SONO TEK CORP 10-K

ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements We discuss expectations regarding our future performance, such as our business outlook, in our annual and quarterly reports, news releases, and other written and oral statements. These “forward-looking statements’ are based on currently available competitive, financial and economic data and our operating plans. They are inherently uncertain, and investors must recognize that events could turn out to be significantly different from our expectations and could cause actual results to differ materially. These factors include, among other considerations, general economic and business conditions, including inflationary pressures; political, regulatory, tax, competitive and technological developments affecting our operations or the demand for our products; the duration and scope of the COVID-19 pandemic; the extent and duration of the pandemic’s adverse effect on economic and social activity, consumer confidence, discretionary spending and preferences, labor and healthcare costs, and unemployment rates, any of which may reduce demand for some of our products and impair the ability of those with whom we do business to satisfy their obligations to us; our ability to sell and provide our services and products, including as a result of continued pandemic related travel restrictions, mandatory business closures, and stay-at home or similar orders; any temporary reduction in our workforce, closures of our offices and facilities and our ability to adequately staff and maintain our operations resulting from the pandemic; the ability of our customers and suppliers to continue their operations as result of the pandemic, which could result in terminations of contracts, losses of revenue; and further adverse effects to our supply chain; maintenance of increased order backlog, including effects of any COVID-19 related cancellations; the imposition of tariffs; the continued strong sales of the multi-axis coatings systems; timely development and market acceptance of new products and continued customer validation of our coating technologies; adequacy of financing; capacity additions, the ability to enforce patents; maintenance of operating leverage; maintenance of increased order backlog; consummation of order proposals; completion of large orders on schedule and on budget; continued sales growth in the clean energy, diagnostic test and next generation semiconductor chip manufacturing markets; successful implementation of initiatives advanced energy, medical device applications and next generation high precision semiconductor coating applications; successful transition from primarily selling ultrasonic nozzles and components to a more complex business providing complete machine solutions and higher value subsystems; and realization of quarterly and annual revenues within the forecasted range of sales guidance. We undertake no obligation to update any forward-looking statement. We undertake no obligation to update any forward-looking statement. 21 Highlights Highlights for fiscal 2022 include: • Net sales for fiscal 2022 increased 16%, from $14.8M to $17.1 million, Sono-Tek’s highest revenue ever. • Gross profit margin for fiscal 2022 increased to 50.3% compared to 47.2% in fiscal 2021, driven by the strength in sales, increased efficiencies, and a favorable product mix. • Operating profit for fiscal 2022 increased 41.0% to $1.9M compared to $1.3M in fiscal 2021, due to less than expected increases in costs associated with sales related travel and trade shows resulting from lingering Covid restrictions. • Backlog at February 28, 2022 was $5.3M compared to the backlog at February 28, 2021 of $3.8M, an increase of 38%. This growth is attributed to the Company’s strategy for product line and system sales expansion with further customization and automation, which delivers increased value to our customer, and higher average selling prices to Sono-Tek. • Operating activities generated an increase of $2.3M in cash, cash equivalents and short-term investments which climbed to $10.7M on February 28, 2022 from $8.6M on February 28, 2021. • Sono-Tek was approved for listing on the Nasdaq Capital Market, which was completed in August 2021. This uplisting from our previous OTCQX platform brought both increased liquidity and a higher appreciation of SOTK’s inherent value in the months since, as we became visible to a wider number of investment entities. • We applied for forgiveness of our Payroll Protection Program funding and our forgiveness application was approved in April 2021. Market and Geographic Diversity We have invested significant resources to enhance our market diversity. By leveraging our core