Edgar Filing: NovaBay Pharmaceuticals, Inc.

nby20161231_10k.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

☒	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 001-33678

NOVABAY PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

Delaware	68-0454536
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

2000 Powell Street, Suite 1150, Emeryville, California 94608

(Address of principal executive offices) (Zip Code)

Registrant’s Telephone Number, Including Area Code: (510) 899-8800

Securities registered pursuant to Section 12(b) of the Act:

Title of each class		Name of each exchange on which registered
Common Stock, $0.01 par value per share		NYSE MKT

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ☐ No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes ☐ No ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☒

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes ☐ No ☒

As of June 30, 2016, the aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the last sale price of such stock as of such date on the NYSE Mkt, was approximately $7,530,005. This figure excludes an aggregate of 6,144,900 shares of common stock held by officers and directors as of June 30, 2016. Exclusion of shares held by any of these persons should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the registrant, or that such person is controlled by or under common control with the registrant.

As of March 22, 2017, there were 15,288,175 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates information by reference from the Proxy Statement for the 2017 Annual Meeting of Stockholders expected to be held in June 2, 2017.

NOVABAY PHARMACEUTICALS, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2016

TABLE OF CONTENTS

		Page
PART I
ITEM 1.	BUSINESS	1
ITEM 1A.	RISK FACTORS	6
ITEM 1B.	UNRESOLVED STAFF COMMENTS	13
ITEM 2.	PROPERTIES	13
ITEM 3.	LEGAL PROCEEDINGS	13
ITEM 4.	MINE SAFETY DISCLOSURES	13

PART II
ITEM 5.	MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES	13
ITEM 6.	SELECTED FINANCIAL DATA	15
ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	16
ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	24
ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	26
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	60
ITEM 9A	CONTROLS AND PROCEDURES	61
ITEM 9B.	OTHER INFORMATION	61

PART III
ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE	61
ITEM 11.	EXECUTIVE COMPENSATION	62
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS	62
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE	62
ITEM 14.	PRINCIPAL ACCOUNTING FEES AND SERVICES	62

PART IV
ITEM 15.	EXHIBITS, FINANCIAL STATEMENT SCHEDULES	62

Unless the context requires otherwise, all references in this report to “we,” “our,” “us,” the “Company” and “NovaBay” refer to NovaBay Pharmaceuticals, Inc. and its subsidiaries. Further, all references to “we,” “us,” “our,” “the Company,” or “NovaBay” herein refer to the California corporation prior to the date of the Reincorporation (as defined below), and to the Delaware corporation on and after the date of the Reincorporation.

NovaBay^®, NovaBay Pharma^®, Avenova^®, NeutroPhase^®, CelleRx^®, AgaNase^®, Aganocide^®, AgaDerm^®, Neutrox^™and Going Beyond Antibiotics^® are trademarks of NovaBay Pharmaceuticals, Inc. All other trademarks and trade names are the property of their respective owners.

On December 18, 2015, the Company effected a 1-for-25 reverse split of its common stock. The accompanying financial statements and related notes give retroactive effect to this reverse stock split.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to our management. These forward-looking statements include, but are not limited to, statements regarding our product candidates, market opportunities, competitions, strategies, anticipated trends and challenges in our business and the markets in which we operate, and anticipated expenses and capital requirements. In some cases, you can identify forward-looking statements by terms such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” and similar expressions intended to identify forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. We discuss many of these risks in greater detail under the heading “Risk Factors” in Item 1A of this report. Given these uncertainties, you should not place undue reliance on these forward-looking statements. You should read this report and the documents that we reference and have filed as exhibits thoroughly and with the understanding that our actual future results may be materially different from what we expect. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this report. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

PART I

ITEM 1.

BUSINESS

Overview

We are a pharmaceutical company that develops, manufactures, and markets innovative anti-infective products for a multitude of uses. However, we are predominantly focused on commercializing prescription Avenova^® for the domestic eye care market in the United States.

Avenova is the only eye care product formulated with our proprietary, stable and pure form of hypochlorous acid (marketed as Neutrox^®). By replicating the antimicrobial chemicals used by white blood cells to fight infection, Avenova has proven in laboratory testing to have broad antimicrobial properties. It removes microorganisms and debris from the skin on the eyelids and lashes without burning or stinging. It is also the only commercial product clinically validated to reduce bacterial load on the ocular skin surface, the buildup of which can cause the chronic eye condition blepharitis.

In November 2015, we introduced a new business strategy to restructure our business and focus on growing sales of Avenova in the United States. This new strategy allowed us to achieve our goal of reaching adjusted positive cash flow from operations (excluding working capital changes) by the end of 2016. Our current three-part business strategy is comprised of: (1) focusing our resources on growing the commercial sales of Avenova in the U.S. eye care market, including the implementation of an innovative sales and marketing strategy to increase product margin and profitability; (2) significantly reducing expenses through the restructuring of our operations and other cost reduction measures; and (3) seeking additional sources of revenue through partnering, divesting and/or other means of monetizing non-core assets in urology, dermatology, and wound care.

In addition to Avenova, we have also developed other commercial products containing Neutrox, including NeutroPhase^® for the wound care market and CelleRxfor the dermatology market. We have partnerships for NeutroPhase in the U.S., as well as select overseas markets, most notably China.

Avenova

Based on positive sales performance in 2015, we incrementally grew our salesforce to 49 medical sales representatives in 2016 and to 55 in January 2017. Having previously been managed through a professional employer organization, we transitioned our contract salesforce to direct employees of the Company in January 2017. This marked an important milestone in establishing ourselves as a truly consolidated company under the direction of one management team. We believe we are poised for success with all our sales representatives having extensive experience with eye care products and medical devices, a skill set critical for rapid adoption of Avenova in the marketplace.

We currently believe our target market to be the estimated 30 million Americans who suffer from blepharitis and chronic dry-eye. To access our target market, our salesforce is calling on a base of prescribers that includes the approximately 17,000 ophthalmologists and approximately 37,000 optometrists in the U.S. Our sales and marketing campaign targets major urban areas such as New York, Los Angeles, Boston, Atlanta, and San Francisco.

Avenova offers distinct advantages, when compared to alternative regimens that contain soaps, bleach, and other impurities, as it removes unwanted microorganisms from the skin without the use of harmful ingredients such as detergents and bleach. The removal of these harmful items helps control eyelid inflammation, itching and other painful symptoms. Many key opinion leaders in the field of ophthalmology and optometry have embraced Avenova as a tool in the management of lid and lash hygiene and have joined our Ophthalmic and Optometry Advisory Boards (the “Advisory Boards”) to promote its use among their peers. Our Advisory Board members are essential in our goal of educating other physicians that Avenova, used twice daily, is well suited for treating a variety of chronic eye conditions.

Because prescription Avenova has been shown to neutralize bacterial toxins in vitro, it was specifically designed for daily eyelid hygiene. It is the only commercially available product to be clinically validated in a multicenter study to significantly reduce the bacteria that can cause blepharitis. Data from the clinical study showed that Avenova reduced the bacterial load on ocular skin surface by more than 90% (S. epidermidis by 99.5%) within 20 minutes of use without affecting the diversity of the remaining bacteria. Results of this clinical study were presented at the Association for Research in Vision and Ophthalmology (“ARVO”) annual meeting in May 2016. We expect to present data from additional clinical studies to further validate the use of Avenova in managing blepharitis and other eye conditions. Avenova may also be useful in pre- and post-surgical settings for LASIK and cataract patients, as well as managing contact lens intolerance. We believe the total potential market for this product is approximately 41 million patients.

We expect continued benefit from the support of the key opinion leaders on the Advisory Board, our active schedule of educational and marketing programs and strong presence at major eye care conferences in the coming months, including the American Academy of Ophthalmology, the American Optometric Association, the American Society of Cataract and Refractive Surgery Conferences and the South-Eastern Congress of Optometry, as well as numerous Vision Expo meetings held around the U.S. We also plan to continue advertising in leading ophthalmic and optometric trade journals. At these meetings, in professional publications, and in surveys, nationally prominent ophthalmologists and optometrists are reporting on patient improvements in eye care from the use of Avenova.

We have distribution agreements with McKesson Corporation, Cardinal Health, and AmerisourceBergen Corporation that make Avenova accessible in 90% of the approximate 67,000 retail pharmacies across the U.S. Avenova also is marketed through the top ophthalmology and optometry networks. These include the Vision Source Independent Optometry Network, the largest independent optometry network in the U.S. representing 2,800 independent optometrist offices, and ALLDocs Optometry Group (also known as The Association of LensCrafters Leaseholding Doctors), the second largest independent optometry group in the U.S., which works closely with its LensCrafters partners.

Throughout 2016 we reported increases in key metrics, including the total number of prescribers, as well as growth in prescription volume as reported by distributors and the number of retail pharmacies ordering Avenova, both of which have been confirmed by third-party prescription data providers. Increases in Avenova volume include growth of Avenova product reorders and new prescriptions.

We expect that our prescription business will be the main driver of long-term Avenova sales growth and gross margin expansion. We are focusing our primary sales efforts on building our prescription business under a value pricing model. Our strategy is supported by the high percentage rate of insurance reimbursement, with over 90% of Avenova prescriptions filled at pharmacies covered by insurance at the end of 2016. As a result of this focus, we have significantly increased the percentage of total Avenova prescriptions. We are working to improve insurance reimbursement coverage for Avenova and we are aligning our product pricing accordingly.

We also expect to invest in systems that support prescribing physicians’ efforts to educate their patients. We have made it easy for doctors to get Avenova into the hands of patients by providing availability through well-known national pharmacy chains, specialty pharmacies, or directly through the practitioners’ office. Furthermore, in order to ensure consistent pricing, we have instituted rebate cards to ensure the best price for the patient at the pharmacy. This method, combined with reimbursement under insurance plans, could provide us with potential additional revenue upside.

Competition

There are many companies that sell lid and lash scrubs, most of these are surfactant (soap) based, such as lid scrubs or baby shampoos. Unlike its competitors, Avenova consists of saline and 0.01% pure hypochlorous acid, without the bleach impurities included in competitive offerings. While newer prescription products have recently been commercially launched, they all include bleach or other impurities. Because it lacks these impurities, we believe that physicians and their patients will choose Avenova over other competitive prescription products or over-the-counter (“OTC”) soap products.

