Earnings Call Transcript - HROW Q2 2020

Operator, Operator

Good afternoon, and welcome to the conference call covering Harrow Health's Financial Results and Business Update for the Second Quarter of 2020. Joining me today are Harrow's Chief Executive Officer, Mark L. Baum, and Chief Financial Officer, Andrew Boll. My name is Christy, and I will be your operator for today's call. All participants are currently in a listen-only mode. We will later conduct a question-and-answer session. By now, you should have received a copy of the earnings press release. If not, please visit the Investor Relations page of the company's website at www.harrowinc.com. Before we begin, I want to remind you that the company's remarks include forward-looking statements under federal securities laws. These statements are subject to various risks and uncertainties, many of which are beyond Harrow Health's control, including those detailed in its SEC filings related to the company’s ability to commercially offer its compounded formulations and technologies, as well as FDA approval of certain drug candidates in a timely manner or at all. For a complete list and description of these risks and uncertainties, please refer to the Risk Factors section of the company's most recent annual report on Form 10-K and subsequent quarterly reports on Form 10-Q filed with the Securities and Exchange Commission. Harrow Health's results may differ significantly from those anticipated. Harrow does not intend to update or revise any financial projections or forward-looking statements based on new information, future events, or otherwise. This conference call contains time-sensitive information and is only accurate as of today. Additionally, Harrow will mention non-GAAP financial metrics, specifically adjusted EBITDA and/or adjusted earnings. A reconciliation of non-GAAP measures with the most comparable GAAP measures is included in the company's letter to stockholders available on the website. I will now turn the call over to Mark Baum for some prepared remarks before we move to the question-and-answer session. Mark?

Mark Baum, CEO

Thanks for joining our call today. I would encourage everyone listening to review our second quarter 2020 letter to stockholders which was posted on the Investor Relations section of our website just after the close of trading today. Before we begin the Q&A portion of today's call, I'd like to quickly touch on a few items to provide some additional color on our business, since we last spoke in May. While the second quarter revenues were impacted by the COVID-19 pandemic and a temporary slowdown in ophthalmic surgery, we have moved forward and are seeing revenue back to pre-COVID levels. Previously, we told investors one, we weren't going to just stay dormant; and two that our goal was to continue to drive revenue growth organically and inorganically. Keeping that promise we recently announced a commercial alliance agreement with EyePoint Pharmaceuticals to sell DEXYCU an FDA-approved single-dose sustained release intracameral steroid 9% dexamethasone injectable for the treatment of inflammation and post-ocular surgery. DEXYCU an injectable steroid for ophthalmic use is paid for through pass-through reimbursement from CMS. Our strategy with DEXYCU is simple, focus on offering the benefits of FDA-approved DEXYCU to our large and loyal customer base who in 2019 bought more than 250,000 injectable steroid-containing products from us. We've surveyed our customers and a number of them have told us they would love to have the option of choosing an FDA-approved product when they order from us. So this partnership with EyePoint is a natural fit and DEXYCU is a complementary offering to the existing ImprimisRx surgical portfolio of products. Because we sell a lot of ophthalmic injectable steroids used in cataract surgery probably more than anyone in the United States the DEXYCU opportunity could be a financial big deal for us. Our Tri-Moxi customers alone represent a more than $25 million annual revenue opportunity at an estimated better than 85% gross margin. Ultimately though, the outcome of this partnership should result in a benefit to prescribers and patients with the economics of the deal having the potential to make a significant impact for both us and EyePoint. Let's get into the results for the second quarter which came in better than our base case predictions. Revenue for the second quarter of 2020 was $8.1 million compared to $13.5 million for the second quarter of 2019. Gross margins were 60% compared to 61% for the same period last year. Adjusted EBITDA in the second quarter was a loss of $1.7 million compared to earnings of $245,000 for the second quarter of 2019. Gross margins and adjusted EBITDA were impacted by the lower unit volumes as a result of the pandemic shutdown. But if revenue can remain at the levels we saw at the end of June and certainly into July, I am confident that those metrics will be closer to what we saw in the fourth quarter of 2019 during our next report. A few notable highlights from our other business interests. Eton has numerous catalysts coming up this quarter with two potential approvals. Surface is expecting data for SURF-201 and SURF-100 in the next 12 months positioning themselves to execute a Series B financing in the near term. Melt Pharmaceuticals had their IND for MELT-100 accepted by FDA and will begin enrolling patients this week for their PK study generating a readout by the fourth quarter of this year. And don't count Mayfield out. It is packaged and ready to go with an experienced and capable leader on board. We hope to also generate data on Stowe's drug candidate's antiviral capabilities by the fourth quarter of this year which could set Stowe up for the next stages of its development, since they've already showed excellent success against bacteria, mold and fungi. We're also expecting big things from Visionology this year including a launch of their exciting platform which will better serve our ophthalmology-focused customers. On our last update, we promised investors that we would keep innovating and pursuing deals that could create more shareholder value and we have and will continue to deliver on those promises. We believe the ImprimisRx ophthalmology platform is well suited to attract more prescribers and marketing of more products. Importantly revenues are returning to pre-pandemic levels. We will remain cautious about giving an all-clear signal related to COVID uncertainties for now. But with that said, we are more comfortable with our balance sheet and cash flow projections today than we were three months ago. And we are certainly more confident that we should make it through this period of challenge. Now let's jump to the Q&A. I will pause to have our operator poll for questions.

