Good morning, and welcome to the Sono-Tek Corporation first half fiscal year 2023 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Stephanie Prince from PCG Advisory. Please go ahead.
Thank you, Gary, and thank you to everyone joining us today. Sono-Tek released their second quarter and first half fiscal 2023 results after the market closed yesterday. If you don't have a copy of the release, please go to the company's website at sono-tek.com and click on the Press Release News tab in the Investors section. The product, market, and geography sales tables on the last page of the release will be part of today's discussion. With me on the call today are Dr. Chris Coccio, Sono-Tek's Chairman and CEO, Steve Harshbarger, President and COO, and Steve Bagley, Chief Financial Officer. Before turning the call over to management, I would like to make the following remarks concerning forward-looking statements.
Please note that various remarks that may be made on this conference call about future expectations, plans, and prospects for the company constitute forward-looking statements for the purposes of safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may vary materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the company's filings with the SEC. The company assumes no obligation to update the information contained in this conference call. I would now like to turn the call over to Chris Coccio, Chairman and CEO of Sono-Tek. Chris.
Good morning, and thank you, Stephanie, in particular for taking care of the Safe Harbor statement. Thank you for joining us. Today, we're going to discuss our results that were released yesterday after the market closed for the second quarter and the first half of fiscal year 2023. Bear in mind, that ended August 31, 2022. I will begin with some opening remarks, and then Steve Bagley, our Chief Financial Officer, will provide a financial review. Steve Harshbarger, President and COO, will then go through the business and operational results. Following his comments, we'll be happy to open the call for your questions. As a reminder, Sono-Tek currently holds two earnings calls per fiscal year. This is our fiscal mid-year call. Our next earnings call for fiscal year end 2023, which ends on February 28, will be in May of 2023.
Now, briefly, for those who are new to us, Sono-Tek developed a revolutionary method of applying precision thin-film coatings several decades ago. The proprietary technology involves the use of patented high-frequency ultrasonic nozzles incorporated into motion control systems that are able to achieve uniform micron thin coatings for our customers. Our solutions offer dramatic savings in raw material, water, and energy usage, and they're all environmentally friendly. Among other advantages, the principal advantage is the ability to apply precision thin films, very important in today's world. The strategic shift that we made several years ago to offer more complex, complete solutions versus component sales has broadened our addressable market and has resulted in significant growth in our average unit selling prices.
Our larger machines now commonly sell for over $300,000, and systems prices more and more often reach $1 million, which can impact quarterly revenue in a more meaningful way than previously. Most recently, we're focusing on opening new markets for our technology. This includes three main areas with very strong global growth, microelectronics and semiconductors, clean energy, including fuel cells and carbon capture, and medical devices. All three of these sectors are experiencing strong demand from long-term societal needs, and they all benefit from Sono-Tek's unique thin-film coating technology and systems. In August, we were excited to receive the largest order to date from the clean energy sector, valued at $1.1 million, validating the resources we've invested in this opening market. This order is also one of the largest in Sono-Tek's corporate history.
As our capabilities continue to advance, more and more of the approximately $8 billion global coating market opens to our advanced solutions. A good example we previously mentioned is the expansion of our coating capabilities in roll-to-roll product handling, which is used in approximately 15% of the global coatings market. In Q2, we were proud to ship our first roll-to-roll order, which went into the food packaging industry, and it's just the beginning of what we expect will become an important product line for us. Revenue for the second quarter ending August 31 was impacted by the slow delivery of components and assemblies that we need to fulfill and ship orders. This resulted in a slight year-over-year increase in the first half sales to $7.8 million and a decline of 8% to $3.8 million in the second quarter.
Our backlog of orders remains strong, ending the quarter at $5 million. Steve Bagley will go into more detail on this subject in a few moments. Operating expenses increased 6% in Q2, in part due to increased employee compensation costs in the current competitive job market. Travel costs for sales and service calls have increased as well now that COVID concerns have faded. Now, the increase in employee compensation is expected to have a continuing impact on our earnings going forward. Salaries have risen substantially to attract and retain the critical technical and managerial personnel that we need in a highly competitive inflationary market. Our people are truly the most important thing. We also expect sales and travel costs to approach pre-pandemic levels over the next nine to 12 months as well.
