Precision Optics Corporation, Inc. (POCI) Q3 2024 Earnings Report, Transcript and Summary

Good afternoon, everyone, and welcome to the Precision Optics Reports Third Quarter Fiscal Year 2024 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 also note today's event is being recorded. At this time, I'd like to turn the floor over to Robert Blum with Lytham Partners. Please go ahead.

All right. Thank you very much, Jamie, as well as to everyone joining us on the call today. As the operator mentioned, on today's call, we will discuss Precision Optics third quarter fiscal year 2024 financial results for the period ended March 31, 2024. With us on the call representing the company today are Dr. Joe Forkey, Precision Optics' Chief Executive Officer; and Mr. Wayne Coll, the company's Chief Financial Officer. At the conclusion of today's prepared remarks, we will open the call for a question-and-answer session. If you dialed in to the call through the traditional teleconference line, as the operator indicated, please press star then one to ask a question. If you are listening through the webcast portal and would like to ask a question, you can submit your question through the Ask a Question feature in the webcast player and we'll do our best to get through as many questions as possible. Before we begin 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, 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 should differ materially from those projected in the forward-looking statements, including the risk 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 the company's 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 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, Precision Optics. Joe, please proceed.

Thank you, Robert, and thank you all for joining our call today to discuss our third quarter fiscal year 2024 results. I am pleased to be speaking with you today following the strong financial results we reported this afternoon as well as the announcement we made last week of our record setting production order to supply a single use endoscope assembly for a cystoscopy surgery system. I'll talk more about this order in a few minutes, but let me start with some comments on our financial results. Revenue for the quarter came in at $5.24 million, close to our all-time quarterly record of $5.29 million in operating revenue that we achieved in the second quarter of fiscal 2023. This comparison excludes the one-time technology license revenue recognized that quarter. The growth is being driven by several new and follow-on production orders we received recently that leverage our unique micro-optics and digital imaging capabilities for medical device and defense/aerospace applications, coupled with record levels of engineering revenue. The stair-step sequential revenue growth throughout fiscal 2024 from $4.3 million in Q1 to $4.8 million in Q2 and now $5.2 million in Q3 is in line with the expectations we communicated on earlier calls, as these new and follow-on production orders and increased engineering work have helped our revenues recover from the pullback and delays of a couple programs earlier this year. As we expand our engineering pipeline and as more programs move from engineering to production, we expect strong quarterly revenue run rates as we finish this fiscal year and start into fiscal 2025. We have pointed out before our strong engineering pipeline is a good indicator of potential future production revenue. Our gross margins were up quarter-over-quarter and year-over-year and adjusted EBITDA was positive $52,000. These improvements highlight our ability to leverage our fixed operating infrastructure. Following the acquisition of Lighthouse Imaging, we maintained two digital imaging system production groups, one in Maine and one in Massachusetts. Over the last six months, as part of an effort to improve overall operating efficiencies, we have consolidated these duplicated production locations and duplicated management groups into a single business unit with a single management team operating at our corporate headquarters in Massachusetts. Going forward, with expectations of additional revenue growth, we expect increased utilization of this consolidated production resource, thereby driving improvements in profitability metrics. As I stated in the beginning, beyond the improved financial results, the other key highlight was our announcement last week that we received a $9 million high volume production order from a leading surgical company to supply a single-use endoscope assembly used in their cystoscopy surgery system. For those of you that have followed Precision Optics closely over the past few years, you will recognize what a significant milestone this is, and I congratulate all of POC's employees on this great accomplishment. This was the largest single order we've ever received, which will help us to sustain a strong production base for future quarters. For the new order, we expect production deliveries to begin in the next couple of months. Our agreed upon volumes result in anticipated revenue levels of approximately $2.2 million in fiscal 2025 and $4.6 million in fiscal 2026, with the remainder of the order in the first half of fiscal 2027. These expectations, however, are modeled on system sales and procedure volumes per system and there is reason for optimism that the consumption of units associated with this order could occur sooner. Additionally, together with our customer, we have begun a continuous improvement engagement for approximately $500,000, the majority of which is expected to occur in the next six months, bringing the total order value to approximately $9.5 million. All production units for this order are anticipated to be manufactured at POC facilities. Consistent with our technology license agreement, however, our customer may decide to transfer production to a non-POC manufacturing facility in which case POC would receive multi-year royalties. Another important point about this program is that this product is a replacement for a current reusable device in a system that is already on the market and highly successful with growing market penetration. Our customer believes it is early in the process of selling surgery systems into a large market, and as they sell more and more systems, the revenue opportunity for us increases. Looking forward to anticipate delivery of units beyond this order, it would be reasonable to conclude from expected system sales by our customer and the number of procedures per unit that future order annual volumes could be substantially larger than those of this initial