Bruce Wass - IR Mark Sieczkarek - President and CEO Tom Paulson - CFO

Lauren Chung - Maxim Group Ed Woo - Ascendiant Capital Michael Bardaky - Geneva Group

Welcome to the NovaBay Q3 2016 Conference Call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks, we will hold a Q&A session. [Operator Instructions] As a reminder, this conference is being recorded November 10, 2016. I would now like to turn the call over to Mr. Bruce Wass. Sir please go ahead.

This is Bruce Wass with LHA, thank you all for participating in today's call. Joining me from NovaBay Pharmaceuticals are Mark Sieczkarek, President & CEO and Tom Paulson the Company's CFO. I would like to remind listeners that comments made during this call by management will include forward looking statements within the meaning of federal securities laws. These forward looking statements involve risks and uncertainties that could cause actual results to be materially different from any anticipated results. For a list and description of those risks and uncertainties, please review NovaBay Pharmaceuticals filings with the Securities and Exchange Commission. Furthermore, the content of this conference call contains information that is accurate only as of the date of the live broadcast November 10, 2016. NovaBay Pharmaceuticals undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call, except as required by law. And now, I'd like to turn the call over to Mark Sieczkarek. Mark?

Yes, thank you Bruce and good afternoon to everyone and thanks for joining the call. I'm very pleased to report exceptional progress in NovaBay during the third quarter, progress that brings us significantly closer to reaching our ultimate goal this year of positive cash flow by year end and renewing our credibility as a well-managed organization. Now we continued executing on a tightly focused business strategy, leading to another quarter of record Avenova sales, expanded gross margin, narrowed operating loss and reduced cash burn. And with the proceeds from the exercise of stock warrants during the quarter, we now have sufficient capital for the first time to achieve our goal and continue our strong growth without a financing overhang. Let me start today by sharing some third quarter highlights with Avenova commercialization. First the sales of Avenova reached $3.1 million, up 176% from last year's third quarter and up 20% from this year's second quarter. We are now tracking against an annualized sales run rate of more than $12 million. Secondly, more than two-thirds of Avenova sales came from retail pharmacies as we directed our commercial activities on the more profitable ophthalmology channel. This is a near reversal in sales mix from a year ago and shows tangible results from the new marketing and pricing strategies we implemented earlier this year. We also achieved record gross margin on Avenova sales of 88% as a result of increases in the new number of prescriptions and positive channel mix. This is up from 78% gross margin in the prior year quarter and it's up from an 85% gross margin for the second quarter of this year. So these improvements along with our cost reductions led to a 62% narrowing of our operating loss versus the prior year, and our adjusted operating cash burn decreased to $1.2 million, down $3.9 million from the prior year quarter and down $750,000 from last quarter. Now under the new marketing strategy we implemented earlier this year we have instituted a rebate program for prescriptions filled through pharmacy for consumers with health plans that currently don't cover Avenova or have high co-pays. This rebate program allows for out of pocket payments by those consumers that are in line with a typical prescription co-pay. It's important to remember that our newly implemented marketing and pricing strategy benefits all constituencies. Consumers pay similarly low prices for Avenova, regardless of their prescription medical plan coverage. The healthcare system has a lower cost and more efficient option for managing blepharitis and dry eye versus the more expensive antibiotics and steroid combinations. And lastly, our shareholders benefit from the increased value of NovaBay due to our high revenue growth and margin improvement. Another highly positive development during the quarter was the exercise of the warrants that boosted our cash position by $6.6 million. Now this was a key aspect in the last tranche of our current financing strategy. The increase in cash on our balance sheet allowed us to meet the Near York Stock exchange marketing requirements and maintain our listing on the exchange. Now in doing so, NovaBay is better positioned to attract the interest of the investors at this crucial time as we continue to build Avenova sales and near our ultimate 2016 goal of positive adjusted cash flow from operations. The additional capital on our balance sheet, has the added and critically important benefit of funding and accelerating our future commercial growth plans. We continue to face significant expansion opportunity in the large and mostly untapped domestic market for Avenova. Now I use the word untapped because our current rep coverage affords us exposure to only roughly one third of the potential marketplace. So before I talk more about our business and our plans going into the future, I'm going to turn the call over to Tom Paulson for a review of our third quarter results. Tom?

