Good afternoon and welcome to the Sonoma Fiscal First Quarter 2019 Conference Call. My name is Chris 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 will now turn the call over to Mr. Jim Schutz. Please proceed sir..

we are always looking for new buy-and-hold institutional investors and we will fund raise if we believe it is necessary to sustain our growth. We believe sustained revenue growth is key to our success. We’re focused on achieving critical mass, building brand awareness for our great products and ultimately creating loyalty with customers and patients.

Higher revenue generates cash to cover expenses and steers us towards profitability. However, we will not sacrifice our growth by cutting expenses to the bone at this crucial time.

Although we had a challenging quarter ending March 31, we saw our business rebound in May and June and now in July, and we adjusted our business model to reflect those challenging changes in health care insurance plan. As a result, we are reviewing our cash burn rate and actively cutting costs, but without impacting our top line growth.

Our primary goal is to grow at a healthy pace. And with Bob, I'll hand the microphone to you..

Thank you, Jim. Over the next 10 minutes, I will discuss the financial results for the June quarter and the progress of action plans executed or being executed to deal with the issues we encountered in the March quarter.

Looking first at the financials, I will cover the high-level results for the key financial metrics, including the revenue, cash operating expenses, EBITDA and the cash position. More details of these results are discussed in the press release and the upcoming 10-Q, which will be released shortly.

In addition, we have a supplemental PowerPoint presentation, which Jim mentioned, which displays these key metrics on Slide 6 compared to the same period last year June 2017 quarter and compared to the last quarter ended March 31, 2018.

As Jim briefly mentioned, the total net revenue for the June quarter was $4.4 million compared to $3.8 million for the same period last year, up 14% and up 20% over the recent March 2018 quarter with increases in both the U.S and the Latin America revenues.

Covering international first, as shown on Page 6, international revenue of $2.1 million is up 22% compared to the same period last year and up 11% compared to the March 2018 quarter.

The revenue was primarily up due to very strong increase in Latin America sales, sold by our partner in Latin America and smaller increases in China, Korea, Australia, New Zealand and India. These increases were partially offset by decreases in the Middle East and Singapore.

As a result of our strong overseas distribution network, Sonoma continues to be the worldwide leader in the manufacture and sale of HOCl products. We make and sell over 300,000 units of HOCl product every month and over 3.6 million units a year.

Our number of units sold are more than 10x larger than the total number of units sold by all of our HOCl competitors. Our HOCl technology enable Sonoma to sell unique, effective and safe products for the use in dermatology and advanced skincare on humans and animals.

U.S product net revenue was $2 million, up 6% for the same period last year and up 45% from the March 2018 quarter, driven by higher sales in dermatology and animal health care, partially offset by a decrease in the acute care products compared to last year.

The dermatology gross revenue based on shipments to customers not prescriptions filled was 3.6 million for the quarter ending June 30, 2018, up 13% compared to the same period last year and up 34% compared to the recent March quarter.

The graphs of our gross revenue in total and by product line over the last three years as shown on pages 7 and 8 and the supplemental PowerPoint presentation.

The reset of the health care plans in January this year and the growth of the high deductible plans continue to impact the factory units sold in the rebate cost in the month of April, while the months of May and June were stronger.

The dermatology net revenue of $1.2 million was up 1% from the same period last year and up 55% compared to the recent March 2018 quarter. Even though the gross revenue was up compared to the same period last year, the net revenue was about the same due to the higher rebate cost as a percentage of the gross revenue of 4 percentage points.

On the other hand, the rebate cost as a percentage of gross revenue were much lower compared to the March 2018 quarter by 5 percentage points. This is shown on Page 6 of our PowerPoint presentation by looking at the change -- the change in the net revenue as a percentage of gross revenue right below the U.S dermatology net revenue line.

As Jim pointed out earlier, we implemented a mail-order program to help preclude or reduce the impact of factors which cause the March quarter to be down in our dermatology business. As you may recall, last quarter we identified the following potential benefits of a more pervasive mail-order program.

One, the mail order pharmacies maintain a limited inventory of our products which we control and which we can keep at a minimum level. Thus far, we've seen low inventories at the mail order pharmacies which prevents large inventory swings like what happened to us in the March quarter with the current wholesalers.

Number two, this delivery method enables us to better control the rebate cost by making a small profit compared to losing money on prescriptions filled for uninsured patients by the wholesalers and retail pharmacies.

Number three, the mail-order delivery will significantly process will deliver -- significantly reduce the number of substitutions from and [indiscernible] in our products which currently occur at the normal retail pharmacy. In general, this method will tend to make the gap between the gross net revenue smaller and more predictable.

