ITEM 2 – 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 pressures; 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; 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.

Overview

Founded in 1975, Sono-Tek Corporation designs and manufactures ultrasonic coating systems that apply precise, thin film coatings to a multitude of products for the microelectronics/electronics, alternative energy, medical and industrial markets, including specialized glass applications in construction and automotive. We also sell our products to emerging research and development and other markets. We have invested significant resources to enhance our market diversity by leveraging our core ultrasonic coating technology. As a result, we have increased our portfolio of products, the industries we serve and the countries in which we sell our products.

Our ultrasonic nozzle systems use high frequency, ultrasonic vibrations that atomize liquids into minute drops that can be applied to surfaces at low velocity providing thin layers of functional or protective materials over a surface such as glass or metals. Our solutions are environmentally-friendly, efficient and highly reliable. They enable dramatic reductions in overspray, savings in raw materials, water and energy usage and provide improved process repeatability, transfer efficiency, high uniformity and reduced emissions.

We believe product superiority is imperative and that it is attained through the extensive experience we have in the coatings industry, our proprietary manufacturing know-how and skills and the unique work force we have built over the years. Our growth strategy is to leverage our innovative technologies, proprietary know-how, unique talent and experience, and global reach to further advance the use of ultrasonic coating technologies for the microscopic coating of surfaces in a broader array of applications that enable better outcomes for our customers’ products and processes.

We are a global business with approximately 54% of our sales generated from outside the United States and Canada in the first six months of fiscal 2022. Our direct sales team and our distributor and sales representative network are located in North America, Latin America, Europe and Asia. We continue to expand our sales capabilities by increasing the size of our direct sales force and adding new distributors and sales representatives. In addition, we have established testing labs at our distribution partner sites in China, Taiwan, Germany, Turkey, Korea and Japan, while also expanding our first testing lab that is co-located with our manufacturing facilities in New York. These labs provide significant value for demonstrating to prospective customers the capabilities of our equipment and enabling us to develop custom solutions to meet their needs. Providing customers that visit our labs with a high level of application engineering expertise to develop their unique coating processes is an area of focus in our sales efforts, as we continually expand Sono-Tek’s services to best support the needs of our customers.

Over the last decade, we have shifted our business from primarily selling our ultrasonic nozzles and components to a more complex business providing complete machine solutions and higher value subsystems to original equipment manufacturers (“OEMs”). This strategy has resulted in significant growth of our average unit selling price; with our larger machines often selling for over $300,000 and system prices sometimes reaching over $1,000,000. As a result of this transition, we have broadened our addressable market and we believe that we can grow sales on a larger scale. We expect that we will experience wide variations in both order flow and shipments from quarter to quarter in part due to the increase of larger orders in the Company’s sales mix.

Second Quarter Fiscal 2023 Highlights (compared with the second quarter of fiscal 2022 unless otherwise noted) We refer to the three-month periods ended August 31, 2022 and 2021 as the second quarter of fiscal 2023 and fiscal 2022, respectively.

First Half Fiscal 2023 Highlights (compared with the first half of fiscal 2022 unless otherwise noted) We refer to the six-month periods ended August 31, 2022 and 2021 as the first half of fiscal 2023 and fiscal 2022, respectively.

RESULTS OF OPERATIONS

Sales:

Product Sales

Total Sales increased by 1% year over year for the first half of fiscal 2023, while decreasing in the second quarter of fiscal 2023 due to delayed shipments resulting from supply chain demand challenges. Strong growth of Fluxing System sales was positively impacted by the introduction of our newly launched SelectFlux X2 product to several large PCB contract manufacturers, resulting in 241% year over year growth in the second quarter of fiscal 2023, and 49% growth for the first half of fiscal 2023. OEM system sales dipped by 10% in the second quarter of fiscal 2023, but remained strong overall for the first half of fiscal 2023, growing by 12%, led by several significant shipments to our OEM partners in Europe. Multi-axis coating systems sales decreased by 21% and 13% respectively for the second quarter of fiscal 2023 and the first half of fiscal 2023 as a result of delayed shipments due to supply chain demand.

Market Sales

Sales to the industrial market recorded growth of 77% in the second quarter of fiscal 2023, and 118% for the first half of fiscal 2023, which were positively impacted by Sono-Tek’s first roll-to-roll system that shipped into the food packaging industry, and the first of seven coating machines valued at $216,000 each, that shipped to an industrial manufacturing company. The remaining six machines are scheduled to ship in the second half of fiscal 2023.

Revenue in the medical sector decreased by 27% in the second quarter of fiscal 2023 and increased by 36% in the first half of fiscal 2023. The increase in the first half of fiscal 2023 resulted from several large US based medical companies incorporating Sono-Tek coating equipment into their operations. The alternative energy market decreased by 27% and 6% respectively for the second quarter of fiscal 2023 and the first half of fiscal 2023, but based on our existing backlog and forecast, we expect growth in this market segment to rebound for the full fiscal year.

Geographic Sales

In the first half of fiscal 2023, approximately 54% of sales originated outside of the United States and Canada compared with 64% in the first half of fiscal 2022.

