SONOMA PHARMACEUTICALS : Management’s Discussion and Analysis of Financial Condition and

Manufacturing


Critical Accounting Policies

The preparation of our consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to exercise its judgment. We exercise considerable judgment
with respect to establishing sound accounting policies and in making estimates
and assumptions that affect the reported amounts of our assets and liabilities,
our recognition of revenues and expenses, and disclosure of commitments and
contingencies at the date of the consolidated financial statements.







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On an ongoing basis, we evaluate our estimates and judgments. Areas in which we
exercise significant judgment include, but are not necessarily limited to, our
valuation of accounts receivable, inventory, income taxes, equity transactions
(compensatory and financing) and contingencies. We have also adopted certain
polices with respect to our recognition of revenue that we believe are
consistent with the guidance provided under Securities and Exchange Commission
Staff Accounting Bulletin No. 104.

We base our estimates and judgments on a variety of factors including our
historical experience, knowledge of our business and industry, current and
expected economic conditions, the attributes of our products, the regulatory
environment, and in certain cases, the results of outside appraisals. We
periodically re-evaluate our estimates and assumptions with respect to these
judgments and modify our approach when circumstances indicate that modifications
are necessary.

While we believe that the factors we evaluate provide us with a meaningful basis
for establishing and applying sound accounting policies, we cannot guarantee
that the results will always be accurate. Since the determination of these
estimates requires the exercise of judgment, actual results could differ from
such estimates.

For a Summary of Critical Accounting Policies, please refer to Notes to
Consolidated Financial Statements, Note 3.

Results of Continuing Operations

Comparison of the Year Ended March 31, 2021 and 2020



Revenue


The following table shows our consolidated total revenue and revenue by
geographic region for the year ended March 31, 2021 and 2020:



                                    Years Ended
                                     March 31,
(In thousands)                   2021         2020       $ Change       % Change
United States                  $  5,419     $  7,991     $  (2,572 )         (32% )
Latin America                     5,976        3,773         2,203            58%
Europe and Rest of the World      7,234        6,164         1,070            17%
Total                          $ 18,629     $ 17,928     $     701             4%



The decrease in United States revenues for the year ended March 31, 2021
compared to the same periods in the prior year of ($2,572,000), is primarily the
result of a decrease in dermatology revenue as the result of the effects of
COVID-19 on our business and the associated restructuring of our sales team in
response to COVID-19. Revenue for acute care products and other indications
declined slightly from the prior year, offset by increases in revenue for our
animal care products of $658,000.

As a result of the asset purchase agreement and arrangement we entered into on
October 27, 2016 with Invekra, we were obligated to supply Invekra with product
at a reduced price through October 27, 2020. We processed orders from Invekra
through March 2021 and we expect fewer future orders as Invekra transitions to
their own manufacturing. We anticipate that we will continue to manufacture for
Invekra after March 2021 in smaller amounts as an overflow manufacturer.
However, we will charge market prices for manufacturing after October 27, 2020.
The increase in Latin America revenues for the year ended March 31, 2021
compared to the prior year periods, was the result of large orders for our
products from Invekra at cost, prior to contract expiration. We expect that once
Invekra starts manufacturing on their own the revenues in Latin America will
drop significantly in future periods.

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







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Cost of Revenue and Gross Profit

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




                                              Year ended
                                              March 31,

(In thousands, except for percentages) 2021 2020 Change % Change
Cost of Revenue

                          $ 12,070     $ 9,806     $  2,264           23%
Cost of Revenue as a % of Revenue             65%         55%         10%
Gross Profit                             $  6,559     $ 8,122     $ (1,563 )        (19)%
Gross Profit as a % of Revenue                35%         45%        (10)%




The gross margin decrease for the year ended March 31, 2021 compared to the year
ended March 31, 2020 is the result of product mix, associated with higher sales
to Invekra at a lower margin and higher product sales to distributors versus
sales through our direct sales force which tend to have higher net selling
prices and thus higher margins. Although distributor sales typically have lower
margins they don’t require the higher operating expenses associated with a
dedicated sales force.

Research and Development Expense

The research and development metrics are as follows:


                                          Year ended
                                           March 31,
(In thousands, except for
percentages)                          2021           2020          Change         % Change

Research and Development Expense $ 555 $ 1,339 $ (784 ) (59)%
Research and Development Expense
as a % of Revenue

                          3%             8%            (5)%




For the year ended March 31, 2021, research and development expenses decreased
as a result the closure of our research and development facility in Seattle,
Washington and its relocation to our facility in Mexico.

Selling, General and Administrative Expense

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




                                          Year ended
                                           March 31,
(In thousands, except for
percentages)                          2021           2020          Change        % Change
Selling, General and
Administrative Expense             $    9,453     $   14,173     $   (4,720 )         (33)%
Selling, General and
Administrative Expense as a % of
Revenue                                   50%            79%          (29)%



The decline in Selling, General and Administrative expense for the year ended
March 31, 2021 was the result of result of reduction in sales force and closing
of our Petaluma facility and moving our corporate offices to Woodstock, Georgia.







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Interest Expense


Interest expense was $12,000 and $16,000, respectively, for the years ended
March 31, 2021 and March 31, 2020.



Interest Income


Interest income for the year ended March 31, 2021 was $16,000, compared to
$50,000, for the year ended March 31, 2020. The decrease is primarily due to
interest income reported related to a discount on deferred revenue from our
agreement with Invekra.




Other (Expense) Income



Other (expense) income for the year ended March 31, 2021 was $(594,000) compared
to $240,000 for the year ended March 31, 2020. The increase in other expense
relates primarily to losses in foreign exchange which was approximately $690,000
for the year ended March 31, 2021 compared to gains in foreign exchange of
$306,000 for the year ended March 31, 2020.



Gain on Sale of Assets


Gain on the sale of assets for the year ended March 31, 2021 was $137,000. We
sold fixed assets no longer needed after closing our Petaluma manufacturing
facility. For the year ended March 31, 2020 we reported income related to the
sale of certain assets to Petagon in the amount of $2,472,000, as well as the
sale of assets to MicroSafe in the amount of $1,100,000.



Income Tax


Income tax expense for the year ended March 31, 2021 was $713,000 compared to
$29,000 for the year ended March 31, 2020. The increase in income tax expense is
the result of tax expense incurred by our Mexico subsidiary primarily as result
of the inability to deduct interest on its intercompany debt due to the Mexico
thin-cap rules.

Net Loss from Continuing Operations

Net loss from continuing operations for the year ended March 31, 2021 and March
31, 2020, was $4,615,000 and $3,573,000, respectively. The increase for the
current year is due to gains $3,572,000 from the sale of assets to Petagon and
Microsafe for the year ended March 31, 2020.

Results of Discontinued…



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