Operator, Operator

Thank you. We'll take our first question from Brooks O'Neil with Lake Street Capital Markets. Please go ahead.

Brooks O'Neil, Analyst

Good afternoon, Mark. Congratulations on surviving the quarter with COVID.

Mark Baum, CEO

Thank you Brooks. Alive and well.

Brooks O'Neil, Analyst

So I – yes, that's good. I have a couple of questions. First, I was a little confused about Dexycu. Are you thinking that's going to have your customers switching from one of your current steroids, or is this something you'll intend to sell in addition to the current steroids you offer your customers now?

Mark Baum, CEO

Well it's actually both.

Brooks O'Neil, Analyst

Okay.

Mark Baum, CEO

We manufacture steroid injectables and believe that Dexycu should replace one of them, which is central to our strategy. In 2019, we sold over 200,000 units of Tri-Moxi, and we anticipate that many of those customers will consider transitioning to Dexycu. While it doesn't provide the steroid and antibiotic they seek, many of these customers also use a moxifloxacin injection. By using Dexycu alongside our moxifloxacin, they can ensure comprehensive coverage and offer their patients a nearly completely dropless experience.

Brooks O'Neil, Analyst

Could you help us understand the economic benefits for Harrow and the potential advantages for customers in making the switch?

Mark Baum, CEO

Sure. Well if you were to take 200,000 units and we said that we think that that's worth more than $25 million to us just on that number of units, you can figure out what we estimate the value of each Dexycu unit to be for us. So it's significant on a relative basis. If you compare that to what we make on Tri-Moxi, it's kind of easy to figure out more or less what we make on Tri-Moxi because it's about a $25 product. So if we made 100% it would only be $25 and we target a 20% net margin. So there's not a lot of profit on a unit of Tri-Moxi. But if you compare that to what we estimate the value of a Dexycu sale at you'll see that it is a great trade for us.

Brooks O'Neil, Analyst

Great.

Mark Baum, CEO

And by the way a lot of value for the surgery center or hospital.

Brooks O'Neil, Analyst

Sure. Absolutely. I get that. Okay. Let's sort of shift just slightly. So will you talk just a little bit about this movement that I sense is underway or at least maybe an additional element to the strategy that involves moving from compounding to adding in FDA-approved drugs? And how do you see that as probably related to the conversation we just had a moment ago? But just talk a little bit about how you're thinking about things today and where you see the biggest opportunities for Harrow going forward.

