Sonoma Pharmaceuticals, Inc.'s (SNOA) CEO James Schutz on Q4 2018 Results - Earnings Call Transcript

| About: Sonoma Pharmaceuticals, (SNOA)

Sonoma Pharmaceuticals, Inc. (NASDAQ:SNOA) Q4 2018 Earnings Conference Call June 13, 2018 4:30 PM ET

Executives

James Schutz - CEO

Robert Miller - CFO

Analysts

Jason McCarthy - Maxim Group

Operator

Good afternoon and welcome to the Sonoma Fiscal Year Fourth Quarter 2018 Conference Call. My name is Brian and I will be your coordinator for today's call. At this time, all participants are in a 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 would now turn the call over to Mr. Jim Schutz. Please proceed sir.

James Schutz

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

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 in today's call, including risks inherent in the development and commercialization of potential products; our ability to become profitable; progress and timing of our development programs and regulatory approvals for our products; the benefits and effectivenesses -- excuse me, 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 funding 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 demand, to expand, would, and 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.

Switching gears, for today's call, I'll cover three areas; first, a review of the key financials from our year ending March 31, 2018; second, a few highlights from the quarter ending March 31; and then finally a short summary of our recent Brazilian news. Bob will then follow with a discussion of our financial results for the quarter and the year; and then we'll open the call for Q&A.

Earlier today, we filed our press release and supplemental PowerPoint detailing our results and we had a solid year ending March 31. For those of you in front of your computer, you can see on slide four of the PowerPoint that total revenue was $16.7 million, up 30%; gross revenue for U.S. Dermatology was up 85%; net revenue for U.S. Dermatology was up 40%; international revenue was up 36%; and U.S. product revenue was up 27%. Please remember that the calculation from gross revenue to net revenue is as follows. Gross revenue minus rebates, wholesaler fees, returns, and reserves equals net revenue.

What we think is important to note about these numbers in our press release earlier today is that our salesforce continues doing a terrific job in driving topline growth through our strong connections to our doctor customers and with patients who are satisfied in reordering our products. With 85% gross revenue growth, our salesforce almost doubled their business over the last 12 months.

Where we face challenges and where we are getting smarter about how to handle these challenges is our gross to net issues. Similar to other U.S. specialty pharmaceutical companies, we too are affected by a challenging managed care environment and high patient usage of rebates.

Focusing on just the quarter ending March 31, we previously provided general guidance that our results for the quarter were going to be seasonally impacted due to health care insurance deductible resets in January of each year and the need for rebates to pick up that slack.

The impact of these insurance plan deductible resets has been cited by many other pharmaceutical companies that have already reported their results for this same time period. The dynamic of these insurance deductible resets impacted our results in two ways; first, a significant increase in rebates used by patients during the quarter; and second, a 12% reduction in prescriptions from the December to March quarters. In response, we're taking multiple steps to lessen the impact of these insurance issues going forward.

As I indicated on our last call, as a first step, we are working with consultants to obtain new insurance reimbursement decisions from health care plans as well as to improve current reimbursement for our products.

Second, we're looking to partner with our customer dermatologist on providing pharmacy home delivery services, which we believe will reduce substitutions at the retail pharmacy counter and better control our rebate process. Bob will spend more time on these tactics in just a few moments.

Bottom-line, we believe that by taking more control of the conversation with our patients and our doctor customers, we can minimize substitution at the pharmacy counter and maximize insurance coverage for our great products. A big thank you to the salesforce for almost doubling their business over the last 12 months and now it's up to us to improve our gross to net issues.

On slide five of the supplemental PowerPoint, we've outlined very active milestones achieved during our fiscal year ending March 31, which we believe is helping build our foundation for future growth.

In the U.S. and most notably our regulatory and R&D teams had a busy year with several FDA approvals to expand the label indications to add antimicrobial language to our products. We continue to believe we are well positioned as the global hypochlorous acid leader across a broad range of indications.

Outside the U.S., in October 2017, we received seven ANVISA regulatory approvals for our dermatology products in Brazil. You may remember that ANVISA is the equivalent of the FDA for all drugs and devices in Brazil.

On slide six, last week, we announced a new partnership with U.SK, a division of NC Group, the largest pharmaceutical company in Brazil, for the commercialization of our seven products approved in Brazil, of which the first three will launch in late summer.

The approved products are indicated for acne, atopic dermatitis, scar management, and post-laser procedures. U.SK has a 70-plus sales rep team calling on 7,000 dermatologists in Brazil. And for clarity sake, for those of you who listened into the call last week, we confirmed the 7,000 derm call point with the U.SK after our announcement last week. The agreement is for five years. The territory is in Brazil.

