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

SONOMA PHARMACEUTICALS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Loss

(In thousands, except per share amounts)

(Unaudited)

On April 1, 2018, the Company adopted Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers Topic 606” (“Topic 606”) using the modified retrospective method. There was no impact to the Company upon the adoption of Topic 606. Revenue is recognized when the entity transfers promised goods or services to the customer, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In determining the appropriate amount of revenue to be recognized as the Company fulfills its obligations under the agreement, the Company performs the following steps: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and Accounts Receivable(v) recognition of revenue when (or as) the Company satisfies each performance obligation. The Company only applies the five-step model to contracts when it is probable that it will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer.

The Company generatesderives the majority of its revenue fromthrough sales of its products to a customer base including hospitals, medical centers, doctors, pharmacies, distributors and wholesalers. The Company sells products directly to end users and to distributors. The Company also has entered into agreements to license its technology and products.

The Company also provides regulatory compliance testing and quality assurance services to medical device and pharmaceutical companies.

The Company recordsconsiders customer purchase orders, which in some cases are governed by master sales agreements, to be the contracts with a customer. For each contract, the Company considers the promise to transfer products, each of which are distinct, to be the identified performance obligations. In determining the transaction price the Company evaluates whether the price is subject to refund or adjustment to determine the net consideration to which it expects to be entitled.

For all of its sales to non-consignment distribution channels, revenue is recognized when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable, and (iv) collectabilitycontrol of the saleproduct is reasonably assured.

The Company requires all product sales to be supported by evidence of a sale transaction that clearly indicates the selling pricetransferred to the customer shipping terms and payment terms. Evidence of an arrangement generally consists of a contract or purchase order approved by the customer. The Company has ongoing relationships with certain customers from(i.e. when our performance obligation is satisfied), which it customarily accepts orders by telephone in lieu of purchase orders.

The Company recognizes revenue at the time it receives confirmation that the goods were either tendered at their destination,typically occurs when shipped “FOB destination,” or transferred to a shipping agent, when shipped “FOB shipping point.” Delivery to the customer is deemed to have occurred when the customer takes title to the product. Generally, title passes to the customer upon shipment but could occur when the customer receives the product based on the terms of the agreement with the customer.

The selling prices of all goods are fixed, and agreed  For product sales to with the customer, prior to shipment. Selling prices are generally based on established list prices. The right to return product is customarily based on the terms of the agreement with the customer. The Company estimates and accrues for potential returns and records this as a reduction of revenue in the same period the related revenue is recognized. Additionally, distribution fees are paid to certain wholesale distributors based on contractually determined rates. The Company estimates and accrues the fee on shipment to the respective wholesaleits value-added resellers, non-stocking distributors and recognizes the fee as a reduction of revenue in the same period the related revenue is recognized. The Company also offers cash discounts to certainend-user customers, generally 2% of the sales price, as an incentive for prompt payment. The Company accounts for cash discounts by reducing accounts receivable by the prompt pay discount amount and recognizes the discount as a reduction of revenue in the same period the related revenue is recognized. Additionally, the Company participates in certain rebate programs which provide discounted prescriptionsgrants return privileges to qualified patients. The Company contracts with a third-party to administer the program. The Company estimates and accrues for future rebates based on historical data for rebate redemption rates and the historical value of redemptions. Rebates are recognized as a reduction of revenue in the same period the related revenue is recognized.

The Company evaluates the creditworthiness of newits customers and monitors the creditworthiness of its existing customers to determine whether an event or changes in their financial circumstances would raise doubt as to the collectability of a sale at the time in which a sale is made. Payment terms on sales made in the United States are generally 30 to 60 days and are extended up to 90 days for initial product launches, payment terms internationally generally range from prepaid prior to shipment to 90 days.

In the event a sale is made to a customer under circumstances in which collectability is not reasonably assured, the Company either requires the customer to remit payment prior to shipment or defers recognition of the revenue until payment is received. The Company maintains a reserve for amounts which may not be collectible due to risk of credit losses.

In the event a sale is made to a customer under circumstances in which returns cannot be estimated, the Company defers recognition of the revenue until sell-through is confirmed.

Product license revenue is generated through agreements with strategic partners for the commercialization of Microcyn® products. The terms of the agreements sometimes include non-refundable upfront fees. The Company analyzes multiple element arrangements to determine whether the elements can be separated. Analysis is performed at the inception of the arrangement and as each product is delivered. If a product or service is not separable, the combined deliverables are accounted for as a single unit of accounting and recognized over the performance obligation period.

When appropriate, the Company defers recognition of non-refundable upfront fees. If the Company has continuing performance obligations then such up-front feesa long history with its customers and is able to estimate the amount of product that will be returned.  Sales incentives and other programs that the Company may make available to these customers are deferredconsidered to be a form of variable consideration and recognized over the period of continuing involvement.Company maintains estimated accruals and allowances using the expected value method.

The Company has entered into consignment arrangementsin which goods are left in the possession of another party to sell. As products are sold from the customer to third parties, the Companyrecognizes royalty revenuesrevenue based on a variable percentage of a fixed price.  Revenue recognized varies depending on whether a patient is covered by insurance or is not covered by insurance. In addition, the Company may incur a revenue deduction related to the use of the Company’s rebate program.

Sales to stocking distributors are made under terms with fixed pricing and limited rights of return (known as “stock rotation”) of the Company’s products held in their inventory. Revenue from licensed productssales to distributors is recognized upon the saletransfer of control to the related products.distributor.

RevenueThe Company assessed the promised goods and services in the technical support to Invekra for a ten-year period as being a distinct service that Invekra can benefit from consulting contractson its own and is recognizedseparately identifiable from any other promises within the contract. Given that the distinct service is not substantially the same as other goods and services are provided. within the Invekra contract, the Company accounted for the distinct service as a performance obligation.

Revenue from testing contracts is recognized as tests are completed and a final report is sent to the customer.

Disaggregation of Revenue

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

Accounts Receivable

Trade accounts receivable are recorded net of allowances for cash discounts for prompt payment, doubtful accounts, and sales returns. Estimates for cash discounts and sales returns are based on analysis of contractual terms and historical trends.

The Company’s policy is to reserve for uncollectible accounts based on its best estimate of the amount of probable credit losses in its existing accounts receivable. The Company periodically reviews its accounts receivable to determine whether an allowance for doubtful accounts is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt. Other factors that the Company considers include its existing contractual obligations, historical payment patterns of its customers and individual customer circumstances, an analysis of days sales outstanding by customer and geographic region, and a review of the local economic environment and its potential impact on government funding and reimbursement practices. Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The allowance for doubtful accounts represents probable credit losses of $26,000 and $17,000 at September 30, 2018 and March 31, 2018, respectively. Additionally, at September 30, 2018 and March 31, 2018 the Company has allowances of $1,103,000 and $1,275,000, respectively, related to potential discounts, returns, distributor fees and rebates. The allowances are included in Accounts Receivable, net in the accompanying condensed consolidated balance sheets.

Inventories

Inventories are stated at the lower of cost, cost being determined on a standard cost basis (which approximates actual cost on a first-in, first-out basis), or market.net realizable value.

Due to changing market conditions, estimated future requirements, age of the inventories on hand and production of new products, the Company regularly reviews inventory quantities on hand and records a provision to write down excess and obsolete inventory to its estimated net realizable value. The Company recorded reservesa provision to reduce the carrying amounts of inventories to their net realizable value in the amountsamount of $191,000$128,000 and $61,000$111,000 at September 30, 20172018 and March 31, 2017, respectively.

Reclassifications

Certain prior period amounts have been reclassified for comparative purposes to conform to the fiscal 2018, presentation. These reclassifications have no impactrespectively, which is included in cost of product revenues on the Company’s previously reportedaccompanying condensed consolidated netstatements of comprehensive loss.

Subsequent Events

The Company evaluates events that have occurred after the balance sheet date but before the financial statements are issued. Based upon the evaluation, the Company did not identify any recognized or non-recognizedManagement has evaluated subsequent events that would have required adjustment or disclosure intransactions occurring through the date the condensed consolidated financial statements.statements were issued.