Mark Baum, CEO

Sure. ImprimisRx is sort of the core of our business. It's the nucleus of the business and it really has fed other parts of the Harrow ecosystem, if you will, because it was through ImprimisRx that we created a couple of products that led to the founding of Eton. It was through ImprimisRx that we created the products that led to the founding of Surface Pharmaceuticals. And the same is true for Melt Pharmaceuticals as well. So ImprimisRx is sort of the nucleus of what we've been able to build at ImprimisRx. One of the great challenges with ImprimisRx is that, it has historically been a compounding-only business. And whether it's an analyst or a shareholder, they look at the business as a compounding business. At Harrow, we look at it very differently. We look at ImprimisRx as an ophthalmology/pharmaceutical platform. We have the ability to make drugs and dispense them in all 50 states. And we have a national sales force to not only sell but also service customers. And we have about 10,000 customers that buy from us on a fairly regular basis. So if you are a company that has an FDA-approved product and you want to get it out there to a large audience and you don't want to take a lot of commercial risk, we're a very attractive potential partner. I think, our friends at EyePoint saw that logic and we were able to partner with them and we're excited about that opportunity. We think there are others that also see that value. And we think that when we're able to incorporate these FDA-approved products into our platform and you see the margin that can be generated and the revenue that can be generated, that folks like you and our shareholders will attribute more value to our business, because we certainly do. We have some more work to do. Obviously we're going to execute on this DEXYCU opportunity. But we think that when ImprimisRx is viewed as an ophthalmology company, as many in the ophthalmology community view it, we'll get a lot more value for that business.

Brooks O'Neil, Analyst

Yes. All of that makes a ton of sense. I appreciate that explanation. So let's just shift gears again. And I think, I saw, just recently that Eton registered some shares that you own in Eton. I recognize there's a standstill mutually agreed upon that takes us out into late this calendar year, I think. But can you just talk a little bit about your thinking with regard to your ownership in Eton and what you might be contemplating with regard to potential sale of those shares?

Mark Baum, CEO

Right. Well, there's no potential sale of the shares. We haven't signaled that there's a potential sale of the shares. As a holder of our Eton position, we would certainly prefer to have Eton stock. At the same time, we did sign a lockup agreement. We locked up our shares. And the inference there should be that we don't need to sell those shares and that's a good thing. That should also infer that our business isn't doing half bad and we don't need the cash from a potential sale of those shares. It's really a sign of strength, I think, that we don't need to sell those shares and we're willing to sign a lockup agreement. At the same time, we want Eton's stockholders, our fellow shareholders at Eton to be able to benefit without this Harrow stock overhang. And so we were able to cut a deal where we got our shares registered and we agreed to sign a lockup. And in due course if, our Board of Directors decides to take action they may, but there is no urgency at all to do that and that's reflected in our lockup agreement, which extends into the summer of next year by the way.

Brooks O'Neil, Analyst

Okay, okay. Thanks a lot. So I'll just ask one more and I appreciate all the color here. So the one area or maybe I guess two areas that were a little bit higher than our forecast this quarter, one was SG&A. It was about almost $1 million above what we were thinking about. And R&D was just a little bit more than double what we were thinking. So could you just talk to us about your priorities what you're spending on and how you think about the spending levels relative to the business opportunities you see out there?

Mark Baum, CEO

Sure. Andrew, would you like to address that question?

Andrew Boll, CFO

Sure. And Brooks thanks for the question. Just from a relative perspective, we were able to decrease SG&A expenses during Q2 versus Q1 by about $1.5 million and we did that. Most of it was related to cost savings from decrease in unit sales. So, there's a lot of variable expenses that are associated with revenue. So we're able to flex a lot of those down. In regards to the difference between actual numbers and what your forecast was, I think, there could have been a difference in revenue versus your forecast and the associated variable expenses on the sales and marketing side.

