Precision Optics Corporation, Inc. (NASDAQ:POCI) Q4 2023 Earnings Call Transcript

Precision Optics Corporation, Inc. (NASDAQ:POCI) Q4 2023 Earnings Call Transcript September 29, 2023

Operator: Good afternoon, and welcome to the Precision Optics Fourth Quarter and Fiscal Year 2023 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Robert Blum with Lytham Partners. Please go ahead.

Robert Blum: All right. Thank you very much, Gary, and thank you to everyone joining us on today’s call. As the operator mentioned, we’re just here to discuss Precision Optics’ fourth quarter and fiscal year 2023 financial results for the period ending June 30, 2023. With us on the call representing the company today are Dr. Joe Forkey, Precision Optics’ President and Chief Executive Officer; and Wayne Coll, the company’s Chief Financial Officer. At the conclusion of today’s prepared remarks, we’ll open the call for a question-and-answer session. Today’s conference call is also being webcast with the replay capabilities available both through the webcast as well as through dial-in instruction, the details of both were included in today’s press release.

Before we open with prepared remarks, we submit for the record the following statements. 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 as 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 a result and 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, Precision Optics. Joe, please proceed.

Joseph Forkey: Thank you, Robert, and thank you all for joining our call today to discuss our fourth quarter and fiscal year 2023 financial results. I’m very happy to be joined for the first time by Wayne Coll, our CFO as of June of this year. I’ll provide a few opening comments, then turn it over to Wayne to discuss financials and then I will provide more color on the business of the fourth quarter and fiscal year. Fiscal year 2023 was a year of tremendous progress for Precision Optics as we continued to leverage our unique technological and production capabilities to drive record revenues and adjusted EBITDA. We continue the integration of our recent acquisitions, uplisted to NASDAQ, strengthened our balance sheet and perhaps, most importantly, recruited two top-notch industry veterans to fill the positions of Chief Operating Officer and Chief Financial Officer.

These achievements position us well to execute on the many new orders we announced during the year and for continued growth in fiscal 2024 and beyond. As we look to fiscal 2024, we expect to continue our growth as we execute on a robust pipeline of opportunities, and we expect to show continued improvement in the EBITDA margin of the business. While we have grown severalfold in recent years, our business can still be somewhat lumpy, and we expect the early part of the year to demonstrate that. But trend should improve as we go through the year with some very specific programs that I’ll discuss in greater detail, and we expect this to be another year where we grow to new record highs of quarterly revenue and profitability. Before going into more detail, let me turn it over to Wayne to discuss the financials.

Wayne Coll: Thank you, Joe. Let me start by saying how excited I am to be part of the Precision Optics team. The technological capabilities we offer, our prospects and customers are unique in the industry and allow us to bring next-generation solutions to medical device, aerospace and defense customers. I believe we have a great opportunity ahead of us, and I look forward to working with the POC team to build on recent successes. Next, I’d like to review our financial highlights. For the fiscal year, total revenue was $21 million, an increase of 34% compared to $15.7 million last year. Production revenue was $13.7 million, while engineering revenue was $6.7 million. Production revenue was up 39% year-over-year, while engineering revenue was up 25%.

On a quarterly basis, revenue for the fourth quarter was approximately $5 million, which compares to $4.8 million in the same quarter a year ago, an increase of approximately 5%. Production revenue was $3 million, while engineering revenue was a record $2 million. For the year, gross margins came in at 36.8% compared to 31.4% in fiscal 2022, an improvement of over 5%. For the fourth quarter, our gross margin was 38.5% compared to 30.1% in the same quarter last year and compared to 34.4% in the sequential third quarter of 2023. The improvement in our processes and procedures, coupled with higher absorption of our fixed overhead, continue to be key drivers of our gross margin expansion. For the fiscal year, operating expenses were $8.4 million compared to $6.4 million in fiscal 2022.