Adoption of Recent Accounting Standards

In March 2016Financial Instruments

On April 1, 2018, the FASB issuedCompany adopted ASU 2016-01 Financial Instruments-Overall, which addressed certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The Company has determined there was no material impact on the Company’s consolidated financial position and results of operations upon adoption of this topic.

Statement of Cash Flows

On April 1, 2018, the Company adopted ASU No. 2016-09, 2016-15,Compensation-Stock CompensationStatement of Cash Flows (Topic 718): Improvements to Employee Share-Based Payment Accounting230). This update simplifiesamendment provides guidance on the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures,presentation and statutory tax withholding requirements, as well as classification inof specific cash flow items to improve consistency within the statement of cash flows.

The Company has determined there was no material impact on the Company’s consolidated financial position and results of operations upon adoption of this topic.

On April 1, 2017,2018, the Company adopted ASU No. 2016-09. As a result2016-18,Statement of adopting ASU No. 2016-09,Cash Flows (Topic 230): Restricted Cash that changes the presentation of restricted cash and cash equivalents on the statement of cash flows. Restricted cash and restricted cash equivalents will be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The Company has made an accounting policy election to account for forfeitures as they occur. This change has been applied on a modified retrospective basis, withdetermined there was no material impactsimpact on the Company’s consolidated financial statements. Theposition and results of operations upon adoption of ASU No. 2016-09 also requires excess tax benefits and tax deficiencies be recorded in the income statement as opposed to additional paid-in capital when the awards vest or are settled and recognize all previously unrecognized excess tax benefits and tax deficiencies upon adoption as a cumulative-effect adjustment to retained earnings. As ofthis topic.

Business Combinations

On April 1, 2017,2018, the Company recognized excess tax benefitadopted ASU 2017-01,Business Combinations (Topic 805) Clarifying the Definition of approximately $533,000a Business. The amendments in this Update is to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as an increase to deferred tax assets. However, the entire amountacquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The Company has determined there was offset by a full valuation allowance.  Accordingly, no cumulative-effect adjustment to retained earnings was recorded as of September 30, 2017.

Additionally, the adoption of ASU No. 2016-09 related to the accounting for minimum statutory withholding tax requirements and cash paid by an employer when directly withholding shares for tax-withholding purposes had nomaterial impact on the Company's currentCompany’s consolidated financial statements or on any prior period financial statements presented.position and results of operations upon adoption of this topic.

Recent Accounting StandardsStock Compensation

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09,Revenue from Contracts with Customers, which supersedes the revenue recognition requirements in Topic 605,Revenue Recognition and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14, which defers by one year the effective date of ASU 2014-09. Accordingly, this guidance is effective for interim and annual periods beginning after December 15, 2017 with early adoption permitted for interim and annual periods beginning after December 15, 2016. In March 2016, the FASB issued ASU 2016-08Principal versus Agent Considerations (Reporting Revenue Gross versus Net) which finalizes its amendments to the guidance in the new revenue standard on assessing whether an entity is a principal or an agent in a revenue transaction. This conclusion impacts whether an entity reports revenue on a gross or net basis. In April 2016, the FASB issued ASU 2016-10Identifying Performance Obligations and Licensing, which finalizes its amendments to the guidance in the new revenue standard regarding the identification of performance obligations and accounting for the license of intellectual property. In May 2016, the FASB issued ASU 2016-12Narrow-Scope Improvements and Practical Expedients, which finalizes its amendments to the guidance in the new revenue standard on collectability, noncash consideration, presentation of sales tax, and transition. In December 2016, the FASB issued ASU 2016-20,Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers, which continues the FASB’s ongoing project to issue technical corrections and improvements to clarify the codification or correct unintended applications of guidance. The amendments are intended to make the guidance more operable and lead to more consistent application. The amendments have the same effective date and transition requirements as the new revenue recognition standard. The Company will adopt the new standard onOn April 1, 2018, and currently plans to use the modified retrospective method. The majority of the Company’s business is ship and bill and, on that primary revenue stream, the Company does not expect significant differences. However, the Company’s analysis is preliminary and subject to change. The Company has not completed its assessment of multiple element arrangements and certain discount and trade promotion programs.

In May 2017, the FASB issuedadopted ASU No. 2017-09, Compensation–StockCompensation-Stock Compensation (Topic 718):Scope of Modification Accounting, clarifying when a change to the terms or conditions of a share-based payment award must be accounted for as a modification. The new guidance requires modification accounting if the fair value, vesting condition or the classification of the award is not the same immediately before and after a change to the terms and conditions of the award. The new guidance isCompany has determined there was no material impact on the Company’s consolidated financial position and results of operations upon adoption of this topic.

Recent Accounting Standards

Leases

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02,Leases (Topic 842). This ASU will require lessees to recognize a right of use asset and lease liability on the balance sheet for leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The amendment will be effective for annual and interim periods beginning after December 15, 2018, including interim periods within those fiscal years. In July 2018, the Company on a prospective basis beginning on April 1, 2018, with earlyFASB issued ASU No. 2018-10,Codification Improvements to Topic 842, Leasesand ASU No. 2018-11,Leases - Targeted Improvements.ASU 2018-10 provides certain amendments that affect narrow aspects of the guidance issued in ASU 2016-02. ASU No. 2018-11 allows entities the option to prospectively apply the new lease standard at the adoption permitted.date instead of recording the cumulative impact of all comparative reporting periods presented within retained earnings. The Company is currently evaluating the impact that ASU 2017-092016-02, ASU 2018-10 and ASU 2018-11 will have on its consolidated financial position, results of operations or financial statement disclosure. 

Reporting Comprehensive Income

In February 2018, the FASB issued ASU No. 2018-02,Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income ("ASU 2018-02"). ASU 2018-02 provides financial statement preparers with an option to reclassify stranded tax effects within accumulated other comprehensive income to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) (or portion thereof) is recorded. ASU 2018-02 is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted for any interim period for which financial statements have not been issued. The Company does not believe that the adoption of this guidance will have a material impact on the Company's consolidated financial statements due to the presence of a full valuation allowance. However, the Company is in the process of evaluating the impact of this new guidance on the Company's consolidated financial statements and disclosures.

Stock Compensation

In June 2018, the FASB issued ASU No. 2018-07,Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. The guidance in this ASU expands the scope of ASC Topic 718 to include all share-based payment arrangements related disclosures.to the acquisition of goods and services from both nonemployees and employees. This amendment will be effective for annual and interim periods beginning after December 31, 2018. The Company is currently evaluating the impact ASU 2018-07 will have on its consolidated financial position, results of operations or financial statement disclosure. 

Accounting standards that have been issued or proposed by the Financial Accounting Standards Board,FASB, the SEC and/or other standards-settingstandard setting bodies that do not require adoption until a future date are not expected to have a material impact on the condensed consolidated financial statements upon adoption.

Description of Sale to Invekra

On October 27, 2016, the Company, along with its Mexican subsidiary and manufacturer Oculus Technologies of Mexico, S.A. de C.V. (“OTM”), closed on an asset purchase agreement with Invekra, S.A.P.I de C.V. (“Invekra”), an affiliate of Laboratorios Sanfer S.A. de C.V., for the sale of certain of its Latin America assets. Specifically, the Company agreed to sell certain patents, patent applications, trademarks and territory rights for Mexico, the Caribbean and South America, excluding the sale of dermatology products in Brazil, as well as to build and deliver equipment that Invekra will use to produce its own product.

The aggregate purchase price that Invekra will pay for the assets is $22,000,000, of which $18,000,000 was paid upon closing, $1,500,000 was paid on March 16, 2017 upon the delivery of certain equipment, and $2,500,000 is to be paid in Mexican currency in quarterly installments over a period of ten years from closing as consideration for the provision of certain services and providing technical assistance, calculated as three percent on net sales of certain products in Latin America, excluding Mexico. Because the $2,500,000 is to be paid in foreign currency, the Company may receive more or less than $2,500,000 due to currency fluctuations. During the six months ended September 30, 2017, the Company recorded $39,000 of service revenue and $33,000 of interest income related to technical assistance which is reflected in the accompanying condensed consolidated statement of comprehensive loss for the six months ended September 30, 2017. The Company agreed to forego recognition any royalty in the second quarter until certain replacement parts will be delivered in the third quarter.

