ProPhase Labs, Inc. Q3 FY2023 Earnings Call

Good day and welcome to the ProPhase Labs Incorporated Third Quarter 2023 Financial Results and Corporate Update. All participants will be in listen-only mode. After today's presentation, there'll be an opportunity to ask questions. Please note that this event is being recorded. I would like to turn the conference over to Mr. Ted Karkus, CEO. Please go ahead.

Thank you, Nick. And thank you everybody for joining. I'm actually really excited to have this call today, because we are at an inflection point in the company. In fact, we're going through an inflection point in our company over the last couple of quarters and over the next couple of quarters. I am thrilled with how well things are going in our development stage subsidiaries. With that said, I want to start with the forward-looking statement. Before we get started, I would like to remind you of the company's Safe Harbor language. During this presentation, we will make forward-looking statements including statements regarding our strategies, plans, objectives and initiatives and underlying assumptions. While we believe that these forward-looking statements are reasonable as and when made, forward-looking statements are based on expectations that involve risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties include, but are not limited to, our ability to obtain and maintain necessary regulatory approvals, general economic conditions, consumer demand for our products and services, challenges relating to entering into and growing new business lines, the competitive environment, and the risk factors listed from time to time in our filings with the SEC. This call will present non-GAAP financial measures such as adjusted EBITDA. Reconciliation of these non-GAAP measures to the most comparable GAAP measures are included in the earnings release furnished to the SEC prior to this call and available on our website. All right, let's start with a couple of shout outs. Number one, I think our equity team has done a phenomenal job working with our investment bankers over the last three years. Not only did they lead a large raise for us, but they were instrumental in finding some great assets that we acquired over the last three years. Some of those assets are poised to bear very significant fruit for our company moving forward. We also have excellent coverage by H.C. Wainwright and by Joshua Levine at Third Stream Research. And, of course, a shout out to Diamond Equity Research, particularly to Hunter Diamond. Thank you all so much. Finally, we do virtual non-deal roadshows presentations about once a month, with one coming up next Thursday, the 16th. I want to keep our shareholders informed about what's going on. So I conduct a virtual presentation, and we go through the presentation, which is on our website. I update that presentation regularly. I believe we just updated it very recently. So feel free to visit our website if you're looking for more details about our company. Okay. With that said, I generally don’t like to prepare a lot of remarks for these calls. I love to get into the Q&A. So I'm going to give everyone a sort of stream of consciousness just off the top of my head, because I live and breathe our company every day. I really want to explain what we’re doing, because I think you'll feel good by the end of this call as I speak this way, rather than reading two pages of remarks. So where do I start? Why don't I start with our accounts receivable, as people ask questions about that every quarter. I’m sure I’ll receive some related inquiries about it this quarter. People worry about our finances. Yes, we are currently in a bear market for microcap development stage companies. We came out for a little while late last year and at some point this year, but with interest rates taking off, it has really hampered the ability to raise capital, which negatively impacts microcap development stage companies that burn cash and need more resources. The valuations in the biotech industry, relative to liquidating value and cash on hand, are incredibly low. Therefore, it’s an incredibly difficult time for microcap development stage companies. And then people ask, what about our accounts receivable? They worry if we have the capital we need to develop the assets. I make it very clear in our press releases that I am the largest shareholder in our company. I care about our shareholders above all else. I even tell the employees that I’m loyal to them, and we have a great set of employees that have really evolved over the last year. But shareholders come first. I do not dilute shareholders unless absolutely necessary. I never have, and I’m not aware of ever diluting shareholders with any of the raises we’ve ever done. I have no intention or current prospects of having to dilute shareholders now or anytime soon. This also means for those that are still short out there – I do not know how you're going to cover, because I do not plan to raise at any point. There are no current plans to do any raise for our parent company ProPhase Labs. Specifically regarding accounts receivable, it’s based on both collecting from those receivables and operating a business that generates new accounts receivable. For example, at year-end 2022, we had about $37 million in accounts receivable. In the first half of this year, we collected on a little less than half of that amount. But we also generated new accounts receivable from COVID testing business during the first half of the year. However, now that it is no longer a public health emergency, a significant percentage of accounts receivable is from COVID testing. Insurance companies are now paying more slowly than they used to, but they are paying; it’s just slower now. There’s nothing we can do to speed it up. We do have dollars coming in from accounts receivable, and I’d point out that from the second quarter to the third quarter, our accounts receivable dropped from $39 million to $33.4 million. That’s a decrease of more than $5 million while we were still conducting business. We’re also now doing business with Nebula Genomics, meaning we have accounts receivable there, as well as with Pharmaloz. So we are collecting on accounts receivable, and it just becomes a question of time with the flow of money in and out, as well as developing our company to enhance our Nebula Genomics lab, requiring the acquisition of state-of-the-art equipment, hiring more people, and building infrastructure, which we believe will pay off in a substantial way this year and into next year. I want to provide a big picture perspective here. This slow inflow of accounts receivable is frustrating for me as CEO, but we have plenty of avenues available to us. We monitor accounts receivable closely on a weekly basis. If we need additional capital – I don’t even know that we do – we have a mortgage option available at Pharmaloz. We own a substantial building and valuable land across from a Walmart. We also possess significant accounts receivable that could set up a credit line again. If we need to raise additional capital, we can do so without resorting to an equity raise or harming our shareholders. I just want to put that concern to rest, as it seems to be a recurring issue for virtually every development stage company currently. Now, having said all that, let’s discuss some really positive developments. The punchline here is I’m going to talk about Pharmaloz. This is our largest manufacturing facility, and I will also mention Nebula Genomics. Both of these subsidiaries are dramatically increasing in value as we speak, and I believe that sometime early next year, we could create liquidity events for some of these subsidiaries. There are several possibilities in this regard, which could collectively yield values far exceeding the entire current market cap of the company. I mention this now because my point is, why would we raise capital for ProPhase Labs the public company and dilute shareholders, when we have underlying assets that are so valuable that we could potentially raise capital for, without diluting our shareholders? Because I am