Jody Cain - IR, LHA Mark Sieczkarek - President & CEO Jack McGovern - CFO

David Solomon - Roth Capital Frank Brisbois - Laidlaw Yi Chen - H.C. Wainwright

Welcome to the NovaBay Q4 2017 Conference Call. At this time all participants are in a listen-only mode. Following management's prepared remarks, we'll hold a Q&A session. [Operator Instructions] As a reminder, this call is being recorded Tuesday, March 20, 20178. I would now like to turn the conference over to Ms. Jody Cain. Please go ahead, Ma'am.

This is Jody Cain with LHA. Thank you for participating in today's call. Joining me from NovaBay Pharmaceuticals are Mark Sieczkarek, President & CEO; and Jack McGovern, the Company's CFO. I'd 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, March 20, 2018. NovaBay Pharmaceutical undertakes no obligation to revise or update any statements to reflect events or circumstances, except as required by law. And now I'd like to turn the call over to Mark Sieczkarek. Mark?

Thank you, Jody and good afternoon to everyone and thank you for joining us. I'm pleased to report on our exceptional fourth quarter performance which caps a highly productive year for NovaBay in 2017. Avenova sales for the quarter were a record $4.9 million with about 90% of those sales coming from the higher margin retail pharmacy channel. Gross margin on Avenova sales of 92%, that's our highest mark for any quarter and we recorded net income of $800,000. So for the full year of 2017, net sales were $18.2 million reaching the high end of the guidance range that we revised in the third quarter and gross margin on Avenova sales of 91% exceeded our guidance. But before we discuss our plans for 2018, I'd like to turn the call over to Jack McGovern to review in more detail the financial results. Jack?

Thank you, Mark. Good afternoon everyone. I'd like to begin by discussing our Q4 results. Total net sales for the fourth quarter of 2017 were $6.3 million, a 55% increase over the fourth quarter of 2016. Avenova sales were up 25% year-over-year to $4.9 million on record unit volume through our retail pharmacy channel. As Mark mentioned, Avenova sales into the retail pharmacy channel increased 45% over the prior year to $4.4 million and comprised 90% of total Avenova sales. Sales through our in-office direct channel for the fourth quarter 2017 were $503,000. And lastly, we had revenue for the quarter of $1.4 million from the sale of our wound care product at phase 1. Gross margin on total sales for the quarter was 85% versus 80% for the prior year period. The gross margins on Avenova sales for the quarter matched our record high at 92%, up from 87% in the prior year period. We've reported operating income for the fourth quarter 2017 of $392,000 which is a significant improvement over the operating loss of $2 million for the fourth quarter 2016. In reviewing expenses by line item, sales and marketing expenses for the fourth quarter of 2017 were $3.3 million, up from $3.1 million for the prior period, due mainly to increases in the number of sales reps, product sampling and marketing programs. G&A expense for Q4 2017 were $1.5 million, which is down from the $2 million for the prior year period due to lower stock based compensation expense associated with performance based awards, that's partially offset by severance payments. R&D expenses for Q4 '17 decreased slightly at $146,000. Non-cash gain on the fair value of warrant liability for the fourth quarter of '17 was $400,000 which is up slightly from the prior year period. We reported net income for 2017 fourth quarter, $793,000 or $0.05 a share. This compares with the net loss for 2016 fourth quarter of $1.6 million or $0.11 per share. Turning now to our full year results. Net sales for 2017 were $18.2 million, which is up 53% from $11.9 million for 2016. Gross margin on total net sales was 85%, up from 79% in the prior year. Gross margin on Avenova sales improved to 91% which as Mark mentioned was above our guidance for the year and compares with 86% for 2016. The operating loss for 2017 was $7.3 million, which is a 33% improvement over the operating loss of $11 million for 2016. Operating expenses for 2017 included sales and marketing expenses of $13.7 million, G&A expenses of $8.6 million, and R&D expenses of $410,000. Non-cash loss on the fair value of warrant liability for 2017 was $101,000 as compared with a non-cash loss of $2.1 million for 2016. The net loss for 2017 was $7.4 million or $0.48 a share as compared with the net loss for 2016 of $13.2 million or $1.40 a share. Turning to cash flow; we used $6.3 million to fund operations in 2017, which is a 48% improvement over the $12.1 million we used the prior year. The narrowing of this cash bur resulted primarily from higher Avenova sales. As we look at our balance sheet, we had cash and cash equivalents at $3.2 million as of December 31, 2017. In February, we completed a $6 million private placement on favorable terms to NovaBay with Hong Kong based OP Financial Investment Limited which replaced the previously announced Gemstone Financing which expired due to government transfer issues. And with that, I'll turn the call back over to Mark.

