Sonoma Pharmaceuticals Inc

NASDAQ:SNOA

Good afternoon, and welcome to the Sonoma Fiscal Second Quarter 2019 Conference Call. My name is Justin, and I will be your coordinator for today's call. At this time all participants are in listen-only mode. At the end of the call, we will be holding a question-and-answer session with company management. As a reminder, this call is being recorded for replay purposes.

I’d now like to turn the call over to Mr. Jim Schutz. Sir, please go ahead.

Good afternoon and thank you all for joining us today. With me on the call are Bob Miller, Sonoma's Chief Financial Officer; and our Chief Operating Officer; Marc Umscheid, will join us for the Q&A portion.

Before we start, let me remind you that today's discussion contains forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties that could cause our actual results to differ materially from those discussed on today's call, including risks inherent in the development and commercialization of potential products; our ability to become profitable; 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; our expectations related to the use of our cash reserves; our future capital needs and our ability to obtain additional funding; and other risks detailed from time to time in our filings with the Securities and Exchange Commission, including our annual and quarterly reports.

These forward-looking statements are identified by the use of words such as expect, to expand, would, anticipate amongst others. Identified product applications and/or uses are intended to highlight potential applications for the investment community and do not infer that the company is marketing for these indications. These forward-looking statements speak only as of the date of this conference call and should not be relied upon as predictions of future events. Sonoma disclaims any obligation to update these statements except as required by law.

For today's call, I’ll cover three areas. First, a review of our key financials from our quarter ending September 30, 2018. Second, we've been receiving many calls from shareholders regarding our S-1 filing and a recent letter made public from Montreux Equity Partners and we’ll address both of those. And then finally a look ahead at two upcoming product launches: one in Brazil and the other in the U.S.

Bob will then follow with a thorough discussion of our financial results for the quarter and then we'll open the call up for Q&A. We filed our press release and supplemental PowerPoint earlier today and are especially pleased with three key numbers for the quarter ending September 30. For those of you in front of your computer, you can see on Slide 4 of the supplemental PowerPoint are three key numbers for this quarter.

Total revenue was $4.9 million, $4.9 million is a record high revenue for us and we think we're just getting started. That number is up 14% versus the same period last year and up 13% just since the June quarter. EBITDA, which is defined as earnings before interest taxes, depreciation and amortization was a negative $1.95 million. Most financial experts believe that EBITDA is a good proxy for operating cash burn. And for those investors, who followed Sonoma, you've heard us say repeatedly we're pushing towards profitability. And as our revenue increases, our EBITDA loss will shrink.

Less than a $2 million loss in this quarter in EBITDA is a step in the right direction. Cash for the quarter closed at $4 million. The good news behind the numbers from this quarter is that four out of five of Sonoma's business units continue to be profitable and shows solid growth. In addition, we've made progress in our U.S. dermatology net profitability while growing quarter-over-quarter net revenue.

Our consistent message is that patient demand for Sonoma’s products is strong and growing. Bob is going to cover Slide number 9 in the supplemental PowerPoint in more detail, but Slide 9 shows this message visually. The demand for our U.S. dermatology prescription dispensed products through September is up into the right, just like we like it. Like many U.S. pharmaceutical companies, we still face gross to net issues due to difficult managed care environment. However, we believe we're getting gross to net issues better under control through diligence with pharmacy and managed care partners, who support the overall value proposition of our products. This value is driven by the key benefits of our products delivered to patients, doctors, and the overall medical community.

Moving now to the second topic, we've been getting telephone calls from shareholders regarding two recent documents filed with the SEC. We have short answers to both questions and fair warning will be sticking to the short answers if asked again during the Q&A portion of this call. Specific to the S-1 filing, we amended the S-1 earlier this week. The S-1/A or the amendment is available on the website sec.gov for review and contains an enormous amount of information.

We're not at liberty to discuss anything more than what's already in that S-1/A and would encourage you to read it because it's exhaustive. Our phones have also been ringing off the hook regarding a recent letter we received from one of our shareholders, Montreux Equity Partners here in the bay area. What we can share as of today is that the board is currently evaluating Montreux’s letter and will formulate an appropriate response shortly.