In connection with the asset purchase agreement, the Company agreed to provide the technology, know-how and assistance to Invekra to enable Invekra to manufacture on its own the products as currently produced by the Company (“Technical Services Arrangement”), and continue to supply product to Invekra for a two year transition period from the Sale Date, subject to mutual extension (“Supply Agreement”). During the three and six months ended September 30, 2017, the Company reported $754,000 and $1,323,000, respectively, of Latin America product revenue related to the Supply Agreement with Invekra.

The Company will provide product under the Supply Agreement at a reduced price from its current price list, while Invekra builds its own manufacturing line. At the conclusion of the transition period, the Company will cease to be a supplier of product to Invekra. The Company is uncertain as to the duration of the transition period or when Invekra will complete the build out of its manufacturing line. Pursuant to the Supply Agreement, the Company is subject to a potential penalty for failure to supply the products for a consecutive period of six months. The penalty, if triggered, will require the Company to make a one-time payment of $2,000,000 to Invekra. The penalty decreases by 12.5% each quarter of the term of the supply period. The Company does not expect to incur this penalty.

Discontinued operations

The Company determined that the sale of its Latin American operations to Invekra qualified as a sale of a component of its business and, as such, all such activity prior to consummation of the sale is required to be included in discontinued operations on the Company’s statement of operations. This includes the direct labor and materials for the product delivered to Invekra, the revenue on the sales to Invekra and the gain on the sale to Invekra, net of tax.

The operations of its Latin American business included in discontinued operations is summarized as follows:

Inventories net

Inventories net consist of the following:

Legal Matters

TheOn March 17, 2017, the Company filed a lawsuit against Collidion, Inc. and several of its former employees, officers and directors, alleging the misappropriation of its confidential, proprietary and trade secret information as well as breach of fiduciary duties in the United States District Court for the Northern District of California, San Francisco Division. During the three months ended September 30, 2018, the Company settled the lawsuit to the satisfaction of all parties. There has been no finding of wrongdoing against any party.

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

Employment Agreements

As of September 30, 2017,2018, the Company had employment agreements in place with sixfive of its key executives. The agreements provide, among other things, for the payment of twelvenine to eighteentwenty-four months of severance compensation for terminations under certain circumstances. With respect to these agreements, at September 30, 2017,2018, aggregated annual salaries would be $1,167,000 and potential severance payments to these key executives would be $1,417,000 if triggered.

Authorized Capital

TheAt the annual meeting, the Company’s stockholders approved an amendment to its Restated Certificate of Incorporation, as amended, to increase the number of authorized common stock, $0.0001 par value per share, from 12,000,000 to a total of 24,000,000 shares. Effective September 13, 2018, the Company filed a certificate of amendment with the Secretary of State of the State of Delaware in order to effect an increase of the total number of shares of common stock authorized for issuance to 24,000,000. Additionally, the Company is authorized to issue up to 12,000,000 shares of common stock with a par value of $0.0001 per share and 714,286 shares of convertible preferred stock with a par value of $0.0001 per share.

Common Stock Issued to Services ProviderProviders

During the three months ended September 30, 2017, theThe Company entered into an agreement with Actual, Inc., a firm that providesfor certain marketing and branding consulting services. In connection with the agreement, the Company pays a portion of the service fees in common stock. On July 27, 2017, the Company issued 2,570 shares of restricted common stock valued at $6.74 per share and on August 22, 2017, the Company issued 3,133 shares of restricted common stock valued at $5.53 per share. The aggregate fair market value of the common stock issued was $35,000. The Company has determined that the fair value of the common stock was more readily determinable than the fair value of the services rendered. On July 12, 2018, the Company issued 17,741 shares of restricted common stock valued at $2.48 per share. The aggregate fair market value of the common stock issued was $44,000. The Company has determined that the fair value of the common stock was more readily determinable than the fair value of the services rendered. Accordingly, during the three and six months ended September 30, 2017, the Company recorded $35,000 of expense related to common stock issued. During the three and six months ended September 30, 2018, the Company recorded $44,000 of expense related to common stock issued. The expense was recorded as selling, general and administrative expense in the accompanying condensed consolidated statement of comprehensive lossloss.

The Company entered into an agreement with The Benchmark Company, LLC for certain finance related consulting services. In connection with the agreement, the Company pays a portion of the service fees in common stock. On July 31, 2018, the Company issued 6,881 shares of restricted common stock valued at $2.18 per share. The aggregate fair market value of the common stock issued was $15,000. The Company has determined that the fair value of the common stock was more readily determinable than the fair value of the services rendered. Accordingly, during the three and six months ended September 30, 2017.2018, the Company recorded $15,000 of expense related to common stock issued. The expense was recorded as selling, general and administrative expense in the accompanying condensed consolidated statement of comprehensive loss.

On April 1, 2017, the Company adopted ASU 2016-09 and, as a result, made a company-wide accounting policy change with respect to accounting for forfeitures. The Company applied a modified retrospective approach for adoption of the new policy and accordingly recorded an $11,000 increase to opening accumulated deficit at April 1, 2017. In accordance with the adoption of the accounting policy, the Company no longer estimates forfeitures based on historical experience and no longer reduces compensation expense based on the expected forfeitures. Beginning April 1, 2017, the Company will record forfeitures as they occur and will reduce compensation cost at the time of forfeiture.

The weighted average grant date fair values of options granted during the three months ended September 30, 2018 and 2017 was $1.96 and $5.58, respectively, and the weighted average grant date fair values of options granted during the six months ended September 30, 2018 and 2017 was $5.58$2.20 and $6.01, respectively.

Share-based awards compensation expense is as follows:

At September 30, 2018, there were unrecognized compensation costs of $1,450,000 related to stock options which is expected to be recognized over a weighted-average amortization period of 1.56 years. At September 30, 2017, there were unrecognized compensation costs of $2,999,000 related to stock options which is expected to be recognized over a weighted-average amortization period of 2.43 years.

At September 30, 2018, there were unrecognized compensation costs of $111,000 related to restricted stock which is expected to be recognized over a weighted-average amortization period of 1.53 years. At September 30, 2017, there were unrecognized compensation costs of $239,000 related to restricted stock which is expected to be recognized over a weighted-average amortization period of 1.69 years.

No income tax benefit has been recognized relating to stock-based compensation expense and no tax benefits have been realized from exercised stock options.

Stock-Based Award Activity

On April 1, 2017, pursuant to “evergreen” provisions in the 2011 Plan and the 2016 Plan, the number of shares authorized for issuance in the 2011 Plan increased by 643,383 shares and the number of shares authorized for issuance in the 2016 Plan increased by 343,137 shares.

Stock options award activity is as follows:

The aggregate intrinsic value of stock options is calculated as the difference between the exercise price of the underlying stock options and the fair value of the Company’s common stock, or $5.22$1.46 per share at September 30, 2017.2018.

Restricted stock award activity is as follows:

No income tax benefit has been recognized relating to stock-based compensation expense and no tax benefits have been realized from exercised stock options.

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

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

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

The Company has completed a study to assess whether a change in control has occurred or whether there have been multiple changes of control since the Company’s formation.formation through March 31, 2018. The Company determined, based on the results of the study, no change in control occurred for purposes of Internal Revenue Code sectionSection 382. The Company, after considering all available evidence, fully reserved for these and its other deferred tax assets since it is more likely than not such benefits will not be realized in future periods. The Company has incurred losses for both financial reporting and income tax purposes for the year ended March 31, 2017.2018. Accordingly, the Company is continuing to fully reserve for its deferred tax assets. The Company will continue to evaluate its deferred tax assets to determine whether any changes in circumstances could affect the realization of their future benefit. If it is determined in future periods that portions of the Company’s deferred income tax assets satisfy the realization standards, the valuation allowance will be reduced accordingly.

AsThe Company only recognizes tax benefits from an uncertain tax position if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a resultposition are measured based on the largest benefit that has a greater than fifty percent likelihood of certain realization requirements of Accounting Standards Codification Topic 718,being realized upon ultimate resolution. To date, the Company’sCompany has not recognized such tax benefits in its consolidated financial statements.