order. Beyond the sheer size of this order, the other key milestone here is the validation this order provides regarding POC's ability to design and manufacture single-use endoscopes with high technical performance at price points consistent with the single-use endoscope market. Studies suggest that the single-use market is growing 2x to 3x more rapidly than the endoscope market in general. As we have discussed on earlier calls, single-use endoscopes have many benefits over traditional reusable endoscopes, including ease of inventory control by the hospital, guarantee a brand-new image quality for the surgeon in every procedure, and importantly, the virtual elimination of the possibility of cross-contamination from one patient to another. With this validated ability to address the single-use part of the medical device market, combined with our many years of experience designing and producing reusable medical devices, our growing technical and production teams, our broad in-house technical capabilities that allow us to design entire medical device imaging systems, and our broad in-house resources that allow us to take a program from concept through mass manufacturing, we are now well-positioned to become the preeminent imaging system partner for our target customers in the medical device market. This will require a continuation of the dedicated efforts of the team we have assembled, but we have all the pieces in place with demonstrated success of our capabilities, both from a technical and customer engagement standpoint. Obviously, we are very excited for the future. Since our last conference call, another key development has been the increasing traction we are achieving within the aerospace and defense market. In the past few weeks, we have received two significant follow-on production orders. The first was for our top-tier defense aerospace company, which leverages our proprietary manufacturing technology developed for high-precision micro-optic systems. Last month, we received a $720,000 order which brings the total production orders for this leading-edge application to more than $1.9 million. From a timing perspective that order, as well as all other orders received previously for this program, are expected to be delivered by August 2024 and we expect additional follow-on orders. The second key order was for $1.25 million from a major U.S. defense contractor to meet continued demand for a highly complex optical assembly. As a reminder, we have supplied this complex assembly to this customer since 2018. This order comes immediately on the heels of us completing a 15-month production order for the same unique assembly, allowing our team to maintain a high level of continuity with the program and realize manufacturing efficiencies. Previously, follow-on orders for this product would be placed by our customer a number of months after final deliveries of the previous orders. We believe that the increase in rate of follow-on orders is due in part to the success and potentially the expansion of the program our product is used for. Given the success of these two programs in particular, we believe there are additional opportunities for our products and technologies in the defense and aerospace market. As I mentioned in our last call, we have begun a dedicated effort to better understand the segments of this market and to identify the best places for us to pursue additional opportunities. That effort continues to show the need for smaller-sized optical systems in certain segments and is well aligned with the industry's SWAP mantra, which stands for reduced size, weight, and power. I look forward to reporting more details of our investigations on coming calls. In addition to exploring the defense aerospace market for expansion opportunities, we have also been updating our marketing approach to the medical device market. Since the acquisition of Lighthouse Imaging, we have engaged in numerous development programs utilizing the combined technical capability to design and build systems that include the entire imaging pipeline, from illumination to imaging to processing to display. We have worked diligently in the quoting and contracting process to maintain ownership and control of the IP embedded in these systems. Over the years, we have frequently debated how to best monetize this investment in IP. Recently, we developed a concept to provide an existing family of baseline designs to new customers. This gives us a competitive advantage in the marketplace as these well-qualified baseline systems can offer an accelerated path to market and reduce development risk to our customers. To be clear, we expect all these customers to continue engagement with POC beyond this initial purchase, but advantages to our customers' time to market generated by starting with this platform approach are compelling. We have already tested this marketing approach with several key customer opportunities and have had an excellent response. We expect, therefore, to extend this updated approach to engage with the market more broadly in the coming months. To wrap things up before I turn it over to Wayne, let me just say how pleased I am with the progress being made at Precision Optics. I believe the business is better positioned today than at any point in the company's history. The enhanced business model we have deployed, where we apply our deep technical knowledge to support a customer from the early design phase all the way through mass manufacture, continues to show great signs of success. We now have a number of programs that have moved through this process and are in, or soon will be in, production, and many more programs progressing through the pipeline now. I believe the receipt of the single-use production order we announced last week will prove to be transformative to the business in the coming years, not only because of the size of the record-setting order, but also because of what it means for our opportunity within the broader industry as a whole. This order, as well as other new and follow-on production orders, will help to drive production revenue higher. As programs transition from engineering to production, we have numerous new engineering programs that will continue to keep engineering revenue at record levels. Taken together, these strong expectations for production and engineering increases will support growing revenues through fiscal 2025 and beyond, with an associated increase in profitability as we utilize production and operating resources more fully. I'll now turn the call over to Wayne to go into greater detail on the financial results. Wayne?