Switching gears to our third topic, on Slide 5, with the supplemental PowerPoint, we're pleased to announce our entry into the acne management regimen space. As many of you know, acne is the number one reason why U.S. patients visit dermatologists. The number two reason people wait to see their dermatologist is a general complaint regarding itch. Our Alevicyn product already on the market has made a small and interesting dent into the prescription itch market as an alternative to topical steroids.

On Slide 5, you'll see a photograph of our new Epicyn Antimicrobial Facial Cleanser product as part of an acne management regimen that we're loading into the big wholesalers, AmerisourceBergen, Mckesson, McKesson and Cardinal in the next few weeks, and will be available to pharmacies throughout the U.S. in December.

Following this load-in our sales force will begin detailing our customer dermatologist in January, and Bob will share just a few thoughts on a recent clinical study for Epicyn on Slide 7, I believe.

On Slide 6, of the Powerpoint, you'll find a photograph of Gramacyn, our new acne product being launched in Brazil by our partner in NC Group/U.SK as we speak. You may remember that NC group, the largest pharmaceutical company in Brazil, licensed seven products from Sonoma earlier this year and is launching now, Gramacyn as an acne treatment, and Celacyn for scar management.

NC Group estimates just the Brazilian acne market size for this product to be greater than $100 annually. NC Groups 70 plus person sales force and our own U.S. sales force of 33 sales reps will be marketing Gramacyn and Epicyn respectively as alternatives to two important classes of acne products.

You're probably familiar with benzoyl peroxide and sulfacetamide based products. 2017 Symphony prescription data just in the U.S. shows that this market is large prescription benzoyl peroxide products alone, and by that I mean not in combination with any other acne medication generated $50 million in sales in 2017. Sulfacetamide products for acne generated $262 million in sales in 2017.

Our marketing experts believe that the immediate U.S. addressable market for Epicyn and in the U.S. is approximately $300 million per year, but where we'd really like to play in the future is in the space with products that combine benzoyl peroxide with a topical antibiotic like Clindamycin.

An example, one brand product plus one generic that combine benzoyl peroxide, with Clindamycin generated $691 million in sales just in 2017. As Dr. Jim Leyden, a world-class acne expert said in an important study published in the magazine Tutus [ph] over the last 20 years, dermatologists have grown more and more worried about the gradual worldwide increase in the prevalence of antibiotic resistant P acne strains due to the use or overuse of Clindamycin.

Our performance stabilized hypochlorous acid antimicrobial solution in our Epicyn product to-date has shown no resistance issue due to a unique mechanism of action. There's not been much innovation in the acne market in the last many years. Just a quick history, benzoyl peroxide or BPO was first synthesized in 1905, five first used as an ointment in the 1930’s and was officially approved as an acne medication in the U.S. in 1960.

BPO side effects include redness, burning, and irritation. A quick PubMed search indicates that about 33% of patients using BPO experience phototoxicity to ultra violet light B, which by the way is sunshine and every family probably remembers the issue of using BPO and the impact on bleaching pillows and bedclothing when applying BPO right before sleep.

The other big class of products in this space, Sulfacetamide, were first synthesized in 1930 in Germany before the advent of penicillin and antibiotics in World War II. By the way, the story of the invention of these sulfa drugs, the Nobel prize awarded to the inventor Nazi Germany's rejection of the Nobel prize and the inventors use of his own discovery using these Sulfacetamide on his own six year old daughter. And it detailed, , in great form in science history, is I think worthy of a screenplay. It's a fascinating quick read.

Side effects from these sulfur based products are dryness, erythemia, pruritis and discomfort, periocular use or the use of sulfacetamide near can cause conjunctival irritation and one study reported that 19% of patients using sulfur based drugs for acne experienced local side effects.

So we believe our new Epicyn product in this space could be a much needed innovation in a still area that's ripe for disruption. Our performance stabilized hypochlorous acid antimicrobial solution in Epicyn, we believe is a better alternative to benzoyl peroxide and sulfacetamide and our many dermatologists that we worked with in developing Epicyn and Gramacyn tell us it's about time for a new product here. An important point to highlight regarding these two new product launches is that Epicyn and Gramacyn in Brazil expand our current hypochlorous acid based product portfolio as opposed to being an offshoot that requires incremental spending and resources.