Thank you, Mark. And good afternoon everyone. As Mark stated, we are reporting another quarter with extra momentum across a number of financial metrics. I'll start with some key highlights and then review our results in greater detail. As has been our practice in prior calls, I will be reviewing operational performance on a quarter-to-quarter basis, which we believe provides a best gauge of our progress. Number one, as Mark noted, total Avenova sales for the third quarter 2016 reached a record $3.1 million, up 20% over Q2. While we did see additional price improvements in the third quarter, the majority of the sales growth was volume related. For reference, Q3 this year sales were 176%, or almost three times higher than the third quarter of last year. Driving this increase were both unit growth and favorable price mix variance as the RX channel sales grew to dominate our overall sales mix. Prescription sales through the pharmacy channel grew to $2.1 million, up 25% from Q2 and represented 68% of all Avenova sales dollars. Again, the increase was substantially due to increased volume. This significant shift towards the reimburse pharmacy channel is reflected in the increase in total Avenova sales and the improvement in gross profit margin, both of which support our path to profitability and positive cash flow. Direct sales to the practitioners' offices channel also grew, reaching a record $1 million, up 10% over Q2 and representing 32% of all Avenova sales. And importantly, during the third quarter we added more than 1100 new Avenova prescribers, bringing total doctors who have prescribed Avenova to approximately 7,700. In reviewing financial highlights for the third quarter, we're providing comparisons of both prior year and the preceding quarter again as a reflection of our progress. So again, total net sales for the third quarter of 2016 reached a record $3.4 million, up 187% from the third quarter of last year and up 29% from the second quarter of this year. Avenova sales for the third quarter of 2016 reached $3.1 million, as we noted earlier, nearly threefold higher than the sales reported for third quarter of last year, and up 20% from second quarter of this year as I mentioned. Our gross profit margin, as a percent of total sales was 84% for the third quarter of this year. This compares with 78% for the third quarter of last year and 82% for our last quarter. The increase was due to higher sales of Avenova and higher average price per prescription. Gross profit margin on Avenova sales grew to 88% in the last quarter. Operating loss for the third quarter was $2 million, an improvement of 62% from the prior year and 9% from the preceding quarter. The year-over-year reduction was due to restructuring and cost reduction measures implemented last year, with our decision to focus resources on Avenova commercialization. In reviewing expenses by line item, first of all R&D expenses were only $4,000, down from $1.6 million a year ago and down from $278,000 in the preceding quarter. This significant reduction reflects our focus on Avenova commercialization, lower spending on clinical trials that are now completed and the exchange of laboratory equipment for R&D services in the third quarter of '16 that were valued in access of the net book value of the equipment, thereby generating a sizable credit. G&A expenses were $2.2 million for this year’s third quarter, compared with $1.7 million a year ago and $1.3 million for this year's second quarter. The increase was primarily due to modifications to the exercise price of warrants issued in May of 2015. By the way this non-cash charge of $270,000 resulted in warrant exercises worth $500,000 in proceeds to NovaBay. Also, the increase was related to higher stock based compensation expense. Additionally, we reported onetime cost associated with the sub-lease of our previous headquarters location. As discussed on our last quarterly call, next month we will begin seeing a sizable reduction in our rent and utility expenses, related to the sub-let of our former office and lab space and move exclusively to office space. We have now completed the relocation of our entire NovaBay team to nearby smaller and more economical space that is suited to our commercial focus. Due to cost savings and credits, sales and marketing expenses for the third quarter of 2016 of $2.7 million decreased 12%, from $3 million a year ago and 7% from the $2.9 million in Q2 of this year. The net loss for the third quarter of this year was $3.7 million or $0.34 per share. This is an improvement from the net loss for the third quarter of last year of $5.2 million or $1.77 per share. Our narrowed net loss includes the impact of -- recognizing $1.2 million of non-cash loss on the increase in the fair market value of our warrant liability, compared with a gain of $139,000 for the prior year period. The non-cash loss on changes in fair market value of the warrant liability was primarily caused by the increase in the price of the Company's common stock during the quarter. The net loss for the third quarter 2016 increased by $1 million or 39% over the net loss in the second quarter of this year. Turning now to nine months' results, net sales for the first nine months of '16 were $7.8 million, up 185% or nearly threefold higher compared with the prior year period due to significantly higher sales of Avenova. Avenova sales for the first nine months are nearly double those reported in all of last year. Gross profit margin for the first nine months of 2016 was 79%, compared with 76% a year ago. Gross profit margin of Avenova sales was 85% for the first nine months of 2016. Our operating loss for the first nine months of 2016 narrowed by a substantial 41% to $8.8 million from $14.9 million in the prior year, reflecting a 73% decrease in R&D expenses and relatively unchanged G&A expenses. Sales and marketing expenses increased by 19% over prior year, due primarily to higher number of reps on the field. Non-cash warrant liability loss for the first nine months of 2016 was $2.5 million, versus the $173,000 gain in the prior year period. The non-operating charge was related to the liability nature of some of our warrants, whereby the liability fluctuates quarterly, depending on NovaBay's market price. The net loss for the first nine months of 2016 was $11.5 million or $1.54 per share, representing a 22% improvement from the net loss of $14.8 million or $5.68 per share for the first nine months of last year. In reviewing our balance sheet, as of September, at the end of September this year, NovaBay had cash and cash equivalents of $9.4 million, the highest level in three years, reflecting the $6.6 million from the exercise of warrants. We also received an additional $500,000 from warrant exercises in October. Turning to cash flows, we are reporting another quarter of substantially reduced adjusted cash burn from operation of $1.2 million. This was down from $5.1 million for the third quarter of last year, and is down another $2 million from the second quarter of this year, representing a reduction of burn of 38% from second quarter. This demonstrates our growing Avenova sales and managing cost by significantly reducing our cash consumption. As a final note, our new marketing and pricing strategies and cost reduction measures are keeping us on track to achieve our year end goal of positive adjusted cash flow from operations as early as next month, which we define as a GAAP cash flow from operations, minus changes in operating assets and liabilities. With that, I'll turn the call back over to Mark.

