Item 7. Management’s Discussion and Analysis
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; political,
regulatory, tax, competitive and technological developments affecting our operations or the demand for our products; inflationary and
supply chain pressures; the continued abatement 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; the recovery of the Electronics/Microelectronics and Medical markets following COVID-19 related slowdowns; 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; 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 medical and alternative
energy markets; 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.
21
Highlights
Highlights for fiscal 2023 include:
· Net sales for fiscal 2023 decreased 12% from
$17.1 million to $15.1 million, due to supply chain challenges which delayed the receipt of necessary parts to complete several customer
shipments. Our customized complex coating systems, which typically require longer than average delivery lead times, were especially impacted
by these remaining supply chain issues.
· Gross profit margin for fiscal 2023 increased
to 50.8% compared to 50.3% in fiscal 2022.
· Operating income for fiscal 2023 decreased 64%
to $683,000 compared to $1.9 million in fiscal 2022, due to the current period’s decrease in net sales combined with an increase
in operating expenses.
· Backlog at February 28, 2023
reached a historical high of $8.5 million compared to the backlog at February 28, 2022 of $5.3 million, an increase of 60%. The large increase in backlog resulted
from the receipt of several large, complex system orders with longer than typical build delivery time frames and higher than average selling prices from the clean
energy sector during the year and from ongoing supply chain issues which slowed the rate at which we completed our backlog of orders.
· Cash, cash equivalents and marketable securities increased to $11.4 million on February
28, 2023 from $10.7 million on February 28, 2022.
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 2023, approximately 55% 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
2023
2022
$
%
Net Sales
$ 15,058,000
$ 17,133,000
$ (2,075,000 )
(12% )
Cost of Goods Sold
7,406,000
8,520,000
(1,114,000 )
(13% )
Gross Profit
$ 7,652,000
$ 8,613,000
$ (961,000 )
(11% )
Gross Profit %
50.8%
50.3%
Gross profit decreased $961,000, or 11% to $7,652,000 for fiscal 2023
compared with $8,613,000 in fiscal 2022. Gross profit margin increased to 50.8% for fiscal 2023, compared to 50.3% for fiscal 2022. The
improvement in the gross profit margin is due to a sales product mix with higher sales margins combined with lower than expected warranty
and installation costs.
In fiscal 2023, our sales included approximately $2,120,000 for orders
that were delivered to two customers.
Product Sales:
Twelve Months Ended
February 28,
% of
February 28,
% of
Change
2023
Total
2022
total
$
%
Fluxing Systems
$ 1,179,000
8%
$ 691,000
4%
$ 488,000
71%
Integrated Coating Systems
1,114,000
7%
1,182,000
7%
(68,000 )
(6% )
Multi-Axis Coating Systems
6,785,000
45%
9,912,000
58%
(3,127,000 )
(32% )
OEM Systems
2,144,000
14%
2,381,000
14%
(237,000 )
(10% )
Other
3,836,000
26%
2,967,000
17%
869,000
29%
TOTAL
$ 15,058,000
$ 17,133,000
$ (2,075,000 )
(12% )
Sales of Multi-Axis coating systems recorded a 32% decrease due
to lingering supply chain challenges, resulting in several large system orders being pushed from planned fiscal 2023 shipments into
planned fiscal 2024 shipments, and are included in our year end fiscal 2023 backlog. Fluxing Systems sales showed an increase of
71%, due to the continued adoption of a newly released spray fluxing platform, SonoFlux X2, which continues to be implemented with
several large printed circuit board contract manufacturers. Sales of the “Other” product basket increased by 29%, or
$869,000, in large part due to increased sales of high value spare parts packages to support our high ASP multi-axis machines
already in the field.
