FORWARD-LOOKING STATEMENTS
We discuss expectations regarding our future performance, such as our business outlook, in our annual and quarterly reports, news releases, and other written and oral statements. These "forward-looking statements" are based on currently available competitive, financial and economic data and our operating plans. They are inherently uncertain, and investors must recognize that events could turn out to be significantly different from our expectations and could cause actual results to differ materially. These factors include, among other considerations, general economic and business conditions; political, regulatory, tax, competitive and technological developments affecting our operations or the demand for our products; the duration and scope of the COVID-19 pandemic; the extent and duration of the pandemic's adverse effect on economic and social activity, consumer confidence, discretionary spending and preferences, labor and healthcare costs, and unemployment rates, any of which may reduce demand for some of our products and impair the ability of those with whom we do business to satisfy their obligations to us; our ability to sell and provide our services and products, including as a result of continued pandemic related travel restrictions, mandatory business closures, and stay-at home or similar orders; any temporary reduction in our workforce, closures of our offices and facilities and our ability to adequately staff and maintain our operations resulting from the pandemic; the ability of our customers and suppliers to continue their operations as result of the pandemic, which could result in terminations of contracts, losses of revenue; the recovery of the Electronics/ Microelectronics and Medical markets following COVID-19 related slowdowns; the forgiveness of our PPP loan; and further adverse effects to our supply chain; maintenance of increased order backlog, including effects of any COVID-19 related cancellations; the imposition of tariffs; timely development and market acceptance of new products and continued customer validation of our coating technologies; adequacy of financing; capacity additions, the ability to enforce patents; maintenance of operating leverage; maintenance of increased order backlog; consummation of order proposals; completion of large orders on schedule and on budget; continued sales growth in the medical and alternative energy markets; successful transition from primarily selling ultrasonic nozzles and components to a more complex business providing complete machine solutions and higher value subsystems; and realization of quarterly and annual revenues within forecasted range.
We undertake no obligation to update any forward-looking statement.
OVERVIEW
Founded in 1975,Sono-Tek Corporation designs and manufactures ultrasonic coating systems that apply precise, thin film coatings to a multitude of products for the microelectronics/electronics, alternative energy, medical and industrial markets, including specialized glass applications in construction and automotive. We also sell our products to emerging research and development and other markets. We have invested significant resources to enhance our market diversity by leveraging our core ultrasonic coating technology. As a result, we have increased our portfolio of products, the industries we serve and the countries in which we sell our products. Our ultrasonic nozzle systems use high frequency, ultrasonic vibrations that atomize liquids into minute drops that can be applied to surfaces at low velocity providing thin layers of protective materials over a surface such as glass or metals. Our solutions are environmentally friendly, efficient and highly reliable. They enable dramatic reductions in overspray, savings in raw material, water and energy usage and provide improved process repeatability, transfer efficiency, high uniformity and reduced emissions. We believe product superiority is imperative and that it is attained through the extensive experience we have in the coatings industry, our proprietary manufacturing know-how and skills and our unique work force we have built over the years. Our growth strategy is to leverage our innovative technologies, proprietary know-how, unique talent and experience, and global reach to further advance the use of ultrasonic coating technologies for the microscopic coating of surfaces in a broader array of applications that enable better outcomes for our customers' products and processes. We are a global business with approximately 62% of our sales generated from outsidethe United States andCanada during the first nine months of fiscal 2021. Our direct sales team and our distributor and sales representative network are located inNorth America ,Latin America ,Europe andAsia . Over the last few years, we have expanded our sales capabilities by increasing the size of our direct sales force, adding new distributors and sales representatives ("reps"). In addition, we have established testing labs at our distribution partner sites inChina ,Taiwan ,Germany ,Turkey ,Korea andJapan , while also expanding our first testing lab that is co-located with our manufacturing facilities inNew York . These labs provide significant value for demonstrating to prospective customers the capabilities of our equipment and enabling us to develop custom solutions to meet their needs. Over the last decade, we have shifted our business from primarily selling our ultrasonic nozzles and components to a more complex business providing complete machine solutions and higher value subsystems to original equipment manufacturers ("OEMs"). The range for our average full system selling price has increased as a result, going from tens of thousands of dollars to hundreds of thousands of dollars. As a result of this transition, we have broadened our addressable market and we believe that we can grow sales on a larger scale, however, we expect that we will experience wide variations in both order flow and shipments from quarter to quarter. 12 Third Quarter Fiscal 2021 Highlights (compared with the third quarter of fiscal 2020 unless otherwise noted) We refer to the three-month periods endedNovember 30, 2020 and 2019 as the third quarter of fiscal 2021 and fiscal 2020, respectively.
