Harrow Health : Q2-2023 Letter to Stockholders

Letter to Stockholders

August 9, 2023

Dear Harrow Stockholders:

I am pleased to report second quarter 2023 record revenues of $33.5 million and record adjusted EBITDA of $11.0 million. Notably, we also reported the largest sequential quarterly increase in revenues and adjusted EBITDA in Harrow's history - from the first to second quarters of 2023. Recall that in my May 11, 2023, Stockholder Letter, I wrote that Harrow had "entered a new revenue paradigm," a notion that I believe is supported by these figures.

What a difference a few months makes. When I last corresponded with you, we were focused behind the scenes on completing three transactions that I believed would give Harrow the best opportunity to achieve the highest financial goals of Harrow's Five-Year Strategic Plan, which we initiated in January of this year. These three transactions, all of which closed at the beginning of the third quarter, were: (1) the acquisition of substantially all products in the North American Santen ophthalmic pharmaceutical portfolio; (2) the acquisition from Novaliq of the North American rights to VEVYE®, a novel FDA-approved drug labeled to treat both the signs and symptoms of dry eye disease (DED); and (3) the strengthening of our balance sheet through a pair of financings, including a well-executed equity financing and the expansion of our Oaktree Capital facility.

Today, the Harrow ophthalmic pharmaceutical portfolio is more potent than ever. We can now more broadly and comprehensively deliver important clinical value to our customers. For Harrow's stockholders, I believe this more robust product portfolio should cause (a) annual revenue growth for many years to come and (b) consolidated quarterly gross margins to begin to float higher this year.

In the balance of this Stockholder Letter, in addition to adding color to our second quarter 2023 performance, I intend to describe what you, as my "business partners," should expect during the balance of this Five-Year Strategic Plan period.

Before I go any further, let me answer the question one might logically ask after reading the second paragraph above: "What are the 'highest financial goals' of our Five-Year Strategic Plan?"

Simply put, we believe that - with our current product portfolio and continued strategic execution by the Harrow team - we can become a top-tierU.S.-focused ophthalmic pharmaceutical company capable of producing annual revenues of $1 billion or more - at very attractive operating margins.

Recognizing that our Five-Year Strategic Plan consists of a series of One-Year Plans, based on our results to date, we remain confident in our 2023 financial guidance of $135 million to $143 million in net revenues and $44 million to $50 million in adjusted EBITDA.

Regarding our 2023 financial guidance, we intend to provide an update to our financial guidance later in the year after we have a few months of operations under our belt with our new product portfolio.

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Second Quarter 2023 Financial Overview

Linkto Selected GAAP Operating Results.

Linkto Selected Core Results (a Non-GAAP Measure).

Record revenues of $33.5 million for the second quarter of 2023 represent a 44% increase over the prior-year's second quarter revenues of $23.3 million.

Adjusted EBITDA increased 144% to $11.0 million for the second quarter of 2023 compared with Adjusted EBITDA of $4.5 million during the same period last year, primarily because of increased revenues of our branded products. Core net loss was ($494,000) for the second quarter of 2023 compared with core net income of $254,000 for the second quarter of 2022.

We had $22.8 million in cash and cash equivalents at the end of the second quarter. Subsequently, our cash balance changed dramatically because of the closing of a $69 million offering of our common stock and a $12.5 million drawdown from our expanded Oaktree Capital loan. We used a portion of the proceeds from these two financings to fund initial payments associated with our acquisitions of VEVYE and the products from Santen.

During the second quarter, Harrow completed the transfer of new drug applications (NDAs) for ILEVRO®, NEVANAC®, and MAXIDEX®. Harrow received net profit transfers on these products during April, but upon NDA transfers in early May, we began booking full revenues from those product sales. Harrow received net profit transfers for VIGAMOX® throughout the second quarter and recently announced the completion of that NDA transfer and began commercialization of VIGAMOX.

We also officially launched IHEEZO® in May of this year at the American Society of Cataract and Refractive Surgeons (ASCRS) annual meeting in San Diego.

Core gross margin improved 500 basis points to 78% in the second quarter of 2023 compared with core gross margin of 73% in the second quarter of 2022.

Selling, general, and administrative (SG&A) expenses for the second quarter of 2023 increased to $20.0 million compared with $14.2 million during the same period last year. The year-over-year increase is due in large part to an expansion of our general operating and sales infrastructure to support our branded product acquisitions and launches in 2023, coupled with an increase in stock-based compensation of over $3 million largely associated with management performance stock units (or PSUs) that have vesting terms based on achievement of Harrow common stock price targets of $25 to $50.

