Sonoma Pharmaceuticals, Inc. — Form 10-Q Summary
Reporting period: Three months ended June 30, 2017 (the company’s fiscal first quarter of 2018); comparative period is the three months ended June 30, 2016. Amounts are in U.S. dollars; financial statement amounts below are in thousands unless stated otherwise.
Business context
Sonoma develops and markets dermatology and advanced tissue-care products, alongside laboratory testing and related services. It reported sales in the United States and 39 other countries. Its strategy emphasized U.S. dermatology growth, expanding its sales force, and developing or acquiring products.
The company sold certain Latin American assets to Invekra in October 2016. It continues to supply Invekra during a transition period and provides technical assistance; the prior-year Latin American business is presented as discontinued operations.
Financial results and liquidity
| Metric | Quarter ended June 30, 2017 | Comparable 2016 period |
|---|---|---|
| Total revenue | $3,835 | $2,638 |
| Gross profit / margin | $1,762 / 46% | $981 / 37% |
| Operating expenses | $5,145 | $4,490 |
| Loss from operations | $(3,383) | $(3,509) |
| Continuing-operations net loss | $(3,508) | $(3,187) |
| Net loss | $(3,508) | $(2,568) |
| Basic and diluted loss per share | $(0.82) | $(0.61) |
| Net cash used in operating activities | $(4,634) | $(2,377) |
Revenue growth was driven by product sales: product revenue rose 49% to $3,603, while service revenue was $232, up $5. U.S. product revenue increased 35% to $1,859; Europe and rest-of-world revenue increased 13% to $1,175. The quarter included $569 of product revenue from Invekra.
Gross margin comparisons are affected by the reclassification of the sold Latin American business to discontinued operations in the prior period. Management attributed higher gross profit partly to that reclassification and said a greater share of higher-margin dermatology products could support future margin improvement.
Research and development expense increased 6% to $382. Selling, general and administrative expense increased 15% to $4,763, primarily reflecting the growing dermatology sales force. The continuing-operations loss widened by $321, which management attributed primarily to higher sales and marketing spending. Other expense was $168, primarily from foreign-exchange losses and franchise taxes.
Cash and cash equivalents were $12,638 at June 30, down from $17,461 at March 31, 2017. Working capital was $16,330, compared with $19,355. Operating cash use was $4,634; investing cash use was $171, mainly for equipment; financing cash use was $26. Total assets were $22,421 and total liabilities were $3,815. Long-term debt, including its current portion, totaled $129; capital lease obligations totaled $391.
Changes, outlook, risks and unusual items
- Management expected available cash, including proceeds from the Invekra transaction, to fund working-capital needs and planned sales, marketing and R&D efforts for at least 12 months from the filing date. It also expected continued losses and said additional capital may be needed for longer-term development and market expansion.
- Under the Invekra arrangement, the company expects Latin American revenue to decrease significantly over time. It is due to receive a 3% royalty on qualifying Latin American net sales excluding Mexico, with a stated minimum payment of $250 annually for ten years, paid in Mexican pesos. The company noted foreign-exchange uncertainty; the asset-sale agreement describes the related $2,500 consideration as paid over ten years.
- The supply agreement includes a potential one-time $2,000 payment to Invekra if the company fails to supply products for a consecutive six-month period. The penalty declines by 12.5% each quarter of the supply term; management said it did not expect to incur it.
- Customer concentration was significant: four customers represented 57% of quarterly net revenue. At quarter-end, two customers represented 41% and 16% of net accounts receivable, respectively.
- Six key executives had employment agreements with potential severance payments totaling $1,417 if triggered. Management described ordinary-course legal matters as currently insignificant, while noting litigation could adversely affect the business.
- The company reported no material changes to previously disclosed risk factors, no defaults on senior securities, and effective disclosure controls as of June 30, 2017. It reported no material changes in internal control over financial reporting during the quarter.
- The quarter included adoption of a share-based compensation accounting standard; the company reported no material financial-statement impact from adoption. The new revenue standard was planned for adoption on April 1, 2018 using the modified retrospective method; assessment remained preliminary.
Important facts for investors to verify
- Whether cash burn and working-capital needs remain consistent with management’s stated 12-month liquidity expectation, and whether additional financing will be required.
- Whether U.S. dermatology growth can offset the expected decline in Latin American revenue and support improved margins, considering the prior-period reclassification.
- Invekra supply-transition timing, royalty and minimum-payment terms, currency exposure, and the potential supply penalty.
- Customer concentration, receivable collection, and the adequacy of reserves for discounts, returns, rebates and inventory obsolescence.
- Progress and costs of product development, regulatory approvals, sales-force expansion, and the company’s path toward profitability.