Good day, and welcome to the Precision Optics Third Quarter Fiscal Year 2025 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Robert Blum with Lytham Partners. Please go ahead, sir.

Thank you, operator, and to everyone joining the call today. As the operator mentioned, on today's call, we will discuss Precision Optics' third quarter fiscal year 2025 financial results, and this is for the period ended March 31, 2025. With us on the call representing the company today are Dr. Joe Forkey, Precision Optics' Chief Executive Officer, and 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. As the operator indicated, if you dialed through the traditional teleconference line, 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. 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 1933 is amended, and Section 21E of the Securities Exchange Act 1934 is 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 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 Exchange Commission. All forward-looking statements contained during this conference call speak only of the date on which they are 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, Precision Optics. Joe, please proceed.

Thank you, Robert, and thank you all for joining our call today. Let's start right at the top with the challenges we encountered during the quarter in some of our production programs that led to significantly lower revenue and margins than we expected. Having rolled out a number of programs from product development into rapidly ramping production over the last 12 months, we sometimes discover process, fixture, or personnel limitations that can result in low yield, delivery delays, and reduced efficiency. These types of issues resulted in lower shipments than planned this quarter, underutilization of resources, greater scrap, and substantial negative adjusted EBITDA. There were also the indirect impacts of management's time and attention and direction of engineering resources to support the production line in addressing these issues. While we are disappointed by these results for the quarter, our confidence and excitement for the future remain undiminished. We have made significant progress on resolving the third quarter issues, and we have the largest production backlog in over 20 years. With a positive response to the launch of our Unity platform in Q3, we believe the underlying fundamentals of our strategy for business growth remain strong, and we look forward to recovering that growth in Q4 and beyond. Today, I'll focus my remarks on the following items. First, the operational challenges we face in Q3. Second, how we resolve these challenges. Third, the exciting sales pipeline we see as we look forward. Fourth, the Unity program rollout. And finally, our two new Board members. One of the major programs driving our production growth is the single-use cystoscope. In mid-January, daily yields on this product line dropped precipitously to less than 50%. This is well below our historical and expected yields of around 90%. As a result, we stopped manufacturing while we…

Thank you, Joe. Let me expand on some of Joe's comments on the financial results, starting with revenue. For the third quarter, revenue was $4.2 million, compared to $5.2 million in the third quarter of fiscal 2024. Breaking it down, production revenue was $3.2 million, compared to $3 million in the year-ago quarter, while engineering revenue was $924,000, compared to $2.3 million in the year-ago quarter. As Joe mentioned, low yields forced us to pause production of our single-use cystoscope, resulting in unplanned increases in non-billable, sustaining engineering activities to support manufacturing-scale programs and conduct a root cause analysis. Our efforts, while ultimately successful, consumed engineering time and resources in these non-billable activities. With the launch of our Unity platform, a customizable solution that encompasses our design approach, and the interest generated by our presentations at three of the four major trade shows we will attend this year, we've seen the pace of engineering pipeline opportunities increasing. We also recognize the comparative impact of the full absorption of our engineering team's efforts to bring the single-use cystoscopy product to launch when we compare current results to the year-ago quarter. We expect to finish our fiscal year strongly with $6 million in sales in the next quarter. Our backlog and demand for production remains strong, driven by the aerospace and single-use programs. Turning to gross margin, for the quarter ended March 31, 2025, gross margins were 10% compared to 35% in the year-ago third quarter. As we mentioned, the low yields and one-month shutdown of the line and the under absorption of engineering resources were contributing factors here. We expect gross margin to recover as manufacturing continues to scale and revenues increase, particularly in the fourth quarter. We increased R&D spending in the quarter from $193,000 to $211,000 compared to the…

Thank you, Wayne. Let me finish by summarizing a few key points. We were certainly frustrated by the impact of lower production yields on the single-use cystoscope and other production programs in the third quarter, but we believe we have corrected the root cause of these issues and are on a pathway to optimal production operations. Our confidence in correcting and achieving optimal yields is based in large part on our success getting through similar issues in our aerospace program, which is now running at 95% yield and continues to grow. Our backlog remains strong, our customer relationships remain strong, and our pipeline opportunities are expanding due to the introduction of Unity. Overall, we expect Q4 revenues to grow significantly from Q3 levels. As discussed, there is demand for as many units as we can produce from key production programs. So, while the path to reaching $6 million in quarterly revenue based on increasing production volume has been bumpier than we anticipated, we are still confident we will reach this milestone in Q4 and that this will be an inflection point leading to positive adjusted EBITDA. One final note before we take questions. We will be at the Medical Design and Manufacturing Exhibit in New York City next week, and I would welcome an opportunity to meet with those of you in the area. Please contact Robert if you'd like to set up a time to meet. 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] The first question will come from Hristo Valchovski, Investor. Please go ahead.