And as U.SK mentioned during our call last week, much of their growth has been through acquisition. Their list of BD activities in both the licensing and flat-out acquisition front is quite impressive.

The more time we spend with the U.SK team from scientists to their sales group [ph], the more enthusiastic we become about working with the largest pharmaceutical company in Brazil. Can't wait to see what their best-in-class salesforce can do with our great products.

With that, I'll hand the microphone to Bob.

Robert Miller

Thank you, Jim. Over the next 10-plus minutes, I will discuss the financial results for the quarter and year ended March 31, 2018, compared to the same period last year, and the action plans executed or being executed to deal with the issues we encountered in the March quarter.

Looking at the financial results, I will cover the high-level results for the key financial metrics for the quarter ended March 31, which includes revenue, cash operating expenses, EBITDA, and cash position. More details of these results are discussed in the press release and the upcoming 10-K. The 10-K will be released before the end of June.

Total net revenue for the March quarter was $3.7 million compared to $4 million for the same period last year. This drop was caused by a decline in the U.S., partially offset by an increase in the international revenue.

U.S. product net revenue was $1.4 million, down $477,000 from the same period last year, caused by lower sales in dermatology and animal health care, partially offset by an increase in the acute care products.

The derm gross revenue, based on shipments to wholesalers, was $2.8 million for the March quarter, up 23% or $530,000 compared to $2.3 million in the same period last year, but 37% below that of the December 2017 quarter.

The prescriptions filled with our products during the March quarter, based on Symphony weekly data, were 17,195, up 25% from the same period last year and down 12% from the December 2017 quarter.

This demonstrates that the March quarter compared to the December of 2017 quarter, while factory units sold to the wholesalers was down 37%, the prescriptions filled were down only 12%, a more normal seasonal change. In other words, the true demand of our products dropped an expected seasonal amount.

What happened to our derm sales in the March quarter, which caused our factory units shipped to be down more than the prescriptions filled? Providing a little background to the answers to this question. First, our major wholesalers maintain an expansive inventory of prescription products, along with those of many other companies with over 110 centers at locations throughout the U.S.

These wholesaler centers are positioned to provide quick delivery of prescriptions to all the pharmacies in the U.S. In our case, they stock our prescription products in the wholesale centers, which support the pharmacies and doctors, which fill and write our prescription products.

If the pharmacies run low on our products, then will request more product from the centers. If the wholesaler centers run low on our products, they will submit a purchase order to Sonoma to deliver the desired type and amount of the product to that center.

Sonoma then delivers the requested product to the appropriate center and we recognize the revenue upon delivery. A key to this discussion is that the wholesalers manage their inventory levels and we have no input on or control of the management of this inventory.

In the quarter ending March 31, the prescriptions filled according to Symphony data, as I mentioned, was 17,000-plus a little and the factory units shipped to the wholesalers was 11,700 in the same period, a substantial difference.

The decline in the sale of factory units sold from the same period last year from the December 2017 quarter and from the prescription data I just mentioned was primarily caused by the filling of prescriptions from the wholesaler inventory, reducing their inventory levels without replenishment of the inventories.

The dermatology net revenue was further impacted by higher level of rebates, caused by the following two key factors, which Jim referred -- mentioned earlier in our discussion. One was the reset of the health care plans in January. Patients who filled prescriptions and have to pay cash for them are very motivated to use the rebates versus when insurance is paying, they may not use the rebates or they will simply delay filling the prescription until their deductible is covered.

Number two, the rebates are correlated to the prescriptions filled, not the factory units sold. When the prescriptions filled are higher than the shipments to the wholesalers, as occurred with us in the March quarter, then the rebate as a percentage of the gross revenue tends to be a higher number, thus producing a lower net revenue for us.

The net revenue for the dermatology in March 2018 quarter was $779,000 compared to $1.1 million in the same period last year due to the higher rebates as a percentage of the gross revenue for the reasons I just mentioned.

What plans are we implementing to reduce the impact of these negative factors in the future? As Jim mentioned earlier, we will be shifting a significant amount of the delivery of our products from the traditional wholesalers to mail order pharmacies over the next several quarters, while maintaining an important presence at the typical wholesaler and retail pharmacies.

What are the benefits of this shift? One, the mail order pharmacies maintain a limited inventory of our products, which we control and which we will keep at a minimum level. Plus, we will not see a significant discrepancy between the prescriptions filled and units shipped to the pharmacies, like what occurred to us in the March quarter, with the current wholesalers

Number two, with the mail order pharmacies, the fees and returns are much lower than that of the current wholesalers. Three and importantly, the delivery method enables us to better control the rebate cost by making a small profit compared to losing money on many of the rebates through the wholesalers in the retail pharmacies.