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Act. The Tax Act reduces the federal corporate income tax rate from 35% to 21%, effective January 1, 2018, which the Company expects will positively impact its future effective tax rate and after-tax earnings in the United States. The Company recognized a decrease related to its federal deferred tax assets and liabilities do not include certain deferred tax assets at September 30, 2017 that arose directly from tax deductionsliabilities, before the valuation allowance. Because a change in the valuation allowance completely offsets the change in deferred taxes, there was no impact on the consolidated financial statements related to equity compensation in excess of compensation recognized for financial reporting purposes. Equity will be increased by approximately $533,000 if and when such deferred tax assets are ultimately realized.the rate change.

The Company may also be affected by certain other aspects of the Tax Act, including, without limitation, provisions regarding repatriation of accumulated foreign earnings and deductibility of capital expenditures. However, these assessments are based on preliminary review and analysis of the Tax Act and are subject to change as the Company continues to evaluate these highly complex rules as additional interpretive guidance is issued. The Company is also in the process of determining the impacts of the new Global Intangibles Low-Taxed Income (“GILTI”) tax law and has not yet included any potential GILTI tax or elected any related accounting policy. The Company will continue to analyze the effects of the Tax Act and any additional impacts of the Tax Act will be recorded as they are identified during the measurement period.

Also on December 22, 2017, the SEC staff issued Staff Accounting Bulletin 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”), which provides guidance on accounting for the impact of the Tax Act. As permitted by SAB 118, both of the tax benefits recorded by the Company for the fiscal year ended March 31, 2018 represent provisional amounts based on its current best estimates. Any adjustments made to those provisional amounts will be included in income from operations and recorded as an adjustment to tax expense through the fiscal year ending March 31, 2019. The recorded, provisional amounts reflect assumptions made based upon our current interpretation of the Tax Act, and may change as the Company receives additional clarification and guidance in the form of technical corrections to the Tax Act or regulations issued by the U.S. Treasury.

The Company does not have any tax positions for which it is reasonably possible the total amount of gross unrecognized tax benefits will increase or decrease within twelve months of March 31, 2018. The unrecognized tax benefits may increase or change during the next year for items that arise in the ordinary course of business.

The Company generates product revenues from products which are sold into the human and animal healthcare markets, and the Company generates service revenues from laboratory testing services which are provided to medical device manufacturers. Additionally, the Company provides technical services to Invekra.

The following table showspresents the Company’s disaggregated product revenues by geographic region:

In connection with the Company’s sale of its Latin America business to Invekra, product related revenues were reclassified from continuing operations to discontinued operations. The amounts were classified in the prior periods as Latin America sales. The amounts reclassified are as follows:

The Company’s service revenues amounted to $181,000$304,000 and $224,000$181,000 for the three months ended September 30, 2018 and 2017, and 2016, respectively. During the three months ended September 30, 2018, the Company recorded service revenue related to technical services provided to Invekra in the amount of $14,000.

The Company’s service revenues amounted to $413,000$578,000 and $451,000$413,000 for the six months ended September 30, 2018 and 2017, respectively. During the six months ended September 30, 2018 and 2016,2017, the Company recorded service revenue related to technical services provided to Invekra in the amount of $28,000 and $39,000, respectively.

For the three months ended September 30, 2018, one customer represented 15% of net revenue and one customer represented 13% of net revenue. For the three months ended September 30, 2017, one customer represented 22% of net revenue, one customer represented 17% of net revenue, and two customers each represented 13% of net revenue.

For the threesix months ended September 30, 2016,2018, one customer represented 29%20% of net revenue and one customer represented 13% of net revenue.

For the six months ended September 30, 2017, one customer represented 20% of net revenue, one customer represented 16% of net revenue, and two customers each represented 12% of net revenue. For the six months ended September 30, 2016, one customer represented 29% of net revenue.

At September 30, 2017,2018, one customer represented 47%13%, one customer represented 19%, and one customer represented 17% of the net accounts receivable balance. At March 31, 2017,2018, one customer represented 26%, one customer represented 12%36%, and one customer represented 10%18% of the net accounts receivable balance.

On October 4, 2018, the Company sold 113,000 shares of common stock, at a price of $2.39 per share, through its At Market Issuance Sales Agreement with B. Riley FBR, Inc. for gross proceeds of $270,000. This sale exceeded the aggregate market value of the Company’s securities sold during the period of twelve calendar months prior to the sale of one-third of the aggregate market value of its common stock held by non-affiliates, and thus, the 113,000 shares of common stock were unregistered. The Company could be liable in the event claims or suits for rescission are brought and successfully concluded for failure to register these securities or for acts or omissions constituting offenses under the Securities Act, the Securities Exchange Act of 1934, or applicable state securities laws, the Company could be liable for damages and penalties assessed by the SEC and state securities regulators.

The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and notes to those statements included elsewhere in this Quarterly Report on Form 10-Q as of September 30, 20172018 and our audited consolidated financial statements for the year ended March 31, 20172018 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on June 28, 2017.26, 2018.

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

Forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to the risks described in our Annual Report on Form 10-K including: our ability to become profitable; the impact of changes to reimbursement levels from third-party payors or increased pricing pressure due to rebates; the impact of the Invekra transaction on our business and results of operations; the vulnerability of our Petaluma facility to extreme weather events; the impact of seasonality on our sales; the progress and timing of our development programs and regulatory approvals for our products; the benefits and effectiveness of our products; the ability of our products to meet existing or future regulatory standards; the progress and timing of clinical trials and physician studies; our expectations related to the use of our cash reserves; our expectations and capabilities relating to the sales and marketing of our current products and our product candidates; our ability to gain sufficient reimbursement from third-party payors; our ability to compete with other companies that are developing or selling products that are competitive with our products; the establishment of strategic partnerships for the development or sale of products; the risk our research and development efforts do not lead to new products; the timing of commercializing our products; our ability to penetrate markets through our sales force, distribution network, and strategic business partners to gain a foothold in the market and generate attractive margins; the expansion of our sales force and distribution network; the ability to attain specified revenue goals within a specified time frame, if at all, or to reduce costs; the outcome of discussions with the U.S. Food and Drug Administration, or FDA, and other regulatory agencies; the content and timing of submissions to, and decisions made by, the FDA and other regulatory agencies, including demonstrating to the satisfaction of the FDA the safety and efficacy of our products; our ability to manufacture sufficient amounts of our product candidates for clinical trials and products for commercialization activities; our ability to protect our intellectual property and operate our business without infringing on the intellectual property of others; our ability to continue to expand our intellectual property portfolio; our expectations about the outcome of litigation and controversies with third parties; the risk we may need to indemnify our distributors or other third parties; risks attendant with conducting a significant portion of our business outside the United States; our ability to comply with complex federal and state fraud and abuse laws, including state and federal anti-kickback laws; risks associated with changes to health care laws; our ability to attract and retain qualified directors, officers and employees; our expectations relating to the concentration of our revenue from international sales; our ability to expand to and commercialize products in markets outside the wound care market; and the impact of the Sarbanes-Oxley Act of 2002 and any future changes in accounting regulations or practices in general with respect to public companies. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based, except as required by law.

Our Business

We are a specialty pharmaceutical company dedicated to identifying, developing and commercializing unique, differentiated therapies to millions of patients living with chronic skin conditions. We offer early-intervention relief with virtually no side-effects or contraindications. We believe our products, which are sold throughout the United States and internationally, have improved patient outcomes for more than fivesix million patients globally by treating and reducing certain topical skin diseases including acne, atopic dermatitis, scarring, infections, itch, pain and harmful inflammatory responses. Our vision is to be a catalyst for improved care and increased access for all patients.

We are focused on the development and commercialization of therapeutic solutions in medical dermatology to treat skin conditions, such as acne, atopic dermatitis and scarring. These diseases impact millions of patients worldwide and can have significant, multi-dimensional effects on patients’ quality of life, including their physical, functional and emotional well-being.

Some of our key products in the United States are:

Our key product outside the United States is:

As of September 30, 2017,To date, we have obtained 17 clearances from the21 U.S. Food and Drug Administration, or FDA, that permit us to sell ourclearances permitting the sale of products as medical devices for Section 510(k) of the Federal Food, Drug and Cosmetic Act in the United States.

