Sonoma Pharmaceuticals, Inc. — Form 10-Q Summary
Business context and reporting period
Sonoma develops and sells stabilized hypochlorous acid (HOCl) products for human and animal health, including wound care, dermatology, eye care and other applications. It sells directly and through partners in 55 countries. This unaudited report covers the three months ended June 30, 2023, the first quarter of fiscal 2024; comparisons are with the three months ended June 30, 2022 unless noted. Amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Quarter ended June 30, 2023 | Prior-year quarter |
|---|---|---|
| Revenue | $3.427 million | $3.983 million |
| Gross profit / margin | $1.204 million / 35% | $1.646 million / 41% |
| Operating expenses | $2.444 million | $2.501 million |
| Operating loss | $(1.240) million | $(0.855) million |
| Net loss / diluted loss per share | $(1.418) million / $(0.29) | $(0.887) million / $(0.29) |
| Net cash used in operations | $(0.215) million | $(1.533) million |
| Cash and cash equivalents | $3.544 million at June 30, 2023 | $5.586 million at June 30, 2022 |
Other expense was $211,000, primarily reflecting foreign-exchange fluctuations. The reported tax benefit was $33,000; the effective tax rate was 2.1%, with U.S. and Netherlands deferred tax valuation allowances cited as the main reason it differed from the 21% federal statutory rate.
At June 30, 2023, working capital was $9.546 million, down from $10.081 million at March 31, 2023. Total liabilities were $8.651 million, including $301,000 of short-term debt and $4.357 million of withholding tax payable. The company also reported $735,000 of deferred consideration, current and non-current combined. The short-term insurance-premium financing note carries 8.98% interest and is due by January 1, 2024.
Operating cash use improved year over year. Investing activities used $17,000 and financing activities used $135,000, principally for short-term debt principal payments. Cash declined $276,000 during the quarter, after a $91,000 favorable exchange-rate effect.
Material changes versus the prior-year quarter
- Revenue declined 14% ($556,000). Human-care product revenue rose to $2.750 million from $2.168 million, while animal-care product revenue fell to $578,000 from $787,000. Service and royalty revenue fell to $99,000 from $1.028 million.
- Management attributed much of the Latin American decline to a prior-year, one-time $750,000 machinery sale; Europe revenue increased 27% to $1.070 million. Revenue fell 7% in the U.S., 6% in Asia and 33% in the rest of the world.
- Gross margin fell from 41% to 35%, which management attributed to the prior-year machinery sale and changes in product mix and shipping territories. R&D expense increased 58% to $325,000, mainly due to clinical expenses; SG&A declined 8% to $2.119 million.
- Net loss increased by $531,000. Weighted-average shares rose to 4.936 million from 3.101 million; reported loss per share remained $0.29.
- Cash used in operations improved from $1.533 million to $215,000. The company’s June 30 cash balance was $2.042 million below the June 30, 2022 balance.
Outlook, commentary, risks and unusual items
- Going concern: Management said further financing may be needed and cannot be assured on acceptable terms. The filing states that these conditions raise substantial doubt about the company’s ability to continue as a going concern. Management may need to reduce costs if additional capital is unavailable, potentially delaying commercialization.
- Business outlook: The company expects revenue to fluctuate and losses may continue in the foreseeable future. It provided no quantified revenue, earnings or cash-flow guidance. It expected its intraoperative pulse-lavage application to be commercially ready in Europe in September 2023 and anticipated a U.S. launch in 2024.
- Tax and currency exposure: Management highlighted Mexican tax, intercompany debt, unpaid technical-assistance charges and accrued interest, which it said are not due until 2027. Management believes balance-sheet assets are sufficient to cover the tax obligation without disrupting operations, and has engaged tax professionals to review options. The company also cited exposure to euro and Mexican peso movements.
- Customer and operating risks: Three customers represented 15%, 14% and 14% of quarterly revenue. Management cited risks from distributor dependence, international sales, regulation, competition, supply-chain and shipping costs, inflation and the economic outlook.
- Controls: Management concluded disclosure controls and procedures were not effective at June 30, 2023 because of material weaknesses. Remediation included additional controls, an interim CFO and a Controller; testing was ongoing and the weaknesses had not yet been considered remediated.
- Other items: The company reclassified $200,000 of prior-year costs from cost of revenue to R&D, with no effect on total costs or earnings. It recorded a $247,000 inventory write-down provision at June 30. June executive compensation approvals included annual bonuses totaling $312,500, 100,000 shares for each of two executives, and a cash payment to reimburse estimated award-related taxes. No subsequent events were reported through issuance of the financial statements.
Most important facts for investors to verify
- Whether the company can obtain additional capital and address the filing’s substantial-doubt going-concern conclusion; monitor cash, operating losses and working capital.
- Whether revenue and margins stabilize, especially given the prior-year one-time machinery sale, lower service revenue and changes in product and geographic mix.
- The status, amount and timing of Mexican withholding-tax and related intercompany obligations, including management’s assessment that assets can cover the exposure.
- Progress in remediating and testing internal-control weaknesses, and any effects on financial reporting.
- Customer concentration, distributor ordering variability, foreign-exchange exposure and commercialization timing for the pulse-lavage product.
- Potential dilution: common shares outstanding were 5,141,596 at June 30, 2023 and 5,142,769 on August 10, 2023.