Strategic Alternatives and Other Assets

The third key aspect of our business strategy is to seek additional sources of revenue through partnering, divesting and/or other means of monetizing non-core assets. We therefore are in the process of seeking additional sources of revenue by licensing or selling select non-core assets in urology, dermatology, and wound care, as described in more detail below.

Aganocide Compounds

In addition to our Neutrox family of products, we have synthesized and developed a second category of novel compounds also aimed at harnessing the power of white blood cell chemistry to address the global, topical anti-infective market. This second product category includes auriclosene, our lead clinical-stage Aganocide compound, which is a patented, synthetic molecule with a broad spectrum of uses against bacteria, viruses and fungi. Mimicking the anti-infective chemistry and mechanism of action that human white blood cells use against infections, Aganocides possess a significantly reduced likelihood of bacteria or viruses developing resistance, which is critical for advanced anti-infectives. Auriclosene has been designated as a new chemical entity and granted broad composition of matter patent protection to 2028 by the U.S. Patent Office.

AIS (Urology)

Our urology program utilizes the technology of our Aganocide compounds and is in an advanced stage of clinical development. Statistically significant and clinically meaningful results have been reported from two Phase 2 clinical studies with our Auriclosene Irrigation Solution (“AIS”) in urinary catheter blockage and encrustation (“UCBE”). We announced the results of a Phase 2b clinical study in September 2016 which demonstrated that AIS, when compared with the product that represents the current standard of care, proved more effective in reducing urinary blockage in patients with chronic indwelling urinary catheters who have repeat history of blockage. In this study, AIS exhibited the potential for rapid decolonization of a range of urologic pathogens. Approximately 100,000 patients in the U.S. currently chronically suffer from UCBE. We estimate that the healthcare costs to manage these patients is in the billion-dollar range.

CelleRx (Dermatology).

Created for cosmetic procedures, CelleRx (0.015% Neutrox) is a gentle cleansing solution that is effective for post-laser resurfacing, chemical peels and other cosmetic surgery procedures. Cosmetic surgeons and aesthetic dermatologists have found that CelleRx results in less pain, erythema, and exudate compared to Dakin solution, which contains bleach impurities. CelleRx is a non-alcohol formulation that doesn’t dry or stain the skin, and most importantly, has been shown to reduce the patient’s downtime post procedure.

CelleRx is well positioned in the cosmetic surgery and aesthetic dermatology space as an adjunct therapy for the pre/post procedural phase of chemical and laser facial skin peels. Currently many generic creams and salves, as well as home-mixed acetic acid potions, are used for this purpose. We believe that CelleRx is clearly differentiated in this field. CelleRx is unique prescription product with 510(k) clearance as a skin and wound cleanser. CelleRx has proven to be safe, soothing and have an unusually broad spectrum antimicrobial action in solution. Many clinicians have used the product clinically and have reported excellent results.

intelli-Case

In addition to improving the eyecare of many Americans through promoting Avenova for lid and lash hygiene, we have developed a contact lens case that improves the safety of those contact lens wearers who use hydrogen peroxide solution to disinfect their lenses. In June 2015, we received FDA-clearance for the intelli-Case, a highly innovative, easy-to-use device for use with hydrogen peroxide disinfection solutions for soft and rigid gas permeable contact lenses. More than 24 million Americans disinfect their contact lenses with a multipurpose disinfection system to prevent potentially serious infections. Approximately two million use hydrogen peroxide as a disinfection solution. Many ophthalmologists and optometrists favor the disinfection and lens material compatibility peroxide systems provide, yet side effects associated with misuse and non-compliance minimize peroxide system use. Hydrogen peroxide in too low of a concentration does not fully disinfect lenses and in too high of a concentration can severely irritate the eye.

The intelli-Case monitors the neutralization of hydrogen peroxide during the disinfection cycle with sophisticated microprocessor electronics embedded in the cap of what otherwise looks like a standard peroxide lens case. The LED indicators on the lid inform the user if the lenses are safe to insert into the eyes, resulting in a disinfection system that is safe yet simple to use. We are seeking potential partners with the resources to make this breakthrough device available to the largest number of contact lens wearers as soon as possible.

NeutroPhase (Wound Care).

We believe that NeutroPhase is a well-suited product to treat the six million patients in the U.S. who suffer from chronic non-healing wounds, such as pressure, venous stasis and diabetic ulcers. Consisting of 0.03% Neutrox, NeutroPhase is used to cleanse and remove microorganisms from any type of acute or chronic wound, and can be used with any type of wound care modality. Recently, NeutroPhase has been found to be an effective irrigation solution as part of the adjunct treatment for Necrotizing Fasciitis (“NF”). Also known as flesh-eating disease, NF typically has a high mortality and amputation rate (30% and 70%, respectively) even with aggressive debridement and antibiotic treatment. In vitro studies have shown that, in solution, NeutroPhase both kills the microorganisms implicated in NF and neutralizes the toxins secreted by the microorganisms. Success using NeutroPhase as an irrigation solution has established it as an effective part of the adjunct treatment for this deadly disease.

In March 2015, the National Necrotizing Fasciitis Foundation (“NNFF”) named NeutroPhase its official “Flesh Eating Disease” wound cleanser. The NNFF is a non-profit organization established in 1997 by two survivors of the disease. NNFF has evolved to become the world’s leading resource for information regarding necrotizing fasciitis, as well as a repository of cases reported worldwide.

NeutroPhase is competing in a crowded wound cleanser market with many older and lower-priced products with similar uses. However, we believe NeutroPhase has distinct competitive advantages in a market where there is currently no dominant product. In the U.S. and internationally, NeutroPhase is distributed through commercial partners, such as Pioneer Pharma Company Limited, or “Pioneer,” a Shanghai-based company, for the distribution of NeutroPhase throughout Southeast Asia and mainland China and in the U.S., by Principle Business Enterprise (“PBE”).

U.S. FDA Regulatory Clearance of Neutrox-based Products. We are marketing Avenova, NeutroPhase, and CelleRx as medical devices regulated under the FDA 510(k) process. Avenova and CelleRx fall under the general intended use of skin and wound cleansers. NeutroPhase was cleared by the U.S. FDA “for use under the supervision of healthcare professionals for cleansing and removal of foreign material, including microorganisms and debris from wounds, and for moistening absorbent wound dressings and cleaning minor cuts, minor burns, superficial abrasions, and minor irritations of the skin. It is also intended for moistening and debriding acute and chronic dermal lesions, such as Stage I to IV pressure ulcers, stasis ulcers, leg ulcers, diabetic foot ulcers, post-surgical wounds, first and second degree burns, and grafted and donor sites.

Recent Events

On October 28, 2016, the Company received a letter from the NYSE MKT informing it that the Company is back in compliance with the NYSE MKT continued listing standards set forth in Part 10 of the NYSE MKT Company Guide (the “Company Guide”). Specifically, the Company had resolved the continued listing deficiencies with respect to Sections 1003(a)(i), 1003(a)(ii) and 1003(a)(iii) of the Company Guide referenced in the NYSE MKT’s letters dated April 28, 2015, July 10, 2015 and March 17, 2016. The Company is subject to ongoing review for compliance with NYSE MKT requirements as part of the NYSE MKT’s routine monitoring.

Equity

In February 2016, we closed a financing with accredited investors in which we raised a total of $2.8 million, or approximately $2.6 million in net cash proceeds after deducting a placement agent commission due to China Kington Asset Management (“China Kington”) and other offering costs of $0.2 million.

In May 2016, we closed the first tranche of an April 2016 financing (the “April 2016 Financing”) in which we raised a total of $7.8 million, or approximately $7.3 million in net cash proceeds after deducting China Kington’s placement agent commission and other offering costs of $0.5 million.

In August 2016, we closed the second tranche of this financing, raising a total of $4.0 million, or approximately $3.8 million in net cash proceeds after deducting China Kington’s placement agent commission and other offering costs of $0.2 million.

During the third quarter of 2016, certain warrant holders exercised warrants in the amount of $6.9 million, or approximately $6.6 million in net cash proceeds after deducting placement agent commissions and other offering costs of $0.3 million.

During the fourth quarter of 2016, certain warrant holders exercised warrants in the amount of $0.9 million, or approximately $0.9 million in net cash proceeds after deducting placement agent commissions and other offering costs of approximately $32 thousand.

For more information on the equity transactions, please see Note 11 to our consolidated financial statements.

Borrowings

In January 2016, in connection with a bridge loan (the “Bridge Loan”) facilitated by China Kington, we issued five (5) promissory notes to certain lenders between December 2015 and January 2016 for an aggregate amount of $3.0 million.

After the closing of the first tranche of the April 2016 Financing, in May 2016, we used $2.5 million of the proceeds to repay the principal on the promissory notes outstanding under the $3.0 million Bridge Loan.

After the closing of the second tranche of the April 2016 Financing, in August 2016 we repaid the final $0.5 million outstanding under the Bridge Loan and all liens on our property and assets associated with the Bridge Loan were released.

Office Lease

On August 24, 2016, we entered into an Office Lease (the “Lease”), pursuant to which we leased approximately 7,799 rentable square feet of real property located on the eleventh floor (Suite 1150) at 2000 Powell Street, Emeryville, California 94608 from KBSIII Towers at Emeryville, LLC (the “Landlord”), for our new principal executive offices. The expiration date of the Lease is February 28, 2022, unless earlier terminated pursuant to any provision of the Lease. The Company has the option to extend the term of the Lease for one five (5)-year period upon written notice to the Landlord due no earlier than twelve (12) months and no later than nine (9) months prior to the expiration of the Lease.

The Company still has a lease commitment for the laboratory facilities and office space at Suite 550, EmeryStation North Building, 5980 Horton Street, Emeryville, California (“EmeryStation”) under an operating lease which will expire on October 21, 2020. On July 11, 2016, the Company entered into a Sublease Agreement to sublease all 16,465 rentable square feet of real property at EmeryStation (the “Sublease Agreement”). The commencement date under the Sublease Agreement was September 8, 2016. The expiration date of the Sublease Agreement is October 21, 2020, as amended (while the expiration date of the Company’s master lease for the EmeryStation premises is October 31, 2020), unless earlier terminated pursuant to the Company terminating its master lease for EmeryStation or the Sublease Agreement.

Employees

As of December 31, 2016, we had 21 direct full-time employees. None of our employees are represented by labor unions or covered by collective bargaining agreements. We consider our relationship with our employees to be good. In January 2017, we internalized our contract salesforce of 58 medical sales representatives. As of February 28, 2017, we have a total of 78 direct full time employees.

