Jody Cain – LHA Mark Sieczkarek – President and Chief Executive Officer Jack McGovern – Chief Financial Officer

Scott Henry – ROTH Capital Karthik Sunkesula – H.C. Wainwright

Welcome to the NovaBay Pharmaceuticals 2018 Second Quarter Earnings Report 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 August 7, 2018. I would now like to turn the conference over to 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 and CEO; and Jack McGovern, 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 time sensitive information that is accurate only as of the date of the live broadcast, August 7, 2018. NovaBay Pharmaceutical undertakes no obligation to revise or update any statements to reflect events or circumstances, except those required by law. Now I'd like to turn the call over to Mark Sieczkarek. Mark?

Yes. Thank you, Jody and good afternoon everyone, and thank you for joining us. At the continuation of what we presented last quarter over the first half of this year, we've identified begun to execute an opportunities to improve net sales and unit volume for the long term. We began implementing a multi-part strategy that gives us optimism about returning to double-digit net sales growth in 2019 and to ensure strong and sustainable growth for the future. Now these were difficult, but necessary decisions as they indeed impacted the current revenue results, we are now reporting and were also based on the macroenvironment changes we are seeing in the pharma industry, which especially hurt companies with the mediocre reimbursement profile. As you may recall, we first reduced and realigned our salesforce at the beginning in the first quarter to geographical locations and provided the best financial return in the first quarter. And net product revenue per unit was also negatively impacted by significantly higher rebates than we paid in the past quarters and this effected our net sales for the certainly the second quarter. Now as I said, we are taking action to address the impact of higher rebates, while also driving growth in the number of units we sell, which certainly then give us the optimism about returning to double-digit net growth in 2019. Before I review those actions, I want to briefly discuss the new macroeconomic dynamic in the pharmaceutical industry. We anticipate the negative seasonal pricing effect and net product revenue per unit at the beginning of each year as health insurance deductible are reset and our rebate cover a greater portion of patients’ out-of-pocket cost. If you recall these healthcare plans to reset, as significantly more pronounced effect than our net product revenue per unit in 2017 versus prior years. And we are experiencing an even greater impact this year. Reduction of our gross to net pricing from the end of 2016 to 2018 year-to-date was about 33% that differently, if we had been able to maintain our 2016 year-end pricing, our reported sales this year would have been increased by $2.3 million. Now, again, NovaBay is not alone in this market dynamic. Some large pharmaceutical manufacturers reported declines in net product revenue per unit in 2017, even in several instances despite product price increases. For instance, the no fee reported net revenues per product decline by more than 8.4% in 2017, even though they took an average price increase of 1.6% across their portfolio. And Johnson & Johnson experienced the 4.6% decrease in net product revenue per unit after paying $15 billion in rebates and discounts. Some pharmaceutical companies are warning investors of more declines, certainly in this coming year and Johnson & Johnson's prediction of up to 6% decline on per unit net pricing – product pricing in 2018. So the higher rebates and discount their having a formidable impact on our net sales even as we increase the number a unit sold through a retail pharmacy channel. As we've experienced in the past, we expect some improvement in net products revenues per unit as the year progresses as more patients satisfy their health plans deductible. With that seasonality impact in mind, late in the second quarter, we did expand and upgraded our sales organization by hiring seven new representatives to match the realignment, which now brings our commercial salesforce up to 45 reps. All of these new representatives have between 10 and 20 years of pharmaceutical sales experience and all have direct experience, promoting ophthalmic product. These new reps have been trained and will be deployed in sales territories that we have identified as under covered and then have good health claim coverage. We expect to further expand their salesforce by hiring additional sales reps before the end of this year based on same formula, which is primarily based on good health plan coverage. This is in keeping with the focus on more profitable growth targeting sales calls on high Avenova prescribers in regions, where we experience higher reimbursement. Our research has shown that the eye care specialist, who understand the benefits of Avenova brings to their patients and have patients who are covered by insurance tend to more embrace the product. We are also doing a better job of managing our commercial operations through our flatten organizational structure. We certainly now have greater oversight of our sales organization with better training of reps in the messaging they are delivering. This includes more focused communication on educating prescribers just to benefits of Avenova to the system in selecting the proper dry eye treatments for their patients. We have taken other actions to reach eye care specialists with our important messages as well such as eye care forums and events where we can discuss the benefits of Avenova to an even broader audience. Most importantly, we are also reporting progress in our actions to secure new or enhanced health plan insurance coverage for Avenova, with the objective of improving net product revenue per unit. We have completed the preliminary activities to support this initiative including, identifying a number of top health care plans as our primary prospects and completing the background documentation and support of Avenova coverage. We are now in the process of arranging meetings with select top health care plans to be held between now and the end of 2018. So we have a powerful premise to support this favorable coverage decision for Avenova. Remember of the two types of dry eye equates efficiency represents about 15% of the market and the eye care products that are heavily promoted to consumers by other companies address this type of dry eye. On the other hand, Avenova addresses bacterial dry eye, which leads to Meibomian Gland Dysfunction and Blepharitis, which I mentioned earlier represents about 85% of market. Avenova validates the reduced bacteria on the ocular skin surfaces that are the underlying cause of bacterial dry eye. Unlike transitional antibiotics certainly, Avenova is safe for chronic use because it does not give rise to anti-biotic resistance. As we mentioned, in last quarter’s call, several large managed care organizations were cold and we’re very unfamiliar with the two types the dry eye. There was such we face the challenge of educating these organization about the dry eye market and the benefit of the Avenova, as we go after better reimbursement formulas. Now additionally we have recognized there in-office direct channel provides a viable opportunity for volume in net sales generation. We are now approaching that channel as the separate one and we are refocusing our efforts to maintain this business through an expanded and financially sustainable inside sales team. And finally, we are seeking opportunity and leverage our salesforce by adding product to their bag via acquisition or co-promotion. And now I'd like to turn over the call to Jack McGovern, who is going to review our financial result. Jack?

