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; political, regulatory, tax, competitive and technological developments affecting our operations or the demand for our products; inflationary and supply chain pressures; the recovery of the Electronics/Microelectronics and Medical markets; maintenance of increased order backlog; 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; 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 2024 include: · Net sales for fiscal 2024 increased 31% to $19.7 million from $15.1 million, driven by strong shipments to the Alternative/Clean Energy, Industrial and Medical Markets. · The Alternative/Clean Energy Market grew by 96%, an increase of $2.94 million, in part due to a $766,000 shipment of a production scale system to a customer in the solar market; with three additional systems valued at $730,000 each to be manufactured for the same customer remaining in backlog and all scheduled to ship in FY2025. · Gross profit margin for fiscal 2024 decreased to 50% compared to 50.8% in fiscal 2023. Decreased profit margin was a result of product mix and a Q4 FY2024 realignment of our organizational framework as an outcome of completion of several successful R&D endeavors, which shifted some costs from R&D to cost of goods sold (COGS). · Operating income for fiscal 2024 increased 73% to $1.2 million compared to $683,000 in fiscal 2023, due to the current period’s increase in gross profit offset by an increase in operating expenses. · Despite record sales, equipment related backlog at February 29, 2024 reached a historical fiscal year end high of $9.1 million compared to the backlog at February 28, 2023 of $8.5 million, an increase of 7%. The increase is due to continued strong orders in the second, third and fourth quarters of fiscal 2024 from the clean energy sector. · Net income was $1.4 million compared to $636k in the prior fiscal year. The increase in net income in fiscal year 2024 is a result of an increase in operating income and interest and dividend income partially offset by an increase in operating expenses, an increase in income tax expense and the creation of a $138k reserve related to certain sales tax expenses. · As of February 29, 2024, we had no outstanding debt. Cash, cash equivalents and marketable securities increased $400,000 to $11.8 million at February 29, 2024 compared to $11.4 million on February 28, 2023. · Interest income, dividend income and unrealized gain on marketable securities increased to $562,000 reflecting the high interest rate environment during fiscal 2024. Market and Geographic Diversity We have invested significant resources to enhance our market diversity. By leveraging our core ultrasonic coating technology, we have 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/clean 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 2024, approximately 45% 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. 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. 22 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. Results of Operations Sales and Gross Profit: Fiscal Year Ended February 29, February 28, Change 2024 2023 $ % Net Sales $ 19,700,000 $ 15,058,000 $ 4,642,000 31% Cost of Goods Sold 9,855,000 7,406,000 2,449,000 33% Gross Profit $ 9,845,000 $ 7,652,000 $ 2,193,000 29% Gross Profit % 50.0% 50.8% Gross profit increased $2,193,000, or 29% to $9,845,000 for fiscal 2024 compared with $7,652,000 in fiscal 2023. Gross profit margin decreased to 50.0% for fiscal 2024, compared to 50.8% for fiscal 2023. Overall, the gross profit margin on our products remained relatively consistent when compared to fiscal 2023. In fiscal 2024 the decrease in gross profit margin is due to increased indirect salaries, an increase in transportation expenses, increased installation costs and increased warranty costs. In fiscal 2023, our warranty costs were lower than expected. Warranty costs fluctuate year to year and are a function of product mix. In addition, our gross profit margin decreased due to the reallocation and recharacterization of specific labor expenses from the engineering department to cost of goods sold. In light of the successful culmination of several innovative R&D endeavors, we have strategically realigned our operational structure. Historically, certain salary expenditures associated with these initiatives were classified under the R&D category during the developmental phase. However, following the recent successful completion of several of these development projects, we have transitioned some of these expenses to the manufacturing labor category. This transition necessitated a change in our organizational framework, where a select group of individuals now fall under the purview of the manufacturing organization rather than the engineering team. Effective December 1, 2023, coinciding with the commencement of the fourth quarter of fiscal 2024, we shifted the cost allocation associated with these individuals to Cost of Goods Sold. This realignment of labor allocation carries no discernible impact on our overarching financial performance; however, it does yield noteworthy adjustments to our cost structure. Notably, while our R&D expenses experienced a modest reduction, our direct labor costs underwent a commensurate increase, resulting in an approximate 2% decline in gross margin for the fourth quarter of fiscal 2024. This trend is anticipated to continue, with a similar annual impact anticipated for fiscal 2025. Product Sales: Twelve Months Ended February 