Market Sales:
Twelve Months Ended
February 28,
% of
February 28,
% of
Change
2023
Total
2022
total
$
%
Electronics/Microelectronics
$ 5,509,000
37%
$ 7,134,000
42%
$ (1,625,000 )
(23% )
Medical
3,702,000
25%
4,338,000
25%
(636,000 )
(15% )
Alternative Energy
3,060,000
20%
3,688,000
22%
(628,000 )
(17% )
Emerging R&D and Other
347,000
2%
918,000
5%
(571,000 )
(62% )
Industrial
2,440,000
16%
1,055,000
6%
1,385,000
131%
TOTAL
$ 15,058,000
$ 17,133,000
$ (2,075,000 )
(12% )
Sales to the Alternative Energy, Electronics, and Medical markets decreased by 17%, 23%
and 15% respectively. Large portions of all these markets use our multi-axis systems which experienced delayed deliveries due to supply
chain challenges, and moving several planned fiscal 2023 orders into fiscal 2024. The industrial market grew by 131% due to a large multi-system
order valued at $1,540,000, $1,080,000 of this order was shipped in fiscal 2023 and the remaining $460,000 of the order shipped after the completion of fiscal 2023.
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Geographic Sales:
Twelve Months Ended
February 28,
February 28,
Change
2023
2022
$
%
U.S. & Canada
$ 6,804,000
$ 5,480,000
$ 1,324,000
24%
Asia Pacific (APAC)
3,260,000
5,301,000
(2,041,000 )
(39% )
Europe, Middle East, Asia (EMEA)
3,448,000
5,255,000
(1,807,000 )
(34% )
Latin America
1,546,000
1,097,000
449,000
41%
TOTAL
$ 15,058,000
$ 17,133,000
$ (2,075,000 )
(12% )
In fiscal 2023, approximately 45% of our sales were to US and Canadian customers. This
is compared to 32% in fiscal 2022. The increased sales to the US and Canada were positively impacted by several US Government initiatives
to invest in the green energy sector and advanced research markets. APAC revenue decreased by 39% in fiscal 2023, impacted by reduced
sales in China due to several China-based manufacturing sites moving operations back to the US and Mexico. Also, the currently strong
US Dollar has made Sono-Tek products more expensive in Japan and South Korea, resulting in several delayed purchases.
Operating Expenses:
Twelve
Months Ended
February 28,
February 28,
Change
2023
2022
$
%
Research and product development
$
2,149,000
$
1,730,000
$
419,000
24%
Marketing and selling
3,170,000
3,367,000
(197,000
)
(6%
)
General and administrative
1,650,000
1,626,000
24,000
2%
Total Operating Expenses
$
6,969,000
$
6,723,000
$
246,000
4%
Research and Product Development:
Research and product development costs increased $419,000 to $2,149,000
for fiscal 2023 due to increased salaries and related costs and an increase in research and development materials and supplies as we continue
the development of new products for new and existing markets.
Marketing and Selling:
Marketing and selling costs decreased $197,000 to $3,170,000 for fiscal 2023 primarily
due to a decrease in commission expense. This decrease was partially offset by increased travel and trade show expenses.
During fiscal 2023, we expended approximately $623,000 for commissions
as compared with $974,000 for the prior fiscal year, a decrease of $351,000. The decrease in commission expense is due to a decrease in
international sales being generated by our external distributors, which are commissioned at a higher rate than our in-house sales team.
During fiscal 2023, we expended approximately $398,000 for travel
and trade show expenses compared with $205,000 for the prior fiscal year, an increase of $193,000. The increased travel and trade show
expenses are a result of the global lifting of COVID-19 restrictions.
General and Administrative:
General and Administrative costs increased $24,000 to $1,650,000 for
fiscal 2023 due to an increase in stock-based compensation expense. This increase was partially offset by decreases in corporate expenses
and bad debt expense.
In fiscal 2023 stock-based compensation expense increased $78,000
to $257,000 compared with $179,000 in fiscal 2022. The increase in stock-based compensation expense in fiscal 2023 is due to option awards
that were issued in the prior fiscal year. Option awards are expensed over three years based on vesting terms.
24
Operating Income:
Our operating income decreased $1,206,000 or 64%, to $683,000 in fiscal
2023 compared with $1,889,000 for the prior fiscal year due to the current period’s decrease in gross profit. Operating margin for
fiscal 2023 decreased to 5% compared with 11% in the prior fiscal year. As a percentage of net sales, operating expenses increased 700
basis points to 46% in fiscal 2023 compared with 39% in fiscal 2022.