Research and development (R&D) costs were $1.2 million in the second quarter of 2023 compared with $914,000 during the same period last year. Throughout the remainder of 2023 and next year, R&D costs should creep up as we expand our medical and clinical affairs capabilities and gain steam on some of the tech transfer manufacturing processes for our recent product acquisitions.

GAAP operating income was $2.4 million for the second quarter of 2023 compared with GAAP operating income of $1.7 million during the same period last year.

Core diluted net loss per share for the second quarter of 2023 was ($0.02) compared with core diluted net income per share of $0.01 during the same period last year.

A reconciliation of all non-GAAP financial measures in this letter begins on page 11.

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GAAP Operating Results

Selected financial highlights regarding GAAP operating results for the three months and six months ended June 30, 2023, and for the same periods in 2022 are as follows:

	For the Three Months Ended					For the Six Months Ended
		June 30,					June 30,
		2023					2022					2023				2022
Total revenues	$	33,470,000				$	23,323,000				$	59,573,000			$	45,443,000
Cost of sales		10,000,000					6,534,000					18,271,000				12,497,000
Gross profit		23,470,000					16,789,000					41,302,000				32,946,000
Selling, general and administrative		19,957,000					14,185,000					35,845,000				27,583,000
Research and development		1,161,000					914,000					1,895,000				1,572,000
Total operating expenses		21,118,000					15,099,000					37,740,000				29,155,000
Income from operations		2,352,000					1,690,000					3,562,000				3,791,000
Total other expense, net		6,596,000					7,889,000					14,737,000				12,428,000
Income tax benefit (expense)		15,000					(40,000)					303,000				(40,000)
Net loss attributable to	$	(4,229,000)		$	(6,239,000)	$(10,872,000)		$	(8,677,000)
Harrow Health, Inc.
Net loss per share of common stock,	$	(0.14)			$	(0.23)				$	(0.36)			$	(0.32)
basic and diluted

Core Results (a Non-GAAP Measure)

Core Results (non-GAAP measures), which we define as the after-tax earnings and other operational and financial metrics generated from our principal business, for the three months and six months ended June 30, 2023, and for the same periods in 2022, are as follows:

	For the Three Months Ended		For the Six Months Ended
	June 30,		June 30,
	2023	2022		2023	2022
Net revenues	$ 33,470,000		$ 23,323,000		$ 59,573,000		$ 45,443,000
Gross margin	70%	72%	69%	72%
Core gross margin(1)	78%		73%		77%		74%
Net loss	(4,229,000)	(6,239,000)	(10,872,000)	(8,677,000)
Core net (loss) income(1)	(494,000)	254,000	(1,536,000)	967,000
Adjusted EBITDA(1)	11,005,000	4,505,000	16,347,000	9,445,000
Basic net loss per share	(0.14)	(0.23)	(0.36)	(0.32)
Diluted net loss per share	(0.14)	(0.23)	(0.36)	(0.32)
Core basic net (loss) income per share(1)	(0.02)	0.01	(0.05)	0.04
Core diluted net (loss) income per share(1)	(0.02)	0.01	(0.05)	0.03

1. Core gross margin, core net (loss) income, core basic and diluted net (loss) income per share (collectively, "Core Results"), and Adjusted EBITDA are non-GAAP measures. For additional information, including a reconciliation of such Core Results and Adjusted EBITDA to the most directly comparable measures presented in accordance with GAAP, see the explanation of non-GAAP measures and reconciliation tables at the endof this Letter to Stockholders.

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"Revenue Buckets"

To achieve a billion dollars in annual revenue during this Five-Year Strategic Planning cycle, Harrow must generate significant sales from what I internally refer to as our "Revenue Buckets." As a result of the recently announced acquisitions, we believe we now have five (5) discreet Revenue Buckets with nine-figure annual revenue potential. We believe sales from products in these Revenue Buckets, in the aggregate, have the potential to achieve the "highest financial goals" I referred to on page 1 of this Stockholder Letter.

Some Revenue Buckets consist of a single product and others contain groups of products. I believe IHEEZO and VEVYE are our largest revenue opportunities - without question. That said, they are also new sources of revenue, with IHEEZO only launching a few months ago and VEVYE expected to launch later in the year. Regardless of the exact timing of the start and steady build of revenue flow from these two exciting products, the key is that (a) Harrow now has them both, and (b) we have an incredibly strong conviction of market need and, ultimately, market acceptance of both products.

Here is a more detailed description of the five Revenue Buckets:

Bucket 1: IHEEZO®

When our team began market research on IHEEZO, some advisors said, "I really don't think I need this product because what I am doing for ocular anesthesia is okay." When we pressed about what their respective ocular anesthesia protocols consisted of, our belief in the future success of IHEEZO gained strength. Responses from these advisors included myriad protocols, with most using multiple different anesthetics during a series of applications - all with inconsistent durations of anesthetic effect. Inconsistent anesthetic durability or reliability isn't good for the doctor and surely isn't good for the patient! Discussions about the importance of an anesthetic caused many of our advisors to realize there was an opportunity for a more reliable ocular anesthetic and one that could create practice efficiencies.

