Sonoma Pharmaceuticals, Inc. — Form 10-Q Summary
Business context and reporting period
The filing covers the quarter and nine months ended December 31, 2017, Sonoma’s fiscal third quarter. Sonoma is a specialty pharmaceutical company focused on developing and commercializing therapies for skin conditions, with product sales in the United States and internationally and a smaller laboratory-services business. The interim financial statements are unaudited.
Financial performance and position
- Quarter revenue: $4.843 million, up 44% from $3.361 million a year earlier. Product revenue was $4.647 million; service revenue was $196,000.
- Nine-month revenue: $13.003 million, up 48% from $8.796 million. Product revenue grew 52% to $12.394 million; service revenue declined 5% to $609,000.
- Profitability: Quarterly gross profit was $2.368 million, or 49% of revenue, versus $1.706 million, or 51%. Nine-month gross profit was $5.978 million, or 46%, versus $3.721 million, or 42%. Operating losses were $3.200 million for the quarter and $9.440 million for nine months.
- Net results: Net loss was $3.187 million for the quarter and $9.565 million for nine months. Prior-year periods reported net income of $16.228 million and $11.710 million, respectively, largely reflecting the Latin American asset sale and related tax items.
- Cash flow and liquidity: Cash and equivalents were $8.625 million at December 31, down from $17.461 million at March 31, 2017. Nine-month operating cash use was $9.391 million; investing cash use was $193,000; financing provided $802,000. Working capital was $12.279 million, down from $19.355 million.
- Debt and obligations: Long-term debt was $47,000, and capital-lease obligations totaled $325,000. Deferred consideration related to the Invekra transaction was $1.621 million, including current and long-term portions.
Material changes versus prior periods
- U.S. product revenue rose 73% in the quarter and 48% for nine months, driven mainly by dermatology and acute-care products. Europe and rest-of-world product sales declined 4% in the quarter but rose 11% for nine months.
- Sales to Invekra under a reduced-price transition supply arrangement contributed $772,000 of product revenue in the quarter and $2.095 million for nine months. Management expects Latin American revenue to decline significantly as Invekra establishes its own manufacturing.
- Quarter gross margin declined year over year, partly because Invekra sales had low profitability; for nine months, margin improved, partly reflecting prior-period reclassification of Latin American operations to discontinued operations and higher U.S. margins.
- SG&A increased 9% for the quarter and 14% for nine months, primarily due to sales and marketing costs for the expanding dermatology sales force. R&D declined 28% and 10%, respectively, reflecting lower product-development and clinical-study spending.
- Prior-year results included discontinued-operation income of $15.465 million for the quarter and $17.450 million for nine months, including a $19.487 million pre-tax gain on the Latin American asset disposal. The 2016 continuing-operations comparisons also included a $4.040 million tax benefit.
Outlook, risks and unusual items
- Going concern: Management expects continued losses and says additional capital may be needed. It states that uncertainty about obtaining financing raises substantial doubt about the company’s ability to continue as a going concern. If capital is unavailable, Sonoma may curtail R&D or reduce costs, potentially delaying commercialization.
- Financing and dilution: A December 2017 at-the-market agreement permits up to $5 million of common-stock sales. Sonoma sold 228,000 shares for $1.034 million gross and $968,000 net during the quarter. The sales agent receives a 3% commission.
- Management outlook: No quantified revenue, earnings, or cash-flow guidance is provided. Management expects dermatology products to support improved margins as they become a larger share of product revenue, while anticipating lower Latin American revenue over time.
- Invekra transaction exposure: The agreement includes a potential $2 million one-time penalty for failure to supply products for a consecutive nine-month period; the penalty declines by 12.5% each quarter of the supply period. The agreement also provides for up to $2.5 million in foreign-currency-denominated payments over ten years, tied to specified services and product sales.
- Other risks: Revenue and receivables are concentrated among a small number of customers. Regulatory approvals, product performance and market adoption, competition, international operations, and access to capital are identified risks. Management described ordinary-course legal matters as currently insignificant, while noting potential adverse effects.
- Tax and subsequent events: The Tax Cuts and Jobs Act lowered the U.S. federal rate; Sonoma estimated a reduction in its deferred-tax-asset valuation allowance from about $42 million to $28 million, subject to further evaluation. January 2018 director and CEO stock awards and related cash tax gross-ups were disclosed after quarter-end.
Most important facts for investors to verify
- Whether cash burn and operating performance improve sufficiently to address the disclosed going-concern uncertainty, and whether additional financing is required.
- How much of reported growth is durable U.S. and other-market demand versus reduced-margin Invekra transition sales, and the timing of Invekra’s manufacturing transition.
- Gross-margin trends as product mix changes, alongside the effects of sales-force expansion and reduced R&D spending.
- Customer concentration, accounts-receivable collectability, and the level of reserves for discounts, returns, distributor fees, and rebates.
- Potential supply-agreement penalties, remaining Invekra payments, ATM share issuance and dilution, and final tax-accounting effects.