Thank you, Joe. Let me expand on some of Joe's comments on the financial results, starting with revenue. The third quarter of fiscal 2024, total revenue was 5.2 million, an increase of 4% compared to 5 million in last year's third quarter. As Joe mentioned, excluding the one-time technology license revenue we received in the second quarter of last year, this is close to the quarterly record revenue for the company. Engineering revenue was a record 2.3 million compared to 1.4 million last year, an increase of 62%. However, production revenue was 3 million compared to 3.6 million in last year's third quarter. The biggest change from the year-ago quarter here is the level of business of our Ross Optics division. As we discussed over the last few quarters, our components business, which is primarily supplied through Ross Optics, continues to be below the peak levels of a year or two ago. In conversations with other similar suppliers and experts in the industry, we all seem to be experiencing the same relative phenomenon as we exited the pandemic and the glut of inventory levels worked their way through the supply chains. We believe we are relatively stable at these new levels but are looking at strategies to increase market share as we move forward. For the third quarter, our gross margin was 35.4% compared to 34.4% in the same quarter last year, this represents a significant improvement over the 30.1% margin in the preceding sequential quarter. The improvement is attributable to higher revenues absorbing against certain fixed costs in our cost of sales. As our production revenue continues to improve, we expect to see margins moving up towards our target of 40%. Total operating expenses in the third quarter were 2.12 million compared to 2.23 million in the third quarter of last year, or a decrease of about $100,000. The main reason for the decrease was a decline in stock-based compensation for the quarter of $216,000, primarily due to timing, partially offset by increases in payroll and benefits. As a result of improved gross profit and lower operating expenses, our operating loss narrowed from 493,000 in the third quarter of fiscal 2023, 258,000 in the current quarter, an improvement of 235,000. The net loss for the third quarter was 317,000 compared to 398,000 in the year-ago third quarter. Adjusted EBITDA, which excludes stock-based compensation, interest expense, depreciation and amortization was $52,000 for the third quarter of fiscal 2024, compared to adjusted EBITDA of 9,000 in the third quarter of last year, and an adjusted EBITDA loss of 269,000 in the previous sequential quarter. Again, the key driver here was the result of improved sales volume, driving better absorption of our COGS, as well as our operating expenses, which are largely fixed. Our cash balance at March 31, 2024, was 925,000, compared to 987,000 at December 31, 2023. The primary change is due to additional capital spending of about $110,000, related primarily to our new ERP system. Also, while we paid down debt of approximately $140,000 during the quarter, we borrowed $400,000 on a revolving line of credit to temporarily support working capital needs. This amount has already been paid down, and as of today, our entire 1.25 million working capital line of credit is available. As we look to the fourth quarter of fiscal 2024, we expect to see sequential quarterly revenue results, similar to what we experienced in the third quarter. We believe revenues at this level, along with improved margins, will result in higher profitability and positive adjusted EBITDA as we move forward. I will now turn the call back over to Joe for some final comments.

