UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period endedSeptemberJune 30, 20182019

OR

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

For the transition period from ______________ to ______________

Commission file number0-21617

ProPhase Labs, Inc.

(Exact name of registrant as specified in its charter)

(215) 345-0919

(Registrant’s telephone number, including area code)

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

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

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

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

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

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

ProPhase Labs, Inc. and Subsidiaries

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1.Financial Statements.

Item 1. Financial Statements.

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)

See accompanying notes to condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations and Other Comprehensive Loss

(in thousands, except per share amounts)

(unaudited)

See accompanying notes to condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Statement of

Stockholders’ Equity

(in thousands, except share data)

(unaudited)

See accompanying notes to condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

See accompanying notes to condensed consolidated financial statements

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 1 – Organization and Business

ProPhase Labs, Inc. (“we”, “us” or the “Company”) was initially organized as a corporation in Nevada in July 1989. Effective June 18, 2015, we changed our state of incorporation from the State of Nevada to the State of Delaware. We are a vertically integrated and diversified branding, marketing and technology company engaged in the research, development, manufacture, distribution, marketing and sale of over-the-counter (“OTC”) consumer healthcare products, dietary supplements and other remedies in the United States. This includes the development and marketing of dietary supplements under the TK Supplements^®brand.

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

In August 2017, we formed ProPhase Digital Media, Inc. (“PDM”), a Delaware corporation and wholly-owned subsidiary of ProPhase Labs, Inc.,subsidiary. PDM is an independent full-service direct marketing agency. PDM’s first initiative will be to marketDuring the second quarter, PDM completed the optimization phase of the marketing campaign for our lead product in the TK Supplements^® product line. If successful, this may lead to the marketing of other companies’ consumer products.line, Legendz XL^®.

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

We use a December 31 year-end for financial reporting purposes. References herein to “Fiscal 2018”2019” shall mean the fiscal year ended December 31, 20182019 and references to other “Fiscal” years shall mean the year whichthat ended on December 31 of the year indicated. The term “we”, “us” or the “Company” as used herein also refer, where appropriate, to the Company, together with its subsidiaries and consolidated variable interest entities unless the context otherwise requires.

Discontinued Operations

Prior to March 29, 2017, our flagship OTC drug brand was Cold-EEZE^® and our principal product was Cold-EEZE^®cold remedy zinc gluconate lozenges. In addition to Cold-EEZE^® cold remedy lozenges, we also marketed and distributed non-lozenge forms of our proprietary zinc gluconate formulation, (i) Cold-EEZE^® cold remedy QuickMelts^®, (ii) Cold-EEZE^® Gummies and (iii) Cold-EEZE^® cold remedy oral spray.

Effective March 29, 2017, we sold our intellectual property rights and other assets related to our Cold-EEZE^® brand and product line, including all then current and pipeline over-the-counter allergy, cold, flu, multi-symptom relief and immune support treatments for adults and children to the extent each was, or was intended to be, branded “Cold-EEZE^®”, including all formulations and derivatives thereof (collectively referred to as the “Cold-EEZE^® Business”) to Mylan Consumer Healthcare Inc. (formerly known as Meda Consumer Healthcare Inc.) (“MCH”) and Mylan Inc. (together with MCH, “Mylan”). As a result of the sale of the Cold-EEZE^® Business, for the three and nine months ended September 30, 2017, we have classified as discontinued operations (i) all income and expenses attributable to the Cold-EEZE^®Business, (ii) the gain from the sale of the Cold-EEZE^® Business, and (iii) the income tax expense attributed to the sale of the Cold-EEZE^® Business. Excluded from the sale of the Cold-EEZE^® Business were our accounts receivable and inventory. We have also retained all liabilities associated with our Cold-EEZE^® Business operations arising prior to March 29, 2017.

