDA) for the first Licensed Product.

~~Future Obligations~~

During the term of the License Agreement, the Company is also required to pay to Licensor 3% royalties on Net Revenue (as defined in the License Agreement) of each Licensed Product, but no less than the minimum royalty of $250,000 of Net Revenue per year minus any royalty payments for any required third party licenses.

Equivir

In March 2023, we commenced patient enrollment in a randomized, placebo-controlled clinical trial of Equivir to evaluate its effect on upper respiratory tract infections. Vedic Lifesciences, a leading clinical research organization, is contracted to conduct the combination prophylactic and therapeutic study, which will be conducted at 12 sites. We ~~have estimated future minimum obligations~~currently anticipate trial completion in the third quarter of 2023 and anticipate launching Equivir (dietary supplement) in the United States toward the end of 2023.

BE-Smart Esophageal Pre-Cancer Diagnostics Screening Test

In March 2023, and in connection with the Asset acquisition of Stella,, we announced a collaboration for the continued development of its BE-Smart Esophageal Pre-Cancer diagnostic screening test. We are pursuing initial

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

commercialization of the BE-Smart test as an ~~executive’s employment agreement over~~LDT (Laboratory Developed Test) and RUO (Research Use Only) for the ~~next five years as~~third quarter of 2023 with full commercialization backed by insurance expected by mid-2024.

In connection with the License Agreement, the Company has incurred approximately $0.2 million in general and administrative expenses that are included in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended March 31, ~~2022, as follows (in thousands):~~

~~Schedule of Estimated Future Minimum Obligations~~

Employment Contracts
Remaining periods in 2022 $ 506
2023 675
2024 675
2025 675
2026 675
Total $ 3,206

2023. No clinical studies have begun under this agreement.

Litigation

In the normal course of our business, we may be named as a defendant in legal proceedings. It is our policy to vigorously defend litigation or to enter into a reasonable settlement where management deems it appropriate.

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

Note ~~12 -~~ 9 – Leases

On October 23, 2020, we completed the acquisition of CPM, which included the acquisition of a 4,000 square foot CLIA accredited laboratory located in Old Bridge, New Jersey, which was owned by CPM (which is now known as ProPhase Diagnostics NJ, Inc.). The lease is for a term of 24 months with a monthly base lease payment of $~~5,950~~.

$5,950.

New York Second Floor Lease

On December 8, 2020, the Company entered into a Lease Agreement (the “NY Second Floor Lease”) with BRG Office L.L.C. and Unit 2 Associates L.L.C. (the “Landlord”), pursuant to which the Company ~~has agreed to lease~~leases certain premises located on the second floor (the ~~“Leased~~“Second Floor Leased Premises”) of 711 Stewart Avenue, Garden City, New York (the “Building”). The Second Floor Leased Premises serve as the Company’s second location and corporate headquarters, offering a wide range of laboratory testing services for diagnosis, screening and evaluation of diseases, including COVID-19 and Respiratory Pathogen Panel Molecular tests.

On June 10, 2022, we entered into a First Amendment to the NY Second Floor Lease (the “Second Floor Lease Amendment”). The Second Floor Lease Amendment amends the NY Second Floor Lease to provide that any uncured default by the Company or any of its affiliate under the NY First Floor Lease (defined below) will constitute a default by the Company under the NY Second Floor Lease.

New York First Floor Lease

On June 10, 2022, the Company entered into a second Lease Agreement (the “NY First Floor Lease”) with Landlord, pursuant to which the Company leases approximately 4,516 sq. feet located on the first floor (the “NY First Floor Leased Premises”) of the Building. As described above, the Company currently leases space on the second floor of the Building. The First Floor Leased Premises will be used to expand the Company’s in-house lab capabilities to include traditional clinical testing across multiple specialty areas and Next Generation Sequencing (NGS) to perform Whole Genome Sequencing (WGS) and an array of genetic diagnostic test offerings for both clinical and research purposes.

The NY First Floor Lease ~~was~~became effective as of ~~December 8, 2020,~~June 10, 2022 and ~~commenced~~will commence upon the date of the Landlord’s substantial completion of certain improvements to the NY First Floor Leased Premises (the “First Floor Commencement Date”), as set forth in ~~January 2021 (the “Commencement Date”) when~~ the ~~facility was made available~~NY First Floor Lease, targeted to ~~us by~~be approximately five months from the ~~landlord.~~execution of the NY First Floor Lease. The initial term of the NY First Floor Lease is 10 ~~years and seven months (the “Initial Term”),~~will expire on July 15, 2031, unless sooner terminated as provided in the NY First Floor Lease. ~~We may extend the term~~As of ~~the NY Lease for one additional option period of five years.~~ ~~We have the option to terminate the NY Lease on the sixth anniversary of the Commencement Date, provided that we give the landlord written notice~~March 31, 2023, lease commencement has not ~~less than nine months and not more than 12 months in advance and that we pay the landlord a termination fee.~~

~~For the first year of the NY Lease, we will pay a base rent of $56,963~~ ~~per month (subject to a seven-month abatement period), with a gradual rental rate increase of~~ ~~2.75% for each 12-month period thereafter in lieu of paying its proportionate share of common area operating expenses, culminating in a monthly base rent of $74,716~~ during the final months of the Initial Term. In addition to the monthly base rent, we are responsible for its proportionate share of real estate tax escalations in accordance with the terms of the NY Lease.

We also have a right of first refusal to lease certain additional space located on the ground floor of the Building containing 4,500 square feet and 4,600 square feet, as more particularly described in the NY Lease. We also have a right of first offer to purchase the Building during the term of the NY Lease.

yet begun.

At March 31, 2023 and December 31, 2022, we had operating lease liabilities for the New York and New Jersey leases of approximately $~~4.8~~$4.5 million and $4.6 million, respectively, and and right of use assets of approximately $~~4.3~~$4.0 million and $4.1 million, respectively, which were included in the condensed consolidated balance sheet.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

The following summarizes quantitative information about our operating leases (amounts in thousands):

~~Summary of Quantitative Information About Operating Leases~~

March 31, 2022 March 31, 2021
For the three months ended
March 31, 2022 March 31, 2021
Operating leases
Operating lease cost $ 204 $ 204
Operating lease expense 204 204
Total rent expense $ 204 $ 204


	For the three months ended
	March 31, 2023		March 31, 2022
Operating leases
Operating lease cost	$	204	$	204
Operating lease expense	204		204
Total rent expense	$	204	$	204

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

Maturities of the Company’s operating leases, excluding short-term leases, are as follows (in thousands):

~~Schedule of Maturity of Operating Leases~~

Remaining Periods Ended December 31, 2022 $ 580
Year Ended December 31, 2023 738
Year Ended December 31, 2024 747
Year Ended December 31, 2025 768
Year Ended December 31, 2026 783
Thereafter 3,876
Total 7,492
Less present value discount (2,704 )
Operating lease liabilities $ 4,788

~~Note 13 -~~ ~~Consulting Agreement and Secured Promissory Note Receivable~~

~~Promissory Note and Security Agreement~~

~~On September 25, 2020 (the “Restatement Effective Date”), we entered into the Secured Note with a company consulting for us (“the Consultant”), pursuant to which we loaned $3.0~~ ~~million to the Consultant (inclusive of $1.0~~ ~~million in the aggregate previously loaned to the Consultant, as described below).~~

~~The Secured Note amended and restated in its entirety (i) that certain Promissory Note and Security Agreement, dated July 21, 2020 (the “Original July 21 Note”), pursuant to which we loaned $750,000~~ to the Consultant and (ii) that certain Promissory Note and Security Agreement, dated July 29, 2020 (the “Original July 29 Note”, and, together with the Original July 21 Note, the “Original Notes”), pursuant to which we loaned $~~250,000~~ ~~to the Consultant.~~

Commencing after September 1, 2021, in addition to payments of interest, the Consultant is also required to make payments on the principal amount of the loan equal to 1/36 of the then outstanding principal amount.

28
Remaining periods in the year ended December 31, 2023	$	659
Year Ended December 31, 2024	747
Year Ended December 31, 2025	768
Year Ended December 31, 2026	783
Year Ended December 31, 2027	804
Thereafter	3,071
Total	6,832
Less present value discount	(2,352)
Operating lease liabilities	$	4,480

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

The entire remaining unpaid principal amount of the Secured Note, together with all accrued and unpaid interest thereon and all other amounts payable under the Secured Note, will be due and payable, if not sooner paid, on September 30, 2022.

The Secured Note contains customary events of default. If a default occurs and is not cured within the applicable cure period or is not waived, any outstanding obligations under the Secured Note may be accelerated.

