Sonoma Pharmaceuticals, Inc. - Quarter Report: 2021 December (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2021

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ______________

Commission file number: 001-33216

SONOMA PHARMACEUTICALS, INC.

(Name of registrant as specified in its charter)

(800) 759-9305

(Registrant’s telephone number, including area code)

N/A

(Former name or former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒     No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒     No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐    No ☒

The number of shares outstanding of the registrant’s common stock, par value $0.0001 per share, as of February 11, 2022, was 3,097,674.

SONOMA PHARMACEUTICALS, INC.

Index

PART I - FINANCIAL INFORMATION

SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(In thousands, except share amounts)

The accompanying footnotes are an integral part of these unaudited condensed consolidated financial statements.

SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income (Loss)

(In thousands, except per share amounts)

(Unaudited)

The accompanying footnotes are an integral part of these condensed consolidated financial statements.

SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

The accompanying footnotes are an integral part of these condensed consolidated financial statements.

SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Stockholders’ Equity

(In thousands, except share amounts)

(Unaudited)

SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Stockholders’ Equity

(In thousands, except share amounts)

(Unaudited)

The accompanying footnotes are an integral part of these condensed consolidated financial statements.

SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES 

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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, nasal care, dermatological conditions and disinfectants. 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 sells its products either directly or via partners in 54 countries worldwide.

Impact of Coronavirus

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 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.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements as of December 31, 2021 and for the three and nine months then ended have been prepared in accordance with the accounting principles generally accepted in the United States of America for interim financial information and pursuant to the instructions to Form 10-Q and Article 8 of Regulation S-X of the Securities and Exchange Commission (“SEC”) and on the same basis as the Company prepares its annual audited consolidated financial statements. The condensed consolidated balance sheet as of December 31, 2021, the condensed consolidated statements of comprehensive income (loss) for the three and nine months ended December 31, 2021 and 2020, the cash flows for the nine months ended December 31, 2021 and 2020 and the condensed consolidated statement of stockholders’ equity for the three and nine months ended December 31, 2021 and 2020 are unaudited, but include all adjustments, consisting only of normal recurring adjustments, which the Company considers necessary for a fair presentation of the consolidated financial position, operating results and cash flows for the periods presented. The results for the three and nine months ended December 31, 2021 are not necessarily indicative of results to be expected for the year ending March 31, 2022 or for any future interim period. The condensed consolidated balance sheet at March 31, 2021 has been derived from audited consolidated financial statements. These unaudited condensed consolidated financial statements of the Company have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) for interim financial information. Accordingly, they do not include all the information and notes required by GAAP for complete financial statements. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements for the year ended March 31, 2021 and notes thereto included in the Company’s annual report on Form 10-K, which was filed with the SEC on July 14, 2021.

The Company reported a net loss of $944,000 and $2,142,000 for the three and nine months ended December 31, 2021. At December 31, 2021 and March 31, 2021, the Company’s accumulated deficit amounted to $181,419,000 and $179,277,000, respectively. The Company had working capital of $13,824,000 and $8,905,000 as of December 31, 2021, and March 31, 2021, respectively.

On June 24, 2020, the Company closed on an asset purchase agreement for the sale of its Micromed Laboratories division and testing facility, including all Micromed’s assets, such as testing equipment, certain office furniture and customer list, with Infinity Labs SD Inc. for an aggregate purchase price of $850,000. On the closing date, the Company received $610,000 in cash from this sale, which was adjusted for working capital, a credit of $100,000 for future testing services from Infinity over the next two years in lieu of cash, and $60,000 held in escrow for one year, subject to adjustment for certain indemnity claims or purchase price adjustments. Since July 2021, the escrow was received. The Company also retained its accounts receivables outstanding on the date of closing in the amount of approximately $81,000 and an insignificant amount of liabilities. As part of the transaction, Infinity also assumed the Petaluma lease for the office and lab space. The Company retained the warehouse space to store inventory and assets until September 30, 2020.

On May 1, 2020, the Company received loan proceeds in the amount of $1,310,000 under the Paycheck Protection Program (“PPP”), from Coastal States Bank in Atlanta, Georgia.

