Sono Tek Corp (SOTK) Q2 2027 Earnings Call Transcript

Good day, everyone, and welcome to the Cenotec Corporation Fiscal Year 2027 Mid-Year Results Conference Call. All participants will be in a 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 and then one on your touch-time phones. To withdraw your questions, you may press star and two. Please also note today's event is being recorded. At this time, I'd like to turn the floor over to Kieran Smith with PCG Advisory. Please go ahead.

Thank you, Jamie, and thank you, everyone, for joining us today. Sonitech released their second quarter and first half fiscal 2027 results this morning. If you do not have a copy of the release, please visit the company's website at www.sonitech.com and navigate to 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, Executive Chairman, Steve Harshbarger, CEO and President, 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. As a reminder, this is our second quarter and first half call for the period ended August 31, 2026. Our next call will be our full year fiscal 2027 update for the period ended February 28, 2027 and will be held in May 2027. I would now like to turn the call over to Chris Coccio, Executive Chairman of Sonotech. Chris, please go ahead.

Thank you, Kieran, and good morning, everyone. Thank you for joining us today to review Sonotech's fiscal second quarter in the first half 2027 results. Steve Harshberger will review the operational performance and business trends, and then Steve Bagley will provide more detail on the financial results. The first half of fiscal 2027 represented solid progress for Sonotech with revenue growth, meaningful gross margin expansion, and improved operating profitability. Our balance sheet also remains very strong with no debt. Our results also reflect an important shift in the composition of our business with particularly strong growth in the medical market and increasing demand for higher value production. In the first half, revenue increased 6% to approximately $10.9 million. Gross margin expanded to 55% compared to 51% in the prior year period. Operating income increased 41% to approximately $1.28 million. and net income increased 22% to approximately $1.1 million. The medical market sales increased 289,000% to approximately $7.1 million. The medical market continues to be an important growth driver for the company. We are seeing customers increasingly move from process development and qualification toward commercial manufacturing, where Sonotech's precision ultrasonic coating technology can play a critical role. At the same time, we continue to see opportunities to expand our install base and our relationships with customers as their production requirements grow. We want to highlight the significance of the recent orders we announced from an existing alternative energy customer. Three orders, $2.2 million, which cover 10 production-scale systems and represent the largest aggregate customer order in Sonotech's history. It's important about the expansion of the relationship. We deployed our technology in an alternative energy manufacturing process. It is now expanding its use for Sonotech production. This is a good example of the long-term opportunity we see across our business. Supporting customers as they move from development into higher-volume manufacturing and then expanding our relationships as their processes scale. Together with the more than $3.6 million medical diagnostic production line order announced in August, these programs alone now represent more than $10.79 million of backlog, with the majority currently expected to be delivered in fiscal year 2028. Importantly, these opportunities involve different customers and two distinct growth markets, medical devices and alternative energy. While the timing of individual production system orders can result in variability from quarter to quarter, this demonstrates the long-term potential. I'll turn the call over to Steve Harshberger, our CEO and president. Steve?

Thank you, Chris, and good morning, everybody. As Chris highlighted, we had a solid first half with continued progress across several important areas of the business. Our results reflected strong medical sector demand, higher-value production systems, improved gross margins, and disciplined execution across the whole organization. For the first half, revenue increased 6% to $10.9 million, while gross profit increased 14% to approximately $6 million. Gross margin expanded to 55%, and operating income increased 41%. Perhaps, and most importantly, we continue to see our encouraging demand for our technology in applications where customers are moving beyond development and into production. The medical market was the largest contributor to our first half growth. Medical sales increased 289% to approximately 7.1 million. And demand was driven by continued activity in drug-eluting balloon coating systems, specialty stent applications and other medical device coating applications we are seeing increasing adoption of our technologies our customers move from development in qualification into commercial manufacturing that transition is really important because production applications involve larger more sophisticated systems and they can create opportunities for follow-on equipment services and additional production lines as customers volumes increase. From a production perspective, multi-axis coating systems were a significant contributor to our first half growths, increasing approximately 50% and that was driven primarily by specially medical coating systems. OEM systems also increased approximately 67% and that was supported by demand from our European Fluxing OEM partner and a China-based semiconductor OEM customer. Inline coding systems declined 14% for the first half, and that's primarily reflecting the difficult comparison with the prior year when we had six high ASP systems that were totaling about $4.4 million that were shipped. So while product line results can vary significantly based on the timing of these larger high ASP system shipments, the underlying demand for high-value production platforms remains very encouraging. We also saw continued improvement in our industrial business which increased approximately 156 percent during the first half and that was influenced by an optics related shipment to the defense sector and this defense sector is going to be an area that we will continue to put increase focused on in the coming years. Alternative energy in the first half reflected reduced demand associated with changes in government policy and spending and that was related to green hydrogen electrolysis and fuel cell electrolysis and fuel cell applications however we continue to view alternative energy as a meaningful long-term opportunity and our recent seven point one nine million order announcement that dr. Cochillo just touched upon earlier is a very good example of why we continue to believe in the long-term potential in this market these orders are from an existing customer that has successfully deployed Sonotech technology in an advanced clean energy manufacturing process. The customer continues to expand that deployment into additional production lines across three geographic locations. The 10 systems are currently expected to ship primarily during fiscal 2028. This continued expansion demonstrates the strength of our business model, where successful process development leads to high volume manufacturing opportunities and additional orders as our customers expand their production capabilities. On August 31st, our backlog was approximately $9.5 million, and that's up 23% from the end of the fiscal quarter. Now, since quarter end, the three new clean energy auditors, totaling $7.19 million, have substantially increased our backlog in Q3 FY2027. A significant amount of this backlog is currently expected to ship in fiscal 2028. Importantly, the recent alternative energy orders, as well as that previously announced medical diagnostic production line order that was more than $3.6 million, represents two different customers in two distinct markets. And with approximately five months or so remaining before the beginning of fiscal 2828, we still have additional time to build upon this backlog even further. Now, turning to our outlook, we are reiterating our expectation for flat to modest revenue growth for this current fiscal 2027. And as we've discussed previously, the timing of several large production systems orders can create variability for us from quarter to quarter. At the same time, we continue to see encouraging demand, particularly in medical devices, and by the increasing value and scale of these systems we're supplying. Our focus remains on supporting our customers as they move from development into commercial manufacturing, expanding our install base, and continuing to invest in engineering, application development, and commercial capabilities. The recent record order activity also gives us increased visibility in fiscal 2028, while we continue to pursue additional opportunities across medical, microelectronics, industrial, and alternative energy applications. And lastly, our balance sheet remains pristine, with cash continuing to grow and no outstanding debt, positioning us really nicely for further execution on our growth strategy. With that, I'll now turn the call over to Steve Bagley, our CFO, for a financial review of the results.