Brooks O'Neil, Analyst

Cool. That's helpful. Yes…

Andrew Boll, CFO

When considering our R&D efforts, a significant portion is dedicated to ongoing formulation development, which Mark discussed extensively in the shareholder letter. This involves the creation of new products and the introduction of new formulations into our outsourcing facility, which we continue to implement each quarter. Regarding our expenses and priorities, we remain focused on investments that will generate value and revenue. If it involves promoting new products, that’s where we will allocate our expenses. If it pertains to R&D for new products, we will direct our efforts there as well.

Brooks O'Neil, Analyst

Great. That's perfect. Thanks a lot and looking forward to Q3.

Mark Baum, CEO

Thanks, Brooks.

Andrew Boll, CFO

Thanks, Brooks.

Operator, Operator

And our next question comes from Andrew D'Silva with B. Riley FBR. Please go ahead.

Andrew D'Silva, Analyst

Hi. Good afternoon. Thanks for taking my question. And just a couple of quick ones for me. So kind of following up on the DEXYCU question, can you just maybe give a little color on how you would expect the transition from Tri-Moxi to DEXYCU how that can look from a cadence standpoint? And also just a little color on how we should expect rev rec and Harrow's growth to look like as that transition from Tri-Moxi to DEXYCU takes place.

Mark Baum, CEO

Thank you for your question, Andy. The recent deal we signed with EyePoint does not mean that Tri-Moxi orders or any other sterile injectable orders will immediately turn into DEXYCU orders. We expect this transition to occur over the next quarter or two. We've spoken to several customers who are familiar with DEXYCU, and we believe that the transition will be quicker with them. It's going to vary by customer. Fortunately, we have a relatively small number of Tri-Moxi customers, fewer than 100, who account for more than half of our overall Tri-Moxi sales. This means we don't need to reach out to a large number of accounts—just about 50. Therefore, we have a manageable path to transition these customers to this opportunity. We anticipate this will occur significantly this year, and we are excited about it. The financial benefits for us are significant. We didn't incur development or initial launch costs for the product, yet we can work with our partners effectively to promote it. We believe DEXYCU is an excellent product, with favorable feedback from doctors who appreciate its results. We are eager to include it in our portfolio. Additionally, it's worth noting that the ambulatory surgery centers and hospitals purchasing this product will also require other elements of the ImprimisRx surgical portfolio. So, while selling DEXYCU is important, we're equally excited about offering the rest of our pharmaceutical products as part of what we call a pharma pack, which encompasses everything needed for surgical cases. Andrew, would you like to discuss the timing for cash flow recognition?

Andrew Boll, CFO

I'm happy to discuss this in more detail later. Generally, the revenue recognition will occur normally, meaning that once the sale is finalized and we receive credit on the EyePoint side at the time of sale, we should be able to accrue our commission. The expenses on their side and our commission related to revenue should align from quarter to quarter.

Andrew D'Silva, Analyst

Okay. Perfect. And then can you just talk about some of the differences about being included as a maybe expense center within the bundle when you're dealing with Tri-Moxi versus how pass-through status works with Part B and having that price fall outside the bundle? And maybe what that means to those 100 or so clients that you referenced make about 50% of Tri-Moxi?

Mark Baum, CEO

Sure. It's very straightforward. Currently, ambulatory surgery centers have a set amount of revenue to cover the costs associated with the surgeries they perform. From this revenue, they need to purchase all necessary pharmaceutical products. When a doctor selects Tri-Moxi for a procedure, it becomes a cost center, meaning its cost needs to be absorbed. In contrast, choosing Dexycu is advantageous because it is reimbursed at ASP plus 6%. Instead of spending around $30 per unit, the surgery center might receive coverage for Dexycu, resulting in a profit of approximately $35. This represents a complete shift from a cost center to a profit center and from a compounded product to an FDA-approved one. Additionally, if there's a need for antibiotics, we also produce compounded moxifloxacin, which we likely sell more of than any other provider in the country. Therefore, not only will the surgery center save on moxifloxacin, but they might even generate enough revenue from Dexycu to offset that cost. This presents significant economic benefits for ambulatory surgery centers, hospitals, and physicians.

