Precision Optics Corporation, Inc.: Form 10-Q for the period ended Mar 31, 2023

The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and notes to those statements included elsewhere in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2032 and with our audited consolidated financial statements for the year ended June 30, 2022 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on September 27, 2022.

This Quarterly Report on Form 10-Q contains forward-looking statements. When used in this report, the words anticipate, suggest, estimate, plan, project, continue, ongoing, potential, expect, predict, believe, intend, may, will, should, could, would and similar expressions are intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described in this report, the risks described in our Annual Report on Form 10-K for the year ended June 30, 2022 and other reports we file with the Securities and Exchange Commission. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made. We do not intend to update any of the forward-looking statements after the date of this report to conform these statements to actual results or to changes in our expectations, except as required by law.

Overview

We have been a developer and manufacturer of advanced optical instruments since 1982. Our medical instrumentation line includes traditional endoscopes and endocouplers as well as other custom imaging and illumination products for use in minimally invasive surgical procedures. Much of our recent development efforts have been targeted at the development of next generation endoscopes. We selectively execute internal research and development programs to develop next generation capabilities for designing and manufacturing 3D endoscopes and very small MicroprecisionTM lenses, anticipating future requirements as the surgical community continues to demand smaller and more enhanced imaging systems for minimally invasive surgery.

As Ross Optical Industries of El Paso, Texas we also operate as a supplier of custom optical components and assemblies for military and defense, medical and various other industrial applications. All products sold by us under the Ross Optical name include a custom or catalog optic, which is sourced through our extensive domestic and worldwide network of optical fabrication companies. Most systems make use of optical lenses, prisms, mirrors and windows and range from individual optical components to complex mechano-optical assemblies. Products often include thin film optical coatings that are applied using our in-house coating department.

As Lighthouse Imaging of Windham, Maine we also operate as a manufacturer of advanced optical imaging systems and accessories. We have a strong expertise in electrical engineering and development of end-to-end medical visualization devices. Product development competencies at Lighthouse Imaging include Systems, Optical, Mechanical, Electrical and Process Development Engineering. Our product development team has extensive experience developing visualization systems that are used in a variety of clinical applications. Lighthouse Imaging is an industry leader in chip on tip visualization systems.

Approximately 30% our business during the nine months ended March 31, 2023 is from engineering services (primarily relating to the design of medical device optical assemblies), 49% from the sale of both internally manufactured and purchased optical components, and 18% from the manufacture of optical assemblies and sub-assemblies (primarily for medical device instrument applications). Our proprietary medical instrumentation line, unique custom design and manufacturing capabilities, and expert electrical engineering and development services have generated orders for traditional proprietary endoscopes and endocouplers as well as for custom imaging and illumination products for use in minimally invasive surgical procedures. We design and manufacture 3D endoscopes and very small MicroprecisionTM lenses, assemblies and complete medical devices to meet the surgical community’s continuing demand for smaller, disposable, and more enhanced imaging systems for minimally invasive surgery.

We are registered to the ISO 9001:2015 and ISO 13485:2016 Quality Standards and comply with the FDA Good Manufacturing Practices and the European Union Medical Device Directive for CE marking of our medical products.

Our internet websites are www.poci.com (http://www.poci.com), www.rossoptical.com (http://www.rossoptical.com), and www.lighthouseoptics.com (http://www.lighthouseoptics.com). Information on our websites is not intended to be integrated into this report. Investors and others should note that we announce material financial information using our company websites (www.poci.com (http://www.poci.com); www.rossoptical.com (http://www.rossoptical.com); www.lighthouseoptics.com (http://www.lighthouseoptics.com)), our investor relations website, SEC filings, press releases, public conference calls and webcasts. Information about Precision Optics, our business, and our results of operations may also be announced by social media posts on our Ross Optical and Lighthouse LinkedIn pages (www.linkedin.com/company/ross-optical-industries/ (http://www.linkedin.com/company/ross-optical-industries/)) (https://www.linkedin.com/company/lighthouse-imaging-corporation/) and Twitter feed (http://twitter.com/rossoptical) and on our Lighthouse Facebook page (https://www.facebook.com/lighthouseoptics/).