Very good. Thank you, Steve, and good morning, everyone. I'll begin with some additional detail on our financial performance for the second quarter and first half of fiscal 2027. For the second quarter ended August 31, 2026, total revenue was approximately $5.23 million compared with $5.16 million for the prior year period, and that is an increase of $69,000. For the first half, revenue increased 6% to approximately $10.9 million, and that compares with $10.3 million in the first half of fiscal 2026. The first half increase was driven primarily by the significant increase in medical market sales and higher sales of multi-access and OEM systems. Gross profit for the second quarter was approximately $2.8 million, and that's an increase of approximately 7% from the prior year. Gross profit margin was approximately 53% in the second quarter, primarily reflecting an unusually favorable and geographic mix. For the first half, gross profit increased 14% to approximately $6 million, while the gross profit margin expanded to 55%, and that compares with 51% in the prior period. The improvement in gross profit margin reflects a favorable product and geographic mix, including a higher contribution from medical systems and other higher-value production equipment. Now, gross margins can vary significantly from period to period based on a specific system shipped, customer and geographic mix, distributor involvement, installation requirements, and other factors. Accordingly, the gross margin levels achieved during the first half of fiscal 2027 should not necessarily be viewed as indicative of margins expected in future periods. and now a review of our operating expenses, which remained well-controlled as we continue to invest in the business. Research and product development costs increased in the second quarter of fiscal 2027 due to increases in employee health insurance, R&D materials, and other engineering expenses. For the first half, R&D costs remained steady at approximately $1.3 million compared to the prior year. As the costs I just mentioned, were partially offset by decreases in some salaries and supplies. Marketing and selling expenses increased in both the second quarter and first half of fiscal 2027 due to increases in salary related to our sales application lab, our forward-deployed engineering group, employee health insurance, and trade show expenses. Now, our sales and marketing costs are variable, and a large portion of the costs are dependent on trade shows and where geographically our sales are generated. General and administrative expenses increased in both the second quarter and first half of fiscal 2027 due to increases in salaries, employee health insurance, corporate expenses, and stock-based compensation, and legal and accounting fees. Our operating income for the second quarter decreased by 9%, or $39,000, to $382,000 due to an increase in operating expenses. However, first-half operating income increased 41% to approximately $1.28 million, compared with approximately $905,000 in the prior year. And this improvement reflects the combination of higher revenue, improved gross margin, and disciplined expense management. Net income for the first half increased 22% to approximately $1.11 million, compared with approximately $909,000 in the prior year. Our balance sheet remains very strong, and as of August 31, 2026, cash and marketable securities totaled approximately $17.7 million, and that compares with $14.8 million at the end of fiscal 2026, and we continue to have no debt. The strength of our balance sheet provides us with the flexibility to continue investing in the business, support working capital requirements associated with larger production system orders, and pursue opportunities to expand our capabilities. Now, as Steve discussed, backlog at August 31 was approximately $9.5 million, representing a 23% increase from the end of the first quarter. Following quarter end, we received three additional orders totaling approximately $7.19 million. Now, those orders, together with the previously announced medical diagnostic production line, order of more than $3.6 million significantly increases the backlog heading into fiscal 2028. Overall, we believe that our balance sheet and backlog position the company very well as we move through the remainder of fiscal 2027 and prepare for our next fiscal year. And with that, I'll turn it back over to Steve.

Thanks, Steve. To summarize, we believe the first half demonstrated continued progress in the business. We delivered revenue growth, meaningful growth margin expansion, and stronger operating profit, while the medical market continued to be a significant growth driver. At the same time, we are seeing increasing evidence of customers moving from development into commercial manufacturing, which can create opportunities for larger and more sophisticated production systems. Now, this recent record, Clean Energy Order, is an excellent example of this progression, and together with a medical diagnostic program, provides significant early visibility into fiscal 2028. You know, our priorities remain super straightforward. You know, we execute well for our customers, we continue expanding our installed base, and invest selectively in our technology and commercial capabilities, and capitalize on opportunities in microelectronics, medical, industrial, and alternative energy applications. With that, we'll open the call for questions.

And at this time, we'll begin the question and answer session. To ask a question, you may press star and then 1 on your touchtone phones. If you are using a speakerphone, we do ask that you please pick up the handset before pressing the keys. To withdraw your questions, you may press star and 2. Once again, that is star and then 1 to join the question queue. We'll pause momentarily to assemble the roster. Our first question today comes from Bill Nicklin from Bill Will Insights. Please go ahead with your question. Hey, good morning. Good morning, Bill.

Thanks for taking my questions. It looks as though the majority of your high ASP orders are coming from opportunities where you become fully integrated into your customer's production lines. You think that's a fair assessment, and maybe there should be some kind of a breakout going forward to show that these are integrated orders because it appears to me that the integrated orders create kind of a flywheel effect where you can get a new customer, but then you get these continuing orders without getting a new customer. So I wonder if you would comment on that and kind of how it affects your outlook for the next months and years.