The unsecured loan, which is in the form of a note dated April 29, 2020, matures on April 29, 2022, and bears interest at a rate of 1% per annum, payable monthly commencing on May 1, 2021. The note may be prepaid at any time prior to maturity with no prepayment penalties. The Company has used a portion of the loan amount for eligible purposes, such as payroll expenses. On September 3, 2021, the Company received approval for forgiveness in the amount of $723,000.

On May 29, June 1 and 2, 2020, the Company received proceeds of $1,799,000 from the exercise of November 2018 common stock purchase warrants by several investors.

On July 30, 2021, the Company entered into an At The Market Offering Agreement with HC Wainwright & Co., LLC under which the Company may issue and sell shares of its common stock from time to time through HC Wainwright acting as sales agent. The Company will pay HC Wainwright a commission of 3% of the gross proceeds from the sale of any shares of common stock under the Agreement. During the quarter ended December 31, 2021, the Company sold 94,600 shares of common stock for gross proceeds of $700,000 and net proceeds of $662,000 after deducting commissions and other offering expenses. During the nine months ended December 31, 2021, the Company sold 950,100 shares of common stock for gross proceeds of $7,901,000 and net proceeds of $7,554,000 after deducting commissions and other offering expenses.

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.

Reclassification 

Certain amounts in the prior period financial statements have been reclassified to conform to the presentation of the current period financial statements. These reclassifications had no effect on the previously reported net loss.

Use of Estimates

The preparation of condensed 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, Petagon, Microsafe and the estimated amortization periods of upfront product licensing fees received from customers. Periodically, the Company evaluates and adjusts estimates accordingly.

Net Income (Loss) per Share

The Company computes basic net income (loss) per share by dividing net income per share available to common stockholders by the weighted average number of common shares outstanding for the period and excludes the effects of any potentially dilutive securities. Diluted earnings per share, if presented, would include the dilution that would occur upon the exercise or conversion of all potentially dilutive securities into common stock using the “treasury stock” and/or “if converted” methods as applicable. 

The computation of basic loss per share for the three and nine months ended December 31, 2021, and 2020 excludes the potentially dilutive securities summarized in the table below because their inclusion would be anti-dilutive. 

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.

Disaggregation of Revenue

The following table presents the Company’s disaggregated revenues by revenue source: 

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 of $88,000 and $125,000 at December 31, 2021 and March 31, 2021, respectively. Additionally, at December 31, 2021 and March 31, 2021 the Company has allowances of $1,382,000 and $1,488,000, respectively, related to potential discounts, returns, distributor fees and rebates. The allowances are included in accounts receivable, net in the accompanying condensed 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 amount of $238,000 and $223,000 at December 31, 2021 and March 31, 2021, respectively, which is included in cost of product revenues on the Company’s accompanying condensed consolidated statements of comprehensive income (loss).

Subsequent Events

Management has evaluated subsequent events or transactions occurring through the date the condensed consolidated financial statements were issued. (See Note 13)

Recent Accounting Standards

Accounting standards that have been issued or proposed by the FASB, the SEC or other standard setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

On June 24, 2020, the Company closed on an asset purchase agreement for the sale of its Micromed Laboratories division and testing facility, including all of Micromed’s assets, such as testing equipment, certain office furniture and customer list, with Infinity Labs SD Inc. (“Infinity”) for an aggregate purchase price of $850,000. On the closing date, the Company received $610,000 in cash from this sale which was adjusted for working capital, a credit of $100,000 for future testing services from Infinity over the next two years in lieu of cash, and $60,000 held in escrow for one year, subject to adjustment for certain indemnity claims or purchase price adjustments. Since July 2021, the escrow was received. The Company also retained its accounts receivables outstanding on the date of closing in the amount of approximately $81,000 and an insignificant amount of liabilities. As part of the transaction, Infinity also assumed the Petaluma lease for the office and lab space. The Company retained the warehouse space to store inventory and assets until September 30, 2020.

Accounting for the disposition

For accounting purposes, the Company determined that there was only one discrete component of the sale to Infinity. This component was the customer base and related services to be provided.