Outside the United States, we sell products for dermatological and advanced tissue care with a European Conformity marking, (known as Conformité Européenne, or CE) coveringCE. These CEs cover 25 of our products andin 48 countries with various approvals in Brazil, China, Southeast Asia, South Korea, India, Australia, New Zealand, and the Middle East.

Our StrategyBusiness Channels

Our strategycore market differentiation is based on being the leading developer and producer of stabilized hypochlorous acid, or HOCl, solutions. HOCl is known to in-license, acquire, developbe among the safest and commercialize unique, affordablemost-effective ways to relieve itch, inflammation and differentiated therapies that we believe advance the standard of care for patients with dermatological diseases. The key components of our strategy are to:burns while stimulating natural healing through increased oxygenation and eliminating persistent microorganisms and biofilms.

Our core market includes patients who suffer from various skin diseases, including dermatoses, acne, scarring, skin-barrier and scaly skin conditions. Our secondary market includes eye-hygiene and acute care markets. These conditions impact patients worldwide who have had to live with less than optimal solutions or ones that come with significant side effects. Skin conditions can have significant, multi-dimensional effects on quality of life, including on patient’s physical, functional and emotional well-being.

We have also built on our HOCl technology foundation by adding two complementary technology platforms: Lipogrid® Skin Barrier solutions and Exuvimax Skin de-scaling solutions. Lipogrid is a lipid structural matrix of solid lipid particles and vesicles containing phospholipids, ceramides, fatty acids and cholesterol-type stabilizers that deliver building blocks to the dermis and protect the skin. Exuvimax contains a combination of dicaprylyl carbonate (Cetiol® Oil) and dimethicones that provide a patented formulation designed for a very effective but safe keratolytic effect which is the shedding of the top layer of skin. Our product Loyon® is based on the Exuvimax technology and its key benefit is to remove scale and therefore allow the topical treatments to work more effectively and faster on the underlying condition.

Dermatology

In the United States, we sell into dermatology markets with a sales team that visits or calls dermatologists. Our dermatology products are primarily purchased by distributors, wholesalers, and pharmacies.

Although specific customer requirements can vary depending on applications, customers generally demand quality, innovation, affordability and clinically-supported efficacy. We have responded to these customer demands by introducing new products that treat persistent and common dermatological afflictions, as well as promote healing and improve results for patients opting for cosmetic dermatology procedures. We are strategically focused on introducing innovative new products that are supported by human clinical data with applications that address specific dermatological procedures currently in demand. In addition, we look for markets where we can provide effective product line extensions and pricing to new product families. In the future, to increase market penetration beyond marketing to core dermatologists, we are also evaluating how our products fit into the aesthetic dermatologists and plastic surgeons practice.

We seek to extend and expand our strong ongoing relationships with customers through new products, sales of existing products, ongoing training and support, and distribution of skincare products. We primarily target practitioners through office visits, workshops, trade shows, webinars and trade journals. We also market to potential patients through brochures, workshops and websites. In addition, we offer clinical forums with recognized expert panelists to promote advanced treatment.

Eye Care and Advanced Tissue Care

Our plan iseye care and advanced tissue care products provide patients similar benefits to evolvethose in dermatology. We support the eye care and advanced tissue care markets with a dedicated in-house sales force and through an inside call center. We have also entered into a leading dermatology company, providing innovativestrategic partnerships with respected and cost-effectiveinfluential physicians and surgeons to promote our products. Our eye care products include prescription and dispensing solutions prescribed mainly by ophthalmologists and optometrists supported by pharmacies and, in some cases, sold through wholesale networks. Our tissue care products are primarily purchased by hospitals, physicians, nurses, and other healthcare practitioners.

Animal Health Care

Our animal health care products provide similar benefits to patients, while generating strong, consistent revenue growththose in human dermatology. For our animal health products, we partnered with Manna Pro Products, LLC to bring relief to pets and maximizing long-term shareholder value.peace of mind to their owners. Manna Pro distributes non-prescription products to national pet store retail chains, farm animal specialty stores, farm animal veterinarians, grocery stores and mass retailers in the United States and Canada. Through Manna Pro, we primarily target marketing efforts to veterinarians through trade shows and to customers through social media.

Additional Information

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

Results of Operations

Comparison of the Three Months Ended September 30, 20172018 and 2016

Revenues2017

Total revenues for the three months ended September 30, 20172018 of $4,325,000$4,939,000 increased by $1,527,000,$614,000, or 55%14%, as compared to $2,798,000$4,325,000 for the three months ended September 30, 2016.2017. Product revenues for the three months ended September 30, 20172018 of $4,144,000$4,635,000 increased by $1,570,000,$491,000, or 61%12%, as compared to $2,574,000$4,144,000 for the three months ended September 30, 2016.2017. This increase was primarily the result of strong growth in product revenue of $158,000, or 7%, in the United States, Europe, and the Restgrowth of the World.product revenue of $243,000, or 32%, in Latin America.

Product revenues in the United States for the three months ended September 30, 20172018 of $2,268,000$2,427,000 increased by $571,000,$159,000, or 34%7%, as compared to $1,697,000$2,268,000 for the three months ended September 30, 2016.2017. This increase was mostly the result of highera $308,000, or 161%, increase in sales of our dermatology and acuteanimal health care products, partly offset by a declinedecrease of $18,000, or 4%, in sales of $120,000 related to our animal healthacute care products.

Product revenue in Europeproducts and the Rest of the World for the three months ended September 30, 2017 of $1,122,000 increased by $245,000, or 28%, as compared to $877,000 for the three months ended September 30, 2016. This increase was mostly the result of higher sales in Europe, China, Hong Kong, Singapore, and India partly offset by a decrease of $137,000, or 8%, in the Middle East.sales of our dermatology products.

As a result of the asset purchase agreement and arrangement we entered into on October 27, 2016 with Invekra, we expect our revenues in Latin America will decrease significantly. We will continue to supply Invekra with product at a reduced price until they set up their manufacturing facility. We expect our revenues in Latin America will decrease significantly once Invekra has set up their manufacturing facility. During the three months ended September 30, 2017,2018, we reported $754,000$749,000 of Latin America product revenue related to Invekra.Invekra as compared to $754,000 during the three months ended September 30, 2017. Additionally, pursuantwe reported $248,000 of Latin America product revenue related to dermatology products sold in Brazil.

Product revenue in Europe and the arrangement, we will receive a royaltyRest of 2.5% on all Latin American net revenues excluding Mexico, with a minimum payment of $250,000 per yearthe World for the next ten years,three months ended September 30, 2018 of $1,212,000 increased by $90,000, or 8%, as compared to be paid quarterly$1,122,000 for the three months ended September 30, 2017. This increase was mostly the result of increases in Mexican pesos.Europe and India, partly offset by decreases in the Middle East, Far East and New Zealand.

The following table shows our product revenues by geographic region:

In connection with our sale of our Latin American business to Invekra, product revenues and cost of revenues reported in the prior period were reclassified from continuing operations to discontinued operations as follows:

Service revenues for the three months ended September 30, 20172018 of $181,000 decreased$304,000 increased by $43,000,$123,000, or 19%68%, when compared to $224,000$181,000 in the prior period. The decreaseincrease was primarily the result of higher laboratory tests and services in the United States. Additionally, during the three months ended September 30, 2018, the Company recorded service revenues wasrevenue related to a decreasetechnical services provided to Invekra in our lab services business.the amount of $14,000.

Gross Profit

For the three months ended September 30, 2017,2018, we reported total revenues of $4,325,000$4,939,000 and total cost of revenues of $2,477,000,$2,512,000, resulting in total gross profit of $1,848,000$2,427,000 or 43%49% of total revenues, compared to a gross profit of $1,036,000$1,848,000 or 37%43% of total revenues, for the same period in the prior year. The increase in gross profit was primarily due to the reclassification, in the prior period, of Latin America product and license revenue and related variable cost of goods sold from continuing operations to discontinued operations. Additionally, as dermatology product revenues increase as an overall percentage of our product revenues, we expect our margins will improve due to higher gross margins associated with our dermatology products.