While we have begun raising our prices to reflect these additional labor and material costs, there clearly is a lag effect in realizing those increases as the higher salary and material costs are already in place. However, we continue to see growth opportunities in many of our traditional markets, such as float class and spray fluxing, and we're especially excited about opportunities in our target sectors of semiconductors, medical devices, and clean energy. We remain confident that our outlook for growth based on the quarter-end $5 million backlog and the continuing very high level of customer visits to our development labs, where customers test out the feasibility for their new applications.
Although we cannot provide any assurance and despite the many economic crosscurrents today, we continue to expect annual sales to be higher than last year, last fiscal year, with the fourth quarter projected to be the highest of the year. Actual results will, of course, depend on how quickly the supply chain goes back to more normal levels. With that, I'll turn the call over to Steve Bagley, our Chief Financial Officer, for some greater details on our financial results. Steve?
Very good. Thank you, Chris, and good morning, everyone. For the second quarter of fiscal 2023, total sales decreased 8% to $3.8 million due to delayed shipments resulting from supply chain challenges. During the quarter, approximately 56% of sales originated outside of the United States and Canada, compared with 62% in the second quarter of fiscal 2022. Gross profit decreased 9% to $1.9 million compared with the second quarter of fiscal 2022. The gross profit margin was 50.4% compared with 51% for the prior year period. The decrease is due to a less than favorable product mix compared to the prior year period. Operating expenses increased 6% to $1.7 million compared to the prior year period.
Research and product development costs increased 23% to $506 thousand, primarily due to increased salaries and the higher costs of research and development materials and supplies, which are directed at ongoing focused growth initiatives. Marketing and selling expenses increased 5% to $777 thousand, primarily due to increased travel and trade show expenses resulting from the global lifting of COVID-19 restrictions. General and administrative expenses decreased 8% to $435 thousand, primarily due to decreases in professional fees and corporate expenses. Our operating income decreased to $178 thousand for the second quarter of fiscal 2023, primarily due to the decreases in revenue and gross profit combined with the increases in operating expenses. Operating margins for the quarter decreased to 5% compared with 11% in the prior year period.
Net income was $162,000 or $0.01 per share, compared with $344,000 or $0.02 per share for the second quarter of fiscal 2022. Diluted weighted average shares outstanding increased slightly to approximately 15.8 million shares. For the first half of fiscal 2023, total sales increased by 1% year-over-year. Approximately 54% of sales originated outside of the United States and Canada, compared with 64% in the first half of fiscal 2022. Our gross profit increased 3% to $4 million for the first half compared with the prior year period. The gross profit margin was 51.2% compared with 50.5% for the prior year period, and that's due to a favorable product mix.
Operating income decreased 29% to $558,000. Operating margin for the first half of fiscal 2023 decreased to 7% compared with 10% in the first half of fiscal 2022. Net income decreased to $468,000 or $0.03 per share, compared with $1.6 million or $0.10 per share for the first half of fiscal 2022. Our net income of $1.6 million, as I just mentioned, does include our pre-tax Paycheck Protection Program loan forgiveness of $1 million. Cash equivalents and short-term investments at August 31, 2022 were $10.7 million, and there continues to be no debt on our balance sheet.
CapEx for the first half of the year was $244,000, and the spending is focused on our ongoing upgrades of our manufacturing facilities. I'll now turn the call over to Steve Harshbarger, President and COO, for an operational review of the second quarter and first half. Steve.
Thanks, Steve, and good morning, everybody. Thanks for joining us today. I wanna start off by saying that in recent years, a growing proportion of Sono-Tek sales are for higher revenue orders and product shipments, which is of course a result of our success, providing our customers with complete full coating solutions, rather than individual spray coating machines. As a result of this ongoing shift, product shipments are now more systematically managed for customer timing requirements, for our own internal production flow management, and current supply chain issues. As well, orders and revenue can now be more highly variable from quarter to quarter, in particular, due to the more frequently seen million-dollar-plus orders, which can result in large fluctuations in our backlog.
Now turning to our results, Sono-Tek breaks down sales in three ways, by market, by product, and by geography, and that's what I'm going to be talking about with you today. You can reference the short tables on the last page of our earnings press release for all these details. For the first half of this FY 2023, total sales increased by 1% to $7.8 million compared to last year, and decreased by 8% to $3.8 million in the second quarter. The Q2 decline was primarily due to delayed shipments resulting from supply chain challenges. We're confident that any delayed orders will roll over into these following quarters.