Sure, sure. Sure. You know, it does, because it certainly makes a difference of where we're going to be putting our investments. You know, we have a substantial amount of cash, as you know, on hand. And I think there's a couple of areas where we'll continue to invest as our business grows and our financial position strength. You know, first, I should point that, you know, people are always saying, hey, where are you going to put that money? And on the acquisition side, you know, we continue to have both inbound and outbound activity. And that's really nothing new for Sonotech, you know, given the nature of our business. We've always had companies approaching us, and we're always going to keep an eye on opportunities, you know, I might say for potential opportunities. But I would say that activity certainly has picked up in that area for our business and is certainly gaining momentum there. And I certainly want to emphasize, though, although that we proactively continue looking at acquisition opportunities, we're really focusing only on companies that we really know very, very well. and these are areas where we have a great understanding of the markets and the business you know we're not looking to venture into areas too far away from what's our core understanding but probably the more interestingly is where we're going to look to invest organically and that kind of goes back more to the core of your question you know that the core ultrasonic technology business you know that's the foundation of a business and we'll certainly make unique investments there, but over the last several years, we're really starting to put a much greater emphasis on expanding our systems integration capabilities, which is what you were just talking about there, you know, particularly through our forward deployed engineering team or that FDE team as we call it. And, you know, what this team does, and it does it with excellence, it's really to work very closely with customers to take our existing ultrasonic technology and integrate it much larger more sophisticated production platforms and that's been you know a really important change in our business you know in instead of just like selling say a coding system you know we're increasingly providing a much more complete production solutions and of course that translates then into significantly higher ESPs higher average selling prices and basic and what's exciting for us I think there is now that we've proven this model works finally you know we're seeing that these large production platform orders they're coming our way more frequently and we believe our investments in the integration and capabilities are really a big part of that reason why and just to give you an idea of our commitment here you know two oh maybe it was two and a half years ago I should say our FDE team consisted of just one person you know into that now today we're up to four people on that team and I would expect us to continue expanding their capabilities over the next year or two and there's another really important reason why we're putting more resources in that particular area and that return on investment you know when we invest in developing the next major innovation say in our core ultrasonic technology and areas like that, you know, it can take, I don't know, five, maybe six years before that investment really starts having, you know, a really meaningful impact on our business. But when we invest in our integration capabilities, then what we find is we can start seeing meaningful return in as little as maybe just one or two years. You know, that's a pretty significant difference in my opinion. So now, and again, don't get me wrong, both types of investments are very important to us and we certainly certainly not don't back away from developing in the new ultrasonic coding technology area but I like the idea of our decades of investment that we've already made in our ultrasonic coding technology with this strategy you know we're leveraging that is super important to us so we're not necessarily having to invent something new every time we want to grow you know we already developed something that's really pretty remarkable technology. And now we're really investing in the engineering capabilities that allow us to take technology into much larger production platforms. And what we're finding is that these investments are showing to generate a return much more quickly than, say, a typical traditional R&D investment from us. So we're really getting more commercial value out of the technology that we've already spent, you know, these decades of time developing. And I believe that's going to be one of the most important investment areas for Sonotech over the next few years for us. I know that was kind of long-winded, Bill, but hopefully that gave you a little bit of an overview.

You touched on a couple of questions I haven't even asked yet. That's pretty good. So, in my mind, if you look at these larger integrated orders, it's really an indication of like a flywheel effect where it's not like you have to go out and get a new customer each time you want to get an order. So, your FDEs are out there getting new orders, But they're also working with customers where, as your customer expands, they pretty much have to come to you. So you're getting a double effect. You're getting a new customer, but then you're getting this follow-on business. Because if you're integrated with their manufacturing, the odds are if their manufacturing grows, your orders are going to grow.

That's exactly right. And this last order that we just announced for $7.2 million is really a prime example of that. You know, that's a customer that we walked through in the R&D phase very successfully and in the pilot line phase. And then we developed, you know, a really sophisticated high-volume production system for them. And that sold well. They loved it. But it doesn't end there. You know, as that customer has success, the orders keep coming because every production line that they build, you know, we are attached at the hip with them. You know, because we are their coding expert. You know, so it really changes our business model significantly when you start having customers like that where you have these integrated partners to you.

Good. Following on that, back to your old forward-deployed engineering strategy, I think you said you had four full-time forward-deployed engineers now. what might you have a year to 18 months from now and what does that indicate about the momentum you see in your business yeah well now that we have proven that not all is successful you know that it's no there's no doubt about it now that you know we put the first guy in there it worked really well then we we doubled it to two and then we doubled it to four and I should say it's four people in total there's one one support a technician in there with three the actual forward deploy engineers, that we've proven that model works.

We're getting these significantly large orders, and now we're going to be doubling down on that, you know, that we're going to be continuing to add this more personnel into there and continuing to make that bet because there's still the demand on the demand side that is pulling us there. So as long as we see our customer base pulling us into that area and wanting it and desiring it, there's no reason for us not to double down on that. So we haven't really said exactly how many we're going to be hiring there, but I wouldn't be surprised to see that team doubled in another year or two, maybe even quicker. The challenge for us there is mostly that these are really skilled, experienced people with our technology and how to do integration. So finding them is always a little bit of a challenge, but, you know, we have some great guys in that area that I think are in the pathway to join that team.

Great. That sounds promising. I appreciate it. Thank you. Good chatting, Bill. Take care.

And our next question today comes from Dick Ryan from Oak Ridge Financial. Please go ahead with your question.

Hey, morning, Dick.

Are you there? um i was break i had a bad mr ryan it's it seems that your line is breaking up uh if you could give us a call back disconnect and rejoin we can get you back in the question queue and our next question does come from ted jackson from northland securities please go ahead with your question thanks good morning guys hey how's it going ted uh couldn't be better i love these days you know reporting seasons companies they're doing well um i got a few questions i wanted to

start out just with the medical market you know you've had a lot of success there you know the company um its initial success was really in the coding of stents and you've kind of done two things within it as you you know up the game in terms of the kind of systems you sell and the asp to them and then you've expanded into you know the balloon market and um i guess i'm curious do you see um additional opportunity in these balloon, you know, these, you know, these medical balloons. Do you see different applications beyond the two that you've had the success with and what those might be at UCM? So I guess I'm asking, is there an opportunity for you to expand the customer account with regards to, you know, this newer, you know, balloon opportunity, And then maybe some discussion about, you know, other things where you feel you're well positioned. I mean, I think things like implants and such would, you know, would be logical. So that's my first question.