~~Amendment and Termination Agreement~~

On January 14, 2021, we entered into an Amendment and Termination Agreement (the “Termination Agreement”) with the Consultant pursuant to which the parties amended the Secured Note and terminated the former consulting agreement with the Consultant (the “Consulting Agreement”). Pursuant to the terms of the Termination Agreement, the Company loaned an additional $1 million to the Consultant in consideration for the termination of the Consulting Agreement and termination of the Company’s obligation to pay any additional consulting fees. As a result, the initial principal amount due under the Secured Note was increased from $~~2.75~~ ~~million to $3.75~~ ~~million plus all accrued and unpaid interest arising under the Secured Note through and including January 14, 2021.~~

Under the terms of the Termination Agreement, the Consultant will continue to sell and process its viral test by RT-PCR (together with other viral and other types of tests). Until the Secured Note is paid in full, each COVID-19 Test Kit sold or processed from and after January 14, 2021, and for which payment of at least the specified amount as defined for the test, is received by the Consultant, the Consultant will pay us a specified amount (the “Test Fee”). We received the first payment in the amount of $~~95,000~~ ~~with respect to the Test Fees from January 15 through February 2021. On June 25, 2021, we were issued~~ ~~1,260,619~~ ~~shares of common stock of the Consultant with a fair value of $315,000~~ ~~as an interest payment under the Secured Note in lieu of Test Fees from March through June 2021.~~

Effective September 1, 2021, in addition to the payment of the Test Fees described above, the Consultant is also required to make payments to us in an amount equal to the greater of (x) the Test Fee, or (y) 1/36th of the then outstanding principal amount together with interest thereon. The Company did not receive any payments from the Consultant for either contractual principal or interest.

~~ProPhase Labs, Inc. and Subsidiaries~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

On October 11, 2021, the Company provided the Consultant with a Notice of Default and demanded the Secured Note be paid in full immediately. On January 25, 2022, the Company filed a complaint with the United States District Court for the District of Delaware for judgment against the Consultant for money damages consisting of principal, interest, default interest and other fees and costs. As a result, the Company considered that it is not probable that it will collect all amounts due under the Secured Note and reduced the carrying value of the Secured Note to $0 ~~as of December 31, 2021 with a corresponding charge-off of $3.75~~ ~~million during the year ended December 31, 2021.~~

~~Note 14 -~~ ~~Significant Customer Concentrations~~

~~Revenue for the three months ended March 31, 2022 and 2021 was $47.5~~ ~~million and $15.3~~ ~~million, respectively. Three diagnostic services clients accounted for~~ ~~36.7~~%, ~~21.4%, and~~ ~~11.0% of our revenue for the three months ended March 31, 2022. Two diagnostic services clients accounted for~~ ~~46.1% and~~ ~~31.6~~% of our revenue for the three months ended March 31, 2021. No contract manufacturing customer’s accounted for a significant portion of our revenue for the three month ended March 31, 2022 or 2021. The loss of sales to any of these large customers could have a material adverse effect on our business operations and financial condition.

~~Two diagnostic services payers comprised~~ ~~33.6~~% ~~and~~ ~~26.5% of our total reimbursement receivable balances from government agencies and healthcare issuers at March 31, 2022. Four diagnostic services payers comprised~~ ~~43.0~~%, ~~11.6~~%, ~~10.7% and~~ ~~10.7% of our total reimbursement receivable balances from government agencies and healthcare issuers at December 31, 2021.~~

Currently, we rely on a sole supplier to manufacture our saliva collection kits used by customers who purchase our personal genomics services. Change in the supplier or design of certain of the materials that we rely on, in particular the saliva collection kit, could result in a requirement for additional premarket review from the FDA before making such a change.

Note 1510 - Segment Information

The Company has identified two operating segments, diagnostic services and consumer products, based on the manner in which the Company’s CEO as CODM assesses performance and allocates resources across the organization. The operating segments are organized in a manner that depicts the difference in revenue generating synergies that include the separate processes, profit generation and growth of each segment. The diagnostic services segment provides COVID-19 diagnostic information services to a broad range of customers in the United States, including health plans, third party payers and government organizations. The consumer products segment is engaged in the research, development, manufacture, distribution, marketing and sale of OTC consumer healthcare products and dietary supplements in the United States and also provides personal genomics products and services. The unallocated corporate expenses mainly included professional fees associated with the public company.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

The following table is a summary of segment information for three months ended March 31, ~~2022~~2023 and ~~2021~~2022 (amounts in thousands):

~~Schedule of Segment Information~~

March 31, 2022 March 31, 2021
For the three months ended
March 31, 2022 March 31, 2021
Net revenues
Diagnostic services $ 44,913 $ 12,737
Consumer products 2,618 2,534
Consolidated net revenue 47,531 15,271
Cost of revenue
Diagnostic services 16,702 4,345
Consumer products 2,152 1,999
Consolidated cost of revenue 18,854 6,344
Depreciation and amortization expense
Diagnostic services 576 345
Consumer products 600 3
Total Depreciation and amortization expense 1,176 348
Operating and other expenses 11,591 7,522
Income (loss) from operations, before income taxes
Diagnostic services 20,026 2,839
Consumer products (1,863 ) (35 )
Unallocated corporate (2,253 ) (1,747 )
Total income from operations, before income taxes 15,910 1,057
Income tax expense (3,416 ) -
Total income from operations, after income taxes 12,494 1,057
Net income $ 12,494 $ 1,057


	For the three months ended
	March 31, 2023		March 31, 2022
Net revenues
Diagnostic services	$	14,524	$	44,913
Consumer products	4,779		2,618
Consolidated net revenue	19,303		47,531
Cost of revenue
Diagnostic services	5,222		16,702
Consumer products	3,561		2,152
Consolidated cost of revenue	8,783		18,854
Depreciation and amortization expense
Diagnostic services	931		576
Consumer products	306		600
Total Depreciation and amortization expense	1,237		1,176
Operating and other expenses	8,612		11,591
Income (loss) from operations, before income taxes
Diagnostic services	4,397		20,026
Consumer products	(1,029)		(1,863)
Unallocated corporate	(2,804)		(2,253)
Total income from operations, before income taxes	564		15,910
Income tax expense	14		3,416
Total income (loss) from operations, after income taxes	550		12,494
Net income (loss)	$	550	$	12,494

The following table is a summary of segment information as of March 31, ~~2022~~2023 and December 31, ~~2021~~2022 (amounts in thousands):

March 31,
2022

December 31,
2021

ASSETS
Diagnostic services $ 51,823 $ 51,150
Consumer products 23,378 24,139
Unallocated corporate 24,464 14,006
Total assets $ 99,665 $ 89,295


	March 31, 2023		December 31, 2022
ASSETS
Diagnostic services	$	50,667	$	50,832
Consumer products	23,507		22,080
Unallocated corporate	21,200		14,736
Total assets	$	95,374	$	87,648

Note 1611 - Earnings Per Share

Basic earnings per share (“EPS”) excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or otherwise result in the issuance of common stock that shared in the earnings of the entity. Diluted EPS also utilizes the treasury stock method which prescribes a theoretical buy back of shares from the theoretical proceeds of all options outstanding during the period, and the if-converted method for convertible debt.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

The following is a reconciliation of the weighted average number of common shares outstanding used in calculating basic and diluted net loss per share (in thousands):

~~Schedule of Basic and Diluted Net Loss Per Share~~

March 31, 2022 March 31, 2021
For the three months ended
March 31, 2022 March 31, 2021
Net income - basic $ 12,494 $ 1,057
Interest on unsecured convertible promissory note 232 -
Net income - diluted $ 12,726 $ 1,057

Weighted average shares outstanding - basic 15,486 14,563
Diluted shares- Stock Options 2,232 2,895
Diluted shares- Stock Warrants 222 284
Unsecured convertible promissory note 800 458
Weighted average shares outstanding - diluted 18,740 18,200


	For the three months ended
	March 31, 2023		March 31, 2022
Net income - basic	$	550	$	12,494
Interest on unsecured convertible promissory note	60		232
Net income - diluted	$	610	$	12,726

Weighted average shares outstanding - basic	16,748		15,486
Diluted shares- Stock Options	22		2,232
Diluted shares- Stock Warrants	1,051		222
Unsecured convertible promissory note	240		800
Weighted average shares outstanding - diluted	18,061		18,740

The following table represents the number of securities excluded from the income per share computation as a result of their anti-dilutive effect (in thousands):

~~Schedule~~


	For the three months ended
Anti-dilutive securities	March 31, 2023	March 31, 2022
Common stock purchase warrants	581	455
Stock Options	870	810

Anti-dilutive securities	1,451	1,265

Note 12 - Subsequent Events

On January 30, 2023, the Administration announced that effective May 11, 2023, the federal Public Health Emergency (“PHE”) would expire related to the COVID-19 pandemic. This expiration changes regulatory guidelines around COVID-19 testing including billing codes and reimbursement rates of ~~Anti-dilutive Securities Excluded from the Income Per Share Computation~~

For the three months ended
Anti-dilutive securities March 31, 2022 March 31, 2021
Common stock purchase warrants 455 455
Stock Options 810 -
Anti-dilutive securities 1,265 455

~~Note 17 -~~ ~~Related Parties~~

~~Jason Karkus, Executive Vice President~~in and ~~Co-Chief Operations Officer~~out of ~~ProPhase Diagnostics, is the son of Ted Karkus, the Company’s Chairman and Chief Executive Officer. For the three months ended March 31, 2022 and 2021, Mr. Karkus received compensation of $55,000~~ ~~and $30,000, respectively.~~

~~Note 18 –~~ ~~Subsequent Event~~

~~Appointment of Chief Financial Officer~~

~~On May 9, 2022,~~network laboratories. While the Company ~~announced that has appointed Bill White as Chief Financial Officer of~~is still assessing the impact this may have on our operations and financial performance, it could impact our ability to collect insurance reimbursements and could negatively impact revenues in future periods.