Part of the increase is due to an additional quarter of operations this year compared to last year from Lighthouse Imaging. Other sources of the increase were increases in sales and marketing expenses as we recovered from pandemic limitation in this area as well as increased corporate costs associated with our uplisting to NASDAQ. On a quarterly basis, OpEx was $2.5 million versus $1.9 million in last year’s fourth quarter and $2.2 million in the sequential third quarter of 2023. Included in OpEx is an increase in our reserves for doubtful accounts of $464,000 incurred in the fourth quarter primarily related to development work that we performed in the first and second quarters of fiscal 2023 for a small publicly traded start-up company that ran into funding difficulties when their main investor was unable to honor a funding vehicle they had previously established.

We still believe that the technology market for this program remains viable, and this customer is currently pursuing funding and has indicated they plan to return it to us and continue their program once successful. Excluding the bad debt expense, operating expenses would have been lower in Q4 than Q3. I, along with our entire senior management team, have been tasked with keeping our operating expenses relatively stable while still making targeted investments, particularly in sales and marketing, as we continue to scale the business. During the fourth quarter, we had a onetime pickup in other income of $572,000 and a total of $715,000 for the year compared to $746,000 in the prior year. These amounts primarily pertain to reversal of contingent earn-out liabilities associated with the acquisition of Lighthouse Imaging.

We determined that Lighthouse Imaging would not achieve the metrics required for potential earn-out payments. The earn-out itself was structured to bridge evaluation, and then worked as intended – therefore, worked as intended. As the concern was the uncertainty in near-term revenue from Lighthouse programs. So while the earn-out criteria was not achieved, the Lighthouse acquisition was strategically and synergistically an ideal addition to the company as evidenced by our improved competitive position and the new development orders already realized that were specifically made possible only through the combination of technical capabilities that resulted from the acquisition. On the income side, net loss during the fiscal year was $145,000 compared to a net loss of $928,000 in fiscal 2022.

For the fourth quarter, the net loss was $96,000 compared to net income of $269,000 in the fourth quarter a year ago. And a net loss of $398,000 in the sequential third quarter of 2023. Adjusted EBITDA, which excludes stock-based compensation, interest expense, depreciation, amortization, other income and acquisition expenses, was positive $491,000 for fiscal 2023 compared to negative adjusted EBITDA of $242,000 in fiscal 2022. Without the bad debt expense of $464,000 adjusted EBITDA would have been $955,000 for the year. Higher revenue along with an improved gross profit percentage, partially offset by higher operating costs, were the key drivers of the increased adjusted EBITDA. On a quarterly basis, Q4 adjusted EBITDA was a negative $412,000.

Again, this is impacted by the bad debt expense, without which adjusted EBITDA for the quarter would have been positive at $52,000. Our cash balance at June 30, 2023, was $2.9 million, reflecting the receipt of proceeds from a capital raise and a new term loan, both executed in June. This influx of capital along with an expanded line of credit will help the company manage anticipated working capital requirements as we continue to improve bottom line profitability and invest for future growth. As we move forward, our goal is to drive the gross margin of the business higher during the year. The company has historically cited a target of 40% gross margins, and we’re nearing that level on an annual basis. Our mix of revenues, of course, impacts our gross margin.

But in general, we are looking to make improvements in gross margin while managing costs in order to reach an adjusted EBITDA margin that reflects the value of the skills and technology we provide to our customers and also be able to reinvest the profits back into the business. As we look to the first quarter of fiscal 2024, we expect to see strong continued engineering revenue. Our Ross operations experienced a pullback from Q4 of 2023 to Q1 of 2024 that will cause overall revenue to be somewhat lower in the first quarter. With the expectation of a number of pipeline projects, including certain key projects with a significant long-term revenue potential transferring to production, along with continued strong performance from our engineering team, we expect overall revenue growth during fiscal 2024.

I will now turn the call back over to Joe to comment further on the specific programs that support our optimism for the year.

Joseph Forkey: Thank you, Wayne. As we’ve discussed before, our business model is based on developing and maximizing the value of our proprietary optics-based technology. By engaging with our customers early in their product development cycle and incorporating our technology into their new product designs, we create a strong likelihood that we will continue to be their partner for the long-term manufacture of their product. As we transfer more programs into production, we anticipate an ever-increasing number of products in production and a corresponding increase in revenue. Our financial results for fiscal year 2023 demonstrate the effectiveness of this model as we recorded both record production revenue of $13.7 million and simultaneously maintained strong engineering revenue of $6.7 million.