Thanks, Jack. Avenova continues to present a significant commercial opportunity for our Company and our shareholders, and ultimately for the patients that suffer from chronic dry eye and blepharitis. And rather than simply addressing the symptoms of these conditions, Avenova is clinically proven to attack the bacteria that is the underlying cause of over 80% of dry eye conditions. Again, Avenova is uniquely formulated with our proprietary pure hypochlorous acid which is significant advantage over the other hypochlorous based products that also contain leach particles. As we've said on past calls, we've only begun to address the sizeable and largely untapped U.S. market which addresses millions of Americans who suffer from blepharitis and dry eye and who undergo ophthalmic procedures such as LASIK, retinal and cataract surgeries, or experienced contact lens and tolerance issues. Now we've made significant progress in driving Avenova sales since we launched the product two years ago. We garnered support from ophthalmology, optometry leaders, we've established widespread distribution so that Avenova is now accessible in more than 90% of retail pharmacies across the U.S. We've also successfully built a base of more than 10,000 Avenova prescribers which is not an easy task for a product that represents a paradigm shift in the management of dry eye. And lastly, we've developed the following of loyal customers who have found relief for chronic dry eye and more importantly, blepharitis. You may recall that our initial focus at the time of launch was to reeducate eye care specialists as to the advantages of Avenova and to offer the product directly to patients through their offices. In the following year, we revised our sales and marketing strategy to encourage eye care specialists to write Avenova prescriptions to be filled through retail pharmacies. This strategy allows us to capitalize on insurance reimbursement which has successfully driven revenue growth and expanded gross margins. Now as you may know, through the prescription retail pharmacy channel, we offer rebates on Avenova pricing to patients with high co-pays or no insurance. We found last year that some of these rebates have a negative impact on a per unit sales, in particular this is the first half of the year as patient satisfy their annual insurance deductibles. We are now shifting our focus for more profitable grow through measures aimed at improving reimbursement while optimizing our sales and marketing resources. As discussed on last quarters call, we have collected substantial data over the past several years and now have gained a better understanding of our market. This includes the fact their reimbursement tends to be significantly higher in specific geographic regions. Our data analysis also shows that many prescribing physicians were writing only 1 or 2 prescriptions per month while there is we're responsible for multiple prescriptions. As such, our sales representative were making calls on low prescribers and seeing minimal returns for those calls. We also found that when eye care specialists understand the benefits of Avenova for their patients, and their patients are covered by insurance, they tend to embrace the product. From this analysis, we developed a group of high prescribing target and high reimbursement regions. Earlier this year we redeployed our sales representative to focus these select targets with the objective of increasing prescription, purposes driver, and net sales per unit. In conjunction with this new strategy, we paired by our commercial organization from the 46 sales reps that we have in 2017 year end to 39 reps of today. Our current reps are directing their sales calls on these targeted prescribers while we continue to service us the additional territories through our sales team. We intend to substantially increase our sales representation in the second half of 2018 as we obtain further geographical reimbursement. The transition to this financial efficient approach coupled with the reduction in the number of sales representatives in the short-term will negatively impact first quarter sales which are already affected by the seasonal slowdown in scripts and reimbursement due to deductible resets as I just mentioned previously. However, we expect to rapid addition of reps in the second half of the year as we systematically obtain reimbursement and that will overcome a slow start. Regarding the second part of our strategy, to improvement reimbursement we are preparing to work more closely through our highly respected consultant organization, with managed care organizations to obtain new and/or improved coverage for Avenova. Now this is a process that begins with collecting a substantial amount of information to support that coverage and then initiating contact with the key healthcare plans to present our case. We expect to begin contacting these plans in the second quarter of this year. We are also embarking on a strategy to obtain other products and services through arrangements underway with others in the eye care space focusing on both, the OD and the ophthalmology channel. Now as a final note, we continue to benefit from the awareness created by heavy consumer advertising and promotion of dry eye products by other companies; we are approaching the market with a message of Avenova's ability to reduce the bacteria that can be the underlying cause of dry eye which makes Avenova use complementary with these other products. In closing, I'm proud of your progress and our organization over the past several years in building a prescriber base for a new paradigm in the treatment of chronic dry eye. We are now entering the next chapter in our commercial development by implementing strategies aimed at optimizing our sales and marketing resources and improving reimbursement with a focus on profitable growth. We plan to continue managing expenses and reduce cash burn as we did in 2017 by more efficiently executing on the data we have collected over the past two years. We also continue to pursue opportunities to monetize non-core assets, to bring in additional capital while we focus on our core eye care franchise. As always, our goal is to create value for our shareholders. So with that overview of our business and our plans for 2018, I thank you for your attention. And operator, we're ready to take questions.