By product, we recently launched the SelectaFlux X2 product to several large PCB contract manufacturers, resulting in strong Q2 fluxing sales, which grew 241% over last year's second quarter to $399,000, and grew 49% to $707,000 for the first half of fiscal 2023. OEM sales dipped 10% to $762,000 in the second quarter, but remained strong overall for the first half, growing 12% to $1.3 million. This growth was led by several significant shipments to our OEM partners in Europe.
Multi-axis coating systems sales decreased by 21% and 13% to $1.5 million and $3.5 million respectively for the second quarter and first half as a result of the delayed shipments due to some supply chain challenges, as already mentioned. By market, sales to the industrial market grew by 77% to $528 thousand in the second quarter, and 118% to $806 thousand for the first half of FY 2023. This growth included the shipment of the first of seven coating machines that ship to an industrial manufacturing company.
The remaining six machines are scheduled to ship in the second half of our current fiscal year, and these machines are valued at around $216,000 each. Also included in this segment is the first shipment of a Sono-Tek roll-to-roll system. You know, Sono-Tek has invested significant capital into integrating our ultrasonic coating systems with roll-to-roll product handling technology. This first system shipped into a food packaging industry application. Looking ahead, we also expect to service several other industries with this integrated roll-to-roll technology, including the medical and the clean energy sectors. Revenue from the medical sector decreased by 27% to $798,000 in the second quarter, while increasing by 36% to $2.5 million for the first half of the fiscal year.
The increase in the first half was the result of several large U.S.-based medical companies incorporating Sono-Tek equipment into their operations. The alternative energy market decreased by 27% and 6% to $697,000 and $1.3 million, respectively for the second quarter and for the first half of the year. However, we expect solid growth for the full fiscal year in this segment based on our existing backlog and our forecast. By geography, strong sales growth from the U.S., EMEA, and Latin America in both the second quarter and the first half was offset by a 49% and 46% decrease, respectively, in APAC sales. This was primarily due to decreased shipments to China impacted by COVID-19 related lockdowns.
Backlog on August 31st, 2022 increased 19% to $5 million compared to backlog on May 31st, 2022, the end of our Q1. This growth was strongly influenced by new orders from the electronics sector. Backlog decreased 5% compared to backlog of $5.3 million on February 28, 2022, which was the end of our last fiscal year. Customer deposits increased 52% from fiscal year-end to $1.8 million, reflecting the new orders received in the first half of fiscal 2023. In closing, as Chris mentioned earlier, we currently expect supply chain challenges to continue to impact our deliveries in Q3, resulting in lower revenue when compared to the third quarter of fiscal 2022.
We do anticipate following that to see an increase of shipments in the fourth quarter and higher year-over-year sales for the twelve months of fiscal year 2023, which ends on February 28, 2023, bearing any additional significant changes in the economic environment or new unanticipated challenges with our supply chains. We'll now, I guess, open the call up for questions, and I'll turn it back over to the operator.
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question is from Bill Nicklin with Circle N. Please go ahead.
Morning, and thanks for taking my call.
Morning, Bill.
How you doing? I have a couple of narrow questions and then one that's quite broad. The first is on the supply chain. Can you describe what a resolution of the supply chain constraints might look like? Will it result in a lot of machines sitting right in inventory and then suddenly moving out very quickly? Or do you think it will be different parts, different components coming in and then just a gradual drawdown in what's been held back?
It's a good question because, you know, I guess everybody's encountering the supply chain issues these days. This past Q2 was really the first quarter we really got noticeably impacted by supply chain challenges. You know, we were, I guess, way out ahead of most companies predicting supply chain problems but still got hit with some obstacles this past quarter. We are fortunate, however, to have a solid team in place, you know, that's been able to plan our way through these supply chain challenges. You know, we have a very systematic method on our approach this way. You know, the first is in areas where we can predict upcoming parts needed like for our more standard modules and systems. We're buying inventory now and buying it earlier in much larger quantities than typical.
