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SOTK > SEC Filings for SOTK > Form 10-K on 22-May-2013All Recent SEC Filings

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Form 10-K for SONO TEK CORP


22-May-2013

Annual Report


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, press 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. These factors include, among other considerations, general economic and business conditions; political, regulatory, competitive and technological developments affecting our operations or the demand for our products; timely development and market acceptance of new products; adequacy of financing; capacity additions, the ability to enforce patents and the ability to achieve increased sales volume and continued profitability.

We undertake no obligation to update any forward-looking statement.

Overview

We have developed a unique and proprietary series of ultrasonic atomizing nozzles, which are being used in an increasing variety of electronics, advanced energy (solar and fuel cells), medical device, glass, textiles and food applications. These nozzles are electrically driven and create a fine, uniform, low velocity spray of atomized liquid particles, in contrast to common pressure nozzles. These characteristics create a series of commercial applications that benefit from the precise, uniform, thin coatings that can be achieved. When combined with significant reductions in liquid waste and less overspray than can be achieved with ordinary pressure nozzle systems, there is lower environmental impact and lower energy use.

Market Diversity

During the past four years we have invested significant time, monies and efforts to enhance our market diversity. Based on our core ultrasonic coating technology, we increased our portfolio of products, the industries we serve and the countries in which we operate.

Today we serve six major industries: electronics, advanced energy (solar and fuel cells), medical device, glass, textiles and food.

A majority of our sales now originate outside the United States, and we are geographically present directly and through distributors and trade representatives in North and Latin America, Europe and Asia. The infrastructure upon which this diversified market approach is based, includes a newly equipped process development laboratory, a strengthened sales organization with application engineers, an engineering team with additional talent and the latest, most sophisticated design software tools, as well as an expanded, highly trained installation and service organization.

The new products which were introduced, the new markets that were penetrated, and the regions in which we now operate, are a strong foundation for our future sales growth and enhanced profitability.

Liquidity and Capital Resources

Working Capital - Our working capital increased $25,000 from a working capital of $4,655,000 at February 29, 2012 to $4,680,000 at February 28, 2013. The increase in working capital is due to: net income of $132,000 and cash proceeds of $25,000 for the exercise of stock options, offset by cash outflows of $32,000 for patent costs, $352,000 for the purchase of equipment and furnishings and $121,000 for the repayments of notes payable. In addition, we incurred non-cash expenses for depreciation and amortization expense of $350,000, stock based compensation expense of $27,000, $6,000 for inventory reserve, $(4,000) increasing our deferred tax asset and $(6,000) decreasing our accounts receivable reserve. The Company's current ratio is 5.3 to 1 at February 28, 2013 as compared to 4 to 1 at February 29, 2012.

Our customer deposits on hand decreased $247,000 from $316,000 at February 29, 2012 to $69,000 at February 28, 2013. During the year ended February 28, 2013 we have seen an increase in the use of bank issued letters of credit by our international customers. The use of these letters of credit has reduced the need for our customers to submit cash deposits to us. The decrease in deposits for the year ended February 28, 2013 is a result of the utilization of letters of credit and the completion of sales for which we did receive cash deposits. We only accept letters of credit in US Dollars which must be issued by a bank. We do not believe that there is any material risk in the acceptance of these letters of credit.

Stockholders' Equity - Stockholders' equity increased $184,000 from $5,808,000 at February 29, 2012 to $5,992,000 at February 28, 2013. The increase in stockholders' equity is the result of the current year's net income of $132,000, stock based compensation of $27,000 and the exercise of stock options for $25,000.

Operating Activities - Our operating activities provided $611,000 of cash for the year ended February 28, 2013 as compared to providing $1,192,000 for the year ended February 29, 2012. During the year ended February 28, 2013, we had net income of $132,000, accounts receivable increased $181,000, inventories decreased $723,000, prepaid expenses and other assets decreased $33,000, deferred tax assets increased $4,000 and accounts payable, accrued expenses and customer deposits decreased $444,000 and income taxes payable decreased $31,000. In addition, we incurred non-cash expenses of $350,000 for depreciation and amortization, $27,000 for stock based compensation expense, $6,000 for inventory reserve and $6,000 for allowance for accounts receivable.