[Operator Instructions]

And while we're waiting for the first question, I'd like to mention that we will be presenting at the LD Micro Invitational Conference being held June 4-6 in Los Angeles; and we look forward to seeing you there.

Our first question is from Frank Brisbois with Laidlaw. Please go ahead with your question. And I do apologize, it looks like he has withdrawn his question. Our next question is from David Solomon with ROTH Capital Partners. Please go ahead with your question.

Firstly, I was just wondering how should we be thinking about operating expenses for 2018 compared to this past year?

I think given the rep profile that Mark mentioned, in the first half of the year we're definitely going to be running at a lower rate than we were in Q4 and even in Q3 last year. So on an annual basis that would be a lower, if we start to add reps in the second half of the year as we're intending, it will probably be out or about last year. So lower in the first half of the year and then based on that adding reps in the second half of the year, we'll probably be at the same $13.7 million, $13.8 million that we were for all of 2017.

Just on the Avenova scripts, how should revenue per script track throughout the year? And when would you guys expect scripts to reach their new highs again?

Again, the seasonality is such that we are paying much more and we're experiencing so right now in the first quarter much more rebate contribution. So our gross to net is certainly down in the first quarter and that will probably trickle over into the second quarter. So I think if you were to draw lines, it would parallel last year's ramp where gross to net is probably in the $120 million, $130 million range early in the year and gets up north of $130 million to $140 million in the second half of the year. And then on the scripts number, right now our scripts are going to be down. Again, as Mark said as we do the realignment and wait reimbursement, we're at 39 reps whereas the average number of scripts per rep is a little bit higher, the arithmetic total is lower as a result of being down to 10 reps; so we're going to be down a bit in the first quarter and again, for the whole year that's going to be a function of how quickly we place those reps back on the payroll.

Our next question is going to come from Frank Brisbois with Laidlaw. Please go ahead with your question.

So can you just remind us what the percentage of sales was last year for the -- last quarter for the retail pharmacy channel?

For the fourth quarter?

For the third quarter; you have 90% now that were through retail pharmacy; just wondering what it was last quarter?

I thought it was at top of my head, 87%. Yes, it was very close to the 90%.

With the first half of the year, you guys without giving exact guidance seems like it's going to be lower a little bit; is there any -- when you guys think you might feel comfortable with the guidance for the end of the year numbers next year for '18?

Frank, I think throughout the opening discussion and now you can see that there is a lot of moving parts and the moving part on reimbursement, again, we don't want to really add people until we see the lights of the eyes if you will of reimbursement; so it's a tough one to call but once we have that reimbursement, I think we'll be in a better position but realistically, I don't really see that happening until the second half of the year at this point. In the meantime, we're managing our expenses and we've got an all-out effort going on again obtaining reimbursement and we're feeling pretty good about that approach given again the number of doctors and the number of patients that we have that are very satisfied with Avenova but we still need to go through if you will the steps with the major healthcare plans to obtain better reimbursement and coverage for Avenova.

Yes, there are definitely a lot of moving parts to that. Can you just re-explain the first half of the deductibles at least, that issue?