To incentivize doctors and patients to utilize this method, we reduced the co-pays which the patients have to pay. This program was implemented at the end of May and that it was introduced to our doctor customer base for only a month before the end of the June quarter. What have been our results thus far with this program.

The primary mail-order pharmacy filled with over 900 prescriptions for the month of June, which represents 20% of our factory units sold for prescriptions during June. Thus far we're happy with the high quality of the customer service and the quick uptake of the program hence first full month of implementation.

For the month of July, our primary mail-order pharmacy filled over 1,500 prescriptions, which represents 28% of the factory units sold per prescriptions in July. While this appears to be an effective program, we will continue to make great relationships with the wholesale distributors and the retail pharmacies.

Many doctors and patients prefer to use this very convenient, but more extensive distribution network to obtain that prescription products. Now returning to a discussion of the financials for the June quarter.

The cash operating expenses for the quarter ended June 30 were $4.9 million, up $209,000 or 4% from the same period last year and down 5% from the March quarter 2018. The increase in cash operating expenses compared to last year were due to higher legal and marketing costs in the U.S.

The loss from operations minus noncash expenses EBITDA for the June quarter was $3.1 million, up $249,000 from the same period last year, primarily due to lower gross margins and higher operating cash expenses. The cash position on June 30 was $7.7 million compared to $10.1 million on March 31, 2018.

We look forward to the following for the rest of fiscal year 2019. Number one, growth in the sales rep productivity with increases in the average covered or prescriptions with good insurance or we call them good scripts per rep per quarter. This is a primary focus of our sales reps. They receive no commission for the quote bad scripts.

This is designed to produce growth and profitable net revenue and will be aided by two strong product launches in the U.S dermatology market which Jim talked about. Number two, continued growth in our especially mail-order programs, which Jim and I talked about.

Number three, moderate price increases since our price per gram is lower than the competitive products. Number four, our cash operating expenses are expected to remain relatively flat. And lastly number five, the profitable revenue growth should result in a reduction in our EBITDA.

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

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

Hi. Thank you for taking my question. One of the -- in addition to the mail-order effort that you’ve got underway, you also last quarter talked about engaging some consultants to look at the reimbursement rates for products.

So I was wondering if you’ve made any progress on that front during the quarter?.

Yes, good question, Bruce. Yes, I briefly mentioned it. I gave an example in my prepared remarks the financial arguments that we will be making to the Blue Cross Blue Shield anthems of the world. But we’ve a really good day consultants, we're arming that consultant with the information he's asking for and we will keep you posted on the results..

Okay. And then a quick question on Invekra.

How long do you see that agreement continuing right now? It seems to be a little bit stronger than you originally anticipated?.

Well, if [indiscernible] Bob, contractually, we've extended for an additional two years that expires late fall 2020, I believe, correct? Something like that..

Yes..

Yes, and they’re a terrific partner for us. We love to see their growth and our international guru is really pressing Invekra to expand into other Latin America countries in Central and South America other than Brazil..

Okay, great..

We think that they’ve asked to extend it, because the making of the product is a lot more difficult than they -- I think envisioned initially. And so -- and that’s we’re fine with that, because it does give us additional revenue and additional profits..

Okay.

Then last question for me with the new Brazil agreement with [indiscernible] skin, when do you anticipate the first orders to start flowing for that?.

Yes, this is Marc. Thanks for the question. We’ve already started -- we’ve already received two significant orders and we’re in the process of shipping the first out now. We expect those products to hit market in Brazil within the next 60 to 90 days..

Okay. Super. Thank you very much..

Thank you, Bruce..

Thank you, Bruce..

And our next question comes from Laura Engel with Stonegate Capital Partners. Your line is now open. If your phone is on mute Laura, please take it off..

Yes, sorry. Good afternoon. Thanks for taking my questions. The -- just look like circling back to the [indiscernible] if that deal is going to continue, can you just comment a little bit on the effect of margins.

And then I guess, over this upcoming -- the remainder -- remaining three quarters, may be what if this is as far as margin levels kind of normal or if we should expect and see additional changes with the change in your business a little bit..

Yes. So you’re right. The Latin America margins, especially the Invekra ones are in the mid-high teens. And we would expect them to stay there during this extension. In terms of our overall mark and of course the longer they stay, then that margin will have a tendency to influence margin to a lower level.

But as our derm business grows, which has 75%, 80% plus margins. As that grows as a percentage of the overall business, which we expected to do, then we should see an improvement in the margins and I think in the past we’ve said that they should be up in the high 60% to low 70% levels..

