PRECISION OPTICS CORPORATION, INC. quarterly report, Q3 FY2012

Precision Optics Corporation, Inc. — Form 10-Q Summary

Reporting period: The filing covers the quarter and nine months ended March 31, 2012 (fiscal 2012 Q3), not 2011 Q3 as stated in the request metadata. Amounts are in U.S. dollars.

Business context and financial performance

The company develops and manufactures micro-optics, medical instruments and optical systems, including endoscopes and products using its Lenslock and microprecision technologies. It sells primarily to OEM customers and operates in a competitive, regulated market.

Nine-month 2012 net income included a $2,276,286 gain from the patent sale; the company remained loss-making at the operating level. Quarterly and nine-month revenue declined 22.8% and 14.5%, respectively. Management attributed the declines mainly to lower unit sales of micro-optics and a spinal-surgery visualization system, partly offset by higher endoscope sales. Lower volume and, over nine months, less favorable product mix sharply reduced gross margin.

Cash flow, balance sheet and debt

• Cash was $436,219 at March 31, 2012, versus $19,556 at June 30, 2011. Current assets were $1,292,467 and current liabilities were $625,967.
• Operating cash flow was negative $1,313,269 for the nine months, compared with negative $392,852 in the prior-year period. Investing activities provided $2,470,904, including $2,463,171 net proceeds from the patent sale; financing activities used $740,972, primarily for note principal and interest payments.
• Stockholders’ equity was $713,601, compared with a deficit of $1,194,632 at June 30, 2011. The improvement included issuance of 245,326 shares to settle $674,645 of deferred compensation and professional-services liabilities.
• At March 31, $68,819 remained due on the 10% senior secured convertible notes: $50,000 principal and $18,819 accrued interest. The remaining principal maturity was extended to July 31, 2012. The accrued interest was paid April 13, 2012, and a warrant for 5,000 shares was issued May 8. The company reported no debt default as of March 31.

Outlook, risks and notable items

• Management expected operating losses to continue through fiscal 2012 and until sales reached breakeven and profitable levels. It gave no quantified revenue or earnings guidance.
• In April 2012, the company accepted a $1,032,000 endoscope purchase order. It is conditional on a supply agreement, including delivery terms, and the products meeting the customer’s requirements; the company is responsible for testing and validation.
• Management identified Lenslock endoscopes, sub-1 mm microprecision products and single-use micro-medical cameras, and high-definition 3D stereo endoscopes as potential growth areas. It cautioned that customer order timing is unpredictable, products can take years to commercialize, and regulatory requirements add cost and time.
• Management warned that if additional revenue does not materialize promptly, the company may need debt or equity financing or a strategic alliance. Financing may be unavailable or unacceptable; new equity or convertible debt could dilute shareholders. Failure to raise funds or generate positive cash flow could impair ongoing operations and product development.
• The July 2011 patent sale to Intuitive Surgical generated $2.5 million gross proceeds, less $36,829 transaction expenses, and a $2,276,286 gain. Intuitive Surgical received specified patents and applications, while the company retained a royalty-free worldwide license outside medical robotics, subject to stated exceptions.
• Disclosure controls and internal control over financial reporting were reported ineffective as of March 31, 2012. The filing identifies material weaknesses involving segregation of accounting duties and inventory valuation. Management described remediation efforts but could not guarantee resolution or that further issues would not arise.
• The filing reported no material changes to previously disclosed risk factors and no known pending or threatened litigation expected to have a material impact.

Important facts for investors to verify

• Whether the conditional $1.032 million order becomes binding, meets validation requirements, and converts into revenue on the expected schedule.
• Cash burn, working-capital needs and the company’s ability to fund operations after the patent-sale proceeds; nine-month operating cash use was $1.31 million.
• Repayment or other resolution of the remaining $50,000 note principal by its July 31, 2012 maturity.
• Progress toward restoring gross margins and growing sales amid customer concentration; one customer represented 36% of nine-month revenue.
• Whether the disclosed material weaknesses are remediated and financial reporting controls become effective.
• Share dilution from equity compensation and deferred-compensation settlements. Shares outstanding were 1,245,339 at March 31 and 1,251,339 at May 9, 2012.