• Net sales were
sales of our integrated coating systems in the Industrial market segment
and OEM systems. • Gross profit increased$134,000 or 7% to$1,931,000 compared with
50.5% compared with 48.9%. In the quarter, gross profit margin increased
due to a change in the product mix for the quarter. • Operating income increased$177,000 to$447,000 or 66%, compared with
operating income of
gross profit and decreased operating expenses improved operating income
during the quarter. • Backlog onNovember 30, 2020 was up 29% to$4,549,000 , compared with
backlog of
to a large order for the textile industry valued at
to ship in the fourth quarter of fiscal 2021 or first quarter of fiscal
2022. Nine Month Fiscal 2021 Highlights (compared with the first nine months of fiscal 2020 unless otherwise noted) We refer to the nine-month periods endedNovember 30, 2020 and 2019 as the first nine months of fiscal 2021 and fiscal 2020, respectively. • Net sales were$10,736,000 , up 9% or$895,000 , led by strong sales of integrated coating systems to the Industrial market, and continued expansion of our customer base for the Alternative Energy sector.
• Gross profit margin was consistent at 47% for both periods, but on a dollar
basis, improved due to increased sales.
• Operating income increased to
revenue and gross profit were key factors in the improvement of operating
income during the quarter. RESULTS OF OPERATIONS Sales Product Sales: Three Months Ended Nine Months Ended November 30, Change November 30, Change 2020 2019 $ % 2020 2019 $ % Fluxing Systems$ 242,000 $ 261,000 $ (19,000 ) (7% )$ 680,000 $ 863,000 $ (183,000 ) (21% ) Integrated Coating Systems 1,071,000 628,000 443,000 71% 2,920,000 1,438,000 1,482,000 103% Multi-Axis Coating Systems 1,249,000 1,631,000 (382,000 ) (23% ) 4,147,000 4,519,000 (372,000 ) (8% ) OEM Systems 523,000 400,000 123,000 31% 1,177,000 965,000 212,000 22% Other 742,000 752,000 (10,000 ) (1% ) 1,812,000 2,056,000 (244,000 ) (12% ) TOTAL$ 3,827,000 $ 3,672,000 $ 155,000 4%$ 10,736,000 $ 9,841,000 $ 895,000 9%
Sales growth in the third quarter and the first nine months of fiscal 2021 was driven by several significant shipments of our Integrated Coating systems into the Industrial and Electronic markets. The increase in sales of Integrated Coating systems more than offset the decrease in sales of our Fluxing systems, Multi-Axis Coating systems and the Other categories. Market Sales: Three Months Ended Nine Months Ended November 30, Change November 30, Change 2020 2019 $ % 2020 2019 $ % Electronics/Microelectronics$ 1,455,000 $ 1,104,000 $ 351,000 32%$ 4,504,000 $ 4,017,000 $ 487,000 12% Medical 831,000 1,083,000 (252,000 ) (23% ) 2,484,000 2,875,000 (391,000 ) (14% ) Alternative Energy 783,000 917,000 (134,000 ) (15% ) 2,004,000 1,527,000 477,000 31% Emerging R&D and Other 207,000 252,000 (45,000 ) (18% ) 723,000 937,000 (214,000 ) (23% ) Industrial 551,000 316,000 235,000 74% 1,021,000 485,000 536,000 111% TOTAL$ 3,827,000 $ 3,672,000 $ 155,000 4%$ 10,736,000 $ 9,841,000 $ 895,000 9% 13 Significant growth in the Industrial market in the third quarter and the first nine months of fiscal 2021, was driven by a$463,000 shipment to the textile industry, which was part of a previously announced$1.6M order received early this fiscal year. The remaining balance of this order is scheduled to ship in the fourth quarter of fiscal 2021, or the first quarter of fiscal 2022. As anticipated, the Alternative Energy market showed significant growth with the expansion of fuel cell activities in the first nine months of fiscal 2021, as a global hydrogen energy infostructure continues to gain acceptance in many countries. The Medical and Emerging R&D markets both declined with several potential orders being put on hold due to COVID-19 concerns. We believe that these orders will