On April 4, 2023, the Company ~~effective May 23, 2022 (the “Effective Date”), replacing Monica Brady, who is currently serving as Chief Financial Officer of~~granted, in the ~~Company. Ms. Brady will remain with the Company~~aggregate, 550,000 stock options to its CEO and ~~continue to serve as the Company’s Chief Accounting Officer, and Chief Financial Officer of the Company’s wholly-owned subsidiary, ProPhase Diagnostics, as of the Effective Date.~~

~~As an inducement to his employment as Chief Financial Officer of the Company, the Compensation Committee granted Mr. White a stock option (the “Option Award”) to purchase up to~~ ~~400,000~~ ~~shares of the Company’s common stock. This award was made in accordance with the employment inducement award exemption provided by Nasdaq Rule 5635(c)(4) and was therefore not awarded~~CFO under the ~~Company’s stockholder approved equity plan. The option award will vest over a four year period,~~2022 Plan with~~12.5% vesting every six months following the Effective Date, and contingent upon the commencement of his employment and continued service through each vesting date. The options have~~ an exercise price of $~~6.74~~ ~~per share,~~$9.00. The options vest over a 5-year period in equal annual installments. The estimated fair value of these options at the ~~closing price~~date of ~~the Company’s common stock on May 9, 2022, and~~grant was $2.7 million, which will be ~~exercisable for a period of seven years.~~

~~Announcement of Cash Dividend~~

expensed over the vesting term.

On ~~May 9, 2022, the board of directors of~~April 6, 2023, the Company ~~declared~~issued 250,000 five year warrants to a ~~special cash dividend~~consultant that vested at the time of $~~0.30~~ ~~per share for stockholders of record as of May 25, 2022, which will approximate $4.6~~ ~~million. On the same date, the Compensation Committee of the board of directors approved~~grant and an adjustment to the stock option granted to Mr. Karkus on February 23, 2018 (the “CEO Option”), as required under the Company’s 2018 Stock Plan, as a consequence of the special cash dividend. The board of directors has adjusted the terms of the CEO Option, such that the exercise price of $9.00. The estimated fair value of these options at the ~~CEO Option~~date of grant were $1.4 million, which will be ~~reduced from $0.90~~ ~~per share~~expensed over the term of the consulting agreement.

On April 7, 2023, the Company replaced, 250,000 stock options to $~~0.60~~ ~~per share, effective as~~an employee under the 2022 Plan with an exercise price of ~~June 3, 2022,~~$10.00, The options vest 25% on the date of grant with the ~~special cash dividend is to~~remaining 75% vesting over a 3-year period in equal annual installments. The estimated fair value of these options at the date of grant was $1.5 million, which will be ~~paid.~~

expensed over the vesting term. The Company will recognize the incremental fair value resulting from the modification of these options.

Table of Contents

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 consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q (“Quarterly Report”) and the audited financial statements and notes thereto as of and for the year ended December 31, 2021 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March ~~31, 2022~~29, 2023 (the ~~“2021~~“2022 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, unless the context otherwise requires.

Forward-Looking Statements

This Quarterly Report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements relate to future events or our future financial performance. 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 also contain forward-looking statements attributable to third parties relating to their estimates regarding the growth of our markets.

You are cautioned that forward-looking statements are not guarantees of performance and are subject to known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance, achievements or prospects 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.

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

	●	~~Our ability to generate revenue and sufficient profits from Respiratory Pathogen Panel (“RPP”) Molecular tests if and when demand for COVID-19 testing decreases or becomes no longer necessary;~~

	●	~~Our ability to collect payment for the tests we deliver;~~

	●	~~Our ability to manage our growth successfully;~~

	●	~~Our ability to compete effectively, including our ability to maintain and increase our markets and/or market share in the markets in which we do business;~~

	●	~~Our dependence on our largest diagnostic services customers;~~

	●	~~Our ability to successfully offer, perform and generate revenues from our personal genomics businesses;~~

	●	Our ability to secure additional capital, when needed to support our diagnostic services business, personal genomics business, manufacturing business and product development and commercialization programs;

	●	~~Potential disruptions to our supply chain or increases to the price of or adulteration of key raw materials or supplies;~~

	●	~~Potential disruptions in our ability to manufacture our products and those of others;~~

	●	~~Seasonal fluctuations in demand for the products and services we provide;~~

	●	~~Our ability to successfully develop and commercialize our existing products and any new products;~~

	●	~~Our ability to attract, retain and motivate our key employees;~~

	●	~~Our ability to protect our proprietary rights;~~

•our ability to manage our growth successfully and to compete effectively;

•

	●	~~Our ability to comply with regulatory requirements applicable to our businesses;~~

	●	~~The complexity of billing for, and collecting revenue for, testing services;~~

	●	~~Our dependence on third parties to provide services critical to our lab diagnostic services business;~~

	●	~~General economic conditions, including as a result of the ongoing COVID-19 pandemic and the war in Ukraine; and~~

	●	~~Our ability to remediate the material weakness in our internal controls over financial reporting and prevent other material weaknesses.~~

potential disruptions to our supply chain, increases in the price of testing supplies, equipment and raw materials need for our businesses, or the adulteration of key testing materials and raw materials needed for our businesses;

•potential product liability claims;

•our ability to secure additional capital, when needed to support our businesses;

•our dependence on key personnel and our ability to attract, retain and motivate our key employees;

•our ability to generate revenue and sufficient profits from Respiratory Pathogen Panel (“RPP”) Molecular tests if and when demand for COVID-19 testing becomes no longer necessary;

•Our ability to collect payment for the tests we deliver and to comply with complex billing requirements;

•Our dependence on our largest diagnostic services customers;

•Our ability to successfully offer, perform and generate revenues from our personal genomics businesses;

•Potential disruptions in our ability to manufacture our products and those of others;

•Seasonal fluctuations in demand for the products and services we provide;

•Risks related to the initiation, cost, timing, progress and results of current and future research and development programs, preclinical studies and clinical trials and our ability to obtain and maintain regulatory approvals;

•Our ability to successfully develop and commercialize our existing products and any new products;

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•Our ability to protect our proprietary rights;

•Our ability to comply with complex regulatory requirements applicable to our businesses;

•Our dependence on third parties to provide services critical to our businesses; and

•General economic conditions, including rising inflation and interest rates.

Given the risks and uncertainties surrounding forward-looking statements, you should not place undue reliance on these statements. You should also consider carefully the statements we make under other sections of this Quarterly Report and in our ~~2021~~2022 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

We are a diversified company that offers a range of services including ~~diagnostic~~genomics testing, ~~genomics~~diagnostic testing and contract manufacturing. We ~~provide traditional CLIA molecular laboratory services, including SARS-CoV-2 (“COVID-19”) testing~~are also focused on licensing, developing and ~~seek to leverage our~~ ~~Clinical Laboratory Improvement Amendments~~ ~~(“CLIA”) accredited laboratory services to provide whole genome sequencing~~commercializing novel drugs, dietary supplements, compounds and ~~research direct to consumers, while building a genomics data base to be used for further research. In addition, we have~~ ~~deep experience with over-the-counter (“OTC”) consumer healthcare products and dietary supplements.~~ diagnostics.

We conduct our operations through two operating segments: diagnostic services and consumer products.

Until late fiscal year 2020, we were engaged primarily in the research, development, manufacture, distribution, marketing and sale of OTC consumer healthcare products and dietary supplements in the United States. This includes the development and marketing of dietary supplements under the TK Supplements® brand. However, commencing in December 2020, we also began offering COVID- 19 and were prepared to validate other RPP Molecular tests through our diagnostic service ~~business, and in~~business. In August 2021 we began offering personal genomics products and ~~services.~~services and in July 2022 we began focusing on the licensing, development and commercialization of novel drugs, dietary supplements, compounds and diagnostics.