As I have stated in the past, our engineering pipeline is the source of future production programs and, therefore, the best indicator of long-term growth potential. Our fourth quarter engineering revenue of $2.0 million was a new quarterly record as we ramped up work on a number of key programs that we expect to be contributors to growth in fiscal 2024 and beyond. Our pipeline is strong based on several metrics, including aggregate size, average deal size and quality of customers. Today, we are dealing with more established, better capitalized companies than at any other time in our history. Our success is largely attributable to the strength of our team. And a highlight of fiscal 2023 was the addition of Mahesh Lawande as Chief Operating Officer and Wayne as Chief Financial Officer, both hired in the fourth quarter.

They both have many years of experience managing high-tech medical device organizations through process development and periods of significant growth. In recent years, our business has grown in terms of revenues but also in terms of complexity in some stresses. These two critical additions to our team give us the management bandwidth to keep the operations running smoothly, reduce risk and drive cost efficiency. They also free up more of my time to be spent with customers and thinking more about emerging technologies. We finished fiscal 2023 with a number of steps taken to address our growing working capital needs through a combination of three actions: first, a new $750,000 term loan with Main Street Bank; second, the expansion of our line of credit facility to $1.25 million from $500,000; and finally, the completion of a $2.5 million private placement with a number of high-quality institutional and accredited investors.

All three of these moves allow us to better manage the working capital requirements necessary to continue scaling our business. I’d like to spend a few minutes now on some program specifics, starting with production. For the year, production revenue was a record $13.7 million, while the fourth quarter was approximately $3.0 million. As we always mentioned, we expect some turnover in production programs from quarter-to-quarter as some pull back due to redesigns or excess inventory while others transfer from our development pipeline to production or grow due to successful market adoption. So at our size and scale, our growth of production revenue is not linear and smooth even though the overall trend is positive. In fiscal 2023, there were five key programs that drove production revenue.

Our defense program that started production prior to the pandemic and slowed down during the pandemic is now back in full swing with deliveries against the $2.6 million order that we announced in December. This was the largest order we’ve ever received for this program. In the fourth quarter, we delivered approximately $477,000 against this order. Our customer is very happy with our performance and has indicated that reorders are likely to be issued on an ongoing basis. We also are seeing the reinitiation of the otoscopy program, which was on hold during the pandemic. During the fourth quarter, we delivered approximately $327,000 against the $2.3 million order that we announced in January, and we expect these deliveries to continue at comparable levels for the next few quarters and then potentially ramp even higher towards the end of the fiscal year.

We also continue to deliver against our order from CardioFocus for the ongoing manufacturer of a micro endoscope used to help treat cardiac atrial fibrillation. During the fourth quarter, we delivered approximately $100,000 worth of product. During fiscal 2023, we ramped up production against our $2.4 million order from a large medical device company for a spinal surgery application. After a number of strong quarters, we had minimal fourth quarter revenue as we have nearly completed the current orders. As expected, our customer will take some time to deliver their now replenished inventory to the end user market, but we have worked with this customer for more than 10 years and fully expect follow-on orders in the future. Our newer defense aerospace program contributed revenue during the fourth quarter of about $269,000 as we completed the current orders from this customer.

As I mentioned last quarter, this customer has been working on a next-generation redesign. The redesign came back with a very substantial change in product specifications and, ultimately, require the use of a manufacturing technology that falls outside of Precision Optics’ specialized expertise. Because of this, we do not expect the reorder of the same magnitude as previous orders. But the customer was very pleased with the work we did and remains engaged with us now that we are on their approved supplier list to explore possibilities for us to work on more limited aspects of this program and the potential for our involvement in other programs. Even as this defense aerospace program is transitioning away from a design that utilizes our technology, another new customer in the same space is moving forward with significant prototype orders.

