Precision Optics Corporation, Inc. — Form 10-Q
Reporting period: Second quarter and six months ended December 31, 2019 (fiscal 2020). The interim financial statements are unaudited. The company develops and manufactures optical components, medical instruments and imaging products. Results include Ross Optical, acquired effective June 1, 2019.
Financial performance
| Metric | Three months ended Dec. 31, 2019 | Three months ended Dec. 31, 2018 | Six months ended Dec. 31, 2019 | Six months ended Dec. 31, 2018 |
|---|---|---|---|---|
| Revenue | $2.797 million | $1.478 million | $5.312 million | $3.037 million |
| Gross profit | $918,000 | $356,000 | $1.892 million | $818,000 |
| Gross margin | 32.8% | 24.1% | 35.6% | 26.9% |
| Operating loss | $(552,000) | $(126,000) | $(637,000) | $(424,000) |
| Net loss | $(551,000) | $(126,000) | $(637,000) | $(425,000) |
| Basic and diluted loss per share | $(0.04) | $(0.01) | $(0.05) | $(0.04) |
Quarterly revenue rose 89.2%; six-month revenue rose 74.9%. Ross Optical contributed $1.151 million of quarterly revenue and $2.242 million for the six months. Revenue by category for the six months was $2.949 million in optical components, $1.474 million in medical device products and assemblies, and $888,000 in engineering design services.
Gross-margin improvement was primarily attributed to Ross Optical, whose six-month gross margin was 48–50%, compared with 26.4% for non-Ross business. Two non-Ross engineering projects had cost overruns in the quarter; together they represented 18% of revenue and reduced the quarter’s gross margin by 6.5 percentage points, according to management.
Six-month R&D expense was $381,000, versus $226,000. Six-month SG&A was $2.149 million, versus $1.016 million; the increase included $598,000 of Ross Optical expense and higher compensation and stock-based compensation. Quarterly SG&A was $1.241 million, versus $356,000.
Cash, liquidity and obligations
- At December 31, cash and cash equivalents were $348,000, down from $2.288 million at June 30, 2019. Current assets were $4.500 million and current liabilities were $2.022 million.
- For the six months, operating cash use was $469,000, investing cash use was $1.500 million (including $1.443 million paid for the acquisition), and financing cash provided was $29,000. Cash declined by $1.941 million.
- Accounts receivable was $2.000 million; inventory was $2.019 million. Customer advances, recorded as current liabilities, were $389,000.
- Reported obligations included a $500,000 acquisition earn-out liability, $9,894 current capital-lease obligation, and operating-lease liabilities totaling $145,428. The company also disclosed approximately $976,440 in open purchase-order commitments.
- Common shares outstanding increased to 12,880,047 from 12,071,139 at June 30, 2019. The company reported $25,000 in private-placement proceeds during the six months and issued shares for services and option exercises.
Outlook, commentary and risks
Management provided no quantified revenue, earnings or cash-flow guidance. It said profitability depends on sustaining sufficient revenue and gross margins, controlling operating expenses, collecting receivables promptly, and managing fluctuations in sales mix and project costs. Management views its production projects and engineering pipeline in Microprecision optics, micro medical cameras and 3D endoscopes as potential sources of growth, but cautioned that outcomes depend on project progression and customer demand.
The company has incurred recurring losses and warned that pricing pressure, engineering challenges and production cost overruns can depress margins. It also identified possible supplier disruption from the coronavirus outbreak in China, particularly because precision-grade optical glass is available from a limited number of sources there. Competition includes larger companies with greater resources.
Management reported disclosure controls and internal control over financial reporting as ineffective and described material weaknesses involving segregation of accounting duties and inventory valuation. It said remediation efforts were ongoing but could not guarantee resolution. The filing’s controls discussion refers once to an evaluation date of December 13, 2019 and elsewhere to December 31, 2019.
The company adopted lease accounting Topic 842 on July 1, 2019; the El Paso facility lease is a three-year operating lease. Management reported no estimated impairment of goodwill or patents at December 31, 2019 and no known pending or threatened litigation expected to have a material impact.
Investor verification priorities
- Assess how much reported revenue growth and improved margins are attributable to Ross Optical versus organic business, and whether Ross’s margins can be sustained.
- Track cash burn, receivable collections, working-capital needs and the company’s ability to fund operations given the $348,000 cash balance and recurring losses.
- Monitor whether the two engineering project overruns are resolved and whether management’s expected temporary margin impact proves accurate.
- Review progress in remediating the material weaknesses, especially inventory valuation and segregation of duties; clarify the inconsistent controls evaluation date.
- Verify supplier continuity and the effect of China-related disruption on optical-glass availability, costs and delivery schedules.
- Review the acquisition earn-out terms, open purchase-order commitments, lease obligations, and the effect of further share issuance and stock-based compensation on dilution.