Thank you, Mark. Good afternoon, everyone. Starting with our Q2 results, net sales for the second quarter of 2018 were $2.8 million, compared with $4.1 million in the prior year period, with the decrease due largely to the impact of the timing of hiring new sales reps and securing contracted managed care. In reviewing Q2 2018 sales by channel, Avenova sales into the retail pharmacy channel were $2.3 million or 84% of the total. Sales through our in-office direct channel were $331,000. Gross margin on net product revenue for the second quarters of both 2018 and 2017 was unchanged at 83%. In reviewing expenses by line item, sales and marketing expenses for the second quarter of 2018 were $3 million, down 12% from $3.4 million for the prior year period. The decrease was due mainly to a reduction in number of sales representatives and employee-related costs. We expect sales and marketing expenses to increase as we continue to expand our sales organization. G&A expenses for 2Q 2018 were $1.4 million, down from $1.7 million for the prior year period. The 22% decrease was due primarily to lower stock based compensation expense and lower professional services and consulting fees. R&D expenses for Q2 2018 decrease slightly to $61,000. The operating loss for the second quarter 2018 was $2.1 million that's compared with an operating loss of $1.8 million for the second quarter 2017. The non-cash gain and the fair value of warrant liability for Q2 2018 was $490,000, which compares with a non-cash gain of $15,000 for Q2 2017. We reported a net loss for 2018 second quarter of $1.6 million or $0.09 a share. This compares with a net loss of 2017 second quarter of $1.7 million or $0.11 a share. Turning now to our six months results, net sales for the six months ended June 30, 2018 were $5.7 million, as compared with $7.8 million for the six months ended June 30, 2017. Gross margin on product revenue was 87% for the first half of 2018, which is up from 84% for the first half of 2017. The operating loss for the first six months of 2018 was $4.5 million, which is a 20% improvement from the $5.5 million operating loss for the comparable period in 2017. Operating expenses for the first half of 2018 included sales and marketing expenses of $6.4 million, G&A expenses of $3.0 million, and R&D expenses of $107,000. Non-cash gain on the fair value of warrant liability for the first six months of 2018 was $704,000, versus a non-cash loss for the first six months of 2017 of $220,000. The net loss for the six months ended June 30, 2018 was $3.7 million, or $0.22 a share, as compared with a net loss for the six months of 2017 of $5.7 million, or $0.38 per share. Turning to cash flow, we use $2 million to fund operations in the first half of 2018, which is considerable improvement over the $3.6 million that we used in the prior year period. This reduction in cash burn resulted primarily from a decrease in the net loss, as well as favorable changes in working capital. In reviewing our balance sheet, we had cash and cash equivalents of $6.8 million as of June 30, 2018. You may recall in February 2018, we announced private placement on favorable terms for net proceeds of $5.6 million with Hong Kong based OP Financial Investments Limited. Looking forward, we expect net sales for the third and fourth quarters to increase sequentially over second quarter as our new reps gain tenure and we make progress with our managed care initiatives. We expect to benefit from our growth initiatives by the beginning of 2019, we also expect gross margin on Avenova sales to be 90% range for the full-year 2018. And with that I'll turn the call back to Mark.