Four, the method of -- this method of delivery will significantly reduce the number of substitutions in our products, which currently occur at the normal retail pharmacy. It is conservatively estimated that the substitution rate is in the 20% to 30%-plus range.

In general, this method of delivery will tend to make our gross to net revenues more predictable. In addition, the price to the patient is lower, because it's eliminating 20% to 25% upcharge for the profit which the retail pharmacy charges. Now to incentivize doctors and patients to utilize this method of delivery, we will be reducing the co-pays, which the patients have to pay.

Now returning back to discussion of the financials for the March quarter. The sales in Latin America of $912,000 to Invekra, our current partner, for the quarter ended March 31 were up 9% compared to the same period last year.

The cash operating expenses for the quarter ending March 31 were $5.1 million, up $664,000 and 15% in the same period last year. The increase in cash operating expenses was due to higher sales, marketing, legal and administrative costs in the U.S.

The loss from operations minus noncash expenses EBITDA for the March quarter was $3.7 million, up $1.3 million from the same period last year, primarily due to lower sales in dermatology and higher cash operating expenses. The cash position on March 31 was $10.1 million, up $1.5 million from $8.6 million on December 31, 2017.

Now despite the hiccup in the derm fourth quarter results, as Jim mentioned earlier, our fiscal year 2018 was a year of strong revenue growth in dermatology as well as strong revenue growth in the total U.S. and the international revenue markets.

As mentioned earlier, the following are some of the highlights with a little bit more detail. One, the gross revenue for the dermatology increased to $14.9 million from $8.6 million, up $6.8 million or 85%, a strong increase in the topline with our strong best-in-class derm sales teams.

Number two, net revenue from dermatology of $5.8 million was up 40%. International revenue of $7.2 million was up 36%. And U.S. product revenue of $8.4 million was up 27%, which includes the derm net revenue as well.

We look forward to the following for fiscal year 2019; one, growth in the sales rep productivity with increases in the average prescriptions per rep per quarter. Two, moderate price increases since our price per gram is lower than the competitive products.

Three, our operating -- cash operating expenses are expected to remain fairly flat throughout the year on a quarterly basis. And this should result in a reduction in our EBITDA as we go through the quarter.

With that, I'll turn it back -- turn it over for Q&A.

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions]

And our first question will come from the line of Jason McCarthy with Maxim Group. Your line is now open.

Jason McCarthy

Hi, thanks for taking my question. So, I'd like to see if you could give us a bit more color on those upcoming growth drivers and any guidance as we enter fiscal 2019, in particular as it relates to the recently launched Loyon and the recent Brazil deal?

James Schutz

You want to split them?

Robert Miller

Okay.

James Schutz

Specific to Loyon, Jason, as you're aware, we are working with the FDA on expanding the label indication, knock on wood, to include psoriasis in that label. We're awfully excited about selling that product with an expanded label.

We're actually working with the German pharma manufacturer that we licensed the product for – on to new clinical data that they're sharing with us that we'd like to cut and paste and turn into a terrific docket with the FDA. So, stay tuned for more information on Loyon. And then Brazil drivers, help me here, Bob, but I think we're targeting a late summer launch.

Robert Miller

Yes, I think it's -- I think one of the things we mentioned on the call is that we've received orders already -- purchase orders from the Brazilian EMS or NC Group of well over the minimums for the first year, and it's probably a confirmation that those minimums go up to $1 million over a five-year period at this point.

And so, we see a large company -- the largest company in pharmaceutical company in Brazil that has 70 salespeople working on dermatology and some really good indications for us, and we see a good benefit from that. It will also help us get to our breakeven and reduce our cash flow and get to breakeven faster.

Jason McCarthy

All right. Thank you very much.

James Schutz

Thanks Jason.

Operator

Thank you. [Operator Instructions]

And our next question will come from the line of Pete Hansen, Private Investor. Your line is now open.

Unidentified Analyst

Yes, thank you. What was the number of prescriptions written in the March quarter compared to the March quarter last year?

James Schutz

The -- I think that's actually -- the number of prescriptions written, if you look on our schedule that we handed out --.

Unidentified Analyst

17,000?

James Schutz

You can see that the prescriptions written for the March quarter that we just finished, we're talking about the 17,195. The prescriptions written last year were 13,000, almost a little less than 800. Is that the question?

Unidentified Analyst

Okay. So you saw--

James Schutz

We saw a 25% increase in those scripts from last year. That's on slide number eight in the supplemental PowerPoint.

