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, 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 and systems, 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.
Ultrasonic nozzle systems atomize low to medium viscosity liquids by converting
electrical energy into mechanical motion in the form of high frequency ultrasonic vibrations that break liquids into minute drops
that can be applied to surfaces at low velocity. The principal advantage of these nozzle systems is that they use much less liquid
than competitive nozzle systems to attain the required coatings on solar cells, fuel cells, glass, advanced textiles, food and
food packaging, circuit boards, medical devices and many other coating applications. This advantage translates into precise thin
films and lower costs for materials, less costly liquid consumption, less energy required for subsequent drying operations and
less release into the environment of spray that would typically bounce back and scatter while using competitive nozzle systems.
These factors are increasingly important to customers at a time of rising commodity and energy costs and supply limitations.
We use our core ultrasonic spray coating technology to provide both standard
and customized coating solutions to a wide range of manufacturing companies, enabling them to reduce their product costs and to
develop new products with superior features and quality. Presently, our customers are in six major industries: electronics, advanced
energy (solar and fuel cells), medical device, glass, textiles and foods. Our systems are widely used by leading high tech companies
and research institutions, as well as by governmental, defense, energy and health agencies around the world.
Our diversified group of customers provides the base for both financial
stability and business growth opportunities.
Market Diversity
During the past several 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 sell our products.
Today we serve six major industries: electronics, advanced energy (solar
and fuel cells), medical device, glass, textiles and food.
In recent years, a substantial portion of our sales originated 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 we have introduced, the new markets that we have
penetrated, and the regions in which we now sell our products, are a strong foundation for our future sales growth and enhanced
profitability.
Markets We Serve
Our diverse offerings have positioned us to provide a unique and superior
family of customized products to the six major industries that we serve. All of these systems are based on our core technology
of ultrasonic spray coating. Many of these systems have been commercially proven in 24/7 working schedules, under harsh and challenging
manufacturing environments, where they provide value in a continuous and reliable fashion.
We serve this industry primarily in two sectors; Printed Circuit Board (“PCB”)
manufacturing and Semiconductor manufacturing.
We provide manufacturers of PCBs with state-of-the-art solder fluxers. Spray
fluxers are used in the manufacturing process of PCBs to apply flux, which removes oxidation and prepares the PCB for the process
of soldering components onto it.
Our ultrasonic spray fluxers reduce the amount of fluxing chemical needed,
enhance the quality of the boards, and provide our customers with a better product at reduced costs of operations, when compared
with conventional foam fluxers and pressure assisted fluxers.
We are recognized as a standard setter in the industry and our systems are
incorporated by various original equipment manufacturers (OEM) in their manufacturing lines for the production of electronic printed
circuit boards. Some examples of products that we market to the electronics industry include: SonoFlux 2000F, SelectaFlux, SonoFlux
EZ and SonoFlux Servo.
Pursuant to an exclusive distribution agreement with EVS International Ltd
(“EVS”) for the territories of the United States and Canada, we offer the EVS solder recovery system to our PCB customer
base.
We also have a significant established customer base in the semiconductor
industry. The semiconductor industry utilizes our ultrasonic atomizing nozzles and robotic XYZ coating platforms for the application
and deposition of photo-resist onto semiconductor wafers. Many of our semi-conductor manufacturing industry customers engaged
in the production of micro-electro-mechanical systems, “MEMS”, have proven the ability of our technology to apply
micron thick coatings to these complex wafers.
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2.
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Advanced Energy Industry.
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Manufacturers of solar cells, fuel cells and advanced batteries share two
major technical and business challenges: enhancing the energy efficiency of their products and manufacturing their products in
a cost effective way. Extremely uniform, thin layer coatings are at the heart of the solution for these advanced energy systems’
challenges.