Available Information

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our corporate website, located at www.novabay.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”).

ITEM 1A. RISK FACTORS

Our business is subject to a number of risks, the most important of which are discussed below. You should consider carefully the following risks in addition to the other information contained in this report and our other filings with the SEC before deciding to buy, sell or hold our common stock. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected, the value of our common stock could decline and you may lose all or part of your investment. The risks and uncertainties described below are not the only ones facing our Company. Additional risks and uncertainties not presently known to us or that we currently believe are immaterial may also impair our business operations.

Risks Relating to Our Liquidity

We have a history of losses and we may never achieve or maintain sustained profitability.

We have historically incurred net losses and we may never achieve or maintain sustained profitability. In addition, at this time:

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we expect to incur substantial marketing and sales expenses as we continue to attempt to increase sales of our Avenova product

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our results of operations may fluctuate significantly;

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we may be unable to develop and commercialize our product candidates; and

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it may be difficult to forecast accurately our key operating and performance metrics because of our limited operating history.

We will need to generate significant revenues to achieve and maintain profitability. If we cannot successfully market and sell Avenova, either independently or with partners, we will not be able to generate sufficient revenues to achieve or maintain profitability in the future. Our failure to achieve and subsequently maintain profitability could have a material adverse impact on the market price of our common stock.

Risks Relating to Owning Our Common Stock

If we conduct offerings in the future, the price at which we offer our securities may trigger a price protection provision included in warrants originally issued in July 2011, March 2015 and October 2015, reducing the probability and magnitude of any future share price appreciation.

As part of our October 2015 offering, we agreed to provide certain price protections affecting currently outstanding warrants exercisable for an aggregate of 565,695 shares of our common stock, of which 281,093 shares must be issued, if at all, by March 6, 2020, and 284,602 shares must be issued, if at all, by October 27, 2020 (the “Warrants”). Specifically, in the event that we undertake a third-party equity financing of either: (1) common stock at a sale price of less than $5.00 per share; or (2) convertible securities with an exercise price of less than $5.00 per share, we have agreed to reduce the exercise price of all Warrants to such lower price. The exercise price of the Warrants is currently set at $1.81 as a result of our February 2016 private placement offering. The further reduction of the exercise price for the Warrants would limit the probability and magnitude of future share price appreciation, if any, by placing downward pressure on our stock price if it exceeds such offering sale price. All of the Warrants are currently exercisable and will remain so after any exercise price adjustment. In the past, we have extended the expiration dates or adjusted other terms of the Warrants as consideration for certain offering conditions, and we cannot assure you that we will not do so in the future. Any such modifications would reduce the probability and magnitude of any share price appreciation during the period of the extension. We cannot guarantee that you will receive a return on your investment when you do sell your shares or that you will not lose the entire amount of your investment. If you do receive a return on your investment, it may be lower than the return you would have realized in the absence of the price protection provisions discussed hereof.

The price of our common stock may fluctuate substantially, which may result in losses to our stockholders.

The stock prices of many companies in the pharmaceutical and biotechnology industry have generally experienced wide fluctuations, which are often unrelated to the operating performance of those companies. The market price of our common stock is likely to be volatile and could fluctuate in response to, among other things:

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the announcement of new products by us or our competitors;

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the announcement of partnering arrangements by us or our competitors;

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quarterly variations in our or our competitors’ results of operations;

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announcements by us related to litigation;

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changes in our earnings estimates, investors’ perceptions, recommendations by securities analysts or our failure to achieve analysts’ earnings estimates;

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developments in our industry; and

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general, economic and market conditions, including volatility in the financial markets, a decrease in consumer confidence and other factors unrelated to our operating performance or the operating performance of our competitors.

The volume of trading of our common stock may be low, leaving our common stock open to the risk of high volatility.

The number of shares of our common stock being actively traded may be very low and any stockholder wishing to sell his, her, or its stock may cause a significant fluctuation in the price of our stock. We have a number of large stockholders, including our principal stockholders China Pioneer Pharma Holdings Limited (“China Pioneer”), Pioneer Pharma (Hong Kong) Company Limited as a wholly-owned subsidiary of China Pioneer and the recipient of all of the holdings of Pioneer Pharma (Singapore) Pte. Ltd. pursuant to an internal corporate reorganization of China Pioneer (“Pioneer Hong Kong”) and Mr. Jian Ping Fu. Each of China Pioneer and Mr. Fu own 34% and 26% of our common stock, respectively. The sale of a substantial number of shares of common stock by such large stockholders within a short period of time could cause our stock price to decrease substantially. In addition, low trading volume of a stock increases the possibility that, despite rules against such activity, the price of the stock may be manipulated by persons acting in their own self-interest. We may not have adequate market makers and market making activity to prevent manipulation.

Our amended and restated certificate of incorporation and bylaws and Delaware law contain provisions that could discourage a third party from making a takeover offer that is beneficial to our stockholders.

Anti-takeover provisions of our amended and restated certificate of incorporation, amended and restated bylaws and Delaware law may have the effect of deterring or delaying attempts by our stockholders to remove or replace management, engage in proxy contests and effect changes in control. The provisions of our charter documents include:

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a classified board so that only one of the three classes of directors on our Board of Directors is elected each year;

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elimination of cumulative voting in the election of directors;

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procedures for advance notification of stockholder nominations and proposals;

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the ability of our Board of Directors to amend our bylaws without stockholder approval; and

●

the ability of our Board of Directors to issue up to 5,000,000 shares of preferred stock without stockholder approval upon the terms and conditions and with the rights, privileges and preferences as our Board of Directors may determine.

In addition, as a Delaware corporation, we are subject to the Delaware General Corporation Law (“DGCL”), which includes provisions that may have the effect of deterring hostile takeovers or delaying or preventing changes in control or management of our Company. Provisions of the DGCL could make it more difficult for a third party to acquire a majority of our outstanding voting stock by discouraging a hostile bid, or delaying, preventing or deterring a merger, acquisition or tender offer in which our stockholders could receive a premium for their shares, or effect a proxy contest for control of NovaBay or other changes in our management.

We have not paid dividends in the past and do not expect to pay dividends in the future, and any return on investment may be limited to the value of our stock.

We have never paid cash dividends on our common stock and do not anticipate paying cash dividends on our common stock in the foreseeable future. The payment of dividends on our common stock will depend on our earnings, financial condition and other business and economic factors affecting us at such time as our Board of Directors may consider relevant. If we do not pay dividends, you will experience a return on your investment in our shares only if our stock price appreciates. We cannot assure you that you will receive a return on your investment when you do sell your shares or that you will not lose the entire amount of your investment.

China Pioneer, Pioneer Hong Kong, Mr. Jian Ping Fu and/or China Kington might influence our corporate matters in a manner that is not in the best interest of our general stockholders.

As of March 1, 2017, China Pioneer beneficially owns approximately 34% of our common stock. Our director Mr. Xinzhou “Paul” Li is the chairman of China Pioneer. Pursuant to the arrangement of our Bridge Loan, two (2) of our directors were nominated by China Kington, including Mr. Mijia “Bob” Wu, who is the Managing Director of China Kington and Non-Executive Director of Pioneer Hong Kong, and Mr. Xiaoyan “Henry” Liu, who has worked closely with China Kington on other financial transactions in the past. Mr. Jian Ping Fu beneficially owns approximately 26% of our common stock. China Kington and its affiliates have served as placement agent for three purchases of Company securities by Mr. Fu during the last year.

As a result, China Pioneer, Pioneer Hong Kong as a wholly-owned subsidiary of China Pioneer and China Kington have input on all matters before our Board of Directors and may be able to exercise significant influence over all matters requiring board and stockholder approval. Please see the risk factor entitled “We may be unable to raise additional capital on acceptable terms in the future, which may in turn limit our ability to develop and commercialize products and technologies.” China Pioneer, Pioneer Hong Kong and China Kington may choose to exercise their influence in a manner that is not in the best interest of our general stockholders.

In addition, were China Pioneer, Pioneer Hong Kong and Mr. Fu to cooperate, they could unilaterally elect all of their preferred director nominees at our 2017 Annual Meeting of Stockholders. Even with our classified board, China Pioneer, Pioneer Hong Kong and Mr. Fu could ensure that five (5) of our eight (8) directors are either nominees of China Pioneer, Pioneer Hong Kong or China Kington. In the interim, China Pioneer, Pioneer Hong Kong, China Kington and/or Mr. Fu could exert significant indirect influence on us and our management.

Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited.

Under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), if a corporation undergoes an “ownership change,” generally defined as a greater than 50% change (by value) in its equity ownership over a three-year period, the corporation’s ability to use its pre-change net operating loss (“NOL”) carryforwards and other pre-change tax attributes (such as research tax credits) to offset its post-change income may be limited. Since our formation, we have raised capital through the issuance of capital stock on several occasions which, combined with the purchasing shareholders’ subsequent disposition of those shares, may have resulted in one or more changes of control, as defined by Section 382 of the Code. We have not currently completed a study to assess whether any change of control has occurred, or whether there have been multiple changes of control since our formation, due to the significant complexity and cost associated with such study. If we have experienced a change of control at any time since its formation, its NOL carryforwards and tax credits may not be available, or their utilization could be subject to an annual limitation under Section 382. In addition, since we may need to raise additional funding to finance our operations, we may undergo further ownership changes in the future. If we earn net taxable income, our ability to use our pre-change NOL carryforwards to offset United States federal taxable income may be subject to limitations, which could potentially result in increased future tax liability to us.

Risks Relating to Our Business

Our future success is largely dependent on the successful commercialization of Avenova.

The future success of our business is largely dependent upon the successful commercialization of Avenova. We are dedicating a substantial amount of our resources to advance Avenova as aggressively as possible. If we encounter difficulties in its commercialization, we may not have the resources necessary to continue our business in its current form. If we are unable to establish and maintain adequate sales, marketing and distribution capabilities or enter into or maintain agreements with third parties to do so, we may be unable to successfully commercialize our products. We believe we are creating an efficient commercial organization. However, we may not be able to correctly judge the size and experience of the sales and marketing force and the scale of distribution necessary to be successful. Establishing and maintaining sales, marketing, and distribution capabilities are expensive and time-consuming. Such expenses may be disproportionate compared to the revenues we may be able to generate on sales of Avenova.