Unidentified Analyst

Okay.

James Schutz

So, we had a good strong growth in the prescriptions from last year.

Unidentified Analyst

So, 17,000 prescriptions were written in the current quarter, yet the -- yet recognized revenue in the quarter was only 12,000 of the 17,000 because of -- as mentioned in the --

James Schutz

So, the factory units -- the prescriptions filled are when they obviously -- we recognize when we ship to the wholesalers. That's why I went through sort of the process when we ship to wholesalers versus when they actually fill prescriptions. And so they -- what they do is they hold an inventory level, a significant amount of inventory. In this case, it was in the 4,000, 5,000 unit range was the inventory that they brought it down to.

So, they reduced their inventory almost by 4,000 units from January to the end of March. They managed their inventory. We don't really control it, and they turned it back and that's the reason for the difference. That's one of the primary reasons for the difference between the prescriptions filled and the units sold.

Unidentified Analyst

Okay. It's great to see the number of prescriptions written year-over-year was up significantly.

James Schutz

Absolutely, yes.

Unidentified Analyst

Regarding Loyon, are the drugs Loyon will compete with in the United States the same drugs Loyon competes with in Germany?

Robert Miller

Great question, Pete. Just for clarification, Loyon is a medical device in the United States. The classification in Europe is slightly different, but just so we're speaking with specificity, it's a medical device.

Are the products that Loyon competes with United States different than the products that Loyon competes with in Europe? Yes. U.S. has some really interesting upcoming biologics for psoriasis. So, some pretty serious drugs expensive with a laundry list of side effects and we think safety profile for a product like our Loyon product should hold up well when compared against the side effects and price points for some of these biologics.

Unidentified Analyst

Okay. If Loyon were to get a similar market share in the United States as it does in Germany, then what would the revenue for Loyon be in the United States?

James Schutz

Good question. Loyon is sold in Europe in U.K. and in Germany with some reasonably healthy sales. We'd love to get this expanded label claim like they have in Europe to include psoriasis. And Pete, check back in with us as we make progress with the FDA.

Unidentified Analyst

Is Loyon sales in Germany and U.K. roughly $15 million? In one of the last conference calls, it said.

James Schutz

I think it was something like that. What you maybe could do is do a population-to-population comparison.

Robert Miller

Germany and neighbors and the U.S.

James Schutz

Yes. And then do -- say that if it's $10 million, $15 million in Germany and there, what, about $100 million, where do you think Germany is?

Robert Miller

Or just population in--

James Schutz

Yes, you never -- I don't know that -- those numbers off the top of my head. But do a comparison -- a relative comparison, let's say, it would be 4x that in the U.S.

Robert Miller

And just to be clear, at the risk of repetition, Pete, we do not have the same label indication in the U.S. as their strong label indication in Europe. We'd like to get it, but tough to do an apples-to-apples comparison at the moment.

Unidentified Analyst

Okay. One question on the company's branded products in U.S. currently. The branded products have superior outcomes than the competition. And from previous conference calls, it's mentioned that your products are priced at about half of the generic competition.

Why not match price to the competition, given you have an antimicrobial label and you have superior outcomes with higher safety. And if you matched pricing with the competition, it would make the company nicely profitable at the current volumes.

James Schutz

So, we thought about that from time-to-time. we're -- our plan and our pricing approach is to not do large -- really big increases in one fell swoop, but doing more slowly over time. And that's been our pricing strategy, even though it's tempting, quite frankly, from a financial perspective to do that.

In our comments, we made before are on a per gram basis, because a lot of our competitive products are these little tiny tubes that don't have much volume to them either, so.

Unidentified Analyst

Okay. And lastly, in the current quarter, what would the revenue have been in the March quarter if the rebates and the resets had not occurred?

James Schutz

I -- then I think they would have been -- you can go back and then go back to the December quarter and say okay, just because of seasonality, we have like a 10% drop. And so I think you'd say -- and we have, like, $4.8 million was our revenue last quarter. So, probably about a 10% drop off of that $4.8 million would probably be what it would have been.

Unidentified Analyst

Okay. Those are my questions. Thank you.

James Schutz

Thank you, Pete.

Operator

Thank you. And I'm showing no further questions in the queue. So, now I'd like to hand the conference back over to Mr. Jim Schutz for some closing comments or remarks.

James Schutz

A final thought. Thank you all for joining us on today's call and for your continued support. We look forward to sharing our progress as we build Sonoma to become a pure-play multi-technology dermatology company and achieving our purpose of relentless passion for healing. Thank you very much.

Operator

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program and you may all disconnect. Everybody, have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!