Sonoma Pharmaceuticals, Inc. — Form 10-Q
Reporting period: Quarter and six months ended September 30, 2020 (fiscal second quarter); filed November 20, 2020. Unaudited consolidated results. Dollar amounts below are in millions unless noted.
Business context and reporting period
Sonoma develops and sells stabilized hypochlorous acid (HOCl) healthcare products, including human care, animal care, eye care and disinfectants, directly and through partners in 53 countries. The company sold its Micromed Laboratories division in June 2020 and reports that business as discontinued operations. Its corporate office moved from California to Georgia.
Financial performance and position
| Metric | Three months ended September 30, 2020 | Six months ended September 30, 2020 | Comparable 2019 period |
|---|---|---|---|
| Revenue | $5.769 | $11.536 | $4.727 / $9.221 |
| Gross profit; gross margin | $2.502; 43% | $4.757; 41% | $2.175; 46% / $4.468; 48% |
| Operating income (loss) | $0.169 | ($0.496) | ($1.287) / ($3.058) |
| Net income (loss) | $0.120 | $0.360 | ($1.203) / ($0.488) |
- Six-month revenue rose 25%; Latin America revenue increased 154% to $4.350 million, while U.S. revenue declined 23% to $3.605 million. Human care was the largest product category, generating $10.094 million for the six months.
- Six-month gross margin fell seven percentage points to 41%, primarily due to the mix of low-margin Invekra sales. Selling, general and administrative expense fell 30% to $4.862 million; research and development expense fell 36% to $0.391 million.
- Six-month net income includes a $0.795 million gain on the Micromed disposal; discontinued operations contributed $0.917 million of income. Continuing operations recorded a six-month loss of $0.557 million.
- Cash and cash equivalents were $4.320 million at September 30, versus $3.691 million at March 31, 2020. Working capital was $11.698 million, compared with $7.518 million at March 31.
- Operating cash flow was negative $2.648 million for the six months, versus negative $0.160 million in 2019. Investing activities provided $0.475 million; financing activities provided $2.797 million. Financing included $1.919 million from option and warrant exercises and $1.310 million of PPP borrowing.
- Reported debt was $1.359 million at September 30, including $1.310 million of PPP debt; the PPP note bears 1% interest and matures April 29, 2022. Forgiveness had not been determined. The company reported compliance with loan covenants.
Material changes, outlook and risks
- Management expects Invekra to transition to its own manufacturing after December 2020. It expects lower Invekra and Latin American revenue, but anticipates improved margins from market-priced manufacturing and operational changes. Management also expects service revenue to be negligible following the Micromed sale and completion of Invekra’s facility.
- U.S. dermatology sales remained below the prior-year level through September, which management attributed to COVID-19 restrictions, economic effects and sales-team restructuring. The company could not estimate the pandemic’s ultimate effect on results or liquidity.
- Management stated that additional financing may be needed and that available financing on acceptable terms is not assured. It said these conditions raise substantial doubt about the company’s ability to continue as a going concern. The financial statements contain no adjustments for a possible inability to continue operations.
- Customer concentration is significant: one customer accounted for 35% of quarterly revenue and 37% of six-month revenue; management identifies Invekra as a major source of sales. Invekra’s manufacturing transition presents a material revenue and margin uncertainty.
- The company sold Micromed for an aggregate stated price of $0.850 million, including $0.610 million cash received at closing, a $0.100 million credit for future services and $0.060 million held in escrow, subject to adjustments.
- The company disclosed material errors in its June 2020 quarter, filed a restatement on November 17, 2020, and adjusted the six-month figures in this filing. Management concluded disclosure controls were ineffective at September 30 due to material weaknesses involving spreadsheet controls, separation of preparation and review, and revenue analysis. Remediation was underway but not yet verified as effective.
- No formal quantified revenue or earnings guidance was provided. Management described potential margin improvement and lower future revenue from Invekra, while emphasizing uncertainty around COVID-19, capital access, reimbursement, rebates, regulation and commercialization.
Important facts for investors to verify
- Whether the PPP loan is forgiven, and the company’s cash runway and financing needs given negative operating cash flow and the going-concern warning.
- Actual Invekra orders, revenue and margins after its manufacturing transition, and the extent of customer concentration.
- Whether U.S. dermatology sales recover and how COVID-19, rebates and reimbursement affect demand and margins.
- Completion and independent effectiveness testing of internal-control remediation, and whether further corrections to reported financial information are required.
- Collection of the Micromed escrow and realization of the future-services credit, plus inventory recoverability given the $0.757 million obsolescence reserve.