Yes, plans typically renew on a calendar year basis and typically, especially with the high deductible HSA type of plans that are coming into vogue; I think I mentioned last year that probably 10 years ago we didn't have HSA plans and they've grown now I believe -- last year they were 32% of healthcare plans in the U.S. and with the high deductibles that come along with them, as well as the higher copays, people again tend to watch their medical spend; and especially for something like Avenova -- and once they eat into those copays and deductibles, we have seen historically now for the past two years a rise than in the -- either late second quarter as we saw last year and then into the third and with the fourth quarter being our strongest.

Okay. In terms of sales and marketing expenses, the number of reps of 39, that's now or was that at the end of the year? I'm just wondering, was that still around 50 or is that why it was pretty much in line with the past quarters and that number just came down recently or what was it at the end of the year for the number of reps?

At the end of the year, we have -- we ended with 50 and as we cut into the New Year, we -- again, we took a look at the data as we talked an and where we had territories that weren't paying for themselves and weren't going to pay for themselves in the near future given the reimbursement data in the background. We felt it more appropriate to pull those back and again, wait for the proper time to either reinstate those territories or shift to other territories and we did some of that shift focused on other territories where we had good reimbursement.

And then lastly, on R&D you guys really keep that very low; is there any though to maybe use the size of the dry eye market to reduce study that would involve dry eye as a kind of combo therapy or any thought there for R&D?

Yes, we've kind of -- we have some programs that were putting -- have in place and also some new ones that we're putting in place. And we keep it kind of a tight lid if you will on exactly for competitive purposes in terms of exactly how these studies are put together. So I'd rather not comment specifically but obviously I think there are some studies that would probably be more obvious than others that we should do in terms of comparative and/or complementary products.

Your next question will come from [indiscernible]. Please go ahead with your question.

I was wondering -- you mentioned that Avenova gross margins was at record high; how high -- how much further do you think it can go?

How much further would you like us to go? Look, there is two ways to increase our sales and implied in our whole discussion, and that's increasing the gross to net which again, if we increase our reimbursement that will increase our gross to net and then the other obvious one is units themselves. In both cases, they do drive gross margin, the gross to net is pretty self-explanatory, we get higher reimbursement, we payout less than rebates, and hence our gross margin goes up. The second one, driving units ultimately also drives our gross margin as we put higher volumes through our plants, we absorb more of the overhead across the larger unit based and that adds to profitability as well. I think there is a [indiscernible], realistically, I think 92, 95 is probably a realistic number to look for in the longer term but I'd settle if you will for 92 at this point; I think that's a real nice mark but we can see it going higher than that.

And then you mentioned last year -- earlier in the year you guys had a lot of rebates to some of the patients who didn't have those coverage or the insurance. Are you going to continue at a pretty similar level in the first half of this year and similarly backup in the back half like you did this year?

Yes, I think that's a good way of looking at it because I think our -- given the way we're approaching reimbursement, I think it will see pretty static rates in the first half of the year and not until we get the healthcare plans to sign-off on reimbursement while we have an understanding where we're going in the second half. And quite frankly, I mean, I'll be honest with you; I mean in some cases these prices are negotiated with major managed care plans as well and it remains to be seen in terms of how those negotiations will go in terms of ultimate price of Avenova.

Your next question will come from Yi Chen with H.C. Wainwright.

Congratulations, you had a revenue gross rate of 53% in 2017; do you feel confident that you can maintain this growth rate in 2018?

I think where that comes into play is certainly two ways; first is, certainly having sales representation out there, that's going to obviously drive growth. As we've said, we're down a little bit in this quarter; and again, we're trying to be financial astute in terms of putting our resources and spending the money where we have demand and demand is -- a lot of it is focused on reimbursement. So I think when I used that term reimbursement, that's going to determine how far we take this further in 2018. I know we haven't given guidance but we certainly anticipate even as we sit here today, double-digit growth in terms of revenue but in terms of the range of spread at that it's really uncertain now until such time that we can really put our finger on the reimbursement and the pulse in the -- how quickly then we can follow that up with sales people on the territories to execute on scripts.