It's a good question because the medical market's really evolving for us quickly these days. You know, what in BASIC happened is, you know, we gained all this high-volume production expertise in the clean energy sector. and that was primarily in the electrolysis area for things like fuel cells and as that market started to shift with government policy and slow down for us in that particular sector we immediately then shifted resources over to the medical sector and what that allowed us to do is to take product lines like this developing balloon drug eluding balloon product line that we make machines for and could develop a system that was much more extensive and had a lot more capabilities than say like our stent coating systems you know when we first started going into the stent coating market we sold relatively small systems because that was what our capabilities we had internally at that time so we were selling maybe 75 to 100 000 systems entering into the balloon market where we now had a lot more capabilities internally to offer the customer a much larger package that had a lot more offerings to it all of a sudden the ASP of these machines took off much higher so they were more in the quarter million dollar to three hundred thousand dollar area and the customers wanted that really they would have even liked to have it back in the days for the stent coating market but we didn't have that capabilities at that time So as we enter into DEV, which is, I have to say, somewhat, I wouldn't call it its infancy, but it's coming out of its infancy. This is a market that's really maturing right now that we are what I would consider the industry leader for coding drug-eluting balloons. You know, the largest companies in that area pretty much use Sonotech machines for that process. not everyone but a good chunk of the major ones use us for that process and I think there's a lot of more road ahead of that you know that when we look at their forecast from our customers if things go as they plan we should be able to continue to support them as they add on additional manufacturing lines and that is their intent in the future for most of our customers in that particular market. What's probably more exciting for me, though, is that most of these companies that make the drug-eluting balloons or make the stents also make other medical devices, as you've indicated. They make, whether it's heart valves or meshes, internal meshes that go to the body or diabetes devices that so many of these devices now need thin film coatings onto them that prove some sort of functionality and Sonotech is no longer now being considered say a stent coating company now we're being considered a medical device implantable company and one that has the capabilities for high volume production and it's proven i know they see our customer base sees these press releases out there and they know we're shipping to the largest medical device companies in the world and they see that we're a financially stable company and so it brings this huge amount of credibility so customers that wouldn't have necessarily come to us in the past now have a very high level of confidence coming to us with their next gen medical device to bring it into our lab, improve it in, and that's something we have happening on a weekly basis here, where somebody's bringing their next-gen medical device in, improving it, and as those get proven in, they'll prove their R&D sector, and then they'll go through FDA, and then they'll be in the production line, and that's where we start to really see the benefit of selling multiple machines at high ASPs.

Well, that's pretty exciting.

Yeah, it's definitely, it's super exciting. I mean, to see what you hope for actually happening is super exciting to see that actually go through successfully.

And then it ties into this, I think, somewhat, but, you know, you talked a bit in your prepared remarks about, you know, a lot of, you know, excitement in developing markets and new things that were coming. Is that excitement that's driving that commentary from you greater than these newer opportunities in the medical market? Maybe some discussion on other areas where you're, you know, where you have some enthusiasm. I know in the past you kind of bounced around some of the next-gen display stuff, but maybe some color with regards to what you're excited about for new markets that, you know, Sonotech really hasn't tapped yet.

Yeah, there is most definitely a plethora of new applications that are outside of what we've announced. You know, as an example, like the defense sector has a lot of applications that are out there that we can have a nice fit into. The microelectronics sector, including semiconductor, has a lot of nice applications. And then there's a lot of them that are what I would describe a little bit more in the infancy, but have huge upside potential like we've spoken before, like the micro LED markets or the insulation market for conductive coatings. You know, these are all areas that companies, not just Sonotech, but other associated companies are putting many millions of dollars of investment into this. So if you're making, say, a large cell phone company or a display company, they all have these very active and expensive R&D programs, which Sonotech is now very often part of. And they all won't be home runs, but the ones that are successful, we are more than likely to be the chosen technology because we're the one that's proven on the R&D and pilot line level. and when they pull the trigger to go to high volume it's sometimes difficult for us to predict because it's not within our control this is the transition of them developing the whole product and bringing it to market but when they do it we see the benefit and now we're starting to see that happen with many of our customers things that we were working on two three four years ago So all of a sudden, it's got their approvals. They've got, whether it's a large phone manufacturer or a TV manufacturer, said, hey, yes, we're going to make the switch to this technology, and Sonotech will be the standard. So it's spread over a large breadth of industries, but the concept of us getting in on the R&D level, proving it, making it work well, building a relationship where the customer were attached at the hip, and then them transitioning to high-volume production is the real strategy. And it's almost always focused on the high-tech industry sectors primarily. That's really where we're putting our focus in.

Okay. And then my final question, just to refresh on the capacity in your current facility, I know you've gone through a number of expansions and, you know, sort of restructurings to bring it up. Like, where do you stand with regards to what you can produce out of, you know, your current footprint, and how long do you think that will last?

Yeah, we are intending to start a major, what we consider a major expansion at the end of this current calendar year. It would be like December, maybe January, where we'll start actually making things happen there. I actually have a meeting tomorrow on this because with these latest orders, it's kind of accelerated things to get things going quicker. And that will allow us to take our existing manufacturing footprint from approximately what we believe is around $27 million capped up to around $33 to $36 million peak within our existing buildings that we're in today. And Intel is pretty much building a mezzanine structure and also doing some optimization, I should point out, of our manufacturing flow. We're in several buildings, so optimizing the flow of our manufacturing will really bring us some efficiencies. And following that, we still have one building here on our campus that we do not occupy, and we have a very short-term lease on it, of which that will be the last phase. And that would take us up to around $44 to $45 million in manufacturing capability. And, you know, that's on the radar. We have a plan in place for that. We haven't started or implemented that, but we have a plan in place for that retrofit as well. Now, due to this increased frequency of these larger, higher ASP orders now coming in, we do have to start thinking about well where do we go from 45 to get up to 85 you know so we have we're going to have to start that process coming up here in that planning phase we won't start the building phase or anything like that but we will have to start that planning phase in particular because some of the orders coming in now it only takes three or four orders that are significant size that could require us to make a significant structural move for more space so we've got to at least have it on paper plan in place to be able to take it to that next phase but that will be something that I'm looking forward to having that prepared for us you know it's not like the old days where if you got two or three more orders it didn't make any significant difference now if we get two, three, four more orders of these multi-million dollar systems, it all of a sudden makes a big shift in our outlook.