You know, we've come to recognize that, you know, we just simply can't trust our vendors' anticipated deliveries like we could in the past. You know, a vendor will commonly tell us, "Oh, you're gonna get it in four weeks." All of a sudden that becomes four months, and then all of a sudden it becomes 14 months. You know, we recognize now we need to put these common parts on our shelves and in enough quantity to eliminate the possibility of running out of parts. Fortunately, our healthy balance sheet, you know, of course, allows us to take on and have the luxury of this extra inventory. The second area that we've really put a lot of energy into is that, you know, we have a lot of...
an excellent engineering team that often allows us to engineer our way around supply chain problems. This can unfortunately, you know, use some of our valuable engineering resources in areas that, you know, sometimes we don't really plan for it, but it can sometimes be an outcome of designing better engineered solutions, and provides us with more depth in our parts and components selection for the future. The last approach that we sometimes take is to address supply chain, which has been a substantial shift for us recently, was to start building in-house several large subsystems that we were presently having Sono-Tek partners out-of-house build for us. This approach, you know, will ultimately have a significant impact in two areas for us.
First, we anticipate seeing better margins for those items that we're now shifting to build in-house. Secondarily, we'll have better control, of course, of our supply chain because we can manage our own inventory on these systems. With that being said, you know, I do believe we're going to some level, work out our own supply chain problems by shifting the method of how we approach supply chain issues. We will, for the short term, see some backlog that will end up ultimately building up.
Once supply chain is resolved completely, then I would think we would see a big surge, you know, as that happens, where orders that we would normally ship in three or four months, we will be shipping in three or four months, in addition to the orders that have been sitting out there for 9 or 10 months at the same time, as those parts start to come in.
Thanks for such a complete answer. My second narrow question is, there's been mention of the high level of customer visits to your development lab. Can you give us some insight into what this entails, these visits, kind of the mix of business it represents, particularly versus a year ago, and the trajectory of the visits and what percentage of these visits have traditionally turned into equipment or service revenue?
Sure, sure. You know, it's been fortunate that we saw that our laboratories were coming busier and busier, so we did some pretty significant laboratory expansions over this past year, both an addition of a new lab and an expansion on our existing lab with existing equipment as well. A huge chunk of that right now we're seeing with customers coming into us are from the clean energy sector. You know, we always have a large flow business coming through from the medical sector in that area for us. But the clean energy sector seems to really be accelerating, in particular, when you get into the hydrogen areas that are coming in. We're fortunate that we did make that expansion for us.
Although the process is a little bit longer than some sectors, like the clean energy sector, it typically might take us 6-9 months from the first lab visit to when they ultimately will buy a machine. Then it could be another 6-9 months from when they'd actually get that machine delivered. The activity is super high, and it's still maintaining right around that 75% mark. It has not dropped for us at all. For any customer that walks into our lab and is ultimately buying a machine. That's very encouraging for us, and that's the model that we're really trying to expand and press in other international labs outside of the U.S. lab as well.
All right. That 75% is the percentage of customers or potential customers that visit the lab, have some work done there, fool around with the instrumentation, they ask questions, and 75% of those end up being purchasers of either equipment or some kind of service that the lab provides?
Correct. It usually starts with the initial phase is a service. We don't really track the percentage of services, but, or I should say we do, but it's a different percentage than the 75% I'm talking about. The 75% I'm talking about is that they've actually ultimately buy a machine. A lot of that 75% prior to buying a machine will actually be buying some of our coating services, whether it's application, expertise, or contract coating prior to buying in the full system.
Thanks. All right. Now, I don't wanna monopolize the entire call, but I have a broad question based on some recent observations. That is that, looking back, I've been able to see that Sono-Tek has been expanding its customer base and application techniques and electrolyzers for the hydrogen industry for well over a decade. There appeared to be a lot of interest, but the, you know, the progress looked plodding for many years. Now with the passage of the Inflation Reduction Act and in a similar bill in Europe called REPowerEU, there seems to be a dramatic change. Experts I'm reading say that to achieve the goals laid out in those bills, there's gonna have to be a significant increase in hydrogen production and a significant increase, pardon me, decrease in cost.
Jefferies recently came out and said that that area, hydrogen production, particularly green hydrogen, will see an eight-fold increase. It looks like, too, that the green hydrogen supply chain starts with the production of electrolyzers, and nothing happens without electrolyzers because doesn't make any difference how much demand you have. If there's no supply, the market's not going anyplace. I was reading where the head of HIF said that the numbers, quote, "The numbers are very, very big, and we need electrolyzer producers to build a lot more capacity." They are the one critical pinch point in the capacity to actually produce hydrogen. The IEA came out and said the ramp, we need a ramp of several orders of magnitude.
