Harrow Inc (HROW) 2020 Q2 法說會逐字稿

Good afternoon and welcome to the conference call covering Harrow Health's financial results and business update for the second quarter of 2020. On the call joining me today, I have Harrow's Chief Executive Officer, Mark L. Baum; and Harrow's Chief Financial Officer, Andrew Boll. Today -- my name is Christy, and I will be your operator for today's call.

(Operator Instructions) By now, you should have received a copy of the earnings press release. If you have not received a copy, please go to the Investor Relations page of the company's website at www.harrowinc.com.

Before we begin today, let me remind you that the company's remarks include forward-looking statements within the meaning of federal securities laws. Forward-looking statements are subject to numerous risks and uncertainties, many of which are beyond Harrow Health's control, including risks and uncertainties described from time to time in its SEC filings such as the risks and uncertainties related to the company's ability to make commercially available its compounded formulations and technologies and FDA approval of certain drug candidates in a timely manner or at all. For a list and description of those risks and uncertainties, please see the Risk Factors section of the company's most recent annual report on Form 10-K and subsequent quarterly reports on Form 10-Q filed with the Securities and Exchange Commission.

Harrow Health's results may differ materially from those projected. Harrow disclaims any intention or obligation to update or revise any financial projections or forward-looking statements, whether because of new information, future events or otherwise.

This conference call contains time-sensitive information and is accurate only as of today. Additionally, Harrow will refer to non-GAAP financial metrics, specifically, adjusted EBITDA and/or adjusted earnings. A reconciliation of any non-GAAP measures with the most directly comparable GAAP measures is included in the company's letter to stockholders available on the website.

With that, I would like to turn the call over to Mark Baum to go over some prepared remarks prior to the question-and-answer session. Mark?

Thanks for joining our call today. I would encourage everyone listening to review our second quarter 2020 letter to stockholders, which was posted on the Investor Relations section of our website just after the close of trading today. Before we begin the Q&A portion of today's call, I'd like to quickly touch on a few items to provide some additional color on our business since we last spoke in May.

While the second quarter revenues were impacted by the COVID-19 pandemic and a temporary slowdown in ophthalmic surgery, we have moved forward and are seeing revenue back to pre-COVID levels. Previously, we told investors, one, we weren't going to just stay dormant; and two, that our goal was to continue to drive revenue growth organically and inorganically.

Keeping that promise, we recently announced a commercial alliance agreement with EyePoint Pharmaceuticals to sell Dexycu, an FDA-approved single-dose, sustained release, intracameral steroid 9% dexamethasone injectable for the treatment of inflammation and post-ocular surgery. Dexycu, an injectable steroid for ophthalmic use is paid for through pass-through reimbursement from CMS.

Our strategy with Dexycu is simple, focus on offering the benefits of FDA-approved Dexycu to our large and loyal customer base who, in 2019, bought more than 250,000 injectable steroid-containing products from us. We've surveyed our customers, and a number of them have told us they would love to have the option of choosing an FDA-approved product when they order from us. So this partnership with EyePoint is a natural fit and Dexycu is a complementary offering to the existing ImprimisRx surgical portfolio of products.

Because we sell a lot of ophthalmic injectable steroids used in cataract surgery, probably more than anyone in the United States, the Dexycu opportunity could be a financial "big deal" for us. Our Tri-Moxi customers alone represent a more than $25 million annual revenue opportunity at an estimated better than 85% gross margin. Ultimately, though, the outcome of this partnership should result in a benefit to prescribers and patients with the economics of the deal having the potential to make a significant impact for both us and EyePoint.

Let's get into the results for the second quarter, which came in better than our base case predictions. Revenue for the second quarter of 2020 was $8.1 million compared to $13.5 million for the second quarter of 2019. Gross margins were 60% compared to 61% for the same period last year. Adjusted EBITDA in the second quarter was a loss of $1.7 million compared to earnings of $245,000 for the second quarter of 2019.

Gross margins and adjusted EBITDA were impacted by the lower unit volumes as a result of the pandemic shutdown. But if revenue can remain at the levels we saw at the end of June and certainly into July, I am confident that those metrics will be closer to what we saw in the fourth quarter of 2019 during our next report.

