Bruce Voss - Investor Relations, LHA Mark Sieczkarek - Chief Executive Officer and Chairman of the Board of Directors John McGovern - Chief Financial Officer

François Brisebois - Laidlaw & Company UK Ltd.

Hello, and welcome to the NovaBay Pharmaceuticals Q1 2018 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 May 10, 2018. I would now like to turn the conference over to host, Mr. Bruce Voss. Sir, you may begin your conference.

This is Bruce Voss with LHA. Thank you all for participating in today's call. Joining me from NovaBay Pharmaceuticals are Mark Sieczkarek, President and CEO; and Jack McGovern, the Company's Chief Financial Officer. 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, May 10, 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?

Yeah, thank you, Bruce, and good afternoon to, everyone, and thank you for joining us. Well, the good news from a seasonally impacted Q1 is that the sell-through units of Avenova in our retail pharmacy channel increased 12% over the first quarter of last year, while we continue to significantly decrease cash usage, which was down to $464,000 for the quarter. That was as compared to $2 million a year ago. Now, on our fourth quarter conference call, we discussed the anticipated negative seasonal pricing effect on first quarter Avenova sales, due to ever-increasing health insurance deductible resets at the beginning of each year and the need for rebates to pick up the slack. The macro impact to deductible resets has been cited by many other pharma companies who have already reported Q1 results. The ever-increasing dynamic of these resets resulted in a gross to net pricing decrease of 19%, in our retail pharmacy channel over the prior year. That we sheltered the bottom line by delaying our sales-force expansion until later in Q2, in line with our commitment to a strategy aimed at more profitable growth. Although we anticipated these macro impacts, the actual effect was much more than we expected with rebating and related discounts costing us up to 60% of sales versus 51% just one year ago. In response, we have already taken multiple steps to align ourselves more closely to this dynamic environment. First, as I indicated in our last call, we're working with consultants to obtain new reimbursement decisions from healthcare plans as well as to improve current reimbursement for Avenova. We have identified the areas we will target to enhance our insurance coverage. Secondly, we are now recruiting sales representatives in under-covered territories. You may recall that early in the first quarter, we reduced the number of field representatives from 50 down to 39, as we eliminated direct representation in certain territories with lower reimbursement profiles. Now, again, this was in keeping with our focus on more profitable growth. Between now and the end of the year, we anticipate growing our sales-force as we make progress on insurance coverage. We are also seeking opportunities to leverage our sales-force, by adding products to our bag via acquisition or co-promotion. And lastly, we did flatten the sales organization to streamline our communication and enhance training and strategic execution. The tremendous opportunity we have with Avenova bears repeating of the two types of dry eye, one is aqueous deficiency, which represents about 15% of the total dry market. Now, the two eye-care products that are heavily promoted by other companies address this type of dry eye. The second type is bacterial, which leads to Meibomian gland dysfunction and blepharitis and represents 85% of the dry eye market. Now, Avenova is the only commercial product clinically validated to reduce bacteria in ocular skin surfaces that are the underlying cause of bacterial dry eye. The clinical knowledge of the impact of MGD in bacteria that causes the dry eye only begun to surface in the last decade, leading to a relative lack of understanding by the majority of eye care specialists. We have refocused our marketing to do a better job of educating and communicating the very powerful messages around Avenova to assist them in selecting the proper dry eye treatment options for their patients. Remember, only other commercially available dry eye products lacks the anti-microbial availability to deal with the bacterial aspects of dry eye. We also find that many prescribers are running prescriptions for the one or two patients with extreme blepharitis for whom Avenova is the last resort. Our message has been refined to get the prescribers to better understand the potential benefits of Avenova in managing chronic dry eye for a broader patient base. So as we expand our sales force we have already committed to better train our sales representatives in this messaging that they are delivering. We have taken other actions to reach dry eye specialist with our important messages as well such as eye care forums and events, where we can discuss the benefits of Avenova to a broader audience. This includes more the effective use of our KOL network through outreach activities. We have a tremendous resource with many top thought leaders in the dry eye category, who are members of NovaBay advisory board. Now I'd like to turn over the call to Jack to review the financial results. Jack?