Okay, thanks Tom. Just to kind of wrap this up for you, our corporate focus is squarely on accelerating commercialization of Avenova in the domestic market. Now that being said, we have pursued additional opportunities to improve our longer term revenue position. And among these in September we announced that our Neutrox product line, which includes Avenova received CE mark and ISO certification for the European Union. Now the importance of these authorizations is that they clear the way for future Avenova sales in the major EU markets. Now these authorizations also further demonstrate our compliance with highly stringent safety and quality standards. Another component of our strategy is to monetize non-core NovaBay assets, and to this end, we are delighted with the Phase IIb clinical trial results announced earlier this quarter that showed the ability of Auriclosene to produce statistically significant and clinically meaningful results for the prevention of urinary catheter blockage and Encrustation in subjects with chronic indwelling urinary catheters. Auriclosene is our proprietary non-antibiotic fast-acting, broad-spectrum antimicrobial that has been designated as a new chemical entity and granted patent protection by the U.S. patent office. Now Auriclosene in this indication represents a significant market of roughly $700 million. The highly favorable phase IIb trial results and the stringing trial design set the stage for a pivotal trial that could lead to FDA approval. We are currently reviewing our options to monetize this non-core program and advance it through pivotal trials to commercialization. Now these include partnering, licensing, or joint venturing. Now this strategy is aimed at bringing in additional capital into NovaBay while we focus on building our core Avenova franchise. Now regarding Avenova, we certainly have a superior product based on the 100% pure hypochlorous acid with no bleach impurities and the clinical validation that supports its effectiveness in the management of several troubling eye conditions, including blepharitis. We intend to continue driving sales and supporting growth in key metrics including the number of prescriptions, the number of total prescribers and the number of prescribers writing multiple prescriptions. We have already seen the positive impact from our marketing and pricing strategies introduced earlier this year, and we're going to continue to direct our sales activities towards the more profitable ophthalmology channel and benefit from reimbursed pricing. Importantly, we see ongoing evidence in customer satisfaction and patient testimonials and strong reorder rates. We have ample room for growth in the U.S. market for Avenova, which again we estimate at 41 million Americans. This includes about 30 million who suffer from blepharitis and dry eye. Many physicians have found that these chronic conditions are best managed by regular twice daily use of Avenova. The remaining 11 million in our total market count includes use for ophthalmic procedures such as Lasik and Cataract surgeries as well as for contact lens wearers. And another sign of our confidence, we are taking steps to convert our current contract salesforce that NovaBay employs in the first quarter of 2017. So in summary, I think it's fair to say that less than one year we achieved our near-term goals of resizing the Company, setting and beginning to execute on a new strategy, and rebuilding the balance sheet to sustain our high growth. What remains and is in grasp is our goal of cash flow breakeven. I want to at this point thank the loyal employees of NovaBay, who saw and believed in this vision and had the courage to stay during this difficult time. It's now behind us and I applaud their exceptional efforts and look forward to building with them an extraordinary Company that we all can be proud of and bring continued growth and value to our shareholders. So with that overview of our business and our plans, we're ready to take your questions. Operator?

[Operator Instructions] Our first question is from the line of Jason Kolbert with Maxim Group.

This is [indiscernible] for Jason Kolbert. Can you hear me okay?

Yes, we can.

Great, thanks for taking the call. My question is can you talk about the prescription pattern or -- to the extent that you can. So optometrist versus ophthalmologists.

Yes, again we're focused this year on the ophthalmologists. Last year if you recall, we began this business by focusing on the optometry channel, and what we refer to as our buy and build channel. And with the change in strategy January 1st, we basically retrained our salesforce and we're making calls again on the ophthalmology channel. And as Tom had indicated and I did also in my remarks, we basically have flipped the channel and the reliance on the channel's last year. In round numbers our reliance on the optometry channel is about 70% of our sales, 30% for ophthalmology and as of the end of the third quarter, it's basically the opposite, about 70% now in ophthalmology, which are the prescriptions and 30% on that buying, builder optometry channel.

