Business context and reporting period
Sonoma Pharmaceuticals, Inc. develops and sells stabilized hypochlorous acid (HOCl) products for human and animal care, wound care, eye, oral and nasal care, dermatology, and disinfectant markets. It sells directly and through partners in 54 countries. This Form 10-Q covers the quarter and nine months ended December 31, 2020, the third quarter of the company’s fiscal year. Financial amounts below are in U.S. dollars; unless stated otherwise, figures are in millions.
During the period, Sonoma sold its Micromed Laboratories division for an aggregate stated price of $850,000, including $610,000 cash proceeds, a $100,000 credit for future services, and $60,000 held in escrow. Micromed is reported as discontinued operations.
Financial performance and position
| Metric | Three months ended Dec. 31, 2020 | Prior-year quarter | Nine months ended Dec. 31, 2020 | Prior-year period |
|---|---|---|---|---|
| Revenue | $4.936 | $4.395 | $16.472 | $13.616 |
| Gross profit | $1.995 | $2.001 | $6.753 | $6.469 |
| Gross margin | 40% | 45% | 41% | 48% |
| Operating loss | $(0.138) | $(1.108) | $(0.635) | $(4.166) |
| Loss from continuing operations | $(0.626) | $(1.210) | $(1.183) | $(1.824) |
| Net loss | $(0.650) | $(1.084) | $(0.290) | $(1.572) |
| Basic and diluted loss per share | $(0.32) | $(0.72) | $(0.15) | $(1.14) |
Quarterly revenue increased 12%; nine-month revenue rose 21%. Gross margin declined in both comparisons, which management attributed primarily to sales mix, including greater distributor and Invekra sales that carry lower margins. Lower research and development and selling, general and administrative costs contributed to reduced operating losses. Nine-month net loss includes $893,000 income from discontinued operations, including a $770,000 disposal gain; the prior-year period included a $2.472 million gain on asset sales.
Other expense was $490,000 for the quarter and $687,000 for nine months, largely reflecting foreign-exchange losses of approximately $560,000 and $980,000, respectively.
- Liquidity: Cash and cash equivalents were $5.541 million at December 31, 2020, versus $3.691 million at March 31, 2020. Working capital was $12.329 million, compared with $7.518 million at March 31.
- Cash flow: The cash flow statement reports nine-month operating cash use of $1.902 million, investing cash inflow of $392,000, financing inflow of $3.039 million, and a $321,000 favorable exchange-rate effect on cash.
- Debt: Long-term debt was $1.310 million, comprising a Paycheck Protection Program (PPP) loan at 1% interest, maturing April 29, 2022. The company believes $930,000 may qualify for forgiveness but cannot assure forgiveness. No current portion was reported at quarter-end.
- Balance sheet: Total assets were $18.231 million, total liabilities $5.915 million, and stockholders’ equity $12.316 million. Accumulated deficit was $172.536 million.
Material changes, outlook and risks
- U.S. revenue fell 4% for the quarter and 17% for nine months, with management citing COVID-19 effects on dermatology demand and restructuring of the sales team. Animal-care sales partly offset the decline.
- Latin American revenue increased sharply, driven by Invekra orders ahead of the end of reduced-price manufacturing terms. Invekra represented approximately 26% of quarterly revenue and 33% of nine-month revenue in 2020. Management expects lower future revenue as Invekra transitions to its own manufacturing, although Sonoma may provide overflow manufacturing at market prices.
- COVID-19’s future effects on business, financial results, and liquidity remain uncertain; the company said it could not estimate the extent of any negative impact. Management also cites pricing pressure, patient rebates, reimbursement, seasonality, regulatory and commercialization risks, and reliance on partners and distributors.
- Management expects service revenue to be negligible following the Micromed sale and Invekra’s manufacturing transition. It anticipates possible future losses and says additional capital may be needed. Financing may not be available on acceptable terms; management states these matters raise substantial doubt about the company’s ability to continue as a going concern.
- No quantified financial guidance is provided. The company expects no material capital expenditures for the fiscal year ending March 31, 2021.
- Disclosure controls and procedures were deemed ineffective at December 31, 2020 because of material weaknesses, including inadequate spreadsheet controls, insufficient separation of preparation and review, and deficiencies in revenue analysis. Remediation was underway but had not yet been shown to operate effectively.
- Other notable developments include December 2020 licensing/distribution agreements for U.S. OTC dermatology products with Crown Laboratories and dental product Endocyn with Gabriel Science; the company also reported January 2021 European approval of its HOCl technology for specified biocidal product types.
Important facts for investors to verify
- Reconcile cash-flow figures: the cash flow statement reports operating cash use of $1.902 million, investing inflow of $392,000, and exchange-rate effect of $321,000; the MD&A table instead reports $1.899 million, $664,000, and $47,000, respectively.
- Track Invekra’s manufacturing transition and the resulting effects on Latin American revenue, total sales, and gross margins.
- Confirm the amount and timing of PPP loan forgiveness; the filing says $930,000 is expected to qualify, not that forgiveness has been approved.
- Assess cash burn and financing needs in light of management’s stated substantial doubt about going concern, despite the reported cash and working capital.
- Monitor remediation and testing of internal-control weaknesses and the company’s concentrated customer exposure: two customers accounted for 26% and 24% of quarterly revenue, and one customer exceeded 10% of year-end net receivables.