ultrasonic coating technology, we’ve expanded our portfolio of products, the industries we serve, and the countries in which we sell our products. Today, we serve five industries: microelectronics/electronics, medical, alternative energy, industrial markets and emerging research and development and other. We are a geographically diverse company with a presence either directly or through distributors and trade representatives in the United States and Canada, EMEA (Europe, Middle East and Africa), APAC (Asia Pacific) and Latin America (including Mexico). In fiscal 2022, approximately 68% of sales originated outside of the United States and Canada. We have an established infrastructure of application process development laboratories located at our distributor sites in Japan, China, Germany, Taiwan, Korea and our home office in New York, USA. These laboratories are equipped with Sono-Tek systems and technical personnel to conduct customer demonstrations and process development for new coating applications that our customers bring to us. Our engineering, service and sales teams all continue to grow as we expand our addressable markets and enhance our product line to include larger more sophisticated machinery and systems with increased capabilities. We believe that the new products we have introduced, the new markets we have penetrated, and the expanded regions in which we now sell our products, are a strong foundation for our future sales growth and enhanced profitability. 22 Results of Operations Sales and Gross Profit: Fiscal Year Ended February 28, February 28, Change 2022 2021 $ % Net Sales $ 17,133,000 $ 14,833,000 $ 2,300,000 16% Cost of Goods Sold 8,520,000 7,836,000 684,000 9% Gross Profit $ 8,613,000 $ 6,997,000 $ 1,616,000 23% Gross Profit % 50.3% 47.2% Throughout the COVID-19 pandemic, Sono-Tek has been successful offering virtual, in person, and a hybrid mix of both virtual and in person, customer interactions. Our strong digital connections made this a smooth transition for our customer base and allowed us to remain highly flexible to support the worldwide demand for the full system solutions we provide, and to effectively reach our customers anywhere in the world. Sono-Tek’s ability to rapidly adapt to these changing conditions, and the strong demand for our products in the markets we serve, resulted in 16% revenue growth for fiscal 2022. Gross profit increased $1,616,000, or 23% to $8,613,000 for fiscal 2022 compared with $6,997,000 in fiscal 2021. Gross profit margin increased by 310 basis points, reaching 50.3% for fiscal 2022, compared to 47.2% for fiscal 2021. The improvement in the gross profit margin is due to increased sales and a sales mix with higher sales margins combined with lower than expected warranty and installation costs. In fiscal 2022, our sales include approximately $4,130,000 for orders that were delivered to two customers. Product Sales: Twelve Months Ended February 28, % of February 28, % of Change 2022 Total 2021 total $ % Fluxing Systems $ 691,000 4% $ 798,000 5% $ (107,000 ) (13% ) Integrated Coating Systems 1,182,000 7% 4,219,000 28% (3,037,000 ) (72% ) Multi-Axis Coating Systems 9,912,000 58% 5,614,000 38% 4,298,000 77% OEM Systems 2,381,000 14% 1,582,000 11% 799,000 51% Other 2,967,000 17% 2,620,000 18% 347,000 13% TOTAL $ 17,133,000 $ 14,833,000 $ 2,300,000 16% Multi-Axis coating systems showed 77% growth due to a significant shipment of a six-axis robot machine sold to the Semiconductor industry for over $1,700,000, and strong sales of machines used in the clean energy sector and medical diagnostic markets, both of which use highly sophisticated multi-axis platforms. OEM sales also generated excellent growth in fiscal 2022 increasing by 51% when compared to fiscal 2021. This was a result of several new OEM relationships gaining momentum to incorporate Sono-Tek OEM packages into their new product designs. Integrated coating systems saw a decline of 72%, which was greatly impacted by a large textile machine sold in fiscal 2021, which did not repeat in fiscal 2022. Market Sales: Twelve Months Ended February 28, % of February 28, % of Change 2022 Total 2021 total $ % Electronics/Microelectronics $ 7,134,000 42% $ 5,997,000 40% $ 1,137,000 19% Medical 4,338,000 25% 3,369,000 23% 969,000 29% Alternative Energy 3,688,000 22% 2,144,000 15% 1,544,000 72% Emerging R&D and Other 918,000 5% 1,055,000 7% (137,000 ) (13% ) Industrial 1,055,000 6% 2,268,000 15% (1,213,000 ) (53% ) TOTAL $ 17,133,000 $ 14,833,000 $ 2,300,000 16% 23 The Alternative Energy market delivered 72% growth, due to strong investments from governments and private industries focused on the clean energy sector, and the goal for a net zero carbon society. These