Kinda heading toward what you guys do, S&P Global came out and said we need a rejiggering of the electrolysis technology. The Inflation Reduction Act had $1 billion just for clean hydrogen electrolysis program for reducing costs and increasing efficiency. I did a back of the envelope calculation that showed that your revenues from global electrolyzer activities at some point could be greater than the entirety of all the other markets, even assuming that your other markets are growing at a healthy rate. I'm gonna put you on the spot and ask you if you think that's possible.
Well, I have to tell you know, because we're not a huge company, you know, it's definitely possible. There's, you know, the clean energy and green hydrogen space is, in my opinion, you know, it's our most exciting opportunity for Sono-Tek, certainly for near-term rapid growth. You know, it's an area that's highly unlikely to be impacted by a potential recession because it's driven by, as just you were mentioning, these massive government investments, which are much larger than I've ever seen in any other industry segment. You know, as you mentioned, you know, you have the climate bill, which is $370 billion going into clean energy to reduce greenhouse emissions by 2030. The EU is dropping $300 billion into the green economy.
You know, the Asian governments are also joining in with massive investments, led by South Korea and the Green New Deal for over $100 billion. Like I said, it's near $1 trillion combined with all these governments around the world that are focusing on decarbonization and clean energy. Hydrogen, you know, green hydrogen in particular, is going to be a huge chunk of the worldwide transition to reduce the carbon footprint. You know, this rapidly growing demand for hydrogen is coming from some massive industries. You know, it's like steel and fertilizer, you know, which are all being pushed to become environmentally friendly conscious.
The reason why green hydrogen is so important is, although hydrogen is very environmentally friendly, you know, it emits only water when it burns to create energy, but the creation of hydrogen is commonly done through what they call a gasification process. That's coming from carbon-based fuels like coal or methane, which is bad for the environment. You know, it emits, you know, CO2, which you don't want. Green hydrogen, on the other hand, is created through an electrolysis process. The energy needed for the electrolysis process can come from environmentally friendly sources like solar or wind. Now, just as you mentioned, where Sono-Tek is involved is with this process, I guess, with our machines precisely apply the catalyst coating onto the membranes. They are used in electrolysis reactions for green hydrogen.
The membranes that Sono-Tek machines coat, you know, this is really the vital catalyst. It's the heart of where the reaction takes place for the creation of hydrogen. Sono-Tek systems, you know, we're really considered a leader in this area for coating these electrolyzer membranes. You know, we've done this for over a decade, and we have such a vast experience because it's very similar to the electrolysis process used in PEM fuel cells where we've been providing our full coating systems. You know, our application expertise in this area is really deep. While we're seeing excellent steady growth in recent years from customers using our systems for electrolysis related to fuel cells, we see a much, much larger addressable market for green hydrogen and carbon capture electrolysis in combination with that.
You know, the huge potential customer base becomes huge, and there's massive incentives by governments to implement these changes, and they're trying to do it with expedience. You know, it's very early for us to accurately predict the impact that these hydrogen expansions will have on us, but I would be shocked if it didn't have a major impact on our activity coming up this next year. It's just such a big area.
Great. Thanks. You came up with the same $1 trillion that I was taking a look at. I did some simple math and found out that one tenth of 1% of $1 trillion is $1 billion. I guess there's a lot of opportunity out there. Thank you very much for such a comprehensive answer.
You got it, Bill. Good chatting with you.
That's it for me.
Again, if you have a question, please press star then one. The next question is from Ted Jackson with Northland Securities. Please go ahead.
Thanks for taking my questions. I've got a few of them. First of all, I wanna step back into the forecast and the supply chain issues and, you know, the numbers that you expect going forward. Pretty simply, can you tell me what makes you confident that you're gonna be able to deliver the products that have been delayed by the end of the year, and in particular, you know, how you see it happening just in the fourth quarter?
Yeah. You know, we have gone out to our vendors. You know, we've had to shift our expectations for sure, you know. It did happen this quarter, and we are seeing our vendors that missed. You know, there's kind of a new norm, you know, where a vendor that was saying they would be able to provide it to us in three months was hitting it in six months. We've adjusted all of our expectations from supply chain kind of to the worst case scenario, we believe. Now, can things potentially even get worse? Yeah, it's possible, but we're doing a lot of things here internally at Sono-Tek to avoid that from happening.
