Precision Optics Corporation, Inc. — Q2 FY2018 Form 10-Q
Reporting period: Three and six months ended December 31, 2017. The company designs and manufactures optical instruments, primarily medical devices and related engineering services; less than 10% of its business is military and industrial products.
Financial results
| Metric | Three months ended Dec. 31, 2017 | Year-earlier quarter | Six months ended Dec. 31, 2017 | Year-earlier six months |
|---|---|---|---|---|
| Revenue | $812,773 | $601,590 | $1,841,519 | $1,451,138 |
| Gross profit (margin) | $300,222 (36.9%) | $148,407 (24.7%) | $686,964 (37.3%) | $315,458 (21.7%) |
| Operating loss | $(59,844) | $(312,095) | $(88,113) | $(605,503) |
| Net loss | $(60,326) | $(312,095) | $(89,111) | $(605,503) |
| Loss per share, basic and diluted | $(0.01) | $(0.04) | $(0.01) | $(0.08) |
- For the quarter, revenue rose 35.1%; gross profit more than doubled. For the six-month period, revenue increased 26.9% and gross profit increased 117.8%.
- Management attributed stronger gross margins to higher revenue absorbing more fixed manufacturing costs, lower fixed compensation expense in the quarter, and improved project efficiencies and margins. Management expects compensation costs to rise as hires are planned.
- Operating expenses declined year over year: six-month R&D was $208,458, down 11.7%, and selling, general and administrative expense was $566,619, down 17.4%. Lower staffing and stock-based compensation contributed; reductions were partly offset by a $25,000 doubtful-account reserve related to one customer.
- No income tax provision was recorded for either reported period because the company incurred losses. Deferred tax assets remain subject to a full valuation allowance.
Cash, liquidity and capital
- At December 31, 2017, cash was $381,752, accounts receivable $753,152, current assets $2,201,127, and current liabilities $1,529,694. Working capital was $671,433, versus $479,604 at June 30, 2017.
- Six-month operating cash flow was positive $67,995, compared with cash used of $279,441 a year earlier. The filing shows material working-capital contributions, including $283,152 from increased customer advances; accounts receivable growth used $284,604 of cash.
- Cash increased $263,347 during the six months. Investing activities used $17,189, primarily for patent costs; financing provided $212,541, including $210,001 gross proceeds from a stock placement and $6,667 from warrant exercises.
- Debt is limited to a capital lease: $27,828 carrying value at December 31, 2017, including $8,672 current and $19,156 long-term. Open purchase orders and lease-related commitments totaled approximately $338,000, including the remaining lease commitment.
- Common shares outstanding increased from 8,872,916 at June 30, 2017 to 10,095,139 at December 31, 2017. The August placement sold 466,668 shares for $210,001 gross proceeds; 88,888 additional shares were issued for services. All 666,667 warrants were exercised for $6,667.
Management commentary, outlook and risks
- Management expects customer development projects to transition into production orders and describes its project pipeline as expanding, but provides no quantified revenue, earnings or cash-flow guidance.
- Management warns that cash and working capital are low relative to operating needs and that the company may not have sufficient cash to continue operations for the next six to nine months. If sales do not rise and remain near or above cash-breakeven levels, additional financing may be required; financing may not be available on acceptable terms, and the company could have to significantly reduce or cease operations. Management cites recurring losses and refers to substantial doubt about going concern raised in the auditor’s report on the fiscal 2017 financial statements.
- Customer concentration is significant: approximately 75% of six-month sales came from seven customers. Revenue also fluctuates with individual customer projects, product mix and the timing of engineering-to-production transitions. The filing notes the loss of a customer’s Microprecision technology product in fiscal 2017.
- The company reported two material weaknesses in internal control over financial reporting and concluded disclosure controls and internal controls were ineffective at December 31, 2017: insufficient segregation of accounting duties and inventory valuation. Management describes remediation steps but cannot assure remediation.
- The Tax Cuts and Jobs Act was enacted December 22, 2017. The company was evaluating its effects, including remeasurement of deferred tax assets; any resulting change could create a one-time noncash income-statement charge. Management expects the lower federal corporate tax rate to benefit future U.S. effective tax rates, though the net impact was not yet determined.
- The filing reports no known pending or threatened litigation expected to have a material impact and no off-balance-sheet arrangements with a material effect.
Important facts for investors to verify
- Whether revenue and customer projects convert to recurring production sales, and whether the seven-customer concentration changes.
- Cash runway, receivable collections, customer advances, and the availability and terms of any required financing.
- Progress in remediating the two material weaknesses, particularly inventory valuation and segregation of duties.
- The eventual tax-law impact on deferred tax assets and the financial statements.
- Share dilution from equity issuance and the company’s ability to improve margins while planned hiring raises compensation costs.