Our wholly owned subsidiary, ProPhase Diagnostics, Inc. (“ProPhase Diagnostics”), which was formed on October 9, 2020, offers a broad array of clinical diagnostic and testing services at its CLIA certified laboratories including ~~state-of-the-art~~ polymerase chain reaction (“PCR”) testing for COVID-19. Critical to COVID-19 testing, we provide fast turnaround times for results. We also offer best-in-class rapid antigen ~~and antibody/immunity~~ testing for COVID-19. On October 23, 2020, we completed the acquisition of all of the issued and outstanding shares of capital stock of Confucius Plaza Medical Laboratory Corp. (“CPM”), which owned a 4,000 square foot CLIA accredited laboratory located in Old Bridge, New Jersey for approximately $2.5 million. In December 2020, we expanded our diagnostic service business with the build-out of a second, larger CLIA accredited laboratory in Garden City, New York. Operations at this second facility commenced in January 2021.

On August 10, 2021, we acquired Nebula Genomics, Inc. (“Nebula”), a privately owned personal genomics company, through our new wholly owned subsidiary, ProPhase Precision ~~Medicine. We offer whole genome sequencing and related services through this new subsidiary.~~ Medicine Inc. (“ProPhase Precision”). ProPhase Precision ~~Medicine, Inc.~~ focuses on genomics ~~testing~~sequencing technologies, a comprehensive method for analyzing entire genomes, including the genes and chromosomes in DNA. The data ~~obtained~~obtained from genomic ~~testing~~sequencing can be used to help to identify inherited disorders and tendencies, help predict disease risk, help identify expected drug response, and characterize genetic mutations, including those that drive cancer progression.

Our wholly owned subsidiary, ProPhase BioPharma, Inc. (“PBIO”) was formed on June 28, 2022, for the licensing, development and commercialization of novel drugs, dietary supplements and compounds, beginning with Equivir and Equivir G. PBIO announced a second licensing agreement for two small molecule PIM kinase inhibitors, Linebacker LB-1 and LB-2, in July 2022, with plans to pursue development and commercialization of LB-1 as a cancer co-therapy.

In January 2023, we acquired exclusive rights to the BE-Smart Esophageal Pre-Cancer Diagnostic Screening Test and related intellectual property assets.

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Our diagnostic service business is and will continue to be ~~influenced~~impacted by the level of demand for COVID-19 and other diagnostic testing, how long this demand persists, the price we are able to receive for performing our testing services, our ability to collect payment or reimbursement for our testing services, as well as the availability of COVID-19 testing from other laboratories and the period of time for which we are able to serve as an authorized laboratory offering COVID-19 testing under various Emergency Use Authorizations.

Our personal genomics business is and will continue to be ~~influenced~~impacted by demand for our genetic ~~testing~~sequencing products and services, our marketing and service capabilities, and our ability to comply with applicable regulatory requirements.

Our consumer sales are and will continue to be ~~influenced~~impacted by (i) the timing of acceptance of our TK Supplements® consumer products in the marketplace, and (ii) fluctuations in the timing of purchase and the ultimate level of demand for the OTC healthcare and cold remedy products that we manufacture, which is largely a function of the timing, length and severity of each cold season. Generally, a cold season is defined as the period from September to March when the incidence of the common cold rises as a result of the change in weather and other factors. We generally experience in the first, third and fourth quarter higher levels of net revenues from our contract manufacturing business. Revenues are generally at their lowest levels in the second quarter when customer demand generally declines.

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

While our revenues have increased significantly as a result of our diagnostic services business, we will continue to be dependent on both government agency and insurance company reimbursement as well as the prevalence of COVID-19 associated strains. There can be no assurance that our efforts to offer and perform COVID-19 or other diagnostic testing will continue to be successful and the revenue and operating profits from such business will increase from or maintain their current level.

Results of Operations

Three Months Ended March 31, ~~2022~~2023 as Compared to the Three Months Ended March 31, ~~2021~~

2022

For the three months ended March 31, ~~2022,~~2023, net revenue was ~~$47.5~~$19.3 million as compared to ~~$15.3~~$47.5 million for the three months ended March 31, ~~2021.~~2022. The ~~increase~~decrease in net revenue was the result of a ~~$32.2 million increase~~$30.4 decrease in net revenue from diagnostic services, ~~and an immaterial~~partially offset by a $2.2 million increase in consumer products. The ~~increase~~decrease in net revenue for diagnostic services was due to ~~increased~~decreased COVID-19 testing volumes ~~performed~~compared to the 2022 period as a result of the Omicron variant, which emerged in early 2022. Overall diagnostic testing volume ~~increased~~decreased from ~~113,000 tests in the first quarter of 2021 to~~ 377,000 tests in the first quarter of 2022 to 120,000 tests in the first quarter of 2023, of which ~~60.3%~~69.0% and ~~69.0%~~0% were reimbursed by the HRSA uninsured program, respectively. The average variable consideration received was $121.03 per adjudicated test in the first quarter of 2023 compared to $120.14 per adjudicated test in the first quarter of ~~2022 versus $139.04 per adjudicated test in~~2022.

Cost of revenues for the ~~first quarter~~three months ended March 31, 2023 were $8.8 million, comprised of ~~2021. See “HRSA Funding” section in the Liquidity~~$5.2 million for diagnostic services and ~~Capital Resources management disclosures below~~$3.6 million for ~~additional information.~~

consumer products. Cost of revenues for the three months ended March 31, 2022 were $18.9 million, comprised of $16.7 million for diagnostic services and $2.2 million for consumer products. ~~Cost~~

We realized a gross profit of ~~revenues~~$10.5 million for the three months ended March 31, ~~2021~~ ~~were $6.3 million, comprised of $4.3 million for diagnostic services and $2.0 million for consumer products.~~

~~We realized a gross profit of~~2023 as compared to $28.7 million for the three months ended March 31, ~~2022 as compared to $8.9 million for the three months ended March 31, 2021.~~2022. The ~~increase~~decrease of ~~$19.8~~$18.2 million was comprised of a decrease of $18.9 million in diagnostic services, partially offset by an increase of ~~$19.8~~$0.8 million ~~from diagnostic services offset by an immaterial decrease~~ in consumer products. For the three months ended March 31, ~~2022~~2023 and ~~2021~~2022 we realized an overall gross margin of ~~60.3%~~54.5% and ~~58.5%~~60.3%, respectively. Gross margin for diagnostic services was ~~62.8%~~64.0% and ~~65.9%~~62.8% in the ~~2022~~2023 and ~~2021~~2022 comparable periods, respectively. The ~~decrease~~increase in gross margin was principally due to (i) increased efficiencies in our lab processing, (ii) a decrease in sample collection costs and ~~additional costs for HRSA-related testing for which revenue could not be recognized, partially offset by~~(iii) a decrease in cost of test materials. Gross margin for consumer products was ~~17.8%~~25.5% and ~~21.1%~~17.8% in the ~~2022~~2023 and ~~2021~~2022 comparable periods, respectively. Gross margin for consumer products have historically been influenced by fluctuations in quarter-to-quarter production volume, fixed production costs and related overhead absorption, raw ingredient costs, inventory mark to market write-downs and timing of shipments to customers.

Diagnostic services costs for the three months ended March 31, ~~2022~~2023 were ~~$4.7~~$1.2 million compared to ~~$3.8~~$4.7 million for the three months ended March 31, ~~2021.~~2022. The ~~increase~~decrease of ~~$0.9~~$3.5 million was due to ~~increased~~decreased COVID-19 testing volumes ~~performed~~in 2023 compared to the 2022 period as a result of the Omicron variant, which emerged in ~~early 2022, partially offset by a greater proportion~~late 2021.

Table of ~~costs allocated to cost of revenues as a result of the nature of agreements with network providers.~~Contents

General and administration expenses for the three months ended March 31, ~~2022~~2023 were ~~$7.8~~$8.3 million as compared to ~~$3.8~~$7.8 million for the three months ended March 31, ~~2021.~~2022. The increase of ~~$4.0~~$0.5 million in general and administration expenses was principally related to an increase in personnel expenses and professional fees associated with our diagnostic services business.

Research and development costs for the three months ended March 31, ~~2022~~2023 were ~~$35,000~~$144,000 as compared to ~~$115,000~~$35,000 for the three months ended March 31, ~~2021.~~2022. The ~~decrease~~increase in research and development costs for the three months ended March 31, ~~2022~~2023 as compared to the three months ended March 31, ~~2021~~2022 was principally due to ~~a decrease in personnel expenses associated with our diagnostics services business.~~

increased activities at PBIO. These activities include product research and field testing.