clean energy customers use Sono-Tek machinery to create catalyst coated membranes used in fuel cells, carbon capture, and hydrogen generation applications. The medical market grew to $4,338,000, an increase of 29%, primarily driven by strong sales to China for customized medical device solutions and a significant new North America based customer in the dental device industry. The electronics market grew by 19%, which was driven by a significant sale of a six-axis robot into the semiconductor market. The industrial market saw a 53% dip due to a large fiscal 2021 shipment in the textile market, that did not repeat in fiscal 2022. Geographic Sales: Twelve Months Ended February 28, February 28, Change 2022 2021 $ % U.S. & Canada $ 5,480,000 $ 5,155,000 $ 325,000 6% Asia Pacific (APAC) 5,301,000 4,171,000 1,130,000 27% Europe, Middle East, Asia (EMEA) 5,255,000 4,287,000 968,000 23% Latin America 1,097,000 1,220,000 (123,000 ) (10% ) TOTAL $ 17,133,000 $ 14,833,000 $ 2,300,000 16% In fiscal 2022, approximately 68% of sales originated outside of the United States and Canada. This compares with 65% in fiscal 2021. The increased sales to our international customer base are a result of many overseas customers bringing manufacturing operations back online, with fewer COVID-19 restrictions. South Korea contributed significantly to increased APAC sales, led by solid growth for Sono-Tek machines used in the clean energy sector. Operating Expenses: Twelve Months Ended February 28, February 28, Change 2022 2021 $ % Research and product development $ 1,730,000 $ 1,645,000 $ 85,000 5% Marketing and selling 3,367,000 2,790,000 577,000 21% General and administrative 1,626,000 1,222,000 404,000 33% Total Operating Expenses $ 6,723,000 $ 5,657,000 $ 1,066,000 19% Research and Product Development: Research and product development costs increased $85,000 to $1,730,000 for fiscal 2022 due to increased salaries and related costs. Marketing and Selling: Marketing and selling costs increased $577,000 to $3,367,000 for fiscal 2022 due to increases in salaries, commissions, travel and trade show expenses. During fiscal 2022, we expended approximately $974,000 for commissions as compared with $621,000 for the prior fiscal year, an increase of $353,000. The increase in commission expense is due to an increase in international sales being generated by our external distributors, which are commissioned at a higher rate than our in-house sales team. During fiscal 2022, we expended approximately $70,000 for travel and trade show expense compared with $9,000 for the prior fiscal year, an increase of $61,000. We anticipate that travel and trade show expenses will increase when sales and marketing activities re open when COVID-19 conditions improve. 24 General and Administrative: General and Administrative costs increased $404,000 to $1,626,000 for fiscal 2022 due to increases in professional fees, corporate expenses, and stock-based compensation expense. In fiscal 2022 stock based compensation expense increased $131,000 to $179,000 compared with $48,000 in fiscal 2021. In fiscal 2022 professional fees expense increased $112,000 to $237,000 compared with $125,000 in fiscal 2021. In fiscal 2022 corporate expense increased $129,000 to $347,000 compared with $218,000 in fiscal 2021. In August 2021, our stock was approved for listing on the Nasdaq Capital Market. The expenses associated with obtaining the Nasdaq listing are primarily responsible for the increases in professional fees and corporate expenses in fiscal 2022. In the current fiscal year, we expensed $88,000 in application and entry fees related to procuring our Nasdaq listing. Operating Income: Our operating income increased $549,000 or 41%, to $1,889,000 in fiscal 2022 compared with $1,340,000 for the prior fiscal year. Growth in revenue and gross profit were key factors in the improvement of operating income in fiscal 2022. Operating margin for fiscal 2022 increased to 11% compared with 9% in the prior fiscal year. As a percentage of net sales, operating expenses increased 100 basis points to 39% in fiscal 2022 compared with 38% in fiscal 2021. As Covid-19 conditions improve, many of these costs are expected to increase when sales and marketing related activities reopen for travel and trade shows. Interest and Dividend Income: Interest and dividend income decreased $14,000 to $9,000 for fiscal 2022 as compared with $23,000 for the prior fiscal year. The decrease in interest and dividend income is due to the reallocation of our investments into US Treasury securities and certificates of deposit. Our present investment policy is to invest excess cash in highly liquid, low risk US Treasury securities and certificates of