Fast-forward to the initial phase of the IHEEZO launch and the anecdotal reports we've received from IHEEZO users. With IHEEZO, they can use a single product for ocular anesthesia. The onset and duration of the anesthetic effect are consistent and predictable. Ophthalmologists like the viscosity of the IHEEZO gel, which is 75% less viscous than the leading branded lidocaine-based gel anesthetic. Staff at ambulatory surgery centers (ASCs) and hospitals appreciate the compliance benefits of our single-use packaging. And while it's early in the launch, when we see a growing list of accounts trial IHEEZO, use samples, order it, use those units, and re-order more, our confidence that we have a winning product grows.

One way to explain what we see among IHEEZO users is to draw an analogy to how I felt about my Blackberry cell phone 15 years ago. Similar to how our advisors described their ocular anesthesia protocols during our market research phase as "good," I would have said the utility of my Blackberry was "good," with features like texting, a decent camera, and reliable email access. If approached to switch to the iPhone, I would have said that my Blackberry was "good" and that I didn't need the iPhone. Of course, once I experienced the value and benefits of an iPhone, I never went back to a Blackberry. In turn, we believe eyecare professionals (ECPs) who implement IHEEZO into their ocular anesthesia protocols and experience IHEEZO's benefits won't return to their old, and perhaps less efficient, ways.

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The math on the IHEEZO market opportunity is straightforward. We believe there are two main anesthetic use cases: (1) a surgical intervention such as cataract, glaucoma, and retina procedures, which takes place in a hospital or outpatient setting of care, and (2) an intervention in a physician's office, such as an intravitreal injection. We estimate that, in the aggregate, there are more than 12 million such use cases in the U.S. each year. We were granted a product-specificJ-Code (J2403) for all such use cases, and the current wholesale acquisition cost (or WAC) is $544 per unit.

Regarding reimbursement for the IHEEZO J-Code:

• The ability for an ASC, for example, to bill using J2403 is temporary and will only last for about three years. After this time, we may petition the authorities at the Centers for Medicare & Medicaid Services (CMS) to extend, annually, what is referred to as "pass-through payment" (or payment outside of the capitated fee ASCs are paid for completing a cataract surgery).
  To successfully petition CMS for a pass-through payment extension, we must demonstrate that IHEEZO reduces reliance on opioids. We intend to present such data to CMS beforeour temporary pass-through period ends. If CMS approves our request for a pass-through payment extension, ASCs can utilize J2403 until CMS changes its policy, in general, or specifically, towards IHEEZO.
• On the other hand, the "billability" of J2403 in the physician's office setting of care, for intravitreal injections, for example, is not temporary and has no limitation on the duration of use. Importantly, ophthalmologists and their staff, in this setting of care, are very familiar with "buy and bill" products like IHEEZO, perhaps easing the process for IHEEZO adoption.

We estimate that the number of use cases for the physician's office setting of care is double that of the ASC/hospital, creating a multi-billion-dollar annual revenue opportunity for IHEEZO. Therefore, the physician's office setting of care is our primary market for IHEEZO, and the ASC and hospital market is secondary.

While we are not going to win all the potential business for IHEEZO in either setting of care, given the overall size of the opportunity, even if we eventually achieve a blended market share for IHEEZO close to what we have achieved in, for example, the perioperative cataract surgery market with our ImprimisRx compounded pharmaceutical formulations (i.e., touching an estimated 20% of the total number of U.S. cataract surgeries), IHEEZO will have been a great success! Related to this point, our 2023 financial guidance was conservative and did not include much IHEEZO revenue; however, we expect to see quarterly revenue for IHEEZO build sequentially and for each annual period going forward.

Despite being in the initial phase of our IHEEZO launch, feedback from early adopters has been positive, with indications from users that there may be more potential applications for IHEEZO than we had originally anticipated (e.g., glaucoma and retina surgeries and certain laser procedures). Also, we always hoped IHEEZO would help address the opioid crisis in our country, and we have been thrilled to hear from several surgeons that, with IHEEZO, as was the case in the IHEEZO clinical studies, they, too, were able to eliminate opioid use from most of their cataract surgeries. If we can make even a small impact on the opioid crisis, it would be fantastic for patients and our ophthalmologist-customer's practice. Finally, we are seeing wins in our market access efforts to get IHEEZO on commercial formularies. And, as we hoped, IHEEZO is reimbursed in all labeled care settings.

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