Precision Optics Corporation, Inc. (NASDAQ:POCI) Q2 2023 Earnings Call Transcript

Precision Optics Corporation, Inc. (NASDAQ:POCI) Q2 2023 Earnings Call Transcript February 14, 2023

Operator: Good afternoon, and welcome to the Precision Optics Second Quarter Fiscal Year 2023 Financial Results Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Robert Blum from Lytham Partners. Please go ahead.

Robert Blum: Thank you very much, Gary, and thank you all for joining us today to discuss Precision Optics’ second quarter fiscal year 2023 financial results for the period ended December 31, 2022. With us on the call representing the company today are Dr. Joe Forkey, Precision Optics’ Chief Executive Officer; and Mr. Kevin Dahill, the company’s interim Chief Financial Officer. At the conclusion of today’s prepared remarks, we will open the call for a question-and-answer session. Today’s conference call is also being webcast with replay capabilities available, both through the webcast as well as through dial-in instructions. The details of both were included in today’s press release. Before we begin with prepared remarks, we submit for the record the following statement.

Statements made by the management team of Precision Optics during the course of this conference call may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended, and such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements describe future expectations, plans, results or strategies and are generally preceded by words such as may, future, plan or planned, will or should, expected, anticipates, draft, eventually or projected. Listeners are cautioned that such statements are subject to a multitude of risks and uncertainties that could cause future circumstances, events or results to differ materially from those projected in the forward-looking statements, including the risks that actual results may differ materially from those projected in the forward-looking statements as a result of various factors and other risks identified in our filings with the Securities and Exchange Commission.

All forward-looking statements contained during this conference call speak only of the date in which they were made and are based on management’s assumptions and estimates as of such date. The company does not undertake any obligation to publicly update any forward-looking statements, whether as the result of the receipt of new information, the occurrence of future events or otherwise. With that said, let me turn the call over to Dr. Joe Forkey, Chief Executive Officer of Precision Optics. Joe, please proceed.

Dr. Joe Forkey: Thank you, Robert, and thank you all for joining our call today to discuss our second quarter fiscal year 2023 financial results. This was a quarter of many positive milestones for Precision Optics. Operationally, we achieved record quarterly revenue, gross margin, net income and adjusted EBITDA, and we received a number of significant purchase orders for existing products and new product development that help to bolster our production backlog and product development pipeline. These developments will help us continue our recent trend of increasing top line revenue and bottom line profitability. During the quarter, we completed the uplisting to NASDAQ, and we finalized the technology licensing and royalty agreement that we believe will be a model for greater access to the single-use medical device market and a potential catalyst for long-term growth.

I will discuss the drivers of our second quarter operational successes, but first, I’d like to talk for a few minutes about the strategic milestones that were accomplished during the quarter. We have been working on moving the company’s stock from the OTCQB exchange to NASDAQ for many months. I’m really pleased that we were able to complete the uplisting on November 16. Since we made the move, we have seen an increased level of investor interest in the company. The best evidence of this is the sixfold increase in our average daily trading volume, adjusted for the reverse split. We also had the honor of ringing the opening bell on NASDAQ on December 14. This is a great opportunity to recognize the many years of hard work by everyone involved with the company, including our customers, suppliers, directors, investors and especially our employees.

We continue to believe that the added visibility of our company and its stock that comes from being listed on NASDAQ will be important to support the ongoing growth of the company. The second development in the quarter that could have a long-term impact on the company’s success was the finalization of a technology licensing and royalty agreement with one of our significant customers. The agreement is related to the single-use ophthalmic product that we have discussed on many of our calls over the last few years. I frequently describe how the single-use market brings both technical challenges and cost challenges as the existing micro-optics supply chain is not organized to deliver single-use products at the price points many OEMs think the market will bear.

The signing of this agreement in December is important as it indicates that the launch of this particular product is close and because it provides the business framework that we can use to pursue more of the single-use medical imaging device market. The multiple benefits to using single-use devices include ease of inventory control by the hospital, guarantee of brand-new product image quality for the surgeon in every procedure and importantly, the virtual elimination of the possibility of cross-contamination from one patient to another. Because of the clear benefits to hospitals, doctors and patients, the market for single-use medical imaging devices has grown substantially over the last few years. We estimate that the current total addressable market for these devices is on the order of $500 million per year and that it is growing at a rate of 15% to 20% per year.

We are seeing inbound customer interest for products that are single-use from the beginning and for products moving from a reusable design to single-use. Single-use medical imaging devices are characterized by low cost endoscopes with very good image quality. They require technical expertise and small optics, use of CMOS sensors and digital image single processing as well as very low cost. This is where the business model needs to be different from that used to manufacture and supply reusable medical devices. The supply chain for single-use will need to adjust to these cost realities by integrating new technologies and relying on scale producers to deliver at cost targets. The approach that we and our customer defines in our agreement addresses these business issues.