Okay, great. And then, on the new order program, I guess longer-term and where do you see that as a -- what potential as a percentage of business and then maybe touch on any associated costs with that program, now that you’ve kind of explained how it works..

So I will handle the first, Laura.

Bob, you handle the cost?.

Okay..

Laura, we’re forecasting that the home delivery channel should be about 60% of our U.S prescriptions by the end of calendar 2018. Our physician customers really like this, this channel. So we'd like to give our customers more of what they want.

After that ask us again after that earnings call and we will give you latest thinking from there, but Bob why don’t you answer the cost question versus say the Mercersburg in Cardinal, McKesson [indiscernible]..

Yes, yes. So they’re -- it's very complex. The answers are very complex one. And I will try to make it simple..

Okay..

What it's going to do, what the impact is, it will tend to reduce the -- because it's a consignment sale in terms of the bad scripts, the scripts that our cash payers don't have much insurance or good insurance. It will reduce the gross revenue over time as that becomes a higher percentage. And it will then also should increase the net revenue.

In other words, the difference between the gross and the net is going to get much narrower. And the reason for that is that we will sell the products that our cash pay for a low price rather than recognize any rebate on them. And therefore it will eliminate the rebate -- fairly significant rebate cost relating to cash pay.

Does that give you an answer or is that …?.

It gives me a good idea. So I appreciate that congrats on the quarter. I will get back in the queue..

Hey Laura, one last thought on the fees..

Yes..

Bob likes to hammer home to us and so I will hammer it home that the fees we pay the wholesalers. Mercersburg in Cardinal McKesson to feed every retail pharmacy in the country..

Right..

Are expensive to a small company like us, this ….

Exactly..

… [indiscernible] we pay the home delivery service. Bob, you answered that question. It's ….

Yes, generally what we pay is in the 12% range for the wholesalers and for the mail-orders it's a 8% -- in effect an 8% number, but when you get back to the rebates, we actually -- through the wholesaler system, we're actually rebating and the pharmacies, retail pharmacies actually get a profit out of it.

So that we would -- this mail order eliminates the profit that the retailers get, which means it's actually a lower price to the consumer or to the insurance company..

Okay, great. Well, again, I appreciate it. And again, congrats on the quarter. Thank you..

Thank you, Laura..

And our next question comes from Eric Pansick, Private Investor. Your line is now open..

Hi. Thanks for taking my questions. Just two of them. But just the point of order, I see that the gross profit is down 2% quarter-over-quarter this year versus last year, and the SG&A was up 4% net somewhere in there, surely [ph] numbers includes 30 sales reps.

So I also noticed when you talk about what happened in March and the bounce back, if you add the last two quarters this fiscal year and you comparing the last fiscal year, the sales are only up 2%. So I don't call it impressive with 30 reps on board.

I do like -- it seems that you’ve essentially the numbers, I do like what I heard I think from Bob just now that you’re going to be squeezing the reps a little bit more for a little bit more efficiency. I do like -- the price resistance talk, you currently have some opportunity there, so that sounds good.

But getting to my questions, share price down 50% in the last quarter.

Have you heard of any roadshow? I see on your Investor page, that your last presentation dated February, you don't get many questions from firms, certainly you get some from regional, it's not for major, so I think the share volume kind of tells -- to tell you a disinterest you are -- Jim and Bob, you pulled down $1.2 million last year, $600,000 each in FY18.

So I guess, my questions are two. Do you believe that your biggest duty is to stakeholders, which include shareholders. That’s question one. And if so, have you determined concrete steps outside of operating results, spot your stock price.

If so, what are they? Again, you remember last quarter I mentioned -- did the share prices decreased and you have to go to funding that we get diluted at smaller price, but first [indiscernible] both a -- an option, so to speak, plus preferred shares, meaning dividends and that hole it's hard to climb out of, so I’m really want to focus on what you are doing outside of operations to support the stock price.

Thank you..

Okay. So let me respond on the -- first the last, during the summer, for microcap group that we’re in, there aren't that many conferences. We have a whole -- the last conference we went to was in the early part of June held in micro. We -- I think are scheduled to go to three conferences or four in September and two or three in October at this point.

So we’re generally pretty active and go to most of the Microcap conferences that -- and we think that's really important for communication to current shareholders and new shareholders. So that’s we're pretty active in that arena, we think that’s an important thing.

We try to issue press releases that are meaningful press releases to everybody and we will have some relating to some of our new studies that Jim talked about in the facial cleanser area. There is a large one coming out this weekend.

It's being talked about in the derm conference that we will actually press release either this coming week or next week. And so we're reasonably active in that, in the Investor Conference arena.

Jim you have anything …?.