Our next question is from the line of Ed Woo with Ascendiant Capital.

Yes, thank you for taking my question and congratulations on the quarter. I'm not sure if you can provide more color in terms of the order rates and the number of physicians that you mentioned were ordering your products again. I know the 7,700 number is a great amount. Can you provide any colors on how many of those are still reordering on a regular basis?

Well I can tell you this Ed, that we check the data and we compare it to industry standards, and our reorder rates are above those industry standards and also things like abandonment rates. We're doing really well as compared again to the industry. So I think that by itself speaks to again the ability of our doctors and our salesforce with education to keep people on Avenova, and it also speaks to the effectiveness and the value that it brings to a consumer.

And the other question I have is on the salesforce, you mentioned that you are happy with the progress of the salesforce, but yet coverage is still far short of reaching the whole market. What do you think are the prime opportunities to increase efficiency, effectiveness of the salesforce? Is it to hire more people or is it to work with what you have to conquer the rest of the market, and how quickly would you be able to do that?

Coming out of the chutes with a -- if you will, a new product -- again, we call this a new category as well, we've been watching the data extremely carefully. And it's one of those things where want to walk before we run. I think I mentioned in my comments that we're probably addressing only one third of the marketplace in the U.S. with our current salesforce of about 43 people. And we, as we grow and continue to grow, we're going to put those profits back into revenue growth which primarily are going to be sales representation and also clinical studies that again further reinforce the use of Avenova. So I think those are two areas that we're going to take the -- certainly the profit from this business and reinvest in the revenue growth. But we're going to do it in a manner of that again -- we'll make sure that we have data that supports that investment before we move forward.

[Operator Instructions] We do have a question from the line of Michael Bardaky with Geneva Group.

My questions have been answered, but I would like to make a comment and congratulate you guys on a terrific quarter. You guys are delivering everything you said you were going to deliver and more. I would like to also make a comment. I think your PR firm should be out doing full core press on getting some additional institutions into this company, and getting some eyeballs on deal. It seems like the only analyst that you have has had a hold on this stock for a year and has been dead wrong. Thank god we listen to him because we are up 122% annualized on our portfolio on this stock. It is our biggest profit, and I thank you for that, delivering everything you said you were going to do since the split. Anyhow [indiscernible]

We really appreciate it. Like I said, the organization has been working really hard and really goes back to them and their passion for the product and what we're trying to accomplish. That being said I think yes, it is important for us going forward, very important for us and you will see it in '17. We'd certainly like to get a lot more coverage. I think we're proving obviously through this year, our credibility as a team to get the things done that we said we're going to do, and I think what's worked against us is certainly is this financial overhang, our market cap in the past and I think we're finally getting into a range where now we can attract more people if you will to the stock, and more analyst coverage as well. And I can guarantee you that Tom and I have been out on the road, you know again talking the story and trying to get the interest level up. So all that being said, the goal is for '17, is to do exactly as you had asked and try to get more coverage, because I think we have a jewel here.

And I would make one comment that when you do have one analyst, it's obviously short. They're going to come in with a really unrealistic earnings per share, just to make it appear to be bad. I don't think that that's an issue if you had more than one analyst in there, where you have a little more competition on the estimates. So good luck to you and we're adding every day.

We do have a follow up question from the line of Jason Kolbert.

Hi, just had a follow up question. This is Lauren Chung again. On the European roll out, can you tell me a little more about that. I know you had the announcement in September. When should we expect to see numbers?

Well, you know, we haven't guided, and as I said in my comments I think that's something that's a placeholder right now. We certainly have the ability to go there. Once again given the European market, as it currently stands, it would be most appropriate for us not to go direct there but with a partner, with some sort of arrangement, be it licensing or some sort of partnership arrangement. That's not in the near term. As I mentioned again, that's you know future longer term revenues. But the fact is at least we've greased the skids and cleared the way from a regulatory perspective to go there.

And that is all the questions we have in the queue. Is there any further remarks?

Yes, well, I'd really like to thank you all for joining and also just to alert you that we are going to be presenting at two investment conferences during the month of December. Tom is going to be at the Benchmark Company in Micro Cap Discovery conference on December 1st in Chicago, and I will be at the LD Micro Main Event Conference on December 7th in Los Angeles. So I'd like to see some of you there and please stop by and say hi. And we're also going to be holding meetings with members of the professional investment community in San Francisco during the JPMorgan conference between January 9th and 11th, and if you're interested in scheduling a meeting, just contact us. So operator, I guess that's it. Again, thank you all for joining.

Ladies and gentlemen that concludes your conference call for today. We thank you for your participation and ask that you please disconnect your lines.