HROWL - SRK Capital - Harrow Health: Market Missing The Forest For The Trees

• In 2021 Harrow Health began to expand into branded pharmaceutical products (BPP) by acquiring the rights to several new products.
• The expansion into BPP has led to increased costs.
• With HROW stock down roughly 45% from its highs, I believe the market is missing the forest for the trees.
• As HROW continues to execute on its plan and further strengthens its competitive advantage, investors will begin to realize the value that is being created.

The following segment was excerpted from this fund letter .

Harrow Health ( HROW )

I have written about Harrow Health in my previous two letters to you, but I find it necessary to continue to explain my thought process in order to convey my conviction in the company.

During periods of negative performance, I believe it is more vital than ever that our partners understand my thought process in order for you to adequately discern what it is that I do as your manager. HROW is our largest position, our largest detractor year to date, and the opportunity I am most excited about over the next six months.

Harrow Health is an ophthalmology focused healthcare company. The core business, ImprimisRx, is a compounding pharmacy that customizes medications to the needs of eye care physicians and their patients. It is estimated that north of 90% of ophthalmologists and optometrists use compounded formulations in their practice.

Physicians choose to work with ImprimisRx because they are the largest and most trusted compounding pharmacy in the eye care market and have achieved this by solving pain points for physicians and their patients, where others could not satisfy their needs. An example of how ImprimisRx has been able to solve a pain point is related to cataract surgery and the dosing regimen that is required post operation.

This dosing regimen is typically for 30-days and requires three sets of eye drops with different doses, various lengths of dosing, and if not followed correctly can lead to inflammation and infection. This can be a complicated and confusing process, especially for an elderly individual with diminished cognitive ability. ImprimisRx was able to simplify this process by combining the three separate solutions into one bottle with a much easier dosing regimen for the patient to follow.

This alternative is available for about $75 out of pocket compared to an insurance co-pay of about $150-300 on average for the three separate solutions. Also, this eliminates the burden that is placed on the physicians practice to receive prior authorization from insurance companies for the three separate solutions and spending additional time to educate patients on dosing regimens. This has allowed ImprimisRx to expand quickly in this market, become a trusted partner to the optometry industry, and create a lucrative market for the company which has led to returns on invested capital of over 100%.

If this is such a lucrative business for ImprimisRx why isn’t capital flowing in to eat away at their margins? This is the first question to ask when analyzing any growing business that earns high returns on invested capital. The most important reason is because the regulatory framework of the industry has created a barrier to entry, which has allowed ImprimisRx to create a moat around this business that the competition will have trouble catching up to if they want to dethrone them. Compounding pharmacies are categorized into two segments, 503A and 503B.

503A pharmacies are able to only fill orders on a patient-by-patient basis (the pharmacy has to then get the patients information, payment, and mail the prescription). 503B pharmacies are able to manufacture products in bulk before a physician ever prescribes to a patient, allowing them to sell their products directly to doctors’ offices, hospitals, and ambulatory surgery centers (the patient has their prescription before they leave the office).

In order for a compounding pharmacy to receive 503B status they must invest significant capital into their operations to comply with FDA guidelines, inspections, and cGMP (current good manufacturing guidelines), just like major pharmaceutical companies. ImprimisRx was a first mover focused on the optometry market to become a 503B pharmacy. This first mover advantage has allowed them to outpace any competition and become the respected source to ophthalmologists and their patients.

At this point, the only practical way for a competitor to gain share would be to invest significant dollars to become 503B compliant, undercut on cost, run significant losses, and gain the same status that ImprimisRx has garnered. Most physicians are unlikely to put their reputation and practice on the line to switch to a competitor for a cheaper alternative from a less known source.

In 2021 Harrow Health began to expand into branded pharmaceutical products ((BPP)) by acquiring the rights to several new products. Their goal with this expansion is to use their customer knowledge, relationships, and trust they have established with the ImprimisRx platform to bring FDA approved products to physicians and their patients that complement the compounded pharmaceutical products ((CPP)) they already offer. The most promising of the newly acquired drugs is AMP-100.

AMP-100 is a patented topical intraoperative anesthetic pain medication that Harrow believes will be a great product for use with the 4 million cataract procedures, and almost 6 million intravitreal injection procedures, performed annually in the United States. The product has completed its phase 3 trial and is scheduled for an FDA approval decision with a PDUFA date of October 16, 2022. Harrow estimates that AMP-100 has the potential to double company revenues by 2024 based off of their already 20% market share of product use in cataract surgeries.

The expansion into BPP has led to increased costs as the company ramps up its marketing and sales force for the introduction of FDA approved products but has obscured the profitability of the core CPP business. Expanding into FDA approved products will further serve to strengthen the ImprimisRx platform as the go to pharmacy for ophthalmologists and their patients. By forgoing profits today, the company is expanding their business to raise the probability of long- term success.

With the stock down roughly 45% from its highs, I believe the market is missing the forest for the trees. To get an idea of the disconnect between the market price and the business value we can separate the BPP expansion and its costs from the core CPP business of ImprimisRx. During the first half of 2022 revenues grew 35% YoY and are on track to surpass $85 million for the year with 74% gross profit margins. If we strip increased costs to start-up the BPP business, the current run rate SG&A expenses for the CPP business approximate $37 million per year.

The CPP business of ImprimisRx will produce around $0.90-$1.00 per share of operating cash flow in fiscal 2022. The stock was recently trading less than $7.00 per share. At this price the expansion into BPP is a free growth option that has the potential to double revenues by 2024. Management is excited with what the future holds for HROW, and they are incentivized to follow through on their plans. Members of the senior management team have been issued significant monetary value of performance share units (PSUs) that are tied to certain levels of target share prices of $11.70, $15.60, $19.50, and $21.45.

Harrow Health is a predominantly recession resistant business trading at a large discount to fair value with years of significant growth ahead of it. As the company continues to execute on its plan and further strengthens its competitive advantage investors will begin to realize the value that is being created.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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