SONOMA PHARMACEUTICALS, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
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
December 31, 2021and our audited consolidated financial statements for the year ended March 31, 2021included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commissionon July 14, 2021. 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: the impact of the COVID-19 pandemic on the overall economy and our results of operations; our ability to become profitable; the impact of changes to reimbursement levels from third-party payors or increased pricing pressure due to rebates; our ability to manage our accounts receivable; 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 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 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 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; 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; our ability to protect our information technology and infrastructure; and the impact of 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 global healthcare leader for developing and producing stabilized hypochlorous acid, or HOCl, products for a wide range of applications, including wound care, animal health care, eye care, oral care, disinfectant use and dermatological conditions. Our products reduce infections, itch, pain, scarring and harmful inflammatory responses in a safe and effective manner. In-vitro and clinical studies of HOCl show it to have impressive antipruritic, antimicrobial, antiviral and anti-inflammatory properties. Our stabilized HOCl immediately relieves itch and pain, kills pathogens and breaks down biofilm, does not stingor irritate skin and oxygenates the cells in the area treated assisting the body in its natural healing process. We sell our products either directly or via partners in 54 countries worldwide. 19 Business Channels
Our core market differentiation is based on being the leading developer and producer of stabilized hypochlorous acid, or HOCl, solutions. Unlike many of our competitors, we have been in business for over 20 years and in that time, we have developed significant scientific knowledge of how best to develop and manufacture HOCl products backed by decades of studies and data collection. HOCl is known to be among the safest and most-effective ways to relieve itch, inflammation and burns while stimulating natural healing through increased oxygenation and eliminating persistent microorganisms and biofilms. We sell our products into many markets both in the
U.S.and internationally. In international markets, we ship products to 54 countries. Our core strategy is to work with partners both in the United Statesand around the world to market and distribute our products. In some cases, we market and sell our own products. Dermatology Sonoma Dermatologyhas developed unique, differentiated, prescription-strength and safe dermatologic products that support paths to healing among various key dermatologic conditions. Our products are primarily targeted at the treatment of acne, the management of scars and atopic dermatitis. 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 United States, we partnered with EMC Pharma, LLCin March 2021to sell our prescription products for an initial term of five years, subject to meeting minimum purchase and other requirements. Pursuant to our agreement with EMCPharma, we manufacture products for EMC Pharma and EMC Pharma markets, sell and distribute them to patients and customers. On September 28, 2021, we launched a new product direct to consumers on Amazon.com, Regenacyn® Advanced Scar Gel, which is clinically proven to improve the overall appearance of scars while reducing pain, itch, redness, and inflammation. Additionally, on the same day, we launched Regenacyn® Plus, a prescription-strength scar gel which is available as an office-dispense product through physician offices. We sell dermatology products in Europe, Asia, and Brazilthrough a distributor network. In these international markets, we have a network of partners, ranging from country specific distributors to large pharmaceutical companies to full-service sales and marketing companies. We work with our international partners to create products they can market in their home country. Some products we develop and manufacture are private label while others use branding we have already developed. We have created or co-developed a wide range of products for international markets using our core HOCl technology. First Aid and Wound Care
Our HOCl-based wound care products are intended for the treatment of acute and chronic wounds as well as first-and second-degree burns. They work by first removing foreign material and debris from the skin surface and moistening the skin, thereby improving wound healing. Second, our HOCl products assist in the wound healing process through their antimicrobial properties by removing microorganisms. Since HOCl is an important constituent of our innate immune system and is formed and released by the macrophages during phagocytosis, it is advantageous to other wound-irrigation and antiseptic solutions as highly organized cell structures such as human tissue can tolerate the action of our wound care solution while single-celled microorganisms cannot. Due to its unique chemistry, our wound treatment solution is much more stable than similar products on the market and therefore maintains much higher levels of hypochlorous acid over its shelf life. In