Interest and other income for the three months ended March 31, 2023 and 2022 was $11,000 and ~~2021 was~~ $73,000, ~~and $87,000,~~ respectively. The decrease in interest income for the three months ended March 31, ~~2022~~2023 as compared to the three months ended March 31, ~~2021~~2022 was principally due to the ~~higher~~lower account balance of our investment account that bears interest.

Interest expense for the three months ended March 31, ~~2022~~2023 was ~~$233,000~~$215,000 compared to ~~$251,000~~$233,000 for the three months ended March 31, ~~2021.~~2022. The decrease in interest expense for the three months ended March 31, ~~2022~~2023 as compared to the three months ended March 31, ~~2021~~2022 was principally due to the repayment ~~during~~of notes in the ~~three months ended March 31, 2022~~third quarter of ~~one of the two September 2020 unsecured convertible notes payable that accrued interest at a rate of 10% per year.~~

2022.

As a result of the effects described above, net income ~~from operations~~ for the three months ended March 31, ~~2022~~2023 was ~~$12.5~~$0.6 million, or ~~$0.81~~$0.03 per share, as compared to ~~$1.1~~$12.5 million, or ~~$0.07~~$0.81 per share, for the three months ended March 31, ~~2021.~~2022. Diluted earnings per share for the three months ended March 31, 2023 and 2022 were $0.03 and ~~2021 were~~ $0.68, ~~and $0.06,~~ respectively.

Non-GAAP Financial ~~Measure~~Measures and Reconciliation

In an effort to provide investors with additional information regarding our results of operations as determined by accounting principles generally accepted in the United States of America (“GAAP”), we disclose certain non-GAAP financial measures. The primary non-GAAP financial ~~measure~~measures we disclose are EBITDA and Adjusted EBITDA.

We define EBITDA as net income (loss) before net interest expense, income taxes, depreciation and amortization. Adjusted EBITDA further adjusts EBITDA by excluding acquisition costs, other non-cash items, and other unusual or non-recurring charges (as described in the table below).

Non-GAAP financial measures should not be considered as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP. These non-GAAP financial measures do not reflect a comprehensive system of accounting, differ from GAAP measures with the same names and may differ from non-GAAP financial measures with the same or similar names that are used by other companies. We compute non-GAAP financial measures using the same consistent method from quarter to quarter and year to year. We may consider whether other significant items that arise in the future should be excluded from the non-GAAP financial measures.

We use EBITDA and Adjusted EBITDA internally to evaluate and manage the Company’s operations because we believe they provide useful supplemental information regarding the Company’s ongoing economic performance. We believe that these non-GAAP financial measures provide meaningful supplemental information regarding our operating results primarily because they exclude amounts that are not considered part of ongoing operating results when planning and forecasting and when assessing the performance of the organization. In addition, we believe that non-GAAP financial information is used by analysts and others in the investment community to analyze our historical results and in providing estimates of future performance and that failure to report these non-GAAP measures could result in confusion among analysts and others and create a misplaced perception that our results have ~~chosen to provide this information to investors to enable them to perform more meaningful comparisons~~underperformed or exceeded expectations.

Table of ~~operating results.~~ Contents

The following table sets forth the reconciliations of EBITDA and Adjusted EBITDA excluding other costs to the most comparable GAAP financial measures (in thousands):


	For the three months ended
	March 31, 2023		March 31, 2022
GAAP net income (1)	$	550	$	12,494
Interest, net	204		160
Income tax expense	14		—
Depreciation and amortization	1,292		1,250
EBITDA	2,060		13,904
Share-based compensation expense	947		482

Non-cash rent expense (2)	6		10
Bad debt expense	74		250
Adjusted EBITDA	$	3,087	$	14,646

(1)

For the three months ended
March 31, 2022 March 31, 2021
GAAP net income ⁽¹⁾ $ 12,494 $ 1,057
Interest, net 160 164
Depreciation and amortization 1,250 457
EBITDA 13,904 1,678
Share-based compensation expense 482 428
Non-cash rent expense ⁽²⁾ 10 186
Bad debt expense ⁽³⁾ 250 -
Adjusted EBITDA $ 14,646 $ 2,292

⁽¹⁾We believe that net income (loss) is the financial measure calculated and presented in accordance with GAAP that is most directly comparable to EBITDA and Adjusted EBITDA. EBITDA and Adjusted EBITDA measure the Company’s operating performance without regard to certain expenses. EBITDA and Adjusted EBITDA are not presentations made in accordance with GAAP and the Company’s computation of EBITDA and Adjusted EBITDA may vary from others in the industry. EBITDA and Adjusted EBITDA have important limitations as analytical tools and should not be considered in isolation or as substitutes for analysis of the Company’s results as reported under GAAP.

(2)

⁽²⁾The non-cash portion of rent, which reflects the extent to which our GAAP rent expense recognized exceeds (or is less than) our cash rent payments. For newer leases, our rent expense recognized typically exceeds our cash rent payments, while for more mature leases, rent expense recognized is typically less than our cash rent payments.

⁽³⁾~~Full allowance reserved related to restricted cash.~~

Liquidity and Capital Resources

Our aggregate cash and cash equivalents ~~and restricted cash~~ as of March 31, ~~2022~~2023 were ~~$25.8~~$9.6 million as compared to ~~$8.7~~$9.1 million at December 31, ~~2021.~~2022. Our working capital was ~~$52.8~~42.8 million and ~~$45.8~~$44.8 million as of March 31, ~~2022~~2023 and December 31, ~~2021,~~2022, respectively. The increase of ~~$17.1~~$0.5 million in our cash and cash equivalents ~~and restricted cash~~ for the three months ended March 31, ~~2022~~2023 was principally due to ~~our~~the proceeds from the sale of marketable debt securities of ~~$5.3~~$1.3 million, proceeds issuance of notes payable of $7.6 million, and ~~$20.3~~$0.5 million cash provided by operating activities, offset by (i) ~~purchases~~the asset purchase of ~~marketable securities~~Stella of ~~$0.3~~$2.9 million, (ii) ~~cash dividend payments of $4.6 million, (iii) repayment of note payable of $1.4 million, (iv)~~ repurchase of common shares for ~~$1.2~~payment of statutory taxes due on cashless exercise of options for $5.4 million, (iii) repurchase of common shares for $0.5 million and ~~(v)~~(iii) capital expenditures of ~~$1.1~~$0.5 million.

To date the principal sources of capital to fund our operations have been from diagnostic services, genomics sequencing, product sales, net proceeds from the offering of equity securities, and issuances of promissory notes. Based on management’s current business plans, the Company estimates it will have enough cash and liquidity to finance its operating requirements for at least 12 months from the date of filing these unaudited condensed consolidated financial statements. However, due to the nature of the diagnostic business and the Company’s focus thus far on COVID-19 testing, there are inherent uncertainties associated with managements’ business plan and cash flow projections, particularly if the Company is unable to grow its diagnostic testing business beyond COVID-19 testing services. ~~See “HRSA Funding” below.~~

COVID-19

The COVID-19 pandemic has not had a material adverse impact on our business to date. We experienced higher than normal net revenue for the year ended December 31, 2021 and ~~three~~nine months ended ~~March 31,~~September 30, 2022, primarily as a result of revenue from our diagnostic services business, which offers COVID-19 testing. There can be no assurance that demand for our COVID-19 testing services will continue to exist in the future due to the widespread and effective vaccination of a majority of Americans against COVID-19 and successful containment efforts. If there is no demand for our COVID-19 testing services, and we are unable to generate sufficient profits from other RPP Molecular tests, our business could be materially adversely affected.

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There are still numerous uncertainties associated with the COVID-19 pandemic, including ~~the efficacy of the vaccines that have been developed to treat the virus and~~ their ability to protect against new strains of the virus, people’s willingness to receive a vaccine, possible resurgences of the coronavirus and/or new strains of the virus, the extent and duration of protective and preventative measures that may be adopted by local, state and/or the federal government in the future as a result of future outbreaks, including business closures, the ongoing impact of COVID-19 on the U.S. and world economy and consumer confidence, and various other uncertainties all of which could negatively impact our Company as a whole.

The COVID-19 pandemic has had a negative impact on the global capital markets and economies worldwide and could ultimately have a material adverse impact on our ability to raise capital needed to develop and commercialize products.