All right. Well, thanks for taking the time to answer my questions.

Hey, good catching up, Ted.

And our next question comes from Dan Dufault from Oak Ridge Financial. Please go ahead with your question. Hey, Dan.

Hey, guys. It's Sam. I'm going to field some questions on this. Oh, it's Sam. How you doing, Sam? How are you guys? Doing good, thanks. yeah congrats on the quarter i guess my question i'll uh kind of leapfrog off uh ted's question on the capacity side you know you mentioned the mesazine structure kind of building out some of that capacity what's some of the capital requirement you guys anticipate spending to get this expansion underway yeah the um initial capex we had estimated at around seven hundred thousand dollars of which we are optimistically thinking that we are probably going to get New York State to be able to participate maybe with a

hundred and fifty to two hundred thousand dollars as part of that that's just for that initial mezzanine phase Sam then for retrofitting the next building, which is the building we don't occupy, that will also be somewhere in the area of about a $600,000 CapEx investment. So it's not huge dollars, but it's significant enough that we want to do it at the right timing for us here. And of course, the first phase is going to be underway no matter what. That's kind of a decision that we've already said we have to do it. There's no choice got it and do you think or anticipate the state helping out with that phase two at all or mostly just on the phase one for now I would hope they would I mean that you know as we grow and in particular as we start thinking getting from the 30 to 40 and then 40 to 80 type of model that we have to at least consider other options outside of New York State and we've also already looked been looking and talking to places like like South Carolina there's a lot of very attractive incentives to manufacture outside of New York State as at least an expansion like so maybe we would have two locations and so with those incentives I would hope New York would give us at least close to equally attractive incentives to encourage us not to leave and set up manufacturing in a less expensive area but you know we have to do the responsible thing and look at both options and then from there we'll make a final decision so I think that we'll continue to see state sponsorship or contributions I should say whether it's in New York or alternative states I think we will see contributions to help our expansion.

Got it. And then on the margin side, I mean, you guys have seen some elevated gross margins over the last few quarters. How much of that can you attribute to whether it's a selling mix versus some structural advantages now with the higher ASP machines?

Yeah, it's a little bit of both, but I think the most significant impacts we see there is we're finding on these high ASP production machines that the value we bring is very significant, and that's in the application's expertise and all these additional things we're able to add on for the capabilities of our machines. And the customers are willing to pay for that increased value. So they definitely drive higher ASPs and better gross margins, but where it really starts to impact the gross margin is not on machine number one. It's on machine number two through 15. You know, by then we start to optimize the costs after machine number one, and we can really start to drive margins higher. So repeat high ASP machine orders are kind of the best case scenario for us, and it just happens to be that a lot of those, at least initial customer-wise, are ending and landing in the U.S. marketplace. A lot of our customers have been on shoring recently, especially these high-tech accounts. And that certainly is not a bad thing for Sonotech because our costs become better from a standpoint of eliminating distributor discounts that take place when they go overseas that very often happen. So it's definitely a promising thing for us. And that's going to be nice for us heading forward. You know, these last orders announced that are going to be shipping in FY2028, that $7.2 million, as already disclosed, that is repeat orders. So they should come in at nice margins for us with relatively low install costs and so forth.

Yeah, that was going to be my follow-up question, you know, given the order, you know, with the follow-on orders in the, you know, green energy side. So can you maybe allude to or, you know, provide some commentary on margins going forward, whether it's 2028 or kind of, you know, if the current levels are sustainable or there's room for growth going forward?

Yeah, you know, you notice probably in our commentary, we cautiously worded our margin expansion over the last two quarters. and that was intentional because you know we knew we had some high ASP margin systems that were shipping to us and we had some really excellent gross margins that came out in q1 and q2 as a result of that and that probably the coming quarter maybe not quite as attractive because we don't have those same high ASP systems in them but what is exciting is what's flowing into our backlog is again more of these high ASP, high volume production systems. So what is we're describing as unusually favorable right now, optimistically hoping that we take that unusual away as things go forward and we start to get more and more orders that look like those orders where it won't become unusual anymore. And we'll have to see how that all plays out. But That would be what I would hope to anticipate is more of that type of orders reaching us, high ASP, repeat orders where we're able to optimize the costs, reaching us more commonly so it doesn't become the unusual. It becomes the norm, hopefully, but we'll have to see how that all plays out.

Got it. Well, appreciate the commentary, and, again, congrats on the quarter.

Okay, thanks, Sam. Good talking to you.

And our next question comes from Greg Weaver from Invicta Capital. Please go ahead with your question.

Good morning. Thanks for doing the questions here.

Morning, Greg. Hey, Steve.

You touched on this a bit with your answer to Ted's questions, but maybe I'll put a finer point on it. Could you characterize your visibility on your medical business, continuing at these nice levels, given the noted commercial manufacturing transition?

Yeah. Yeah, I can say that the level of activity in our labs and the level of activity with our FDE team, the Forward Deploy Engineering team, is very high. And that's both for existing successes that we're actually out there implementing as well to expand upon those with more production lines, as well as new products that are coming into the mix. which then would have the potential to mature into something where it becomes significant with multiple lines, high-volume manufacturing. So the medical side is continuing to be one that is really progressing very nicely for us. You know, it's been exciting to see that we had this success with Alt Energy making that transition very cleanly. Now we're making it happen very successfully in the medical side. But I would like to see that continue next on to the microelectronics side. I mean, we have some pretty large systems in the microelectronics side, but I think they could become significantly larger also. So it's kind of taking one chunk off at a time for where we have the most expertise in those areas, but we're gaining that expertise very quickly because of that new forward deployed engineering team that we've got some really smart guys in that area that know their business.

Excellent. Excellent. All right, yeah, you've filled that giant hole from the alternative energy there nicely, but it doesn't show on the top line, but you can see it in the segments for sure. How about kind of related to that, on the spares and repairs side of things, you're on the spot $4 million-ish run rate right now, but I guess with the transition of these larger production systems, you know, do you think there will be a pickup in that business, especially some of these medical systems come off warranty?