the United States, we sell our wound care products directly to hospitals, physicians, and other healthcare practitioners. We have also begun partnering with distributors to expand our reach into the wound care markets. In March 2021, we granted EMC Pharma the non-exclusive right to sell wound care products to certain governmental entities. In January 2022, we entered into an agreement with Salus Medical, LLCfor a non-exclusive right to sell our wound care products. 20
Europe, we rely on agreements with country-specific distributors for the sale of our wound care products under a variety of brand names into 27 countries, including Austria, Belgium, Croatia, Italy, the Netherlands, Germany, Greece, Hungary, the Czech Republic, Spain, Norway, Switzerland, Poland, Portugal, Slovenia, the Slovak Republic, Finland, Denmark, Montenegroand Serbia. To respond to market demand for our HOCl technology-based products, we launched our first direct to consumer over the counter product in the United Statesin February 2021. Microcyn® OTC Wound and Skin Cleanser is formulated for home use without prescription to help manage and cleanse wounds, minor cuts, and burns, including sunburns and other skin irritations. Microcyn® OTC Wound and Skin Cleanser is available without prescription through Sonoma's online store. It is also available as a prescription product through physicians. Eye CareOur prescription product Acuicyn™ is an antimicrobial prescription solution for the treatment of blepharitis and the daily hygiene of eyelids and lashes and helps manage red, itchy, crusty and inflamed eyes. It is strong enough to kill the bacteria that causes discomfort, fast enough to provide near instant relief, and gentle enough to use as often as needed. In the United States, our partner EMC Pharma is selling our prescription-based eye care product through its distribution network. On September 28, 2021, we launched Ocucyn Eyelid & Eyelash Cleanser, which is sold directly to consumers on Amazon.com. Ocucyn Eyelid & Eyelash Cleanser, designed for everyday use, is a safe, gentle, and effective solution for good eyelid & eyelash hygiene. In international markets we rely on a network of distribution partners to sell our eye products. On May 19, 2020, we entered into an expanded license and distribution agreement with our existing partner, Brill International S.L. for our Microdacyn60® Eye Care HOCl-based product. Under the license and distribution agreement, Brill has the right to market and distribute our eye care product under the private label Ocudox™ in Italy, Germany, Spain, Portugal, France, and the United Kingdomfor a period of 10 years, subject to meeting annual minimum sales quantities. In return, Brill will pay us a one-time fee, and the agreed upon supply prices. In parts of Asia, Dyamed Biotech markets our eye product under the private label Ocucyn.
Oral and nasal care
We sell a variety of oral and nasal products worldwide.
the United States, on December 14, 2020, we partnered with Gabriel Science, LLCto market our HOCl-based products in the dental, head and neck markets and launched Endocyn®, a biocompatible root canal irrigant. On January 19, 2022, we added Salus Medical, LLC, as a partner to distribute Endocyn as well as dermatology, wound care and eye care products on a non-exclusive basis. Internationally, our product Microdacyn60® Oral Caretreats mouth and throat infections and thrush. Microdacyn60 solution assists in reducing inflammation, pain, soothing cough relief and does not contain any harmful chemicals. It does not stain teeth, is non-irritating, non-sensitizing, has no contraindications and is ready for use with no mixing or dilution. In New Zealandand Australia, our partner Te Arai BioFarma Ltd.markets our oral product under their label Oracyn® Oral Care. Our partner, Dyamed Biotech, expects to launch Oracyn® Oral Carein parts of Asiathis year. On January 18, 2022, we partnered with Anlicare Internationalto seek regulatory clearances for our dental and oral products in Chinaand Macau. Our international nasal care product Sinudox™ based on our HOCl technology is a solution intended for nasal irrigation. Sinudox Hypotonic Nasal Hygiene clears and cleans a blocked nose, stuffy nose and sinuses by ancillary ingredients that may have a local antimicrobial effect. Sinudox is sold through Amazon in Europe. In New Zealandand Australia, our partner Te Arai markets our nasal product under their label Nasocyn® Nasal Care. 21 Animal Health Care MicrocynAH® is a HOCl-based topical product that cleans, debrides and treats a wide spectrum of animal wounds and infections. It is intended for the safe and rapid treatment of a variety of animal afflictions including cuts, burns, lacerations, rashes, hot spots, rain rot, post-surgical sites, pink eye symptoms and wounds to the outer ear of any animal. For our animal health products sold in the U.S.and Canada, we partnered with Manna Pro Products, LLCto bring relief to pets and peace of mind to their owners. Manna Pro distributes non-prescription products to national pet-store retail chains, farm animal specialty stores, in the United Statesand Canada, such