HRSA Funding

In March 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted, providing for reimbursement to healthcare providers for COVID-19 tests provided to uninsured individuals, subject to continued available funding. Approximately ~~69%~~0% and ~~57%~~69.0% of our diagnostic services revenue for the three months ended March 31, ~~2022~~2023 and ~~2021,~~2022, respectively, was generated from this program for the uninsured. On March 22, 2022, the Health Resources & Services Administration (“HRSA”) uninsured program stopped accepting claims for COVID-19 testing and treatment due to lack of sufficient funds. Despite requests from the Acting Director of the Office of Management and Budget and the White House Coordinator for COVID-19 Response for additional emergency funding for the uninsured program, emergency funding has not been allocated to the HRSA uninsured program. We continue to perform testing for uninsured persons and are incurring the accompanying costs. ~~However, as a result of~~

On January 30, 2023, the ~~suspension of~~Administration announced that effective May 11, 2023, the ~~HRSA uninsured program, we did not recognize $4.3 million in revenues~~federal Public Health Emergency (“PHE”) would expire related to the COVID-19 pandemic. This expiration changes regulatory guidelines around COVID-19 testing ~~that we performed for uninsured individuals from March 23, 2022 through March 31, 2022. If funding for~~including billing codes and reimbursement rates of in and out of network laboratories. While the ~~HRSA program~~Company is ~~reinstituted, we will submit eligible claims for reimbursement to HRSA and record~~still assessing the ~~associated revenues. If the HRSA program remains unfunded and we are unable to submit claims for reimbursement, there could be a material adverse effect~~impact this may have on our ~~business~~operations and financial ~~condition.~~

performance, it could impact our ability to collect insurance reimbursements and could negatively impact revenues in future periods.

At-the-Market Facility

On December 28, 2021, we entered into a Sales Agreement (the “Sales Agreement”) with ThinkEquity LLC (the “Sales Agent”), pursuant to which we may offer and sell, from time to time through the Sales Agent, shares of our common stock having an aggregate offering price of up to $100,000,000, subject to the terms and conditions of the Sales Agreement. We are not obligated to make any sales of shares under the Sales Agreement.

We will pay the Sales Agent a fixed commission rate of 2.0% of the aggregate gross proceeds from the sale of any shares pursuant to the Sales Agreement and have agreed to provide the Sales Agent with customary indemnification and contribution rights. We also agreed to reimburse the actual out-of-pocket accountable expenses of the Sales Agent up to $60,000 (of which a $25,000 advance was paid on December 7, 2021).

Additionally, we will pay to H.C. Wainwright & Co. (“Wainwright”), a fee equal to 1.0% of the gross proceeds of the sales price of all the shares sold under the Sales Agreement, pursuant to a separate financial services agreement with Wainwright. Wainwright is not a sales agent under the Sales Agreement.

As of March 31, ~~2022,~~2023, we have not sold any shares under the Sales Agreement.

Impact of Inflation

We are subject to normal inflationary trends and anticipate that any increased costs for our contract manufacturing and retail operations would be passed on to our customers; however, any increased costs related to diagnostic services would be absorbed by the Company. Inflation has not had a material effect on our business.

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Critical Accounting Policies and Estimates

Our significant accounting policies are described in Note 2 of the Notes to Condensed Consolidated Financial Statements included under Item 8 of this Part II. However, certain accounting policies are deemed “critical”, as they require management’s highest degree of judgment, estimates and assumptions. These accounting policies, estimates and disclosures have been discussed with the Audit Committee of our Board of Directors. A discussion of our critical accounting policies and estimates, the judgments and uncertainties affecting their application and the likelihood that materially different amounts would be reported under different conditions or using different assumptions are as follows:

Use of Estimates

The preparation of condensed consolidated 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 condensed consolidated financial statements and reported amounts of revenues and expenses during the respective reporting periods. Examples include revenue recognition and the estimation of the variable consideration associated with the diagnostic reimbursement rates, the provision for bad debt and billing discrepancies, sales returns and allowances, inventory obsolescence, useful lives of property and equipment, impairment of goodwill, intangibles and property and equipment, income tax valuations and assumptions related to accrued advertising. The estimates and assumptions are based on historical experience, current trends and other factors that management believes to be relevant at the time the condensed consolidated financial statements are prepared. Management reviews the accounting policies, assumptions, estimates and judgments on a quarterly basis. Actual results could differ from those estimates.

Revenue Recognition and Accounts Receivables

We generate revenue principally through four types of revenue streams: diagnostic services, contract manufacturing, genomic products and services, and retail and other. The process for estimating revenues and the ultimate collection of receivables involves assumptions and judgments.

Revenue from our diagnostic services is recognized when the lab test is complete, and the diagnostic test result is provided to the customer. Revenue from our genomics services is recognized when the sequencing report is provided to the customer. Revenue from our consumer products is recognized when the shipments to contract manufacturing and retailer customers are recognized at the time ownership is transferred to the customer. We bill the providers at standard price and take into consideration for negotiated discounts and an anticipated reimbursement remittance adjustments based on the payer portfolio, when revenue is recorded. We use the most expected value method to estimate the transaction price for reimbursements that may vary from the standard price.

We carry our accounts receivable at cost less an allowance for doubtful accounts. Allowances for doubtful accounts are based upon our judgment regarding collectability. On a periodic basis, we evaluate our receivables and establish an allowance for doubtful accounts, based on a history of past write-offs, collections, current credit conditions or generally accepted future trends in the industry and/or local economy. Accounts are written off as uncollectible at the time we determine that collections are unlikely. The reserve is not intended to address return activity or disputed balances with ongoing customers, as this should be addressed in a reserve for credit memos with a corresponding charge to revenue.

Goodwill and Long-lived Assets

We review our goodwill at least annually for impairment as well as the carrying value of goodwill and our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be fully recoverable. When it is determined that the carrying amount of long-lived assets or goodwill is impaired, impairment is measured by comparing an asset’s estimated fair value to its carrying value. 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; and industry competition, general economic and business conditions, among other factors.

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Income Taxes

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

We recognize in income the effect of a change in tax rates on deferred tax assets and liabilities in the period that includes the TCJA enactment date. We utilize the asset and liability approach which requires the recognition of deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns. In estimating future tax consequences, we generally consider all expected future events other than enactments of changes in the tax law or rates. Until sufficient taxable income to offset the temporary timing differences attributable to operations and the tax deductions attributable to option, warrant and stock activities are assured, a valuation allowance equaling the total net current and non-current deferred tax asset is being provided.

Inventories

~~Inventories~~

Inventory is valued at the lower of cost, determined on a first-in, first-out basis (“FIFO”), or net realizable value. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on current and anticipated customer demand, production and laboratory requirements.

~~Recently Adopted Accounting Standards~~

~~The Financial Accounting Standards Board (“FASB”) recently issued Accounting Standards Update (“ASU”) 2020-06,~~ Debt - Debt with Conversion and Other Options (Subtopic 470- 20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, to reduce complexity in applying GAAP to certain financial instruments with characteristics of liabilities and equity. The guidance in ASU 2020-06 simplifies the accounting for convertible debt instruments and convertible preferred stock by removing the existing guidance that requires entities to account for beneficial conversion features and cash conversion features in equity, separately from the host convertible debt or preferred stock. The guidance in ASC 470-20 applies to convertible instruments for which the embedded conversion features are not required to be bifurcated from the host contract and accounted for as derivatives. In addition, the amendments revise the scope exception from derivative accounting in ASC 815-40 for freestanding financial instruments and embedded features that are both indexed to the issuer’s own stock and classified in stockholders’ equity, by removing certain criteria required for equity classification. These amendments are expected to result in more freestanding financial instruments qualifying for equity classification (and, therefore, not accounted for as derivatives), as well as fewer embedded features requiring separate accounting from the host contract. The amendments in ASU 2020-06 further revise the guidance in ASC 260, ~~Earnings Per Share~~, to require entities to calculate diluted earnings per share (EPS) for convertible instruments by using the if-converted method. In addition, entities must presume share settlement for purposes of calculating diluted EPS when an instrument may be settled in cash or shares. The amendments in ASU 2020-06 are effective for public entities, excluding smaller reporting companies, for fiscal years beginning after December 15, 2021. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020. The adoption of ASU 2020-06 did not have a material impact on our condensed consolidated financial statements or disclosures.

In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40). This ASU reduces diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (for example, warrants) that remain equity classified after modification or exchange. This ASU provides guidance for a modification or an exchange of a freestanding equity-classified written call option that is not within the scope of another Topic. It specifically addresses: (1) how an entity should treat a modification of the terms or conditions or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange; (2) how an entity should measure the effect of a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange; and (3) how an entity should recognize the effect of a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange. This ASU will be effective for all entities for fiscal years beginning after December 15, 2021. An entity should apply the amendments prospectively to modifications or exchanges occurring on or after the effective date of the amendments. Early adoption is permitted, including adoption in an interim period. The adoption of ASU 2021-04 did not have a material impact on our condensed consolidated financial statements or disclosures.