Yes. Thanks, Jack. To conclude, we've only really begun to address the sizable on largely untapped U.S. market for Avenova, which is comprised of millions of Americans who suffer from blepharitis and dry eye, and who undergo ophthalmic procedure such as Lasik, retinal and cataract surgery or experience contact lens intolerance issues. Now we have a program to better educate our eye care specialist and payers about Avenova as the only clinically proven product to treat the underlying cause the 85% of cases of dry eye. As I said, we expand and upgraded our salesforce and we're making progress in executing on the key strategic issue, which is to improve reimbursement. And again, this is the most important issue facing us in this changing macro environment. We are refocusing our attention to better capitalize on the opportunity, also with our in-office direct channel and we're looking for product and partners that can help leverage our salesforce asset. With successful execution on these initiatives, we expect to expand our net sales, unit volume and certainly improve our net product revenue per unit. And we're optimistic about returning to that double-digit dollar growth in 2019. And with that overview of our business and our plans, I thank you again, for your attention. And operator, at this point, we're ready to take questions.

[Operator Instructions] Your first question comes from the line of the Scott Henry with ROTH Capital.

Thank you and good afternoon. A couple questions, first, your revenue per script as you mentioned in the prepared remarks, did decline according to my model, when we may use different denominators, I've got 144 dropping to 120 in Q2. In prior years, the second half has been stronger than even the best quarter, which would imply if it went from 144 to 120 that it would jump back up towards that kind of 170 plus number. Should we still think about it that way or is there anything different this time around?

Jack, you want to take a shot that one.

Sure. There's no question that the third and fourth quarter, gross to net will be better. It is hard. I think to put a precise number of because of the varying channels whether it's a relay or Rx solutions or [indiscernible] channel in terms of how the scripts are actually adjudicated. I don't have a precise number but directionally your assumption is correct. I don't suspect we'll get as high as 175, if we would get back into the 145, 150 range I think that would represent a good second half for us.

So that would imply that the pricing is should be worse in the second half of 2018 than it was in the second half of 2017. Is that fair?

Yes. I think that’s the fair statement.

Okay. And then my other question, I’m just looking at the trends and I think you've said, you expect sequential increases in revenues for the remainder of the year. But also sequential increases in spending for the remainder of the year and I'm wondering, if you get a sense of which one of those is going to be the overlying factor and what I mean is, should we expect the operating loss to decline sequentially or will the spending increases outweigh the revenue increases?

I would say that given the ramp of the new seven folks and potentially we up to seven to 10 folks that will add in the fourth quarter. The expense ramp will be steeper if you will than the – their generation of revenue. So we will probably widen our operating losses in Q3 and Q4 as those folks get up to speed with hopefully that topping out by the time we hit Q1 2019.

Yes, Scott. Just to embellished that a little bit too. On the other hand, I think there is a little bit of an offset because as you said, the tendency is really to pick up both units and pricing in the second half of the year by our already existing representative. So we’ll see a bigger unit ramp if you will by those existing and as Jack said, a little bit more of a lag certainly with newer people and the expense is a little bit certainly out in front of the revenue at that point in time. But I think with the one thing to keep in mind, when we did takeout those reps at the end of the fourth quarter last year, it was purely certainly in anticipation of what we're seeing in the macro environment. And the expansion of the rebate and paying a higher portion of by down the script. And then again, we anticipated with the second half surge that it was a good time to put reps back in territories that based on our data analysis. Again, we're underserved and also had good reimbursement. So you got a little bit of a balancing act there. And again, further, as we gain reimbursement going into 2019, certainly those new representatives as well as our existing one will certainly help us get back on growth track in 2019.

Okay. And just one clarification on the product sales, it looks like to get to all of your numbers you had about $100,000 of kind of other product sales. I think that's the other NeutroPhase in those wound healing kits. Is that correct?

It is about $121,000.

Okay, great. All right guys. Thanks for taking the questions.

Thanks, Scott.

Your next question comes from the line of [indiscernible].

Thanks for taking my question. Previously, you guys mentioned about utilizing your salesforce better will possible additional products. Have you yet kind of put that on hold or is that still something that you guys are working on?

No, Ed. I mentioned in – if you go back to my prepared remarks that we are definitely looking for other partners and/or products to utilize our asset, which is salesforce. There's a lot of companies in, let’s say, similar circumstance right now that don't have their salesforces or coming close to having products approved et cetera. And certainly that asset of – with over 45 reps now in the field certainly something that's interesting to the other companies, so yes, we're very much involved in looking to add products to the bag.

Would you have to wait until you're salesforce are ramped up on Avenova by 2019 first before you want to risk, put a new product in there? Or do you think that if you find right opportunity, you would stick it in and get those salesforce up any time?