Thank you, Mark. Good afternoon, everyone. Turning to our Q1 results, total net sales for the first quarter of 2018 were $2.9 million compared with $3.7 million in the prior year period, with the decrease due in part to the impact of higher rebates. Avenova sales accounted for nearly all of total. In reviewing Q1 2018 sales by channel, Avenova sales into the retail pharmacy channel were $2.6 million or 88% of sales. Sales through our in-office direct channel were $347,000. Gross margin on total sales for the quarter was 91% versus 84% for the prior year period. The gross margin on Avenova sales for the quarter was 91%, up from 88% a year-ago. The operating loss for the first quarter of 2018 was $2.4 million, which is an improvement from the operating loss of $3.8 million for the first quarter of 2017. In reviewing expenses by line item, sales and marketing expenses for the first quarter of 2018 were $3.4 million, which is down 9% from the $3.7 million for the prior year period. The decrease was due mainly to a reduction in the number of sales representatives and employee related cost, partially offset by higher marketing expenses. We expect sales and marketing expenses to increase as we expand our sales organization. G&A expenses for Q1 2018 were $1.6 million, as compared with $3.1 million for the prior year period. The 47% decrease was due primarily to lower stock-based compensation expense and lower professional services and consulting fees. R&D expenses for Q1 2018 decreased slightly to $46,000. The non-cash gain on the fair value of warrant liability for Q1 2018 was $214,000 and this compares with non-cash loss of $235,000 for Q1 2017. We reported a net loss for 2018 first quarter of $2.2 million or $0.13 a share. This compares with a net loss for 2017 first quarter of $4 million or $0.26 a share. Turning to cash flow, we used $464,000 to fund operations in the first quarter of 2018, which is a considerable improvement from the $2 million we used in the prior year period. This reduction in cash burn resulted primarily from a decrease in net loss and favorable changes in working capital. As we look at our balance sheet, we had cash and cash equivalents of $8.3 million as of March 31, 2018. You may recall that in February of this year, we completed a $6 million private placement on favorable terms with Hong Kong based OP financial investment limited. And with that, I'll turn the call back over to Mark.

Thanks, Jack. Given this strategic importance both as to this year 2018 as well as to the future, I wanted to briefly updated progress on our managed care strategy to improve reimbursement amounts for prescription by obtaining new or improved healthcare plan coverage for Avenova. Now in collaboration with consultancies that highly respected by healthcare organizations, we've completed the background documentation to support of Avenova coverage. And we've also identified a limited a number of top organizations as our primary prospects and are in the process of making initial contacts. During this process, we polled several large managed care organizations to determine their familiarity with two types of dry eye. Like, eye care specialists which I had mentioned prior, we found that these plans lack the understanding of the differences, which gives us the opportunity to educate as we also see coverage. Working with these large managed care organizations is a process, and we expect to engage in many meaningful discussions for the remainder of this year. In closing, executing on our reimbursement strategy and integrating those positive reimbursement results with our sales force expansion is a large challenge to getting us back to strong double-digit unit growth. We must continue to improve the execution of our strategy to target high Avenova prescribers in high reimbursement regions to increase prescriptions per physician and revenue per unit. As I already noted, we have new programs to better educate dry eye care specialists and payers about Avenova as the only clinically proven product to treat the underlying cause of the 85% of dry eye, which is a huge paradigm shift in treatment. Now, with that overview of our business and our plans, I thank you for your attention. And operator, we're ready to take questions.

Yes, sir. [Operator Instructions] And your first question comes from François Brisebois of LaidLaw. François Brisebois: It's not that. All right, thanks for the questions. Just so in terms of the burn, how - what's the main - what are the main triggers that enabled you, I guess, to have such a small burn, $0.5 million? Where is - is it just the sales reps? What are the big cuts there?

Yeah, the two things that led into it, Franc, were number one at the end of the year, as I mentioned, we took out 10 underperforming territories that, again, if you recall we just received data relative to reimbursement late last year. And we found that the reimbursement in those territories specifically was fairly low, so we said let's do the smart thing and take those territories out. On the other side of that, we also found the territories where we had good reimbursement and hence the expansion that I was talking about towards the end of this quarter. The in between is we are planning originally to add those people on in the first quarter. So you're seeing the combination of the people that we - the territories we left in combination with not bringing the new territories onboard, delaying that until second quarter. And then, if you will, that preserved the cash usage. And I think, Jack as well has done a good job of really putting in some good financial discipline and making sure that we're not spending ahead of our revenues at this point in time. François Brisebois: Is that 10 territories or reps that aren't performing - that weren't performing?

10 territories. François Brisebois: And it's just coincides with also about 10 reps, 50 to 39, I guess?