Recently Issued Accounting Standards, ~~Not Yet~~ Adopted

~~In September 2016,~~

On January 1, 2023, the ~~FASB issued~~Company adopted ASU 2016-13, ~~Financial~~“Financial Instruments - Credit Losses (Topic 326)~~. The~~ : Measurement of Credit Losses on Financial Instruments” (“ASU ~~sets forth a “current~~2016-13”) ASU 2016-13 requires an impairment model (known as the current expected credit ~~loss” (CECL) model which requires~~loss (“CECL”) model) that is based on expected losses rather than incurred losses. Under the ~~Company to measure all~~new guidance, each reporting entity should estimate an allowance for expected credit losses, ~~for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts.~~which is intended to result in more timely recognition of losses. This model replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost, accounts receivable and available for sale debt securities and applies to some off-balance sheet credit exposures. In February 2020, the FASB issued ASU 2020-02, Financial Instruments - Credit Losses (Topic 326), which amends the effective date of the original pronouncement for smaller reporting companies. ASU 2016-13 and its amendments will be effective for usthe Company for interim and annual periods in fiscal years beginning after December 15, 2022. ~~We are currently assessing the impact of the~~The adoption of ~~this~~ ASU 2016-13 did not have a material impact on ~~our~~the Company's consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

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

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

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

Except for the broad effects of COVID-19 including its negative impact on the global economy and major financial markets, there have been no material changes to our market risk exposures since December 31, 2021.

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Item 4. Controls and Procedures.

Disclosure Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed with or submitted to the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our principal executive officer and principal financial and accounting officer, to allow timely decisions regarding required disclosure.

We carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, ~~2022.~~2023. This evaluation was carried out under the supervision and with the participation of our principal executive officer and principal financial and accounting officer. Based on that review, our management, including our principal executive officer and principal financial and accounting officer, concluded that ~~due to the material weakness described below,~~ our disclosure controls and procedures were ~~not~~ effective at the reasonable assurance level as of March 31, ~~2022.~~

2023.

~~Material Weakness~~

~~In connection with our 2021 Annual Report, our management conducted an evaluation of the effectiveness of our system of internal control over financial reporting based on the framework in~~ ~~Internal Control-Integrated Framework~~ issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework). Based upon that review, our management, including our principal executive officer and principal financial and accounting officer, concluded that the Company’s internal controls over financial reporting were not effective as of March 31, 2022, as a material weakness exists. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our financial statements could occur but will not be prevented or detected on a timely basis.

The material weakness that was identified relates to the lack of appropriate standard operating procedures and billing system controls associated with the diagnostic billing and revenue process, as well as the lack of contemporaneous assessments and associated documentation of the reimbursement receivables leading to additional allowance requirements.

Management is committed to remediating the material weakness. We have begun the process of implementing changes to our internal control over financial reporting to remediate the control deficiencies that gave rise to the material weakness, including further improvements in our processes, the current billing system and analyses that support the estimates associated with the allowances. Further, we expect to perform a comprehensive review of our billing standard operating procedures, training and resources in our billing and accounting functions.

We will not consider the material weakness remediated until the remedial controls operate for a sufficient period of time and we have concluded, through testing, that these controls are effectively designed and operating effectively. We will continue to assess throughout 2022.

Changes in Internal Control Over Financial Reporting

Except as described above, no change in internal control over financial reporting occurred during the most recent quarter with respect to our operations, which materially affected, or is reasonable likely to materially affect, our internal controls over financial reporting.

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~~Part~~

PART II. ~~Other Information~~

OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, we have been and may again become involved in legal proceedings arising in the ordinary course of business. We are not presently a party to any material litigation.

The Company’s wholly-owned subsidiary, TK Supplements, Inc., is the defendant in Aviles v. TK Supplements, Inc., a purported class action pending in the Superior Court for the State of California, County of Los Angeles. In the complaint that was filed on April 27, 2023, the plaintiff alleges that TK Supplements falsely advertised its Legendz XL male enhancement supplement in violation of California’s Consumer Legal Remedies Act. The plaintiff is seeking certification of a class of California purchasers; actual, statutory and punitive damages; an award of attorneys’ fees and costs; and all other relief at law or in equity as may be proper. The Company believes the lawsuit and the allegations contained therein are without merit and intends to vigorously defend against the litigation.

Item 1A. Risk Factors.

Factors that could cause our actual results to differ materially from those in this Quarterly Report are any of the risks described in our Annual Report on Form 10-K filed with the SEC on ~~March 31, 2022.~~March29, 2023. Any of these factors could result in a significant or material adverse effect on our results of operations or financial condition. Additional risk factors not presently known to us or that we currently deem immaterial may also impair our business or results of operations. 

As of the date of this Quarterly Report on Form 10-Q, ~~except as described below,~~ there have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K filed with the SEC on March ~~31, 2022.~~29, 2023. However, we may disclose changes to such factors or disclose additional factors from time to time in our future filings with the SEC. 

~~Our ability to achieve or sustain profitability depends on our collection of payment for the tests we deliver, which we may not be able to do successfully.~~

Our customer base for our COVID-19 tests is principally comprised of governmental bodies, municipalities, and large corporations who pay us directly or through third-party payors. In March 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted, providing for reimbursement to healthcare providers for COVID-19 tests provided to uninsured individuals, subject to continued available funding. Approximately 60 and 57% of our diagnostic services revenue for the three months ended March 31, 2022 and 2021, respectively was generated from this program for the uninsured. On March 22, 2022, the Health Resources & Services Administrations (“HRSA”) uninsured program stopped accepting claims for COVID-19 testing and treatment due to the lack of sufficient funds. Despite requests from the Acting Director of the Office of Management and Budget and the White House Coordinator for COVID-19 Response for additional emergency funding for the uninsured program, emergency funding has not been allocated to the HRSA uninsured program. We continue to perform testing for uninsured persons and are incurring the accompanying costs. However, as a result of the suspension of the HRSA uninsured program, we did not recognize $4.3 million of revenues related to COVID-19 testing which was performed for uninsured individuals from March 23, 2022 through March 31, 2022. If funding for the HRSA program is reinstituted, we will submit eligible claims for reimbursement to HRSA and record the associated revenues. If the HRSA program remains unfunded and we are unable to submit claims for reimbursement, there could be a material adverse effect on our business and financial condition.

Further, healthcare policy changes that influence the way healthcare is financed or other changes in the market that impact payment rates by institutional or non-institutional customers could also affect our collection rates. If we are unable to convince customers of the value and benefit provided by our tests, these customers may slow, or stop altogether, their purchases of these tests. Our collection risks also include the potential for default or bankruptcy by the party responsible for payment and other risks associated with payment collection generally. Any inability to maintain our past payment collection levels could cause our revenue and ability to achieve profitability to decline and adversely affect our business, prospects and financial condition.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Issuer Purchases of Equity Securities


—	Total Number of Shares Purchased (1)	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1)
January 1 through January 31, 2023	31,784	$	9.04	31,784	$	5,712,644
February 1 through February 28, 2023	11,096	8.06		11,096	$	5,623,260
March 1, 2023 through March 31, 2023	20,736	7.93		20,736	$	5,458,874
Total	63,616	$	25.03	63,616	5,458,874

(1)

On March 15, 2023, the board of directors of the Company approved a share repurchase program authorizing the Company to purchase up to $6 million of the Company’s common stock. The program will expire on September 15, 2023.

~~None.~~

Item 3. Defaults Upon Senior Securities.

None

Item 4. Mine Safety Disclosures.

Not applicable

Item 5. Other Information.

None

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~~None~~

Item 6. Exhibits


Exhibit No.						Description

10.1						Unsecured Promissory Note and Guaranty issued to JXVII Trust, dated January 26, 2023 (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K (File No. 000-21617) filed on January 30, 2023)

10.2						Common Stock Purchase Warrant issued to JXVII Trust, dated January 27, 2023 (incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K (File No. 000-21617) filed on January 30, 2023)

31.1						Certification by the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2						Certification by the Chief ~~Financial~~Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1						Certification by the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2						Certification by the Chief ~~Financial~~Accounting Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101. INS#						Inline XBRL Instance Document

101.SCH#						Inline XBRL Taxonomy Extension Schema Document

101.CAL#						Inline XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF#						Inline XBRL Taxonomy Extension Definition Linkbase Document

101.LAB#						Inline XBRL Taxonomy Extension Label Linkbase Document

101.PRE#						Inline XBRL Taxonomy Extension Presentation Linkbase Document

104						Cover Page Interactive Data File (embedded within the Inline XBRL document)

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	ProPhase Labs, Inc.