Our commercialized products are not approved by the FDA as a drug, so we rely solely on the 510(k) clearance of Neutrox as a medical device.

Our business and future growth depend on the development, use and sale of products that are subject to FDA regulation, clearance and approval. Under the U.S. Federal Food, Drug, and Cosmetic Act and other laws, we are prohibited from promoting our products for off-label uses. This means that we may not make claims about the safety or effectiveness of our products and may not proactively discuss or provide information on the use of our products, except as allowed by the FDA. As a medical device, our claims regarding efficacy are limited. Without claims of efficacy, market acceptance of our products may be slow.

There is a risk that the FDA or other federal or state law enforcement authorities could determine that the nature and scope of our sales and marketing activities may constitute the promotion of our products for a non-FDA-approved use in violation of applicable law. We also face the risk that the FDA or other regulatory authorities might pursue enforcement based on past activities that we have discontinued or changed, including sales activities, arrangements with institutions and doctors, educational and training programs and other activities.

Government investigations concerning the promotion of off-label uses and related issues are typically expensive, disruptive and burdensome and generate negative publicity. If our promotional activities are found to be in violation of applicable law or if we agree to a settlement in connection with an enforcement action, we would likely face significant fines and penalties and be required to substantially change our sales, promotion, grant and educational activities. In addition, were any enforcement actions against us or our senior officers to arise, we could be excluded from participation in U.S. government healthcare programs such as Medicare and Medicaid.

We do not have our own manufacturing capacity, and we rely on partnering arrangements or third-party manufacturers for the manufacture of our products and potential products.

We do not currently operate manufacturing facilities for production of our product and product candidates. We have no experience in product formulation or manufacturing, and we lack the resources and the capabilities to manufacture any of our product candidates on a clinical or commercial scale. As a result, we have partnered and expect to partner with third parties to manufacture our products or rely on contract manufacturers to supply, store and distribute product supplies for our clinical trials. Any performance failure on the part of our commercial partners or future manufacturers could delay clinical development or regulatory approval of our product candidates or commercialization of our products, producing additional losses and reducing or delaying product revenues.

Our products and product candidates do and will require precise, high-quality manufacturing. The failure to achieve and maintain high manufacturing standards, including the incidence of manufacturing errors, could result in patient injury or death, product recalls or withdrawals, delays or failures in product testing or delivery, cost overruns or other problems that could seriously harm our business. Contract manufacturers and partners often encounter difficulties involving production yields, quality control and quality assurance, as well as shortages of qualified personnel. These manufacturers and partners are subject to ongoing periodic unannounced inspection by the FDA and corresponding state agencies to ensure strict compliance with Quality Systems Regulations, current Good Manufacturing Practice and other applicable government regulations and corresponding foreign standards. If any of our manufacturers or partners fails to maintain compliance, the production of our products could be interrupted, resulting in delays, additional costs and potentially lost revenues.

In addition, if the FDA or other regulatory agencies approve any of our product candidates for commercial sale, we will need to manufacture them in larger quantities. Significant scale-up of manufacturing will require validation studies, which the FDA must review and approve. If we are unable to successfully increase the manufacturing capacity for a product, the regulatory approval or commercial launch of any products may be delayed or there may be a shortage in supply and our business may be harmed as a result.

We depend on skilled and experienced personnel and management leadership to operate our business effectively and maintain our investor relationships. If we are unable to retain, recruit and hire such key employees, our ability to manage our business will be harmed, which would impair our future revenue and profitability.

Our success largely depends on the skills, experience and efforts of our officers and other key employees. The efforts of our officers and other key employees are critical to us as we continue to focus on the commercialization of our Avenova product with the goal of achieving positive cash flow from operations by the end of 2016. The loss of any of our senior management team members could disrupt our business, affect key partnerships and impair our future revenue and profitability. In particular, our Chief Executive Officer, Mark M. Sieczkarek, is critical to our successful commercialization of Avenova, and we have entered into an executive employment agreement with him, expiring on May 31, 2017.

We intend to rely on a limited number of pharmaceutical wholesalers to distribute Avenova.

We intend to rely primarily upon a limited number of pharmaceutical wholesalers in connection with the distribution of Avenova. If we are unable to establish or maintain our business relationships with these pharmaceutical wholesalers on commercially acceptable terms, it could have a material adverse effect on our sales and may prevent us from achieving profitability.

If we grow and fail to manage our growth effectively, we may be unable to execute our business plan.

Our future growth, if any, may cause a significant strain on our management and our operational, financial and other resources. Our ability to grow and manage our growth effectively will require us to implement and improve our operational, financial and management information systems and to expand, train, manage and motivate our employees. These demands may require the hiring of additional management personnel and the development of additional expertise by management. Any increase in resources devoted to research and product development without a corresponding increase in our operational, financial and management information systems could have a material adverse effect on our business, financial condition, and results of operations.

Government agencies may establish usage guidelines that directly apply to our products or proposed products or change legislation or regulations to which we are subject.

Government usage guidelines typically address matters such as usage and dose, among other factors. Application of these guidelines could limit the use of our products and products that we may develop. In addition, there can be no assurance that government regulations applicable to our products or proposed products or the interpretation thereof will not change and thereby prevent the marketing of some or all of our products for a period of time or permanently. The FDA’s policies may change and additional government regulations may be enacted that could modify, prevent or delay regulatory approval of our product candidates. We cannot predict the likelihood, nature or extent of adverse government regulation that may arise from future legislation or administrative action, either in the U.S. or in other countries.

We and our collaborators are and will be subject to ongoing FDA obligations and continued regulatory review, such as continued safety reporting requirements, and we and our collaborators may also be subject to additional FDA post-marketing obligations or new regulations, all of which may result in significant expense and which may limit our ability to commercialize our medical devices and drug products and candidates.

Any regulatory approvals that we receive may also be subject to limitations on the indicated uses for which the product may be marketed or contain requirements for potentially costly post-marketing follow-up studies. The FDA may require us to commit to perform lengthy post marketing studies, which would require us to expend additional resources and thus could have an adverse effect on our operating results and financial condition. In addition, if the FDA approves any of our drug product candidates, the labeling, packaging, adverse event reporting, storage, advertising, promotion and record keeping for the drug will be subject to extensive regulatory requirements. The subsequent discovery of previously unknown problems with the drugs, including adverse events of unanticipated severity or frequency, may result in restrictions on the marketing of the drugs or the withdrawal of the drugs from the market. If we are not able to maintain regulatory compliance, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution. Any of these events could prevent us from marketing any products we may develop and our business could suffer.

Our past clinical trials may expose us to expensive liability claims, and we may not be able to maintain liability insurance on reasonable terms or at all.

Even though we have concluded all our clinical trials, an inherent risk remains. If a claim were to arise in the future based on our past clinical trial activity, we would most likely incur substantial expenses. Our inability to obtain sufficient clinical trial insurance at an acceptable cost to protect us against potential clinical trial claims could prevent or inhibit the commercialization of our product candidates. Our current clinical trial insurance covers individual and aggregate claims up to $5.0 million. This insurance may not cover all claims and we may not be able to obtain additional insurance coverage at a reasonable cost, if at all, in the future. In addition, if our agreements with any future corporate collaborators entitle us to indemnification against product liability losses and clinical trial liability, such indemnification may not be available or adequate should any claim arise.

The pharmaceutical and biopharmaceutical industries are characterized by patent litigation, and any litigation or claim against us may impose substantial costs on us, place a significant strain on our financial resources, divert the attention of management from our business and harm our reputation.

There has been substantial litigation in the pharmaceutical and biopharmaceutical industries with respect to the manufacture, use and sale of new products that are the subject of conflicting patent rights. For the most part, these lawsuits relate to the validity, enforceability and infringement of patents. Generic companies are encouraged to challenge the patents of pharmaceutical products in the United States because a successful challenger can obtain six months of exclusivity as a generic product under the Hatch-Waxman Act. We expect that we will rely upon patents, trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position, and we may initiate claims to defend our intellectual property rights as a result. Other parties may have issued patents or be issued patents that may prevent the sale of our products or know-how or require us to license such patents and pay significant fees or royalties to produce our products. In addition, future patents may be issued to third parties which our technology may infringe. Because patent applications can take many years to issue, there may be applications now pending of which we are unaware that may later result in issued patents that our products infringe.

Intellectual property litigation, regardless of outcome, is expensive and time-consuming, would divert management’s attention from our business and could have a material negative effect on our business, operating results or financial condition. If such a dispute were to be resolved against us, we might be required to pay substantial damages, including treble damages and attorney’s fees if we were found to have willfully infringed a third party’s patent, to the party claiming infringement, to develop non-infringing technology, to stop selling any products we develop, to cease using technology that contains the allegedly infringing intellectual property or to enter into royalty or license agreements that may not be available on acceptable or commercially practical terms, if at all. Our failure to develop non-infringing technologies or license the proprietary rights on a timely basis could harm our business. Modification of any products we develop or development of new products thereafter could require us to conduct additional clinical trials and to revise our filings with the FDA and other regulatory bodies, which would be time-consuming and expensive. In addition, parties making infringement claims may be able to obtain an injunction that would prevent us from selling any products we develop, which could harm our business.

If product liability lawsuits are brought against us, they could result in costly litigation and significant liabilities.

Despite all reasonable efforts to ensure safety, it is possible that we or our collaborators will sell products, including Avenova, NeutroPhase, CelleRx, and intelli-Case, which are defective, to which patients react in an unexpected manner, or which are alleged to have side effects. The manufacture and sale of such products may expose us to potential liability, and the industries in which our products are likely to be sold have been subject to significant product liability litigation. Any claims, with or without merit, could result in costly litigation, reduced sales, significant liabilities and diversion of our management’s time and attention, and could have a material adverse effect on our financial condition, business and results of operations.

If a product liability claim is brought against us, we may be required to pay legal and other expenses to defend the claim and, if the claim is successful, damage awards may not be covered, in whole or in part, by our insurance. We may not have sufficient capital resources to pay a judgment, in which case our creditors could levy against our assets. We may also be obligated to indemnify our collaborators and make payments to other parties with respect to product liability damages and claims. Defending any product liability claims, or indemnifying others against those claims, could require us to expend significant financial and managerial resources.

If we are unable to protect our intellectual property, our competitors could develop and market products similar to ours that may reduce demand for our products.

