Sonoma Pharmaceuticals, Inc. — Form 10-Q Summary
Business context and reporting period
Fiscal third quarter ended December 31, 2016, with nine-month results for the period then ended; financial figures are unaudited and in U.S. dollars. Sonoma, formerly Oculus Innovative Sciences, develops and markets dermatology and advanced tissue-care products. It changed its name on December 6, 2016 and completed a 1-for-5 reverse stock split effective June 24, 2016.
The company is shifting its focus toward U.S. prescription dermatology and its direct sales force. Its October 27, 2016 sale of certain Latin American assets to Invekra was treated as discontinued operations.
Financial results and liquidity
| Metric | Three months ended Dec. 31, 2016 | Nine months ended Dec. 31, 2016 |
|---|---|---|
| Continuing-operations revenue | $3.361 million, up 35% | $8.796 million, up 29% |
| Gross profit / margin | $1.706 million / 51% | $3.721 million / 42% |
| Operating loss | $3.565 million | $10.062 million |
| Continuing-operations income (loss) | $0.763 million | ($5.740 million) |
| Discontinued-operations income, net of tax | $15.465 million | $17.450 million |
| Net income (loss) | $16.228 million | $11.710 million |
| Basic and diluted EPS | $3.84 | $2.78 |
- Product revenue was $3.174 million for the quarter, up 43%; U.S. product revenue rose 65% to $1.671 million. Service revenue declined to $187,000. For nine months, product revenue rose 43% to $8.158 million, while service revenue fell to $638,000.
- Reported gross-margin improvement versus the prior periods is substantially affected by reclassifying Latin American activity to discontinued operations. Management also expects a higher dermatology product mix to support margins.
- Quarterly and nine-month net income were dominated by the Latin American asset-sale gain. Continuing operations remained loss-making over nine months; the quarter’s continuing income included a $4.040 million tax benefit.
- Nine-month cash used in operating activities was $5.472 million, versus $7.024 million used in the prior-year period. Investing activities provided $17.232 million, principally from the Latin American sale; financing activities used $119,000. Cash and cash equivalents were $18.983 million at December 31, 2016, including $1.500 million of restricted cash. Working capital was $21.374 million.
- Total debt was approximately $60,000 ($12,000 current and $48,000 long-term). Total liabilities were $4.644 million. Accumulated deficit was $140.665 million.
Material changes and unusual items
- Under the Invekra transaction, stated aggregate consideration is $22 million: $18 million paid at closing, $1.5 million held in escrow pending equipment delivery, and $2.5 million payable in Mexican pesos over ten years, tied to services and a 3% share of specified Latin American net sales. The company recorded a $19.487 million pre-tax disposal gain, primarily related to intellectual property and territory rights.
- The transaction generated $4.581 million of tax expense in discontinued operations; use of net operating losses produced a $4.040 million tax benefit in continuing operations. The company also reported $229,000 of current tax payable and a $312,000 deferred tax liability.
- The company expects Latin American revenue to decline significantly following the sale. During a two-year transition period, subject to possible extension, it will supply Invekra at reduced prices while Invekra builds manufacturing capacity. The filing says the transition’s duration is uncertain. A $2 million supply-failure penalty may apply in specified circumstances; management does not expect it to be triggered. Equipment-delivery costs are estimated at approximately $325,000.
- Quarterly SG&A increased 15% to $4.784 million, largely due to sales-force, sampling and stock-compensation costs. Nine-month SG&A increased 10% to $12.557 million; R&D fell 10% to $1.226 million. Management expects SG&A to rise as it adds sales territories and personnel.
Outlook, risks and contingencies
- Management expects cash and cash equivalents to fund working capital, sales and marketing, and R&D for at least 12 months from the filing date. It also expects continuing losses for the foreseeable future and says additional capital may be needed for longer-term plans.
- The company had 28 U.S. salespeople and expected to reach 30 by the end of March 2017. Management anticipates short-term total revenue declines from the Latin American divestiture until U.S. dermatology revenue grows.
- Foreign-exchange movements may change the U.S.-dollar value of Mexican-peso payments and contributed to reported other income. Customer concentration is notable: one customer represented 27% of nine-month net revenue, and five customers represented 13%–30% each of year-end net accounts receivable.
- Risks include product development and regulatory approval, reimbursement, competition, sales execution, international operations, intellectual-property matters, healthcare-policy changes and possible future financing needs. The filing reports ordinary-course legal matters as currently insignificant, while noting litigation could have a material adverse effect. Management concluded disclosure controls were effective at December 31, 2016.
Most important facts for investors to verify
- How much of reported earnings and cash generation is attributable to the one-time Invekra transaction rather than continuing operations.
- Whether U.S. dermatology sales growth and margin improvement can offset the expected loss of Latin American revenue and declining service revenue.
- Receipt and timing of escrow and deferred consideration, including the effects of peso exchange rates and Invekra’s sales performance.
- Cash burn, execution of the sales-force expansion, and whether additional financing will be required despite management’s 12-month liquidity estimate.
- Customer concentration, inventory and receivable reserves, and potential obligations under the Invekra supply and equipment arrangements.