A few notable highlights from our other business interests. Eton has numerous catalysts coming up this quarter with 2 potential approvals. Surface is expecting data for SURF-201 and SURF-100 in the next 12 months, positioning themselves to execute a Series B financing in the near term. Melt Pharmaceuticals had their IND for MELT-100 accepted by FDA and will begin enrolling patients this week for their PK study, generating a readout by the fourth quarter of this year. And don't count Mayfield out. It is packaged and ready to go with an experienced and capable leader on board.

We hope to also generate data on Stowe's drug candidate's antiviral capabilities by the fourth quarter of this year, which could set Stowe up for the next stages of its development since they've already showed excellent success against bacteria, mold and fungi. We're also expecting big things from Visionology this year, including a launch of their exciting platform, which will better serve our ophthalmology-focused customers.

On our last update, we promised investors that we would keep innovating and pursuing deals that could create more shareholder value and we have and will continue to deliver on those promises. We believe the ImprimisRx ophthalmology platform is well suited to attract more prescribers and marketing of more products. Importantly, revenues are returning to pre-pandemic levels.

We will remain cautious about giving an all-clear signal related to COVID uncertainties for now. But with that said, we are more comfortable with our balance sheet and cash flow projections today than we were 3 months ago. And we are certainly more confident that we should make it through this period of challenge.

Now let's jump to the Q&A. I will pause to have our operator poll for questions. Operator?

(Operator Instructions) And we'll take our first question from Brooks O'Neil with Lake Street Capital Markets.

Congratulations on surviving the quarter with COVID.

Thank you, Brooks. Alive and well.

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

Well, it's actually both. So we make steroid injectables that we think Dexycu can replace -- should replace and so that's really the base of the strategy. We sell over 200,000 units, we did in 2019, of Tri-Moxi and we think many of those customers will strongly consider moving to Dexycu.

And that doesn't give them the steroid and the antibiotic that they desire, but many of these customers also use a moxifloxacin injection. And so they can get the coverage and really provide their patients with a nearly -- well, a completely dropless experience by using Dexycu along with our moxifloxacin that we make.

Okay. And could you just -- I mean I'm obviously not familiar with all the economics here. But could you help us to think about the benefit to Harrow and potentially the benefit to customers and making this switch from an economic standpoint?

Sure. Well, if you were to take 200,000 units, and we said that we think that, that's worth more than $25 million to us just on that number of units, you can figure out what we estimate the value of each Dexycu unit to be for us. So it's significant on a relative basis.

If you compare that to what we make on Tri-Moxi, it's kind of easy to figure out more or less what we make on Tri-Moxi because it's about a $25 product. So if we made 100%, it would only be $25 and we target a 20% net margin. So there's not a lot of profit on a unit of Tri-Moxi. But if you compare that to what we estimate the value of a Dexycu sale at, you'll see that it is a heck of a trade for us. And by the way, a lot of value for the surgery center or hospital.

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

Sure. We -- ImprimisRx is sort of the core of our business. It's the nucleus of the business, and it really has fed other parts of the Harrow ecosystem, if you will, because it was through ImprimisRx that we created a couple of products that led to the founding of Eton. It was through ImprimisRx that we created the products that led to the founding of Surface Pharmaceuticals. And the same is true for Melt Pharmaceuticals as well. So ImprimisRx is sort of the nucleus of what we've been able to build at ImprimisRx.

One of the great challenges with ImprimisRx is that it has historically been a compounding-only business. And whether it's an analyst or a shareholder, they look at the business as a compounding business. At Harrow, we look at it very differently. We look at ImprimisRx as an ophthalmology/pharmaceutical platform. We have the ability to make drugs and dispense them in all 50 states. And we have a national sales force to not only sell but also service customers. And we have about 10,000 customers that buy from us on a fairly regular basis.

So if you are a company that has an FDA-approved product and you want to get it out there to a large audience and you don't want to take a lot of commercial risk, we're a very attractive potential partner. I think our friends at EyePoint saw that logic and we were able to partner with them and we're excited about that opportunity.

We think there are others that also see that value. And we think that when we're able to incorporate these FDA-approved products into our platform and you see the margin that can be generated and the revenue that can be generated, that folks like you and our shareholders will attribute more value to our business because we certainly do.