For the three months ended September 30, 2017,2018, we reported product revenues of $4,144,000$4,635,000 and cost of product revenues of $2,308,000,$2,313,000, resulting in product gross profit of $1,836,000,$2,322,000, or 44%50% of product revenues, compared to product gross profit of $1,016,000,$1,836,000, or 39%44% of product revenues, for the same period in the prior year. The increase in gross profit as a percentage of product revenues was primarily due to the reclassification,a decrease in rebate costs in the prior period, of Latin America product and related variable cost of goods sold from continuing operations to discontinued operations. Additionally, as dermatology product revenues increase as an overall percentage of our product revenues, we expect our margins will improve due to higher gross margins associated with our dermatology products.current period.

For the three months ended September 30, 2017,2018, we reported service revenues of $181,000$304,000 and cost of service revenues of $169,000,$199,000, resulting in service gross profit of $105,000, or 35% of service revenues, compared to service gross profit of $12,000, or 7% of service revenues, compared to service gross profit of $20,000, or 9% of service revenues, for the same period in the prior year. The decrease in service gross profit was primarily related to lower service revenue in the current period and the mix of tests and services performed.

Research and Development Expense

Research and development expenses for the three months ended September 30, 20172018 of $368,000 decreased$390,000 increased by $11,000,$22,000, or 3%6%, as compared to $379,000$368,000 for the three months ended September 30, 2016.2017. The decreaseincrease is largely due to a decreaseprimarily the result of higher salaries and benefits in spending on product development.the current period.

Selling, General and Administrative Expense

Selling, general and administrative expenses for the three months ended September 30, 20172018 of $4,337,000$4,689,000 increased by $694,000,$352,000, or 19%8%, when compared to $3,643,000$4,337,000 for the three months ended September 30, 2016.2017. The increase for the three months ended September 30, 2017 was primarily due to higher salesresult of increased legal and marketing expenses related to our growing dermatology sales force.in the U.S.

Interest Expense

Interest expense for the three months ended September 30, 20172018 of $10,000 increased$7,000 decreased by $9,000$3,000 when compared to $1,000$10,000 for the three months ended September 30, 2016.2017. The increasedecrease in interest expense relates primarily to capital leases.

Interest Income

Interest income for the three months ended September 30, 20172018 of $18,000$47,000 increased by $17,000$29,000 when compared to $1,000$18,000 for the three months ended September 30, 2016.2017. The increase is primarily due to interest income earnedreported related to a discount on increased cash and cash equivalent balances.deferred revenue from our agreement with Invekra.

Other Expense

Other expense for the three months ended September 30, 20172018 of $21,000$208,000 increased by $12,000$187,000 when compared to $9,000other expense of $21,000 for the three months ended September 30, 2016.2017. The increase in other expense relates primarily to fluctuationfluctuations in foreign exchange and increasedstate franchise tax payments.taxes.

Net Loss from Continuing Operations

Net Loss from continuing operations for the three months ended September 30, 20172018 of $2,870,000 increased $231,000, or 9%,$2,820,000 decreased $50,000, when compared to $2,639,000net loss of $2,870,000 for the three months ended September 30, 2016.2017. The increasedecrease in net loss from continuing operations is primarily due to $356,000 of income tax benefit recorded in the prior period offset by a decrease in loss from continuing operations before income taxes of $125,000 in the current period.

Income from Discontinued Operations, net of Tax

Income from discontinued operations, net of tax for the three months ended September 30, 2016 includes $1,046,000 ofoperating losses, caused by higher sales and gross profit reclassified from continuing operations to discontinued operations during the period. Additionally, for the three months ended September 30, 2016, we recorded income tax expense related to the transaction in the amount of $356,000 and we recorded a $356,000 tax benefit resulting in no tax expense during the period.profitability.

The following summarizes operations of our Latin American business included in discontinued operations:

Comparison of the Six Months Ended September 30, 20172018 and 2016

Revenues 2017

Total revenues for the six months ended September 30, 20172018 of $8,160,000$9,308,000 increased by $2,724,000,$1,148,000, or 50%14%, as compared to $5,436,000$8,160,000 for the six months ended September 30, 2016.2017. Product revenues for the six months ended September 30, 20172018 of $7,747,000$8,730,000 increased by $2,762,000,$983,000, or 55%13%, as compared to $4,985,000$7,747,000 for the six months ended September 30, 2016.2017. This increase was primarily the result of strong growth in product revenue of $270,000, or 7%, in the United States, Europe, and the Restgrowth of the World.product revenue of $753,000, or 57%, in Latin America.

Product revenues in the United States for the six months ended September 30, 20172018 of $4,127,000$4,397,000 increased by $1,057,000,$270,000, or 34%7%, as compared to $3,070,000$4,127,000 for the six months ended September 30, 2016.2017. This increase was mostly the result of highera $430,000, or 98%, increase in sales of our dermatology and acuteanimal health care products, partly offset by a declinedecrease of $41,000, or 5%, in sales of $265,000 related to our animal healthacute care products and a decrease of $126,000, or 4%, in sales of our dermatology products.

Product revenue in Europe and the Rest of the World for the six months ended September 30, 2017 of $2,297,000 increased by $382,000, or 20%, as compared to $1,915,000 for the six months ended September 30, 2016. This increase was mostly the result of increases in Europe, China, Hong Kong, Singapore, New Zealand and India partly offset by a decrease in the Middle East.

As a result of the asset purchase agreement and arrangement we entered into on October 27, 2016 with Invekra, we expect our revenues in Latin America will decrease significantly. We will continue to supply Invekra with product at a reduced price until they set up their manufacturing facility. We expect our revenues in Latin America will decrease significantly once Invekra has set up their manufacturing facility. During the six months ended September 30, 2017,2018, we reported $1,323,000$1,828,000 of Latin America product revenue related to Invekra.Invekra as compared to $1,323,000 during the six months ended September 30, 2017. Additionally, pursuantwe reported $248,000 of Latin America product revenue related to dermatology products sold in Brazil.

Product revenue in Europe and the arrangement, we will receive a royaltyRest of 2.5% on all Latin American net revenues excluding Mexico, with a minimum payment of $250,000 per yearthe World for the next ten years,six months ended September 30, 2018 of $2,257,000 decreased by $40,000, or 2%, as compared to be paid quarterly$2,297,000 for the six months ended September 30, 2017. This decrease was mostly the result of decreases in Mexican pesos.the Middle East, Far East and New Zealand partly offset by increases in Europe and India.

The following table shows our product revenues by geographic region:

In connection with our sale of our Latin American business to Invekra, product revenues and cost of revenues reported in the prior period were reclassified from continuing operations to discontinued operations as follows:

Service revenues for the six months ended September 30, 20172018 of $413,000 decreased$578,000 increased by $38,000,$165,000, or 8%40%, when compared to $451,000$413,000 in the prior period. The decreaseincrease was primarily the result of higher laboratory tests and services in the United States. Additionally, during the six months ended September 30, 2018 and 2017, the Company recorded service revenues wasrevenue related to a decreasetechnical services provided to Invekra in our lab services business.the amount of $28,000 and $39,000, respectively.

Gross Profit

For the six months ended September 30, 2017,2018, we reported total revenues of $8,160,000$9,308,000 and total cost of revenues of $4,550,000,$5,150,000, resulting in total gross profit of $3,610,000$4,158,000 or 44%45% of total revenues, compared to a gross profit of $2,017,000$3,610,000 or 37%44% of total revenues, for the same period in the prior year. The increase in gross profit was primarily due to the reclassification, in the prior period, of Latin America product and license revenue and related variable cost of goods sold from continuing operations to discontinued operations. Additionally, as dermatology product revenues increase as an overall percentage of our product revenues, we expect our margins will improve due to higher gross margins associated with our dermatology products.

For the six months ended September 30, 2017,2018, we reported product revenues of $7,747,000$8,730,000 and cost of product revenues of $4,221,000,$4,737,000, resulting in product gross profit of $3,526,000,$3,993,000, or 46% of product revenues, compared to product gross profit of $1,955,000,$3,526,000, or 39%46% of product revenues, for the same period in the prior year. The increase in gross profit was primarily due to the reclassification, in the prior period, of Latin America product and related variable cost of goods sold from continuing operations to discontinued operations. Additionally, as dermatology product revenues increase as an overall percentage of our product revenues, we expect our margins will improve due to higher gross margins associated with our dermatology products.