as Chewy.com, PetSmart and Tractor Supply. Most recently, we expanded our animal health product offerings by adding a MicrocynAH line for felines at PetSmart. For the Asian and European markets, on May 20, 2019, we partnered with Petagon, Limited, an international importer and distributor of quality pet food and products for an initial term of five years. We supply Petagon with all MicrocynAH products sold by Petagon. On August 3, 2020, Petagon received a license from the People's Republic of Chinafor the import of veterinary drug products manufactured by us. This is the highest classification Petagon and Sonoma can receive for animal health products in China. Surface Disinfectants In-vitro and clinical studies of HOCl show it to have impressive antipruritic, antimicrobial, antiviral and anti-inflammatory properties. HOCl has been formulated as a disinfectant and sanitizer solution for our partner MicroSafe Group, Dubai, and is sold in numerous countries. It is designed to be used to spray in aerosol format, to areas and environments which are suspected to serve as a breeding ground for the spread of infectious disease, likely to result in epidemics or pandemics. The medical-grade surface disinfectant solution is used in hospitals worldwide to keep doctors and patients protected and safe. In May 2020, Nanocyn® Disinfectant & Sanitizer, received approval to be entered into the Australian Registerof Therapeutic Goods, or ARTG, as well as in Canada, for use against the coronavirus SARS-CoV-2, or COVID-19. Nanocyn has also met the stringent environmental health and social/ethical criteria of Good Environmental Choice Australia, or GECA, becoming one of the very few eco-certified, all-natural disinfectant solutions in Australia. Through our partner Microsafe Group DMCC, Dubai, we sell hard surface disinfectant products into Europe, the Middle Eastand Australia. On July 31, 2020, we partnered with MicroSafe Groupto seek regulatory approval in the United Statesto sell hard surface disinfectants in the United States. To date, we have not received such regulatory approval. 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), SECfilings, 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 from continuing operations
Comparison of the three and nine month periods ended
The following tables present our consolidated revenues and our revenues by geographic region for the three and nine months ended
Three Months Ended December 31, (In thousands) 2021 2020 $ Change % Change United States
$ 933 $ 1,978 $ (1,045 )(53% ) Latin America 273 1,307 (1,034 ) (79% )
Europe and Rest of the World 1,696 1,651 45
$ 2,902 $ 4,936 $ (2,034 )(41% ) 22 Nine Months Ended December 31, (In thousands) 2021 2020 $ Change % Change United States $ 3,872 $ 5,582 $ (1,710 )(31% ) Latin America 1,356 5,659 (4,303 ) (76% )
Europe and Rest of the World 5,102 5,231 (129 )
(2% ) Total
$ 10,330 $ 16,472 $ (6,142 )(37% )
The decrease in
United Statesrevenues for the three and nine months ended December 31, 2021, compared to the prior year of $1,045,000and $1,710,000, respectively, was primarily related to the transfer of sales of our prescription dermatology products to EMC Pharma. As a result of the transfer, we now sell our prescription products to EMCat a reduced price instead of selling directly to patients, which has brought our U.S.prescription drug business to profitability by eliminating the overhead costs of a direct sales force. Prior to this transaction, our U.S.prescription dermatology business had operated at a significant loss and partnering with EMChas improved our overall financial health while retaining lower, but now profitable, revenues from the U.S.prescription dermatology business. Wound care product revenues were essentially flat from the prior year. For the three months ended December 31, 2021, we saw a decline in U.S.animal care revenue versus the prior year of $500,000which was due to quarterly order fluctuations as for the nine months ended December 31, 2021, animal care revenue was flat compared to the prior year. As a result of the asset purchase agreement and arrangement we entered into on October 27, 2016, with Invekra, we were obligated to supply Invekra with product at a reduced price through October 27, 2020. Although the end of this contract has caused a reduction in the top line, the overall impact has been neutral to our bottom line due to the low margins required by the contract. Since then, Invekra has started its own manufacturing and we have continued to manufacture for Invekra in small amounts as overflow manufacturing. However, we now charge market prices for manufacturing since the contract ended. The decrease in Latin American revenues for the three and nine months ended December 31, 2021, compared to the prior year periods was the result of the Invekra revenue declining to $273,000and $1,356,000from $1,307,000and $5,659,000, respectively. The increase in Europeand Rest of the World revenues for the three months ended December 31, 2021, compared to the prior year was the result of increases in Asiapartially offset by decreases in Europeand the Middle East. For the nine months ended December 31, 2021, the decrease in Europeand Rest of the World revenues was the result of decreases in Europeand the Middle Eastpartially offset by increases in Asia.