Our precision coating systems provide superior surface uniformity and density,
which are directly related to enhanced energy efficiency, compared to conventional systems. Our systems also afford our energy
industry clients with the capabilities to significantly reduce the consumption of the expensive catalysts and nano-materials used
in these manufacturing processes. Some examples of our products marketed to the advanced energy industry include: ExactaCoat FC
& SC, Sonic Syringe, VersiCoat, and FlexiCoat FC & SC, and SonoFlow Fusion.
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3.
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Medical Device Industry.
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Our ultrasonic coating technology is used by medical device manufacturers
worldwide. The leading applications for this industry are coating of arterial stents and balloon catheters with precise and uniform
micron layers of polymers and drugs; coating of various implantable devices with biomedical materials and coating of blood collection
tubes with anti-coagulants. These applications are typically performed under strict regulatory supervision of governmental agencies
in different countries, and the continuing demand for our systems from these customers is indicative of the high quality performance
that our systems provide these customers. Some examples of our products marketed to the medical device industry include: MediCoat
I; MediCoat II; MediCoat PSI; MedXT; MediCoat BCC and ExactaCoat MD.
Our glass coating systems are primarily sold in two separate sub-markets,
which we identify as “Float Glass” and “Panel Glass”.
Float Glass - The manufacture of float glass occurs under extremely harsh
conditions of elevated temperatures. Our ultrasonic coating technology provides this manufacturing process with the means to precisely
and uniformly apply anti-stain, and other specialty chemical agents, on the hot glass. Our customers benefit from an improved quality
product, enhanced productivity and significantly reduced expenditures on annual maintenance, often resulting in a return on investment
of less than one year. Based on this equipment’s recent successful performance, our systems are now specified by many global
float glass manufacturers as their equipment of choice.
Panel Glass – Panel glass primarily refers to glass used in the manufacture
of TV’s, tablets, phones, lenses and other consumer viewing devices. By using our coating equipment, manufacturers can apply
a wide range of functional coatings to these devices, such as conductive layers, hard coatings, anti-reflection, and other nano-material
formulations.
The equipment we offer to the glass industry is typically the WideTrack
and FlexiCoat platforms.
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5.
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Advanced Textiles Industry.
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The textiles industry is expanding the introduction of high performance
value adding coatings onto fabrics, such as anti-microbial, anti-stain, flame retardant and moisture barriers. The current manufacturing
process for applying these expensive coatings creates significant waste of material, energy and water. We are working with this
industry to incorporate our ultrasonic technology, often in combination with unique pre and post treatments of the coating materials,
to reduce the effective material and energy usage by as much as 90%.
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6.
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Food Safety and Food Coatings Industry.
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The food industry is evolving in response to greater demands for reduction
of food borne illnesses. We have successfully introduced an anti-microbial coating system for sliced packaged meats, and we are
focusing efforts on those global food companies that will need this technology to meet the new demands. We have also introduced
our systems to other segments of the food industry for the coating of flavors, ingredients and other additives of interest. Most
of our food industry equipment is designed on the WideTrack platform.
Products We Offer
We have core technology and have developed and market the following products:
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1.
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SonoFlux Spray Fluxers
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a.
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SonoFlux 2000F – spray fluxer product – designed for high volume operations with standard width lines requiring
low maintenance using a variety of solder fluxes, including rosin flux. It is designed to be used by electronic circuit board manufacturers
to apply solder flux to fixed width circuit boards. The primary customers for the SonoFlux 2000F are original equipment manufacturers
that produce their own electronic circuit boards.
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b.
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SonoFlux EZ- spray fluxer product - applies solder flux to electronic printed circuit boards that vary from two inches to up
to 18 inches in width in a cost-effective and uniform manner. They are designed to be used by either OEMs or contract manufacturers
of electronic circuit assemblies. This is an economically priced system which sells effectively to smaller manufacturers.
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c.
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SonoFlux Servo – a higher end spray fluxer capable of providing flux to both wide areas of a circuit board as well as
selective fluxing. We also sell a selective fluxing apparatus known as Selectaflux.
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2.