Investing Activities - For the year ended February 28, 2013, we used $1,106,000 in our investing activities as compared to using $491,000 for the year ended February 29, 2012. In 2013 and 2012, we used $352,000 and $475,000, respectively, for the purchase or manufacture of equipment, furnishings and leasehold improvements. In 2013 and 2012 we used $32,000 and $12,000, respectively, for patent application costs. In 2013 and 2012 we used $722,000 and $5,000, respectively for the purchase of marketable securities.

Financing Activities - For the year ended February 28, 2013, we used $96,000 in our financing activities as compared to their providing $147,000 of cash for the year ended February 29, 2012. We had proceeds of $25,000 and $10,000 for stock option exercises in 2013 and 2012, respectively. In addition, we made repayments of notes payable of $121,000 and $100,000 in 2013 and 2012, respectively. During the year ended February 29, 2012, we had proceeds of a note payable for $237,000 for the purchase of additional production equipment.

Net Decrease in Cash - For the year ended February 28, 2013, our cash balance decreased by $591,000 as compared to an increase of $848,000 for the year ended February 29, 2012. During the year ended February 28, 2013, our operations provided $611,000 of cash, we used $1,106,000 in investing activities and used $96,000 in our financing activities.

Net Increase in Marketable Securities - For the year ended February 28, 2013, our marketable securities increased to $976,000 from $254,000 at February 29, 2012.

We currently have a revolving credit line of $750,000 and a $250,000 equipment purchase facility, both of which are with a bank. The revolving credit line is collateralized by all of the assets of the Company, except for the land and buildings. The line of credit is payable on demand and must be retired for a 30 day period once annually. As of February 28, 2013, we had no outstanding borrowings under the line of credit.

We had outstanding borrowings of $141,000 under the equipment facility at February 28, 2013. The borrowing has a repayment term of 48 months and bears interest at 2.12%.

We had outstanding borrowings under a note payable of $1,973,000 at February 28, 2013. The note is payable over 20 years and bears interest at 5.5%. The note payable is secured by a mortgage on our land and buildings.

Results of Operations

For the year ended February 28, 2013, our sales decreased by $2,510,000 to $9,542,000 as compared to $12,053,000 for the year ended February 29, 2012, a decrease of 21%. During the year ended February 28, 2013, we experienced a decrease in sales of our nozzles and generators, fluxers, stent coating units, XYZ units, widetrack units and hypersonic units. We did, however, see an increase in sales of our servo units.

For the year ended February 28, 2013, we were affected by the slowdown of solar energy projects due to an overcapacity in that industry, combined with a decrease in government incentives. In addition, other customers and segments slowed their purchasing activities, as governments here and overseas waited to correct imbalances. Our ultrasonic systems are often directly or indirectly funded by these governmental agencies. For the year ended February 28, 2013, our sales include approximately $1,700,000 related to direct/indirect governmental funding. For the twelve months ended February 29, 2012, our sales included approximately $2,800,000 related to direct/indirect governmental funding.

For the year ended February 28, 2013, sales to customers located in European countries decreased by $1,571,000 or 55%, sales to customers located in Asian countries decreased by $654,000 or 16% and sales to U.S. based customers decreased by $247,000 or 5%.

Our gross profit decreased $1,634,000, to $4,532,000 for the year ended February 28, 2013 from $6,166,000 for the year ended February 29, 2012. Our gross margin percentage was 48% for the year ended February 28, 2013 compared to 51% for the year ended February 29, 2012. The decrease in the current year's gross profit is due to the reduced sales volume we experienced this year. For the year ended February 28, 2013, the gross profit percentage on our individual product lines remained steady when compared to the year ended February 29, 2012.

Research and product development costs decreased $235,000 to $894,000 for the year ended February 28, 2013 as compared to $1,129,000 for the year ended February 29, 2012. The decrease is due to decreased engineering personnel and engineering materials. During the year ended February 28, 2013, we expended approximately $572,000 for engineering personnel as compared to $711,000 during the year ended February 29, 2012. During the year ended February 28, 2013, we expended approximately $128,000 for additional research, materials and product development as compared to $218,000 during the year ended February 29, 2012.

Marketing and selling costs decreased $183,000 to $2,215,000 for the year ended February 28, 2013 as compared to $2,398,000 for the year ended February 29, 2012. For the year ended February 28, 2013, we experienced decreases in commission expense, travel and entertainment expense, trade show expenses and depreciation expense.