We are engaged with this new customer to build an assembly that is higher on the value chain and that utilizes a more unique aspect of our technology. We believe, therefore, that we are in a strong competitive position, and we are optimistic that this program could be even larger than the previous one. Again, the timing of one program winding down and the other starting may result in some reduction in defense aerospace revenue for a quarter or two, but overall, we see this new market as a target for long-term growth. To better address the defense aerospace market, we are pursuing investigations in two directions. First, we are ramping up our efforts to communicate with major players in this market to better understand market segmentation and critical technologies required.

Second, we are exploring various approaches to utilizing our existing technology to address these market requirements. A good example of the benefits of these efforts is the recognition that the technology we have developed from micro-optics can readily be extended to high-precision active alignment of larger optics. The main point here is that micro-optics, by virtue of their very small size, naturally require very high-precision alignment. As we explore the defense aerospace market, we have discovered a number of opportunities where we can utilize this high-precision alignment capability even when working with slightly larger optics. We have several programs transitioning from our engineering pipeline to production in the first half of the year, giving us confidence that our annual production revenue will grow in fiscal 2024 and that we will exit the year running at a higher and sustainable level of revenue.

As we have already mentioned, the fourth quarter engineering revenue was the highest in the company’s history, coming in at about $2 million. The increase is a result of the recognition by customers of the breadth and depth of our technical capabilities following the acquisition of Lighthouse Imaging. Engineering talent is very hard to recruit these days, but we continue to be successful in selectively adding to our engineering team in order to increase the revenue-generating capacity in engineering. A key highlight to this area has been our development program for a next-generation single-use urology product for which we have received two product development orders totaling $2.25 million. This customer is moving very aggressively with the goal of starting production before the end of POC’s fiscal 2024.

This program is also important from an overall business strategy standpoint as it is the second single-use program that is predicated on POC receiving either production revenue or royalties on production revenue, a novel approach that we believe will allow us to continue to attract profitable business in the single-use medical device space. During the fourth quarter of fiscal 2023, we also advanced development work on our original single-use program for an ophthalmic endoscope. During the fourth quarter, we recognized development revenue, which is independent of future royalties, of approximately $300,000 from this program. This program is currently transitioning to production, which is expected to officially start in Q2 or Q3 of fiscal 2024.

Another key development program is for a next-generation neurological endoscope for which we announced a development contract totaling approximately $1.3 million from an established medical device company for whom we provided an individual component for our previous product for many years. This new program highlights our expanding role as a value-added solutions provider. The initial development agreement is expected to be completed over the coming 12 months with opportunities for further development in commercial production contracts upon successful completion and approval. While there are a number of other development programs that our engineering team is working on, I want to highlight one final one that we are developing for ear, nose and throat applications and that we again believe could also launch before the end of fiscal 2024.

The overall product is based on our customers’ proprietary approach to combining endoscopic visualization with unique surgical tool design. For this program, we are designing and ultimately will manufacture the entire endoscope imaging system, including a wireless display. In summary, whereas in years’ past our largest development programs ran in the hundreds of thousands of dollars, we are now consistently attracting programs with sizes in the millions of dollars. This is due in part to the size of the customers we are attracting but it is also due to the fact that we are able to design and manufacture more of the overall product, so each program has a much higher revenue potential, both during development and during production. I have mentioned several programs with credible revenue expectations that could drive growth for years to come.

I hope to be able to provide more detail soon, but suffice it to say, based on discussions with customers, we are optimistic that production phase of these programs will materialize. Of course, we recognize that our success is dependent on our customers’ success selling their products in the market, but we believe the demand for the products we expect to produce is very high. Our Ross Optical division tracks strongly in the fourth quarter and finished out the fiscal year with record revenue for the fourth year in a row. Ross Optical revenue has consistently grown since our acquisition with revenue increases even during the pandemic. Recently, however, we have seen a substantial pullback from a number of customers consistent with the general reduction in activity in the optical component market across the board.