deposit. At February 28, 2022, the majority of our holdings are rated at or above investment grade. Income Tax Expense: We recorded income tax expense of $362,000 for fiscal 2022 compared with $227,000 for the prior fiscal year. The increase in income tax expense in fiscal 2022 is due to the current period’s increase in operating profit. Net Income: Net income increased by $1,422,000 or 127%, to $2,543,000 for fiscal 2022 compared with $1,121,000 for the prior fiscal year. The increase in net income in fiscal 2022 is a result of an increase in operating income combined with the PPP Loan forgiveness offset by an increase in income taxes. Impact of COVID-19 In December 2019, the COVID-19 outbreak occurred in China and has since spread to other parts of the world. On March 11, 2020, the World Health Organization declared COVID-19 to be a global pandemic and recommended containment and mitigation measures. On March 13, 2020, the United States declared a national emergency concerning the outbreak. Along with these declarations, extraordinary and wide-ranging actions have been taken by international, federal, state, and local public health and governmental authorities to contain and combat the outbreak and spread of COVID-19 in regions across the United States and the world. These actions include quarantines, social distancing and “stay-at-home” orders, travel restrictions, mandatory business closures and other mandates that have substantially restricted individuals’ daily activities and curtailed or ceased many businesses’ normal operations. 25 In response to the pandemic and these actions, we began implementing changes in our business in March 2020 to protect our employees and customers. These changes include adjusting our policies on social distancing, flexing our workforce hours, enhanced cleaning and sanitary procedures, limiting travel when appropriate, and restricting access of non-employees to our facility when necessary. These policies continue to be modified and adjusted dependent upon government regulations and CDC guidelines. While these measures are necessary and appropriate, they may result in additional costs and may adversely impact our business and financial performance. As our response to the pandemic evolves, we may incur additional costs and will potentially experience adverse impacts to our business, each of which may be significant. In addition, an extended period of remote work arrangements could impair our ability to effectively manage our business, and introduce additional operational risks, including, but not limited to, cybersecurity risks and increased vulnerability to security breaches, cyber-attacks, computer viruses, ransomware, or other similar events and intrusions. We may experience, decreases in demand and customer orders for our products in all sales channels, as well as temporary disruptions and closures of our facilities due to decreased demand and government mandates. COVID-19 has also impacted various aspects of the supply chain as our suppliers experience similar business disruptions due to operating restrictions from government mandates. We continue to monitor procurement of raw materials and components used in the manufacturing, distribution and sale of our products, but continued disruptions in the supply chain due to COVID-19 may cause difficulty in sourcing materials or unexpected shortages or delays in delivery of raw materials and components, and may result in increased costs in our supply chain. We have implemented plans to reduce spending in certain areas of our business, including reductions or delays in capital expenditures, reduced trade show participation costs, reduced travel expenditures and may need to take additional actions to reduce spending in the future. We are closely monitoring and assessing the impact of the pandemic on our business. The extent of the impact on our results of operations, cash flow, liquidity, and financial performance, as well as our ability to execute near- and long-term business strategies and initiatives, will depend on numerous evolving factors and future developments, which are highly uncertain and cannot be reasonably predicted. Given the inherent uncertainty surrounding COVID-19, the pandemic may continue to have an adverse impact on our business in the near term. Should these conditions persist for a prolonged period, the COVID-19 pandemic, including any of the above factors and others that are currently unknown, may have a material adverse effect on our business, results of operations, cash flow, liquidity, and financial condition. Liquidity and Capital Resources Working Capital – Our working capital increased $1,880,000 to $10,782,000 at February 28, 2022 from $8,902,000 