The Company determined an arm’s length selling price for each component of the sale and then allocated the net proceeds received to the components on a relative selling price basis. The Company estimated the selling prices of each component as described below:

Proceeds were allocated to the components of the sale based upon their relative selling prices are as follows: 

Discontinued operations

During the three months ended June 30, 2020, the Company’s Board of Directors approved the sale of certain assets related to the Micromed business. On June 24, 2020, the Company closed on an asset purchase agreement with Infinity Labs SD, Inc. The Company decided to divest the Micromed business, resulting in a strategic shift that had a major effect on its operations and financial results. Therefore, the divested Micromed operations meet the criteria to be reported as discontinued operations.

There were no assets and liabilities of discontinued operations on the condensed consolidated balance sheets as of December 31, 2021, or March 31, 2021.

Income (loss) from discontinued operations, net of tax for the three months ended December 31, 2021, and 2020 includes $0 and $(24,000), respectively, of gross profit reclassified from continuing operations to discontinued operations during the periods. Income from discontinued operations, net of tax for the nine months ended December 31, 2021, and 2020 includes $0 and $893,000, respectively, of gross profit reclassified from continuing operations to discontinued operations during the periods.

Gain on disposal of discontinued operations for the nine months ended December 31, 2020, includes $795,000 of gain primarily from the value of the customer base of Micromed.

The operations of the Micromed business included in discontinued operations is summarized as follows:  

Inventories, net

Inventories, net consist of the following: 

The Company reserved $238,000 and $223,000 for obsolescence at December 31, 2021 and March 31, 2021, respectively.

Leases

The Company's operating leases are comprised primarily of operating facility leases. The Company did not have any finance leases as of December 31, 2021, and March 31, 2021. Balance sheet information related to our leases is presented below: 

Other information related to operating leases is presented below:

As of December 31, 2021, the annual minimum lease payments of our operating lease liabilities were as follows: 

Legal Matters

The Company may be involved in legal matters arising in the ordinary course of business including matters involving proprietary technology. While management believes that such matters are currently insignificant, matters arising in the ordinary course of business for which the Company is or could become involved in litigation may have a material adverse effect on its business and financial condition of comprehensive loss.

Employment Agreements

As of December 31, 2021, the Company had employment agreements in place with three of its key executives. These executive employment agreements provide, among other things, for the payment of up to twelve months of severance compensation for terminations under certain circumstances. With respect to these agreements, at December 31, 2021, aggregated annual salaries would be $775,000 and potential severance payments to these key executives would be $775,000 if triggered.

Related Party Transactions

Effective September 25, 2019, Ms. Trombly was appointed the Chief Executive Officer of the Company. Ms. Trombly is the owner of Trombly Business Law, PC which has been retained by the Company to advise on certain corporate and securities law matters. During the three months ended December 31, 2021, and 2020, the Company incurred $30,000 and $51,000, respectively, in legal services from Trombly Business Law, PC. During the nine months ended December 31, 2021, and 2020, the Company incurred $136,000 and $165,000, respectively in legal services from Trombly Business Law, PC.

On May 1, 2020, the Company received loan proceeds in the amount of $1,310,000 under the Paycheck Protection Program (“PPP”), from Coastal States Bank in Atlanta, Georgia. The unsecured loan, which is in the form of a note dated April 29, 2020, matures on April 29, 2022, and bears interest at a rate of 1% per annum, payable monthly commencing on December 1, 2021. The note may be prepaid at any time prior to maturity with no prepayment penalties. The Company used the loan amount for eligible purposes, such as payroll expenses. On September 3, 2021, The Company received approval for forgiveness in the amount of $723,000.

Authorized Capital

The Company is authorized to issue up to 24,000,000 shares of common stock with a par value of $0.0001 per share and 714,286 shares of convertible preferred stock with a par value of $0.0001 per share.

At The Market Issuance of Common Stock

On July 30, 2021, the Company entered into an At The Market Offering Agreement with HC Wainwright & Co., LLC under which the Company may issue and sell shares of its common stock from time to time through HC Wainwright acting as sales agent. The Company will pay HC Wainwright a commission of 3% of the gross proceeds from the sale of any shares of common stock under the Agreement.