increase as countries come back online from COVID-19 lockdowns. Geographic Sales: Three Months Ended Nine Months Ended November 30, Change November 30, Change 2020 2019 $ % 2020 2019 $ % U.S. & Canada$ 1,165,000 $ 1,278,000 $ (113,000 ) (9% )$ 4,076,000 $ 3,440,000 $ 636,000 18% Asia Pacific (APAC) 462,000 1,049,000 (587,000 ) (56% ) 1,180,000 1,602,000 (422,000 ) (26% ) China 577,000 323,000 254,000 79% 2,236,000 1,110,000 1,126,000 101%Europe ,Middle East ,Asia (EMEA) 1,216,000 737,000 479,000 65% 2,414,000 2,249,000 165,000 7% Latin America 407,000 285,000 122,000 42% 830,000 1,440,000 (610,000 ) (42% ) TOTAL$ 3,827,000 $ 3,672,000 $ 155,000 4%$ 10,736,000 $ 9,841,000 $ 895,000 9%
In the third quarter of fiscal 2021, approximately 70% of sales originated
outside of
In the first nine months of fiscal 2021, approximately 62% of sales originated
outside of
In the first nine months of fiscal 2021, the increase in US andCanada based sales was influenced by the COVID-19 pandemic, as we saw several manufacturers transfer operations back to the US; also resulting in a decrease in orders from several geographic territories outside the US. Timing and severity of overseas sales dips has varied country to country, as each location has come in and out of lock downs. Sales toChina continued to show strong growth, however, a majority of this revenue was for orders received prior to the COVID-19 pandemic. Sales toLatin America decreased due to a decrease in sales of our spray fluxer units toMexico during the COVID-19 lockdowns, and due to a large medical system sold intoLatin America in the prior fiscal year.Sono-Tek has proven capable at adapting to COVID-19 country wide lockdowns by quickly refocusing efforts to those countries that are operational. This flexibility has been helpful in softening the impact of the pandemic and will continue to be part of our strategy for the foreseeable future. Gross Profit: Three Months Ended Nine Months Ended November 30, Change November 30, Change 2020 2019 $ % 2020 2019 $ % Net Sales$ 3,827,000 $ 3,672,000 $ 155,000 4%$ 10,736,000 $ 9,841,000 $ 895,000 9% Cost of Goods Sold 1,896,000 1,875,000 21,000 1% 5,624,000 5,192,000 432,000 8% Gross Profit$ 1,931,000 $ 1,797,000 $ 134,000 7%$ 5,112,000 $ 4,649,000 $ 463,000 10% Gross Profit % 50.5% 48.9% 47.6% 47.2% For the third quarter of fiscal 2021, gross profit increased$134,000 , or 7%, compared with the prior-year period due to increased revenue. Gross profit margin increased to 50.5% during the quarter compared with 48.9% for the prior year period. The current quarter's increase in gross profit margin is due to a change in the product mix for the quarter. Gross profit increased$463,000 , or 10%, to$5,112,000 for the first nine months of fiscal 2021 compared with$4,649,000 in the prior year period due to increased revenue. Gross profit margin remains strong at 47.6% compared with 47.2% for the prior year period. 14 Operating Expenses: Three Months Ended Nine Months Ended November 30, Change November 30, Change 2020 2019 $ % 2020 2019 $ % Research and product development$ 407,000 $ 362,000 $ 45,000 12%$ 1,242,000 $ 1,020,000 $ 222,000 22% Marketing and selling 766,000 849,000 (83,000 )
(10% ) 2,155,000 2,326,000 (171,000 ) (7% ) General and administrative 311,000 316,000 (5,000 )
(2% ) 883,000 936,000 (53,000 ) (6% ) Total Operating Expenses$ 1,484,000 $ 1,527,000 $ (43,000 ) (3% )$ 4,280,000 $ 4,282,000 $ (2,000 ) -
Research and Product Development:
Research and product development costs increased in both the third quarter and the first nine months of fiscal 2021 due to increased salaries and related costs. In the prior year periods, some of our personnel were assigned to specific customer sales orders and the associated research and development costs were recorded in inventory, as incurred.
