ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies
The preparation of our consolidated financial
statements in conformity with accounting principles generally accepted in the United States of America requires management to exercise
its judgment. We exercise considerable judgment with respect to establishing sound accounting policies and in making estimates and assumptions
that affect the reported amounts of our assets and liabilities, our recognition of revenues and expenses, and disclosure of commitments
and contingencies at the date of the consolidated financial statements.
On an ongoing basis, we evaluate our estimates
and judgments. Areas in which we exercise significant judgment include, but are not necessarily limited to, our valuation of accounts
receivable, inventory, income taxes, equity transactions (compensatory and financing) and contingencies. We have also adopted certain
polices with respect to our recognition of revenue that we believe are consistent with the guidance provided under Securities and Exchange
Commission Staff Accounting Bulletin No. 104.
We base our estimates and judgments on a variety
of factors including our historical experience, knowledge of our business and industry, current and expected economic conditions, the
attributes of our products, the regulatory environment, and in certain cases, the results of outside appraisals. We periodically re-evaluate
our estimates and assumptions with respect to these judgments and modify our approach when circumstances indicate that modifications are
necessary.
While we believe that the factors we evaluate
provide us with a meaningful basis for establishing and applying sound accounting policies, we cannot guarantee that the results will
always be accurate. Since the determination of these estimates requires the exercise of judgment, actual results could differ from such
estimates.
For a Summary of Critical Accounting Policies,
please refer to Notes to Consolidated Financial Statements, Note 3.
Results of Continuing Operations
Comparison of the Year Ended March 31, 2021
and 2020
Revenue
The following table shows our consolidated total
revenue and revenue by geographic region for the year ended March 31, 2021 and 2020:
Years Ended March 31,
(In thousands) 2021 2020 $ Change % Change
The decrease in United States revenues for the
year ended March 31, 2021 compared to the same periods in the prior year of ($2,572,000), is primarily the result of a decrease in dermatology
revenue as the result of the effects of COVID-19 on our business and the associated restructuring of our sales team in response to COVID-19.
Revenue for acute care products and other indications declined slightly from the prior year, offset by increases in revenue for our animal
care products of $658,000.
As a result of the asset purchase agreement and
arrangement we entered into on October 27, 2016 with Invekra, we were obligated to supply Invekra with product at a reduced price through
October 27, 2020. We processed orders from Invekra through March 2021 and we expect fewer future orders as Invekra transitions to their
own manufacturing. We anticipate that we will continue to manufacture for Invekra after March 2021 in smaller amounts as an overflow manufacturer.
However, we will charge market prices for manufacturing after October 27, 2020. The increase in Latin America revenues for the year ended
March 31, 2021 compared to the prior year periods, was the result of large orders for our products from Invekra at cost, prior to contract
expiration. We expect that once Invekra starts manufacturing on their own the revenues in Latin America will drop significantly in future
periods.
The increase in Europe and Rest of the World revenues
for the year ended March 31, 2021 compared to the prior year was the result of increases in Europe and the Middle East partially offset
by decreases in Asia.
Cost of Revenue and Gross Profit
The cost of revenue and gross profit metrics are
as follows:
Year ended March 31,
(In thousands, except for percentages) 2021 2020 Change % Change
Cost of Revenue as a % of Revenue 65% 55% 10%
Gross Profit as a % of Revenue 35% 45% (10)%
The gross margin decrease for the year ended
March 31, 2021 compared to the year ended March 31, 2020 is the result of product mix, associated with higher sales to Invekra at a lower
margin and higher product sales to distributors versus sales through our direct sales force which tend to have higher net selling prices
and thus higher margins. Although distributor sales typically have lower margins they don’t require the higher operating expenses associated with a dedicated sales force.
Research and Development Expense
The research and development metrics are as follows:
Year ended March 31,
(In thousands, except for percentages) 2021 2020 Change % Change
Research and Development Expense $ 555 $ 1,339 $ (784 ) (59)%
Research and Development Expense as a % of Revenue 3% 8% (5)%
For the year ended March 31, 2021, research and
development expenses decreased as a result the closure of our research and development facility in Seattle, Washington and its relocation
to our facility in Mexico.
Selling, General and Administrative Expense
The selling, general and administrative expense
metrics are as follows:
Year ended March 31,
(In thousands, except for percentages) 2021 2020 Change % Change
Selling, General and Administrative Expense $ 9,453 $ 14,173 $ (4,720 ) (33)%
Selling, General and Administrative Expense as a % of Revenue 50% 79% (29)%
The decline in Selling, General and Administrative
expense for the year ended March 31, 2021 was the result of result of reduction in sales force and closing of our Petaluma facility and
moving our corporate offices to Woodstock, Georgia.
Interest Expense
Interest expense was $12,000 and $16,000, respectively,
for the years ended March 31, 2021 and March 31, 2020.
Interest Income
Interest income for the year ended March 31, 2021
was $16,000, compared to $50,000, for the year ended March 31, 2020. The decrease is primarily due to interest income reported related
to a discount on deferred revenue from our agreement with Invekra.
Other (Expense) Income
Other (expense) income for the year ended March
31, 2021 was $(594,000) compared to $240,000 for the year ended March 31, 2020. The increase in other expense relates primarily to losses
in foreign exchange which was approximately $690,000 for the year ended March 31, 2021 compared to gains in foreign exchange of $306,000
for the year ended March 31, 2020.
Gain on Sale of Assets
Gain on the sale of assets for the year ended
March 31, 2021 was $137,000. We sold fixed assets no longer needed after closing our Petaluma manufacturing facility. For the year ended
March 31, 2020 we reported income related to the sale of certain assets to Petagon in the amount of $2,472,000, as well as the sale of
assets to MicroSafe in the amount of $1,100,000.
Income Tax
Income tax expense for the year ended March 31,
2021 was $713,000 compared to $29,000 for the year ended March 31, 2020. The increase in income tax expense is the result of tax expense
incurred by our Mexico subsidiary primarily as result of the inability to deduct interest on its intercompany debt due to the Mexico thin-cap
rules.
Net Loss from Continuing Operations
Net loss from continuing operations for the year
ended March 31, 2021 and March 31, 2020, was $4,615,000 and $3,573,000, respectively. The increase for the current year is due to gains
$3,572,000 from the sale of assets to Petagon and Microsafe for the year ended March 31, 2020.
Results of Discontinued Operations
Comparison of Year ended March 31, 2021 and 2020
On June 24, 2020, we closed on an asset purchase
agreement with Infinity Labs SD, Inc. We decided to divest our Micromed business, resulting in a strategic shift that had a major effect
on our operations and financial results. Therefore, the divested Micromed operations meet the criteria to be reported as discontinued
operations.
The related assets, liabilities, results of operations
and cash flows for our Micromed business are classified as discontinued operations for all periods presented.
The operations of the Micromed business included in discontinued operations
is summarized as follows:
Year ended March 31,
Selling general and administrative expenses 38,000 130,000
Income from discontinued operations before tax 123,000 357,000
Gain on disposal of discontinued operations before income taxes 770,000 –
Total income from discontinued operating, before tax $ 893,000 $ 357,000
Income from discontinued operations, net of tax $ 665,000 $ 265,000
Gain on disposal of discontinued operations for
the year ended March 31, 2021, includes $770,000 of gain primarily from the value of the customer base of Micromed partially offset by
a working capital adjustment.
Net Loss
The following table provides the net loss for
each period along with the computation of basic and diluted net income per share:
For the Year Ended March 31,
(In thousands, except per share data) 2021 2020
Numerator:
Loss from continuing operations $ (4,615 ) $ (3,573 )
Income from discontinued operations 665 265
Denominator:
Loss per share from continuing operations $ (2.31 ) $ (2.42 )
Income per share from discontinued operations 0.33 0.18
Net loss per share: basic and diluted $ (1.97 ) $ (2.24 )
Liquidity and Capital Resources
We reported a net loss of $3,950,000
for the year ended March 31, 2021. We reported a net loss of $3,308,000 for the year ended March 31, 2020. At March 31, 2021 and March
31, 2020, our accumulated deficit amounted to $179,277,000 and $175,327,000, respectively. As of March 31, 2021, we had cash and cash
equivalents of $4,220,000 compared to $3,691,000 on March 31, 2020. Since our inception, substantially all of our operations have been
financed through sales of equity securities. Other sources of financing that we have used to date include our revenues, as well
as various loans and the sale of certain assets to Invekra, Petagon, Microsafe and Infinity Labs.
Since April 1, 2020, substantially all of our
operations have been financed through the following transactions:
The following table presents a summary of our
consolidated cash flows for operating, investing and financing activities for the year ended March 31, 2021 and 2020 as well balances
of cash and cash equivalents and working capital:
Year ended March 31,
Net cash provided by (used in):
Operating activities $ (3,378 ) $ (4,591 )
Effect of exchange rates on cash 211 (80 )
Net change in cash and cash equivalents 529 2
Cash and cash equivalents, beginning of the period 3,691 3,689
Cash and cash equivalents, end of the period $ 4,220 $ 3,691
Working capital (1), end of period $ 8,905 $ 7,554
(1) Defined as current assets minus current liabilities.
As of March 31, 2021, we had cash and cash equivalents
of $4,220,000, compared to $3,691,000 as of March 31, 2020.
Net cash used in operating activities during the
year ended March 31, 2021 was $3,378,000, primarily due to a net loss of $3,950,000 for the period.
Net cash used in operating activities during the
year ended March 31, 2020 was $4,591,000, primarily due to the gain on sale of assets related to Petagon and Microsafe totaling $3,572,000,
an increase in our accounts receivable of $2,190,000, and our net loss of $3,308,000, partially offset by stock-based compensation of
$839,000 and a provision for doubtful accounts of $1,004,000.
Net cash provided by investing activities for
the year ended March 31, 2021 was $388,000, primarily related to the proceeds from the sale of our Micromed division of $610,000 partially
offset by the purchase of equipment.
Net cash provided by investing activities was
$3,644,000 for the year ended March 31, 2020, primarily related to proceeds from the sale of assets to Petagon and Microsafe of 3,800,000
partially offset by purchases of equipment.
Net cash provided by financing activities for
the year ended March 31, 2021 was $3,308,000, primarily related to proceeds from the exercise of stock options and warrants of $2,287,000,
and PPP loans of $1,310,000 partially offset by payments on long term debt.
Net cash provided by financing activities was
$1,029,000 for the year ended March 31, 2020, primarily related to net proceeds from the sale of common stock of $1,376,000, offset by
principal payments of debt and financing leases of $347,000.
We expect revenues to fluctuate and may incur
losses in the foreseeable future and may need to raise additional capital to pursue our product development initiatives, to penetrate
markets for the sale of our products and continue as a going concern. We cannot provide any assurances that we will be able to raise additional
capital.
Management believes that we have access to capital
resources through possible public or private equity offerings, debt financings, corporate collaborations or other means; however, we cannot
provide any assurance that new financing will be available on commercially acceptable terms, if at all. If the economic climate in the
U.S. deteriorates, our ability to raise additional capital could be negatively impacted. If we are unable to secure additional capital,
we may be required to take additional measures to reduce costs in order to conserve our cash in amounts sufficient to sustain operations
and meet our obligations. These measures could cause significant delays in our continued efforts to commercialize our products, which
is critical to the realization of our business plan and our future operations. These matters raise substantial doubt about our ability
to continue as a going concern.
Capital Expenditures
We currently forecast capital expenditures in
order to execute on our business plan and maintain growth; however, the actual amount and timing of such capital expenditures will ultimately
be determined by the volume of business. We currently do not anticipate that a material amount will be purchased for the year ended March
31, 2022. If we purchase capital equipment, we expect to pay cash for those expenditures or to finance them through equipment leases.
Material Trends and Uncertainties
On March 26, 2021, we entered into a licensing
and distribution agreement with EMC Pharma, LLC, for the exclusive right to sell and distribute prescription dermatological and eye care
products based on our Microcyn® technology in the United States. EMC has to purchase certain minimum product quantities and pay a
quarterly royalty to retain the exclusive rights. The agreement has a five-year initial term, subject to mutual extension. EMC Pharma
is a national healthcare industry products and service company specializing in the development of FDA-approved prescription products,
distribution of pharmaceuticals, and specialty pharmacy services. EMC Pharma, LLC offers years of experience in product commercialization,
trade relations, and supply chain management and has a broad network of industry partners in pharmaceutical manufacturing, pharmaceutical
wholesale and distribution. As a result of this transaction, we reduced our sales force dedicated to direct sales of prescription dermatology
products in the United States. Our direct sales model for our U.S. dermatology products has not been profitable since its inception and
management expects that partnering with EMC will allow us to reduce significant overhead while working with EMC to build a profitable
model to distribute our prescription products. The partnership also expands our distributor model which has built profitable sales for
the company around the world.
For the year ended March 31, 2021 and 2020, sales
to Invekra amounted to approximately 32% and 19% of our revenues, respectively. Our agreement with Invekra which obligated us to provide
manufacturing for Invekra at reduced prices ended on October, 27, 2020. We processed product orders for Invekra through December 2020.
We may continue to provide manufacturing support at prices commensurate with the market as backup manufacturer. As we make this transition,
we expect our overall revenues from Invekra will decrease while our margins will increase. However, we expect that our future overall
revenues from Latin American sales will be substantially reduced.
Use of Estimates
The preparation of consolidated financial statements
in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the dates of the consolidated
financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from
these estimates. Significant estimates and assumptions include reserves and write-downs related to receivables and inventories, the recoverability
of long-lived assets, the valuation allowance related to our deferred tax assets, valuation of equity and derivative instruments, debt
discounts, valuation of investments and the estimated amortization periods of upfront product licensing fees received from customers.
Off-Balance Sheet Transactions
We currently have no off-balance sheet arrangements that have or are
reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital resources.
ITEM 7A. Quantitative and Qualitative Disclosures About
Market Risk
As a smaller reporting company as defined by
Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations
and therefore are not required to provide the information requested by this Item.
ITEM 8. Consolidated Financial Statements and Supplementary
Data
Sonoma Pharmaceuticals, Inc.
Index to Consolidated Financial Statements
Page
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets as of March 31, 2021 and 2020 F-3
Notes to Consolidated Financial Statements F-7
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
To the Shareholders and Board of Directors of
Sonoma Pharmaceuticals, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated
balance sheets of Sonoma Pharmaceuticals, Inc. and Subsidiaries (the “Company”) as of March 31, 2021 and 2020, the related
consolidated statements of comprehensive loss, changes in stockholders’ equity and cash flows for each of the two years in the period
ended March 31, 2021, and the related notes (collectively referred to as the “financial statements”). In our opinion, the
financial statements present fairly, in all material respects, the financial position of the Company as of March 31, 2021 and 2020, and
the results of its operations and its cash flows for each of the two years in the period ended March 31, 2021, in conformity with accounting
principles generally accepted in the United States of America.
Explanatory Paragraph – Going Concern
The accompanying consolidated financial statements
have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 2, the Company has incurred
significant losses and needs to raise additional funds to meet its obligations and sustain its operations. These conditions raise substantial
doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in
Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. We
are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are
required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and
regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the
standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged
to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding
of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal
control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess
the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond
to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements.
Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating
the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below
are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to
the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our
especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion
on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions
on the critical audit matters or on the accounts or disclosures to which they relate.
Revenue Recognition from Contracts with Customers - Measurement
of the Transaction Price, including the Constraint on Variable Consideration for Rebates And Discounts
Critical Audit Matter Description
As discussed in Note 3 to the consolidated financial
statements, the Company offers sales incentives and other programs that they may make available to certain customers, which are considered
to be a form of variable consideration. The Company maintains estimated accruals and allowances using the expected value method. Revenue
recognized varies depending on whether a patient is covered by insurance or is not covered by insurance. In addition, the Company may
incur a revenue deductions related to the use of the Company’s rebate program.
The principal considerations for our determination
that performing procedures relating to the identification of contractual terms in customer arrangements to determine the transaction price
is a critical audit matter are there was significant judgment by management in identifying contractual terms due to the volume and customized
nature of the Company’s customer arrangements. This in turn led to significant effort in performing our audit procedures which were
designed to evaluate whether the contractual terms used in the determination of the transaction price and the timing of revenue recognition
were appropriately identified and determined by management and to evaluate the reasonableness of management’s estimates.
Addressing the matter involved performing procedures
and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements.
How We Addressed the Matter in Our Audit
Our audit procedures included, amongst others:
/s/ Marcum llp
Marcum llp
We are uncertain as to the year we began serving
consecutively as the auditor of the Company’s financial statements; however, we are aware that we have been the Company’s
auditor consecutively since at least 2006.
New York, NY
July 14, 2021
SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
ASSETS
Current assets:
Cash and cash equivalents $ 4,220 $ 3,691
Prepaid expenses and other current assets 3,218 2,256
Current portion of deferred consideration, net of discount 209 182
Property and equipment, net 360 365
Operating lease, right of use assets 769 359
Deferred consideration, net of discount, less current portion 763 786
Non-current assets held for sale – 704
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accrued expenses and other current liabilities 1,154 1,774
Deferred revenue Invekra 52 45
Current portion of long-term debt 596 481
Operating lease liabilities 240 134
Long-term deferred revenue Invekra 229 245
Long-term debt, less current portion – PPP 1,310 –
Liabilities associated with assets currently held for sale – 646
Operating lease liabilities, less current portion 529 235
Commitments and Contingencies (Note 13)
Stockholders’ Equity
Accumulated other comprehensive loss (4,579 ) (5,610 )
Total liabilities and stockholders’ equity $ 14,987 $ 14,561
The accompanying footnotes are an integral part
of these consolidated financial statements.
SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands, except per share amounts)
Year Ended March 31,
Revenues
Cost of revenues
Operating expenses
Selling, general and administrative 9,453 14,173
Interest expense (12 ) (16 )
Interest income 16 50
Other income (expense) (594 ) 240
Loss before income taxes (3,902 ) (3,544 )
Income tax (expense) (713 ) (29 )
Loss from continuing operations (4,615 ) (3,573 )
Income from discontinued operations, net of tax 665 265
Income per share from discontinued operations 0.33 0.18
Net loss per share: basic and diluted $ (1.97 ) $ (2.24 )
Weighted-average number of shares used in per common share calculations:
Foreign currency translation adjustments 1,031 (1,261 )
The accompanying footnotes are an integral part
of these consolidated financial statements.
SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’
EQUITY
For the Years Ended March 31, 2021 and 2020
(In thousands, except share amounts)
Shares Amount Shares Amount Capital Deficit Loss Total
Adoption of ASC 842 – – – – – – – –
Shares issued in connection with vesting of restricted stock – – 3,919 – – – – –
Shares issued with conversion of C shares (1.55 ) – 17,222 – – – – –
Employee stock-based compensation expense – – – – 332 – – 332
Foreign currency translation adjustment – – – – – 1,031 1,031
Shares Amount Shares Amount Capital Deficit Loss Total
Reclassification of stock liability to equity – – 12,556 – 270 – – 270
Stock based compensation, net of forfeitures – – – – 801 – – 801
Foreign currency translation adjustment – – – – – – (1,261 ) (1,261 )
SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended March 31,
Cash flows from operating activities
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 227 312
Provision for (recovery of) doubtful accounts (903 ) 1,004
Provision for discounts, rebates, distributor fees and returns 259 787
Provision for obsolete inventory – 526
Stock-based compensation 371 839
Operating lease right-of-use asset – 464
Loss on disposal of equipment – 18
Gain on sale of assets (770 ) (3,572 )
Changes in operating assets and liabilities:
Deferred consideration, net of discount 143 (217 )
Prepaid expenses and other current assets (5 ) (19 )
Accrued expenses and other current liabilities (668 ) 330
Withholding tax payable 397 362
Operating lease liabilities (215 ) (489 )
Deferred revenue (15 ) (97 )
Net cash used in operating activities (3,378 ) (4,591 )
Cash flows from investing activities:
Purchases of property and equipment (179 ) (206 )
Proceeds from Invekra – 2,700
Proceeds from Micromed Transaction 610 1,100
Net provided by investing activities 388 3,644
Cash flows from financing activities:
Proceeds from sale of common stock, net of offering costs – 1,376
Proceeds from PPP Loan 1,310 –
Proceeds from exercise of common stock options and warrants 2,287 –
Principal payments on long-term debt (481 ) (334 )
Benefit from lease assumed less principal payments on ROU assets 192 (13 )
Net cash provided by financing activities 3,308 1,029
Effect of exchange rate on cash and cash equivalents 211 (80 )
Net increase in cash and cash equivalents 529 2
Cash and cash equivalents, beginning of year 3,691 3,689
Cash and cash equivalents, end of year $ 4,220 $ 3,691
Supplemental disclosure of cash flow information:
Cash paid for interest $ 12 $ 16
Cash paid for taxes $ 941 $ –
Non-cash operating and financing activities:
Insurance premiums financed $ 596 $ 481
The accompanying footnotes are an integral part
of these consolidated financial statements.
SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – Organization and Recent
Developments
Organization
Sonoma Pharmaceuticals, Inc. (the “Company”)
was incorporated under the laws of the State of California in April 1999 and was reincorporated under the laws of the State of Delaware
in December 2006. The Company’s principal office was moved to Woodstock, Georgia from Petaluma, California in June 2020. The Company
is a global healthcare leader for developing and producing stabilized hypochlorous acid (“HOCl”) products for a wide range
of applications, including wound care, animal health care, eye care, oral care and dermatological conditions. The Company’s products
reduce infections, itch, pain, scarring and harmful inflammatory responses in a safe and effective manner. In-vitro and clinical studies
of HOCl show it to have impressive antipruritic, antimicrobial, antiviral and anti-inflammatory properties. The Company’s stabilized
HOCl immediately relieves itch and pain, kills pathogens and breaks down biofilm, does not sting or irritate skin and oxygenates the cells
in the area treated assisting the body in its natural healing process. The Company sell its products either directly or via partners in
54 countries worldwide.
NOTE 2 – Liquidity and Financial
Condition
The Company reported a net loss of $3,950,000
for the year ended March 31, 2021. At March 31, 2021 and March 31, 2020, the Company’s accumulated deficit amounted to $179,277,000
and $175,327,000, respectively. The Company had working capital of $8,905,000 and $7,554,000 as of March 31, 2021 and March 31, 2020,
respectively.
Management believes that the Company has access
to additional capital resources through possible public or private equity offerings, debt financings, corporate collaborations or other
means; however, the Company cannot provide any assurance that other new financings will be available on commercially acceptable terms,
if needed. If the economic climate in the U.S. deteriorates, the Company’s ability to raise additional capital could be negatively
impacted. If the Company is unable to secure additional capital, it may be required to take additional measures to reduce costs in order
to conserve its cash in amounts sufficient to sustain operations and meet its obligations. These measures could cause significant delays
in the Company’s continued efforts to commercialize its products, which is critical to the realization of its business plan and
the future operations of the Company. These matters raise substantial doubt about the Company’s ability to continue as a going concern.
The accompanying consolidated financial statements do not include any adjustments that may be necessary should the Company be unable to
continue as a going concern.
COVID – 19
On March 11, 2020 the
World Health Organization declared the novel strain of coronavirus (COVID-19) a global pandemic and recommended containment and mitigation
measures worldwide. In an effort to mitigate the continued spread of the virus, federal, state and local governments, as well as certain
private entities have mandated various restrictions, including travel restrictions, restrictions on public gatherings and quarantining
of people who may have been exposed to the virus. As a result of these restrictions, together with a general fear of the impact on the
global economy and financial markets, there is significant uncertainty surrounding the potential impact on the Company. As events are
rapidly changing, the Company is unable to accurately predict the impact that the coronavirus will have on its business due to uncertainties
including, but not limited to, the duration of quarantines and other travel restrictions within China, the U.S. and other affected countries,
the ultimate geographical spread of the virus, the severity of the disease, the duration of the outbreak and the public’s response
to the outbreak.
NOTE 3 – Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries, Aquamed Technologies, Inc. (“Aquamed”), Oculus Technologies
of Mexico S.A. de C.V. (“OTM”), and Sonoma Pharmaceuticals Netherlands, B.V. (“SP Europe”). Aquamed has no current
operations. All significant intercompany accounts and transactions have been eliminated in consolidation. The functional currency for
the Company's wholly-owned subsidiaries incorporated outside the United States (“U.S.”) is the U.S. dollar. All intercompany
transactions and balances have been eliminated in consolidation.
Basis of presentation
The accompanying consolidated financial statements have been prepared
by us pursuant to the rules and regulations of the U.S. Securities and Exchange Commission ("SEC") and are in conformity with
U.S. generally accepted accounting principles ("GAAP"). Our fiscal year end is March 31. Unless otherwise stated, all years
and dates refer to our fiscal year.
Correction of an Immaterial Misstatement in a Prior Period Financial
Statement
During the year ended March 31, 2021, the Company discovered that it
had failed to accrue withholding taxes that would become due to Mexico upon the payment of interest and royalties from the Mexico subsidiary
OTM to the United States parent. Due to the large net operating losses in the United States, there would be no benefit available for a
subsequent foreign tax credit on the United States tax return, resulting in a net tax expense. The error understated by an immaterial
amount the SG&A expenses for each year from the year ended March 31, 2004 to March 31, 2020 as well as understated net loss. The net
impact to the opening balance of retained earnings for the year ended March 31, 2020 would be $2,720,000 and the effect to the profit
and loss statement would have been $362,000 for the year ended March 31, 2020.
Based on an analysis of Accounting Standards Codification (“ASC”)
250 – “Accounting Changes and Error Corrections” (“ASC 250”), Staff Accounting Bulletin 99 – “Materiality”
(“SAB 99”) and Staff Accounting Bulletin 108 – “Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements” (“SAB 108”), the Company determined that these errors were immaterial
to the previously issued financial statements, and as such no restatement was necessary. Correcting prior period financial statements
for immaterial errors would not require previously filed reports to be amended. Such correction may be made the next time the registrant
files the prior period financial statements. Accordingly, the misstatements were corrected during the period ended March 31, 2021 in the
accompanying balance sheet as of March 31, 2020 and statements of operations for the twelve months ended March 31, 2020.
The effects of the revision
to the balance sheet as of March 31, 2020 are as follows (in thousands):
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and all highly liquid
investments with an original maturity of three months or less when purchased. Our cash equivalents are held in prime money market investments
with strong sponsor organizations which are monitored on a continuous basis.
Use of Estimates
The preparation of consolidated financial statements
in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the dates of the consolidated
financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from
these estimates. Significant estimates and assumptions include reserves and write-downs related to receivables and inventories, the recoverability
of long-lived assets, the valuation allowance relating to the Company’s deferred tax assets, valuation of equity and derivative
instruments, fair value allocation of assets sold to Invekra, and the estimated amortization periods of upfront product licensing fees
received from customers. Periodically, the Company evaluates and adjusts estimates accordingly.
Revenue Recognition
On April 1, 2018, the Company adopted Accounting
Standards Update ("ASU"), "Revenue from Contracts with Customers Topic 606” (“Topic 606”) using the modified
retrospective method. There was no material impact to the Company upon the adoption of Topic 606. Revenue is recognized when the Company
transfers promised goods or services to the customer, in an amount that reflects the consideration which the Company expects to receive
in exchange for those goods or services. In determining the appropriate amount of revenue to be recognized as the Company fulfills its
obligations under the agreement, the Company performs the following steps: (i) identification of the promised goods or services in
the contract; (ii) determination of whether the promised goods or services are performance obligations, including whether they are
distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration;
(iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) the Company
satisfies each performance obligation. The Company only applies the five-step model to contracts when it is probable that it will collect
the consideration it is entitled to in exchange for the goods or services it transfers to the customer.
The Company derives the majority of its revenue
through sales of its products directly to end users and to distributors. The Company also sells products to a customer base, including
hospitals, medical centers, doctors, pharmacies, distributors and wholesalers. The Company also has entered into agreements to license
its technology and products. The Company also provides regulatory compliance testing and quality assurance services to medical device
and pharmaceutical companies.
The Company considers customer purchase orders,
which in some cases are governed by master sales agreements, to be the contracts with a customer. For each contract, the Company considers
the promise to transfer products, each of which are distinct, to be the identified performance obligations. In determining the transaction
price the Company evaluates whether the price is subject to refund or adjustment to determine the net consideration to which it expects
to be entitled.
For all of its sales to non-consignment distribution
channels, revenue is recognized when control of the product is transferred to the customer (i.e. when its performance obligation is satisfied),
which typically occurs when title passes to the customer upon shipment but could occur when the customer receives the product based on
the terms of the agreement with the customer. For product sales to its value-added resellers, non-stocking distributors and
end-user customers, the Company grants return privileges to its customers, and because the Company has a long history with its customers,
the Company is able to estimate the amount of product that will be returned. Sales incentives and other programs that the Company
may make available to these customers are considered to be a form of variable consideration, and the Company maintains estimated accruals
and allowances using the expected value method.
The Company has entered into consignment arrangements,
in which goods are left in the possession of another party to sell. As products are sold from the customer to third parties, the Company
recognizes revenue based on a variable percentage of a fixed price. Revenue recognized varies depending on whether a patient is
covered by insurance or is not covered by insurance. In addition, the Company may incur a revenue deduction related to the use of the
Company’s rebate program.
Sales to stocking distributors are made under
terms with fixed pricing and limited rights of return (known as “stock rotation”) of the Company’s products held in
their inventory. Revenue from sales to distributors is recognized upon the transfer of control to the distributor.
The Company assessed the promised goods and services
in the technical support to Invekra for a ten-year period as being a distinct service that Invekra can benefit from on its own and is
separately identifiable from any other promises within the contract. Given that the distinct service is not substantially the same as
other goods and services within the Invekra contract, the Company accounted for the distinct service as a performance obligation.
Service revenue from testing contracts is recognized
as tests are completed and a final report is sent to the customer.
Disaggregation of Revenue
The following table presents the Company’s disaggregated revenues
by revenue source:
Year Ended March 31,
Product
Concentration of Credit Risk and Major Customers
Financial instruments that potentially subject
the Company to concentration of credit risk consist principally of cash, cash equivalents and accounts receivable. Cash and cash equivalents
are maintained in financial institutions in the United States, Mexico and the Netherlands. The Company is exposed to credit risk in the
event of default by these financial institutions for amounts in excess of the Federal Deposit Insurance Corporation insured limits. Cash
and cash equivalents held in foreign banks are intentionally kept at minimal levels, and therefore have minimal credit risk associated
with them.
The Company grants credit to its business customers, which are primarily
located in Mexico, Europe and the United States. Collateral is generally not required for trade receivables. The Company maintains allowances
for potential credit losses. At March 31, 2021 and 2020, no customers represented more than 10% of net accounts receivable balance, respectively.
For the year ended March 31, 2021, one customer represented 32%, and one customer represented 15% of net revenues. For the year ended
March 31, 2020, one customer represented 15%, and one customer represented 11% of net revenues.
Accounts Receivable
Trade accounts receivable are recorded net of
allowances for cash discounts for prompt payment, doubtful accounts, and sales returns. Estimates for cash discounts and sales returns
are based on analysis of contractual terms and historical trends.
The Company’s policy is to reserve for uncollectible
accounts based on its best estimate of the amount of probable credit losses in its existing accounts receivable. The Company periodically
reviews its accounts receivable to determine whether an allowance for doubtful accounts is necessary based on an analysis of past due
accounts and other factors that may indicate that the realization of an account may be in doubt. Other factors that the Company considers
include its existing contractual obligations, historical payment patterns of its customers and individual customer circumstances, an analysis
of days sales outstanding by customer and geographic region, and a review of the local economic environment and its potential impact on
government funding and reimbursement practices. Account balances deemed to be uncollectible are charged to the allowance after all means
of collection have been exhausted and the potential for recovery is considered remote. The allowance for doubtful accounts represents
probable credit losses at March 31, 2021 and 2020 in the amounts of $125,000 and $1,028,000, respectively. Additionally, at March 31,
2021 and 2020, the Company has allowances of $1,488,000 and $1,230,000, respectively, related to potential discounts, returns, distributor
fees and rebates. The allowances are included in Accounts Receivable, net in the accompanying consolidated balance sheets.
Inventories
Inventories are stated at the lower of cost, cost
being determined on a standard cost basis (which approximates actual cost on a first-in, first-out basis), or net realizable value.
Due to changing market conditions, estimated future
requirements, age of the inventories on hand and production of new products, the Company regularly reviews inventory quantities on hand
and records a provision to write down excess and obsolete inventory to its estimated net realizable value. The Company recorded a provision
to reduce the carrying amounts of inventories to their net realizable value in the amounts of $223,000 and $600,000 at March 31, 2021
and 2020, respectively, which is included in cost of product revenues on the Company’s accompanying consolidated statements of comprehensive
(loss) income.
Financial Assets and Liabilities
Financial instruments, including cash and cash
equivalents, accounts receivable and accounts payable are carried at cost, which management believes approximates fair value due to the
short-term nature of these instruments. The fair value of capital lease obligations and equipment loans approximates their carrying amounts
as a market rate of interest is attached to their repayment. The Company measures the fair value of financial assets and liabilities based
on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous
market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company maximizes
the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. The Company uses three levels of
inputs that may be used to measure fair value:
Level 1 – quoted prices in active
markets for identical assets or liabilities
Level 2 – quoted prices for similar
assets and liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived
valuations in which all significant inputs and significant value drivers are observable in active markets
Level 3 – inputs that are unobservable
(for example cash flow modeling inputs based on assumptions)