Hello. Just to be clear, are you saying that you had engineering clients lined up and you just couldn't collect revenue because you had to use your engineers to fix the prediction issue?

That was part of the problem, yes.

Okay, so now that it is fixed, you'll be able to collect engineering fees as well as production fees?

Correct. Just to be clear, it's not just about collection. It's about the execution. We used some of the engineers to work on the issues we had on the production line, so they were unable to work on billable projects that we could have collected on. That's correct.

Okay. It's nice to hear this about your win for the military customer. Is that a program that might continue after 2026? Do you see it as a long-term $1 million per quarter thing or will it be just done?

Yes. This is for the aerospace program where they've committed to the $4 million per year. All indications from them and given what we know about the program is that it's likely to continue well beyond 2026. That was simply the timeframe that they were willing to commit to as part of the negotiation, but I have every expectation that it will continue much beyond that. Similarly, the numbers that we reported, the nearly $4 million a year, are the minimum order levels. And already, you can see from the backlog that we have today that they have been ordering at a higher rate than that. So our hope and expectation is that the order rates will be higher and that they will continue beyond 2026.

Your backlog. You said that you had $6 million from that program in your backlog. Are you saying that you only count backlog for one year ahead?

No. That's the total backlog for that customer, but we do believe we can work through that backlog within 12 months.

I see. Okay. That's good news. That endoscope program, did you have any contractual problems because of the production delay? Are you okay on the contract? Is there a risk of them getting a second supplier or anything like that?

So, we are okay on the contract. This is a customer that we have a very good relationship with. And so they were involved while we were dealing with the shutdown of the line. They had some engineers here. They were collaborating with us. We were working together. Of course, they were disappointed that we weren't satisfying the delivery rates that they would like, but they're very cooperative and very supportive, even to the point where, as I mentioned in my comments, but I went through it quickly, they gave us an order to stand up a second production line actually in the midst of all of this happening, I think because they saw the way that we were dealing with the issue and the way that we were resolving it. To answer your question fully, the question of having a second supplier, there is a mechanism where they can manufacture themselves or have a second supplier, and we're paid a royalty as part of the agreement we have with them. For risk reasons, they've told us that they will likely do that at some point, but it's not because of the issue we had this quarter. As I say, despite having that issue, they've given us a new contract to stand up a second line. This is partly because we're delivering slower than they would like, but more importantly, with the second line, they're looking forward at the fact that their volume demands are going up faster than they anticipated when they gave us the original order a year ago. The short answer to your question is, there's no contract problems, that things are moving forward in a positive way, and the relationship with the customer is very good.

Okay, that's good to hear. I apologize if I missed that during the call. Have you stuffed up all your positions, have you fixed that?

I think as of today, we have almost a full complement of assembly techs. We're now at a point where we're looking to have a little bit of extra because we need the line to be running smoothly. We're still looking for a few more people, but our team has done a good job of bringing in the assembly techs that we need. This is why the line is running much better today than it was even a month or so ago.

And when is the second line going to be stood up?

The second line, we expect to start running in the first half of fiscal '26.

Okay.

Sometime in the summer or fall. And we're working to add staff to the existing line now. I just said we're looking for extras. Partly that's to have backup for the line now. It's also to be able to hit the ground running with that second line because we can move people from the first line to the second line when it's ready to go.

Yes, that makes sense. Okay. Just to get you on the record, you expect the current quarter to come in EBITDA positive, so there probably won't be any need for additional stock issues. Is that correct?

That's correct.

Okay. Well, that's it for me. Thanks. Good luck, and congratulations on all your customer wins.

Thanks, and thanks for all those questions.

[Operator Instructions]

All right. Operator, I guess we'll wait to see if any additional questions come in through the live teleconference line. I've got a couple here on the webcast. Actually, you know what? It looks like we do have someone on the live line. Chuck, I'll turn it back over to you to queue up the next participant.

Yes, sir. The next question will come from Mr. Rick Keller, Investor. Please go ahead.

Yes. Hi, Joe. I have a question about the development of the Unity line. Basically, you're taking your engineers, and instead of them working, designing custom work for customers, you're having them develop this standardized production line, various components and whatnot that they can mix and match and put together modularly, you might say. That means there are engineers that instead of bringing in money as they're paid to do work for customers, you're having to pay them, and that shows up in your R&D spending. How long and how heavy will those expenses be until you can say, well, we've got the basics of the Unity line all developed, and from here on out, other than some little tweaks and changes as components change and technology changes, we don't have to spend much more time on the basic line. All the engineers can go back customizing work for clients. Is this going to be a couple of years or a couple of quarters, and are we going to see R&D jump way, way up or more modest increases?