Communicating the benefits of Sonoma's core technology while maintaining hypochlorous acid’s use in a new and larger therapeutic space, we believe will benefit Sonoma entire hypochlorous acid based products by increasing our scale, further connecting all of our business units and improving the efficiency and return on investment of all of Sonoma's marketing and sales efforts.

We believe this is a critical strategic move that will fundamentally help improve our EBITDA and our path to profitability. Bob adores discussing p-values, probability values, and statistical significance. So with that, Bob, I'll hand the microphone to you to cover Slide 7.

Thank you Jim. In August, Dr. Nestor, a world renowned clinical or dermatologist presented at a Dermatology Conference in Colorado. The results of not only his study of the effectiveness of HOCl on topical management of acne, but also to other studies, which also evaluated the impact of HOCl topical treatment on acne, a total of 127 patients. Dr. Nestor has conducted treatment of acne studies, not only using our HOCL products, but also using most of the products which are currently standard of care for the treatment acne. All three studies confirmed statistically significant reductions in the inflammatory acne lesions of 60%, plus and the non-inflammatory acne lesions of 40% percent plus over a 12-week period with p-values ranging from 0.1% to 0.02%. The results point zero two percent. The results of the largest study are shown on slide seven comparing our HOCL products to those of benzoyl peroxide and a placebo.

Sonoma issued a more detailed press release on these studies on August 16, 2018 if you'd like to read more details. Dr. Nestor is an Associate Professor in Department of Dermatology and Surgery at the University of Miami, Miller School of Medicine. He's conducted over 150 clinical trials and authored over 100 articles and book chapters.

In the press release that we issued, Dr. Nester stated “I can envision a time in the very near future when this, HOCL imprints will become a standard protocol in the treatment of acne vulgaris either alone or in combination with other treatments.”

Moving on now over the next 15 minutes, I will discuss the financial results for the September 2018 quarter and the status of our business units. Looking first at the financials, I will cover the high level results for the key financial metrics including revenue, cash, operating expenses, EBITDA and cash position. More details of these results are discussed in the press release and the 10-Q. In addition to supplemental PowerPoint presentation, which Jim and I referred to earlier displays these key metrics on Slide 8 compared to the same period last year to September 2017 quarter, and compared to the last quarter ended June 30, 2018.

Net revenue for the September quarter, as Jim mentioned was $4.3 million, compared to – $4.9 million sorry, compared to $4.3 million for the same period last year up 14% and up 13% over the recent June 2018 quarter with increases in both the U.S., European and Latin American revenues.

As Jim mentioned earlier, this is our highest quarter ever, followed by a $4.8 million of revenue in the December 2017 quarter.

Covering international first, as shown on Page 8, international revenue of $2.8 million is up 18%, percent compared to the same period last year, and up 4% compared to the June 2018 quarter. The revenue was primarily up due to this strong increase in Europe and the shipment to Brazil. These increases were partially offset by decreases in the Middle East, Far East and New Zealand. In Mexico, our HOCl products are standard of care with 40% plus market share as an antiseptic in the pharmacy market. The shipments to Brazil – to our Brazilian partner in the September quarter were $248,000 for launching the acne product in Brazil.

As a result of the strong overseas distribution network and growing position of the U.S. Sonoma continues to be the worldwide leader in the manufacturing and sale of HOCI products. We make or sell over 400,000 units of HOCl products every month. Our HOCl technology enables Sonoma to sell unique, effective, and safe products for use in dermatology and advanced skin care on humans and animals. HOCl is a unique combination of an anti-inflammatory and anti-infective while healing without any resistance and completely safe.

U.S. product net revenue was $2.4 million, up 7% from the same period last year and up 23% from the June 2018 quarter, driven by higher sales in animal healthcare, partially offset by slight decrease in acute care and acting products compared to last year. More specifically, animal health care was up 308,000 or 161% over the same period last year with strong demand for HOCI products at PetSmart and Tractor Supply under the brand name of MicrocynAH. HOCl is a premium animal healthcare product and it's on its way to becoming a standard in treating animals.