Yeah, we just actually had this conversation yesterday, and that's part of what's exciting about these high-volume multi-system orders going out there in the field. I think we'll see two significant things happen. One is high-volume production orders first. These machines can't be down ever. It's not like an R&D machine. So having things like calibration contracts and service contracts in place are much more likely to be welcomed because there's a higher level of criticality to make sure everything is running perfect. And even through government agencies like the FDA, there's a higher level of scrutiny to make sure that you have things like your machines calibrated, which comes at a cost. So we would anticipate as these machines fall out of warranty, these newer high-volume production machines, that we will start to see a reoccurring revenue stream start to fold into our process. And that's been one of the things that we've been spending a lot of time on is trying to get a real steady, significant services-related reoccurring revenue stream. And we're optimistic, thinking that that will be the start of something significant for us in the coming year as these machines start to fall out of warranty for us. And there should be also associated a fairly nice spare parts business there also. Both are spare parts being kept on the shelf because they're critical lines that can't be down, as well as just normal consumables that will wear over time. And because most, again, these lines in general, many of them run three shifts a day, 24 hours, you know, seven days a week. So the wear on them is significant, and over periods of time, they should start to need replacement parts and support as well. So the larger the fleet we have out there in the field, the larger potential revenue stream we should see from services coming from that as well.

Excellent. Yeah, it's good to see a nice revenue-based buildup here. And I guess on that note, kind of you've made a lot of investments over the past few years as you've kind of readied the business to do this rinse and repeat, you know, production orders, larger systems. Could we talk a little bit maybe about what you foresee as operating leverage from this $22 million run rate? You know, what should we think about as flow through, you know, for incremental dollars of sales? How much should we see go down to the bottom line?

Yeah, you know, I've got to believe we're going to see, and again, we'll see how it flows up, but I've got to believe we're going to see some significant leverage here, at least from this next phase, from that $22 million to, say, $40 million area. There shouldn't be a lot of significant extra costs there, so it's going to flow through. And in all honesty, I don't really know how far it's going to flow through and how much of an impact it's going to happen. But it's got to happen. I mean, we certainly don't need to be increasing costs for a lot of things here, you know, other than direct personnel building these machines. You know, we've got so much accomplished already there. And the one area, though, outside of that, we will continue to really be investing heavily, which will increase our costs, would be in that forward deployed engineering team area. because I just believe that that's really a key aspect to having customers that are very attached to our hip and loyal to us, and they really recognize the benefit that we're bringing.

Sure, yeah, it's definitely shown to be a good investment. And just the last one for me, you highlighted this optics order for defense and then kind of made a comment off the cuff about you were bullish on defense. Can we talk a little bit about what you're seeing there and maybe what's the use case for this particular system you sold?

Yeah, this particular one, I can't say too much with it being a defense sector area, but there is lots of optics-related technologies when it comes to flying objects. that they're all over it, and they all need sensors and different type of optics-related things that have to happen on them. And we see that there's a market there. There's a demand there. It's growing. We see our technology has some really good fits for several of the applications. It's not an area that we presently, like, say, go to defense sector trade shows or market very heavily to it. Even if you look at our website, you don't see like a defense sector chunk of our website, which I suspect there probably should be something that we're more focused to that sector. It's kind of one of those ideal candidates for us. You know, we're always looking for markets that are high tech, that are not so price sensitive, that can, you know, spend, we can get the margins that we hope for in them. And the defense sector certainly falls in that category. It may require us to do a little bit of work on some of our internal requirements of how we maintain and keep documents. The defense sector requires some special compliances in that area, but they're not, you know, they're all areas that after a little bit of investment, we could comply. So we're looking at that as well. So I wouldn't be surprised in, say, another quarter or so if you're like, oh, Sinotech now has another tab. And in addition to clean energy, microelectronics, and medical, now they have a tab that says defense sector. And we'll start advertising and focusing on areas that we know we've had some proven successes in.

Great. Appreciate that. Keep up the good work. Thanks. Hey, good talking.

Our next question comes from Karen Niawera from Encore Holdings Group. Please go ahead with your question. Hi, Karen. You with us still? Karen, is it possible your phone is on mute? And we'll move on to Jason Arasner from Bumbershot Holdings. Please go ahead with your question.

Good morning. Thanks for taking the questions. And I appreciate the call. It's getting long, so I'll try to keep it quick. No problem. Similarly, focusing for a second on the semiconductor and microelectronics side, I think I saw you guys are currently at Semicon West and then also going to Semicon Europa. I don't really, you know, in defense said kind of don't participate in the trade shows. I don't really remember you doing much participation in the events in semiconductors either in the past. So just wondering if maybe you could talk about that opportunity kind of specifically in semi. Is it entirely spray coating of photoresists, you know, or is it mostly the alternative substrates, kind of 200 millimeter below, or are you also moving up to 300 millimeter wafer stuff? Sure. I just thought that there's a lot of interest in optical components in semi as well as defense, so just any kind of color there.

Yeah, sure. It's a very broad area for us, broader than I actually recognized myself, even when we first started jumping into it because in the beginning I thought it was all photoresist. But what we are recognizing as we start to introduce products that are high-volume manufacturing capable, all of a sudden we are starting to receive inquiries in areas that are outside of photoresist and I can't go into unfortunately to too much detail because they're super tight-lipped with confidentialities and NDAs in this particular industry because this is usually on most of like the next-gen chips that are being used like in the AI world so they they really tight-lipped us on very much what we what we do there but we think there's both areas for our continued marketplace for photoresist in both in 200 millimeter which we're already attacking but also making a shift towards larger 300 millimeter wafers and trying to bring that from the lab and low volume production area to the fab area and that's that's going to be our focus at Semi-Con Europe. Semi-Con West that we're at right now, we're not so much focusing on that because it's just a little bit too early, just a few months too early, but we will be focusing on that in Semi-Con Europe, but I firmly believe there will be more applications outside of photoresist as well that may actually even pull us there into the larger 300 millimeter area, maybe even faster than the planned photoresist area. You know, there's a lot of unique thin film processes that take place in that whole semiconductor manufacturing area. And all we need is to find two or three of them that are like, oh, that's a perfect fit for Sonotech. And these are companies in general that would not have even asked us to be that fit if we didn't now have the capabilities that we have today because they're not even interested in talking to somebody unless you've proven it that you can work in super high volume production but now they see that all right this company has made that transition where they can provide us the appropriate equipment if the application is successful so we do have some things happening on the laboratory area to prove for high volume manufacturing and that's the main thing that they want proof to transition into high volume manufacturing capabilities and so I think although that's it's not as short-term as say like medical or alt energy but I think that's on the horizon as maybe even the potentially largest sector for us to come in the future it's just the one that we've kind of approached third in line here for our focus but it's now rising up to the surface for us here in this coming year.