For the six months ended September 30, 2017,2018, we reported service revenues of $413,000$578,000 and cost of service revenues of $329,000,$413,000, resulting in service gross profit of $165,000, or 29% of service revenues, compared to service gross profit of $84,000, or 20% of service revenues, compared to service gross profit of $62,000, or 14% of service revenues, for the same period in the prior year. The increase in service gross profit was primarily related to the mix of tests and services performed.

Research and Development Expense

Research and development expenses for the six months ended September 30, 20172018 of $750,000 increased by $11,000, or 1%,$740,000 decreased as compared to $739,000$750,000 for the six months ended September 30, 2016.2017. The increasedecrease is largely due toprimarily the result of lower spending for studies in the current period offset by an increase in spending on product development.salaries and benefits.

Selling, General and Administrative Expense

Selling, general and administrative expenses for the six months ended September 30, 20172018 of $9,100,000$9,622,000 increased by $1,327,000,$522,000, or 17%6%, when compared to $7,773,000$9,100,000 for the six months ended September 30, 2016.2017. The increase foris the six months ended September 30, 2017 was primarily due to higher salesresult of increased legal and marketing expenses related to our growing dermatology sales force.in the U.S.

Interest Expense

Interest expense for the six months ended September 30, 20172018 of $20,000 increased$19,000 decreased by $18,000$1,000 when compared to $2,000$20,000 for the six months ended September 30, 2016.2017. The increasedecrease in interest expense relates primarily to capital leases.

Interest Income

Interest income for the six months ended September 30, 20172018 of $71,000$102,000 increased by $69,000$31,000 when compared to $2,000$71,000 for the six months ended September 30, 2016.2017. The increase is primarily due to interest income earnedreported related to a discount on increased cash and cash equivalent balances.deferred revenue from our agreement with Invekra.

Other Expense

Other expense for the six months ended September 30, 20172018 of $189,000 increased$157,000 decreased by $183,000$32,000 when compared to $6,000other expense of $189,000 for the six months ended September 30, 2016.2017. The increasedecrease in other expense relates primarily to fluctuationfluctuations in foreign exchange and increased franchise tax payments.exchange.

Net Loss from Continuing Operations

Net Loss from continuing operations for the six months ended September 30, 20172018 of $6,378,000 increased $552,000, or 9%,$6,278,000 decreased $100,000, when compared to $5,826,000net loss of $6,378,000 for the six months ended September 30, 2016.2017. The increasedecrease in net loss from continuing operations is primarily due to $675,000the decrease of income tax benefit recorded in the prior period offset byother expense of $32,000 related to foreign exchange fluctuation and a $36,000 decrease in loss from continuing operations before income taxes of $123,000 in the current period.operating losses.

Income from Discontinued Operations, net of Tax

Income from discontinued operations, net of tax for the six months ended September 30, 2016 includes $1,984,000 of gross profit reclassified from continuing operations to discontinued operations during the period. Additionally, for the six months ended September 30, 2016, we recorded income tax expense related to the transaction in the amount of $675,000 and we recorded a $675,000 tax benefit resulting in no tax expense during the period.

The following summarizes operations of our Latin American business included in discontinued operations:

Liquidity and Capital Resources

We reported a net loss of $6,378,000$6,278,000 for the six months ended September 30, 2017.2018. At September 30, 20172018 and March 31, 2017,2018, our accumulated deficit amounted to $149,490,000$163,718,000 and $143,101,000,$157,440,000, respectively. We had working capital of $13,992,000$8,591,000 and $19,355,000$12,993,000 as of September 30, 20172018 and March 31, 2017,2018, respectively.

We currently anticipateexpect to continue incurring losses for the foreseeable future and will need to raise additional capital to pursue our product development initiatives, to penetrate markets for the sale of our products and continue as a going concern. We cannot provide any assurances that we will be able to raise additional capital.

Management believes that we have access to capital resources through possible public or private equity offerings, debt financings, corporate collaborations or other means; however, we cannot provide any assurance that new financings will be available on commercially acceptable terms, if at all. If the economic climate in the U.S. deteriorates, our ability to raise additional capital could be negatively impacted. If we are unable to secure additional capital, we may be required to take additional measures to reduce costs in order to conserve our cash and cash equivalents will bein amounts sufficient to sustain operations and meet our working capital requirementsobligations. These measures could cause significant delays in our continued efforts to commercialize our products, which is critical to the realization of our business plan and our future operations. These matters raise substantial doubt about our ability to continue our sales and marketing and research and development efforts for at least 12 months from the date of filing this report.as a going concern.

Sources of Liquidity

As of September 30, 2017,2018, we had cash and cash equivalents of $9,983,000.$4,048,000. Since our inception, substantially all of our operations have been financed through sales of equity securities. Other sources of financing that we have used to date include our revenues, as well as various loans and the sale of certain Latin American assets to Invekra.

Since October 1, 2015,2016, substantially all of our operations have been financed through the following transactions:

Cash Flows

As of September 30, 2017,2018, we had cash and cash equivalents of $9,983,000,$4,048,000, compared to $17,461,000$10,066,000 as of March 31, 2017.2018.

Net cash used in operating activities during the six months ended September 30, 2018 was $6,607,000, primarily due to our net loss of $6,278,000 offset by non-cash stock compensation of $932,000 in the period. Additionally, we had an increase in accounts receivable of $1,456,000 related an increase in sales.

Net cash used in operating activities during the six months ended September 30, 2017 was $7,233,000, primarily due to our net loss of $6,378,000 offset by stock related compensation of $900,000 in the period. Additionally, we had increases in prepaid expenses of $681,000 mostly related to taxes in Mexico, an increase in accounts receivables of $886,000 and inventories of $310,000 related to increased sales.

Net cash used in operatinginvesting activities during thewas $95,000 for six months ended September 30, 2016 was $4,001,000,2018, primarily duerelated to our net lossthe purchase of $4,517,000.equipment.

Net cash used in investing activities was $176,000 for six months ended September 30, 2017, primarily related to the purchase of equipment.

Net cash used in investingprovided by financing activities was $59,000$675,000 for the six months ended September 30, 2016, consisting of primarily $64,0002018 related to equipment purchasesnet proceeds from the sale of common stock of $957,000 offset by principal payments on debt and $5,000 related to changes in long-term assets.capital leases of $282,000.

Net cash used in financing activities was $92,000 for the six months ended September 30, 2017 related to principal payments on debt and capital leases of $144,000 offset by proceeds from exercise of common stock purchase warrants of $52,000.

Net cash used in financing activities for the six months ended September 30, 2016 was $100,000 related to principal payments on debt.Material Trends and Uncertainties

Operating Capital and Capital Expenditure Requirements

We reported a net loss of $6,378,000 for the six months ended September 30, 2017. At September 30, 2017 and March 31, 2017, our accumulated deficit amounted to $149,490,000 and $143,101,000, respectively. We had working capital of $13,992,000 and $19,355,000 as of September 30, 2017 and March 31, 2017, respectively.

We may need to raise additional capital from external sources in order to continue the long-term efforts contemplated under our business plan. We expect to continue incurring losses for the foreseeable future and maywill need to raise additional capital to pursue our product development initiatives, and to penetrate markets for the sale of our products.products and continue as a going concern. We cannot provide any assurances that we will be able to raise additional capital as we need it.

OurManagement believes that we have access to capital resources through possible public or private equity offerings, debt financings, corporate collaborations or other means; however, we cannot provide any assurance that new financing will be available on commercially acceptable terms, if at all. If the economic climate in the U.S. deteriorates, our ability to raise additional capital could be negatively impacted. If we are unable to secure additional capital, we may be required to curtail our research and development and other business initiatives and take additional measures to reduce costs in order to conserve our cash in amounts sufficient to sustain operations and meet our obligations. These measures could cause significant delays in our continued efforts to commercialize our products, which is critical to the realization of our business plan and our future funding requirements will depend on many factors, including:operations. These matters raise substantial doubt about our ability to continue as a going concern.