Thank you, Wayne. I want to finish by thanking all the team members of Precision Optics for their incredible dedication over the past few years. We have accomplished a lot over this time. Today, we have an engineering pipeline larger than any time in the past. We have a number of products that have recently, or very soon, will transition to production, the most notable of which is the single-use product for which we received the $9 million order we announced last week. Today, our products tend to be at a higher level in the value-add supply chain, and our customers tend to be larger, well-established companies that can better support the introduction and growth of new products. We have updated our management structure and consolidated production facilities and infrastructure. Combined, these advances have positioned us well for continuing revenue growth and improved profitability through fiscal year 2025 and beyond. Before I turn it over to questions, I want to mention that we will be participating in the Lytham Partners Spring 2024 Investor Conference on May 30th. If anyone would like to schedule a one-on-one meeting, please reach out to Robert Bloom to coordinate. To all of you on the call, I thank you for your continued support of Precision Optics. We'd be happy to take questions at this time.

[Operator Instructions].

All right, Jamie. While we wait to see if anyone comes into the live teleconference line, we'll go ahead and take a couple of questions through the webcast here. And again, as a reminder to everyone on the webcast, if you'd like to ask a question, you can type it into the question box on the webcast player. Joe, a couple of questions here. First one is, I guess, given the consolidation of the production resources into a single location and with this new production order, talk about the anticipated need to expand production facilities.

Yeah, sure. So, there's really a couple of parts to this. So, the first part is that as our lease expires and our main facility will actually be moving to a smaller facility there. So on that side, we'll be sort of reducing the overall footprint that we have to continue to support in Maine. We will continue to keep an engineering group that came from Lighthouse, which was one of the main reasons we did the acquisition, running in the main facility. But it'll be a new facility that'll be somewhat simpler than the one that supported manufacturing as well. It's true in Massachusetts with the new order coming in and with the consolidation of manufacturing, we are in need of more space than we needed previously. We do have a couple of buildings. We actually have four facilities now that we're using in Massachusetts. One of those is set up in such a way that we can flex the amount of space that we have pretty easily and pretty cost effectively up and down. So, in the near term, we're pretty well covered in terms of being able to support the additional production that will be done in Massachusetts, again, in large part because of the new order. In the longer term, though, it is true. I just mentioned we have four facilities in Massachusetts. And so, there is a need in Massachusetts to consolidate the space that we have. And so, we are beginning to look around and to see what kinds of opportunities there are out there to be able to consolidate into a single building. So, I guess the short answer is there is a need to look at ways to continue to improve efficiencies as we grow, and we're looking at that. But there's nothing that's catastrophic that'll happen in the immediate term because we have systems and facilities that allow us to flex a little bit up and down as we need to.

All right, perfect. That's helpful. Again, just once again, everyone on the teleconference line, star one to ask a question, or you can type it in if you're on the webcast here. Next question, I'll sort of paraphrase it here. You mentioned sort of this approach to accelerate the time to market for new customers by utilizing sort of this platform system based on other customer programs. Talk about how you're able to charge, I guess, for development work, but still maintain IP and the rights associated with these platform systems.

