Precision Optics Corporation, Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended June 30, 2017. The filing is a 10-K, not a report for calendar 2016 Q4. Amounts are in U.S. dollars unless stated otherwise.
Business context
The company designs and manufactures optical instruments, primarily medical devices and components for minimally invasive procedures, including endoscopes, endocouplers, Microprecision lenses, micro-camera assemblies and 3D endoscopes. About 3% of its business is military and industrial products. It earns revenue from both engineering and design services and product manufacturing, mainly for OEM customers.
Financial performance and liquidity
| Metric | FY2017 / June 30, 2017 | FY2016 / June 30, 2016 |
|---|---|---|
| Revenue | $3,154,547 | $3,916,702 |
| Gross profit | $773,724 | $942,021 |
| Gross margin | 24.5% | 24.1% |
| Operating loss | $(1,002,401) | $(1,055,434) |
| Net loss | $(1,006,457) | $(1,034,765) |
| Basic and diluted loss per share | $(0.12) | $(0.15) |
| Cash used in operating activities | $(667,434) | $(876,298) |
| Cash and cash equivalents | $118,405 | $50,059 |
| Working capital | $479,604 | $518,058 |
| Current liabilities | $1,218,781 | $1,503,961 |
FY2017 selling, general and administrative expenses were $1,313,478, down 15.4%; research and development expense was $464,162, down 2.9%. Total assets were $1,800,725 and stockholders’ equity was $558,380 at June 30, 2017. Debt-like obligations consisted principally of a capital lease: $31,955 in total, including $8,391 current. The filing reports no material off-balance-sheet arrangements.
Changes versus FY2016
- Revenue fell $762,155, or 19.5%. Production revenue declined 28%, partly offset by growth in selected coupler, Microprecision component and laparoscope products. Engineering revenue declined 4%, primarily as projects moved into production or completed initial phases.
- Gross profit dollars decreased 17.9%, but gross margin increased from 24.1% to 24.5%. Management attributed the higher rate to manufacturing and engineering efficiencies; lower sales also left fixed manufacturing costs under-absorbed.
- Net loss narrowed by $28,308, while operating cash use improved by $208,864. Cash increased from the prior year, supported in part by financing proceeds.
- Customer concentration remained significant: three customers represented 31% of revenue in FY2017, versus 35% for the top three in FY2016. One customer that represented 12% in FY2016 was not listed among the FY2017 top customers.
Outlook, risks and unusual items
- Going concern: The auditor’s report highlights substantial doubt about the company’s ability to continue as a going concern, due to recurring losses and negative operating cash flows. The company says it may need additional capital, positive cash flow, or cost reductions; financing may not be available on acceptable terms. No specific revenue or earnings guidance is provided.
- Funding and dilution: On August 22, 2017, after year-end, the company raised approximately $210,001 gross from a common-stock sale and issued 88,888 additional shares for services. These proceeds were intended for working capital. The November 2016 financing also included warrants with a $0.01 exercise price after performance criteria were not met; exercise would dilute existing holders.
- Commercial execution: Management described a growing pipeline and 38 engineering projects in FY2017, nearly double FY2016, but reported only limited production orders for certain new technologies. Converting development projects into manufacturing revenue is important to the company’s plans.
- Other operating risks: Customer and receivable concentration, fixed-price contracts, dependence on a small number of suppliers and key personnel, regulatory requirements, competition, and the risk that customers shift to other vendors could affect results and liquidity.
- Controls: Management concluded that disclosure controls and internal control over financial reporting were not effective at June 30, 2017, citing material weaknesses in segregation of duties and inventory valuation controls. The company reported remediation procedures but did not say the weaknesses were resolved.
- Unusual financing/accounting items: FY2016 included $22,050 of non-cash other income from settling service liabilities with stock and a $32,707 gain on asset sales; FY2017 had a $1,515 asset-sale gain and no other income. The FY2017 statements include a $912 minimum state income-tax provision despite the net loss.
Most important facts for investors to verify
- Whether post-year-end financing and subsequent cash flows were sufficient to fund operations, and whether the going-concern uncertainty has changed.
- Whether engineering projects convert into recurring production orders, and the timing, economics and customer commitments behind that pipeline.
- The extent of potential dilution from outstanding warrants, options and future capital raises. The filing gives different warrant totals in different sections; reconcile the figures and confirm which warrants remained outstanding or were exercised after year-end.
- Whether revenue declines, customer concentration and accounts-receivable exposure are improving, and whether inventory is recoverable at recorded values.
- Whether the identified internal-control material weaknesses have been remediated and what independent oversight is in place. The filing says the board performs audit committee functions and that there is no audit committee financial expert.