Business context and reporting period
Sono-Tek Corporation designs and manufactures ultrasonic coating systems and related components for electronics, medical, alternative energy, industrial, and other markets. This unaudited Form 10-Q covers the fiscal third quarter and nine months ended November 30, 2018; comparisons are with the corresponding 2017 periods unless noted.
Financial results and position
| Metric | Three months ended Nov. 30, 2018 | Nine months ended Nov. 30, 2018 |
|---|---|---|
| Net sales | $3.155 million | $8.674 million |
| Gross profit / margin | $1.296 million / 41.1% | $3.912 million / 45.1% |
| Operating income / margin | $50,023 / 1.6% | $96,000 / 1.1% |
| Net income | $20,259; diluted EPS $0.00 | $100,813; diluted EPS $0.01 |
| Operating cash flow | Not provided for the quarter | $88,149 |
At November 30, cash and cash equivalents were $1.627 million and marketable securities were $4.091 million, totaling $5.718 million. Working capital was $6.332 million. Total debt was $910,096, including $161,102 due within one year. The $750,000 revolving credit facility had $659,078 committed to collateralize a customer letter of credit, leaving $90,922 unused; the filing says the letter of credit expires in 2020.
Changes versus the prior comparable periods
- Quarterly and nine-month sales each rose 7%, but gross margin fell from 48.7% to 41.1% and 45.1%, respectively. Management attributed the margin pressure to a mix shift toward complex systems with more outsourced content and, in the quarter, aggressive pricing to establish a position in China’s fuel-cell market.
- Operating income declined from $188,038 to $50,023 for the quarter and from $299,439 to $96,000 for nine months. Net income fell from $194,442 to $20,259 and from $264,956 to $100,813, respectively.
- New accounting treatment under ASU 2016-01 put fair-value changes in marketable securities into net income. The filing reports unrealized losses of $59,359 for the quarter and $189,016 for nine months; prior-year unrealized gains were reported in other comprehensive income instead.
- Nine-month operating cash flow fell from $1.405 million to $88,149. Cash and marketable securities together decreased $704,000 from February 28, 2018, principally reflecting higher receivables, inventory and equipment spending, partly offset by increased customer deposits. Cash alone declined $389,583.
- Sales growth was concentrated in multi-axis coating systems and OEM systems, while integrated coating systems declined. Alternative energy sales rose 86% in the quarter and 41% for nine months; nine-month medical sales rose 20%.
Outlook, commentary, risks and unusual items
Management said it expects alternative-energy sales to grow for the remainder of fiscal 2019 and expects substantial longer-term demand as fuel-cell production scales. It also said continued growth could bring operating leverage and improved margins. The filing gives no quantified revenue or earnings guidance.
Backlog reached a record $3.040 million at November 30, versus $1.238 million at February 28 and $1.448 million at August 31. It includes a roughly $1.670 million machine order scheduled for delivery by the end of fiscal 2020; management expects the remaining backlog to ship within one year. The company cautions that orders and shipments vary substantially by quarter.
Management expected fiscal 2019 capital expenditures to total approximately $0.5 million, with spending for the remainder of the year expected to be nominal. Risks identified include economic and competitive conditions, tariffs and other regulatory or tax developments, product acceptance and customer validation, financing and capacity, backlog and order conversion, on-time and on-budget delivery of large orders, and execution of the shift toward complete systems and higher-value subsystems. The company reported no legal proceedings and stated disclosure controls were effective, with no material quarterly change in internal controls over financial reporting.
Important facts for investors to verify
- Whether record backlog, particularly the large fuel-cell machine order, converts to revenue on schedule and at acceptable margins.
- Whether gross margins recover as product mix, outsourced content and China pricing evolve.
- Whether receivables and inventory convert to cash, given the sharp year-over-year decline in operating cash flow.
- How marketable-security valuations affect earnings under the adopted accounting standard, and whether the reported losses persist.
- The availability and terms of the revolving facility, including its annual 30-day paydown requirement and the customer letter-of-credit commitment.