shareholder-friendly, I feel this way. My background is on Wall Street, so rest assured, if you're concerned about the stock price, I believe that the future is very bright from a capital markets perspective. Let’s briefly delve into our businesses before moving to Q&A. Let’s start with Pharmaloz. We did a press release not long ago regarding it. I don't want to elaborate too much today; just read the last press release on Pharmaloz and our press release today. The bottom line is we are in a sweet spot in an industry where we’ve owned a state-of-the-art manufacturing facility for 30 years. It so happens we’re at a time where capacity around the country and worldwide has diminished significantly. Demand has never been greater. Some of the largest lozenge brands in the world want to give us as much business as we can handle. Logically, if we had the capacity right now, we could be generating $100 million in revenue, earning pretax profits of $20 million to $25 million off that business. Now, we are currently generating $8 million to $10 million in revenue, and we have equipment coming in this month that’s going to increase our capacity to $15 million in December. So, going into the first quarter, our revenues will surge, as we already have demand for that $15 million of business. We have also instituted price increases. When we take into account the margin improvements within our existing base business and the margins on new business, we are set to start generating substantial profits. Further, in the second quarter, we plan to launch a new lozenge line along with the ancillary automated equipment to reach $30 million or even $35 million of capacity. Our goal is to generate at least $30 million in revenues, reaching pre-tax profits of $6 million to $7 million, or even $8 million in pretax profits by that point. These figures reflect significant increases to our earnings, cash flow, and EBITDA just from Pharmaloz. Understand, when I mention capacity, we already have the demand for it. Additionally, I have been informed that private equity will pay 10 to 15 times pretax. This gives you a glimpse of the potential here in the upcoming quarters. Again, our plans for growth are already set in motion, with two more lozenge lines ordered that are expected to come in late next year. We could be forecasting revenues between $60 million to $80 million based on a three-and-a-half-day work week. I must note that downtime for maintenance will be required, and managing employee capacity is crucial. We don’t exactly know today what the revenues will be, but our capacity could range from $80 million to $200 million by the end of next year, and it is incredible to consider if we were generating $20 million to $25 million in pretax profits and multiply that by 10 to 15 times. A facility could be valued at $300 million. I must emphasize that I’m not claiming this value will be achieved, nor am I suggesting that it is our ultimate goal, but the potential warrants consideration. With our market cap trading at around $70 million to $80 million, we possess a manufacturing facility with a potential value that could significantly exceed our entire market cap next year. Thus, I'd be remiss if I did not explore all avenues in that regard. I can provide further insights in the Q&A, but this overview gives a better context as we are connected to the bigger picture. I’m not suggesting we’re executing any raises on our subsidiaries at this time, but it's crucial to realize we have options available that ensure our shareholders that we're not going to follow the trend that many other microcap development stage companies do, which is to surprise you with an equity raise. This will not occur at ProPhase Labs. I can guarantee that at some point, things will change, but I can tell you that for the foreseeable future I have no interest in such actions. Now let’s discuss Nebula Genomics. To me, Pharmaloz is a thriving business. Nebula Genomics is distinct and has even greater future potential. What really fascinates me about Nebula Genomics is whole genome sequencing, which was the vision of George Church 20 years ago, and it’s finally materializing. Historically, whole genome sequencing did not explode for one critical reason: price. Now, prices have decreased, and medical doctors, academic researchers, and medical research communities are paying much closer attention to whole genome sequencing. I must clarify that universities and researchers were already conducting genomic testing, but I’m referring to a broader scope of research, wherein whole genome sequencing is currently experiencing a surge in interest. Until recently, a singular company had a monopoly on whole genome sequencing, maintaining prohibitively high prices that dissuaded both consumers and medical researchers from broader experimentation. A newly settled company entered the U.S. market at the beginning of the year, granting us access to their high-throughput, extremely efficient equipment for whole genome sequencing, allowing us to provide pricing lower than any laboratory in the country. This is an incredible accomplishment for our microcap company, and yes, it is an accurate one. Initially, we were selling directly to consumers online, but it did not feel as if the business was taking off as it should have. It was growing nicely, but from a small base. So stating a 50% or 100% increase from a limited base felt less impactful. We had to rely on advertising for that growth. However, we now have a business that doesn't require any advertising. We’re becoming known as the low-cost provider of whole genome sequencing in the United States, and the business is coming to us. We were recently at a genomics conference, and the responses we received were tremendous. My team is doing a phenomenal job building this business. Yes, Jason Karkus, my son, has played a significant role here, analogous to his work in building our COVID testing business, which achieved $100 million in annual revenues. Now, he’s building our genomics business alongside a senior employee we are bringing on board. I firmly believe they can replicate the same success achieved with COVID testing. Jason and I adopted the strategy that if we build it, they will come, similar to our approach with the COVID testing business. We created a large COVID testing lab that ultimately generated an enormous level of business over the two years that it operated. Presently, however, very few people are undergoing COVID tests; most testing occurs in hospitals. Consequently, we are not involved in the COVID testing business anymore. In contrast, our approach with Nebula Genomics has begun to attract significant demand. This demand stems not only from physicians but also from telemedicine companies that have networks comprising thousands of physicians and millions of patients. Our collaborations or partnerships with them could yield substantial interest. It’s noteworthy that, unlike others in the industry dabbling in whole genome sequencing, we offer a robust capability that is hard to overstate in this country currently. While I do not know the specifics of how this market will develop, it’s surely going to be exciting to follow where it goes in the upcoming quarters and years. Regarding the biotechnology plays, such as our esophageal cancer test, I won't delve into detail today. The stock market has little care for that for now. However, I want to reiterate that we have active studies with remarkable results. I hold high hopes for our esophageal cancer test, which is not just about detecting cancer but can also assess risk levels. Insurance companies have conveyed strong interest in our offering. If we can provide this test without needing an endoscopy, it would be a game changer. With our technology, we’re on the cusp of doing just that. Finally, we’re making progress with Aquiver, a clinical study currently oversubscribed with promising results. I look forward to sharing more data that will finalize claims for our packaging and push the product towards commercialization. Let me take a moment to invite any further topics or concerns you may have raised during the call.