You know, there's some cases where we have multiple paths we're going down, where we're having a vendor still build something for us, but we're also engineering a solution around it just as a backup. You know, it's taking a lot more time than we would like, but we have a pretty high confidence level at this point, that with these already anticipated delayed dates that, you know, we're anticipating supply chain will continue to hit us, that we'll be able to hit these machine dates, for our revenue and for our customers. You know, our customers need these machines. They're anxious to receive this equipment as well. They're for some very important applications out there, especially in the clean energy sector, that they need to get up and running.
Our confidence level is pretty high because of our approach of how we're looking at the backlog and supply chain demand.
Going into kind of the weighting, I know you're expecting to see year-over-year growth in terms of full year, and you're looking for your third quarter to be down year-over-year. Can you give some kind of guidance in terms of like, where you think your third quarter revenues might be? I ask more just in terms of like, as I reflow my forecast to kind of make sure I align with, you know, what you're expecting.
Yeah, yeah. We haven't given too much guidance there. Very upfront, the reason being is we have a lot of orders that could potentially shift into Q3, and we hope they're in Q3, but they could go out one month later. They're right on the edge. When we look at our supply chain issues of where they will drop, they're very much close to that edge of which side they're gonna fall. You know, I suspect, you know, we're probably gonna be something in the area like we were this past quarter, but we'll have to kind of see how that plays out. There's just a lot of variables that could come into play here, for that to happen.
You know, a good chunk of our quarter, I mean, it's not like you're not gonna see some sort of drastic drop or anything like that.
Okay. Shifting over to operating expenses. I mean, I know when I had done all my due diligence and rolled out coverage that, you know, this was something you'd flag. It's not that I wasn't expecting it to be up, but they were actually substantially higher than I expected them to be. Can you provide a little color on how you see your OpEx on a go-forward basis? I mean, is it kind of, you know, at this point, we've got this jump up and kinda sort of trend sideways, or are we gonna continue to see it at this percentage of revenue and grow with revenue going forward?
Yeah, I think.
Would you like to comment?
Go ahead, Chris. You want to take that one?
Yeah. Yeah, thank you. Yeah, this is a key point for a high technology company like ours. You know, some companies may just let the staff disappear because of competitive offers elsewhere or, you know, unwilling to meet what is driven by inflation. We made the decision that we're gonna meet that because it would be a much more difficult situation if we were to allow some key technology and management people to disappear, and then we have to refill all that. I think we're gonna be in stronger position. That said, I think we've accomplished that in the past six months or so. We've adjusted throughout the company salaries so that we will be much less subject to, let's call it poaching or whatever you wanna call it, inflation-driven losses.
I think that has come to sort of an end, not 100%, but I would say pretty much we've addressed it throughout our staff, and we're not anticipating another major change in compensation. We started pricing increases at least 3-6 months ago, but they take a while to roll through the system. I think we're gonna see an improvement over time in that relationship between inflation-driven compensation and our product pricing.
Okay, thanks. I wanna just a quick question. Is the drop in tax rate? Can you just give a little color into what brought the tax rate down so much?
Steve Bagley, do you wanna answer that one?
Absolutely.
Kind of what you see it going forward, too.
Well, let's see. The drop in the tax rate, what you see happening right now this year is, in the prior year, we did not pick up the R&D tax credits that were flowing through. That was primarily because you had to earn enough of those credits before you could apply them. Now, what our accountants have told us is that, yes, you can pick them up during the year as you earn them, versus having to wait to have a whole quite a bit of the tax credits themselves. You combine that with the drop in the income before taxes, and that is primarily why you see that drop.
It's fair to say with the tax rate, the reason the rate was down was a catch up for the R&D tax credit. Going forward, you're just gonna be accounting for the R&D tax credit on a quarter by quarter basis.
Yes. If you look prior year, if you took our earnings. Hang on. I'm running through the numbers here with the. All right, we had about 11 prior, and I think it was about 21%, if you exclude the PPP forgiveness.
Mm-hmm.
You should still be. I'm gonna have to say that you're gonna be at what is 85 and 5.3. I would run with about 15%-20% right now, going forward.
On a go-forward basis.
Yes, yes.
Okay.
Like I said, the biggest thing is the application of those R&D tax credits. Basically just right now, it was the decrease in earnings before income taxes. It all comes together.
Okay. My last question, just kind of around financials. You know, I mean, if you look at the quarter, you know, your operating cash flow was negative. You had a big tick-up in receivables. Sounds like you've got a fair amount of sales, I'd say, sitting in your inventory. I assume that the tick-up in receivables is tied to your supply chain issues and, you know, the kind of pig in the python that's gonna come through in third and fourth quarters of this year. What can we expect to see with regards to kind of your receivables as we roll into the back part of the year? Same thing with inventories, and then what does that mean in terms of operating cash flow?