Yes. The stable part of our salesforce certainly had some tenure and I think are certainly ready to takedown newer – new products. So I would say, we're going to be opportunistic there and if something were to pop-up even in the short term. We certainly take a strong hard look at it.

Very well. Thank you for answering my question. And I wish you guys good luck. Thank you.

We appreciate that and thank you.

[Operator Instructions] Your next question comes from the line of Yi Chen with H.C. Wainwright.

Hi, Mark. Thanks for taking the question. This is Karthik on behalf of Yi. So I know you spoke about your rebate and the checks of negative pricing. But would you be able to provide additional color on that?

Well, in my remarks, I talked about the 33% decrease in pricing from the end of 2016. And what you're saying and in the broader market place like I said in pharmaceutical is what's happening is more and more is coming out of what I call the middle and that includes the healthcare plans with larger rebates as well as the managed care or PBM. And when you talk about a company like J&J that increased their prices about 5%, yet saw a decrease in overall price of 5%, it strikes people little bit funny, who don't have knowledge of the pharmaceutical industry. But that's something that have affected all of us. And as I said in my remarks, it has a bigger impact than those that we have call them more a mediocre reimbursement scale. We're still not up to speed on the reimbursement, hence I've been preaching this since I think last year that we're going to put effort into increasing our reimbursement. And again, I think just to reiterate, I think I spoke about this last quarter, we've engaged with a company D2 has a broad experience and representation across the country with health care plans. And we are just in the process now of creating those meetings. We have our [indiscernible] already to go. We have beta tested it with several health plans before we introduce it at these meetings and we feel comfortable that we're going to secure formal reimbursement from some major plans certainly going into 2019. And that's going to affect that about gross to net pricing dramatically. Again, our rebate structure of buying down a prescription to $60 for somebody who is insured and not reimbursed for $35 who is insured and had some level of reimbursement, it has cost us more as time has gone on and hence the drop in gross to net. So we can impact that.

Right. And in addition to targeting prescribers in areas of higher reimbursement, are there further potential changes that you foresee in the marketing strategy that could perhaps help the revenue growth?

Well. One other things that we've put it in heavier emphasis on is – Jack dig deeper into the metrics is our average script amount written per doctor per month. We have a number of doctors who that do write greater than 10 scripts in a given months. And we have even more doctors probably over 90% that are writing one script per months. What we're doing is going back to not only the high utilizers but the people who have written Avenova from the beginning of time, but not in terms of the utilization that would be equivalent to again 85% of dry eye being caused by bacterial issues and only 15% by aqueous issue. And I think that is the big part of our messaging moving forward. And as I said before, we are changing a paradigm in this whole dry eye category, because up to now, basically, people have just been using Restasis and Xiidra and again, they certainly are effective in dealing with aqueous dry eye, but certainly not effective in the bacterial side. And changing that paradigm again, does take some level of time and persistence and we are seeing it changing slowly, certainly, not fast enough. But that's a key marking point that we’re – in our messaging that's out in the field.

Okay. And in regards to the current usage and predicted usage of Avenova, are you seeing that patients are mostly using Avenova alone or in combination with their prescription of OTC products for dry eye?

It's little bit all over the place. That's a good question. The doctors who actually use that the most are those who also use in combination with over space with Restasis or Xiidra, they've captured if you will that the theory that the dry eyes either caused by bacterial and deficiency of the aqueous and rather in treat it one way and without a proper diagnosis. They're just training it both ways. Those are they typically end up being the higher prescribers. I would say, the other ones are still in that paradigm shift quite honestly and it's hard to move away from 15 years of using basically one way to treat something and moving into something new and as I said that, this whole bacterial piece really has just been in the scientific journals in the last 10 to 15 years. So, it's still relatively new and that's part of the hill we have to climb in terms of educating our physicians and then getting them into a habit of treating dry eye really first with Avenova since it comprised with the majority of dry eye patient.

I see. Well thanks so much for the question Mark and that's moving forward.

I appreciate that. Thank you.

And there are no further questions at this time. Please proceed with your presentation or any closing remarks.

All right. Well, thank you again for joining us today and your continued interest in Avenova. As I said, we're still bullish on the market and we're going to certainly we've had some setbacks in this year. As we said at the beginning, we would use this pause to really work on reimbursement, which again is the key strategy. And again we're very optimistic about our gains that we're going to make there. And again, we've made some decisions that have affected the short term. But again, we look at this business as the long term business with a lot of upside and hence the decision that we have made in the short term. So again thank you for joining us and we'll see you again and talk to you again in next three months. Thank you.

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