29, % of February 28, % of Change 2024 Total 2023 total $ % Fluxing Systems $ 724,000 4% $ 1,179,000 8% $ (455,000 ) (39% ) Integrated Coating Systems 2,889,000 14% 1,114,000 7% 1,775,000 159% Multi-Axis Coating Systems 10,075,000 51% 6,785,000 45% 3,290,000 48% OEM Systems 1,533,000 8% 2,144,000 14% (611,000 ) (28% ) Other 4,479,000 23% 3,836,000 26% 643,000 17% TOTAL $ 19,700,000 $ 15,058,000 $ 4,642,000 31% 23 Total sales for the fiscal 2024 grew by 31%, propelled by heightened demand for our Multi-Axis Coating systems which are commonly used in the clean energy sector. Integrated Coating System sales accelerated by 159%, or $1.8M, to $2.9M due to continued success with our newly developed float glass coating platform and a newly completed custom-built system tailored for a key strategic partner within the solar energy market. Following uncharacteristically high revenue for Printed Circuit Board “PCB” Fluxing systems for our fiscal year ended February 28, 2023, PCB Fluxing sales dipped by 39% for fiscal 2024. Also, sales to our OEM Printed Circuit Board customers that integrate our ultrasonic nozzles into their own spray fluxers declined, causing OEM sales to decrease by 28%. We believe the slowdown in sales to the PCB spray fluxer market has returned us to what is closer to our historical revenue norms. The dip in OEM sales was largely mitigated by an increase in spare parts and service-related revenue, which is a growing revenue stream, categorized in the ”Other” product category. Market Sales: Twelve Months Ended February 29, % of February 28, % of Change 2024 Total 2023 total $ % Electronics/Microelectronics $ 5,602,000 29% $ 5,509,000 37% $ 93,000 2% Medical 4,180,000 21% 3,702,000 25% 478,000 13% Alternative Energy 5,997,000 30% 3,060,000 20% 2,937,000 96% Emerging R&D and Other 315,000 2% 347,000 2% (32,000 ) (9% ) Industrial 3,606,000 18% 2,440,000 16% 1,166,000 48% TOTAL $ 19,700,000 $ 15,058,000 $ 4,642,000 31% Sales to the Alternative/Clean Energy market recorded growth of 96% in fiscal 2024, which were positively impacted by a growing number of our customers transitioning from our R&D systems to production scale systems that carry much higher average selling prices. Electronics market revenue experienced a modest uptick in fiscal year 2024. This growth was strongly influenced by three significant orders totaling $497,000, from the semiconductor market. However, this positive momentum was partially tempered by a $455,000 decrease in sales from our PCB spray fluxers. Medical sales rebounded strongly in the second half of Fiscal 2024 and ended with 13% growth for fiscal 2024. Industrial sales remain very strong, showing growth of 48% for fiscal 2024, influenced by shipment of two next-gen float glass coating systems totaling approximately $700,000, and the last two machines of a multi-system order to a US based customer for $432,000. Geographic Sales: Twelve Months Ended February 29, February 28, Change 2024 2023 $ % U.S. & Canada $ 10,878,000 $ 6,804,000 $ 4,074,000 60% Asia Pacific (APAC) 3,268,000 3,260,000 8,000 0% Europe, Middle East, Asia (EMEA) 4,333,000 3,448,000 885,000 26% Latin America 1,221,000 1,546,000 (325,000 ) (21% ) TOTAL $ 19,700,000 $ 15,058,000 $ 4,642,000 31% In fiscal 2024, approximately 55% of our sales were to US and Canadian customers. This is compared to 45% in fiscal 2023. 24 We continue to record strong sales from the U.S. and Canada, growing 60% for fiscal 2024. This achievement can be attributed to various factors, including proactive governmental initiatives such as the CHIPS ACT and the Inflation Reduction Act. Additionally, the ongoing trend of onshoring for high-technology products has significantly bolstered our sales performance in these regions. Asia sales remained flat for fiscal 2024. While robust sales from the clean energy sector were shown from India, South Korea and Singapore, China sales continue a downward trajectory amidst the uncertain economic landscape prevailing in the region. In Latin America, we encountered a discernible decline of 21%, representing a reduction of $325,000. This decrease can be largely attributed to the sluggish performance in the spray fluxer segment, a market segment commonly associated with our customer base in this region. In fiscal 2024, EMEA sales experienced a notable surge, marking a 26% increase equivalent to $885,000. This upward trajectory was driven by robust sales in Ireland, where we secured orders and shipments for two unique machines catering to separate customers within the medical sector. These systems are designed for the specialized coating of unique implantable devices, reflecting our commitment to innovation in thin film coatings on next gen healthcare devices. Furthermore, Germany had continued sales growth of our electrolysis membrane coating systems, impacted by government initiatives aimed at fostering expansion of the clean energy sector. Operating Expenses: Twelve Months Ended February 29, February 28, Change 2024 2023 $ % Research and product development $ 2,886,000 $ 2,149,000 $ 737,000 34% Marketing and selling 3,696,000 3,170,000 526,000 17% General and administrative 2,080,000 1,650,000 430,000 26% Total Operating Expenses $ 8,662,000 $ 6,969,000 $ 1,693,000 24% Research and Product Development: Research and product development costs increased $737,000 to $2,886,000 for fiscal 2024 due to increased salaries and related costs and an increase in research and development materials and supplies, which are used in the focused growth initiatives we continue to implement. Marketing and Selling: Marketing and selling costs increased $526,000 to $3,696,000 for fiscal 2024 due to increased salaries and increased travel and trade show expenses. During fiscal 2024, we expended approximately $505,000 for travel and trade show expenses compared with $398,000 for the prior fiscal year, an increase of $107,000. The increased travel and trade show expenses are a result of the global lifting of COVID-19 restrictions aligning closely with pre-pandemic levels. General and Administrative: General and Administrative (G&A) costs increased $430,000 to $2,080,000 for fiscal 2024 due to an increase in salaries, professional fees and corporate expenses. These increases were partially offset by a decrease in stock-based compensation expense. 