Interest and Dividend Income:
Interest and dividend income increased $131,000 to $140,000 for fiscal
2023 as compared with $9,000 for the prior fiscal year. The increase in interest and dividend income is due to the reallocation of our
investments into US Treasury securities and certificates of deposit combined with the increase in current interest rates. Our present
investment policy is to invest excess cash in highly liquid, low risk US Treasury securities and certificates of deposit. At February
28, 2023, the majority of our holdings are rated at or above investment grade.
Income Tax Expense:
We recorded income tax expense of $154,000 for fiscal 2023 compared
with $362,000 for the prior fiscal year. The decrease in income tax expense in fiscal 2023 is due to the current period’s decrease
in operating profit.
Net Income:
Net income decreased by $1,907,000 or 75%, to $636,000 for fiscal
2023 compared with $2,543,000 for the prior fiscal year. The decrease in net income in fiscal 2023 is a result of a decrease in operating
income and income tax expense combined with the PPP Loan forgiveness recorded in the prior year.
Impact of COVID-19
In response to the COVID-19 pandemic and related government 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.
25
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
$335,000 to $11,117,000 at February 28, 2023 from $10,782,000 at February 28, 2022. 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.
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, 2023 and February 28, 2022, our working capital included:
February 28,
2023
February 28,
2022
Cash
Increase
Cash and cash equivalents
$ 3,355,000
$ 4,841,000
$ (1,486,000 )
Marketable securities
8,090,000
5,868,000
2,222,000
Total
$ 11,445,000
$ 10,709,000
$ 736,000
The following table summarizes the accounts and the major reasons
for the $736,000 increase in “Cash”:
Impact on Cash
Reason
Net income, adjusted for non-cash items
$
853,000
To reconcile increase in cash.
Accounts receivable increase
(497,000
)
Increase primarily due to shipments in the last month of the fiscal year.
Inventories increase
(875,000
)
Additional inventory purchases and increase in work in process due to supply chain delays in receipt of required components.
Customer deposits increase
1,670,000
Received for new orders.
Accounts payable
126,000
Timing of disbursements.
Accrued expenses
(376,000
)
Timing of disbursements.
Prepaid and Other Assets decrease
69,000
Decreased prepaid expenses.
Income taxes payable increase
322,000
Timing of disbursements.
Equipment purchases
(556,000
)
Equipment and facilities upgrade.
Net increase in cash
$
736,000
Stockholders’ Equity – Stockholders’
equity increased $893,000 from $13,741,000 at February 28, 2022 to $14,634,000 at February 28, 2023. The increase was a result of the
current year’s net income of $636,000 and $257,000 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 $1,325,000
of cash in our operating activities in fiscal 2023 compared with generating $2,319,000 in fiscal 2022. The decrease in cash generated
by operating activities was the result of increases in accounts receivable and inventories, a decrease in accrued expenses combined with
the current period’s decrease in net income. These uses of cash were partially offset by increases in customer deposits, income
taxes payable, an increase in accounts payable and a decrease in prepaid expenses.
26
Investing Activities – In fiscal 2023, we used
$2,811,000 in our investing activities compared with using $1,631,000 of cash in fiscal 2022. Capital spending in fiscal 2023 was
$556,000 for the purchase or manufacture of equipment, furnishings and leasehold improvements and patent costs. This compares with $327,000
for the purchase of equipment and furnishings in fiscal 2022.
In fiscal 2023, we used $2,255,000 of cash compared with using $1,304,000
for the purchase of marketable securities in fiscal 2022.
Financing Activities – In fiscal years 2023 and
2022, we received $0 and $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, 2023, there were no outstanding borrowings under the line of credit.
As of February 28, 2023, $145,000 of the Company’s credit line
was being utilized to collateralize letters of credit issued to customers that have remitted cash deposits to the Company on existing
orders. The unused portion of the credit line was $1,355,000 as of February 28, 2023. The letters of credit expire in fiscal year 2024.
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, 2023.
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.
27
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, 2023, management believes that there are no critical accounting policies applicable to the Company that
are reflective of significant judgments and or uncertainties.
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, 2023 and February 28, 2022, 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.
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.
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