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MediCoat Stent Coaters
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MediCoat DES 1000 / 2000 / 3000 / 4000, MediCoat II and MediCoat
PSI provide a full range of stent coating platforms for uses ranging from research and development to high volume production in
the application of thin layers of polymer and drug coatings to arterial stents with high precision. The system incorporates motion
control of the stent during the coating process and produces coatings having excellent uniformity. The MediCoat systems use either
the AccuMist or MicroMist nozzle systems, which are precision nozzle configurations used in applications where precise patterns
and coatings are required. These products minimize waste of expensive drug polymer coatings and provide high uniformity of drug
addition from stent to stent. We also have additional medical coating platforms to address developing market segments for drug
coated balloons, catheters and other implantable devices.
Wide area modular coating system – designed to be used in
applications that require efficient web-coating or wide area spraying capability. One module can cover substrates from six inches
to 24 inches wide, depending on the application. Much greater widths can be achieved by linking modules together, and these systems
have been applied in glass lines of up to 13 feet wide. A large number of systems have been sold over the past six years, and this
application holds promise for the future due to cost and environmental savings demonstrated at customer sites. It uses non-clogging
ultrasonic atomizing nozzles to produce a low velocity, highly controllable spray. The WideTrack System offers significant advantages
over conventional pressure-spray methods in a broad range of applications such as non-woven fabrics, float glass, or odd-shaped
industrial or consumer products. Since the ultrasonic spray can be easily controlled, it is possible to use fewer chemicals and
less water and energy in applying coatings to glass, textiles, food products and packaging materials than with traditional nozzles.
This also results in reduced environmental impact due to less overspray.
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4.
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ExactaCoat/FlexiCoat/SIMCoat
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We offer a line of robotic XYZ coating equipment for applications
involving coatings for fuel cell membranes, solar energy panels and specialty lens products. This equipment is offered in bench-top
configurations as our SIMCoat and ExactaCoat product and standalone as our FlexiCoat product. These platforms position and move
our nozzle systems in a precise three dimensional application pattern. These coaters are extremely efficient especially when combined
with our patented ultrasonic syringe pump to agitate and suspend nano-particles, which are often used in many of our applications.
The VersiCoat platform is a standalone conveyorized ultrasonic
coating machine that incorporates WideTrack technology, using either one or two nozzles. The system can coat widths ranging from
2” – 24” and is used for high volume production needs. The machine is typically used for panel glass and advanced
energy coating applications.
ALIGN is an acronym for our fully integrated ultrasonic spray
module containing five primary components and stands for: a) Air delivery, b) Liquid delivery, c) Interface Electronics, d) Generator
to run ultrasonics, and e) Nozzle. We successfully introduced ALIGN in our fiscal year ended February 28, 2017. This product is
typically used by customers wishing to integrate ultrasonic spray technology onto an existing platform.
Services
We recently expanded our in-house coating capabilities, with both additional
machinery and applications engineering personnel, to allow us to provide low-mid volume contract coating services. In addition
to purchasing our equipment, our customers can now access our coating expertise and specific customer process optimization on for
a fee-for-service basis. We also provide these services at our customers’ sites where we can assist in the design and development
of customized coating systems.
Other Product Offerings – EVS Solder Recovery System
We have an exclusive distribution relationship with EVS to distribute EVS’s
line of solder recovery systems and spare parts in the United States and Canada. EVS manufactures the EVS 10K and EVS 8K solder
recovery systems which are used to reclaim solder from the dross which accumulates in the wave-solder equipment of circuit board
manufacturers. The customer base for distribution of these systems is synergistic with our existing customer base for spray fluxer
sales in the printed circuit board industry.
Rental Real Estate Operations
In December 2010, we purchased the industrial park where our facilities
are located in Milton, NY. The park is an improved 3.13 acre parcel of land comprised of five buildings of office/industrial space,
with 50,000 square feet of gross leasable floor area. We currently utilize 29,000 square feet of the park for our operations. We
presently lease 21,000 square feet of the park to unrelated third parties.
For financial reporting purposes, we report the results of the park as rental
real estate operations.