We will initially produce in our Gardner facility, the product we designed for the customer. And the customer may transfer production to their own facility or a third-party facility using tools and fixtures that we have designed and validated. In return, they have agreed to pay us royalties for an agreed-upon period of time if and when production is moved out of a POC facility. We are, in effect, being paid a royalty not only for the intellectual property and the product design, but also for the IP and know-how in the production process. This program has resulted in 2 patent applications, 1 of which was recently granted by the U.S. Patent Office as well as the development of significant know-how that will be useful in future programs. Our agreement provides our customer with rights to these technologies for the manufacture of their product and in some cases, exclusive rights, but only in a very narrow field of use.

POC maintains ownership and control of these technologies and has broad leeway to use these technologies on other products. As part of this agreement, POC received a onetime nonrefundable payment of $600,000 upon execution of the agreement. This payment is nonrefundable irrespective of any future production revenues or royalties received by POC. To be clear, if and when production is shifted to a non-POC facility, POC will begin to receive royalty payments based on the number of units produced and sold. The $600,000 payment is reflected in our second quarter financials as a onetime sale of technology rights and therefore, has a positive impact on our quarterly revenue, gross margin, income and adjusted EBITDA. As we review our operational performance, I will comment on our numbers with and without this sale included since our performance in the second quarter set new records, even when the impact of the $600,000 payment is excluded.

Revenue for the second quarter was $5.9 million, which is a new quarterly record. Even without the $600,000 technology rights revenue, revenues of $5.3 million would have been a record. These strong revenue levels are being fueled by the programs that have recently gone into production. For the second quarter, production revenue was $3.6 million compared to $2.3 million in the second quarter of fiscal 2022, which represents an increase of 59%. This was also an increase of $140,000 from the first quarter. Similar to last quarter, the key drivers here were the increase in production orders for our spinal products for a major long-time customer, which we announced last year; our new defense aerospace production contract, which we also announced last year; and the transition to production of Lighthouse’s next-generation otoscope, which we announced in May of last year.

We have talked on recent calls about the defense aerospace order that is now in full production. Last year, we announced initial production orders for this program, and we have received subsequent follow-on orders. During the second quarter of fiscal 2023, we delivered over $800,000 to this customer. We expect to work with this customer on a next-generation redesign. This redesign may create a bit of a gap in production during the fourth quarter, but we expect it to ramp back up in the first quarter of fiscal 2024. We are pleased with the development of this program to date and look forward to a long future with this customer. In March of last year, we reported that we received production orders totaling approximately $2.5 million for a spinal surgery product that we have been delivering to a large medical device customer for over 10 years.

We delivered nearly $250,000 in product to them in the second quarter. These orders serves to restock our customers’ inventory so we expect there will be a reduction in orders for the next 12 months or so, but we believe the long-term ongoing market opportunity for this product remains strong. As we talked about the last 2 quarters, the first program from our Lighthouse acquisition to transition to production occurred during the fourth quarter of fiscal 2022, and continued through to the second quarter of fiscal 2023. This product is a highly complex optical and electronic assembly used for imaging in the ENT space. This customer is seeking to secure additional funding for a broader market launch, which has caused some variability in our deliveries to them.

While it is difficult to predict the future delivery schedule of this product, we expect deliveries to be reduced or even paused for the next couple of quarters. While some of these programs that have contributed to our recent revenue increases may pull back a bit in the next couple of quarters, 2 of our major programs that had experienced order reductions due to the pandemic have now come back at levels greater than the levels before the pandemic. We believe these will fill the temporary gap that may be caused by the pullback in the other programs. In December, we received our second follow-on production order in the past year from the major U.S. defense contractor we have worked with since 2018 to meet increased demand for a highly complex optical assembly.

A year ago, we received an $875,000 order. The new order we announced in December was $2.6 million, representing a nearly threefold increase. The timing of deliveries was such that this program did not contribute to second quarter revenue. We will begin delivering against this newer order and continue deliveries against the earlier order in the third fiscal quarter and into the future. Based on discussions with the customer, the end market product is seeing increased demand, and the customer expects to continue ongoing renewals of production orders in the years to come. In January, we announced the receipt of a follow-on production order totaling approximately $2.3 million from a large medical device company for an otoscopy application to meet enhanced demand for the product.

The order is expected to be delivered over the next 12 to 24 months, commencing in the third or fourth quarter of fiscal 2023. We had supplied this sophisticated optical assembly to the customer since 2018. Due to the impact of the pandemic, however, production of the assemblies had halted in December 2020 with little revenue recognized during the past 8 quarters from this customer. The end product application has since regained traction in the marketplace with an expectation for ongoing production orders into the future. The positive impact of this program restarting is gratifying as it highlights the benefits of having multiple products in production at any given time and the growth opportunities that can be presented when end market demand for these products take off.