Andrew D'Silva, Analyst

Okay. Great. And actually it's a perfect transition. There was a notice for comment related to ketorolac and more importantly moxifloxacin. Can you just let us know what happens next or what happens if it gets removed from the list? And what alternative options, can you institute from a non-compounded drug standpoint and timing and things of that nature. I'm just curious on your take of the notice for comment.

Mark Baum, CEO

Yes. So thanks for the question and we certainly appreciate the question on that. The reality is that over the last six years or so we have lived through numerous changes that were required for active ingredients. And so this is not anything new to us. And without giving away anything that would reveal how we plan to deal with this strategically all I can tell you is that we have compliant formulations whether the change takes place or whether the change does not take place. We will continue to serve our customers and make our formulations and the formulations they want available for them.

Andrew D'Silva, Analyst

Okay. Great. Hey, thank you very much. Good luck closing out the year and congrats on the progress you've made.

Mark Baum, CEO

Andy, thank you very much for your question.

Operator, Operator

And next we'll go to Greg Kitt with Pinnacle Family Office. Please go ahead.

Greg Kitt, Analyst

Hi, Mark and Andrew. Thanks for taking my question. Thanks for your hard work during this quarter. I'm really encouraged by the cash management that you just displayed. And I think you proved the durability of your operating model in Q2. So I think I'm more enthusiastic about Harrow than I've ever been. I appreciated the color that you gave around ImprimisRx being a platform from which to grow. And I think the fact that you're able to form this EyePoint-Dexycu partnership is a result of that. And I'm excited to see what other partnership opportunities you can initiate? I'd love it if you can expound a little bit more upon the reverse inquiries for new products that you got from customers. Can you help us understand generally how to think about the development costs for these programs relative to the revenue opportunities?

Mark Baum, CEO

Thank you for your support and your question, Greg. I believe no one in the pharmaceutical industry can bring products to market—whether compounded or FDA-approved—more efficiently than we do. We maintain low expenses by collaborating with partners and physicians who generate the ideas, all while protecting our competitive edge. This year has been one of the most innovative periods in our company's history. We recently filed intellectual property on a family of formulations we have been developing for three years, which presents a significant opportunity. We believe this formulation will be widely used in nearly every ophthalmology and optometry office across the United States, tapping into a large market. We continue to advance our efforts in presbyopia, as we've mentioned before, and our R&D function remains active. Although I don't think we spend excessively on bringing these products to market, I can confidently say that the first half of the year has been highly productive on the R&D front.

Greg Kitt, Analyst

Thank you very much. I have one more follow-up question. I was pleased to see that you're making progress towards your $100 million revenue target, with gross margins of 70% or more and EBITDA margins of 20% or better. In your Q4 shareholder letter, you mentioned that you expect to reach these targets between mid-2022 and the end of 2022. Currently, your company is valued at $150 million, and the worth of your deconsolidated subsidiaries is $50 million. If we assign zero value to your consolidated subsidiaries, which seems unreasonable, then Harrow would be valued at $100 million, essentially equivalent to ImprimisRx. Achieving a $100 million revenue run rate and a 20% EBITDA margin within the next two to two and a half years suggests that Harrow is trading at five times your projected EBITDA. This further indicates that your business might grow at a compound annual growth rate of 30% to 40% over the next two to two and a half years from the pre-COVID levels to reach that target. I doubt that Harrow would be trading at that multiple if investors were confident in your ability to reach these goals. Could you provide some context regarding your confidence as we emerge from this COVID period and your capacity to meet these operational targets? While I understand you cannot control potential outbreaks or shutdowns, I would appreciate an update on this matter.