The information that we post on these social media channels could be deemed to be material information. Therefore, we encourage investors, the media, and others interested in Precision Optics to review the information that we post on these social media channels. These social media channels may be updated from time to time on Precision Optics’ investor relations website. The information on, or accessible through, our websites and social media channels is not incorporated by reference in this Quarterly Report on Form 10-Q.

The markets in which we do business are highly competitive and include both foreign and domestic competitors. Many of our competitors are larger and have substantially greater resources than we do. Furthermore, other domestic or foreign companies, some with greater financial resources than we have, may seek to produce products or services that compete with ours. We routinely outsource specialized production efforts as required to obtain the most cost-effective production. Over the years we have developed extensive experience collaborating with other optical specialists worldwide.

We believe that our future success depends to a large degree on our ability to develop new optical products and services to enhance the performance characteristics and methods of manufacture of existing products. Accordingly, we expect to continue to seek and obtain product-related design and development contracts with customers and to selectively invest our own funds on research and development, particularly in the areas of MicroprecisionTM optics, micro medical cameras, illumination, single-use endoscopes and 3D endoscopes.

Current sales and marketing activities are intended to broaden awareness of the benefits of our new technology platforms and our successful application of these new technologies to medical device projects requiring surgery-grade visualization from sub-millimeter sized devices and 3D endoscopy, including single-use products and assemblies. We market directly to established medical device companies primarily in the United States that we believe could benefit from our advanced endoscopy visualization systems. Through this direct marketing, referrals, attendance at trade shows and a presence in online professional association websites, we have expanded our on-going pipeline of projects to significant medical device companies as well as well-funded emerging technology companies. We expect our customer pipeline to continue to expand as development projects transition to production orders and new customer projects enter the development phase.

General

This management’s discussion and analysis of financial condition and results of operations is based upon our unaudited consolidated financial statements, which have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

There have been no significant changes in our critical accounting policies as disclosed in the Notes to our Financial Statements contained in our Annual Report on Form 10-K for the year ended June 30, 2022 filed with the Securities and Exchange Commission on September 27, 2022.

Results of Operations

Our total revenues for the quarter ended March 31, 2023, were $5,048,065, as compared to $4,651,352 for the same period in the prior year, an increase of $396,713, or 8.5%, primarily due to an increase in component revenue to a large defense contractor. Other fluctuations in revenue categories were considered customary during the quarter ended March 31, 2023 when compared to the same quarter of the prior fiscal year.

Our total revenues for the nine months ended March 31, 2023 were $16,020,327, as compared to $10,884,737 for the same period in the prior year, an increase of $5,135,590, or 47.2% due in part to the inclusion of the Lighthouse division since its acquisition on October 4, 2021, increases in component sales in the El Paso and Gardner locations, an increase in engineering revenues, and one-time technology rights revenue in the quarter ended December 31, 2022.

Our two largest customers accounted for 13.0% and 8.4% of our revenue during the quarter ended March 31, 2023, and 8.0% and 13.1%, respectively, of our revenue during the nine months ended March 31, 2023. One of our two largest customers is a defense/aerospace company and the other is a medical device company. We generated revenues from 318 unique customers during the nine months ended March 31, 2023, and no other customer represented over 10% of our revenue during the three and nine months ended March 31, 2023.

The COVID-19 world-wide pandemic that began during the quarter ended March 31, 2020 and the domestic and international impact of policy decisions being made in major countries around the world has had, and could continue to have, an adverse impact on our sources of supply, current and future orders from our customers, collection of amounts owed to us from our customers, our internal operating procedures, and our overall financial condition.

