Precision Optics Corporation, Inc. — FY2020 Form 10-K
Reporting period: Fiscal year ended June 30, 2020, compared with fiscal 2019. The filing is an annual report, not a report for 2019 Q4. Ross Optical, acquired in 2019, contributed a full year of results in FY2020 versus one month in FY2019.
Business context
The company designs and manufactures optical systems, components and assemblies, with medical endoscopy and imaging as its core business. It also sells sourced optical components through Ross Optical, primarily for industrial applications, with military and medical markets also served. Development priorities include Microprecision lenses, micro medical cameras, illumination systems and 3D endoscopes.
Financial performance and liquidity
| Metric | FY2020 | FY2019 | Change |
|---|---|---|---|
| Revenue | $9.92 million | $6.80 million | Up 45.8% |
| Gross profit | $3.36 million | $2.12 million | Up 58.4% |
| Gross margin | 33.9% | 31.2% | Up 2.7 percentage points |
| Operating loss | $1.42 million | $0.61 million | Loss widened |
| Net loss | $1.43 million | $0.61 million | Loss widened |
| Loss per share | $0.11 | $0.05 | Loss per share increased |
| Cash and cash equivalents at year-end | $1.13 million | $2.29 million | Down $1.15 million |
| Working capital | $1.80 million | $2.76 million | Down $0.96 million |
| Net cash used in operating activities | $0.59 million | $1.03 million | Use decreased |
The cash flow statement reports operating cash use of $592,492; MD&A reports $592,491. The filing does not explain the $1 difference.
Revenue included $4.58 million from Ross Optical, compared with $0.66 million for its one reported month in FY2019. Revenue from the non-Ross business fell 13.1% to $5.34 million. Product and service mix shifted: optical components revenue rose to $5.77 million from $1.82 million, while medical device products and assemblies declined to $2.76 million from $3.67 million. Engineering design services were $1.39 million, versus $1.31 million.
Ross Optical reported a 47.6% gross margin, compared with 22.1% for the non-Ross business. Company-wide margin improved largely because Ross contributed a higher-margin revenue mix. Higher R&D spending ($0.89 million, up 75.4%) and SG&A ($3.90 million, up 85.5%) contributed to the larger operating loss.
Year-end current liabilities were $3.15 million, including an $808,962 Paycheck Protection Program (PPP) loan, customer advances of $417,059 and current acquisition earn-out and lease obligations. The company reported total assets of $6.35 million and stockholders’ equity of $2.77 million. The PPP loan bears 1% interest; management expected full forgiveness, but forgiveness had not yet been confirmed. If not forgiven, the loan converts to a term loan maturing May 2022.
Material changes and notable items
- The Ross Optical acquisition expanded the components and assemblies business; total FY2020 revenue growth should be viewed in light of its full-year contribution.
- Non-Ross revenue declined amid reduced production sales, customer-cycle variability and COVID-19-related delays. A customer also cancelled a 3D optical project; the company does not expect further project revenue.
- A separate 3D engineering project had cost overruns that management estimated reduced consolidated gross margin by five percentage points. Management said those overruns would not continue after the project’s cancellation.
- R&D expense increased to $886,129 as the company added engineering personnel and internal development work. Stock-based compensation rose to $502,345 from $263,326.
- Cash used in investing activities was $1.60 million, including $1.44 million paid for the acquisition. The company also raised $250,000 through a common-stock placement and received the $808,962 PPP loan.
- Shares outstanding increased to 13.19 million at June 30, 2020 from 12.07 million a year earlier. The company also had 2.07 million options outstanding.
Outlook, risks and contingencies
Management said it believes Ross Optical and customer projects moving from development into production could support improved performance, and that break-even or profitable results depend on revenue levels, gross margins and expense control. It provided no quantified revenue, earnings or cash-flow guidance and cautioned that future results could not be predicted with confidence.
COVID-19 had caused supply disruptions and customer delays and could affect future orders, collections, operating efficiency and overall financial condition. Other key risks include recurring losses and possible need for additional financing, dependence on a limited number of suppliers and key personnel, customer concentration, fixed-price project overruns, regulatory requirements, acquisition integration, tariffs and potential dilution. The company reported no pending or threatened litigation known to it that it considered material, and no material off-balance-sheet arrangements.
Management concluded disclosure controls and internal control over financial reporting were ineffective at year-end, citing material weaknesses in segregation of accounting duties and inventory valuation. The auditor issued an unqualified opinion on the financial statements but was not engaged to audit internal controls. The company reported no impairment of goodwill or patents.
Investor verification priorities
- Confirm the status and terms of PPP loan forgiveness, and the resulting liquidity impact if any amount is not forgiven.
- Assess whether the Ross Optical acquisition is generating sustainable growth and whether its margins and integration benefits continue.
- Track non-Ross revenue, customer production orders and conversion of engineering projects into commercial production, including the effects of COVID-19 and cancelled projects.
- Review cash burn, working capital, receivable collections, inventory valuation and the potential need for additional financing.
- Monitor remediation of the disclosed internal-control material weaknesses and verify the small cash-flow-use discrepancy reported in MD&A versus the cash flow statement.
- Evaluate dilution exposure from outstanding options, future equity compensation and potential capital raises.