Revenue cost and gross profit
The revenue cost and gross margin measures are as follows:
Three Months Ended
(In thousands, except for percentages) 2021 2020 Change % Change Cost of revenue
$ 1,699 $ 2,941 $ (1,242 )(42% ) Cost of Revenue as a % of Revenue 59% 60% (1% ) Gross Profit $ 1,203 $ 1,995 $ (792 )(40% ) Gross Profit as a % of Revenue 41% 40%
1% Nine Months Ended
(In thousands, except for percentages) 2021 2020 Change % Change Cost of Revenue
$ 6,433 $ 9,719 $ (3,286 )(34% ) Cost of Revenue as a % of Revenue 62% 59%
$ 3,897 $ 6,753 $ (2,856 )(42% ) Gross Profit as a % of Revenue 38% 41% (3% ) 23
For the three months ended
December 31, 2021, gross margins increased by 1% and for the nine months ended December 31, 2021, gross margins decreased by 3%. The increase in margins for the three months ended December 31, 2021was the result of Invekra prices changing as described above. The decline of 3% for the nine months ended December 31, 2021was the result of the EMC Pharma transaction. Our partnership with EMC Pharma has resulted in lower revenue from the sale of our prescription dermatology products in the U.S.because the transfer price that EMC Pharma, LLCpays is lower than the prices we received for these products when we sold them ourselves directly to patients. However, our operating costs associated with this business have dropped substantially due to the elimination of the direct sales force for these prescription products and reduction of associated overhead costs. As a result, our U.S.prescription product business is now smaller, but profitable, and is improving the overall health of Sonoma.
Research and development costs
The research and development indicators are as follows:
Three Months Ended December 31, (In thousands, except for percentages) 2021 2020 Change % Change
Research and Development Expense $ 26 $ 33
$ (7 )(21% ) Research and Development Expense as a % of Revenue 1% 1% - Nine Months Ended December 31, (In thousands, except for percentages) 2021 2020 Change % Change
Research and Development Expense
$ 121 $ 425 $ (304 )(72% ) Research and Development Expense as a % of Revenue 1% 3% (2% ) For the three months ended December 31, 2021, research and development expenses of $26,000decreased by $7,000from the prior year and was nearly flat. The decrease in research and development expenses of $304,000for the nine months ended December 2021versus the prior year was the result of closing our Seattlefacility and moving the R&D function to Mexico.
Selling, general and administrative expenses
Selling, general and administrative expense measures are as follows:
Three Months Ended December 31, (In thousands, except for percentages) 2021 2020 Change % Change Selling, General and Administrative Expense
$ 2,135 $ 2,100 $ 352% Selling, General and Administrative Expense as a % of Revenue 74% 43% 31% 24 Nine Months Ended December 31, (In thousands, except for percentages) 2021 2020 Change % Change Selling, General and Administrative Expense $ 6,603 $ 6,963 $ (360 )(5% ) Selling, General and Administrative Expense as a % of Revenue 64% 42% 22% The increase in Selling, General and Administrative expense for the three months ended December 31, 2021, was $35,000due to increased insurance costs. The decrease in Selling, General and Administrative expenses for the nine months ended December 31, 2021of $360,000was the result the reduction in sales force related to the EMC Pharma transaction partially offset by increased insurance costs.
Interest income (expense), net
Interest (expense) income, net for the three and nine months ended
December 31, 2021, was $3,000and ( $1,000), respectively, compared to $(2,000)and $2,000, for the three and nine months ended December 31, 2020, respectively. Other (Expense) Income, net Other (expense) income for the three and nine months ended December 31, 2021, was $11,000and $542,000respectively, compared to $(490,000)and $(687,000), respectively, for the three and nine months ended December 31, 2020. The increase in other income relates primarily to the recognition of PPP loan forgiveness in the amount of $723,000. Gain on Sale of Assets Gain on the sale of assets was $0for the three months ended December 31, 2021and $150,000for the nine months ended December 31, 2021, respectively, compared to $4,000and $137,000, respectively, for the three and nine months ended December 31, 2020. During the three months ended December 31, 2020, we sold fixed assets no longer needed after closing our Petaluma manufacturing facility and during the nine months ended December 31, 2020, we also sold assets to Infinity along with our Micromeddivision. In September 2021, we recognized revenue related to the sale of asset to Microsafe previously held in deferred revenue.
Net income (loss) from continuing operations
Net losses from continuing operations for the three and nine months ended
December 31, 2021, were $944,000and $2,136,000, respectively, compared to net losses of $626,000and $1,183,000, respectively, for the three and nine months ended December 31, 2020.