Well, I'm looking at. You mentioned there was a negative cash flow on operations. I don't know if you were looking at just for the three months.
Just for the three months.
Okay. Okay.
Just for the three months.
Yeah. I all I have right in front of me is the six months, and our operating cash flow was positive at $223,000. Now, if you look at the AR, my AR increased $885,000. The primary reason for that was there are. Well, number one, customer agreements that we have. There were a few customers who were. It was set up, okay, they did not have to pay us until there was final installation, an approved installation took place. Do I anticipate that to happen? I would hope not, but to be quite honest, it's all gonna depend upon the agreements that we have. Our inventories, of course, did increase.
Part of that increase was due to some WIP and finished goods that we had sitting here that we couldn't ship due to customer requirements. I mean, the supply chain goes both ways. It's getting stuff in and getting stuff out. A lot of our customers ask us to use their own freight forwarders, and logistics is certainly affected by these supply chain issues as we have seen going forward. I would have to say, I mean, one of the biggest things we do work on here is for the next quarter and year end, of course, to have the least amount of open AR. I mean, we are always gonna have it. It's gonna depend upon timing of the sales.
All I can speak to right now is that large increase in AR, which I tell you, it did drop subsequent to the quarter end.
I should note that, you know, it's funny that our AR here, we take very little risks at Sono-Tek. We're fortunate that way, that, you know, we write off almost nothing from with our customers. They give us pretty hefty deposits. The only people that get good terms with us are companies that are super stable, and we feel like there's no risk of not collecting. Like international sales as an example, we collect a lot more upfront on an international sale than we would, for example, on a U.S.-based sale, which we know the company and we have a very ability to collect with, you know, with much easier.
I guess what I'm at, where I'm driving at this, I'm just kinda trying to get a sense into second half of 2023, you know, cash flow generation. You have this, you know, a large piece of, you know, this large receivables number. I'm kinda curious where that receivable number is gonna go as we kinda march through this year. You know, there's kind of a cross current in terms of inventory messaging in that one is that, you know, you probably have a fair amount of inventory that will go out the door because of your supply chain issues. On the other hand, as you're have a higher inventory level than you might have had, say, 12 or 18 months ago because of supply chain issues.
I'm kinda curious, you know, where you see your inventories going for the back half of the year. Really where I'm driving at is just I'm kinda curious in terms of what happens with, you know, operating cash flow in the back part of 2023.
Yeah. I understand that. Let's see. I just look at the inventory at year end was $2.4, and as of the quarter end, we were at $2.8. As Steve mentioned, and we've mentioned it before, we do purchase additional inventory items to protect us from the supply chain. Also the flip side is I know that I have a few units sitting in there at quarter end that should have shipped. Can I tell you specifically what the number's gonna be at year end? Of course not. It's all gonna depend upon a certain number of factors going forward. The AR I know that that did drop subsequent to quarter end, and that was due to a number of agreements that we had with our customers.
As Steve just mentioned, we try to minimize that, the amount of risk we have out there. We do not ship outside of the U.S. without having a considerable cash deposit or a letter of credit in process. Those two items are gonna be in flux. I think the key thing is that we're gonna have to see where we are at the end of the third quarter and go from there. I mean, that's the best I can do for you right now, Ted.
We do predict inventory to grow up, Ted, in for the second half of the year. That is something that will be happening. It's. It will be a conscious decision. Some of that will be because we have machines that are sitting here that are big, expensive machines that are waiting for a part, you know, to come in in order to ship them. Some of that is just conscious, the building up inventory, for the future, so we can stop having these supply chain demand issues.
Yeah. I would like to say too, Ted, that one of the benefits of where we have positioned the company over time is to have so much cash and marketable securities and no debt, is that we can make more intelligent decisions. They're not driven short range. We can say we think our team is the key thing, and so we can make decisions about compensation. We think that by having more inventory, we can protect ourselves for future problems and, you know, get back on track in terms of delivery schedules. We can do that, and it's a very small impact on our total balance sheet. That gives us the freedom to act in a way that's best for the company's long-term interest.