No, and Eric we will obviously update the PowerPoint the next time we do conference. My only other note was Eric commented on our pay, it is public. Bob and I both make the same thing. We both pay cuts when we took over the company.

We both make $250,000 a year, I’m not sure where you're getting your other numbers, but don’t want to [indiscernible] with that. You can see in our proxy just recently filed exactly what we get paid. But we also like to buy stock in the open market, we would like to align ourselves with our shareholders and make money on the stock, not on the cash.

But thank you for the great question..

And I would add that Jim's compensation is probably at the 25th percentile of other CEOs get the same size companies. So [multiple speakers]..

Yes, it came out of the proxy, but I like what you say, if there were an announcement you bought some stock on open market that would be helpful, I’m not to guess you do so.

And as far as press releases are concerned, you obviously issue stuff that’s meaningful to get it, but you could, if you so chose to release one month-to-month, saying here is what our scripts are this month compared to last year. So there are other things you can do, but I appreciate your response..

No, it's a great point we have debated, issuing more press releases, but I will tell you my strong opinion Eric is that we announce something when it's material, when it's important to our shareholders and no fluff, no grey press releases, no wiggly press releases say for the -- the poor analogy there, but it is a conversation.

We see lots of other companies that issue fluffy press releases. That’s not the kind of company I want to run. When we issue something its meaningful and important..

So, yes, let me also say that the shareholders and the stock price is very important to us. One of our jobs as a management team to do the utmost we can to increase the value of the company over time and we think that's extremely important. We think the communication is important, but at the same time the execution is extremely important too..

Yes, I get you. We just know just by the numbers, you need to go back to the trough and I just take the [indiscernible] you’re going back to the trough in such a low stock price and what you call it position of strength. But thank you again very much for your responses..

Hey, thank you, Eric..

And our next question comes from Walter [indiscernible]. Your line is now open..

Good afternoon..

Hi, Walter..

Hi. At the beginning of the call you went through three different products, relative pricing for a similar type of application you used a program evaluation. I don't know if the efficacy per gram is the same with the disparity so large.

And while the point you were trying to make I think is that you provide a dramatically better value sitting here thinking about the business my own thought was which crazy person set the pricing on this? Why didn’t you price it at 250 a gram, make more money and still be a quarter of the other guy or a third of the other guy depending on how you look at it.

And so the world is not breaking down your door because you are much cheaper and I don't think you're going to be that successful to some personal experience in convincing insurance companies to prohibit the use of other approved drugs necessarily. So why it's not a attractive strategy? I think it's a double negative.

Why isn't the strategy to at least where you’ve very large pricing disparities, push pricing, I know you do raise prices reasonably aggressively since being below dramatically low-price person is, I assume, it's helping you get in some doors, but doesn't seem to be -- we’re still at $4 million a quarter growing at mid teen percent business..

Good questions. When sitting across from an insurance carrier like Blue Cross Blue Shield, first conversations tend to be with someone like Bob, our CFO, financially driven, spreadsheet focused and we need to be fully armed with price per gram analysis which is the example that I gave you.

Down the road exactly to your point, we will have efficacy conversations, clinical trial information and alike, but first conversations and the one I wanted to highlight was price per gram. We certainly have examined increasing our product prices. We don't want to be greedy. We want to increase prices gently on a regular basis.

You raise a great point, could we do something draconian and really raise the prices? We certainly explored it. We’ve done price sensitivity analysis and we believe that our patients with the insurance carriers with our patients and our physicians support doing gentle price increases rather than a knee-jerk.

I don't know if that gives you a satisfactory answer Walter. You’re right, we are less expensive and we like being less expensive, if your argument is we may be leading too much on the table than we will continue to gently increase prices over time..

Okay. And then just the points been made and I don't have a solution, but the value of the company with a $2 stock and that’s within if you get an uptick tomorrow, which I assume you will get and I understand we burn cash is well under 1x sales. I’m just wondering and my experience as you know is very expensive in microcap companies.

Unfortunately, I think we're flowing into the penalty box of -- you’ve got a $12 million market cap, $13 million market cap, the value gets sufficiently low, it's not attractive to people who have to build a position. I normally lecture everybody just run the business, that’s going to take care of itself.

However, in today's market increasingly I am seeing pretty decent good companies once they fall sufficiently out-of-favor becoming very difficult to come back, especially if the nature the business is we are going to show good steady growth, but there's nothing breakthrough dramatic in what we do and therefore that’s just a question, but more as a statement it really is important and I normally don't say this for you people, meaning the two of you, to make an intensified effort to reverse the negative psychology and get the stock back up some, not because I needed in the short-term but because once you fall into these holes and may have to raise money, it is a catch-22 that makes it very difficult.