Our success, competitive position and potential future revenues will depend in significant part on our ability to protect our intellectual property. We rely on the patent, trademark, copyright and trade secret laws of the U.S. and other countries, as well as confidentiality and nondisclosure agreements, to protect our intellectual property rights. We apply for patents covering our technologies as we deem appropriate.

There is no assurance that any patents issued to us or licensed or assigned to us by third parties will not be challenged, invalidated, found unenforceable or circumvented, or that the rights granted thereunder will provide competitive advantages to us. If we or our collaborators or licensors fail to file, prosecute or maintain certain patents, our competitors could market products that contain features and clinical benefits similar to those of any products we develop, and demand for our products could decline as a result. Further, although we have taken steps to protect our intellectual property and proprietary technology, third parties may be able to design around our patents or, if they do infringe upon our technology, we may not be successful or have sufficient resources in pursuing a claim of infringement against those third parties. Any pursuit of an infringement claim by us may involve substantial expense and diversion of management attention.

We also rely on trade secrets and proprietary know-how that we seek to protect by confidentiality agreements with our employees, consultants and collaborators. If these agreements are not enforceable, or are breached, we may not have adequate remedies for any breach, and our trade secrets and proprietary know-how may become known or be independently discovered by competitors.

We operate in the State of California. The laws of the State prevent us from imposing a delay before an employee who may have access to trade secrets and proprietary know-how can commence employment with a competing company. Although we may be able to pursue legal action against competitive companies improperly using our proprietary information, we may not be aware of any use of our trade secrets and proprietary know-how until after significant damage has been done to our company.

Furthermore, the laws of foreign countries may not protect our intellectual property rights to the same extent as the laws of the U.S. If our intellectual property does not provide significant protection against foreign or domestic competition, our competitors, including generic manufacturers, could compete more directly with us, which could result in a decrease in our market share. All of these factors may harm our competitive position.

Our current patent portfolio could leave us vulnerable to larger companies who have the resources to develop and market competing products.

We aggressively protect and enforce our patent rights worldwide. However, certain risks remain. There is no assurance that patents will issue from any of our applications or, for those patents we have or that do issue, that the claims will be sufficiently broad to protect our proprietary rights, or that it will be economically possible to pursue sufficient numbers of patents to afford significant protection. For example, we do not have any composition of matter patent directed to the Neutrox composition. This relatively weak patent portfolio leaves us vulnerable to competitors who wish to compete in the same marketplace with similar products. If a potential competitor introduces a formulation similar to Avenova or NeutroPhase with a similar composition that does not fall within the scope of the method of treatment/manufacture claims, then we or a potential marketing partner would be unable to rely on the allowed claims to protect its market position for the method of using the Avenova or NeutroPhase composition, and any revenues arising from such protection would be adversely impacted.

If physicians and patients do not accept and use our products, we will not achieve sufficient product revenues and our business will suffer.

Even if the FDA has cleared or approves product candidates that we develop, physicians and patients may not accept and use them. Acceptance and use of our products may depend on a number of factors including:

●

perceptions by members of the healthcare community, including physicians, about the safety and effectiveness of our products;

●

published studies demonstrating the cost-effectiveness of our products relative to competing products;

●

availability of reimbursement for our products from government or healthcare payers; and

●

effectiveness of marketing and distribution efforts by us and our licensees and distributors, if any.

The failure of any of our products to find market acceptance would harm our business and could require us to seek additional financing.

ITEM 1B.

UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2.

PROPERTIES

Our principal executive offices and administrative operations are located in Emeryville, California. In total, we lease approximately 7,799 square feet of office space in the facility pursuant to the Lease expiring on February 28, 2022.

The Company also leases laboratory facilities and office space at Suite 550, EmeryStation North Building, 5980 Horton Street, Emeryville, California (“EmeryStation”) under an operating lease which will expire on October 21, 2020. On July 11, 2016, the Company entered into a Sublease Agreement to sublease 16,465 rentable square feet of real property at EmeryStation (the “Sublease Agreement”). The commencement date under the Sublease Agreement was September 8, 2016. The expiration date of the Sublease Agreement is October 21, 2020, as amended (while the expiration date of the Company’s master lease, as amended, for the EmeryStation premises is October 31, 2020), unless earlier terminated pursuant to any provision of the Company’s master lease for EmeryStation, or the Sublease Agreement.

ITEM 3.

LEGAL PROCEEDINGS

We are currently not a party to, nor is our property the subject matter of, any pending or, to our knowledge, contemplated material legal proceedings. From time to time, we may become party to litigation and subject to claims arising in the ordinary course of our business.

ITEM 4.

MINE SAFETY DISCLOSURES

Not Applicable.

PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock is listed on the NYSE MKT, under the symbol “NBY.” The following table sets forth, for the periods indicated, the high and low sales prices for our common stock as reported by the NYSE Mkt, after giving effect to the 1 for 25 reverse stock split:

	2016				2015
	High		Low		High		Low
First Quarter	$	3.42	$	1.77	$	18.75	$	10.50
Second Quarter	$	3.42	$	1.90	$	26.25	$	12.75
Third Quarter	$	5.29	$	2.12	$	17.00	$	5.50
Fourth Quarter	$	5.09	$	3.25	$	9.50	$	1.75

Holders

As of March 7, 2017, there were approximately 37 holders of record of our common stock. This figure does not reflect persons or entities that hold their stock in nominee or “street” name through various brokerage firms.

Dividend Policy

We have not paid cash dividends on our common stock since our inception. We currently expect to retain earnings primarily for use in the operation and expansion of our business, therefore, we do not anticipate paying any cash dividends in the near future. Any future determination to pay cash dividends will be at the discretion of our Board of Directors and will be dependent upon our financial condition, results of operations, capital requirements, restrictions under any existing indebtedness and other factors the Board of Directors deems relevant.

Performance Graph(1)

The following graph compares our total stockholder returns for the past five years to two indices: the NYSE MKT Composite Index and the RDG MicroCap Biotechnology Index. The total return for each index assumes the reinvestment of all dividends, if any, paid by companies included in these indices and is calculated as of December 31, of each year.

As a member of the NYSE MKT Composite Index, we are required under applicable regulations to use this index as a comparator, and we believe it is relevant since it is composed of peer companies in lines of business similar to ours.

The stockholder return shown on the graph below is not necessarily indicative of future performance, and we do not make or endorse any predictions as to future stockholder returns.

12/11

12/12

12/13

12/14

12/15

12/16

NovaBay Pharmaceuticals, Inc.

100.00

84.33

91.79

47.01

6.03

9.85

NYSE MKT Composite

100.00

106.15

115.07

118.71

106.60

117.67

RDG MicroCap Biotechnology

100.00

102.30

100.33

94.53

63.14

27.30

(1)

This section is not “soliciting material,” is not deemed “filed” with the SEC and is not to be incorporated by reference in any of our filings under the Securities Act or the Exchange Act whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

ITEM 6.

SELECTED FINANCIAL DATA

The following table presents selected financial information as of and for the dates and periods indicated below which have been derived from our audited consolidated financial statements and other information. The information set forth below is not necessarily indicative of results of future operations, and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of this report and our consolidated financial statements and related notes included elsewhere in this report.

	Year Ended December 31,
	2016			2015			2014			2013			2012
	(in thousands, except per share data)
Statements of Operations Data:
Sales:

Product Revenue, net	$	11,617		$	4,146		$	684		$	223		$	14

Other Revenue, net		280			235			370			3,254			6,933
Total Sales, net		11,897			4,381			1,054			3,477			6,947

Product Cost of Goods Sold		2,464			1,261			486			162			8
Gross Profit		9,433			3,120			568			3,315			6,939

Operating expenses:
Research and development		1,371			5,728			9,483			12,461			9,275
Sales and marketing		11,809			10,523			1,754			—			—
General and administrative		7,235			8,006			6,235			6,366			5,991
Total operating expenses		20,415			24,257			17,472			18,827			15,266
Operating Loss		(10,982	)		(21,137	)		(16,904	)		(15,512	)		(8,327	)
Non-cash gain (loss) on changes in fair value of warrant liability		(2,099	)		2,149			1,664			(555	)		1,439
Other income (expense), net		(68	)		17			48			27			(137	)
Loss before provision for income taxes		(13,149	)		(18,971	)		(15,192	)		(16,040	)		(7,025	)
Provision for income taxes		(2	)		(2	)		(2	)		(2	)		(2	)

Net loss	$	(13,151	)	$	(18,973	)	$	(15,194	)	$	(16,042	)	$	(7,027	)

Loss per share:
Basic	$	(1.40	)	$	(6.82	)	$	(7.65	)	$	(10.51	)	$	(5.97	)
Diluted	$	(1.40	)	$	(6.82	)	$	(7.65	)	$	(10.51	)	$	(5.97	)
Shares used in computing net loss per share:
Basic (after 1 for 25 reverse stock split)		9,408			2,784			1,985			1,527			1,178
Diluted (after 1 for 25 reverse stock split)		9,408			2,784			1,985			1,527			1,178

	2016		2015			2014		2013		2012
	(in thousands)
Balance Sheet Data:
Cash, cash equivalents and short-term investments	$	9,512	$	2,385		$	5,429	$	13,053	$	16,870
Working capital		10,148		(106	)		3,607		11,163		15,108
Total assets		15,381		5,077			7,537		15,650		19,235
Deferred revenue—current and non-current		4,053		2,418			2,425		1,871		1,892
Common stock and additional paid-in capital		110,772		85,422			73,395		64,884		54,373
Total stockholders’ equity (deficit)		7,101		(5,098	)		1,848		8,516		14,049

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read together with our consolidated financial statements and related notes included in Part II, Item 8 of this report. This discussion contains forward-looking statements that involve risks and uncertainties. Words such as “expects,” “anticipated,” “will,” “may,” “goals,” “plans,” “believes,” “estimates,” “concludes,” determines,” variations of these words, and similar expressions are intended to identify these forward-looking statements. As a result of many factors, including those set forth under the section entitled “Risk Factors” in Item 1A and elsewhere in this report, our actual results may differ materially from those anticipated in these forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions based upon assumptions made that we believed to be reasonable at the time, and are subject to risks and uncertainties. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Except as required by law, we undertake no obligation to revise or update publicly any forward-looking statements.

Overview

We are a pharmaceutical company predominantly focused on eye care. We develop, manufacture and market innovative anti-infective products for a multitude of uses; however, we are currently focused primarily on commercializing prescription Avenova for the domestic eye care market in the United States.