Continuing Operations

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

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

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 2 – Summary of Significant Accounting Policies

For the three and ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, our revenues from continuing operations have come principally from OTC health carehealthcare contract manufacturing and sales to retail customers of dietary supplement products for third parties.products.

Basis of Presentation

The unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial statements and within the rules of the Securities and Exchange Commission (“SEC”) applicable to interim financial statements, and therefore do not include all disclosures that might normally be required for financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The accompanying unaudited condensed consolidated financial statements have been prepared by management without audit and should be read in conjunction with our audited consolidated financial statements, including the notes thereto, appearing in our Annual Report as amended on Form 10-K for the fiscal year ended December 31, 2017.2018. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial position, consolidated results of operations and consolidated cash flows, for the periods indicated, have been made. The results of operations for the three and ninesix months ended SeptemberJune 30, 20182019 are not necessarily indicative of operating results that may be achieved over the course of the full year.

Discontinued Operations Carve Out and ProPhase Allocations

 For the three and nine months ended September 30, 2017, results from operations for our Cold-EEZE^® Business are classified as discontinued operations. The carve out of the discontinued operations (i) were prepared in accordance with the SEC’s carve out rules under Staff Accounting Bulletin (“SAB”) Topic 1B1 and (ii) are derived from identifying and carving out the specific assets, liabilities, net sales, cost of sales, operating expenses and interest expense associated with the Cold-EEZE^®Business’s operations. General administrative and overhead expenses, including personnel expenses and bonuses, and research and development overhead expenses incurred by us (for which the discontinued operation benefits from such resources) are allocated to discontinued operations based upon the percentage of the Cold-EEZE^® Business’s net sales to our consolidated net sales. For the three and nine months ended September 30, 2017, we allocated $348,000 of administrative expenses and $52,000 of research and development expenses to discontinued operations in the accompanying condensed statements of operations. For the three and nine months ended September 30, 2018, there were no discontinued operations (see Note 5).

Product Innovation, Seasonality of the Business and Liquidity

Our net sales are derived principally from our contract manufacturing of OTC healthcare and dietary supplementssupplement products sold in the United States. In addition, we are engaged in early stage commercialization and market testingmarketing activities for the TK Supplements^®product line of dietary supplements.

Our sales are influenced by and subject to (i) bythe scope and timing of TK Supplements^® product market acceptance, of our TK Supplement^® products and (ii) byfluctuations in the timing of purchase and the ultimate level of demand for our contract manufacturedthe OTC healthcare and dietary supplement products that we manufacture for others, which are a function of the timing, length and severity of each cold season. Generally, a cold season is defined as the period offrom September to March when the incidence of the common cold rises as a consequence of the change in weather and other factors. We generally experience in the first, third and fourth quarters higher net sales from our contract manufacturing services. Revenues are generally at their lowest levels in the second quarter, when customer demand generally declines.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

As a consequence of the scope and timing of our TK Supplements^®product market launchacceptance and the seasonality of our contract manufacturing OTC business, we realize variations in operating results and demand for working capital from quarter to quarter. As of SeptemberJune 30, 2018,2019, we had working capital of approximately $17.2$12.5 million, including $6.9$4.7 million of marketable debt securities, which are available for sale. We believe our current working capital at SeptemberJune 30, 20182019 is at an acceptable and adequate level to support our business for at least the next twelve months.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Use of Estimates

The preparation of financial statements and the accompanying notes thereto, in conformity with GAAP, requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the respective reporting periods. Specific estimatesExamples include the provision for bad debt, sales returns and allowances, inventory obsolescence, useful lives of property and equipment, and intangible assets, impairment of property and equipment, and intangible assets, income tax valuations and assumptions related to accrued advertising. When providing for the appropriate sales returns, allowances, cash discounts and cooperative incentive promotion costs, we apply a uniform and consistent method for making certain assumptions for estimating these provisions. These estimates and assumptions are based on historical experience, current trends and other factors that management believes to be relevant at the time the financial statements are prepared. Management reviews the accounting policies, assumptions, estimates and judgments on a quarterly basis. Actual results could differ from those estimates.

Cash and Cash Equivalents

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

Marketable 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 losses included as a separate component of stockholders’ equity. Realized gains and losses from our marketable debt securities are recorded as other interest income (expense). We initiated short term investments in marketable debt securities, which carry maturity dates between one and three years from date of purchase with interest rates of 1.89%1.99% - 3.56%3.08%, during the first threetwo quarters of Fiscal 2018.2019. For the three months and ninesix months ended SeptemberJune 30, 2018,2019, we reported an unrealized gain of $28,000$8,000 and $54,000$23,000, respectively, and have an accumulated unrealized loss of $24,000.$1,000. Unrealized gains and losses are classified as other comprehensive income (loss) and the cost is determined on a specific identification basis. The following is a summary of the components of our marketable debt securities and the underlying fair value input level tier hierarchy (see long-lived assets below) (in thousands):

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

We have determined that the unrealized losses are deemed to be temporary as of SeptemberJune 30, 2018.2019. We believe that the unrealized losses generally are the result of increases in the risk premiums required by market participants rather than an adverse change in cash flows or a fundamental weakness in the credit quality of the issuer or underlying assets. We have the ability and intent to hold these investments until a recovery of fair value, which may be maturity. We do not consider the investment in corporate bonds to be other-than-temporarily impaired at SeptemberJune 30, 2018.2019.

Inventory

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 SeptemberJune 30, 2018,2019, after the 20182019 write-off of certain inventory previously recorded, the financial statements include adjustments to reduce inventory for excess, obsolete or short-dated shelf-life inventory of $427,000,$382,000, inclusive of adjustments of $165,000$307,000 for product samples of TK Supplements^® products. At June 30, 2019, the inventory adjustment for excess, obsolete or short-dated shelf-life inventory included $113,000 in finished goods and $269,000 in raw material and work in process. At December 31, 2017,2018, the financial statements include adjustments to reduce inventory for excess, obsolete or short-dated shelf-life inventory of $1.1 million,$377,000, inclusive of an adjustment of $541,000$270,000 for product samples of TK Supplements^® products.

ProPhase Labs, Inc. At December 31, 2018, the inventory adjustment for excess, obsolete or short-dated shelf-life inventory included $319,000 in finished goods and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

$58,000 in raw material and work in process. The components of inventory are as follows (in thousands):

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–ten to thirty-nine years; machinery and equipment – three to seven years; computer equipment and software – three to five years; and furniture and fixtures – five years. We have reviewed our property, plant and equipment for the six months ended June 30, 2019 and 2018 and concluded there were no impairments or changes in useful lives.

Concentration of Risks

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

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

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

We maintain cash and cash equivalents with certain major financial institutions. As of SeptemberJune 30, 2018,2019, our cash and cash equivalents balance was $2.3$1.0 million and our bank balance was $2.4$1.2 million. Of the total bank balance, $500,000$250,000 was covered by federal depository insurance and $1.9$0.9 million was uninsured at SeptemberJune 30, 2018.2019.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Trade accounts receivable potentially subject us to credit concentrations from time-to-time as a consequence of the timing, payment pattern and ultimate purchase volumes or shipping schedules with our customers. We extend credit to our customers based upon an evaluation of the customer’s financial condition and credit history and generally we do not require collateral. Our customers include consumer productsproduct companies and large national chain, regional, specialty and local retail stores. These credit concentrations may impact our overall exposure to credit risk, either positively or negatively, in that our customers may be similarly affected by changes in economic, regulatory or other conditions that may impact the timing and collectability of amounts due to us. As a consequence of an evaluation of our customer’s financial condition, payment patterns, balance due to us and other factors, we did not offset our account receivable with an allowance for bad debt at SeptemberJune 30, 20182019 and December 31, 2017.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)2018.

Long-lived Assets

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

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

Fair Value of Financial Instruments

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

There were no transfers of marketable debt securities between Levels 1, 2 or 3 for the ninesix months ended SeptemberJune 30, 2018 and 2017.2019.

Revenue Recognition

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

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

We have not made any significantadopted ASC 606 as of January 1, 2018 using the modified retrospective method. There were no changes to judgments in applyingour opening balances upon the adoption of ASC 606 duringand the three or nine months ended September 30, 2018.amounts which would have been reported under the standards in effect prior to adoption.

Performance Obligations

We generate sales principally through two types of customers, contract manufacturing and retail customers. Sales from product shipments to contract manufacturing and retailer customers are recognized at the time ownership is transferred to the customer. Net sales from OTC healthcare contract manufacturing and retail dietary supplement product customers were $2.3was $1.5 million and $115,000,$0.2 million, respectively, for the three months ended SeptemberJune 30, 20182019 and $3.0$3.1 million and $40,000,$80,000, respectively, for the three months ended SeptemberJune 30, 2017.2018. Net sales from contract manufacturing and retail customers was $8.8$3.6 million and $269,000,$0.4 million, respectively, for the ninesix months ended SeptemberJune 30, 20182019 and $5.6$6.4 million and $150,000,$0.2 million, respectively, for the ninesix months ended SeptemberJune 30, 2017.2018. Revenue from retailer customers is reduced for trade promotions, estimated sales returns, cash discounts and other allowances in the same period as the related sales are recorded. No such allowance is applicable to our contract manufacturing customers. We make estimates of potential future product returns and other allowances related to current period revenue. We analyze historical returns, current trends, and changes in customer and consumer demand when evaluating the adequacy of the sales returns and other allowances.

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

Transaction Price

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

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

Recognize Revenue When the Company Satisfies a Performance Obligation

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

We do not accept returns in the contract manufacturing revenue stream. Our return policy for retailer customers accommodates returns for (i) discontinued products, (ii) store closings and (iii) products that have reached or exceeded their designated expiration date. We do not impose a period of time within which product may be returned. All requests for product returns must be submitted to us for pre-approval. The main components of our returns policy are: (i) we will accept returns that are due to damaged product that is un-saleable and such return request activity falls within an acceptable range, (ii) we will accept returns for products that have reached or exceeded designated expiration dates and (iii) we will accept returns in the event that we discontinue a product provided that the customer will have the right to return only such items that it purchased directly from us. We will not accept return requests pertaining to customer inventory “Overstocking” or “Resets”. We will accept return requests for only products in its intended package configuration. We reserve the right to terminate shipment of product to customers who have made unauthorized deductions contrary to our return policy or pursue other methods of reimbursement. We compensate the customer for authorized returns by means of a credit applied to amounts owed or to be owed and in the case of discontinued product only, also by way of an exchange. We do not have any significant product exchange history.

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

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

As of SeptemberJune 30, 20182019 and December 31, 2017,2018, we included a provision for sales allowances from continuing operations of $2,300 and $1,000, and $2,000, respectively.respectively, which are reported as a reduction to account receivables. Additionally, accrued advertising and other allowances from discontinued operations as of SeptemberJune 30, 20182019 included (i) $260,000$138,000 for estimated returns, which is reported as a reduction to account receivables, and (ii) $88,000$76,000 for cooperative incentive promotion costs.costs, which is reported as accrued advertising and other allowances under current liabilities. As of December 31, 2017,2018, accrued advertising and other allowances from discontinued operations included (i) $480,000$181,000 for estimated future sales returns, which is reported as a reduction to account receivables, and (ii) $200,000$88,000 for cooperative incentive promotion costs.costs, which is reported as accrued advertising and other allowances under current liabilities.

As of SeptemberJune 30, 2018,2019, we have deferred revenue of $57,000$302,000 in relation to Research and Development (“R&D”) stability and release testing programs. 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 for implementation, maintenance and other services, as well as initial subscription fees. We recognize deferred revenues as revenues when the services are performed and the corresponding revenue recognition criteria are met. Customer prepayments are generally applied against invoices issued to customers when services are performed and billed.

The following table disaggregates the Company’s deferred revenue by recognition period (in thousands):

Disaggregation of Revenue

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

The following table disaggregates the Company’s revenue by revenue source for the three and ninesix months ended SeptemberJune 30, 2019 and 2018 (in thousands):

Practical Expedients Elected

We have elected the following practical expedients in applying ASC 606 across all each revenue stream:

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 we perform after a customer obtains control of the good 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 sales and marketing expense, (ii) cooperative incentive promotions and coupon program expenses, which are accounted for as part of net sales, and (iii) free product, which is accounted for as part of cost of sales. Advertising and incentive promotion expenses (i) incurred from continuing operations for the three months ended SeptemberJune 30, 2019 and 2018 were $55,000 and 2017 were $14,000 and $22,000, respectively, and (ii) attributed to and classified as discontinued operations for the three months ended September 30, 2018 and 2017 were zero for both periods.$39,000, respectively. Advertising and incentive promotion expenses (i) incurred from continuing operations for the ninesix months ended SeptemberJune 30, 2019 and 2018 were $82,000 and 2017 were $51,000 and $78,000, respectively, and (ii) attributed to and classified as discontinued operations for the nine months ended September 30, 2018 and 2017 were zero and $2.8 million,$72,000, respectively.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Share-Based Compensation

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

Stock and stock options for the purchase of our common stock, $0.0005 par value (“Common Stock”), have been granted to both employees and non-employees pursuant to the terms of certain agreements and stock option plans (see Note 5)4). Stock options are exercisable during a period determined by us, but in no event later than tenseven years from the date granted.

Research and Development

Research and development costs are charged to operations in the period incurred. Research and development costs incurred for the three months ended SeptemberJune 30, 2019 and 2018 were $95,000 and 2017 (i) from continuing operations were $144,000 and $60,000, respectively, and (ii) attributed to and classified as discontinued operations were zero for both periods.$87,000, respectively. Research and development costs incurred for the ninesix months ended SeptemberJune 30, 2019 and 2018 were $189,000 and 2017 (i) from continuing operations were $319,000 and $318,000, respectively, and (ii) attributed to and classified as discontinued operations were zero and $52,000,$174,000, respectively. Research and development costs are principally related to personnel expenses and new product development initiatives and costs associated with our OTC health carehealthcare products, dietary supplements and other remedies.

Income Taxes

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

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

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

Recently Adopted Accounting Standards

In May 2014,February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers”2016-02, Leases (Topic 842) in order to increase transparency and comparability among organizations by, among other provisions, recognizing lease assets and lease liabilities on revenue recognition. The new standard providesthe balance sheet for those leases classified as operating leases under previous GAAP. For public companies, ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 (including interim periods within those periods) using a single five-step model tomodified retrospective approach and early adoption is permitted. In transition, entities may also elect a package of practical expedients that must be applied in its entirety to all revenue contracts with customersleases commencing before the adoption date, unless the lease is modified, and permits entities to not reassess (a) the existence of a lease, (b) lease classification or (c) determination of initial direct costs, as wellof the adoption date, which effectively allows entities to carryforward accounting conclusions under previous GAAP. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, which provides entities an optional transition method to apply the guidance under Topic 842 as requires additional financial statement disclosures that will enable users to understandof the nature, amount, timing and uncertaintyadoption date, rather than as of revenue and cash flows relating to customer contracts. Companies have an option to use either a retrospective approach or cumulative effect adjustment approach to implement the standard.earliest period presented. We adopted Topic 842 on January 1, 2019, using the optional transition method to apply the new standardguidance as of January 1, 2018, using2019, rather than as of the modified retrospective method. Seeearliest period presented, and elected the Revenue Recognition section within the Summarypackage of Significant Accounting Policies in Note 2 for further details on the impact to our consolidated financial statements upon adoption and practical expedients elected.described above. The implementationadoption of the new revenue recognitionthis standard did not have a material impact on our condensed consolidated financial statements.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

In November 2016,August 2018, the FASB issued ASUSEC adopted SEC Final Rule Release No. 2016-18 “Statement33-10532, Disclosure Update and Simplification, which amended certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements regarding stockholders’ equity for interim financial statements. Under the amendments, a description of Cash Flows: Restricted Cash”the changes in each caption of stockholders’ equity presented in the balance sheet must be provided in a note or separate statement. The description must include a reconciliation of the beginning balance to the ending balance of each period for which requires a statement of cash flowscomprehensive income is required to explainbe filed. The condensed consolidated financial statements included in this Quarterly Report include a reconciliation of the change during abeginning balance to the ending balance of stockholders’ equity for each period in the total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Under the new standard, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown in thewhich a statement of cash flows. ASU 2016-18 was effective for us as of January 1, 2018. We have not generally had restricted cash or restricted cash equivalents,operations and therecomprehensive income (loss) is no restricted cash on the balance sheet as of September 30, 2018. The adoption of this update did not have a material impact on our consolidated financial statements.provided.

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

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

Recently Issued Accounting Standards, Not Yet Adopted

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

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

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

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

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

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 3 – Discontinued Operations, Sale of the Cold-EEZE^® Business

Effective March 29, 2017, we completed the sale of the Cold-EEZE^®Business to Mylan.

As a consequence of the sale of the Cold-EEZE^® Business,Depreciation expense incurred for the three months ended June 30, 2017, we classified as discontinued operations (i)2019 and 2018 was $101,000 and $95,000, respectively. Depreciation expense incurred for the gain from the sale of the Cold-EEZE^® Business, (ii) all gains and losses attributable to the Cold-EEZE^® Business operations and (iii) the income tax expense attributed to the sale of the Cold-EEZE^®Business. Excluded from the sale of the Cold-EEZE^®Business were our accounts receivable and inventory, and we also retained all liabilities associated with our Cold-EEZE^®Business operations arising prior to March 29, 2017.

Pursuant to the terms of the asset purchase agreement entered into with Mylan on January 6, 2017 (the “Asset Purchase Agreement”), we also agreed to a one-time sale to Mylan of certain non-lozenge-based Cold-EEZE^® inventory. At September 30, 2017, we have classified as assets held for sale approximately $22,000 of such inventory, which approximates our cost.

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

For the ninesix months ended SeptemberJune 30, 2017, we incurred $4.2 million in closing2019 and transaction costs associated with the sale of the Cold-EEZE^® Business which were comprised of (i) transaction fees2018 was $202,000 and related closing costs of $1.9 million and (ii) performance bonuses, contract termination compensation and severance payments to certain employees associated with the sale of the Cold-EEZE^® Business of $2.3 million. The compensation committee of our board of directors approved these compensation arrangements. These compensation and termination payments were paid by us in April 2017.$190,000, respectively.

The following table sets forth the condensed operating results of our discontinued operations for the nine months ended September 30, 2018 and 2017, respectively, (in thousands):

There was no activity related to discontinued operations for the three months ended September 30, 2018 and 2017, and nine months ended September 30, 2018. For the three months and nine months ended September 30, 2018, we incurred costs of $160,000 which was charged against the gain on sale of the Cold-EEZE^® Business (See Note 5).

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 4 – Secured Promissory Notes and Other Obligations

Secured Promissory Notes

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

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

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

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

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

Note 54 – Transactions Affecting Stockholders’ Equity

Our authorized capital stock consists of 50 million shares of Common Stock, $0.0005 par value (“Common Stock”), and 1 million shares of preferred stock, $.0005$0.0005 par value (“Preferred Stock”).