Liquidity and Capital Resources
Working Capital –
Our working capital increased $90,000
from $6,070,000 at February 28, 2017 to $6,160,000 at May 31, 2017. The increase in working capital is due to the current period’s
net income of $16,000 and our non-cash expenses of $102,000 for depreciation and amortization, $10,000 for stock based compensation
and $27,000 for an increase in our Available-For-Sale Investments. These non-cash expenses were offset by cash outflows of $40,000
for the purchase of equipment and furnishings and $37,000 for the repayment of notes payable. The Company’s current ratio
is 4.54 to 1 at May 31, 2017 as compared to 5.19 to 1 at February 28, 2017.
At May 31, 2017, working capital included $2,301,000 of cash and $2,906,000
of marketable securities, for a total of $5,207,000. At February 28, 2017, working capital included $2,557,000 of cash and $2,342,000
of marketable securities, for a total of $4,899,000. The aggregate balance of cash and marketable securities increased $308,000
during the three-month period ended May 31, 2017.
Stockholders’ Equity –
Stockholder’s
Equity increased $53,000 from $7,923,000 at February 28, 2017 to $7,976,000 at May 31, 2017. The increase is a result of the current
period’s net income of $16,000, stock based compensation expense of $10,000 and an increase in our accumulated other comprehensive
income of $27,000.
Operating Activities –
Our operating activities
provided $358,000 of cash for the three months ended May 31, 2017 as compared to providing $439,000 for the three months ended
May 31, 2016. During the three months ended May 31, 2017, we had net income of $16,000, accounts receivable increased $136,000,
prepaid expenses decreased $37,000, accounts payable and accrued expenses increased $22,000, customer deposits increased $268,000
and income taxes payable increased $13,000. In addition, in the current period we incurred non-cash expenses of $102,000 for depreciation
and amortization, $10,000 for stock based compensation expense and $27,000 for our inventory reserve.
Investing Activities –
For the three months
ended May 31, 2017, we used $577,000 in our investing activities as compared to $156,000 for the three months ended May 31, 2016.
For the three Months Ended May 31, 2017 and 2016, we used $40,000 and $94,000, respectively, for the purchase or manufacture of
equipment, furnishings and leasehold improvements. For the three months ended May 31, 2017 and 2016 we used $537,000 and $62,000,
respectively, for the purchase of marketable securities.
Financing Activities –
For the three months
ended May 31, 2017 and 2016, we used $37,000 and $36,000, respectively, for the repayment of our notes payable.
Net (Decrease) Increase in Cash –
For the three months
ended May 31, 2017, our cash balance decreased by $256,000 as compared to an increase of $247,000 for the three months ended May
31, 2016. During the three months ended May 31, 2017, our operations provided $358,000 of cash. Of this, we used $40,000 for the
purchase or manufacture of equipment, furnishings and leasehold improvements, $537,000 for the purchase of marketable securities
and $37,000 for the repayment of our notes payable.
Results of Operations
Ultrasonic Spraying – Sales and Gross Profit:
Sales:
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Three Months
Ended May 31,
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Increase
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2017
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|
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2016
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$
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|
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%
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Net Sales
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$
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2,501,000
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$
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2,216,000
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$
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285,000
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13%
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Cost of Goods Sold
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1,310,000
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1,217,000
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93,000
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8%
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Gross Profit
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$
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1,191,000
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$
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999,000
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$
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192,000
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19%
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Gross Profit %
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48%
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45%
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For the three months ended May 31, 2017, our sales increased $285,000 to
$2,501,000 as compared to $2,216,000 for the three months ended May 31, 2016. During the three month period ended May 31, 2017,
we experienced an increase in sales of our stent coating units and servo units compared to the prior years quarter. The increase
was offset by decreases in sales of XYZ Platform Units, Widetrack units and fluxer units.
Sales of our Stent Coater units, XYZ platform units, Widetrack Units and
Servo Units typically vary from quarter to quarter. Demand for our products fluctuates and is dependent upon market conditions.