Gross profit for the quarter ended March 31, 2023 was $1,736,098, compared to $1,728,209 for the same period in the prior year, an increase of $7,889. Gross profit for the quarter ended March 31, 2023 as a percentage of our revenues was 34.4%, an decrease from the gross profit percentage of 37.2% for the same period in the prior year. Gross profit for the nine months ended March 31, 2023 was $5,975,011 as compared to $3,486,823 for the same period in the prior year, an increase of $2,488,188 or 71.4%. Gross profit for the nine months ended March 31, 2023 as a percentage of our revenues was 37.3%, an increase from the gross profit percentage of 32.0% for the same period in the prior year. Quarterly gross profit and gross profit percentage depend on a number of factors, including overall sales volume, facility utilization, product sales mix, the costs of engineering services, and production start-up costs and challenges in connection with new products, the effects of COVID-19 pandemic policy decisions on various economies and our suppliers and customers, as well as the effects on production efficiencies due to the augmented policies we have incorporated into our operations as a result of the COVID-19 pandemic.

Our gross profit on individual engineering projects is dependent on a number of factors and is expected to fluctuate from quarter to quarter based on the number of new engineering projects, the nature and status of engineering projects, unanticipated cost over-runs, design challenges and changes, start-up production activities, or other customer-imposed project changes or delays. Our increase in gross profit dollars during nine months ended March 31, 2023 compared to the same periods in the previous years was primarily due to inclusion of the Lighthouse division since its acquisition on October 4, 2021, Other fluctuations in gross profit dollars and margins in the quarter and nine months ended March 31, 2023 when compared to the same periods of the prior fiscal year are considered customary considering the factors impacting variability as previously described.

Research and development expenses were $206,375 for the quarter ended March 31, 2023, compared to $214,898 for the same period in the prior year, a decrease of $8,523, or 4.0%. Research and development expenses were $660,518 for the nine months ended March 31, 2023, compared to $433,248 for the same period in the prior year, an increase of $227,270, or 52.5%. In-house research and development and certain internal functions not directly related to customer engagements are classified as research and development expenses with the majority of our engineering, research and development activities being consumed in revenue generating engagements with our customers for the development of their products. During the nine months ended March 31, 2023 compared to the same periods of the prior year we had an increase in personnel, and an increase in research and development costs incurred in the development of internal research and development efforts and projects.

Selling, general and administrative expenses were $2,022,991 for the quarter ended March 31, 2023, compared to $1,574,432 for the same period in the prior year, an increase of $448,559, or 28.4%. Selling, general and administrative expenses were $5,338,498 for the nine months ended March 31, 2023, compared to $3,974,824 for the same period in the prior year, an increase of $1,363,674, or 34.3%. The increase in selling, general and administrative expense in the three months ended March 31, 2023 compared to the same period of the prior fiscal year was primarily the result of increased compensation due to expanded headcount, incentive bonuses and sales commissions resulting from increased revenues, increased sales conference and show costs, and increased stock based compensation. The increase in selling, general and administrative expenses in the nine months ended March 31, 2023 compared to the same periods of the prior fiscal year was primarily due to inclusion of the Lighthouse division since its acquisition in October, 2021, plus increased compensation due to expanded headcount, incentive bonuses and sales commissions resulting from increased revenues, and increased sales conference and show costs.

Liquidity and Capital Resources

We have sustained recurring net losses from operations for several years. During the quarter ended and nine months ended March 31, 2023 we incurred operating losses of $493,268 and 24,005, respectively. During the years ended June 30, 2022 and 2021 we incurred operating losses of $1,513,890 and $905,583, respectively. At March 31, 2023, cash was $612,095, accounts receivables were $4,389,907 and current liabilities were $6,494,885, including $1,387,806 of customer advances received for future order deliveries.