We have some more work to do. Obviously, we're going to execute on this Dexycu opportunity. But we think that when ImprimisRx is viewed as an ophthalmology company, as many in the ophthalmology community view it, we'll get a lot more value for that business.

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

Right. Well, there's no potential sale of the shares. We haven't signaled that there's a potential sale of the shares. As a holder of our Eton position, we would certainly prefer to have Eton stock. At the same time, we did sign a lockup agreement. We locked up our shares. And the inference there should be that we don't need to sell those shares and that's a good thing. That should also infer that our business isn't doing half bad and we don't need the cash from a potential sale of those shares. It's really a sign of strength, I think, that we don't need to sell those shares and we're willing to sign a lockup agreement.

At the same time, we want Eton's stockholders, our fellow shareholders at Eton, to be able to benefit without this Harrow stock overhang. And so we were able to cut a deal where we got our shares registered and we agreed to sign a lockup. And in due course, if our Board of Directors decides to take action, they may, but there is no urgency at all to do that and that's reflected in our lockup agreement, which extends into the summer of next year, by the way.

Okay. Okay. So I'll just ask one more and I appreciate all the color here. So the one area or maybe, I guess, 2 areas that were a little bit higher than our forecast this quarter, one was SG&A. It was about almost $1 million above what we were thinking about. And R&D was just a little bit more than double what we were thinking. So could you just talk to us about your priorities, what you're spending on and how you think about the spending levels relative to the business opportunities you see out there?

Sure. I'm going to -- Andrew, do you want to cover that question?

Sure. And Brooks, thanks for the question. Just from a relative perspective, we were able to decrease SG&A expenses during Q2 versus Q1 by about $1.5 million and we did that. Most of it was related to cost savings from decrease in unit sales. So there's a lot of variable expenses that are associated with revenue. So we're able to flex a lot of those down.

In regards to the difference between actual numbers and what your forecast was, I think there could have been a difference in revenue versus your forecast and the associated variable expenses on the sales and marketing side.

Cool. That's helpful. Yes...

And then when we're thinking about -- on the R&D side, a lot of that has to do with formulation development that's ongoing within the -- and Mark talked a lot about this in the shareholder letter -- of new product development that the company has going on and also introduction of new formulations into our outsourcing facility, which we continue to do each quarter.

And when we're kind of looking at expenses and what we're really prioritizing, it still continues with what we thought about last quarter, which is we're focused on spending money on areas that are going to generate value and generate revenue. And if that means promoting new products, that's where the expenses are going to go. If that's R&D with new products, it's R&D with new products.

Our next question comes from Andrew D'Silva with B. Riley FBR.

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

Okay. Great. Thank you for the question, Andy. Look, the deal that we signed with EyePoint that we announced here recently, it is not as if we're going to flip a switch and the Tri-Moxi orders or any of the other sterile injectable orders that we take are going to instantly turn into Dexycu orders. That is going to take place, though, we think, over the next quarter or 2.

We have surveyed a number of our customers that have experience with Dexycu. And so they're much more familiar with it and we think that the transition to Dexycu would be much quicker. But it's going to be a customer-by-customer situation.

What is nice is that we have a relatively small number of Tri-Moxi customers, under 100 of them, that make up well over half of the overall Tri-Moxi units that we sell. And the reason why I'm referencing that is to highlight that we don't have to go and call on 600 different accounts. It's about 50 accounts. And so it's not -- there's not a lot of ground to cover in order to hopefully transition these customers or introduce them to this opportunity.

But we do expect that to take place in a fairly meaningful way this year and we're excited about that. The economics are tremendous for us. If you think about it, we didn't spend the money to develop the product. We didn't spend the money to initially launch the product. But yet, we're able to participate with our partners in a very meaningful way to help get the product out.

We think it's a dynamite product. We talk to doctors, the doctors like the product. They like the results the product delivers. And so we're excited to be able to add it to our portfolio.

And what's also exciting, and I also highlighted this in the letter, is that these accounts, these ambulatory surgery centers and hospitals that buy this or that will buy this product, we believe, they all need the other elements, all of the elements of the ImprimisRx surgical portfolio. And so they're buying these other pharmaceutical products from us.