The dermatology net revenue was down 8% compared to last year, but up 23%, compared to the June 2018 quarter, driven by factory unit decline compared to last year of 5% and a factory unit increase of 24%, compared to the June 2018 quarter. The factory unit shipments and sales are shown in graph form on Slide 10 in the supplemental PowerPoint. Compared to last year, we reduced the number of sales reps in territories from 30 to 28 where there was lower volume and transfer those territories to inside sales reps and reduce the number of sales managers. This contributed to our EBITDA loss going below $2 million for the September quarter along with a corporate wide reduction in expenses, especially those not related directly to sales.

While the factory unit metric is important because it is how we recognize our revenue it is also impacted by product loadings and wholesale or inventory reductions. We believe that the best underlying end used demand metric is the prescriptions filled by the pharmacies to the patient, as measured by third-party vendors such as IMS or Symphony.

On Slide 9, we show the prescriptions filled data of our product lines and the total of all products at the top. The total prescriptions filled for the September 2018 quarter were 17,410. The largest number of prescriptions filled per quarter in our history, up 12% from the same period last year and up 18% from the June 2018 quarter.

Our unit growth trend in factory units and prescriptions filled over the March quarter has been very strong in the June and September 2018 quarters. The September and December 2017 quarters last year were strong quarters with a significant load-in during the December 2017 quarter.

The primary difference between these two metrics on factory units shipped and the prescriptions filled as fluctuations relating to changes in the wholesaler inventory. The factory units are shipped to the wholesale distributor or directly to the mail order pharmacies. The prescriptions filled at the retail pharmacies are supplied by the wholesale inventories.

The factory units shipped increase the inventory level and the prescriptions filled decrease the units in the inventory. The wholesaler inventory normally represents one to two months of expected prescriptions filled and all ordering is controlled by the distributors, not the company.

On Slide 11, in the PowerPoint supplement, we show in graph form, the number of units of our products held as inventory by the major wholesale distributors. And the quarterly change in those inventory numbers from December 2015 quarter to the September 2018 quarter.

As you can see, there have been significant reductions in these inventory levels in the March and June 2018 quarters into a lesser extent in the September 2018 quarter. The reduction to an inventory to fill prescriptions reduces the factory units shipped, which reduces our recognized revenue. To reduce this inventory reduction risk, which reduced our revenue in March through September quarters, over the last six months, we've shifted to using mail order pharmacies, which represented about 42% of our units sold during the September 2018 quarter.

While the mail order program is effective and preferred by many, we will continue to maintain great relationships with the wholesale distributors and the retail pharmacies. Many patients prefer filling their prescriptions at the local pharmacy, retail pharmacies that they'd done for many years.

Now returning to the discussion of the financials for the September quarter and going back to Slide 9 or Slide 8 in the PowerPoint. The operating expenses minus noncash expenses for the quarter ended September 30, 2018 was $4.5 million, up $231,000 or 5% from the same period last year and down $447,000 or 9% from the recent June 2018 quarter. The increase in operating expenses compared to last year, the increase in the operating expenses compared to last year were due to higher legal and marketing costs in the U.S.

On the other hand, the decrease from the June quarter represents cost reductions we have made throughout the company to reduce our EBITDA losses and seasonal reduction in the accounting expense. The loss from operations minus noncash expenses, EBITDA loss. And Jim mentioned this earlier where the September quarter was $1.95 million, down $313,000 from the same period last year and down $1.1 million or 37% from the recent June 2018 quarter.

This is our lowest EBITDA loss in the last two years, which was caused by higher revenue, higher gross profitability, and compared to the June 2018 quarter lower operating expenses. The cash position on September 30, 2018 was $4 million as Jim mentioned, compared to $7.7 million on June 30, 2018. The reduction of $3.6 million in cash is explained by the $1.95 million of EBITDA loss, our operating cash burn. The remaining $1.6 million of decrease in cash as a result of an increase in working capital of $1.4 million, including increases in receivables of $752,000, inventory of $353,000, and prepaid expenses of $188,000.

Most of the increases in receivables, inventories and prepaid expenses occurred in the international group with receivables to our Brazilian partner of $248,000, and an increase of inventory, which has been shipped to Europe and its being sold through our distributor partners. We expect that the increased receivables have been or will be collected in the December quarter and our payables have increased back to normal levels.

