Business context and reporting period
Sonoma Pharmaceuticals develops and sells stabilized hypochlorous-acid products for human and animal care, through direct sales and partners in 53 countries. This Form 10-Q covers the three months ended June 30, 2020, Sonoma’s fiscal 2021 first quarter; the filing was signed August 14, 2020.
Key financial results
| Metric | Quarter ended June 30, 2020 | Prior-year quarter |
|---|---|---|
| Revenue | $7.254 million | $4.385 million |
| Gross profit / margin | $2.963 million / 41% | $2.183 million / 50% |
| Operating expenses | $2.845 million | $4.097 million |
| Income from continuing operations | $39,000 | $531,000 |
| Income from discontinued operations | $954,000 | $184,000 |
| Net income | $993,000 | $715,000 |
| Basic and diluted earnings per share | $0.54 | $0.54 |
| Cash flow from operating activities | $(2.282) million | $738,000 |
Revenue grew 65%, while gross margin fell nine percentage points. Human-care product revenue was $6.864 million, animal-care revenue $377,000, and other product revenue $13,000. By geography, U.S. revenue declined 31% to $1.720 million; Latin America rose 255% to $2.320 million; Europe and the rest of the world rose 158% to $3.214 million.
At June 30, cash and cash equivalents were $4.551 million, working capital was $11.617 million, and total assets were $18.652 million. Total debt was approximately $1.575 million, including $1.310 million of long-term PPP debt and $265,000 current debt. The company reported an accumulated deficit of $171.253 million. Operating lease liabilities totaled $355,000.
Material changes and unusual items
- Revenue growth was driven mainly by international markets and Invekra-related Latin American sales, which were $2.279 million versus $654,000 a year earlier. U.S. revenue fell amid pandemic-related office closures and reduced in-person sales.
- Lower selling, general and administrative expense, down 37% to $2.369 million, reflected cost reductions including headcount cuts. Research and development expense increased 41% to $476,000, primarily due to employee costs related to relocating corporate offices.
- Net income included $954,000 from discontinued operations, including a $795,000 gain on the sale of the Micromed Laboratories business. Continuing-operations income was only $39,000. The sale had an aggregate stated purchase price of $850,000, including $610,000 cash proceeds, a $100,000 credit for future testing services, $60,000 in escrow, and a working-capital adjustment.
- Cash declined from operations despite reported net income, chiefly due to inventory growth of $1.945 million, higher accounts receivable of $724,000, and a $1.122 million decrease in accrued liabilities. Cash was supported by $1.490 million of warrant exercises, $1.310 million of PPP proceeds, and $610,000 in Micromed sale proceeds.
Outlook, risks and contingencies
- Management said the company may incur losses and need additional capital; financing may not be available on acceptable terms. The filing states these conditions raise substantial doubt about the company’s ability to continue as a going concern. Management also warned that cost reductions to preserve cash could delay commercialization.
- Management expected Invekra-related revenue to decline as Invekra transitions to its own manufacturing after 2020, while margins may improve as Sonoma’s manufacturing prices move to market rates. Service revenue was expected to be negligible following the Micromed sale and completion of Invekra’s manufacturing facility.
- COVID-19 had reduced U.S. dermatology sales during April and May; management said sales returned to pre-pandemic levels in June but could not predict whether that level would continue. The company said it could not estimate the pandemic’s full effect on results or liquidity.
- The $1.3 million PPP loan bears 1% interest and matures in April 2022. Sonoma had used proceeds for eligible costs and believed it might qualify for forgiveness, but could not assure full or any forgiveness. It reported compliance with loan covenants at quarter-end.
- Invekra represented approximately 32% of quarterly revenue, versus 15% in the prior-year quarter. One customer represented 17% of revenue. Rebates, reimbursement and pricing pressure, international-market exposure, regulatory approvals, and access to capital were identified risks.
- After quarter-end, Sonoma entered a five-year non-exclusive U.S. disinfectant licensing agreement with Microsafe, contingent on regulatory approvals not yet obtained. The agreement provides for potential commissions capped at $1 million. Petagon also received a Chinese import license for Sonoma-manufactured veterinary products on August 3, 2020.
Important facts for investors to verify
- Whether the PPP loan qualifies for forgiveness and how much must be repaid.
- Cash runway, operating cash use, and the availability and terms of any additional financing, given the disclosed going-concern doubt.
- Whether Invekra’s manufacturing transition causes the expected revenue decline and margin improvement, and the resulting effect on cash generation.
- Whether U.S. dermatology sales sustain their reported recovery and whether international growth offsets U.S. weakness.
- Whether regulatory clearances for U.S. disinfectant sales are obtained and whether the licensing arrangement generates material revenue.
- The sustainability of reported net income after excluding the Micromed disposal gain, and the causes of gross-margin compression and elevated inventory.