Precision Optics Corporation, Inc. — Form 10-Q Summary
Reporting period: Second quarter and six months ended December 31, 2011 (fiscal 2012). The unaudited statements consolidate the company and its wholly owned subsidiaries. Precision Optics develops and manufactures optical instruments, including medical endoscopes and micro-optics.
Financial results and position
| Metric | Three months ended Dec. 31, 2011 | Six months ended Dec. 31, 2011 |
|---|---|---|
| Revenue | $493,774 | $998,523 |
| Gross profit / margin | $111,320 / 22.5% | $250,614 / 25.1% |
| Operating loss | $(312,343) | $(575,545) |
| Net income (loss) | $(324,875) | $1,673,566 |
| Basic earnings (loss) per share | $(0.27) | $1.55 |
- Cash flow: Cash used in operating activities was $955,454 for the six months; investing activities provided $2,463,596, principally from patent-sale proceeds; financing activities used $740,972, largely for note principal and interest payments. Cash increased to $786,726 from $19,556 at June 30, 2011.
- Liquidity and balance sheet: At December 31, cash was $786,726, current assets were $1,620,258, and current liabilities were $501,023. Stockholders’ equity was $1,171,479, compared with a deficit of $1,194,632 at June 30, 2011.
- Debt: Remaining 10% senior secured convertible notes and accrued interest totaled $67,569 at December 31, including $50,000 principal. Two noteholders were repaid in full in December. The remaining note was extended to March 31, 2012 after quarter-end. The company reported no debt default at December 31.
Changes versus the prior comparable period
- Quarterly revenue rose 13.3% year over year, primarily on higher endoscope unit sales. Six-month revenue fell 10.8%, reflecting lower micro-optics and spinal-surgery visualization-system sales, partly offset by endoscopes.
- Quarterly gross margin improved to 22.5% from 21.3%, attributed mainly to higher sales volume. Six-month gross margin declined to 25.1% from 39.7% because of lower volume and less favorable product mix.
- R&D expense declined 39.4% for the quarter and 36.6% for the six months, primarily due to lower product-development labor and materials costs; customer reimbursements also declined.
- SG&A expense increased 52.1% for the quarter and 14.7% for the six months. Management attributed the increase primarily to the prior-year comparison involving reductions in accrued vacation liabilities connected with deferred-compensation settlements.
- Six-month net income was driven by a $2,276,286 gain on the sale of patents. The company sold certain intellectual property to Intuitive Surgical in July 2011 for $2.5 million gross proceeds, or $2,463,171 net of transaction expenses; the gain should not be viewed as recurring operating earnings.
Outlook, risks and notable matters
- Management expects operating losses to continue through fiscal 2012 and until sales reach breakeven and profitable levels. It seeks growth from Lenslock endoscopes, micro-precision optics and high-definition 3-D stereo endoscopes, but provides no quantified revenue or earnings guidance.
- Management says revenue timing is difficult to predict because products are at introductory stages and customer orders are unpredictable. It identifies a highly competitive, price-sensitive, regulated market and the time and cost required to develop and commercialize products.
- If revenue growth or positive cash flow is not achieved, the company may need additional debt or equity financing or a strategic alliance. Financing may be unavailable or have unfavorable terms; equity or convertible financing could dilute shareholders. Management warns that failure to raise capital or achieve positive cash flow could impair the company’s ability to continue operations and pursue its plans.
- Customer concentration is significant: for the six months, four customers represented 36%, 14%, 12% and 4% of revenue, respectively.
- Deferred compensation and consulting liabilities of $674,645 were settled in October through issuance of 245,326 common shares rather than cash payment. Common shares outstanding were 1,245,339 at February 14, 2012.
- Disclosure controls and internal control over financial reporting were assessed as ineffective at December 31. Management identified material weaknesses relating to segregation of accounting duties and inventory valuation; it describes remediation efforts but cannot guarantee successful remediation.
- Subsequent events include February 2012 option and share grants, appointment of an executive vice president for corporate development, and adoption of a CEO cash bonus plan of up to $60,000 subject to board discretion.
Important facts for investors to verify
- Whether product sales and gross margins improve enough to reduce recurring operating losses and cash burn.
- Repayment, conversion or further extension of the remaining $50,000 principal note and accrued interest due March 31, 2012.
- Cash requirements and the availability, cost and potential dilution of any additional financing.
- The extent of customer concentration and order variability, and progress in commercializing the company’s new products.
- Remediation of the disclosed material weaknesses and whether subsequent filings report effective controls.