Consistent with other pharmaceutical companies in the United States, we experience seasonal fluctuations in the first quarter of each year, or our fourth fiscal quarter. This decrease in sales of pharmaceutical products is due to patients facing the need to satisfy health insurance deductibles which are reset at the beginning of each year and adjusting to changing copays.

Healthcare providers and insurers heavily influence the price patients pay for our products. Generally, insurers cover a lower percentage of our products compared to other medical products making our products seem relatively more expensive than other medical care. As a result, to remain competitive, we offer rebates on our products directly to patients. Most patients use these rebates to make our products more affordable. While we believe these rebates are necessary for many patients to buy our products and without them our revenues would likely decline, the impact of rebates on our bottom line has been significant. For example, in the three months ended September 30, 2018, dermatology rebates amounted to $1,415,000 and for the six months ended September 30, 2018, dermatology rebates amounted to $3,317,000.

We continue to work with healthcare providers, insurers, third-party payors, pharmacies and others to manage pricing of our products to the consumer and to reduce the impact of rebates on our overall revenue. However, there is no guarantee we will be successful in reducing patient rebate use. Additionally, the legal landscape in healthcare is constantly changing. Adoption of new legislation at the federal or state level could further affect demand for, or pricing of, our products. For example, we face uncertainties due to federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the Affordable Care Act, or ACA, which could leave more patients without insurance coverage which, in turn, could reduce the price patients are willing to pay for our products if they must bear the entire cost.

During the three and six months ended September 30, 2018, revenue from sales to our Latin America partner Invekra amounted to approximately 16% and 20% of our total revenue, respectively. We will continue to supply products to Invekra at a reduced price from list prices, pursuant to our contractual obligations for a transition period until, at the latest, October 27, 2020, while Invekra builds its own manufacturing lines. However, we expect that our future revenues from Latin American sales will be substantially reduced.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. Significant estimates and assumptions include reserves and write-downs related to receivables and inventories, the recoverability of long-lived assets, the valuation allowance related to our deferred tax assets, valuation of equity and derivative instruments, debt discounts, valuation of investments and the estimated amortization periods of upfront product licensing fees received from customers.

Off-Balance Sheet Transactions

We currently have no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

As a smaller reporting company, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information required by this Item.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Accordingly, our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management was necessarily required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2017.2018.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 20172018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II —- OTHER INFORMATION

On March 17, 2017, we filed a lawsuit against Collidion, Inc. and several of our former employees, officers and directors, alleging the misappropriation of our confidential, proprietary and trade secret information as well as breach of fiduciary duties in the United States District Court for the Northern District of California, San Francisco Division. On August 15, 2018, as memorialized in writing on September 26, 2018, we settled the lawsuit to the satisfaction of all parties. There has been no finding of wrongdoing against any party.

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

ThereExcept as follows, there have been no material changes from risk factors previously disclosed in our annual report on Form 10-K for the fiscal year ended March 31, 2017,2018, as filed with the SEC on June 28, 2017.26, 2018.

As of September 30, 2018, we may not have sufficient cash to continue operations for the next six to twelve months.

As of September 30, 2018, we had $4,048,000 in cash and cash equivalents. We had working capital of $8,591,000 and $12,993,000 as of September 30, 2018 and March 31, 2018, respectively. We incurred net losses of $2,820,000, $6,278,000 and $14,328,000 during the three and six months ended September 30, 2018 and the fiscal year ended March 31, 2018, respectively. We used net cash of $6,607,000 in operating activities during the six months ended September 30, 2018. If our sales revenues do not increase or if we do not manage our expenses and cash flow in the near future, we may be required to obtain additional cash for operations from non-working capital sources, which may not be available, in which case we would have to significantly decrease or cease operations. The sale of additional equity or convertible debt securities would result in additional dilution to our stockholders, and debt financing, if available, may involve restrictive covenants that could restrict our operations or finances. Financing, if necessary, may not be available in amounts or on terms acceptable to us, if at all. If we cannot raise funds on acceptable terms or achieve positive cash flow, we may not be able to continue to conduct operations, develop new products, grow market share, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, any of which would negatively impact our business, operating results and financial condition.

Following our planned offering of common stock, our ability to use shares of our common stock to carry out our business plan, to offer stock as a form of compensation or to use stock to meet our financial obligations may be diminished.

We filed a registration statement on Form S-1 with the SEC for an offering of our common stock which is currently pending. We currently have 24,000,000 shares of authorized common stock. Assuming we complete the maximum offering, we will sell and issue a majority of those shares. As of October 31, 2018, we had 6,592,633 shares of common stock outstanding and have committed to issue approximately 2,900,000 shares of common stock upon the exercise of outstanding stock options and warrants. It is possible that some or all of the currently outstanding options and warrants will not be exercised and the shares of common stock we have reserved to satisfy our obligations under the terms of those securities may never be issued. If options or warrants expire prior to exercise, then the shares we have reserved in the event they are exercised may be used for other purposes. Having a limited number of authorized shares of common stock may diminish our ability to execute our business plan, to offer stock or stock options as part of a competitive compensation package for attracting and retaining the highly skilled officers, directors and employees on which our success relies, or to issue equity securities in the future to allow the Company flexibility in meeting our routine financial obligations, raising capital if needed and/or issuing equity securities to acquire assets or businesses or to engage in strategic collaborations where the transaction might be improved for us by issuing equity securities. This may have a material adverse effect on our revenues, financial position, cash flows and results of operations.

We may be liable for the sale of unregistered securities.

On October 4, 2018, we sold 113,000 shares of common stock through our At Market Issuance Sales Agreement and generated gross proceeds of $270,000. Those sales were made in reliance upon our S-3 shelf registration statement. However, due to the size of our market capitalization, the limitations applicable to S-3 shelf registration statements set out in instruction I.B.6 of the Form S-3 registration statement limited the amount of securities that we are permitted to offer and sell under the S-3 shelf registration statement during a twelve-month period to one-third of the aggregate market value of common stock held by non-affiliates. Following the sale, we concluded that the sale exceeded these limitations. If claims or suits for rescission are successfully asserted against us, we may be required to rescind some or all of the sales, and to pay interest thereon. We could also be subject to investigation and/or enforcement by the SEC and state securities regulators, and we could be subject to penalties imposed by them.

On August 22, 2017,July 31, 2018, we issued 3,133 unregistered6,881 shares of common stock at a price of $2.18 per share to a service provider valued at $5.53 per share.provider.

We relied on the Section 4(a)(2) exemption from securities registration under the federal securities laws for transactions not involving any public offering. No advertising or general solicitation was employed in offering the securities. The securities were issued to an accredited investor. The securities were offered for investment purposes only and not for the purpose of resale or distribution. The transfer thereof was appropriately restricted by us.

On October 4, 2018, we sold 113,000 shares of common stock through our At Market Issuance Sales Agreement and generated gross proceeds of $270,000. Those sales were made in reliance upon our S-3 shelf registration statement. However, due to the size of our market capitalization, the limitations applicable to S-3 shelf registration statements set out in instruction I.B.6 of the Form S-3 registration statement limited the amount of securities that we are permitted to offer and sell under the S-3 shelf registration statement during a twelve-month period to one-third of the aggregate market value of common stock held by non-affiliates. Following the sale, we concluded that the sale exceeded these limitations, and thus the 113,000 shares of common stock were unregistered.

We did not default upon any senior securities during the quarter ended September 30, 2017.2018.

Not applicable.

None.On October 4, 2018, we sold 113,000 shares of common stock through our At Market Issuance Sales Agreement and generated gross proceeds of $270,000. Those sales were made in reliance upon our S-3 shelf registration statement. However, due to the size of our market capitalization, the limitations applicable to S-3 shelf registration statements set out in instruction I.B.6 of the Form S-3 registration statement limited the amount of securities that we are permitted to offer and sell under the S-3 shelf registration statement during a twelve-month period to one-third of the aggregate market value of common stock held by non-affiliates. Following the sale, we concluded that the sale exceeded these limitations. If claims or suits for rescission are successfully asserted against us, we may be required to rescind some or all of the sales, and to pay interest thereon. We could also be subject to investigation and/or enforcement by the SEC and state securities regulators, and we could be subject to penalties imposed by them.