Although our revenue and gross margin have increased, our operating expenses have also increased, and we continue to experience pricing pressure from our customers and challenges in engineering projects and production orders that can result in cost over-runs and depressed gross margins. We also experience added uncertainty related to our vendors ability to supply materials and our customers future order levels as a result of the economic impact the COVID-19 world-wide pandemic and related jurisdictional policies and regulations and lingering supply-chain issues. Consequently, critical to our ability to maintain our financial condition is achieving and maintaining a level of quarterly revenues that generate break even or better financial performance as well as timely collection of accounts receivable from our customers. We believe profitable operating results can be achieved through a combination of revenue levels, realized gross profits and controlling operating expense increases, all of which are subject to periodic fluctuations resulting from sales mix and the stage of completion of varying engineering service projects as they progress towards and into production level revenues.

We have traditionally funded working capital needs through product sales, management of working capital components of our business, cash received from public and private offerings of our common stock, warrants to purchase shares of our common stock or convertible notes, manufacturing equipment leases, and by customer advances paid against purchase orders by our customers and recorded in the current liabilities section of the accompanying financial statements. We have incurred year to year and quarter to quarter operating losses during our efforts to develop current products including MicroprecisionTM optical elements, micro medical camera assemblies and 3D endoscopes. Our management believes that the opportunities represented by these technical capabilities and related products have the potential to generate sales increases to achieve breakeven and profitable results.

In connection with our October 2021 acquisition of Lighthouse Imaging, we entered into a $2,600,000 bank term loan, and sold shares of our common stock for gross proceeds of $1,500,000. We also secured a $250,000 bank line of credit from the same bank in October 2021 for working capital needs, which was increased to $500,000 in May 2022. There were no borrowings outstanding on the line of credit at March 31, 2023.

Capital equipment expenditures and additional patent costs during the nine months ended March 31, 2023 were $52,411. Future capital equipment and patent expenditures will be dependent upon future sales and success of on-going research and development efforts.

Contractual cash commitments for the fiscal periods subsequent to March 31, 2023, are summarized as follows:

We have contractual cash commitments related to open purchase orders as of March 31, 2023 of approximately $2,923,320.

Off-Balance Sheet Arrangements

We currently have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

As a smaller reporting company, as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item.

Management’s Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and our Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of March 31, 2023, because of a material weakness in our internal controls over financial reporting described below. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

Material Weakness Identified; Remedial Steps Being Taken

During our review of the results for the fiscal quarter ended March 31, 2023, errors were identified in the Company’s accruals of costs associated with services provided by third-party contractors on certain development projects. Those errors caused an understatement of costs of goods sold for the quarters ended September 30, 2022 and December 31, 2022, for which we have concluded such error is not material to those previously reported financial statements. However, because of the significance of these items, and to facilitate comparisons among periods, the Company decided to revise the previously issued first and second quarter unaudited condensed consolidated financial information by increasing accounts payable and cost of goods sold by $85,213 and $125,752 in the quarters ended September 30, 2022 and December 31, 2022, respectively. Such quarterly and year to date financial statements will be revised in subsequent filings with the Securities and Exchange Commission that include such statements.

To address and remediate the material weakness in internal control over financial reporting described above, we have implemented processes to improve our accounts payable controls and documentation for the recognition of costs incurred for services performed by outside contractors and matching those costs, when applicable, to fiscal periods in which those services are billed to our customers. Specifically, we have implemented procedures to document the receipt of non-physical work product by our outside contractors, accrue for services performed by outside contractors when vendor invoices for such services have not yet been received, and to review billings to customers to ensure related contractor billings are expensed in the same period. Our Chief Executive Officer and our Chief Financial Officer will monitor such accruals in future quarters to confirm that these steps have properly remediated the material weakness in the timing of third-party expense accruals. We believe that the steps outlined above strengthen our internal control over financial reporting and mitigate the material weakness described above.

Changes in Internal Control over Financial Reporting

Except for the material weakness disclosed above, there has been no change in our internal control over financial reporting that occurred during the quarter of our fiscal year covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes from the risk factors previously disclosed in our annual report on Form 10-K for the fiscal year ended June 30, 2022, as filed with the Securities and Exchange Commission on September 27, 2022.