So I'm sure you know that. I know it better than you do because I’m in a lot of these companies. But I reinforce the comment made by others that you can't just run the business. I know you don't. We've met bunches of times, you’re very responsive. But we are falling into a hole here, which is very difficult to climb out of..

Thank you for the comment. We agree with you. We are going to do everything we can to get out of this hole, so to speak. And we think our -- we got a couple of product launches, one in particular that we think is particularly exciting that's a facial [indiscernible] and it's going to be used in the acne regimen.

And hopefully we will see some renewed interest and renewed growth relating to that as well as our other products..

Okay. Thank you..

Thank you, Walter..

[Operator Instructions] And our next question comes from Scott Billeadeau with Walrus Partners. Your line is now open..

Hi, guys. Thanks for taking my call..

Hi, Scott..

Most of my questions have been answered here.

Just a quick thing with the current sales force, is there -- did these guys see through to at all or have any visibility in terms of as they bring on a new client or a new -- what the ultimate rebates are going to be for them? I mean, I’m just trying to compensate for what you guys actually get as opposed to kind of the gross revenue number doesn't really mean much anymore.

Just any thoughts, have you been able to come up with a plan or some way to incent them for what -- for net revenues as opposed to gross revenues or is that just something you got to handle behind the scenes?.

No, no. You're absolutely right. We have -- and they have access to data on doctors if they’re calling on and their selection process is picking up the doctors that generally have patients that have good coverage.

So they're going to be focusing on as -- and as I mentioned, they don't get a commission if they get -- if a script is written, that doesn't have insurance. So you can imagine they’re highly motivated to do that.

They have the data and the information in advance looking at the doctors to understand which doctors have good insured patients and which ones don’t.

And they can -- they're able to make those choices and we're drilling that into them, that’s really important and that’s what we call growth of our profitable net revenue, that I was referring to before.

Now the mail-order houses also help us in this arena because we pay less for a script, that's a bad script in the mail-order side and that's a benefit.

So that as I mentioned on the early question about the impact of that, what that will do as it might reduce the gross revenue, but as we all know the real concern is what's going on with the net revenue. It will reduce the gross revenue, it also reduce the rebate cost.

And it also should eliminate some of the substitution process and abandonment process, so the net it should take our net revenue on a straight comparison basis to the wholesale distribution network. It should take the net revenue up..

Yes. Okay. And then of the reps, from a year-ago, how many are still around? I mean, success and I’m kind of trying to figure out is your classic bottom of the 5%, bottom 10%.

You got a workout or guys that are picking the easy sale that you don't get paid for or have you been able to migrate some of those other, may be give us a little thought on turnover of this -- of your reps..

Scott, voluntary turnover has been skinny. We seem to engender a lot of loyalty with our reps, we pay them well, uncap commissions. In voluntary, turnover Bob likes to say, we don't have a ton of patients. We use data to make those decisions profitability by territory.

We are constantly looking at new ways to share that data with our reps to move them up the food chain. But your first point was a great point. It's really challenging unless you’re armed with an enormous amount of data to know that Dr.

Miller in Northern California to know before going into his office what percentage of his patients are Medicare, Medicaid, no insurance, affluent, that data is available out there, we really try to hammer that home and feed our reps with that information before going into an office..

Okay. And just, I guess, it's all about behavior modification if you can commission -- you can do quite a bit with the commission plan, to modify behavior as long as they have the data. You can't tell them to do things they don't know. So ....

Right..

Other than that -- guys, that’s all I have. Thanks and I will keep tracking you..

Thank you, Scott..

Thanks, Scott. Appreciate your interest..

And I’m not showing any further questions at this time. I would now like to turn the call back to Mr. Jim Schutz for any further remarks..

one, improve our managed care coverage. Two, diversify our distribution channels to better control our process, and three, we're adjusting our sales reps to focus on selling profitable prescriptions as Bob said to the right doctors, for the right patients.

These actions and programs have already put our dermatology business in a stronger position to grow our profitable revenue. As a small company, we pride ourselves on being nimble and being able to quickly address challenges. And as mentioned before, we had a robust May, June and now July. And the trend is in our favor for a strong September quarter.

As Bob said, we just completed a clinical study using our proprietary active ingredient hypochlorous acid for an antimicrobial facial cleanser product to be used part -- as part of the acne regimen with good results.

We will be issuing a press release on these results in the next several weeks, so please stay tuned and we anticipate launching that new product sometime in the fall of 2018. We look forward to sharing our progress as we build Sonoma to become a multi-technology dermatology company and achieving our purpose of relentless passion for healing.

So thank you operator. That's all from us..

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