During the year ended February 28, 2013, we expended approximately $652,000 for commissions as compared to $749,000 during the year ended February 29, 2012, a decrease of $97,000. During the year ended February 28, 2013, we expended approximately $357,000 for travel and trade show expenses as compared to $429,000 during the year ended February 29, 2012, a decrease of $72,000.

General and administrative costs decreased $95,000 to $1,154,000 for the year ended February 28, 2013 as compared to $1,249,000, for the year ended February 29, 2012. For the year ended February 28, 2013, we experienced decreases in salary expense, professional fees and stock based compensation expense. The decrease in these expenses was offset by increased corporate expenses and outside consulting fees related to the consideration of strategic and enhanced growth opportunities.

Rental Real Estate Operations:

Real estate operations expense are expenses for the operations of the Sono-Tek Industrial Park. All inter-company revenue is eliminated in consolidation. For the fiscal years ended 2013 and 2012, the results of our rental real estate operations are as follows:

                                       Fiscal Year Ended
                           February 28, 2013       February 29, 2012
Rental Income             $            51,790     $            86,377

Depreciation              $            59,241     $            57,415
Insurance                 $             9,000     $            10,913
Grounds and Landscaping   $             9,101     $            20,676
Property taxes            $            40,979     $            38,900
Miscellaneous             $               238     $               678
Total Rental Expense      $           118,559     $           128,582

Loss before Interest      $           (66,769 )   $           (42,205 )

Interest expense          $           110,385     $           113,747

Net Loss                  $          (177,154 )   $          (155,952 )

Rental income for the industrial park decreased $34,000 from $86,000 for the year ended February 29, 2012 to $52,000 for the year ended February 28, 2013. The decrease in rental income is a result of reducing the rent for one of our tenants that was experiencing financial hardship. We believe that reducing the rent was the most effective way to maintain our cash flow. The tenant is vacating the premises in May 2013 and its space is now being marketed. In April 2013, we signed a five year lease with a new tenant for 10,000 square feet.

Rental expenses for the industrial park decreased $10,000 from $129,000 for the year ended February 29, 2012 to $119,000 for the year ended February 28, 2013. The decrease is primarily a result of decreased grounds and landscaping expenses.

For the years ended February 28, 2013 and February 29, 2012, net cash outflows related to the industrial park were $181,000 and $159,000, respectively. These cash outflows are net of rental income and depreciation expense and include the principal payments on the industrial park's mortgage. Prior to purchasing the industrial park in December 2010, the Company had rental expense of approximately $142,000. We believe leasing the additional vacant space will provide a positive cash flow for the park when compared to our prior rental payments.

Interest income decreased to $5,000 for the year ended February 28, 2013 when compared to $6,000 for the year ended February 29, 2012. Our present investment policy is to invest excess cash in highly liquid mutual funds. Our holdings are rated at or above investment grade.

Interest expense decreased to $114,000 for the year ended February 28, 2013 as compared to $118,000 for the year ended February 29, 2012.

We recorded an income tax benefit of $74,000 for the year ended February 28, 2013 as compared to a benefit of $291,000 for the year ended February 29, 2012. As of February 28, 2013, we have no net operating loss deductions available to carryforward. The details of the current year's tax benefit are explained in Note 12 in our financial statements.

For the year ended February 28, 2013, we had net income of $132,000 as compared to $1,432,000 for the year ended February 29, 2012. The decrease in our net income is due to the reduced sales volume we experienced for the year ended February 28, 2013.

For the years ended February 28, 2013 and February 29, 2012, we do not believe that our sales revenue or net income has been adversely affected by the impact of inflation or changing prices.

Off - Balance Sheet Arrangements

We do not have any Off - Balance Sheet Arrangements as of February 28, 2013.

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, 2013, management believes there are no critical accounting policies applicable to the Company that are reflective of significant judgments and or uncertainties.

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. We currently use a Black-Scholes option pricing model to calculate the fair value of stock options. We primarily use historical data to determine the assumptions to be used in the Black-Scholes model and have 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

All accounting pronouncements issued but not yet effective have been deemed to be not applicable or the adoption of such accounting pronouncement is not expected to have a material impact on the financials.

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