Good day, Ted, I hope you can hear me okay. Thanks for taking my questions.

Yes, sir.

So when we met last quarter, in the second week in August, you outlined for the market a couple of different ways that you could access near-term bridge liquidity from your existing balance sheet capacity to bridge the modest free cash flow negative performance that you expect over the next couple of quarters, until Pharmaloz and the other businesses really start to generate significant free cash flow. Based on your commentary this quarter, it looks like it's going to be in the second half of 2024. Right now, we're kind of run rate, $3 million to $4 million a quarter in negative free cash flow, forget adjusted EBITDA. You have $38 million in accounts receivable on your balance sheet that you indicated last quarter, is very high quality and could be securitized. You have the ability to take a mortgage on the Pharmaloz business and have various public market and private equity opportunities to raise capital on any of the different subsidiaries. We're in a bear market, we're in a bear market where typically the only way you get your stock to move in the right direction relative to the underlying fundamental value that you're creating is by deploying liquidity to change the trajectory of your stock price. So what steps should we expect you to take over the next quarter on the accounts receivable securitization front to free up liquidity there for funding operations and capital needs, as well as deploying for share repurchase? What kind of capital do you think you can raise from a mortgage on the Pharmaloz fixed asset base, separate from any capital markets activities? Thanks.

Well, that was a mouthful.

Yeah, sorry about that.

That's all right. No, no, I love it. The truth of the matter is, I may have said this on the last call; I don't recall. But if you ever want to come work for ProPhase Labs, I think you would do really well.

I don’t have a day job. Thank you.