Yes, exactly. François Brisebois: Okay, okay. And then, so going forward, I guess, it's hard, you guys had to delay getting back to I guess 50 reps. And I assume the thought is to get above 50. And when you guys obviously delayed this a little bit, but if we were looking, you had given guidance last year for the top line on the year. Is it fair to assume you guys won't be giving any guidance until you have a better idea when the reps come back on or…?

Yeah, it's - we have so many irons in the fire relative to that discussion, Franc. I think, it would be unwise for us to guide at this point in time. First and foremost, we want to see the rebound in pricing. As I mentioned in the script, we had a 19% decrease in pricing year-on-year. We had anticipated some of that, but I think the relevant information as I was just taking a look at the prevalence of HSAs, and last year I think I threw out there a number that HSAs had increased to 37% of healthcare coverage. I just read some data that said this year it's increased now to 50%, which is a big explanation not only for us, but other pharma companies who are going through this gross to net situation. And to your question, we have to wait for that to resolve itself. It always does as those deductibles if you will play out. Last year, we saw that starting to resolve in the May/June timeframe. And at that point in time, we see the increase in gross to net pricing. But again, until we see it, and when it happens, I feel very uncomfortable in giving you an estimate or guidance if you will. François Brisebois: And that - so that seems like May, June, I mean, we're thinking probably more of a third quarter balance of the seasonality - at least for rebates then second quarter here, is that fair to assume or…?

I think, it's fair to assume, and as much as I - to say it. Again, if these plans are going up, at last year if you recall, typically, they would end by the first quarter. Last year, they carried into April and May. And I would suspect that we've seen a little bit of horizon in pricing, but not enough to say that we're through the rough patch. François Brisebois: Okay. And there are no issues with in terms of the product, there are no issues with docs telling you that there might be something wrong with it or they love it, but they are not using it. It's really more of a reimbursement issue right now?

It is a reimbursement issue, and we did some rough calculations on abandonment as a result to of all this rebating and deductibles. And I think in the first quarter, we're somewhere in the range of over 40%. So I think the scripts are still being written. Some of the issue again falls at the patient level, whether or not they're going to spend their own out-of-pocket money on the script. Again, I just want to reinforce the fact that we have an in-house rebate program that carries the script down to $35. But again there is a price sensitivity that plays into everything. And as I said that rebate - us pulling that rebate down brought our gross to net pricing down significantly in the first quarter 19%. François Brisebois: Yeah. And in terms of the reimbursement, the discussions will be happening probably second half of 2018 from then to actually someone take action if they wanted to. How long do you think that time-frame is?

Well, I think we talked about this last quarter as well, the system, the way it typically works is some healthcare plans readjust their reimbursement middle of the year. Others go from year to year. So I don't see a big change in that, if you want, 2018. But we'll certainly talk to you guys and make public any of the advances we're making and alert you to people who have given us a better reimbursement rate and certainly going into 2019. And that's going to be the driver for us. And like I said, since the beginning of - or middle of last year, we realized that that was going to be the future for us in terms of going and selling if you will the concept of Avenova to healthcare plans. François Brisebois: Okay. And then just lastly here, one last one, you mentioned potential M&A, is that appetite kind of growing here as you're working through the reimbursement issues or - and then, I guess, how do you feel about your cash position? Obviously, the burn was very low, but I guess the goal is to hire more reps as this then kind of gets together? So is this an M&A kind of thing or the appetite has grown or is it still U.S. Avenova is one, two and third priority on the listing?

Well, I think, if you're thinking about an overall strategy, I wouldn't say it's grown. I think we see the need for balance and other companies when they have product set aren't affected by macro-environmental - affected by macro-environmental issues that - they have some insurance if you want, the other said that says we have some other products in the bag that don't get impacted by this. And it's just the smart thing to do from a business standpoint. Again, to the certain extent, we can control that macro-environment, so we have to protect ourselves from it. And that dictates then our appetite for putting other things in our bag. François Brisebois: Okay. Thank you.

Thank you, Franc.

[Operator Instructions] And there are no further questions at this time. I will turn the call back over to Mark to proceed with your presentation or any closing remarks.

Yeah, well, again thank you for joining us today and your interest in Avenova and NovaBay. And we certainly look forward to updating you and we certainly have a lot of enthusiasm yet, again, in terms of changing the paradigm both for payers and for physicians. And again, we look forward to a good call in Q2. So thank you.

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