Marketing and Selling:
Marketing and selling costs decreased in the third quarter of fiscal 2021 due to decreases in commissions, travel and trade show expenses. Marketing and selling costs decreased in the first nine months of fiscal 2021 due to decreases in commissions, travel and trade show expenses. These decreases were partially offset by increased salaries and related costs in the first quarter of fiscal 2021.
In the third quarter of fiscal 2021, we expended approximately$195,000 for commissions as compared with$229,000 for the prior year fiscal period, a decrease of$34,000 . For the first nine months of fiscal 2021, we expended approximately$441,000 for commissions as compared with$505,000 for the prior year fiscal period, a decrease of$64,000 . The decrease in commission expense, in both periods, is primarily the result of a decrease in international sales being generated by our external distributors, which are commissioned at a higher rate than our in-house sales team.
General and Administrative:
In the third quarter of fiscal 2021, we experienced decreases in professional fees, corporate expenses, bank fees and stock-based compensation expense. These decreases were partially offset by increased salaries. In the first nine months of fiscal 2021, we experienced decreases in professional fees, stock based compensation expense, travel and bank fees. These decreases were partially offset by increased salaries, health insurance premiums and annual meeting and proxy expenses related to the Covid-19 outbreak.
Health Insurance Premiums:
The Company's health insurance program requires employee contributions. In the third quarter of fiscal 2021, the Company's net health insurance expense was approximately$97,000 as compared with$94,000 for the prior year fiscal period, an increase of$3,000 or 3%. For the first nine months of fiscal 2021, the Company's net health insurance expense was approximately$288,000 as compared with$285,000 for the prior year fiscal period, an increase of$3,000 or 1%.
Operating Income:
Our operating income increased$177,000 , to$447,000 in the third quarter of fiscal 2021, compared with$270,000 for the prior year period. This substantial improvement is the result of revenue growth and cost constraints which generated significant operating leverage. Operating margin for the third quarter increased to 11.7% compared with 7.4% in the prior year period. For the first nine months of fiscal 2021, operating income increased$465,000 , to$832,000 compared with$367,000 for the prior year period. This improvement is the result of revenue growth and cost constraints which generated operating leverage. Operating margin for the first nine months of fiscal 2021 increased to 7.8% compared with 3.7% in the prior year period. 15 Interest Expense:
Interest expense was
Interest and Dividend Income: Interest and dividend income decreased$19,000 to$2,000 in the third quarter of fiscal 2021 as compared with$21,000 for the prior year period. For the first nine months of fiscal 2021, interest and dividend income decreased$50,000 to$27,000 as compared with$77,000 in the prior year period. The decrease in both periods is due to the decline in market rates. Our present investment policy is to invest excess cash in highly liquid, low riskUS Treasury securities, certificates of deposit and mutual funds. AtNovember 30, 2020 , the majority of our holdings are rated at or above investment grade.