Yes, that's a great question. So, the short answer is we work really hard to be able to do it. The key point here, I think, is that the IP that we insist on continuing to own and to control is IP that is centered around our core technology, which is the micro-optics and the micro-optical imaging systems. Our customers, not surprisingly when they first come to us, start from a position of wanting to own and control all of the IP that goes into the products that we make for them. The key is that we have to differentiate between the IP that's critical to their business and the IP that's critical to our business. So, for our customers, their key business competitive advantage is not the imaging system itself. That imaging system that we develop for them typically helps to enable their product, but their sort of special sauce or their critical competitive advantage has something to do with the procedure that they've developed or the tool that they have that supports that procedure. And so, what we have to sort of work with them on is clearly defining the IP that's relevant to their procedure or their product or their tool and differentiating that from the IP that's critical to us, which has to do with the micro-optics and the micro-imaging systems. And once we get through that conversation, to be clear, it sometimes takes two or three rounds and often has to be done at a senior management level. But once we get through that discussion and once it becomes really clear to them that they really need the IP that we already have, the micro-optics imaging systems, we're generally able to negotiate an arrangement where we can maintain the ownership and control of the IP associated with the parts that we're doing, and they continue to own and maintain the IP associated with their part of the system. I will say that there are times when we will agree to license certain parts of our IP to a particular customer in a very specific field of use if the opportunity is significant enough and it's closely enough related to what they're trying to do and they have reasons why they need it. But generally, the key point here is that we have to differentiate between the IP around the micro-optical systems that POC is bringing to the table and concerned with, and the IP associated with the specific procedures or tools that our customer is working on.

Okay. Fantastic. Next question here is, can you talk about the, I guess, contribution margins, if you will, between some of the new products that are coming on board? Is there sort of a target margin and how that relates to your fixed overhead?

Yes. So, I'll take that one, Robert. In terms of the products that are coming on board for single use, we can expect, and the customer kind of requires a lower price point to compete in the marketplace. But as a result of the additional volume, again, absorbing the fixed overhead costs that we have, we still see our margins moving positively with larger orders.

Okay. Great. And I'll just do one last reminder here. If you're on the teleconference line, star then one. If you're on the webcast, go ahead and type it into the question queue there. Final question that I have, at least at the moment, is any sort of outlook that you're able to provide here for the fourth quarter?

So, we expect the fourth quarter to be similar to or higher than the third quarter. We have a number of programs that are running in production. Some of these are new programs. And exactly where the fourth quarter ends up depends on how quickly some of these programs get up to the higher volumes and whether those higher volumes come in in June or July. So, the sort of broader answer is that we expect revenues to continue to increase. Exactly how much hits the fourth quarter versus the first quarter is a little difficult to predict, but it will certainly be at the levels that we saw in the third quarter or higher.

Okay. Great. And actually, I apologize. We did have one additional question come in here. Joe, can you comment on the size of potential production revenue for projects in the engineering phase today and where are some of the near-term opportunities?

Yes, sure. So, part of the answer to that question is related to a couple of the comments I made in the prepared remarks about our customers tending today to be larger customers. And the products that we're designing and building are higher on the value-add chain. In large part, that's because of the combination with Lighthouse, the acquisition of Lighthouse. We can do entire systems now as opposed to individual components or smaller individual endoscopes. Having said all that, our typical rule of thumb is that when a program comes out of production, we expect the starting order sizes to be on the order of $1 million per year. More recently, those have been coming in close to the $2 million to $3 million per year, again, because they're larger programs and larger customers. We have, in addition to the program that we just received the large order for that we've already announced, we have three other programs that are, we think, within six months or so of coming into production. All three of those are through the prototype and testing phase, and two of those are waiting for 510(k) approval. One is just about to submit their 510(k) approval. So, there, we expect those to be relatively – go into production relatively soon.

All right. Fantastic. Joe, Wayne, I show no further questions on this side, so I'll go ahead and turn it over to you for any closing remarks.

Great. Thank you, Robert, and thanks to everyone for joining our call today. I look forward to speaking to everyone soon.

Ladies and gentlemen, that does conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.