Some of this has been caused by overly aggressive purchasing after the pandemic that led to excess inventory. While customer retention remains high, a number of our customers have asked to delay deliveries for some months as opposed to outright cancellation of orders. We believe this pullback could be as significant as $0.5 million per quarter over the next couple of quarters, but we are confident the business will return as excess inventory in the industry is absorbed. This does not appear to be an execution-based issue at Ross, it seems to be a timing issue that will pass. Let me just wrap things up by saying how excited I am with the progress we have made at Precision Optics. We are not yet at a scale where our revenue growth will be smooth quarter-to-quarter, and we expect revenue in the first half of fiscal 2024 to bounce around the current level as we digest some puts and takes in customer programs and transfer new programs to production.

There are, however, programs in our portfolio that have significant potential to drive substantial long-term revenue growth. Because of this, I believe the future of Precision Optics is extremely bright, and I want to thank all of you for your continued support. With that, we’d be happy to take any questions.

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question is from [Chris Fitoski], a private investor. Please go ahead.

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Q&A Session

Unidentified Analyst: Hello. My first question is about the next year, you said that even though the current quarter seems to be a little lower, you’re confident that the year will be higher than this past year. And it makes sense that when you have higher engineering revenues, that would eventually turn into production. I just wanted to maybe kind of check into levels of confidence. Are those kind of like soft deals already made? Or do you hope to make deals for production if your clients indicated that they’ll be ordering production devices and so on?

Joseph Forkey: Yes. Thanks, Chris. It’s a great question. So the programs that we expect to go into production to help drive revenue, particularly in the latter half of the fiscal year, are all based on programs that are currently in the development phase and are currently moving through what we call the transfer phase. So these are programs where the design for the product has already been finalized. The customer has verified the design, so they’ve done their testing with their key opinion leaders and such. And we’re in the transfer phase where we’re going through some of the design validation and then we’re standing up the production line. So these programs are very far advanced from the standpoint of the engineering development work.

And to answer your specific question about contracts with customers, we don’t yet have the contracts for the production because those wouldn’t be issued until after the transfer work was completed. But all indications are that the customers are ready to give us the production orders as soon as we complete the work through the transfer phase that we’re working on with them now.

Unidentified Analyst: That is good to hear. And just to be clear, are you subject to your customers winning any design wins or design awards? Or are you working with end customers that are sure that those devices will be made?

Joseph Forkey: Yes. So in the cases that we’re talking about, these programs that are in the transfer phase, the customers of ours are the ones that control the entire design for the system and ultimately are selling to the end users, so there’s no intermediate phase there. The one to be completely thorough in the answer, the one other piece that has to be completed is they have to get regulatory approval for their product with the design that we have. And some of the work that we’re doing now is collecting the data that they need to bring to the FDA, for instance, in order to be able to do that. In the case of the programs that we’re talking about, while I would never say that regulatory clearance from the FDA is a foregone conclusion, there are different levels of risk when you go for that kind of regulatory approval and regulatory clearance, I should say.

And in all four of these cases, our customers are quite mature in terms of the way that they approach the risks related to regulatory clearance, and so they’ve already done substantial work to have a high degree of confidence that they’ll be able to get through the regulatory clearance.

Unidentified Analyst: Yes, it would make sense that in optical, you wouldn’t be subject to the uncertainty of drugs and pharmaceuticals, right?

Joseph Forkey: Yes, that’s exactly right.

Unidentified Analyst: And also I wanted to ask you, are we on the cusp of some kind of a change in production of medical devices where things are going much more towards disposable devices and you might see kind of a step function in revenues?

Joseph Forkey: So the short answer is yes. There is a significant change that’s happening in the medical device industry as a whole. We’ve talked about this on some of the earlier earnings calls when we were just getting started with what I call our original single-use program that we’ve been working on for a number of years now. There are major benefits to single use, the most obvious of which is that it virtually eliminates the possibility of cross-contamination for the patient. But there are also benefits to the way that the product is inventoried at the hospital. It’s much easier to inventory a single-use item than it is an endoscope that has to sometimes be sent out for repair and has to go to a different part of the hospital to be sterilized, et cetera, et cetera.