Okay, to answer your question, you really, to some extent, answered your own inquiry. I would say that in terms of profitability, I believe that the profitability is going to start improving. It’s a matter of how much it improves, in which quarter, for which subsidiary, but whenever a subsidiary sees improvement in profitability, the bottom line benefits as well. For example, for Pharmaloz, we actually have the automation equipment coming in this month, with pricing increases that will start in December and January. The automation equipment should be up and running by the end of the month. So, by December, we'll see a notable increase in the profitability of Pharmaloz. In the upcoming first quarter, we are likely to reach a run rate that's around 50% higher than what we're doing right now and improve gross profit margins both on existing and new businesses. So our Pharmaloz business is poised for short-term profitability. Once we get the second line, the improvement will be even more dramatic. Our business can realistically see a 50% growth in December and January. To your point, we are witnessing those numbers improve every quarter, reducing the burden of negative cash flow from $3 million to $4 million. The same is true of Nebula; I just can’t predict the timeline. However, we are currently exploring exciting opportunities in the Nebula platform now that Jason and the team are building it. I believe the negative cash flow will be progressively less as we enhance revenues. Once these businesses commence their growth trajectory, our revenues and profitability will elevate. The same applies to Nebula; while I can’t specify the exact month, the shift to profitability could happen quickly. I genuinely believe that Pharmaloz is on track to be profitable by December. Some revenue growth from Nebula is likely to increase steadily, even if there are no immediate prospects for profitability. Our operations could see substantial improvements based on the influx of business, including academic institutions and telemedicine partnerships. We could have the capacity to accommodate those demands too. There remains ample opportunity with our secured assets, as well as revenue flowing in from accounts receivable. We recently saw our accounts receivable drop from $39 million to $33.4 million from the second to third quarter, signifying our continual progress. Essentially, I feel confident that we have several options available to bridge us to profitability, with all our critical subsidiaries experiencing uptrends in revenues and earnings. As for your inquiries into account receivable securitization and mortgage options at Pharmaloz, those details can fluctuate; however, I believe we will have sufficient assets to navigate the landscape effectively. I must stress that we prioritize exploring methods that won't dilute our shareholders. We have underpinnings of significant value in our various subsidiaries. With that said, I hope that clarifies your query. Let’s transition to the next question, Nick.

Hi, thank you for taking my questions. Could you give us some color regarding the total revenue for the third quarter? How much of it was based on testing, and whether you expect those testing revenues to virtually disappear in the fourth quarter?

Yes, so COVID testing has indeed disappeared. It significantly dropped in the third quarter, with only a minimal amount at the beginning of this quarter. I'm unhappy I don’t have those specific revenue figures, but I can obtain them later, or our CFO can clarify. The remaining revenue will primarily come from Nebula Genomics and Pharmaloz manufacturing. As mentioned earlier, I anticipate substantial revenue increases and actual profitability from Pharmaloz and Nebula in the first quarter. Based on indicated demand, I foresee significant growth, and that's not putting any concrete values on overhead. Pharmaloz already has $30 million in contracts confirming demand once capacity increases in the second quarter. Demand continues to grow, and while I cannot guarantee profits in the upcoming quarters, it’s plausible we’ll observe marked profitability for Pharmaloz. Thus, you can expect incremental revenue growth from those two subsidiaries in the fourth quarter, but where the real burst will occur is in the first quarter.

Okay, got it. Thank you. Will the company feel comfortable to provide some kind of revenue guidance on the 2024 full year results earnings call?

I will certainly not do that on this call. I’m not making up numbers. To be honest, we have never issued specific revenue guidance. I can highlight that in the third quarter, there were minimal contributions from our COVID testing. You can assume that both Pharmaloz and Nebula Genomics revenues will see growth in the fourth quarter, but where these two truly accelerate will be in the first quarter.

Hi, great update today. Thank you for the shout out. I wanted to gather some information on the supply-demand imbalance for Nebula Genomics and whole genome sequencing. You’ve discussed the other business, and I want to learn where you’re seeing demand coming from specifically. Is it from insurers or big corporations? What are your thoughts on insurers potentially covering whole genome sequencing in the future?