Avenova is the only eye care product formulated with our proprietary, stable and pure form of hypochlorous acid (marketed as Neutrox). By replicating the antimicrobial chemicals used by white blood cells to fight infection, Avenova has proven in laboratory testing to have broad antimicrobial properties. It removes microorganisms and debris from the skin on the eyelids and lashes without burning or stinging. It also is the only commercial product clinically validated to reduce bacterial load on ocular skin surface, the build-up of which can cause the chronic eye condition blepharitis.

In November 2015, we introduced a new business strategy to focus on growing sales of Avenova in the U.S. market and to restructure our business. This new strategy allowed us to achieve our goal of reaching adjusted positive cash flow from operations (excluding working capital changes) by the end of 2016. Our current business strategy is comprised of: (1) focusing our resources on growing the commercial sales of Avenova in the U.S. eye care market, including the implementation of an innovative sales and marketing strategy to increase product margin and profitability; (2) significantly reducing expenses through the restructuring of our operations and other cost reduction measures; and (3) seeking additional sources of revenue through partnering, divesting and/or other means of monetizing non-core assets in urology, dermatology, and wound care.

We have also developed additional commercial products containing Neutrox, including our NeutroPhase for the wound care market and CelleRxfor the dermatology market. We have partnerships for NeutroPhase in the U.S., as well as select overseas markets, most notably China.

Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. In preparing these consolidated financial statements, management has made its best estimates and judgments of certain amounts, giving due consideration to materiality. On an ongoing basis, we evaluate our estimates and judgments related to revenue recognition, research and development costs, patent costs, stock-based compensation, income taxes and other contingencies. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances. Actual results may differ from these estimates.

While our significant accounting policies are more fully described in Note 2 of the Notes to Consolidated Financial Statements (Summary of Significant Accounting Policies), included in Part II, Item 8 of this report, we believe that the following accounting policies are most critical to fully understanding and evaluating our reported financial results.

Allowance for Doubtful Accounts

We charge “Bad Debt” expense and set up an “Allowance for Doubtful Accounts” when management believes it unlikely a specific invoice will be collected. Management identified amounts due that are in dispute and it believes are unlikely to be collected at the end of 2016. At December 31, 2016 and 2015, management had reserved $10 thousand and $40 thousand, respectively, primarily based on specific amounts that are in dispute and are over 120 days past due.

Inventory

Inventory is comprised of (1) raw materials and supplies, such as bottles, packaging materials, labels, boxes, pumps; (2) goods in progress, which are normally unlabeled bottles; and (3) finished goods. We utilize contract manufacturers to produce our products and the cost associated with manufacturing is included in inventory. At December 31, 2016 and 2015, management had recorded an allowance for excess and obsolete inventory of $196 thousand and $45 thousand, respectively.

Inventory is stated at the lower of cost or market value determined by the first-in, first-out method.

Revenue Recognition

We sell products through a limited number of distributors, direct medical sales representatives, and via our webstore. We generally record product sales upon shipment to the final customer for our webstore sales and upon shipment from our distributor to the final customers for our major distribution partners.

We recognize product revenue when: (i) persuasive evidence that an arrangement exists, (ii) delivery has occurred and title has passed, (iii) the price is fixed or determinable, and (iv) collectability is reasonably assured. Revenue from sales transactions where the customer has the right to return the product is recognized at the time of sale only if: (i) our price to the customer is substantially fixed or determinable at the date of sale, (ii) the customer has paid us, or the customer is obligated to pay us and the obligation is not contingent on resale of the product, (iii) the customer's obligation to us would not be changed in the event of theft or physical destruction or damage of the product, (iv) the customer acquiring the product for resale has economic substance apart from that provided by us, (v) we do not have significant obligations for future performance to directly bring about resale of the product by the customer, and (vi) the amount of future returns can be reasonably estimated. If these factors were to vary, the resulting change could have a material effect on our revenue recognition and on the Company’s results of operations

Product Revenue Allowances

Product revenue is recognized net of cash consideration paid to our customers and wholesalers, for services rendered by the wholesalers in accordance with the wholesalers agreements, and include a fixed rate per prescription shipped and monthly program management and data fees. These services are not deemed sufficiently separable from the customers' purchase of the product; therefore, they are recorded as a reduction of revenue at the time of revenue recognition.

Other product revenue allowances include certain prompt pay discounts and allowances offered to our customers, program rebates and chargebacks. These product revenue allowances are recognized as a reduction of revenue or as a selling expense at the later of the date at which the related revenue is recognized or the date at which the allowance is offered. Calculating certain of these items involves estimates and judgments based on sales or invoice data, contractual terms, utilization rates, new information regarding changes in these programs’ regulations and guidelines that would impact the amount of the actual rebates or chargebacks. We review the adequacy of product revenue allowances on a quarterly basis. Amounts accrued for product revenue allowances are adjusted when trends or significant events indicate that adjustment is appropriate and to reflect actual experience.

The following table summarizes the activity in the accounts related to product revenue allowances (in thousands):

	Wholesaler/ Pharmacy fees			Cash discounts			Rebate			Total
Balance at January 1, 2014	$	—		$	—		$	—		$	—
Current provision related to sales made during current period		—			—			—			—
Payments		—			—			—			—
Balance at December 31, 2014		—			—			—			—
Current provision related to sales made during current period		(28	)		(38	)		—			(66	)
Payments		28			38			—			66
Balance at December 31, 2015		—			—			—			—
Current provision related to sales made during current period		(1,350	)		(222	)		(4,379	)		(5,951	)
Payments		1,019			222			4,871			6,112
Balance at December 31, 2016	$	(331	)	$	—		$	492		$	161

Other Revenue

License and collaboration revenue is primarily generated through agreements with strategic partners for the development and commercialization of our product candidates. The terms of the agreements typically include non-refundable upfront fees, funding of research and development activities, payments based upon achievement of certain milestones and royalties on net product sales. In accordance with authoritative guidance, we analyze our multiple element arrangements to determine whether the elements can be separated. We perform our analysis at the inception of the arrangement and as each product or service is delivered. If a product or service is not separable, the combined deliverables are accounted for as a single unit of accounting and revenue is recognized over the performance obligation period.

Cost of Goods Sold

Cost of goods sold includes third party manufacturing costs, shipping costs, and other costs of goods sold. Cost of goods sold also includes any necessary allowances for excess inventory that may expire and become unsalable.

Research and Development Costs

We charge research and development costs to expense as incurred. These costs include salaries and benefits for research and development personnel, costs associated with clinical trials managed by contract research organizations, and other costs associated with research, development and regulatory activities. Research and development costs may vary depending on the type of item or service incurred, location of performance or production, or lack of availability of the item or service, and specificity required in production for certain compounds. We use external service providers to conduct clinical trials, to manufacture supplies of product candidates and to provide various other research and development-related products and services. Our research, clinical and development activities are often performed under agreements we enter into with external service providers. We estimate and accrue the costs incurred under these agreements based on factors such as milestones achieved, patient enrollment, estimates of work performed, and historical data for similar arrangements. As actual costs are incurred, we adjust our accruals. Historically, our accruals have been consistent with management’s estimates, and no material adjustments to research and development expenses have been recognized. Subsequent changes in estimates may result in a material change in our expenses, which could also materially affect our results of operations.

Stock-Based Compensation

Stock-based compensation expense is measured at the grant date for all stock-based awards to employees and directors and is recognized as expense over the requisite service period, which is generally the vesting period. Forfeitures are estimated at the time of grant and reduce compensation expense ratably over the vesting period. This estimate is adjusted periodically based on the extent to which actual forfeitures (Equity-Based Compensation) differ, or are expected to differ, from the previous estimate. See Note 12 of the Notes to Consolidated Financial Statements for further information regarding stock-based compensation expense and the assumptions used in estimating that expense. For stock options granted to employees, the fair value of the stock options is estimated using a Black-Scholes-Merton option pricing model.

Stock-based compensation arrangements with non-employees are recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the underlying equity instruments vest. Non-employee stock-based compensation charges are amortized over the vesting period on a straight-line basis. For stock options granted to non-employees, the fair value of the stock options is estimated using a Black-Scholes-Merton option pricing model.

Income Taxes

We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion or the entire deferred tax asset will not be recognized.

Common Stock Warrant Liabilities

For warrants that are issued or modified and there is a deemed possibility that we may have to settle them in cash, or for warrants we issue or modify that contain an exercise price adjustment feature that reduces the exercise price and increases the number of shares of our common stock eligible for purchase thereunder in the event we subsequently issue equity instruments at a price lower than the exercise price of the warrants, we record the fair value of the issued or modified warrants as a liability at each balance sheet date and record changes in the estimated fair value as a non-cash gain or loss in the consolidated statements of operations and comprehensive loss. The fair values of these warrants have been determined using the Binomial Lattice (“Lattice”) valuation model. The Lattice model provides for assumptions regarding volatility, call and put features and risk-free interest rates within the total period to maturity. These values are subject to a significant degree of our judgment. For additional information regarding the Company’s outstanding warrants, see Note 10 of the Notes to Consolidated Financial Statements (Warrant Liability).

Recent Accounting Pronouncements

See Note 2 of the Notes to Consolidated Financial Statements (Summary of Significant Accounting Policies) included in Part II, Item 8 of this report for information on recent accounting pronouncements.

Results of Operations

Comparison of Years Ended December 31, 2016 and 2015

	Year Ended
	December 31,						Dollar			Percent
	2016			2015			Change			Change
	(in thousands)
Statement of Operations:
Sales:
Product revenue, net	$	11,617		$	4,146		$	7,471			180	%
Other revenue		280			235			45			19	%
Total sales, net		11,897			4,381			7,516			172	%

Product cost of goods sold		2,464			1,261			1,203			95	%
Gross profit		9,433			3,120			6,313			202	%

Research and development		1,371			5,728			(4,357	)		(76	)%
Sales and marketing		11,809			10,523			1,286			12	%
General and administrative		7,235			8,006			(771	)		(10	)%
Total operating expenses		20,415			24,257			(3,842	)		(16	)%
Operating Loss		(10,982	)		(21,137	)		10,155			(48	)%

Non-cash gain (loss) on changes in fair value of warrant liability		(2,099	)		2,149			(4,248	)		(198	)%
Other income (expense), net		(68	)		17			(85	)		(500	)%

Loss before provision for income taxes		(13,149	)		(18,971	)		5,822			(31	)%
Provision for income tax		(2	)		(2	)		—			—	%
Net loss	$	(13,151	)	$	(18,973	)	$	5,822			(31	)%

Total Net Sales, Product Cost of Goods Sold and Gross Profit

Product revenue, net, increased by $7.5 million, or 180%, to $11.6 million from $4.1 million and other revenue, net, increased by $45 thousand, or 19%, to $280 thousand from $235 thousand for the year ended December 31, 2016, compared to the year ended December 31, 2015. The change in product revenue, net, was primarily the result of increased sales of Avenova in connection with the focus on product commercialization driven by unit growth and price increases. Other revenue increased primarily due to the recognition of deferred revenue upon the termination of a collaboration agreement.