The continuing expansion of our product lines has reduced our dependence on any specific market and provides us flexibility to
adapt to changing economic conditions.
Gross Profit:
Our gross profit increased $192,000 to $1,191,000 for the three months ended
May 31, 2017 from $999,000 for the three months ended May 31, 2016. Our gross profit margin was 48% of sales for the three months
ended May 31, 2017 compared to 45% for the prior year period. The increase in the current period’s gross profit margin is
primarily due to increases in sales of our higher gross margin stent coating units and servo units. In addition, for the three
months ended May 31, 2017, the Company experienced a decrease in manufacturing salaries due to reduced headcount.
Operating Expenses:
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Three Months
Ended May 31,
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Change
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2017
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2016
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$
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%
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Research and product development
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$
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303,000
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$
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304,000
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$
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(1,000
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)
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—
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Marketing and selling
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$
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583,000
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$
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547,000
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$
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36,000
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7%
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General and administrative
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$
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259,000
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$
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269,000
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$
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(10,000
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)
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(4)%
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Research and Product Development:
Research and product development costs decreased $1,000 to $303,000 for
the three months ended May 31, 2017 compared to $304,000 for the three months ended May 31, 2016. During the three months ended
May 31, 2017, we experienced increases in health insurance premiums, supplies and depreciation expense. These increases were
offset by decreases in salaries, research and development materials and travel expense.
Marketing and Selling:
Marketing and selling costs increased $36,000 to $583,000 for the three
months ended May 31, 2017 as compared to $547,000 for the three months ended May 31, 2016. For the three months ended May 31, 2017,
we experienced increases in commission expense due to increased sales in the current period. We also experienced increases in health
insurance premiums, and travel expenses. These increases were partially offset by decreases in advertising and trade show expenses
and depreciation.
General and Administrative:
General and administrative costs decreased $10,000 to $259,000 for the three
months ended May 31, 2017 as compared to $269,000, for the three months ended May 31, 2016. For the three months ended May 31,
2017, we experienced decreases in professional fees and salaries. These decreases were partially offset by increases in health
insurance premiums, stock based compensation expense, travel and other corporate expenses.
Operating Income (Loss) – Ultrasonic Spraying:
Our operating income for the three months ended May 31, 2017 was $46,000
as compared to an operating loss of ($121,000) for the three months ended May 31, 2016, an increase of $167,000. For the three
months ended May 31, 2017, our gross profit increased by $192,000 when compared to the three months ended May 31, 2016. The increase
in gross profit was accompanied by increased marketing and selling expenses and decreases in research and development costs and
general and administrative expenses, which collectively increased by $25,000 when compared to the three months ended May 31, 2016.
Rental Real Estate Operations:
For the three months ended May 31, 2017, our real estate operations generated
$11,000 in rental income from unrelated third parties and incurred $21,000 in operating expenses, $18,000 in depreciation expense
and $12,000 in interest expense resulting in a net loss of $40,000. The $40,000 loss excludes any inter-company rent.
Other Income
:
During the three months ended May 31, 2016, we received a payout of $200,000
in life insurance proceeds from the death of a former employee.
Condensed Consolidated Results:
For the three months ended May 31, 2017, we had net income of $16,000 as
compared to $56,000 for the three months ended May 31, 2016.
For the three months ended May 31, 2017, our revenue increased $272,000,
gross profit increased $179,000, operating expenses increased $20,000 and our operating income increased $159,000 when compared
to the three months ended May 31, 2016. Interest expense/income and other income decreased $200,000 when compared to the three
months ended May 31, 2016.
Critical Accounting Policies
The discussion and analysis of the Company’s financial condition and
results of operations are based upon the 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, 2017.
Accounting for Income Taxes
As part of the process of preparing the Company’s condensed consolidated
financial statements, the Company is required to estimate its income taxes. Management judgment is required in determining the
provision for the deferred tax asset.
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 are not expected to have a material impact on the financial
statements of the Company.