	By:	/s/ Ted Karkus
		Ted Karkus
		Chairman of the Board and Chief Executive Officer (Principal Executive Officer)
Date: May ~~13, 2022~~12, 2023
	By:	/s/ ~~Monica Brady~~Robert A Morse Jr.
			~~Monica Brady~~Robert A. Morse Jr.
		Chief Financial Officer ~~(Principal~~ (Principal Accounting and Financial Officer)
Date: May ~~13, 2022~~12, 2023


Delaware		23-2577138
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)


711 Stewart Ave,, Suite 200
Garden City,, New York		11530
(Address of principal executive office)	(Zip Code)


☒x			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


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

		March 31,			December 31,
	March 31,			December 31,
	2022			2021
	(Unaudited)
ASSETS
Current assets
Cash and cash equivalents	$	25,807		$	8,408
Restricted cash		-			250
Marketable debt securities, available for sale		3,543			8,779
Marketable equity securities, at fair value		-			76
Accounts receivable, net		36,694			37,708
Inventory, net		4,680			4,600
Prepaid expenses and other current assets		1,831			1,496
Total current assets		72,555			61,317

Property, plant and equipment, net		6,440			5,947
Prepaid expenses, net of current portion		251			460
Right-of-use asset, net		4,319			4,402
Intangible assets, net		10,143			10,852
Goodwill		5,709			5,709
Other assets		248			608
TOTAL ASSETS	$	99,665		$	89,295

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	8,204		$	7,026
Accrued diagnostic services		1,012			1,890
Accrued advertising and other allowances		95			104
Lease liabilities		654			663
Deferred revenue		2,246			2,034
Income tax payable		4,285			1,312
Other current liabilities		3,274			2,495
Total current liabilities		19,770			15,524

Non-current liabilities:
Deferred revenue, net of current portion		858			905
Deferred tax liability		443			-
Note payable		18			44
Unsecured convertible promissory notes, net		7,997			9,996
Lease liabilities, net of current portion		4,134			4,198
Total non-current liabilities		13,450			15,143
Total liabilities		33,220			30,667

COMMITMENTS AND CONTINGENCIES		-			-

Stockholders’ equity
Preferred stock authorized 1,000,000, $0.0005 par value, 0 shares issued and outstanding		-			-
Common stock authorized 50,000,000, $0.0005 par value, 15,485,900 and 15,485,900 shares outstanding, respectively		16			16
Additional paid-in capital		105,634			104,552
Retained earnings		10,490			2,642
Treasury stock, at cost, 17,018,846 and 16,818,846 shares, respectively		(49,557	)		(48,407	)
Accumulated other comprehensive loss		(138	)		(175	)
Total stockholders’ equity		66,445			58,628
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	99,665		$	89,295

		March 31, 2022			March 31, 2021
	For the three months ended
	March 31, 2022			March 31, 2021
Revenues, net	$	47,531		$	15,271
Cost of revenues		18,854			6,344
Gross profit		28,677			8,927

Operating expenses:
Diagnostic expenses		4,672			3,809
General and administration		7,824			3,782
Research and development		35			115
Total operating expenses		12,531			7,706
Income (loss) from operations		16,146			1,221

Interest income, net		73			87
Interest expense		(233	)		(251	)
Change in fair value of investment securities		(76	)		-
Income from operations before income taxes		15,910			1,057
Income tax expense		(3,416	)		-
Income from operations after income taxes		12,494			1,057
Net income	$	12,494		$	1,057

Other comprehensive loss:
Unrealized gain (loss) on marketable debt securities		37			(11	)
Total comprehensive income	$	12,531		$	1,046

Earnings per share:
Basic	$	0.81		$	0.07
Diluted	$	0.68		$	0.06

Weighted average common shares outstanding:
Basic		15,486			14,563
Diluted		18,740			18,200

	Common Stock Shares Outstanding				Par Value		Additional Paid in Capital		Retained Earnings			Comprehensive Loss			Treasury Stock			Total
	Common Stock Shares Outstanding			Par Value		Additional Paid in Capital		Retained Earnings			Comprehensive Loss			Treasury Stock			Total
Balance as of January 1, 2022		15,485,900		$	16	$	104,552	$	2,642		$	(175	)	$	(48,407	)	$	58,628
Issuance of common shares for debt conversion		200,000			-		600		-			-			-			600
Cash dividends		-			-		-		(4,646	)		-			-			(4,646	)
Repurchases of common shares		(200,000	)		-		-		-			-			(1,150	)		(1,150	)
Unrealized loss on marketable debt securities		-			-		-		-			37			-			37
Stock-based compensation		-			-		482		-			-			-			482
Net income		-			-		-		12,494			-			-			12,494
Balance as of March 31, 2022		15,485,900		$	16	$	105,634	$	10,490		$	(138	)	$	(49,557	)	$	66,445

	As of March 31, 2022
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
U.S. government obligations	$	667	$	123	$	(44	)	$	746
Corporate obligations		2,839		-		(42	)		2,797
	$	3,506	$	123	$	(86	)	$	3,543

	As of December 31, 2021
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
U.S. government obligations	$	650	$	17	$	-		$	667
Corporate obligations		8,304		-		(192	)		8,112
	$	8,954	$	17	$	(192	)	$	8,779

	March 31, 2022			December 31, 2021
Trade accounts receivable	$	24,727		$	18,520
Unbilled accounts receivable		14,944			23,089
Accounts receivable, gross		39,671			41,609
Less allowances		(2,977	)		(3,901	)
Total accounts receivable	$	36,694		$	37,708

	March 31,			December 31,
	2022			2021
Diagnostic services testing material	$	3,103		$	2,989
Raw materials		1,238			1,514
Work in process		476			260
Finished goods		322			272
Inventory	$	5,139		$	5,035
Inventory valuation reserve		(459	)		(435	)
Inventory, net	$	4,680		$	4,600

	For the three months ended
Revenue by Customer Type	March 31, 2022		March 31, 2021
Diagnostic services	$	44,913	$	12,738
Contract manufacturing		1,154		1,908
Retail and others		546		625
Genomic products and services		918		-
Total revenue, net	$	47,531	$	15,271

Account	Amount
Short term investments	$	1,800
Accounts receivable		171
Inventory		133
Prepaid and other current assets		379
Definite-lived intangible assets		10,990
Total assets acquired		13,473
Accounts payable		(805	)
Accrued expenses and other current liabilities		(43	)
Deferred revenue		(2,391	)
Note payable		(81	)
Deferred tax liability		(1,925	)
Total liabilities assumed		(5,245	)
Net identifiable assets acquired		8,228
Goodwill		4,446
Total consideration, net of cash acquired (1)	$	12,674

	Gross Carrying Value		Estimated Useful Life (in years)
Trade names	$	5,550		15
Proprietary intellectual property		4,260		5
Customer relationships		1,180		1
Total	$	10,990

	March 31, 2022			December 31, 2021			Estimated Useful Life (in years)
Trade names	$	5,550		$	5,550		15
Proprietary intellectual property		4,260			4,260		5
Customer relationships		1,180			1,180		1
CLIA license		1,307			1,307		3
Total intangible assets, gross		12,297			12,297
Less: accumulated amortization		(2,154	)		(1,445	)
Total intangible assets, net	$	10,143		$	10,852


Remaining periods ended December 31, 2022	$	1,669
Year ended December 31, 2023		1,585
Year ended December 31, 2024		1,222
Year ended December 31, 2025		1,222
Year ended December 31, 2026		890
Thereafter		3,555
Total intangible assets, net	$	10,143

	March 31, 2022			December 31, 2021			Estimated Useful Life
Land	$	352		$	352
Building improvements		1,729			1,729		10-39 years
Machinery		4,740			4,740		3-7 years
Lab equipment		4,936			4,330		3-7 years
Computer equipment		1,589			1,211		3-5 years
Furniture and fixtures		468			468		5 years
Property, Plant and Equipment, Gross		13,814			12,830
Less: accumulated depreciation		(7,374	)		(6,883	)
Total property, plant and equipment, net	$	6,440		$	5,947

	Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)		Total Intrinsic Value
Outstanding as of January 1, 2022		5,110		$	3.27		3.4	$	20,820
Forfeited		(20	)		8.99		-		-
Outstanding as of March 31, 2022		5,090		$	3.11		3.2	$	20,767
Options vested and exercisable		4,069		$	2.41		2.4	$	19,398

	Employment Contracts
Remaining periods in 2022	$	506
2023		675
2024		675
2025		675
2026		675
Total	$	3,206

	March 31, 2022		December 31, 2021

ASSETS
Diagnostic services	$	51,823	$	51,150
Consumer products		23,378		24,139
Unallocated corporate		24,464		14,006
Total assets	$	99,665	$	89,295