All in all, we expect some ups and downs with individual production programs during the second half of fiscal 2023. Between the programs recovering from the pandemic, along with new programs moving out of the engineering pipeline, we expect the overall trend of increasing production revenue to continue in the long run. Our development pipeline remains robust, with a number of new projects advancing through the pipeline. Our product development pipeline and the volume and size of new opportunities continues to be as large as it has ever been. In the second quarter of fiscal 2023, our engineering revenue was $1.7 million for the quarter, an increase of 4% compared to the second quarter of the previous fiscal year and up slightly from the previous fiscal quarter.

Because we have so many programs in the product development pipeline, we are able to maintain a high level of utilization of our engineering resources, which explains the nearly flat quarter-over-quarter and year-over-year revenue levels attributable to engineering. This is a good place to be because the robust engineering pipeline is a strong indicator of future production growth. There are several programs in our product development pipeline that have the ability to transition to production in the near term, including programs that support orthopedics, robotic laparoscopy, ophthalmology, urology and ENT applications. While we have made strong progress moving programs from our development pipeline closer to production, we have also been equally successful in replenishing our pipeline with new opportunities.

With the positive market response to the combination of Lighthouse Imaging and Precision Optics, the number of opportunities coming to us for new development projects is greater than ever. One great example of this is the order for approximately $750,000 that we announced in December for the development of a next-generation single-use urology device. This order came from an established medical device company and leverages our unique expertise in micro-optics, medical systems and digital imaging. This marked the second high-volume single-use program in our development pipeline to move beyond the proof-of-concept phase. The development program is expected to continue for 1 to 2 years, with production orders expected upon successful validation.

With increases in revenue, we have also seen an increase in gross margin. We are leveraging higher utilization of our existing infrastructure, along with improved efficiencies as production programs mature to drive improvements in gross margin. We have stated a corporate goal of 40% gross margin. And in the second quarter, we achieved this level for the first time in recent history. This goal was achieved excluding the $600,000 technology rights revenue I mentioned a few minutes ago. Including the impact of the technology rights revenue, gross margin was 46%. With an expectation of changes in product mix as programs come in and out of revenue for various quarters, we expect gross margin to fluctuate from quarter-to-quarter. But achieving our 40% gross margin goal in the second quarter was a great validation of the long-term business plan and potential for profitability.

Another key goal for fiscal 2023 is to achieve bottom line profitability and growth. The increases in both revenue and gross margin, combined with close management of operating expenses, helped us achieve positive net income of $634,000 and adjusted EBITDA of $993,000 in the second quarter. Removing the impact of the $600,000 technology rights revenue, net income and adjusted EBITDA would have been $34,000 and $393,000, respectively. This is a record for adjusted EBITDA and a significant achievement by the entire team at Precision Optics. Before I move on to a quick summary of some of the key items on the income statement and balance sheet, I want to comment on the status of our CFO position. We announced in late December that Dan Habhegger would be resigning from the CFO position.

Dan has taken an active role in finalizing the second quarter 10-Q, and has agreed to be available on an as-needed basis for the indefinite future. While we are disappointed by Dan’s departure, I’m grateful for his willingness to continue to work with us through a transitionary period, and we certainly wish him well in his future endeavors. As Robert mentioned at the beginning, joining us on this call today is Kevin Dahill, our Interim Chief Financial Officer. Kevin has served as a senior executive, CFO and Director at multiple private and public companies across multiple industries, primarily with technology-based businesses. Kevin is not new to Precision Optics as he served as a finance and operations consultant to the company back in 2013 and 2014.

I am thankful that Kevin has been able to step in to assist the company during this time. We have initiated a search for a new permanent CFO and look forward to filling the position in the near future. With that, let me do a quick run-through of the financial highlights, and then I’ll take questions. I’ve already mentioned revenue a few times. But to reiterate, revenue for the second quarter was a record $5.9 million, which compared to $3.9 million in the same quarter a year ago, an increase of 51%. Excluding the $600,000 technology rights revenue, total revenue would have been $5.3 million, which corresponds to a 38% year-over-year increase. Our gross margin was 46% for the second quarter compared to 29% in the same quarter last year. Excluding the $600,000 technology rights revenue, gross margin was 40%, a key milestone achieved for the company, and an 11% improvement year-over-year.

Operating expenses in the second quarter were $2.0 million compared to approximately $1.6 million in the previous year’s second quarter and $1.7 million in the sequential first quarter. On a cash basis, excluding depreciation and amortization as well as stock-based compensation, operating expenses were approximately $1.7 million compared to approximately $1.2 million in the second quarter of last year and $1.6 million in the first quarter of this year. The roughly $100,000 quarter-over-quarter increase is largely due to increased costs related to the NASDAQ listing and increases in commissions due to the increased revenue level. And the year-over-year increases were also impacted by travel, trade shows and other general sales and marketing expenses that have increased with the end of the pandemic and with increasing revenues.