During the quarter ended December 31, 2021, the Company sold 94,600 shares of common stock for gross proceeds of $700,000 and net proceeds of $662,000 after deducting commissions and other offering expenses. During the nine months ended December 31, 2021, the Company sold 950,100 shares of common stock for gross proceeds of $7,901,000 and net proceeds of $7,554,000 after deducting commissions and other offering expenses.

Stock-based compensation expense is as follows:  

At December 31, 2021, there were unrecognized compensation costs of $441,549 related to stock options which is expected to be recognized over a weighted-average amortization period of 2.02 years.

At December 31, 2021, there were no unrecognized compensation costs related to restricted stock.

Stock options award activity is as follows: 

The aggregate intrinsic value of stock options is calculated as the difference between the exercise price of the underlying stock options and the fair value of the Company’s common stock, or $4.56 per share at December 31, 2021.

Restricted stock award activity is as follows: 

The Company did not capitalize any cost associated with stock-based compensation.

The Company issues new shares of common stock upon exercise of stock options or release of restricted stock awards.

The Company issues new shares of common stock upon exercise of stock-based awards.

Deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and net operating loss and credit carryforwards using enacted tax rates in effect for the year in which the differences are expected to impact taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

The Company only recognizes tax benefits from an uncertain tax position if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. To date, the Company has not recognized such tax benefits in its consolidated financial statements.

The Company does not have any tax positions for which it is reasonably possible the total amount of gross unrecognized tax benefits will increase or decrease within twelve months of December 31, 2021. The unrecognized tax benefits may increase or change during the next year for items that arise in the ordinary course of business.

The Company generates revenues from products, which are sold into the human and animal healthcare markets.

The following table shows the Company’s revenues by geographic region: 

For the three months ended December 31, 2021, one customer represented 22% of net revenue. For the nine months ended December 31, 2021, one customer represented 23% of net revenue, and another customer represented 13% of net revenue. For the nine months ended December 31, 2021, two customers represented greater than 10% of accounts receivable.

For the three months ended December 31, 2020, one customer represented 26%, and another customer represented 24% of net revenue. For the nine months ended December 31, 2020, one customer represented 34% of net revenue and, another customer represented 14% of net revenue.

 Option Grants

On January 14, 2022, the Company awarded stock options to certain executive officers, directors and employees of the Company. The grant was part of the annual company-wide grant to all employees in recognition of their services. The exercise price of the options is based on the closing price of our common stock of $4.60 per share on January 14, 2022, and the options vest in three equal tranches on the first, second and third anniversary of the grant date. All options vest upon change of control. Any unvested options will expire if the employment of the respective executive terminates prior to the vesting date. Each director and each of the following executive officers received 30,000 options each: Amy Trombly, Chief Executive Officer, Jerry Dvonch, Chief Financial Officer, and Bruce Thornton, Chief Operations Officer.

The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and notes to those statements included elsewhere in this Quarterly Report on Form 10-Q as of December 31, 2021 and our audited consolidated financial statements for the year ended March 31, 2021 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on July 14, 2021.

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this report, the words “anticipate,” “suggest,” “estimate,” “plan,” “project,” “continue,” “ongoing,” “potential,” “expect,” “predict,” “believe,” “intend,” “may,” “will,” “should,” “could,” “would,” “proposal,” and similar expressions are intended to identify forward-looking statements.

Forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to the risks described in our Annual Report on Form 10-K including: the impact of the COVID-19 pandemic on the overall economy and our results of operations; our ability to become profitable; the impact of changes to reimbursement levels from third-party payors or increased pricing pressure due to rebates; our ability to manage our accounts receivable; the impact of seasonality on our sales; the progress and timing of our development programs and regulatory approvals for our products; the benefits and effectiveness of our products; the ability of our products to meet existing or future regulatory standards; the progress and timing of clinical trials and physician studies; our expectations and capabilities relating to the sales and marketing of our current products and our product candidates; our ability to gain sufficient reimbursement from third-party payors; our ability to compete with other companies that are developing or selling products that are competitive with our products; the establishment of strategic partnerships for the development or sale of products; the risk our research and development efforts do not lead to new products; the timing of commercializing our products; our ability to penetrate markets through our sales force, distribution network, and strategic business partners to gain a foothold in the market and generate attractive margins; the ability to attain specified revenue goals within a specified time frame, if at all, or to reduce costs; the outcome of discussions with the U.S. Food and Drug Administration, or FDA, and other regulatory agencies; the content and timing of submissions to, and decisions made by, the FDA and other regulatory agencies, including demonstrating to the satisfaction of the FDA the safety and efficacy of our products; our ability to manufacture sufficient amounts of our products for commercialization activities; our ability to protect our intellectual property and operate our business without infringing on the intellectual property of others; our ability to continue to expand our intellectual property portfolio; the risk we may need to indemnify our distributors or other third parties; risks attendant with conducting a significant portion of our business outside the United States; our ability to comply with complex federal and state fraud and abuse laws, including state and federal anti-kickback laws; risks associated with changes to health care laws; our ability to attract and retain qualified directors, officers and employees; our expectations relating to the concentration of our revenue from international sales; our ability to expand to and commercialize products in markets outside the wound care market; our ability to protect our information technology and infrastructure; and the impact of any future changes in accounting regulations or practices in general with respect to public companies. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based, except as required by law.

Our Business

We are a global healthcare leader for developing and producing stabilized hypochlorous acid, or HOCl, products for a wide range of applications, including wound care, animal health care, eye care, oral care, disinfectant use and dermatological conditions. Our 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. Our 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. We sell our products either directly or via partners in 54 countries worldwide.

Business Channels

Our core market differentiation is based on being the leading developer and producer of stabilized hypochlorous acid, or HOCl, solutions. Unlike many of our competitors, we have been in business for over 20 years and in that time, we have developed significant scientific knowledge of how best to develop and manufacture HOCl products backed by decades of studies and data collection. HOCl is known to be among the safest and most-effective ways to relieve itch, inflammation and burns while stimulating natural healing through increased oxygenation and eliminating persistent microorganisms and biofilms.

We sell our products into many markets both in the U.S. and internationally. In international markets, we ship products to 54 countries. Our core strategy is to work with partners both in the United States and around the world to market and distribute our products. In some cases, we market and sell our own products.

Dermatology

Sonoma Dermatology has developed unique, differentiated, prescription-strength and safe dermatologic products that support paths to healing among various key dermatologic conditions. Our products are primarily targeted at the treatment of acne, the management of scars and atopic dermatitis. We are strategically focused on introducing innovative new products that are supported by human clinical data with applications that address specific dermatological procedures currently in demand. In addition, we look for markets where we can provide effective product line extensions and pricing to new product families.

In the United States, we partnered with EMC Pharma, LLC in March 2021 to sell our prescription products for an initial term of five years, subject to meeting minimum purchase and other requirements. Pursuant to our agreement with EMC Pharma, we manufacture products for EMC Pharma and EMC Pharma markets, sell and distribute them to patients and customers.

On September 28, 2021, we launched a new product direct to consumers on Amazon.com, Regenacyn® Advanced Scar Gel, which is clinically proven to improve the overall appearance of scars while reducing pain, itch, redness, and inflammation. Additionally, on the same day, we launched Regenacyn® Plus, a prescription-strength scar gel which is available as an office-dispense product through physician offices.

We sell dermatology products in Europe, Asia, and Brazil through a distributor network. In these international markets, we have a network of partners, ranging from country specific distributors to large pharmaceutical companies to full-service sales and marketing companies. We work with our international partners to create products they can market in their home country. Some products we develop and manufacture are private label while others use branding we have already developed. We have created or co-developed a wide range of products for international markets using our core HOCl technology.