And so this isn't just about selling Dexycu. That's a huge factor, obviously. But we're also excited to sell the rest of the portfolio in what we call a pharma pack and that's a trademark that we have on the pharma pack. So that's selling them everything that they need for the surgical case.

In terms of revenue recognition, Andrew, do you want to cover the cadence on timing for -- from a cash flow perspective? For sure...

I'm happy to talk more about this off-line. But generally speaking, it's going to be normal revenue rec where -- once the sale occurs and we get credit for it on the EyePoint side, which is at that time of sale on their end, we should be able to basically accrue our commission. And the expense on their side and our commission on the revenue side should line up quarter-to-quarter.

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

Sure. It's very simple. Right now, if you're an ambulatory surgery center, you've got a fixed amount of money coming in to pay you for the cost of the surgery that you're delivering. And from that, you have to buy all the pharmaceutical products as an example. And when the doctor who's doing the surgery and the surgery center, they choose Tri-Moxi that is a cost center. And whatever Tri-Moxi costs is a cost center.

When doctors and surgery centers choose Dexycu, it's not a cost center. In fact, these -- the product is reimbursed at ASP plus 6%. And so instead of spending, let's say, about $30 a unit, the surgery center will get Dexycu covered and they will actually end up positive about $35 or so. So it's a complete reversal.

You go from a cost center to a profit center, you go from a compounded product to an FDA approved product. And once again, if you need the antibiotic, we also happen to make compounded moxifloxacin, which we sell, probably more of than anyone else in the country.

So not only will you not have to buy the moxifloxacin for whatever we sell it for, but you might even have enough from the Dexycu to cover the cost of the moxi. So it's a great, great economic benefit for these ASCs and hospitals and physicians.

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

Yes. So thanks for the question and we certainly appreciate the question on that. The reality is that over the last 6 years or so, we have lived through numerous changes that were required for active ingredients. And so this is not anything new to us. And without giving away anything that would reveal how we plan to deal with this strategically, all I can tell you is that we have compliant formulations, whether the change takes place or whether the change does not take place. We will continue to serve our customers and make our formulations and the formulations they want available for them.

Okay. Great. Good luck closing out the year and congrats on the progress you've made.

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

Thanks for your hard work during this quarter. I'm really encouraged by the cash management that you just displayed. And I think you proved the durability of your operating model in Q2. So I think I'm more enthusiastic about Harrow than I've ever been.

I appreciated the color that you gave around ImprimisRx being a platform from which to grow. And I think the fact that you're able to form this EyePoint-Dexycu partnership is a result of that. And I'm excited to see what other partnership opportunities you can initiate.

I'd love it if you can expound a little bit more upon the reverse inquiries for new products that you got from customers. Can you help us understand generally how to think about the development costs for these programs relative to the revenue opportunities?

Yes. Thank you for the support, Greg, and your interest and your question. The -- I don't think there's anyone in the pharmaceutical industry that has been able to bring products to market as compounded products or FDA-approved products as efficiently as we have. We don't spend a lot. We work with partners, we work with physicians who come up with the ideas and without once again, revealing anything that would hurt us competitively.

The last, I would say, this year has been one of the most creative times in the history of the company. We have one particular family of formulations that we recently filed IP on in the last 30 days that we've been working on for 3 years. And we have a great -- it's a tremendous opportunity. It's a formulation that we think would be used and stocked in literally every ophthalmic office that's an ophthalmology office or an optometric office in the United States. That happens to be a really big market opportunity.

We continue to make tremendous progress in presbyopia that we've talked about in the past. And so we have this ongoing R&D function within our business. As I said, I don't think on a relative basis, it's that expensive or that we spend that much money bringing these products, getting them positioned to come to market. But I'll just say that it's been a very productive first half of the year. That's for sure on the R&D side.

And I have one more follow-on question. So I was encouraged to see that you're highlighting that you're making progress towards reaching your $100 million in revenue, 70% or better gross margin and 20% or better EBITDA margin targets. And I believe in your Q4 shareholder letter that you said you expect to achieve those targets between mid-'22 and the end of 2022.

And as I look at your company today, you're a $150 million company and the value of your deconsolidated subsidiaries is $50 million. So if I gave 0 value for your consolidated subsidiaries, which I think is unreasonable, then Harrow would be valued at $100 million just -- which is basically ImprimisRx.