That's a great question. The beauty of our genomics business is that none of it currently relies on insurance. Whole genome sequencing is an industry in the initial stages of growth. When I say we are only in the first inning, I genuinely mean it. While many understand the viability of whole genome sequencing, the critical factor holding back the industry has been price. Now that prices have decreased, medical providers and researchers are venturing into whole genome sequencing since they are increasingly evaluating it. The interest wasn’t absent; it just got disregarded due to logistical complications in pricing. The ancestry genomic companies leveraged low-cost tests focusing on SNIPs, which provide limited health data. In contrast, we can unveil substantial insights when applying whole genome sequencing. Our focus now is expanding to telemedicine companies, gaining entry to myriad physicians and patients. If we secure collaborations with telemedicine companies that can connect millions of patients with our affordable whole genome sequencing, the potential is virtually limitless. It’s also essential to realize that as the whole genome sequencing space seeps into larger labs with offerings, our established capacity will become vital. Additionally, many firms are struggling to fulfill their own capacity; we can position ourselves as the sole high-capacity provider in the country. In conclusion, I want you to realize that we are rightly positioned to capitalize on growth opportunities as they arise.

Absolutely. Yeah, that was my only question. I guess it sounds like you see that the enterprise model is more efficient as compared to direct to consumer. You’re targeting larger corporations that already manage and engage patients.

Hunter, you summarized it perfectly. Upon acquiring Nebula Genomics, I inherited a direct-to-consumer model reliant on advertising. We transitioned into operating a lab and assumed all the overhead costs associated with genomic sequencing. That facility was intended to function long-term, but without sufficient revenue, it inevitably pulled us into loss territory. However, I think now we’re at an inflection point where the structure will begin to yield returns. Targeting larger enterprises provides a favorable positioning, minimizing the need for advertising while leveraging the existing networks of physicians and various companies.

Hi, Ted. Thank you for a great presentation. I am a Nebula user. Sometimes I think that people don't grasp the capabilities and the affordability we offer as users. The information we receive is just phenomenal. I think about significant genetic research occurring and I can see where I fit into that scope. However, I wanted to support what you say, in that my contacts within the research world are saying that with the drop in price, the genetic research field is expanding immensely. That reinforces what you're stating about Nebula Genomics operating domestically. However, speaking of a year from now, what will I hear from you about Nebula and its profitability?

Your observations are absolutely accurate, and you reiterate that we’re still in the infancy of this business that is seemingly poised for growth. Not only have we been able to establish substantial credibility, but we are also on the verge of entering the genetic counseling space, focusing on enhancing customer comprehension of test results—a crucial element in the genomic testing journey. The direction we're heading paves the way for potential partnerships; insurance companies have echoed the need for tests assessing not only the presence of cancer but associated risks. Our esophageal cancer tests are increasingly garnering positive attention, especially since we now have evidence showing we can predict risk based on specific protein shifts. We're investing in validating tests while fostering discussions with significant laboratories. Therefore, a year from now, it’s conceivable that I’ll be speaking about the extent of incredible revenues achieved. I don't want to anchor on a specific number today, nor do I have definite estimates available right now. What I certainly believe is that our operational focus and the expected trajectory will make a notable impact. We are cautiously optimistic about our approach and stand prepared for growth on the horizon.

Kid, I love what you're doing with every one of the subsidiaries; their intrinsic value is phenomenal. I know you're going to realize all that money for us one day. Everybody's so excited about Nebula, including me. However, I want to ask you about the esophageal cancer test. It’s potentially life-saving, and we know it works. I’m aware that you’re waiting on samples; how will you help communicate the capabilities of this test to GI doctors in America once we have a CPT code?

That’s a great question. First, many senior executives recently attended a healthcare CEO conference where we met with insurance executives. Universally across the board, if you have a test that can tell individuals whether they have cancer definitively, these insurance companies will endorse the necessity to stay on reporting with their network of physicians. Our test can recognize a person as positive for cancer, which many insurance companies highly value; however, they want a test that indicates risk levels. If we can provide information regarding high-risk versus low-risk patients, many insurance companies will assist physicians in ordering tests with greater efficacy, providing an overwhelming opportunity to make a mark in this arena. Additionally, we are pursuing partnerships for genetic counseling to assist individuals in understanding their test results—a sector we are highly excited about. In parallel, we are exploring alternative testing methods without the need for endoscopies. Potentially with these advancements, your question of how management tells GI doctors about our validation will depend on proximity to completion. Our company’s relationships with top organizations and our innovative strategies should enable great engagement with medical professionals. Overall, we believe our esophageal cancer test holds immense promise for addressing the critical needs present in the healthcare space. I want to say thank you to everyone for joining us today. I’m truly excited about where we’re heading as a company. As previously mentioned, much focus will be on our core operational efficiencies, and I look forward to sharing more updates with you as the company continues to evolve successfully. If you have any further questions, I’m happy to address them. Thank you, everyone.

Thank you for that, sir. Conference is now concluded. Thank you for attending today's presentation. You may now disconnect.