First Aid and Wound Care

Our HOCl-based wound care products are intended for the treatment of acute and chronic wounds as well as first-and second-degree burns. They work by first removing foreign material and debris from the skin surface and moistening the skin, thereby improving wound healing. Second, our HOCl products assist in the wound healing process through their antimicrobial properties by removing microorganisms. Since HOCl is an important constituent of our innate immune system and is formed and released by the macrophages during phagocytosis, it is advantageous to other wound-irrigation and antiseptic solutions as highly organized cell structures such as human tissue can tolerate the action of our wound care solution while single-celled microorganisms cannot. Due to its unique chemistry, our wound treatment solution is much more stable than similar products on the market and therefore maintains much higher levels of hypochlorous acid over its shelf life.

In the United States, we sell our wound care products directly to hospitals, physicians, and other healthcare practitioners. We have also begun partnering with distributors to expand our reach into the wound care markets. In March 2021, we granted EMC Pharma the non-exclusive right to sell wound care products to certain governmental entities. In January 2022, we entered into an agreement with Salus Medical, LLC for a non-exclusive right to sell our wound care products.

In Europe, we rely on agreements with country-specific distributors for the sale of our wound care products under a variety of brand names into 27 countries, including Austria, Belgium, Croatia, Italy, the Netherlands, Germany, Greece, Hungary, the Czech Republic, Spain, Norway, Switzerland, Poland, Portugal, Slovenia, the Slovak Republic, Finland, Denmark, Montenegro and Serbia.

To respond to market demand for our HOCl technology-based products, we launched our first direct to consumer over the counter product in the United States in February 2021. Microcyn® OTC Wound and Skin Cleanser is formulated for home use without prescription to help manage and cleanse wounds, minor cuts, and burns, including sunburns and other skin irritations. Microcyn® OTC Wound and Skin Cleanser is available without prescription through Sonoma’s online store. It is also available as a prescription product through physicians.

Eye Care

Our prescription product Acuicyn™ is an antimicrobial prescription solution for the treatment of blepharitis and the daily hygiene of eyelids and lashes and helps manage red, itchy, crusty and inflamed eyes. It is strong enough to kill the bacteria that causes discomfort, fast enough to provide near instant relief, and gentle enough to use as often as needed. In the United States, our partner EMC Pharma is selling our prescription-based eye care product through its distribution network.

On September 28, 2021, we launched Ocucyn Eyelid & Eyelash Cleanser, which is sold directly to consumers on Amazon.com. Ocucyn Eyelid & Eyelash Cleanser, designed for everyday use, is a safe, gentle, and effective solution for good eyelid & eyelash hygiene.

In international markets we rely on a network of distribution partners to sell our eye products. On May 19, 2020, we entered into an expanded license and distribution agreement with our existing partner, Brill International S.L. for our Microdacyn60® Eye Care HOCl-based product. Under the license and distribution agreement, Brill has the right to market and distribute our eye care product under the private label Ocudox™ in Italy, Germany, Spain, Portugal, France, and the United Kingdom for a period of 10 years, subject to meeting annual minimum sales quantities. In return, Brill will pay us a one-time fee, and the agreed upon supply prices. In parts of Asia, Dyamed Biotech markets our eye product under the private label Ocucyn.

Oral, Dental, and Nasal Care

We sell a variety of oral, dental, and nasal products around the world.

In the United States, on December 14, 2020, we partnered with Gabriel Science, LLC to market our HOCl-based products in the dental, head and neck markets and launched Endocyn®, a biocompatible root canal irrigant. On January 19, 2022, we added Salus Medical, LLC, as a partner to distribute Endocyn as well as dermatology, wound care and eye care products on a non-exclusive basis.

Internationally, our product Microdacyn60® Oral Care treats mouth and throat infections and thrush. Microdacyn60 solution assists in reducing inflammation, pain, soothing cough relief and does not contain any harmful chemicals. It does not stain teeth, is non-irritating, non-sensitizing, has no contraindications and is ready for use with no mixing or dilution. In New Zealand and Australia, our partner Te Arai BioFarma Ltd. markets our oral product under their label Oracyn® Oral Care. Our partner, Dyamed Biotech, expects to launch Oracyn® Oral Care in parts of Asia this year. On January 18, 2022, we partnered with Anlicare International to seek regulatory clearances for our dental and oral products in China and Macau.