And is it sort of process steps that are finally meeting higher technology thin film kind of precision requirements, or is it process steps that sort of never existed before?

And I guess it sounds like you don't quite have the pilot lines yet where you could see that progression similar with the solar customer where it could pull you forward into kind of production spending or the fab more quickly it sounds like it's kind of maybe an inning or two earlier that's probably right i mean they're to the point where they would are saying hey let us come to your lab prove this works and then sonotech designed the machine for us to meet high volume production i don't think we'll have to go to the extent of say doing pilot line because we have I think enough credibility now that they would say hey just make us production machines for this these sort of applications but they do recognize that our technology is unique enough that they're able to do things that they are not able to do with their existing coding technologies and that's I think the primary driver so to answer your question whether it's new or existing processes, it's typically a processes that is not working that well for them. They're getting away with it trying, but they're like, we really don't like what we're doing today. And Sonotech is showing them, oh, we can solve the headaches that you may have. And let us prove that to you.

And just in terms of timing, though, I guess my question a little That is, with kind of the highest technology edge of AI chips, stuff that's going into data centers, kind of optical components, all that stuff, things tend to move really quickly when a technology is kind of unique in solving a problem that hasn't. Is it, I guess, how do you evaluate kind of the speed at which some of these could potentially turn into real opportunities kind of quicker or kind of not so fast?

I think speed for the next gen, like the next rev, will be very quick to give us the thumbs up or thumbs down, like, hey, this meets the need. Speed in general for actual implementation, once you have a proven, known, good processes, does tend to be a little bit slower, believe it or not, in that semiconductor industry where they tend to move very quickly on proven methodologies and are a little more cautious on things that have been only lab proven or pilot line proven you know so I suspect you know for a really significant impact you know we may be out you know one two years maybe even three years for really significant impact for the point where they're saying, hey, I want to buy, you know, 10 of these machines to go into this fab. I think, you know, we could be looking a few years out, but I think we'll start to see some level of impact relatively quick from the standpoint of, oh, we got our first machine in, or we got the first couple of machines in for this new processes.

That will be able to, I think, get under our belt relatively quickly, meaning within, say, like a year or something along those lines. okay and then just following up on the question you got on operating leverage um obviously in the quarter and i guess the outlook for the second half of the fiscal year you're kind of getting through this gap of you know tougher order period um before you start to have this bigger resumption of growth in fiscal year 28 um obviously had stepped up the marketing spend i guess it's around a million a quarter, leveraged that pretty nicely in Q1, kind of less so in this quarter, and maybe the outlook, presumably, for the second half. Is this going to be, you know, you have to carry that cost because you're seeing pretty significant benefits, but aren't going to have the revenue at least for a quarter or Is that kind of the right way to be thinking about it?

I think so. You know, we are now starting to say, hey, let's, in order to really accelerate things, We have to start making some more significant investments prior to that. And, you know, we've got the money and, you know, we're profitable enough that we could say, hey, you know, double down on this bet. You know, like, do you really want to only hire one or two guys in this area when you can hire four and get a much more significant benefit in a year from now? So although the short-term Q1 or Q3, Q4, you know, it may not be as attractive of margins as, say, like the earlier first half. But right behind that is going to be orders that we're anticipating will be higher revenue. And it should, based upon our existing backlogs, looking like maybe better margin orders as well. And I'm hoping that we'll see more of that fall into the backlog of these high ASP, high volume orders, which give really good gross margins. You know, we still have a pretty good amount of time left in this current fiscal year to fill up next fiscal year. So I'm hoping that we'll see, you know, this – we need to make these large high ASP orders not happen, you know, twice a year. We need to make them be happening, you know, every month, you know. So that's our strategy that we need to get to that point.

And when you talk about the ASP progression and kind of the high ASP orders, I know, I guess in the past, you sort of delineated it between orders less than 75,000, kind of have that middle range, 75 to 150, and then the upper range of over 150. Is the 150 kind of still a good gauge of a commercial? Yeah, I guess, like, how do I square that versus a $7 million order? Or, you know, is there kind of big R&D orders that kind of get lumped into the high ASP versus it sounds like what you're really trying to do is kind of move up into this system aggregator where you're, you know, much bigger orders than, let's say, $150,000. So it's a bit hard to tell from that progression chart.

Yeah, you're right. And, you know, perhaps we should break out another segment in there of the 150 to say 500, you know, and then have the 500 and over possibly, you know, some of these larger orders like take this last $7.2 million order. that's 10 machines, but they're each around $700,000. So, you know, they're not even million dollar machines, but they're significantly large machines. And there's quantity 10 of them. And that's because it's a mature customer shipping a lot of machines. The order prior to that for $3.6 million was a single manufacturing line. And that's a customer that was buying machines that was around $700,000, $800,000. And they probably could have been buying, even back when we sold them $700,000, $800,000 machines, they could have been buying machines that were $3.6 million from us had we had the capabilities at that time. So in an ideal world, when that customer says, I want three or five machines, and I don't know when that will be, you know, that's going to be driven by their manufacturing needs, that we won't be selling three or five, seven or $800,000 machines, we'll be selling three or five $3.6 million machines. You know, so continuing to drive that ASP higher and higher is super vital for our strategy. And right now, what we're seeing is the high ASP orders are more coming in through like the mid area, you know, that $500, $700,000 single price ASP machine, but they're coming through for lots of them. Ultimately, we certainly We would like to see those coming through for a million-plus, maybe even two million-plus-dollar order machines. So that's going to be a super important part of our strategy to make those machines, offer this customer so much capabilities and so much incentive to want to buy the whole existing platform with as much as we can provide will be very important to drive the company's growth.