Other Income:
Included in other income is the net revenue related to the rental of the Company's real estate. For the third quarter of fiscal 2021, the Company's net rental income was$11,000 compared to net rental income of$7,000 for the third quarter of fiscal 2020. For the first nine months of fiscal 2021, the Company's net rental income was$30,000 compared with net rental income of$19,000 for the first nine months of fiscal 2020. Income Tax Expense:
We recorded income tax expense of$132,000 for the third quarter of fiscal 2021 compared with$10,000 for the prior year period and recorded income tax expense of$199,000 for the first nine months of fiscal 2021 compared with$23,000
for the prior year period.
The increase in income tax expense in the third quarter and the first nine months of fiscal 2021 is due to the current period's increase in income before taxes and to provide for the estimated tax liability associated with the first nine months of fiscal 2021. Net Income:
Net income increased by
Net income increased by
Impact of Covid 19 InDecember 2019 , the novel coronavirus ("COVID-19") outbreak occurred inChina and has since spread to other parts of the world. OnMarch 11, 2020 , theWorld Health Organization declared COVID-19 to be a global pandemic and recommended containment and mitigation measures. OnMarch 13, 2020 ,the United States declared a national emergency concerning the outbreak. Along with these declarations, extraordinary and wide-ranging actions have been taken by international, federal, state, and local public health and governmental authorities to contain and combat the outbreak and spread of COVID-19 in regions acrossthe United States and the world. These actions include quarantines, social distancing and "stay-at-home" orders, travel restrictions, mandatory business closures and other mandates that have substantially restricted individuals' daily activities and curtailed or ceased many businesses' normal operations.
In response to the pandemic and these actions, we began implementing changes in
our business in
• We implemented social distancing and other health and safety protocols.
• We have flexed the workforce in our manufacturing operations based on
business needs, including the addition of a second shift and the
implementation of remote, alternative and flexible work arrangements.
• We have enhanced cleaning and sanitary procedures.
• We temporarily eliminated domestic and international travel for the first
quarter of fiscal 2021 and have maintained significantly reduced travel
for the second and third fiscal quarters of 2021.
• We restricted access to our facilities to only employees and essential
non-employees with strict protocols. 16 While all of these measures have been necessary and appropriate, they may result in additional costs and may adversely impact our business and financial performance. As our response to the pandemic evolves, we may incur additional costs and will potentially experience adverse impacts to our business, each of which may be significant. In addition, an extended period of remote work arrangements could impair our ability to effectively manage our business, and introduce additional operational risks, including, but not limited to, cybersecurity risks and increased vulnerability to security breaches, cyber-attacks, computer viruses, ransomware, or other similar events and intrusions. We may experience, decreases in demand and customer orders for our products in all sales channels, as well as temporary disruptions and closures of our facilities due to decreased demand and government mandates. COVID-19 has also impacted various aspects of the supply chain as our suppliers experience similar business disruptions due to operating restrictions from government mandates. We continue to monitor procurement of raw materials and components used in the manufacturing, distribution and sale of our products, but continued disruptions in the supply chain due to COVID-19 may cause difficulty in sourcing materials or unexpected shortages or delays in delivery of raw materials and components, and may result in increased costs in our supply chain. We have implemented plans to reduce spending in certain areas of our business, including reductions or delays in capital expenditures, reduced trade show participation costs, reduced travel expenditures and may need to take additional actions to reduce spending in the future. We are closely monitoring and assessing the impact of the pandemic on our business. The extent of the impact on our results of operations, cash flow, liquidity, and financial performance, as well as our ability to execute near- and long-term business strategies and initiatives, will depend on numerous evolving factors and future developments, which are highly uncertain and cannot be reasonably predicted.
Given the inherent uncertainty surrounding COVID-19, we expect the pandemic may continue to have an adverse impact on our business in the near term. Should these conditions persist for a prolonged period, the COVID-19 pandemic, including any of the above factors and others that are currently unknown, may have a material adverse effect on our business, results of operations, cash flow, liquidity, and financial condition.