Well, I mean, I'm not, yeah, I'm not being judgmental on it. I mean, I think the more important is, you know, the growth opportunities in front and the top line. It's, you know, it's just more from just getting an understanding of modeling and, you know, I mean, longer term, and at the end of the day, you know, eventually you do wanna see this stuff fall down to the bottom line. Can I ask?
Sure.
I mean, I actually thought I was done with financials. I do have one kind of more fun question. Just kind of going into your delays and listening to the commentary and reading, you know, what you put in the press release, it sounds like a big chunk of what is waiting to go out the door is in your multi-axis coating systems. Is that a fair statement?
That is a fair statement. That's a big chunk of where we had supply chain and demand hiccups waiting to ship things was in that area of the multi-axis coating systems. You know, there's a lot of complex parts in there and a lot of parts that require semiconductor chips. There's one of the biggest areas for supply chain and demand glut that we're seeing right now, and everybody's seeing this. It comes from the chips area. Those chips are needed on some of our circuit boards, and trying to get those can be a real battle these days.
Would it be because of that? Then would it also be fair, I mean, you know, that when we look at the back half of this year and those systems ship out, if my memory is correct, it's generally a relatively, say, your fluxing and your integrated coating solutions, a better margin sale for you that we would see your gross margins maybe 1% or 2% better than we've seen, you know, say, in the first half because of that?
Our multi-axis coating systems have okay margins. They're not like one of the ones that's like, well, that's the best margins. You know, our systems like our medical systems or our OEM platforms have the best margins that we have in there. Now, if we sell some of these larger platforms like the six-axis robotic platforms, they actually have really excellent margins. But there's not one of those in the existing backlog mix right now at this point.
Okay. Okay. My last question, which is just more for helping me learn and educate. I know you're excited about the roll-to-roll products and shipments and stuff. I wondered if you could just take a couple of minutes and just describe what that is and, you know, in terms of a, you know, a technology, a solution, and the different industries that use it.
Sure.
You see what I'm saying? I mean, you know what I mean? Like, I'm still learning Sono-Tek, to be honest.
Yeah. No problem. If you picture taking it in the simplest format, you know, you have sheets of things to cover or like boards to cover, or you have a continuous roll. It's a difference between napkins and a paper towel roll. You know, if I'm covering napkins, that would be individual pieces coming through. We don't really cover napkins, of course. If I'm covering something the size of a napkin, I coat it goes and enters the machine, then it leaves the machine. It's a process where you go in, you stop, you coat, and then you leave.
Well, a lot of manufacturers are switching to a roll-to-roll process where they can just continuously roll product through, nonstop, like, almost like a paper towel roll or picture a big roll of paper. Especially in things like the clean energy sector, they're making a lot of flexible films these days. The membranes that we're coating in the hydrogen space are flexible films. Right now most manufacturers are coating them piece by piece today. As you start to increase your production volumes for high volume throughput, there's all of a sudden desire to say, "Hey, can we make this go roll-to-roll so we can put through a higher quantity in a set period of time?" We've been seeing this coming with our existing customer base.
As they start to have interest of transitioning from R&D to pilot to high volume production, the interest level starts to increase to say, "Hey, we are thinking about going to roll-to-roll." Sono-Tek wants to be able to be there with them when they're ready to make that transition. It's in several marketplaces. You know, the clean energy space is one that's very significant and targeted for us. Things like anything where you see a film, whether that's food packaging going on top of a container or whether it's medical devices, a lot of bandages, and gauze type applications are wound up in rolls before they're cut, so they're coated in a roll format.
again, they're all really to increase the efficiency of your throughput, and it's just a matter of the product handling of how you manipulate that roll through the coating system and how you do things like curing it and drying it and everything else comes into play, too. Roll-to-roll handling, it sounds super simple, but it's actually not. Believe it or not, every product when it's moving through has different, technical aspects of how you need to move that through successfully so as not to rip it or break it or damage the product that you're coating.
That was very educational. Thanks. Thanks for the patience with all my questions.
No, it was great. Nice talking to you, Ted. Talk to you later.
This concludes our question and answer session. I would like to turn the conference back over to Chris Coccio for any closing remarks.
Well, thank you, and thank everyone for joining us today. Sono-Tek continues to have a strong outlook, and we're excited about our opportunities for growth. Please contact us directly if you have any additional questions. We'll hold a fiscal year-end conference in mid-May when we report results for the twelve months of fiscal 2023, ending February 2023. Have a great day. Be well. Goodbye.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.