Harrow, Inc.: Blinded by the light

[The shareholder letters, earnings reports and company presentation can be found on Harrow’s website: www.harrow.com. Images are taken from there.]

Harrow’s H1 2024 results presented an ongoing staggering growth spread over all business segments. Consequently, the stock price took a high jump, and keeps rising.

Given this is already my third post on Harrow, and I don’t want this blog to become the Harrow blog, it shall also be the last, and a short one. There’s always something to do, and there are always other fish to fry.

Like I did in my previous post on Harrow, I will comment on the preceding one, quotes of which will be reproduced in italics. The preceding post can be found here and is recommended reading for understanding this one.
And in my last post I wrote: “an update to my last article that would paint a brighter picture was called for. Now both sides are laid out, and the future development of the business will decide between them.” I’m just an emotional basket case that, when looking at Harrow’s stock price chart, has great willingness to believe that the future development of the business has already been decided between the two scenarios, and that it is the brighter scenario that has been decided for, and that it is getting increasingly brighter.

To be clear: this is no investment advice. Frankly speaking, you wouldn’t want to take advice on any matter from an emotional basket case. Just to put that out of the way. And with that, let’s take a brief look. 

Positives

In my last post I commented on the difference, in FY 2023 reporting, between the Iheezo and Veyve charts, the latter offering greater transparency with monthly break-down going up until the day of Harrow reporting in March, while the former, the Iheezo chart, stopped after Q4 2023. I duly noted: “Why this diverse treatment? The likely reason is: that in Q1 2024, Iheezo demand did not continue to go up and to the right.”
And in Q1 2024 reporting HROW finally showed the chart displaying just that, although the decline proved to not be stark:

“If we look past the inventory unwinding, Iheezo is likely operating at a $40m annual revenue pace currently. Assuming conservatively an incremental increase only, Iheezo’s revenue could reach $50m in 2024.”
While I expected the overloaded supply chain to unload during 2024 and Iheezo return to growth, I was surprised first by how quickly it unloaded and then second by how significant the rebound was:

Q1 2024 took the revenu-suppressing brunt of the digital security breach at Change Healthcare, a medical claim processing company, so we shouldn’t lightly assume a sequential growth-rate in the following quarters as we saw from Q1 to Q2. This having been said, the 50m Iheezo revenue I bullishly penciled in for 2024 appear now to be undershooting what will likely materialise.

“Attempts to revive the Fab 4, although management called them promising in Q3 2023, have not brought results so far — and, sure enough, management preferred not to mention them on the FY 2023 earnings call —, thus no increase shall be assumed here.”
This needs amending. The CEO Mr. Baum signaled that the anterior segment grew revenue by 40% from Q1 to Q2. “While we expect to experience quarter-to-quarter revenue variability, the overall revenue trend for this part of our business is improving” (H1 2004 shareholder letter).

ImprimisRX, Harrow’s traditional compounding business, saw record high revenue in Q2 2024, and management expects it to grow by +10% for FY 2024.

The dry-eyes drug Vevye, Harrow’s greatest opportunity, is off to a blistering start:

“But let’s not get ahead of ourselves and assume that albeit Mr. Baum’s optimism Triesence won’t happen.”
From all I can read between the lines written in the shareholder letter, and spoken on the earnings call, it is very likely that Triesence will happen indeed in 2024, but in the last quarter.

“So let’s contain the bullishness and keep at $205m revenue, which is in line with Harrow’s guidance of at least $180m revenue for 2024.”
This is ex-Triesence, and ex-Triesence Mr. Baum now firmly says: “ … I believe that it’s really a question of how much ‘greater than’ $180 million it will be” (H1 2024 shareholder letter).
Anything below 200m would be an unfavourable surprise now, but 205m ex-Triesence still seems good enough for me in a tentatively bullish base case.  



A little splash of cold water

The surge in revenue and the concomitant surge in the stock price generate some fever that is feeding on itself, taking the Harrow stock to lofty valuations. It should not be forgotten, though, that Harrow is still an unprofitable business. Looking at operations, growth in revenue is dearly paid for by growth in expenses.

“Already in Q4 2023 Harrow had an annual run-rate of ca. $45m in cost of sales, $104m in SG&A, and of ca. $13m in R&D (45+104+13=$162m). These numbers are likely to grow, as Mr. Baum already noted in the Q3 shareholder letter that ‘we expect our operating costs to increase incrementally’ in 2024. Still, as this is the bull-case here, and we’ve been conservative in all the preceding assumptions, we have some lee-way for optimism at this point and will just stick with the Q4 2023 run-rate in operating costs.”
While this has not been too far off, still it’s been too optimistic. At H1 2024 we already have an annual run rate of roughly 178m (cost of sales 23m + 66m operating expenses see below, times 2), which only is further to grow.

Importantly, while revenue rose ca. 40% from H1 2023 to H1 2024, expenses (cost of sales + operating expenses) rose from 55m to 98m, a 78% increase. With rise in expenses far outpacing rise in revenue, the high-flying revenue growth proves to be costly at this point. 

Arguably, Harrow even understates costs by relocating elements that could be declared as costs of sales. The revenue figure in the profit and loss statement is reported net of rebates and other sales deductions: “The transaction price is based on an amount that reflects the consideration to which the Company expects to be entitled, net of accruals for estimated rebates, wholesaler chargebacks, discounts, copay assistance and other deductions (collectively, sales deductions)” (H1 report). But then, where do the sales deductions end up? Not in the profit and loss statement; not as costs of sales. They end up as current liabilities on the balance sheet:

So — again, arguably — to give a better picture of Harrow’s costs for generating their H1 revenue we should add costs of sales (23m) + operating expenses (66m) + sales deductions taken from current liabilities (24.5m), which amounts to 113m total costs, against revenue of 83m.

Thus, not surprisingly, Harrow keeps burning cash even before taking interest payment on debt into account:

Accounts receivable (AR) continue to be a major drag on cash generation. The bullish explanation is that Harrow is growing like a weed and with a generous payment policy towards customers, evidently AR would be running high. I’ve been skeptical of this explanation before, but given that they actually collected a fair amount of AR as visible by Q1 2024 results:

… I now tend to concur with this explanation. Still, I’m surprised that inventories, which would be a corollary of the above explanation, are not growing likewise like a weed:

Inventories actually slightly declined, while AR rose roughly 43% in H1 2024. I don’t say that it’s an abnormality; I’m just saying that it’s intriguing.



Summary

Well, what to say? Costs run higher than revenue and there’s no cash coming in the door from operations, but how can anybody not be bullish on a stock that is hitting new all-time-highs every day (maybe not strictly true, but that’s the feeling I have)? Besides, anyone will tell me to look at the revenue growth and the untapped total addressable market.
And is cash really an issue? At these stock prices, Harrow can raise equity at liberty and has thus easy access to abundant cash. Coupled with an acquisition of some sorts, a good explanation for raising equity could quickly be found. Needless to say, the founder, CEO and chairman of the board, Mark Baum, is a charismatic person who talks well, which is always a great asset in capital markets.