LIQUIDITY AND CAPITAL RESOURCES
Working Capital - Our working capital increased$875,000 to$8,048,000 atNovember 30, 2020 from$7,173,000 atFebruary 29, 2020 . The increase in working capital was mostly the result of the current period's net income and noncash charges and the proceeds of a long term note payable partially offset by purchases of equipment and the repayment of long-term debt. The Company aggregates cash and cash equivalents and marketable securities in managing its balance sheet and liquidity. For purposes of the following analysis, the total is referred to as "Cash." AtNovember 30, 2020 andFebruary 29, 2020 , our working capital included: Cash November 30, February 29, (Decrease) 2020 2020 Increase Cash and cash equivalents$ 6,014,000 $ 3,660,000 $ 2,354,000 Marketable securities 3,226,000 4,219,000 (993,000 ) Total$ 9,240,000 $ 7,879,000 $ 1,361,000 17
The following table summarizes the accounts and the major reasons for the
Impact on Cash Reason Net income, adjusted for$ 1,008,000 non-cash items To reconcile increase in cash. Accounts receivable increase (744,000) Timing of cash receipts. Inventories increase (119,000) Required to support backlog. Prepaid expense decrease 27,000 Timing of disbursements. Equipment upgrade for Equipment purchases (327,000) productivity. Customer deposits increase 133,000 Received for new orders. Accounts payable and accrued expenses increase 193,000 Timing of disbursements. Repayment of long-term debt (127,000) Repayment of debt. Paycheck Protection Program loan Note payable proceeds 1,002,000 proceeds. Capital expenditure grant proceeds 100,000 Receipt of grant proceeds. Taxes payable increase 215,000 Timing of disbursements. Net increase in cash$ 1,361,000 Stockholders' Equity - Stockholders' Equity increased$694,000 to$10,476,000 atNovember 30, 2020 , from$9,782,000 atFebruary 29, 2020 . The increase was a result of the current period's net income of$666,000 and$28,000 in additional equity related to stock based compensation awards. Operating Activities - We generated$713,000 of cash in our operating activities in the first nine months of fiscal 2021 compared with$1,023,000 in the first nine months of fiscal 2020. The decrease in cash generated by operating activities was mostly the result of decreased accounts payable, accrued expenses, customer deposits and an increase in accounts receivable. These uses of cash were partially offset by decreased spending on inventories and an increase in income taxes payable, and an increase in income for the period. Investing Activities - For the nine months of fiscal 2021, our investing activities generated$767,000 of cash compared with using$1,767,000 in the first nine months of fiscal 2020. For the first nine months of fiscal years 2021 and 2020, we used$327,000 and$392,000 , respectively, for the purchase or manufacture of equipment, furnishings and leasehold improvements. For the first nine months of fiscal 2021, our marketable securities provided$994,000 compared with the use of$1,374,000 for the purchase of marketable securities in the first nine months of fiscal 2020. In the second quarter of fiscal 2021, we received$100,000 in grant proceeds from the utility which provides our electricity as a result of our completion of certain energy efficiency related improvements.