And so if you can achieve that $100 million revenue run rate and 20% EBITDA margin run rate target within the next 2 to 2.5 years, that implies that Harrow is trading at 5x your run rate EBITDA target. And further, that would imply your business is growing at a 30% to 40% CAGR over the next 2 to 2.5 years from sort of the pre-COVID levels to reach that target.

And so I don't think that Harrow would be trading at 5x your 2 year out EBITDA run rate target if investors believe that you could achieve it. So maybe you can give us some context around your confidence exiting this COVID era and your ability to achieve those operating targets. Clearly, you can't control if there's another outbreak and complete shutdown, but I'd love to get an update there.

Sure. The -- what I would say is it's -- we are very comfortable in the medium term, the time frames that you laid out with the targets that you described and that we previously described. It is hard and during a COVID period, it's been very challenging. It was certainly very challenging during the second quarter. So I'm reticent to stick my neck out or get too far over my skis on revenue targets and gross margins when we're still in the midst of this pandemic to a certain extent.

That said, our business is really good. We had a really good June and we had an even better July. And I said in the letter, we had record days in July. It's terrific. And this third quarter is, by the way, a pretty slow quarter, generally. This is the time of vacations for a lot of our customers.

But what's nice is, as we said on our last call, we didn't think a lot of our customers were going to be taking vacations during the third quarter and they're not. They're working. So business is good. We're excited about the back half of the year. We've got a lot of exciting things in store and a lot of value, I think, to deliver.

Related to the value of the business, I talk to people in the ophthalmology world, business development people, I talk to bankers from time to time and folks that are professionals in kind of valuing these businesses. And they always say that our value -- the value of ImprimisRx is significantly more than our market cap. I don't think I've had anyone tell me that it was less than $150 million or even at $150 million. So they tell me it's worth more on using a number of different valuation metrics.

I do go to Sean over at Eton and Kamran over at Surface and Greg over at Melt and I tell them, "Hey, I don't think our ownership interest in your company is worth anything. You're the one that's not worth anything." But they don't agree with me. They think that their stock is worth a lot, too.

But somehow we're getting discounted and that's okay. I think what we need to do as a management team is execute. And that's going to be the focus of the back half of the year and as we get into 2021. We need to execute, and our belief is that when we do, the market will reward us in due course.

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

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

Yes. Well, first of all, it's a new relationship, but like any -- like most business relationships, it's a business that was -- it's a business relationship that's forged on the foundation of a great contract, a strong contract, a written contract that protects them as well as Harrow and ImprimisRx.

So we've got a great agreement, and they are -- we're really excited about the relationship. They're good people. They've got a great product. And that's really the important factor here is the quality of the product. They've got a strong but small commercial team and we're excited to work with them and supplement them. They're largely taking the lead on a lot of the commercial activities like marketing and such, but we're going to get out there and we're going to focus on our own customers.

And so in terms of our concern about them disrupting existing relationships, the way the agreement is structured, Brooks, it doesn't work like that. It would disallow that from happening. We actually get credit on specific customers. And these are customers definitionally that are our customers, and they're not buying to execute because they're our customers right now. And so we want them to consider to execute. We have, as I said, a strong belief in the product and the value of the product, and that's what we're going to do. And every time we have a success, it's not only a great clinical success, we believe, but also a great economic success for our stockholders.

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

Yes, it's a good question. Dexycu is -- what powers Dexycu is a delivery technology and it's a front-of-the-eye delivery technology. And there are certainly opportunities down the line to talk to the EyePoint people about developing that. That was not the focus of our agreement. Our agreement is specific to Dexycu. And once again, we're really excited about launching this product or relaunching it effectively with them to our customer base.

But when we talk about other deals that we've been working on, it is outside of the EyePoint relationship. We've been very active really for the last 12 months working on these deals. And so EyePoint is the first. We hope we'll have more, hopefully, maybe by the next time -- before the next time we speak, we'll see. And we're going to continue to execute the strategy that we described earlier over the last couple of quarters.

We're going to bring in FDA-approved products. We're going to show that people -- companies with FDA-approved products are really excited about the ImprimisRx platform, the value it delivers. And then, of course, we're going to execute commercially and sell stuff and get these guys to hopefully reorder from us so we can drive value for our stockholders.

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

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