Product Cost of Goods Sold increased by $1.2 million, or 95%, to $2.5 million from $1.3 million for the year ended December 31, 2016, compared to the year ended December 31, 2015. The increase in product cost of goods sold was primarily the result of increased in the sales of Avenova, along with increased reserves for excess and obsolete inventory.

Gross Profit increased by $6.3 million, or 202%, to $9.4 million from $3.1 million for the year ended December 31, 2016, compared to the year ended December 31, 2015. The increase in gross profit was primarily the result of increased sales of Avenova, along with the recognition of deferred revenue upon the termination of a collaboration agreement.

Research and Development

Research and Development expenses decreased by $4.3 million, or 76%, to $1.4 million for the year ended December 31, 2016, from $5.7 million for the year ended December 31, 2015. The reduction is primarily the result of our previously-announced change in business strategy, as reflected by our reduced spending on clinical trials and our shift of capital resources from research and development to the commercialization of Avenova. Also, contributing to the decrease was a gain recognized on the sale of laboratory equipment of $232 thousand during the third quarter of 2016.

Sales and marketing

Sales and marketing expenses increased by $1.3 million, or 12%, to $11.8 million for the year ended December 31, 2016, from $10.5 million for the year ended December 31, 2015. The increase was primarily due to our previously-announced change in business strategy, as reflected by our increase in sales representative headcount and sales and marketing activities, partially offset by reduced expenses associated with our out-sourced sales team.

General and administrative

General and administrative expenses decreased by $0.8 million, or 10%, to $7.2 million for the year ended December 31, 2016, from $8.0 million for the year ended December 31, 2015. The decrease was primarily a result of our overall cost reduction efforts, including a reduction in staff-related expense and reductions in consulting and outside services, partially offset by the modification of the exercise price of the warrants issued in May 2015, higher stock-based compensation, and costs associated with the subleasing of our former headquarters.

Non-cash gain (loss) on changes in fair value of warrants

The adjustments to the fair value of warrants was a loss of $2.1 million and a gain of $2.1 million for the years ended December 31, 2016 and December 31, 2015, respectively.

For additional information regarding the Warrants and their valuation, please see Note 10 in the Notes to Consolidated Financial Statements included in Part I, Item 8 of this report. In the year ended December 31, 2016, non-cash loss on changes in fair value of Warrants was caused by a reduction in the exercise price of the Warrants pursuant to the price protection provision in such Warrants, along with an increase in the price of the Company’s common stock above the Warrants’ exercise prices. During the year ended December 31, 2015, we incurred a non-cash gain resulting from the re-valuation of the pre-modified July 2011 Warrants to zero.

Other income (expense), net

Other income (expense), net, was an expense of $68 thousand compared to income of $17 thousand for the years ended December 31, 2016 and December 31, 2015, respectively. The increase in expense was a result of the interest due on the notes the Company entered into in December 2015 and January 2016 as part of our Bridge Loan, which was fully paid off on August 1, 2016. For additional information regarding the notes and the Bridge Loan, please see Note 8 in the Notes to Consolidated Financial Statements (Related Party Notes Payable) included in Part II, Item 8 of this report.

Comparison of Years Ended December 31, 2015 and 2014

	Year Ended
	December 31,						Dollar			Percent
	2015			2014			Change			Change
	(in thousands)
Statement of Operations:

Sales:
Product revenue, net	$	4,146		$	684		$	3,462			506	%
Other revenue		235			370			(135	)		(36	)%
Total sales, net		4,381			1,054			3,327			316	%

Product cost of goods sold		1,261			486			775			159	%
Gross profit		3,120			568			2,552			449	%

Research and development		5,728			9,483			(3,755	)		(40	)%
Sales and marketing		10,523			1,754			8,769			500	%
General and administrative		8,006			6,235			1,771			28	%
Total operating expenses		24,257			17,472			6,785			39	%
Operating Loss		(21,137	)		(16,904	)		(4,233	)		25	%

Non-cash gain (loss) on changes in fair value of warrant liability		2,149			1,664			485			29	%
Other income (expense), net		17			48			(31	)		(65	)%

Loss before provision for income taxes		(18,971	)		(15,192	)		(3,779	)		25	%
Provision for income tax		(2	)		(2	)		—			—	%
Net loss	$	(18,973	)	$	(15,194	)	$	(3,779	)		25	%

Total Net Sales, Product Cost of Goods Sold and Gross Profit

Product revenue, net increased by $3.5 million, or 506%, to $4.1 million from $0.7 million and other revenue decreased by $135 thousand, or 36%, to $235 thousand from $370 thousand for the year ended December 31, 2015, compared to the year ended December 31, 2014. The change in the product revenue, net was primarily the result of increased sales of Avenova in connection with the focus on product commercialization, partially offset by a reduction in other revenue because of our de-emphasis of technology and collaboration agreements.

Product Cost of Goods Sold increased by $775 thousand, or 159%, to $1.3 million from $486 thousand for the year ended December 31, 2016, compared to the year ended December 31, 2015. The increase in product cost of goods sold was primarily the result of increased in the sales of Avenova.

Gross Profit increased by $2.6 million, or 449%, to $3.1 million from $568 thousand for the year ended December 31, 2015, compared to the year ended December 31, 2014. This increase was primarily the result of increased sales of Avenova.

Research and Development

Research and Development expenses decreased by $3.8 million, or 40%, to $5.7 million for the year ended December 31, 2015, from $9.5 million for the year ended December 31, 2014. The reduction was primarily the result of reduced spending on clinical trials and shifting responsibilities to production support from research and development.

Sales and marketing

Sales, and marketing expenses increased by $8.8 million, or 500%, to $10.5 million for the year ended December 31, 2015, from $1.8 million for the year ended December 31, 2014. The increase was primarily due to the increase in the number of sales representatives and sales and marketing activities for the launch of Avenova, which began in August of 2014.

General and administrative

General and administrative expenses increased by $1.8 million, or 28%, to $8.0 million for the year ended December 31, 2015, from $6.2 million for the year ended December 31, 2014. The increase was primarily due to the increase in accounting, consulting and legal expenses, wages and stock based compensation.

Non-cash gain (loss) on changes in fair value of warrants

The adjustments to the fair value of warrants were gains of $2.1 million, and $1.7 million for the years ended December 31, 2015, and December 31, 2014, respectively.

The non-cash gain on changes in the fair value of warrants relates primarily to warrants issued or modified as part of the October 2015 financing. The change in fair value was primarily the result of two factors. First, the October 2015 financing included the following elements that increased the fair value of the warrant liability: the term of the warrants issued in July 2011 was extended and the exercise price adjusted to the then market price, the terms of the warrants issued in March 2015 were similarly adjusted, which caused the March 2015 warrants to be reclassified from equity to a liability, and additional warrants were issued as part of the October 2015 financing. The October 2015 warrants were classified as a liability when they were issued. Second, the warrants issued in July 2011, March 2015 and October 2015 were all valued when they were issued and re-measured as of December 31, 2015, the result being a reduction in the warrant liability of $2,149 thousand. Please see Note 10 in the Notes to Consolidated Financial Statements (Warrant Liability) in Part II, Item 8 of this report for a more complete explanation.

Other income (expense), net

Other income, net, was $17 thousand and $48 thousand for the years ended December 31, 2015, and December 31, 2014, respectively. The decrease was primarily due to a general reduction in cash balance. The change is primarily the result of converting investments in securities to operating cash during 2015, instead of being invested in accounts that generated returns.

Cash Used in Operating Activities

For the year ended December 31, 2016, cash used in operating activities was $12.1 million compared to $18.6 million for the year ended December 31, 2015. The decrease was primarily due to increased sales of Avenova and a decrease in operating expenses, partially offset by an increase in cost of sales.

For the year ended December 31, 2015, cash used in operating activities was $18.6 million compared to $15.1 million for the year ended December 31, 2014. The increase in 2015 was due to increased spending on sales and marketing activities in the amount of $8.8 million, partially offset by a decrease in spending on clinical activity of $1.8 million.

Cash Provided By or Used In Investing Activities

For the year ended December 31, 2016 and 2015, cash used in investing activities was for the purchase of property and equipment of $0.2 million and $0.1 million, respectively. For the year ended December 31, 2014, cash provided by investing activities of $2.6 million was primarily attributable to the net effects of purchases, sales and maturities of short-term investments.

Cash Provided by Financing Activities

Net cash provided by financing activities of $19.4 million for the year ended December 31, 2016 was primarily attributable to the net sale of $13.6 million of our common stock in our financings in February, May and August 2016, and Warrants exercised in a net amount of $7.4 million in August, September, October, and November 2016, and the borrowing of $1.4 million in connection with the final tranche of the Bridge Loan, fully offset by the full repayment of $3.0 million of our Bridge Loan.

Net cash provided by financing activities of $15.6 million for the year ended December 31, 2015, was primarily attributable to proceeds from the sale of common stock and Warrants in March, May and October, the sale of our common stock under our ATM agreement and the proceeds from the Bridge Loan.

Net cash provided by financing activities of $7.4 million for the year ended December 31, 2014, was primarily attributable to proceeds from the sale of our common stock under our ATM agreement and the sale of common stock and warrants in our March financing.

Quarterly Results of Operations (unaudited)

The following table presents unaudited quarterly results of operations for the eight most recent quarters ending with the quarter ended December 31, 2016. This information has been derived from our unaudited consolidated financial statements and has been prepared by us on a basis consistent with our audited annual consolidated financial statements and includes all adjustments, consisting only of normal recurring adjustments, which management considers necessary for a fair presentation of the information for the periods presented.