Bottom line is that most of these increases have been or will be converted to cash as collected in the December quarter. And our EBITDA loss of $1.9 million represents our quarterly cash burn for the September 2018 quarter. We look forward to the following for the rest of fiscal year 2019 and fiscal year 2020. One, the growth in sales rep productivity with increases in the average prescriptions per rep per quarter, this will be aided by the near-term strong product launch of the Epicyn Antimicrobial Facial Cleanser in the U.S. dermatology market, which Jim talked about.

Number two, our animal health care, acute care in the international businesses will continue to grow. As an example, the launch of our seven products in Brazil by the largest pharmaceutical company in Brazil, starting with the acne and the scar products in the near-term will support our revenue growth and improve our profitability. Number three, we expect to have new partners in the U.S. and international is similar to the Brill pharmaceuticals in Spain and others in the U.S. in our noncore businesses. Four, our cash operating expenses are expected to remain flat to down as a result of our general cost reduction program. And five last, this should result in growth of revenue and a reduction in our EBITDA loss.

I will now pass the call back to the operator for questions-and-answers.

Thank you. [Operator Instructions] Our first question comes from Bruce Jackson from Benchmark. Your line is now open.

Thanks for taking my question. If we could discuss the mail order pharmacy program a little bit. Last quarter I believe you said that about 20% of revenues went through this program. Was there any change in that number during the quarter?

Yes. It went – it is now for – September quarter unit volume is a little over 40%. So it's gone up.

Okay. And then just broadly, how do you feel about the rebate situation with some of the channel? So is it – are there any rebates hanging out through that? You're still expecting to recognize or has that stabilized?

That's generally stabilized with a lot of the mail order houses. We actually have a program that if somebody does not have cash – if somebody has to pay cash, that we will basically sell it to him for a lower price and a lower co-pay to get him go through mail order and that's $35 as a repay – as a co-pay. So that's been an unsuccessful program and it's basically, in fact, controlled our rebate cost, if you will, by doing it that way. So our rebates…

Okay.

We have not seen – it's been a similar rebate cost, but it's been controlled at this point.

Okay, great. And then last question about the growth potential for your new relationship in Brazil, the Latin American sales ticked up nicely this quarter. How much of that was due to the shipping of the new products? And then do you foresee any acceleration in the sales to Latin America over the next couple of quarters?

The shipment that we have actually mentioned was $248,000 is what we got; is what we in terms of dollars what we shipped to them at this point. They are in the process of launching. We expect – and that was only acne. And we expect them to be launching the scar products. So we expect to see a good volume growth continued out of that going to Brazil with the seven launches that we have at this point. They far exceeded what their contractual agreement was with us at this point already. So we expect to see good, strong growth out of that.

Okay, great. Well, thank you very much.

Thank you, Bruce.

Thank you, Bruce.

Thank you. [Operator Instructions] I'm showing no further questions.

Justin, we'll wrap up. Just a quick final note. Thank you all for joining today's call and for your continued support. As Bob said, in our September quarter, we think we made solid progress in putting our dermatology business back on track. With the growth of prescriptions filled; and bear with me here, March 2018 quarter we filled 13,667 prescriptions, in the June 2018 quarter it ticked up slightly to 14,726 prescriptions filled, and then September was our largest prescription quarter ever up to 17,410 units filled.

We also think we diversified our channel distribution in U.S. dermatology to include now these mail order programs, which Bruce was just asking us about, which represented 42% of our unit sales in the September quarter. We think this diversification reduces the risk of inventory reductions in our patients. We've implemented a cost reduction program to reduce our operating expenses while growing the improved productivity of our derm sales group, the growth of current products and the launch of the new antimicrobial facial cleanser in the – as part of an acne management regimen. And finally, the launch of these approved acne products into the current large addressable markets.

Our product launches are supported by strong clinical studies; a sales force of 33 people, a Brazilian sales force of 70 plus people, with the support of the largest pharmaceutical company in Brazil. And then finally, the combination of revenue growth and holding our operating expenses of the current level should continue to reduce our EBITDA loss. We look forward to sharing our progress on the next call as we build Sonoma to becoming a multi-technology dermatology company and achieving our purpose of relentless passion for healing.

So Justin, that's it from us. Thank you all for joining.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.