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 SeptemberJune 30, 2018,2019, no shares of Preferred Stock have been issued. Our board of directors havehas the full authority permitted by law to establish, without further stockholder approval, one or more series of Preferred Stock and the number of shares constituting each such series and to fix by resolution voting powers, preferences and relative, participating, optional and other special rights of each series of Preferred Stock, and the qualifications, limitations or restrictions thereof, if any. Subject to the limitation on the total number of shares of Preferred Stock that we have authority to issue under our certificate of incorporation, the board of directors is also authorized to increase or decrease the number of shares of any series, subsequent to the issue of that series, but not below the number of shares of such series then-outstanding. In case the number of shares of any series is so decreased, the shares constituting such decrease will resume the status that they had prior to the adoption of the resolution originally fixing the number of shares of such series. We may subject to any required stockholder approval amend from time to time our certificate of incorporation and bylaws to increase the number of authorized shares of Preferred Stock or Common Stock or to make other changes or additions to our capital structure or the terms of our capital stock.

2015 Equity Line of Credit

On July 30, 2015, we entered into a new equity line of credit agreement (the “2015 Equity Line”) with Dutchess Opportunity Fund II, LP (“Dutchess”). Pursuant to the 2015 Equity Line, Dutchess committed to purchase, subject to certain restrictions and conditions, up to 3,200,000 shares of our Common Stock, over a period of 36 months from the effectiveness of the registration statement registering the resale of shares purchased by Dutchess pursuant to the Investment Agreement.  The 2015 Equity Line of Credit expired in July 2018.

ProPhase Labs, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

The 2010 Equity Compensation PlanCommon Stock Dividend

On May 5, 2010, our stockholders approved7, 2018, the 2010 Equity Compensation Plan, which has been subsequently amended and restated by our stockholders (the “2010 Plan”). The 2010 Plan provides thatBoard declared a special cash dividend of $1.00 per share on the total number of shares ofCompany’s Common Stock that may be issued underresulting payable on June 5, 2018 to holders of record of the 2010 Plan is 3.9 million shares.

During the nine months ended September 30,Company’s Common Stock on June 6, 2018. On June 5, 2018, we granted 30,000 options, exercisable at $2.35made cash payment of $11.7 million.

On December 24, 2018, the Board declared a special cash dividend of $0.25 per share and subjecton the Company’s Common Stock resulting in $2.9 million payable on January 24, 2019 to vesting over a three-year term, to a consultant pursuant to the termsholders of record of the 2010 Plan. For the nine month ended September 30, 2017,Company’s Common Stock on January 10, 2019. On January 24, 2019, we granted, 600,000 options to employees, exercisable at $2.00 per share and subject to vesting over a four-year term. We use the Black-Scholes option pricing model to determine the fair valuemade cash payment of the stock options and Warrants at the date of grant. Based upon our limited historical experience, we determined the expected term of the stock option grants to be 4.5 years, calculated using the “simplified” method in accordance with the SEC Staff Accounting Bulletin 110. We use the “simplified” method since our historical data does not provide a reasonable basis upon which to estimate expected term. Presented below is a summary of the terms of the grant of options. The assumptions used in determining the fair value of the 30,000 stock options granted in the first quarter of Fiscal 2018 were (i) expected option life of 4.5 years, (ii) weighted average risk rate of 2.37%, (iii) dividend yield of 0% and (iv) expected volatility of 40.06%.

During the nine months ended September 30, 2018 and 2017, we issued 490,000 and 682,000 shares of common stock, respectively, upon the exercise of stock options granted under our 2010 Plan, including 250,000 shares that were issued in the nine months ended September 30, 2018 pursuant to a cashless exercise. At September 30, 2018, there were 519,500 stock options outstanding under the 2010 Plan and 791,159 shares available to be issued pursuant to the terms of the 2010 Plan.$2.9 million.

