Precision Optics Corporation, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended March 31, 2017. The filing covers FY2017 Q3, notwithstanding the request metadata’s “2016 Q3” label. Amounts are in U.S. dollars unless stated otherwise.
Business context
The company designs and manufactures optical instruments, principally medical devices and imaging products; approximately 5% of its business is military and industrial products. Management emphasizes Microprecision optics, micro medical cameras, and 3D endoscopy. Sales are primarily to OEM customers, and the company reported that seven customers accounted for approximately 62% of FY2016 sales.
Financial performance and liquidity
| Metric | Three months ended Mar. 31, 2017 | Three months ended Mar. 31, 2016 | Nine months ended Mar. 31, 2017 | Nine months ended Mar. 31, 2016 |
|---|---|---|---|---|
| Revenue | $983,186 | $1,140,825 | $2,434,324 | $2,954,024 |
| Gross profit | $278,124 | $273,533 | $593,582 | $622,893 |
| Gross margin | 28.3% | 24.0% | 24.4% | 21.1% |
| Operating loss | $(162,770) | $(243,678) | $(767,013) | $(906,878) |
| Net loss | $(163,353) | $(222,097) | $(768,856) | $(885,297) |
| Loss per share, basic and diluted | $(0.02) | $(0.03) | $(0.09) | $(0.13) |
- Quarterly revenue declined 13.8%; nine-month revenue declined 17.6% year over year. Management attributed declines to project transitions or completions, loss of a Microprecision subassembly customer, and cyclical weakness in traditional products.
- Gross margin improved, which management attributed to better production margins, reduced fixed costs after closing the thin-film coating department, and fewer manufacturing inefficiencies. SG&A fell 21.8% for the quarter and 14.9% for nine months; nine-month R&D expense fell 5.0%.
- Cash from operations was a use of $631,924 for the nine months, versus a use of $750,213 in the prior-year period. Financing provided $772,506, including $780,000 gross proceeds from a November 2016 stock placement. Cash increased by $108,530 over the nine-month period to $158,589.
- At March 31, 2017, current assets were $1,918,087, including $158,589 cash, $533,922 accounts receivable, and $1,123,222 inventory. Current liabilities were $1,252,988. Total capital lease obligations were $33,968; the filing reports no other material off-balance-sheet arrangements.
- Stockholders’ equity was $749,112, with an accumulated deficit of $44,433,131. Shares outstanding rose from 7,539,582 at June 30, 2016 to 8,872,916 at March 31, 2017.
Changes, outlook, and risks
- Engineering revenue was down 11% in the quarter and 3% over nine months; production revenue was down 3% and 14%, respectively. Management said the number of engineering projects increased 71% to 36 for the nine-month period, which it viewed as evidence of a growing project pipeline.
- Management said margins could improve as sales and facility utilization increase, and expects development projects to move into production orders. The filing provides no specific revenue or earnings forecast.
- The company reported recurring losses and stated that its financial condition may raise substantial doubt about its ability to continue as a going concern. It said cash and receivables at May 9, 2017 were approximately $180,000 and $268,000, respectively, and warned that without revenue approaching cash breakeven within three to six months it might need external funding or could significantly reduce or cease operations.
- Potential funding options include debt, equity, or a strategic alliance; availability and acceptable terms are not assured. Equity or convertible financing would dilute shareholders, while debt could impose restrictive covenants. The company may also curtail R&D and reduce costs if it cannot obtain funding or achieve positive cash flow.
- The November 2016 placement sold 1,333,334 units at $0.60 each and included warrants with exercise prices linked to revenue and net-income criteria. At March 31, the company had not met the income criterion. Warrants and other outstanding options may create dilution; the filing excluded approximately 5.15 million potentially dilutive shares from diluted EPS as antidilutive.
- Management concluded disclosure controls and internal control over financial reporting were not effective at March 31, 2017. It identified material weaknesses involving segregation of accounting duties and inventory valuation; remediation efforts were ongoing, with no assurance they would resolve the weaknesses.
- The filing reports no material pending or threatened litigation known to the company. It notes competition from larger, better-resourced domestic and foreign companies, as well as customer concentration and dependence on successful product development and commercialization.
Important facts for investors to verify
- Reconcile discrepancies in the filing: the risk-factor discussion gives quarterly operating loss as $167,770, versus $162,770 in the income statement; it also says cash decreased $357,989 for the quarter, while the cash-flow statement shows a $108,530 increase over nine months and the balance sheet shows cash rising from $50,059 to $158,589.
- Reconcile accounts receivable figures: the balance sheet reports $533,922 at March 31, while the risk-factor discussion reports $533,589.
- Assess near-term cash runway, collections, revenue conversion from engineering projects, and whether additional financing is available on acceptable terms.
- Review the status of internal-control remediation, customer concentration, and the effect of outstanding warrants and options on potential dilution.