25 Effective January 1, 2024, Steve Harshbarger became our Chief Executive Officer and President, having previously served as Chief Operating Officer and President prior to such date. We have implemented adjustments to the allocation of certain expenses in fiscal 2024 associated with this transition. Specifically, we reclassified the expenses related to Mr. Harshbarger's compensation in connection with this positional change. Prior to January 1, 2024, we categorized Mr. Harshbarger’s salary under sales expenses due to his instrumental involvement in nurturing strategic accounts. In connection with Mr. Harshbarger's assumption of the principal executive officer role, the costs associated with his compensation have been reallocated to the G&A category ensuring a more precise representation of resource allocation in our financial statements. In the fourth quarter of fiscal 2024, we were notified by the State of California that we were required to collect sales tax on our shipments to customers in California. According to California, we have both physical and economic nexus in the state and are required to collect sales tax. We have taken the position that we do not have physical nexus, but that we are subject to the economic nexus filing requirements. The California economic nexus requirements have a look back period that began on April 1, 2019. We are in the process of reviewing our sales to California for the period beginning April 1, 2019. For taxable sales, we are in the process of trying to collect any sales tax due from our customers. As of February 29, 2024, on the basis of a preliminary analysis of our sales to our California customers since April 1, 2019, we have recorded an accrual in the amount of $138,000 for the estimated sales tax, penalties and interest that we may be required to remit to the State of California. Operating Income: Our operating income increased $499,000 or 73%, to $1,182,000 in fiscal 2024 compared with $683,000 for the prior fiscal year. In fiscal 2024, the increase in operating margin is a result of an increase in revenue and gross profit offset by an increase in operating expenses. Operating margin for fiscal 2024 increased to 6% compared with 5% in the prior fiscal year. As a percentage of net sales, operating expenses decreased 200 basis points to 44% in fiscal 2024 compared with 46% in fiscal 2023. Interest and Dividend Income: Interest and dividend income increased $390,000 to $530,000 for fiscal 2024 as compared with $140,000 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 29, 2024, the majority of our holdings are rated at or above investment grade. Income Tax Expense: We recorded income tax expense of $303,000 for fiscal 2024 compared with $154,000 for the prior fiscal year. The increase in income tax expense in fiscal 2024 is due to the increase in income before income taxes offset by the application of available research and development tax credits. Net Income: Net income increased $805,000 or 127%, to $1,441,000 for fiscal 2024 compared with $636,000 for the prior fiscal year. The increase in net income in fiscal 2024 is a result of an increase in operating income and interest and dividend income partially offset by an increase in operating expenses and an increase income tax expense. 26 Liquidity and Capital Resources Working Capital – Our working capital increased $1,006,000 to $12,123,000 at February 29, 2024 from $11,117,000 at February 28, 2023. The increase in working capital was primarily the result of the current year’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 29, 2024 and February 28, 2023, our working capital included: February 29, 2024 February 28, 2023 Cash Increase Cash and cash equivalents $ 2,135,000 $ 3,355,000 $ (1,220,000 ) Marketable securities 9,712,000 8,090,000 1,622,000 Total $ 11,847,000 $ 11,445,000 $ 402,000 The following table summarizes the accounts and the major reasons for the $402,000 increase in “Cash”: Impact on Cash Reason Net income, adjusted for non-cash items $ 1,915,000 To reconcile increase in cash. Accounts receivable decrease 163,000 Decrease due to timing of receipts. Inventories increase (2,027,000 ) Additional inventory purchases and increase in work in process due to customer requirements and supply chain delays in receipt of required components. Customer deposits increase 582,000 Received for new orders. Accounts payable 239,000 Timing of disbursements. Accrued expenses 312,000 Timing of disbursements. Prepaid and Other Assets decrease 46,000 Decreased prepaid expenses. Income taxes payable decrease (33,000) Timing of disbursements. Equipment purchases (795,000 ) Equipment and facilities upgrade. Net increase in cash $ 402,000 Stockholders’ Equity – Stockholders’ equity increased $1,645,000 from $14,634,000 at February 28, 2023 to $16,279,000 at February 29, 2024. The increase was a result of the current year’s net income of $1,441,000 and $204,000 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 $1,164,000 of cash in our operating activities in fiscal 2024 compared with generating $1,325,000 in fiscal 2023. The decrease in cash generated by operating activities was the result of an increase in inventories. This use of cash was partially offset by increases in customer deposits, increases in accounts payable and accrued expenses and decreases in accounts receivable and prepaid expenses. In fiscal 2024, we used $2,027,000 of cash compared with using $875,000 in fiscal 2023 for the purchase of inventories, a 132% increase. Approximately half of this increase aligns with Sono-Tek's 31% revenue growth, necessitating additional inventory to fulfill order demand efficiently. Of the remaining half of the inventory increase, approximately $730,000, stems from finished goods and work-in-progress items associated with three substantial orders associated with high-volume production systems. These systems boast high average selling prices and lengthy lead times, with all three scheduled for shipment in fiscal year 2025. 27 In addition, approximately $220,000 of finished goods comprise buy-ahead modules designed to mitigate supply chain challenges. It's anticipated that this figure will decrease to $110,000 by Q3 FY2025, reflecting improved supply chain conditions. Investing Activities – In fiscal 2024, we used $2,384,000 in our investing activities compared with using $2,811,000 of cash in fiscal 2023. Capital spending in fiscal 2024 was $795,000 for the purchase or manufacture of equipment, furnishings and leasehold improvements and patent costs. This compares with $556,000 for the purchase of equipment and furnishings in fiscal 2023. In fiscal 2024, we used $1,589,000 of cash compared with using $2,255,000 for the purchase of marketable securities in fiscal 2023. 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 29, 2024, there were no outstanding borrowings under the line of credit. As of February 29, 2024, $72,000 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 $1,428,000 as of February 29, 2024. The letters of credit expire in fiscal year 2024. Backlog We typically disclose our equipment-related backlog at the close of each fiscal quarter. However, we have not previously included our services-related backlog, encompassing repair parts, contract coating, paid applications development time in our laboratories, and purchase orders for planned paid installation commitments, in our reported backlog figures. While historically the services-related backlog has represented an insignificant portion of our total backlog in dollar terms, our strategic focus is aimed at growing this aspect of our business to become significant in the future. Accordingly, beginning with our fiscal 2024 year-end figures included in this discussion, we will incorporate service-related backlog into our reported total backlog number and present it separately. Despite its current size, we believe that service-related backlog holds potential for considerable growth. At the end of fiscal year 2024, our total backlog amounted to $9,277,168, comprised of $9,079,422 in equipment backlog and $197,746 in services-related backlog. Off - Balance Sheet Arrangements We do not have any Off - Balance Sheet Arrangements as of February 29, 2024. Critical Accounting Estimates 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. 28 Management’s estimates and judgements are continually evaluated and are based on historial experience and expectations regarding future events that are believed to be reasonable under the specific circumstances. Critical accounting estimates 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 29, 2024, 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. Based on management’s estimate, 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. Management evaluates the valuation allowance based on current estimates and historical experience. 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 29, 2024 and February 28, 2023, 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. Judgement is required when determining at what point in time control of the Company’s manufactured equipment is transferred to its customers. Management’s judgement is based on each customer contract and the transfer of control of the equipment to the customer. The sales revenue to be recorded is based on each contract. Impact of New Accounting Pronouncements In December 2023, the FASB issued ASU 2023-09, Improvements to Income Tax Disclosures. This ASU requires greater disaggregation of information about a reporting entity’s effective tax rate reconciliation as well as information on income taxes paid. This ASU applies to all entities subject to income taxes and is intended to help investors better understand an entity’s exposure to potential changes in jurisdictional tax legislation and assess income tax information that affects cash flow forecasts and capital allocation decisions. This ASU is effective for annual periods beginning after December 15, 2024, with early adoption permitted. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements and related disclosures. Other than ASU 2023-09 discussed above, 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. 29 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.