Yes. Great question, Rick. Let's see if I can answer this succinctly because there's a lot there. The first point I'd make is that, as we've talked about in some of our earlier calls, what we're really doing here is capitalizing on the designs and the IP that we've developed over the years working on programs for our customers because one of the things we always insist on is that we maintain ownership of the IP. So that's the first thing. We're not starting from scratch, and so the amount of time that our engineers have to spend in order to put together the package that becomes Unity is much less than would be required if we were not piggybacking on top of the work we do for our customers, which is in fact billable. So even though there was some increase in the R&D cost, it's not nearly the increase that we would have seen if we were starting from scratch. That's the first thing. The second thing is people can see if they go to our website, but we've identified four sort of families of Unity platform projects that we expect the overall market will sort of gravitate towards. And so these are defined, the first three are defined by endoscope size, and then the last one is sort of a catch-all for high precision and ultra-high definition kinds of things. We've already essentially completed the first two categories, and with those categories we've gone out and launched Unity. The other two categories we certainly want to get finished, but we have a lot of flexibility on when and how aggressively we pursue those, and when and how aggressively we add sort of additional modular elements to these first two systems that have come out. So we treat…

Your last sentence is what I would have said.

Okay. There you go.

Okay. Then one other question related to Unity. From the point of view of potential customers who are saying, well, we could design this -- we thought of a good new – possibly good new product, and we could design it ourselves or get some other independent outfit, maybe a POC competitor to design it for us, or we could go with Unity. Once Unity is fully developed, let's say a customer -- we're talking about a customer showing up, let's say, a year from now, what would be the difference in terms of time to market between them going with Unity versus going with complete custom design?

Yes, we've looked at that pretty carefully because it's part of what we talk about a lot when we talk with our customers. Because in some sense, this is critically important for them because they always want to get to market as fast as possible. It depends, of course, on how complex the system is and how much it's going to deviate from the Unity platform itself. But generally speaking, we expect that it will accelerate the timeline by 6 to 12 months. Sorry. Yeah, 6 to 12 months. Half a year to a year.

Okay. Good. All right. Thank you.

Thank you, Rick.

[Operator Instructions]

All right, Chuck, I'll jump in again while we wait to see if additional people come in to dial in and call. We do have a couple of webcast questions. Once again, if you're dialed into the webcast or linked into the webcast, you can type in your question through the Ask a Question feature on the webcast player there. Question here, Joe, surrounding the facilities. Previous calls, you've commented on potential need for updated facilities. Could you provide an update on that?

Yes, I'm going to let Wayne take that because he's been working on the leases.

Thanks, Joe. So we operate in three different states. In El Paso, Texas, where we've had facilities down there for a number of years, we've extended our lease recently. That lease was expiring, so we've extended. In Wyndham, Maine, we have a lease that's expiring at the end of July. So we took the opportunity to locate space closer to Portland, where there's a better concentration of engineering talent that will help us as we grow going forward. In Massachusetts, we operate in four different buildings, and at the moment, we're evaluating options for consolidation and expect to make some decisions soon.

Okay, great. Thank you, Wayne. Again, final reminder, if you're dialed in, star then one to ask a question, or on the webcast player, you can type it into the Ask a Question feature there. Perhaps the final question here, gentlemen. Are the tariffs impacting POC's business?

Yes, sure. In some sense, the tariffs are impacting everyone's business to one extent or another. There are -- we're really in a growth mode. So in terms of the overall expectations, it's not going to change our expectations for the kind of growth that we're going to see and the positive impact that growth can have. Having said that, we do source components overseas. The main part of the business where we're doing the single-use endoscopes and the aerospace programs and those sorts of things, there are some individual components. CMOS sensors come from overseas, for instance. But the total value of those components to the overall system is limited because most of the value in those cases is embodied in the design and the manufacturing. The one place where we do see a fair amount of impact is on our Ross Optical business. This is a group that's down in El Paso, Texas, that sources and then builds individual components and small subassemblies. That group, which today represents about 20% of our business, sources most of their components from other companies, some in the U.S., but many of them outside the U.S. We're looking at and watching what's happening with the tariffs. We have already had some communication with customers and made some initial indications that if the tariffs end up at an extreme place, at a very high place, that we'll have to share those additional costs with our customers. And by and large, those customers have reacted in an understanding way. We also are constantly pursuing alternative suppliers. So I think on the whole, we don't expect that the tariffs are going to derail our growth plans or have a major impact on the performance of the company.

All right. Very good. Joe, Wayne, I am not showing any further questions here. So with that, I'll turn it over to you for any closing remarks.

Thanks, Robert. And thank you, everyone, for joining us on the call today. I look forward to speaking with you soon. Thanks, everyone. Have a good evening.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.