Marvelous Microcaps
ProPhase Labs, Inc.: An emerging play in laboratory and genetic testing
INTRO:
At Perritt Capital Management, we take focused positions in companies where we have a high conviction in their success; companies that are out of the mainstream of small cap investing. To highlight our process, we are pleased to present the newest installment in our new series “Marvelous Microcaps – Big Ideas on Small Companies.” This series profiles companies that we believe have a niche in their existing markets or are launching a product that could disrupt their marketplace.
THE COMPANY:
ProPhase Labs, Inc. (PRPH) is a provider of diagnostic services, OTC pharmaceutical products, and contract manufacturing services for third-party companies. Their diagnostics services consist primarily of processing COVID-19 tests through their wholly owned laboratory in Garden City, NJ. They also have a subsidiary called ProPhase Precision Medicine which was formed in August of 2021 in conjunction with their purchase of Nebula Genomics, Inc., a genetic testing company that sells kits online. Their consumer product lines primarily manufactures and markets nutritional supplements, sexual health supplements, and cold and cough lozenges.
The diagnostics business comprised approximately 87% of their revenues for 2021. This division was founded in October of 2020 in conjunction with the purchase of their initial laboratory in New Jersey to address the need for additional laboratory testing capacity as screening for the COVID-19 became more commonplace. As testing increased, the Company built a state-of-the-art 25,000 square feet lab in Garden City, NY which became their new headquarters. The outbreak of the Omicron Variant during this past winter led to that division growing revenues significantly as testing volume reached record levels. On a consolidated basis, the company reported revenues of $47.5 million in the most recent quarter, up from $15.3 million the previous year, an increase of 211%. They reported net income of $12.5 million and earnings-per-share of $0.81. They also announced a special dividend of $0.30 per share due to their strong results. Notably, just in the past two quarters combined, the Company reported $32.7 million in adjusted EBITDA on approximately 15.5 million shares outstanding. 69% of their testing revenues came from funding from the Department of Health Human Resources (HRSA) through a program for the uninsured. Funding for this program ended on March 22, 2022, and management stated on their most recent earnings call that due to this, revenues will be sequentially lower for the rest of the year, but each quarter will be higher on a year-over-year basis. There is also expected to be some seasonality with COVID-19 similar to the flu so testing revenues are expected to be higher in the winter than in the summer quarters.
WHY WE OWN: THE PERRITT ADVANTAGE
We own ProPhase Labs in both of our mutual funds and believe in the name due to their ability to position themselves strategically and execute in their marketplaces as demonstrated by their success in establishing a presence in two exciting markets with their COVID-19 and genetic testing capabilities. While there are some questions around the funding mechanism for uninsured patients through HRSA, the Biden administration is pushing for funding to be reinstated and the company is only accepting patients with insurance or that meet certain other criteria. This will mean lower revenues from that division for at least the rest of the year, but it likely will remain profitable with the goal to fund future growth opportunities for the company. The projected cash flow from this subsidiary along with approximately $21 million in net cash on their balance sheet sheet and over $50 million in net working capital should provide ample funding for their emerging growth opportunity in their genetic testing kits. While these kits are currently available online, ProPhase is working to sell them through their brick-and-mortar channels where they already have relationships through their other subsidiaries. Per commentary from CEO Ted Karkus during the recent earnings call, these tests provide the consumer with access whole genome sequencing. This is a key differentiator for personalized health related information compared to more well-known offerings from Ancestry.com and 23andMe that provide more limited genetic information primarily used for ancestry analysis. They are intended to provide consumers with detailed information regarding their genetic makeup and any diseases or conditions they may be predisposed to. Once consumers have their results, they can learn more about each potential condition through an extensive library of information that ProPhase provides allowing them to get the information they need to both understand their results and discuss them with their healthcare provider. We believe that this new offering and its extension into brick-and-mortar retailers later this year will fuel the next stage of growth for the company. In addition, their healthy balance sheet reduces the risk of any capital raises taking place during these challenging times in the market.
We consider ProPhase Labs to be a high conviction name. It is currently a top ten holding for both funds and we are encouraged by their most recent results, their return of capital to shareholders in the form of a special dividend in March and June, as well as their commitment to continuing to drive growth through their purchase of Nebula Genomics and its future integration into their distribution network.
Perritt. Marvelous Microcaps – Big Ideas on Small Companies.