	Quarter Ended
	December 31,			September 30,			June 30,			March 31,			December 31,			September 30,			June 30,			March 31,
	2016			2016			2016			2016			2015			2015			2015			2015
	(in thousands, except per share data)
Statements of Operations Data:
Sales:
Product Revenue, net	$	4,046		$	3,262		$	2,654		$	1,655		$	1,587		$	1,136		$	931		$	492
Other Revenue, net		31			176			9			64			48			64			77			46
Total Sales, net		4,077			3,438			2,663			1,719			1,635			1,200			1,008			538

Product Cost of Goods Sold		808			566			479			611			591			269			253			148
Gross Profit		3,269			2,872			2,184			1,108			1,044			931			755			390
Operating expenses:
Research and development		156			4			278			933			1,225			1,563			1,357			1,583
Sales and marketing		3,149			2,663			2,853			3,144			3,263			3,035			2,311			1,914
General and administrative		1,994			2,266			1,293			1,682			2,742			1715			1,975			1,574
Total operating expenses		5,299			4,933			4,424			5,759			7,230			6,313			5,643			5,071
Operating loss		(2,030	)		(2,061	)		(2,240	)		(4,651	)		(6,186	)		(5,382	)		(4,888	)		(4,681	)
Non-cash gain (loss) on change in fair value of warrant liability		381			(1,671	)		(424	)		(385	)		1,976			139			—			34
Other income (expense), net		1			(4	)		(24	)		(41	)		6			1			3			7
Loss before provision for income taxes		(1,648	)		(3,736	)		(2,688	)		(5,077	)		(4,204	)		(5,242	)		(4,885	)		(4,640	)
Provision for income tax		—			—			(2	)		—			—			—			(2	)		—
Net loss	$	(1,648	)	$	(3,736	)	$	(2,690	)	$	(5,077	)	$	(4,204	)	$	(5,242	)	$	(4,887	)	$	(4,640	)
Net loss per share:
Basic	$	(0.11	)	$	(0.34	)	$	(0.36	)	$	(1.24	)	$	(1.26	)	$	(1.76	)	$	(1.84	)	$	(2.13	)
Diluted	$	(0.13	)	$	(0.34	)	$	(0.36	)	$	(1.24	)	$	(1.26	)	$	(1.76	)	$	(1.84	)	$	(2.13	)
Shares used in computing net loss per share:
Basic (after effect of 1-for-25 reverse stock split)		15,148			10,913			7,407			4,086			3,337			2,985			2,653			2,175
Diluted (after effect of 1-for-25 reverse stock split)		15,459			10,913			7,407			4,086			3,337			2,985			2,653			2,175

Net Operating Losses and Tax Credit Carryforwards

As of December 31, 2016, we had NOL carryforwards for federal and state income tax purposes of $90.2 million and $78.2 million, respectively. If not utilized, the federal and state NOL carryforwards will begin expiring at various dates between 2024 and 2036. As of December 31, 2016, we also had tax credit carryforwards for federal income tax purposes of $1.3 million and $0.3 million for state tax purposes. If not utilized, the federal tax credits will begin expiring in 2031. The state tax credits have an indefinite carryover period.

Current federal and California tax laws include substantial restrictions on the utilization of NOL carryforwards in the event of an ownership change of a corporation. Accordingly, our ability to utilize NOL carryforwards may be limited as a result of such ownership changes and result in expiration before utilization.

Inflation and Seasonality

We do not believe that inflation has had a material impact on our business and operating results during the periods presented, and we do not expect it to have a material impact in the near future, although there can be no assurances that our business will not be affected by inflation in the future.

We do not believe our business is subject to seasonality or any other cyclical trends.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements as of December 31, 2016,

Contractual Obligations

Our contractual cash commitments as of December 31, 2016, were as follows (in thousands):

Contractual Obligations

Total

Less than

1 year

1 - 3 years

3 - 5 years

More than

5 years

Operating leases

4,725

987

2,199

1,464

4,725

987

2,199

1,464

Our commitments as of December 31, 2016, consist of two operating leases: the Lease and the lease for Emery Station. The total commitment for the Lease as of December 31, 2016 was $2.1 million due over the lease term, compared to zero as of December 31, 2015.

The total commitment of the Emery Station lease as of December 31, 2016 was $2.6 million due over such lease term, compared to $3.3 million as of December 31, 2015. On July 11, 2016, we entered into a Sublease Agreement to sublease our former corporate headquarters. Sublease rental reimbursement is not deducted from the above table. We anticipate collecting $709 thousand, $609 thousand, $690 thousand, and $576 thousand in the years ending December 31, 2017, 2018, 2019, and 2020, respectively, under the Sublease for the lease of Emery Station.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our market risk consists principally of interest rate risk on our cash, cash equivalents, and short-term investments. Our exposure to market risk is limited primarily to interest income sensitivity, which is affected by changes in interest rates, particularly because our current liquid assets at December 31, 2016 are held in cash and cash equivalents.

Our investment policy restricts our investments to high-quality investments and limits the amounts invested with any one issuer, industry, or geographic area. The goals of our investment policy are as follows: preservation of capital, assurance of liquidity needs, best available return on invested capital, and minimization of capital taxation. Some of the securities in which we invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with an interest rate fixed at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. To minimize this risk, in accordance with our investment policy, we maintain our cash and cash equivalents in short-term marketable securities, including money market mutual funds, Treasury bills, Treasury notes, certificates of deposit, commercial paper, and corporate and municipal bonds. The risk associated with fluctuating interest rates is limited to our investment portfolio. Due to the short-term nature of our investment portfolio, we believe we have minimal interest rate risk arising from our investments. As of December 31, 2016 and 2015, a 10% change in interest rates would have had an immaterial effect on the value of our investment portfolio. We do not use derivative financial instruments in our investment portfolio. We do not hold any instruments for trading purposes.

With most of our focus on Avenova in the domestic U.S. market, we have not had any material exposure to foreign currency rate fluctuations.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements required by this Item 8 are set forth below. Our quarterly financial information is set forth in Item 7 of this report and is hereby incorporated into this Item 8 by reference.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
	Page
Report of Independent Registered Public Accounting Firm	27
Consolidated Balance Sheets as of December 31, 2016, and 2015	28
Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2016, 2015 and 2014	29
Consolidated Statements of Stockholders’ Equity (Deficit) for the Years Ended December 31, 2016, 2015 and 2014	30
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014	31
Notes to Consolidated Financial Statements	33

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

NovaBay Pharmaceuticals, Inc.

We have audited the accompanying consolidated balance sheets of NovaBay Pharmaceuticals, Inc. as of December 31, 2016 and 2015 and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements audited by us present fairly, in all material respects, the consolidated financial position of NovaBay Pharmaceuticals, Inc. as of December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

/s/ OUM & CO. LLP

San Francisco, California

March 23,2017

NOVABAY PHARMACEUTICALS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

	December 31,
	2016			2015

ASSETS
Current assets:
Cash and cash equivalents	$	9,512		$	2,385
Accounts receivable, net of allowance for doubtful accounts ($10 and $40 at December 31 2016, and December 31, 2015, respectively)		2,120			536
Inventory, net of allowance for excess and obsolete inventory ($196 and $45 at December 31, 2016 and 2015, respectively)		873			1,345
Prepaid expenses and other current assets		1,966			261
Total current assets		14,471			4,527
Property and equipment, net		371			395
Other assets		539			155
TOTAL ASSETS	$	15,381		$	5,077

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Liabilities:
Current liabilities:
Accounts payable	$	455		$	2,483
Accrued liabilities		1,801			1,980
Deferred revenue		2,067			170
Total current liabilities		4,323			4,633
Deferred revenue - non-current		1,986			2,248
Deferred rent		327			189
Notes payable, related party		—			1,655
Warrant liability		1,446			1,450
Other liabilities		198			—
Total liabilities		8,280			10,175
Commitments and contingencies (Note 9)
Stockholders' equity (deficit):
Preferred stock: 5,000 shares authorized; none outstanding at December 31, 2016 and 2015		—			—
Common stock, $0.01 par value; 240,000 shares authorized 15,269 and 3,486 shares issued and outstanding at December 31, 2016 and 2015, respectively		153			35
Additional paid-in capital		110,619			85,387
Accumulated other comprehensive loss		—			—
Accumulated deficit		(103,671	)		(90,520	)
Total stockholders' equity (deficit)		7,101			(5,098	)
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)	$	15,381		$	5,077

The accompanying notes are an integral part of these consolidated financial statements

NOVABAY PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(in thousands except per share data)

	Year Ended December 31,
	2016			2015			2014

Sales:
Product Revenue, net	$	11,617		$	4,146		$	684
Other Revenue, net		280			235			370
Total Sales, net		11,897			4,381			1,054

Product Cost of Goods Sold		2,464			1,261			486
Gross Profit		9,433			3,120			568

Research and development		1,371			5,728			9,483
Sales and marketing		11,809			10,523			1,754
General and administrative		7,235			8,006			6,235
Total Operating Expenses		20,415			24,257			17,472

Operating Loss		(10,982	)		(21,137	)		(16,904	)

Non-cash gain (loss) on changes in fair value of warrant liability		(2,099	)		2,149			1,664
Other income (expense), net		(68	)		17			48

Loss before provision for income taxes		(13,149	)		(18,971	)		(15,192	)
Provision for income tax		(2	)		(2	)		(2	)
Net loss		(13,151	)		(18,973	)		(15,194	)

Change in Unrealized gains on available for sale securities		—			—			15
Comprehensive loss	$	(13,151	)	$	(18,973	)	$	(15,179	)


Loss per share (basic and diluted)	$	(1.40	)	$	(6.82	)	$	(7.65	)


Basic and Diluted Shares used in loss per share calculation		9,408			2,784			1,985

The accompanying notes are an integral part of these consolidated financial statements

NOVABAY PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

(in thousands)

							Accumulated
					Additional		Other						Total
	Common Stock				Paid-In		Comprehensive			Accumulated			Stockholders'
	Shares		Amount		Capital		Loss			Deficit			Equity (Deficit)
Balance at December 31, 2013		1,785	$	18	$	64,866	$	(15	)	$	(56,353	)	$	8,516
Net loss		—		—		—		—			(15,194	)		(15,194	)
Change in unrealized gains (losses) on investments		—		—		—		15			—			15
Issuance of common stock in connection with shelf offering, net of offering costs		275		3		7,122		—			—