Mark Baum, CEO

We are very comfortable in the medium-term with the targets we previously described. It has been challenging, especially during the COVID period and the second quarter. Therefore, I am cautious about making revenue and gross margin predictions while we are still dealing with the pandemic. However, our business is performing well. We had a strong June and an even better July, with record days in July. The third quarter is typically slow due to vacations, but many of our customers are still working. We're optimistic about the second half of the year, with exciting developments ahead that will add value. In discussions with professionals in ophthalmology and business valuation, they consistently suggest that the value of ImprimisRx exceeds our market cap, with estimates not dropping below $150 million. I often tell my counterparts in other companies that I don't see value in our ownership in their firms, but they have a different perspective. Despite the current discount, our focus as a management team will be on execution in the latter part of the year and into 2021, with the belief that our efforts will eventually be recognized by the market.

Greg Kitt, Analyst

Thanks, Mark.

Mark Baum, CEO

Thank you, Greg.

Operator, Operator

And it looks like we have a follow-up question from Brooks O'Neil with Lake Street Capital Markets. Please go ahead.

Brooks O'Neil, Analyst

Thank you. And I was just sitting here, thinking a little bit more. I'm curious Mark, if you could describe your relationship with EyePoint and whether you feel any risk in your current products or in the relationship you're developing with them? Is it exclusive arrangement, or do you have any protections from them coming in and trying to steal any of your business that you have today?

Mark Baum, CEO

Yes. Well first of all it's a new relationship but like any – like most business relationships, it's a business that was – it's a business relationship that's forged on the foundation of a great contract, a strong contract, a written contract that protects them as well as Harrow and ImprimisRx. So we've got a great agreement and they are – we're really excited about the relationship. They're good people. They've got a great product. And that's really the important factor here is the quality of the product. They've got a strong but small commercial team and we're excited to work with them and supplement them. They're largely taking the lead on a lot of the commercial activities like marketing and such but we're going to get out there, and we're going to focus on our own customers. And so in terms of our concern about them disrupting existing relationships, the way the agreement is structured Brooks, it doesn't work like that. It would disallow that from happening. We actually get credit on specific customers. And these are customers, definitionally that are our customers and they're not buying to execute because they're our customers right now. And so we want them to consider, to execute. We have, as I said a strong belief in the product and the value of the product and that's what we're going to do. And every time we have a success, it's not only a great clinical success we believe but also a great economic success for our stockholders.

Brooks O'Neil, Analyst

Absolutely. It makes total sense. So I guess, I'll just ask one more. So do you see opportunities for additional products from EyePoint, or as you think about other FDA-approved products, are they more likely to come from other companies developing drugs for this market?

Mark Baum, CEO

Yes it's a good question. Dexycu is – what powers Dexycu is a delivery technology and it's a front-of-the-eye delivery technology. And there are certainly opportunities down the line to talk to the EyePoint people about developing that. That was not the focus of our agreement. Our agreement is specific to Dexycu. And once again, we're really excited about launching this product or relaunching it effectively with them to our customer base. But when we talk about other deals that we've been working on, it is outside of the EyePoint relationship. We've been very active, really for the last 12 months working on these deals. And so EyePoint is the first. We hope we'll have more, hopefully maybe by the next time – before the next time we speak, we'll see. And we're going to continue to execute the strategy that we described earlier over the last couple of quarters. We're going to bring in FDA-approved products. We're going to show that people – companies with FDA-approved products are really excited about the ImprimisRx platform, the value it delivers. And then of course, we're going to execute commercially and sell stuff and get these guys to hopefully reorder from us, so we can drive value for our stockholders.

Brooks O'Neil, Analyst

That’s great. Thanks a lot for taking my questions.

Mark Baum, CEO

Thank you, Brooks.

Operator, Operator

And with that I would like to turn the conference call back over to Mark L. Baum, CEO for Harrow Health, for any closing remarks.

Mark Baum, CEO

Thanks, again for attending our call today. I just hope that our nation's recovery continues to flourish over the coming months and until we speak again, please stay safe. If you have any investor-related questions, please e-mail at the following e-mail address: ir@harrowinc.com. That's I as in Igloo, R as in Robert at harrowinc.com. And this will conclude our call. Thank you.