at February 28, 2021. The increase in working capital was primarily the result of the current period’s net income and non-cash charges partially offset by purchases of equipment and repayment of long-term debt. We aggregate cash and cash equivalents and marketable securities in managing our balance sheet and liquidity. For purposes of the following analysis, the total is referred to as “Cash.” At February 28, 2022 and February 28, 2021, our working capital included: February 28, 2022 February 28, 2021 Cash Increase Cash and cash equivalents $ 4,841,000 $ 4,084,000 $ 757,000 Marketable securities 5,868,000 4,564,000 1,304,000 Total $ 10,709,000 $ 8,648,000 $ 2,061,000 26 The following table summarizes the accounts and the major reasons for the $2,061,000 increase in “Cash”: Impact on Cash Reason Net income, adjusted for non-cash items $ 2,177,000 To reconcile increase in cash. Accounts receivable decrease 665,000 Timing of cash receipts. Inventories decrease 195,000 Increased sales. Accounts payable and accrued expenses decrease (553,000) Timing of disbursements. Prepaid and Other Assets increase (172,000) Increased prepaid expenses and deposits. Equipment purchases (327,000 ) Equipment and facilities upgrade. Other - net 76,000 Timing of disbursements. Net increase in cash $ 2,061,000 Stockholders’ Equity - Stockholders' equity increased $2,790,000 from $10,951,000 at February 28, 2021 to $13,741,000 at February 28, 2022. The increase was a result of the current year’s net income of $2,543,000, proceeds from the exercise of stock options of $68,000 and $179,000 in additional equity related to stock-based compensation awards. The details of stock-based compensation are explained in Note 4 in our financial statements. Operating Activities – We generated $2,319,000 of cash in our operating activities in fiscal 2022 compared with generating $725,000 in fiscal 2021. The increase in cash generated by operating activities was mostly the result of a decrease accounts receivable and inventories. These sources of cash were partially offset by decreases in accounts payable and accrued expenses and an increase in prepaid and other assets. Investing Activities – In fiscal 2022, we used $1,631,000 in our investing activities compared with their using $595,000 of cash in fiscal 2021. Capital spending in fiscal 2022 was $327,000 for the purchase or manufacture of equipment, furnishings and leasehold improvements and patent costs. This compares with $344,000 for the purchase of equipment and furnishings in fiscal 2021. In fiscal 2022, we used $1,304,000 of cash compared with using $344,000 for the purchase of marketable securities in fiscal 2021. In fiscal 2021 we received $100,000 in grant proceeds from the utility which provides our electricity as a result of our completion of certain energy efficiency related improvements. Financing Activities – In fiscal years 2022 and 2021, we used $0 and $708,000 in cash, respectively, for the principal payments on our mortgage. In fiscal 2021, we borrowed $1,001,640 from a bank under the Paycheck Protection Program. In fiscal 2022, we received $69,000 from the exercise of stock options. Bank Credit Facilities: We currently have a revolving credit line of $1,500,000 and a $750,000 equipment purchase facility, both of which are with a bank. The revolving credit line is collateralized by the Company’s accounts receivable and inventory. The revolving line of credit is payable on demand and must be retired for a 30-day period, once annually. As of February 28, 2022, there were no outstanding borrowings under the line of credit. 27 As of February 28, 2022, $5,000 of the Company’s credit line was being utilized to collateralize a letter of credit issued to a customer that has remitted a cash deposit to the Company on an existing order. The unused portion of the credit line was $1,495,000 as of February 28, 2022. The letter of credit expires in fiscal year 2023. Paycheck Protection Program Loan Forgiveness: During fiscal 2021, we entered into a loan transaction pursuant to which we received proceeds of $1,001,640 (the “PPP Loan”) under the Paycheck Protection Program (“PPP”). The PPP, established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), provides for loans to qualifying companies and is administered by the U.S. Small Business Administration (the “SBA”). The Company applied for forgiveness of the PPP Loan in December 2020. On April 1, 2021, the Company received notice from the Bank that the Bank had received confirmation from the SBA that the application for forgiveness of the PPP Loan had been approved. The loan forgiveness request in the amount of $1,001,640 was applied to the Company’s entire outstanding PPP Loan balance with the Bank. During fiscal 2022, the Company recorded a gain on the forgiveness of the PPP Loan and accrued interest in the amount of $1,005,372. The gain on the forgiveness of the PPP Loan is a non-taxable event. Off - Balance Sheet Arrangements We do not have any Off - Balance Sheet Arrangements as of February 28, 2022. Critical Accounting Policies The discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure on contingent assets and liabilities at the date of the financial statements. Actual results may differ from these estimates under different assumptions and conditions. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties and may potentially result in materially different results under different assumptions and conditions. As of February 28, 2022, management believes that there are no critical accounting policies applicable to the Company that are reflective of significant judgments and or uncertainties. 28 Accounting for Income Taxes The Company accounts for income taxes under the asset and liability method. Under this method, deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized. We use a recognition threshold and a measurement attribute for financial statement recognition and measurement tax positions taken or expected to be taken in a return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities. As of February 28, 2022 and February 28, 2021, there were no uncertain tax provisions. Stock-Based Compensation The computation of the expense associated with stock-based compensation requires the use of a valuation model. ASC 718 is a complex accounting standard, the application of which requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility, expected option lives, and expected option forfeiture rates, to value equity-based compensation. The Company currently uses a Black-Scholes option pricing model to calculate the fair value of its stock options. The Company primarily uses historical data to determine the assumptions to be used in the Black-Scholes model and has no reason to believe that future data is likely to differ materially from historical data. However, changes in the assumptions to reflect future stock price volatility and future stock award exercise experience could result in a change in the assumptions used to value awards in the future and may result in a material change to the fair value calculation of stock-based awards. ASC 718 requires the recognition of the fair value of stock compensation in net income. Revenue Recognition The Company recognizes revenue in accordance with ASC 606, Revenue from Contracts with Customers, the core principle of which is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to receive in exchange for those goods or services. Impact of New Accounting Pronouncements Accounting pronouncements issued but not yet effective have been deemed to be not applicable or the adoption of such accounting pronouncements is not expected to have a material impact on the financial statements of the Company. In June 2016, the FASB issued ASU 2016-13 - Financial Instruments-Credit Losses-Measurement of Credit Losses on Financial Instruments. Codification Improvements to Topic 326, Financial Instruments – Credit Losses, have been released in November 2018 (2018-19), November 2019 (2019-10 and 2019-11) and a January 2020 Update (2020-02) that provided additional guidance on this Topic. This guidance replaces the current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. For SEC filers meeting certain criteria, the amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. For SEC filers that meet the criteria of a smaller reporting company (including this Company) and for non-SEC registrant public companies and other organizations, the amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early adoption will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently in the process of its analysis of the impact of this guidance on its consolidated financial statements and does not expect the adoption of this guidance to have a material impact on the Company’s consolidated financial statements. 29 Other than Accounting Standards Update (“ASU”) ASU 2016-13 discussed above, all new accounting pronouncements issued but not yet effective have been deemed to be not applicable to the Company. Hence, the adoption of these new accounting pronouncements, once effective, is not expected to have an impact on the Company. ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK – Not Required for Smaller Reporting Companies. ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our financial statements are presented on pages 43 to 60 of this Report. ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE – None.