The 2010 Directors’ Equity Compensation Plan

On May 5, 2010, our stockholders approved the 2010 Directors’ Equity Compensation Plan, which was has been subsequently amended and restated by our stockholders (the “2010 Directors’ Plan”). A primary purpose of the 2010 Directors’ Plan is to provide us with the ability to pay all or a portion of the fees of directors in restricted stock instead of cash. The 2010 Directors’ Plan provides that the total number of shares of Common Stock that may be issued under the 2010 Directors’ Plan is equal to 675,000 shares. For

During the ninethree and six months ended SeptemberJune 30, 20182019, 3,571 and 2017, 7,47410,737 shares and zero shares, respectivelyof restricted stock were granted to our directors under the 2010 Directors’ Plan. At SeptemberWe recorded $34,000 of director fees during the six months ended June 30, 2018,2019 in connection with these grants, which represented the fair value of the shares calculated based on the average closing price of the Company’s shares of Common Stock for the first five trading days of the quarter in which the Board fee was earned. No shares were granted during the three and six months ended June 30, 2018.

As of June 30, 2019, there were 390,334372,123 shares of Common Stock that may be issued pursuant to the terms of the 2010 Directors’ Plan.

ProPhase Labs, Inc.The 2010 Equity Compensation Plan

On May 5, 2010, our stockholders approved the 2010 Equity Compensation Plan, which was subsequently amended and Subsidiariesrestated by our stockholders (the “2010 Plan”). The 2010 Plan provides that the total number of shares of Common Stock that may be issued under the 2010 Plan is 3.9 million shares.

Notes

No options were granted under the 2010 Plan for the three and six months ended June 30, 2019. During the three and six months ended June 30, 2018, we granted 30,000 options, exercisable at $2.35 per share and subject to Condensed Consolidated Financial Statementsvesting over a three-year term, to a consultant pursuant to the terms of the 2010 Plan.

(unaudited)

As of June 30, 2019, there were 649,500 options outstanding and 661,159 options available to be issued pursuant to the terms of the 2010 Plan. We will recognize approximately $345,000 of share-based compensation expense over a weighted average period of 2.3 years.

The 2018 Stock Incentive Plan

On April 12, 2018, our 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 nonstatutory stock options to eligible employees, directors and consultants. The purpose of the 2018 Stock Plan is to advance the interests of the Company and its stockholders by providing an incentive to attract, retain, and reward persons performing services for the Company and by motivating such persons to contribute to the growth and profitability of the Company. The 2018 Stock Plan provides that the total number of shares that may be issued pursuant to the 2018 Stock Plan is 2.3 million shares. AtAs of September 30, 2018, all 2.3 million shares have been granted in the form of stock options to Ted Karkus (the “CEO Option”), our Chief Executive Officer and no stock options have been exercised under the 2018 Stock Plan (the “CEO Option”).Plan. We use the Black-Scholes option pricing model to determine the fair value of the stock options and Warrants at the date of grant. Based upon our limited historical experience, we determined the expected term of the stock option grants to be 4.5 years, calculated using the “simplified” method in accordance with the SEC Staff Accounting Bulletin 110. We use the “simplified” method since our historical data does not provide a reasonable basis upon which to estimate expected term. The assumptions used in determining the fair valueWe will recognize approximately $835,000 of the 2,300,000 stock options granted in the second quarter of Fiscal 2018 were (i) expected option life of 4.5 years, (ii)share-based compensation expense over a weighted average risk rateperiod of 2.42%, (iii) dividend yield of 0%1.7 years.

ProPhase Labs, Inc. and (iv) expected volatility of 40.10%.Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

The 2018 Plan requires certain proportionate adjustments to be made to the stock options granted under the 2018 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 of the CEO Option, such that the exercise price of the CEO Option was reduced from $3.00 per share to $2.00 per share, effective as of June 5, 2018, the date the special $1.00 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 following table summarizes stock options activity during the six months ended June 30, 2018 and 2019 for both the 2010 Plan and 2018 Stock Plan (in thousands, except per share data):