Results of discontinued operations
Comparison of the three and nine month periods ended
June 24, 2020, we closed on an asset purchase agreement with Infinity Labs SD, Inc.We decided to divest our Micromedbusiness, resulting in a strategic shift that had a major effect on our operations and financial results. Therefore, the divested Micromedoperations meet the criteria to be reported as discontinued operations.
The assets, liabilities, results of operations and related cash flows of our
25 The operations of the
Micromedbusiness included in discontinued operations is summarized as follows: Three Months Ended December 31,
Nine month period ended
2021 2020 2021 2020 Revenues $ - $ - $ -
$ 214,000Cost of revenues - - - 53,000 Selling general and
administrative expenses - (1,000 ) - 38,000 Income from discontinued operations before tax - 1,000 - 123,000 Gain on disposal of discontinued operations before income taxes - (25,000 ) - 770,000 Total income (loss) from discontinued operations, before tax - (24,000 ) - 893,000 Income tax benefit (expense) - - - - Income (loss) from discontinued operations, net of tax $ -
$ (24,000 )$
$ 893,000Gain on disposal of discontinued operations for the nine months ended December 31, 2020, includes $795,000of gain primarily from the value of the customer base of Micromed.
Cash and capital resources
We reported a net loss of
$944,000and $2,142,000for the three and nine months ended December 31, 2021. At December 31, 2021and March 31, 2021, our accumulated deficit amounted to $181,419,000and $179,277,000, respectively. As of December 31, 2021, we had cash and cash equivalents of $8,529,000compared to $5,541,000on December 31, 2020. 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 assets to Invekra, Petagon, Microsafe and Infinity Labs. The following table presents a summary of our consolidated cash flows for operating, investing and financing activities for the nine months ended December 31, 2021, and 2020 as well as balances of cash and cash equivalents and working capital: Nine Months Ended December 31, (In thousands) 2021 2020 Net cash provided by (used in): Operating activities $ (2,853 ) $ (1,902 )Investing activities (38 ) 392 Financing activities 7,174 3,039
Effect of exchange rates on cash 26 321 Net change in cash and cash equivalents 4,309 1,850 Cash and cash equivalents, beginning of the period 4,220 3,691 Cash and cash equivalents, end of the period $ 8,529 $ 5,541 Working capital (1), end of period
$ 12,329(1) Defined as current assets minus current liabilities 26
Net cash used by operating activities during the nine months ended
December 31, 2021, was $2,853,000, primarily due to a net loss of $2,142,000and forgiveness on PPP loans of $723,000.
Net cash used by operating activities during the nine months ended
December 31, 2020, was primarily due to an increase in inventories of $403,000, a decrease in accrued expenses of $779,000and a decrease in accounts payable of $168,000and a net loss of $290,000for the period. These uses were partially offset by a decrease in accounts receivable of $464,000.
Net cash used by investing activities was
Net cash provided by investing activities for the nine months ended
Net cash provided by financing activities was
Net cash provided by financing activities for the nine months ended
December 31, 2020, was primarily related to proceeds from the exercise of stock options and warrants of $2,210,000, and PPP loans of $1,310,000. We expect revenues to fluctuate and may incur losses in the foreseeable future and may 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 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 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 operations. These matters raise substantial doubt about our ability to continue as a going concern.
Material trends and uncertainties
As we have previously discussed in our annual report on Form 10-K filed with the
SECon July 14, 2021, we face a substantial Mexicotax liability, intercompany debt, unpaid technical assistance charges and accrued interest. These amounts are not due until 2027. At this time, management believes there are sufficient assets on the balance sheet to more than cover any tax obligation without interrupting the Company's operations or business. We have engaged tax professionals to review all options to limit our exposure to these amounts and to proceed in a manner that is most advantageous to the Company. 27 As Covid impacts economies worldwide, we are closely watching inflation, shipping costs, supply chain issues and labor costs. At this time, the overall impact of these issues has been minimal. The potential impact to our business operations, customer demand and supply chain due to increased shipping costs may ultimately impact sales. We continue to evaluate our end-to-end supply chain and assess opportunities to refine the impact on sales. Currently, most of our customers pay for shipping expenses, including increased shipping costs, if any. We have not yet faced labor shortages however it is possible we may have difficulties retaining and finding qualified employees in a tight labor market in the future. Furthermore, overall inflation tendencies may put pressure on our product pricing and/or costs. Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United Statesrequires 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.
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