Financing Activities - In the first nine months of fiscal years 2021 and 2020,
we used
Paycheck Protection Program Loan
During the first quarter of fiscal 2021, we borrowed$1,001,640 (the "PPP Loan") from a bank under the Paycheck Protection Program ("PPP"). The PPP, established as part of the Coronavirus Aid, Relief and Economic Security Act ("CARES Act"), provides for loans to qualifying companies and is administered by theU.S. Small Business Administration (the "SBA"). The PPP Loan has a two-year term, bears interest at the rate of 1.0% per annum, and may be prepaid at any time without payment of any premium. No payments of principal or interest were scheduled to be due untilNovember 2020 , at which time we were to have been required to make 18 monthly payments of principal and interest in the amount of$56,370 . Under the terms of the CARES Act, PPP loan recipients can apply for and be granted forgiveness for all or a portion of the loan granted under the PPP, with such forgiveness to be determined, subject to limitations, based on the use of the loan proceeds for payment of payroll costs and any payments of mortgage interest, rent, and utilities. However, at least 60 percent of the PPP Loan proceeds must be used for eligible payroll and payroll related costs. The terms of any forgiveness may also be subject to further requirements in any regulations and guidelines the SBA may adopt. We believe that we have used the entire PPP Loan proceeds for designated qualifying expenses and have applied for forgiveness of the PPP Loan in accordance with the terms of the PPP. Under the Paycheck Protection Program Flexibility Act, payments of principal and interest shall be deferred until the date that theSmall Business Administration remits the forgiveness amount to the Company's lender or determines that some or all of the PPP loan is not eligible for forgiveness. If all or a portion of the loan is not forgiven the unforgiven balance and accrued interest shall be payable during the remainder of the term of the PPP loan. No assurance can be given that we will obtain forgiveness of the PPP Loan in whole or in part. With respect to any portion of the PPP Loan that is not forgiven, the PPP Loan will be subject to customary provisions for a loan of this type, including customary events of default relating to, among other things, payment defaults, breaches of the provisions of the PPP note and cross defaults. As of the date of this Report, we have incurred approximately$2,342,000 in payroll, payroll related costs and other qualifying expenses.
18 Net Increase (Decrease) in Cash and Cash Equivalents - In the first nine months of fiscal 2021 our cash balance increased by$2,354,000 compared with a decrease of$865,000 in the first nine months of fiscal 2020. In the first nine months of fiscal 2021, our operating activities generated$713,000 of cash. In addition, we used$327,000 for the purchase or manufacture of equipment, furnishings and leasehold improvements, our marketable securities provided$994,000 of cash, and we used$127,000 for the repayment of our notes payable. In the nine months of fiscal 2021, we received$1,002,000 in proceeds from a PPP Loan and$100,000 in grant proceeds from the utility which provides our electricity as a result of our completion of certain energy efficiency related improvements.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
CRITICAL ACCOUNTING POLICIES The discussion and analysis of the Company's financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States of America . The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure on contingent assets and liabilities at the date of the financial statements. Actual results may differ from these estimates under different assumptions
and conditions. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and may potentially result in materially different results under different assumptions and conditions. The Company believes that critical accounting policies are limited to those described below. For a detailed discussion on the application of these and other accounting policies see Note 2 to the Company's consolidated financial statements included in Form 10-K for the year endedFebruary 29, 2020 .
Accounting for Income Taxes
The Company accounts for income taxes under the asset and liability method. Under this method, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized. We use a recognition threshold and a measurement attribute for financial statement recognition and measurement of tax positions taken or expected to be taken in a return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities.
Stock-Based Compensation
The computation of the expense associated with stock-based compensation requires the use of a valuation model. ASC 718 is a complex accounting standard, the application of which requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility, expected option lives, and expected option forfeiture rates, to value equity-based compensation. The Company currently uses a Black-Scholes option pricing model to calculate the fair value of its stock options. The Company primarily uses historical data to determine the assumptions to be used in the Black-Scholes model and has no reason to believe that future data is likely to differ materially from historical data. However, changes in the assumptions to reflect future stock price volatility and future stock award exercise experience could result in a change in the assumptions used to value awards in the future and may result in a material change to the fair value calculation of stock-based awards. ASC 718 requires the recognition of the fair value of stock compensation in net income. Although every effort is made to ensure the accuracy of our estimates and assumptions, significant unanticipated changes in those estimates, interpretations and assumptions may result in recording stock option expense that may materially impact our financial statements for each respective reporting period.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
For information regarding new accounting pronouncements and their effect on the Company, see "New Accounting Pronouncements" in Note 2 of the unaudited notes to the condensed consolidated financial statements.
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