As I mentioned, we achieved operating profitability for the first time in many years, with net income of $634,000, or $34,000 when excluding the $600,000 technology rights revenue. This is a significant improvement from the $507,000 loss in the second quarter a year ago and from a $74,000 loss in the first quarter of this year. Adjusted EBITDA, which excludes stock-based compensation, interest expense, depreciation, amortization and any acquisition expenses, was positive $993,000 for Q2 compared to a loss of $72,000 for the second quarter a year ago and a positive $110,000 in Q1. Again, even excluding the technology rights revenue, adjusted EBITDA would have been $393,000, a significant improvement compared to both previous periods. Despite the substantially positive adjusted EBITDA for the second quarter, our cash balance at the end of the quarter was $381,000, down $292,000 from the end of the previous quarter.

This is due in large part to the heavy weighting of shipments towards the end of the quarter, along with a couple of slow-paying customers. This can be seen in the increase in accounts receivable balance of $618,000 at the end of the second quarter compared to the end of the first quarter. We will continue careful cash management and judicious use of our $500,000 line of credit as we work to collect on this significant outstanding AR balance. As we look to the third quarter of fiscal 2023, we expect our run rate of overall revenue to be steady or slightly higher compared to Q2 as some projects slow down, but new projects come online. We still expect solid revenue growth in the range of 20% for this fiscal year overall. Importantly, with the improvement in gross margin and as we hold the line on operating expenses, we believe we will continue to see improved bottom line profitability.

This is an extremely exciting time for Precision Optics. With another successful operating quarter, highlighted by record revenues, significant gross margin improvements, positive net income, the impact of a number of projects moving to production, a large pipeline that continues to move projects through the development process and strategic plans to support long-term opportunities, I believe we are in a great position to continue the acceleration of growth through this fiscal year and into the future. I thank you all for your continued support of Precision Optics, and I’d now be happy to take any questions.

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Q&A Session

Operator: Our first question is from Sergio Heiber with Heiber Research.

Sergio Heiber: Hey Joe. Congratulations, fantastic quarter and especially on the part of reaching profitability. and does that come from a new customer, an established customer?

Dr. Joe Forkey: Sorry. Sergio, you broke up for just a minute there. I heard the end of the question, whether it’s from a new customer, an old customer, I didn’t hear the beginning of the question.

Sergio Heiber: Could you give us more color on the AR, on the accounts receivable?

Dr. Joe Forkey: On the accounts receivable?

Sergio Heiber: Yes.

Dr. Joe Forkey: It’s fairly broad. I mean there are 2 or 3 customers who have been customers for many years that are slow-paying a little bit as they’re managing their cash. But that’s only a part of the large AR. That’s maybe 25% of it. The rest of it is really spread out across many, many customers. And it comes from the fact that we deliver products heavily in the end of the quarter.

Sergio Heiber: And do you want to give us any guidance going forward?

Dr. Joe Forkey: None beyond what I’ve already said.

Sergio Heiber: There wasn’t very much as far as guidance, just that there’s a very strong pipeline. So can you give us any color on what you expect from the pipeline as far as going to commercial in the next 12 months?

Dr. Joe Forkey: Yes, sure. I can comment a little more on that. So we have something like 7 or 8 programs that could go into production in the next 12 to 18 months. There are 3 or 4 in particular that are sort of poised and pretty ready to go into production and are limited from a timing standpoint really by the steps that the customers have to go through, either finalizing the funding in order to get into launch or waiting for their final clearance from the FDA. So here, I can give you an example of just 2 or 3 of those that are in that sort of latter category where we sort of see things coming fairly imminently. One of them is the ophthalmology single-use program that I talked a lot about that has to do with that agreement, right?

That agreement in part is an indication of how close we are. We’re finalizing validation units now. The customer is planning to submit to the FDA in the next few months. And then we’ll start production to build the pipeline, hopefully, before the end of the year — to build the inventory, I should say. The second one is for a robotic surgery customer. We just finished the final prototype run. They’re waiting for us to build a certain number of pilot units to put into inventory while they’re waiting for their final approval from the FDA on their final clinical test. So that one also looks like it could launch before the end of this calendar year. And then the third one that I put in that category is the urology program, where we basically finished the final prototypes, and we’re ready to build the pilot build.

Again, that would fill the pipeline. And in this case, the customer is doing their next round of funding so that they can fully fund their launch plans. So, we’ve got a number of customers, each of which is waiting for various things from clinical trials to final funding. But because our pipeline is so large now, it’s not — it won’t be unusual going forward for us to have multiple customers that are sort of poised and ready to go into production. And while some of them may take a little longer than others, I expect we’ll start to see a pretty good cadence of things coming out of the pipeline and going to production.