In the second quarter of fiscal 2023, approximately 56% of sales originated outside of the United States and Canada compared with 62% in the second quarter of fiscal 2022.

We had strong sales growth from the US, EMEA and Latin America in both the second quarter of fiscal 2023 and the first half of fiscal 2023.

A significant dip in APAC sales was primarily impacted by decreased shipments to China due to COVID-19 related lockdowns and delays with order placement, resulting in a 49% and 46% decrease in APAC revenue for the second quarter of fiscal 2023 and the first half of fiscal 2023, respectively.

We continue to adapt and refocus our sales efforts to those countries that are operational during COVID-19 peaks and dips. This strategy has been helpful in softening the impact of the pandemic on our operations.

Gross Profit:

For the second quarter of fiscal 2023, gross profit decreased by $178,000, or 9%, compared with the second quarter of fiscal 2022. The gross profit margin was 50.4% compared with 51.0% for the prior year period. The decrease in the gross profit margin is due to decreased sales of nozzles and medicoat units which traditionally have a higher profit margin compared to our other product lines.

Gross profit increased by $105,000, or 3%, to $4,003,000 for the first half of fiscal 2023 compared with $3,898,000 in the first half of fiscal 2022. The gross profit margin was 51.2% compared with 50.5% for the prior year period. The improvement in the gross profit margin is due to a favorable product mix with increased OEM sales, and strong sales to the medical industry which can typically realize higher prices for our full system coating solutions.

Operating Expenses:

Research and Product Development:

Research and product development costs increased in the second quarter of fiscal 2023 due to increased salaries and research and development materials and supplies, which are used in the focused growth initiatives we continue to implement. In the second quarter of fiscal 2022, some of our personnel, previously assigned to research and development projects, were assigned to specific customer sales orders and the associated costs were recorded in inventory, as incurred.

Marketing and Selling:

Marketing and selling expenses increased in the second quarter of fiscal 2023 due to increased travel and trade show expenses. The increased travel and trade show expenses are a result of the global lifting of COVID-19 restrictions. We believe that these expenses will level out over time and return to prior COVID-19 amounts. These increased travel and trade show amounts were partially offset by decreased salaries and commission expenses.

Marketing and selling costs increased in the first half of fiscal 2023 due to increased travel and trade show expenses. These increases were partially offset by a decrease in salaries and commission expense .

General and Administrative:

In the second quarter of fiscal 2022, we expensed $88,000 in non-recurring application and entry fees related to the listing of our stock on the Nasdaq Capital Market. In the second quarter of fiscal 2023, we experienced decreases in professional fees and corporate expenses primarily resulting from the absence of the Nasdaq related expense but partially offset by an increase in salaries and stock based compensation expense. The increase in stock-based compensation expense in the first half of 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.

Operating Income:

In the second quarter of fiscal 2023, operating income decreased by $271,000, to $178,000 compared with $449,000 for the second quarter of fiscal 2022. Operating margin for the quarter decreased to 5% compared with 11% in the prior year period. In the second quarter of fiscal 2023, decreases in revenue and gross profit combined with increases in operating expenses were key factors in the decrease of operating income.

In the first half of fiscal 2023, operating income decreased by $233,000, to $558,000 compared with $791,000 for the first half of fiscal 2022. Operating margin for the first half of fiscal 2023 decreased to 7% compared with 10% in the first half of fiscal 2022. In the first half of fiscal 2023, increases in operating expenses partially offset by increased gross profit were key factors in the decrease of operating income.

Interest and Dividend Income:

Interest and dividend income increased by $11,000 to $19,000 in the second quarter of fiscal 2023 as compared with $8,000 for the second quarter of fiscal 2022. In the first half of fiscal 2023 interest and dividend income increased by $15,000 to $26,000 as compared with $11,000 for the first half of fiscal 2022. Our present investment policy is to invest excess cash in highly liquid, lower risk US Treasury securities. At August 31, 2022, the majority of our holdings are rated at or above investment grade.

Income Tax Expense:

We recorded income tax expense of $15,000 for the second quarter of fiscal 2023 compared with $112,000 for the second quarter of fiscal 2022. For the first half of fiscal 2023, we recorded income tax expense of $85,000 compared with $197,000 for the first half of fiscal 2022.

The decrease in income tax expense in the second quarter and first half of fiscal 2023 is due to the decrease in income before income taxes combined with the application of available research and development tax credits partially offset by an increase in permanent timing differences.

Paycheck Protection Program Loan Forgiveness:

In fiscal year 2021, the Company obtained a loan under the Paycheck Protection Program (“PPP”) in the amount of $1,001,640. In the first quarter of fiscal 2022, the Company received notice from the SBA that the loan was forgiven in full and recorded a gain on forgiveness of $1,005,372, which is recorded on the condensed consolidated statements of income.

The gain on the forgiveness of the PPP Loan is a non-taxable event. 

Net Income:

Net income decreased by $182,000 to $162,000 for the second quarter of fiscal 2023 compared with $344,000 for the second quarter of fiscal 2022. The decrease in net income during the second quarter is primarily a result of a decrease in operating income combined with a decrease in income tax expense.