My second question is can you clarify a little bit when you mentioned that in 2018 you plan to increase net sales per unit; is that based on a combination of increasing the reimbursement per unit and reduction in the use of rebate because of the elasticity of patients who are already using Avenova?

Yes, exactly. Every dollar more that we're getting reimbursement is a dollar less than we put into our rebates. So I would anticipate exactly what you said to happen overall. The way I look at it is, there is no looking back; I mean, the reimbursement that we have and at this point in time I can only assume it's only going to get better and to me that's predicated on the fact that we have doctors and patients that understand the efficacy of Avenova moving forward and now is the time to go -- the healthcare providers to prove that concept, show them the economic benefit if you will of using Avenova.

The other piece that I would add to Mark's comment there, if you remember at the end of the third quarter call we had talked about -- for the first two years we were really focused on growing that prescriber base from zero to the now 10,000. As we mature a little bit and get better visibility about the 10,000, our emphasis is less on growing that 10,000 doctors to say -- in this example, 11,000 and really having our reps look at the detail of the prescribing base in terms of doctors that are prescribing one script a month versus doctors that are prescribing 10 or more scripts a month. So the reason why we were optimistic or can predict that we're going to have better script per month is we're not driving so much to increase the denominator in terms of number of prescribing doctors but really starting to focus on look at the data in terms of specific doctors that are prescribing 10 or more. So the leverage in the model would be to probably just to say -- succinctly focus on a fewer number of doctors that are prescribing more per doctor than a broad slot as we were thinking through a member a 1.5 year ago we were at 100 doctors per territory per rep at 2 or 3 scripts per month and that's probably more licitly in terms of logistics and focus a better effort at 30 doctors prescribing 10 a month. So we really think it's a narrowing of the focus, there is plenty of denominator or doctors in that base; and now we just need to focus on that more highly productive ones.

So based on what you said, we shouldn't expect a significant increase in the denominator which is the number of prescriber but more prescriptions per doctor within those doctors who prescribe a lot of Avenova, right?

That's correct, that's the focus. And hence, even narrowing the sales team down from 48 to the 39 we're at now is really -- that's kind of the initial step in that focus is to really figure out who our high prescribers are, who really carries the product and see if we can get more leverage out of that at that base with a more focused approach.

[Operator Instructions] Our next question is from [indiscernible]. Please go ahead with your question.

Couple of my questions were already answered, so I didn't want to hang up because I wanted just for one other thing out there. A while back you guys have mentioned you possibly, maybe getting off the AMX and going on to NASDAQ; is that still something that we can think about or is the nickel increment pile up program really sucks.

I think that's a question that -- one, where the other will probably be answered in the next 6 months; so I don't have anything definitive to share with you on that but I do share your frustration in the program that you were making reference to and the -- obviously, I think over a period of time now the NASDAQ has kind of taken over a little bit over the NYSE, the old AMX as we know it but we haven't made that call as of yet.

Well, I want you to know that you have mine and all my clients, and friends and family vote. So any decisions that's going forward in that area, feel confident you're going to get a yes vote from me.

All right, I appreciate that.

Previously, I was in the business for years and I have a little bit of an actually grind with Mr. Viola [indiscernible]. Anyhow, great year, good luck and keep things going Mark.

Okay, thank you. Thank you again.

At this time, there are no further questions in queue. At this time, I would like to turn it over to Mark Sieczkarek for any closing remarks at this time.

Thank you, operator. So, thank you all for again, joining us and for your support and your interest in NovaBay. The organization has a lot to be proud of, I'm certainly proud of each and every employee, they've worked extremely hard to take us from the edge to a company now that has a lot of great future in front of it. And we're certainly excited about the progress we've made but that's done and now we're always looking forward to be able to make more progress. And I think Avenova, certainly is proving itself in the field that's the thing can't be understated is the love of the product by both, patients and doctors, and the fact that it works. For certainly, we feel a lot of -- we feel complaints as we're required to by the FDA and I can tell you that nothing we receive has to do with the efficacy of the product, it's a winner and nobody can deny that. So we look forward to updating you during the next call discussing our first quarter results. And again, thank you for your support and have a great day.

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