Our international nasal care product Sinudox™ based on our HOCl technology is a solution intended for nasal irrigation. Sinudox Hypotonic Nasal Hygiene clears and cleans a blocked nose, stuffy nose and sinuses by ancillary ingredients that may have a local antimicrobial effect. Sinudox is sold through Amazon in Europe. In New Zealand and Australia, our partner Te Arai markets our nasal product under their label Nasocyn® Nasal Care.

Animal Health Care

MicrocynAH® is a HOCl-based topical product that cleans, debrides and treats a wide spectrum of animal wounds and infections. It is intended for the safe and rapid treatment of a variety of animal afflictions including cuts, burns, lacerations, rashes, hot spots, rain rot, post-surgical sites, pink eye symptoms and wounds to the outer ear of any animal.

For our animal health products sold in the U.S. and Canada, we partnered with Manna Pro Products, LLC to bring relief to pets and peace of mind to their owners. Manna Pro distributes non-prescription products to national pet-store retail chains, farm animal specialty stores, in the United States and Canada, such as Chewy.com, PetSmart and Tractor Supply. Most recently, we expanded our animal health product offerings by adding a MicrocynAH line for felines at PetSmart.

For the Asian and European markets, on May 20, 2019, we partnered with Petagon, Limited, an international importer and distributor of quality pet food and products for an initial term of five years. We supply Petagon with all MicrocynAH products sold by Petagon. On August 3, 2020, Petagon received a license from the People’s Republic of China for the import of veterinary drug products manufactured by us. This is the highest classification Petagon and Sonoma can receive for animal health products in China.

Surface Disinfectants

In-vitro and clinical studies of HOCl show it to have impressive antipruritic, antimicrobial, antiviral and anti-inflammatory properties. HOCl has been formulated as a disinfectant and sanitizer solution for our partner MicroSafe Group, Dubai, and is sold in numerous countries. It is designed to be used to spray in aerosol format, to areas and environments which are suspected to serve as a breeding ground for the spread of infectious disease, likely to result in epidemics or pandemics. The medical-grade surface disinfectant solution is used in hospitals worldwide to keep doctors and patients protected and safe. In May 2020, Nanocyn® Disinfectant & Sanitizer, received approval to be entered into the Australian Register of Therapeutic Goods, or ARTG, as well as in Canada, for use against the coronavirus SARS-CoV-2, or COVID-19. Nanocyn has also met the stringent environmental health and social/ethical criteria of Good Environmental Choice Australia, or GECA, becoming one of the very few eco-certified, all-natural disinfectant solutions in Australia.

Through our partner Microsafe Group DMCC, Dubai, we sell hard surface disinfectant products into Europe, the Middle East and Australia. On July 31, 2020, we partnered with MicroSafe Group to seek regulatory approval in the United States to sell hard surface disinfectants in the United States. To date, we have not received such regulatory approval.

Additional Information

Investors and others should note that we announce material financial information using our company website (www.sonomapharma.com), our investor relations website (ir.sonomapharma.com), SEC filings, press releases, public conference calls and webcasts. The information on, or accessible through, our websites is not incorporated by reference in this Quarterly Report on Form 10-Q.

Results of Continuing Operations

Comparison of the Three and Nine Months Ended December 31, 2021, and 2020

Revenue

The following tables shows our consolidated revenue and revenue by geographic region for the three and nine months ended December 31, 2021, and 2020:

The decrease in United States revenues for the three and nine months ended December 31, 2021, compared to the prior year of $1,045,000 and $1,710,000, respectively, was primarily related to the transfer of sales of our prescription dermatology products to EMC Pharma. As a result of the transfer, we now sell our prescription products to EMC at a reduced price instead of selling directly to patients, which has brought our U.S. prescription drug business to profitability by eliminating the overhead costs of a direct sales force. Prior to this transaction, our U.S. prescription dermatology business had operated at a significant loss and partnering with EMC has improved our overall financial health while retaining lower, but now profitable, revenues from the U.S. prescription dermatology business. Wound care product revenues were essentially flat from the prior year. For the three months ended December 31, 2021, we saw a decline in U.S. animal care revenue versus the prior year of $500,000 which was due to quarterly order fluctuations as for the nine months ended December 31, 2021, animal care revenue was flat compared to the prior year.