Okay. And when you talk about the capacity kind of going from that, I guess, mid-20s to mid-30s to maybe using the last day, mid-40s, and then you kind of have that next phase where you sort of talk about like 40 to 80. But when you think about the capacity versus the orders, when you're going from, let's say, a 700,000 ASP machine to a 3 million because you're adding on various capabilities, I'm assuming a lot of those capabilities are things that your forward deployed engineering team is kind of aggregating together, but things you're not necessarily making in-house. I guess, how do you kind of square some of that with what you're talking about with capacity?

Yeah, you hit the nail on the head. It's definitely not equipment that we are making, say, the core components in-house, but we're doing all the systems integration, which is very significant, and even more so, we're doing the application engineering process integration. So understanding, for example, what type of post-cleaning process or after a curing process, you know, and how to do, say, a measurement machine in the process and what type of measurement machine. So we are actually, the FDE team becomes these experts in not just applying a thin film coating, but it's how to measure the coating, how to clean the product prior, how to cure the product after. So it's a very difficult, challenging area unless you have that application's know-how. So no one really wants to buy those machines from somebody else other than Sonotech because we're the only one that's going to prove to them that what we spec in will work for your particular coding need. And they're willing to pay a premium in order to get rid of that risk where they have to try to figure it out themselves. but it also then drastically reduces our time to be able to figure out how to make that particular product and become experts in everything. And for sure, as we sell more and more of a particular expertise, then we certainly would consider bringing it in-house, but we'd certainly prefer to become experts in understanding it before we consider manufacturing it.

And our next question, once again, is Karen Nayewera from Encore Holdings Group. Karen, please go ahead with your question. And once again, Karen, is it possible your phone is on mute? We are unable to hear you.

I'm not on mute. Oh, I hear you now. Okay, Karen.

I hear you, Karen. How are you doing?

I'm good. Thank you so much. So I wanted to follow up on the earlier discussions where some of the other people in the call have touched upon the go-to-market motion, Where, A, I think I'd want to understand anything with the forward deployed engineers. We said we have four available. I'm curious if they are assigned by industry or industry agnostic. And then maybe a second quick follow-up to that is, like, maybe how many accounts or how many clients is each forward deployed engineer associated with?

Sure. And I should specify, there's actually three forward-deployed engineers, but four in the group. There's also a project manager that works with that forward-deployed engineering team that helps to coordinate everything coming in. And that's the area where we're considering bringing in more of the forward-deployed engineers. And these are guys that have in-depth experience in both ultrasonic coding, but also equipment integration and the processes. Most of them have gone through the area for the application engineering area for many, many years. it would be common for a mature proven application something that we consider oh this has got high priority for it to shift from our existing application engineering team which has typically already proven things in the lab for the customer and then they say listen this group is now ready to scale and we are going to then shift that customer over to the FDE team for them to show them how we can scale into production for their requirements and and it would be typical for them to work on who may be two to three major accounts that are impossibly that are orders in-house to some level while also feeding in every month maybe one to two other proposals that they would be putting together for new potential customers so you know they might look at a dozen things or maybe even two dozen things potentially per year some of them only may be taking a day but some of them stretching over several months maybe even a full year for a very big one you know so for example this last 7.2 million dollar order that engineer there he has been working with that customer on and off probably 25 percent of his time for three years and that customer has given us oh in the area of now 14 million dollars of orders something in that area and and we anticipate and hope for more orders from that customer also so you know he will probably actually always be into that account 25% of his time as long as the customer is still moving forward with us so it's not a huge group and that's why it's critical that as we start to see and get pulled in by enough customers where we say oh we could really use two more forward deployed engineers it's really very easy bets to make I mean they're low risk bets for us to say big return. And so far, that strategy seems to be working nicely.

Okay. Then, quick last question. So, I'll take you up. You're forward deployed engineers that are reporting to the project manager. And who is the project manager reporting to?

Yeah. So, the project manager is more coordination for the forward deploy engineering team. They're kind of a support role, I would describe it, for the forward deployed engineering team, so they can be spending their time on the really hardcore technical stuff where the project manager is more likely just to coordinate, you know, how we're going to be deploying what the forward-deployed engineers has already decided. And one more time with the question there. I apologize, Karen.

I just want to understand the reporting structure, right, because I think that at least what was missing for me in one of the discussions that I've had is that it seems as if maybe there might be an information flow gap between the forward-deployed engineering team and maybe like sales in terms of being able to predict or understand when the orders come next. I'm trying to understand that reporting.

Yeah, yeah, sure. So the forward-deployed engineers, they report to our application engineering manager who actually manages two teams. He manages the application engineering team, which is, again, those are the guys that are taking orders into the lab, proving it primarily on the R&D level, and feeding it back to the customers for R&D machines. and then he and with consulting with the sales team will make a decision and say hey this is a significant opportunity that is ready to shift from R&D to production and then they feed it off to the forward deployed engineering team and then once it treats the forward deployed engineering team and if it does turn into an order we actually then have another team that comes in and says all right, this is going to be a significant production system going through our processes. So we have to then get, you know, the quality system in and everybody else from a manufacturing standpoint of how we're going to build the machines and how we're going to do it at an economical cost, of course.

Okay, thank you. Thank you so much.

And nice talking to you, Karen.

And with that, we'll be concluding today's question and answer session. I'd like to turn the floor back over to management for any closing remarks.

Let me just see here. I apologize. Long conversations there. I just want to thank everybody today for joining us. I hope you enjoyed the conference call, and we look forward to updating you again at the end of the fiscal year. And thanks again for everybody that joined the conference call.

And with that, ladies and gentlemen, we'll be concluding today's conference call and presentation. we thank you for joining. You may now disconnect your lines.