Net income decreased by $1,143,000 to $468,000 for the first half of fiscal 2023 compared with $1,611,000 for the first half of fiscal 2022. The decrease in net income in the first half of 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 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.

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 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 $579,000 to $11,361,000 at August 31, 2022 from $10,782,000 at February 28, 2022. The increase in working capital was mostly the result of the current period’s net income and noncash charges partially offset by purchases of equipment.

The Company aggregates cash and cash equivalents and marketable securities in managing its balance sheet and liquidity. For purposes of the following analysis, the total is referred to as “Cash.” At August 31, 2022 and February 28, 2022, our working capital included:

The following table summarizes the accounts and the major reasons for the $52,000 decrease in “Cash”:

Stockholders’ Equity – Stockholders’ Equity increased $580,000 from $13,741,000 at February 28, 2022 to $14,321,000 at August 31, 2022. The increase is a result of the current period’s net income of $468,000 and $112,000 in additional equity related to stock-based compensation awards.

Operating Activities – We generated $224,000 of cash in our operating activities in the first half of fiscal 2023 compared to $1,197,000 of cash in the first half of fiscal 2022, a decrease of $973,000. The decrease was mostly the result of increases in accounts receivable and inventories offset by an increase in customer deposits.

Investing Activities – We used $755,000 in the first half of fiscal 2023 in our investing activities compared with cash generated of $862,000 in the first half of fiscal 2022. For the first halves of fiscal years 2023 and 2022, we used $244,000 and $147,000, respectively, for the purchase or manufacture of equipment, furnishings and leasehold improvements. For the first half of 2023, we invested $511,000 in our marketable securities compared with $1,009,000 provided by our marketable securities in the first half of fiscal 2022.

Net Changes in Cash and Cash Equivalents – In the first half of fiscal 2023, our cash balance decreased by $532,000 as compared to an increase of $2,059,000 in the first half of 2022. In the first half of fiscal 2023, our operating activities generated $224,000 of cash. In addition, we invested $511,000 in marketable securities and used $244,000 for the purchase or manufacture of equipment, furnishings and leasehold improvements.

Backlog – Our backlog decreased $276,000 to $5,049,000 at August 31, 2022 from $5,325,000 at February 28, 2022. The reduction in backlog is due to shipments during the first half of fiscal 2023 that were included in backlog at February 28, 2022 and weaker demand for our products during the three months ended August 31, 2022. Orders can be highly variable from quarter to quarter resulting in large fluctuations in backlog, as product shipments are more systematically managed for both customer timing requirements and staffing management.

Critical Accounting Policies

The discussion and analysis of the Company’s financial condition and results of operations are based upon the unaudited condensed 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. The Company believes that critical accounting policies are limited to those described below. For a detailed discussion on the application of these and other accounting policies see Note 2 to the Company’s consolidated financial statements included in Form 10-K for the year ended February 28, 2022. 

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.

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. Although every effort is made to ensure the accuracy of our estimates and assumptions, significant unanticipated changes in those estimates, interpretations and assumptions may result in recording stock option expense that may materially impact our financial statements for each respective reporting period.

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 3 - Quantitative and Qualitative Disclosures about Market Risk

The Company does not issue or invest in financial instruments or derivatives for trading or speculative purposes. Substantially all of the operations of the Company are conducted in the United States, and, as such, are not subject to material foreign currency exchange rate risk. All of our sales transactions are completed in US dollars.

Although the Company's assets included $4,309,000 in cash and $6,348,000 in marketable securities, the market rate risk associated with changing interest rates in the United States is not material.

ITEM 4 – Controls and Procedures

The Company has established and maintains “disclosure controls and procedures” (as those terms are defined in Rules 13a –15(e) and 15d-15(e) under the Securities and Exchange Act of 1934 (the “Exchange Act”). Christopher L. Coccio, Chief Executive Officer (principal executive) and Stephen J. Bagley, Chief Financial Officer (principal accounting officer) of the Company, have evaluated the Company’s disclosure controls and procedures as of August 31, 2021. Based on this evaluation, they have concluded that the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to Management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding timely disclosure.

In addition, there were no changes in the Company’s internal controls over financial reporting during the second fiscal quarter of 2023 that have materially affected, or are reasonably likely to materially affect, internal controls over financial reporting.

PART II - OTHER INFORMATION

Item 1.      Legal Proceedings

None

Item 1A.    Risk Factors

There are no material changes from risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended February 28, 2022.

Item 2.       Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3.       Defaults Upon Senior Securities

None

Item 4.       Mine Safety Disclosures

None

Item 5.       Other Information

None

Item 6.       Exhibits and Reports

31.1 – 31.2– Rule 13a - 14(a)/15d – 14(a) Certification

32.1 – 32.2 – Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002

101 – The financial information from the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended August 31, 2022 formatted in Inline XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Income, (iii) Condensed Consolidated Statements of Stockholders’ Equity, (iv) Condensed Consolidated Statements of Cash Flows, and (v) Notes to Unaudited Condensed Consolidated Financial Statements.

104 – Cover Page Interactive Data File formatted in Inline XBRL and contained in Exhibit 101.

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: October 17, 2022