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. Although the end of this contract has caused a reduction in the top line, the overall impact has been neutral to our bottom line due to the low margins required by the contract. Since then, Invekra has started its own manufacturing and we have continued to manufacture for Invekra in small amounts as overflow manufacturing. However, we now charge market prices for manufacturing since the contract ended. The decrease in Latin American revenues for the three and nine months ended December 31, 2021, compared to the prior year periods was the result of the Invekra revenue declining to $273,000 and $1,356,000 from $1,307,000 and $5,659,000, respectively.

The increase in Europe and Rest of the World revenues for the three months ended December 31, 2021, compared to the prior year was the result of increases in Asia partially offset by decreases in Europe and the Middle East. For the nine months ended December 31, 2021, the decrease in Europe and Rest of the World revenues was the result of decreases in Europe and the Middle East partially offset by increases in Asia.

Cost of Revenue and Gross Profit

The cost of revenue and gross profit metrics are as follows:

For the three months ended December 31, 2021, gross margins increased by 1% and for the nine months ended December 31, 2021, gross margins decreased by 3%. The increase in margins for the three months ended December 31, 2021 was the result of Invekra prices changing as described above. The decline of 3% for the nine months ended December 31, 2021 was the result of the EMC Pharma transaction. Our partnership with EMC Pharma has resulted in lower revenue from the sale of our prescription dermatology products in the U.S. because the transfer price that EMC Pharma, LLC pays is lower than the prices we received for these products when we sold them ourselves directly to patients. However, our operating costs associated with this business have dropped substantially due to the elimination of the direct sales force for these prescription products and reduction of associated overhead costs. As a result, our U.S. prescription product business is now smaller, but profitable, and is improving the overall health of Sonoma.

Research and Development Expense

The research and development metrics are as follows:

For the three months ended December 31, 2021, research and development expenses of $26,000 decreased by $7,000 from the prior year and was nearly flat. The decrease in research and development expenses of $304,000 for the nine months ended December 2021 versus the prior year was the result of closing our Seattle facility and moving the R&D function to Mexico.

Selling, General and Administrative Expense

The selling, general and administrative expense metrics are as follows:

The increase in Selling, General and Administrative expense for the three months ended December 31, 2021, was $35,000 due to increased insurance costs. The decrease in Selling, General and Administrative expenses for the nine months ended December 31, 2021 of $360,000 was the result the reduction in sales force related to the EMC Pharma transaction partially offset by increased insurance costs.

Interest (expense) income, net

Interest (expense) income, net for the three and nine months ended December 31, 2021, was $3,000 and ($1,000), respectively, compared to $(2,000) and $2,000, for the three and nine months ended December 31, 2020, respectively.

Other (Expense) Income, net

Other (expense) income for the three and nine months ended December 31, 2021, was $11,000 and $542,000 respectively, compared to $(490,000) and $(687,000), respectively, for the three and nine months ended December 31, 2020. The increase in other income relates primarily to the recognition of PPP loan forgiveness in the amount of $723,000.

Gain on Sale of Assets

Gain on the sale of assets was $0 for the three months ended December 31, 2021 and $150,000 for the nine months ended December 31, 2021, respectively, compared to $4,000 and $137,000, respectively, for the three and nine months ended December 31, 2020. During the three months ended December 31, 2020, we sold fixed assets no longer needed after closing our Petaluma manufacturing facility and during the nine months ended December 31, 2020, we also sold assets to Infinity along with our Micromed division. In September 2021, we recognized revenue related to the sale of asset to Microsafe previously held in deferred revenue.

Net Income (Loss) from Continuing Operations

Net losses from continuing operations for the three and nine months ended December 31, 2021, were $944,000 and $2,136,000, respectively, compared to net losses of $626,000 and $1,183,000, respectively, for the three and nine months ended December 31, 2020.

Results of Discontinued Operations

Comparison of Three and Nine Months Ended December 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: