Precision Optics Corporation, Inc. — Form 10-Q Summary
Business context and period: The company designs and manufactures optical instruments, with most business in medical devices and less than 10% in military and industrial products. This report covers the first quarter of fiscal 2018, the three months ended September 30, 2017; comparisons are with the three months ended September 30, 2016 unless noted.
Financial performance
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Revenue | $1,028,746 | $849,548 |
| Gross profit / margin | $386,742 / 37.6% | $167,051 / 19.7% |
| Operating loss | $28,269 | $293,408 |
| Net loss | $28,785 | $293,408 |
| Operating cash flow | $(131,646) | $157,788 |
| Capital expenditures | $0 | $3,500 |
- Revenue rose 21.1%. Engineering services increased 22% and production revenue increased 20%. Production growth included higher defense-customer optical-component sales, partly offset by lower sales of a traditional product. Engineering growth reflected new projects across customers, offsetting reduced work for one customer.
- Gross profit increased 131.5%. Management attributed the margin improvement to increased volume absorbing fixed manufacturing costs, stable production margins, and targeted or better margins on seven engineering projects.
- Research and development expense was $118,427, up 1.2%. Selling, general and administrative expense was $296,584, down 13.7%, mainly reflecting lower stock-based compensation and wages, partly offset by a $25,000 doubtful-account reserve.
- At September 30, cash was $194,714, accounts receivable $613,961, current assets $1,827,354, and current liabilities $1,096,876; reported working capital was $730,478. Cash increased $76,309 during the quarter, supported by $207,955 net financing cash flow, including a private placement; operations used $131,646.
- Total capital lease obligations were $29,909, including $8,531 current. The filing reports approximately $235,000 of open purchase-order commitments, including the remaining lease obligation.
Material changes, financing, and outlook
- The company sold 466,668 shares to investors at $0.45 per share for $210,001 gross proceeds, for general working capital, and issued 88,888 shares for services at the same price. These issuances increased shares outstanding to 9,428,472 at September 30. After quarter-end, holders exercised warrants for 666,667 shares for $6,667. Separately, warrants for 2,994,893 shares expired unexercised on September 28.
- Management said customer development projects may lead to production revenue upon commercialization and expects the customer pipeline to expand. No specific revenue or earnings guidance was provided.
- The company has sustained recurring losses and used cash in operations in recent fiscal years. Management stated that if quarterly sales do not reach near cash breakeven within six to nine months, additional financing may be needed and may not be available; significant reductions or cessation of operations could result. The company was evaluating debt, equity, or a strategic alliance. Additional equity could dilute shareholders; debt could carry restrictive covenants.
- About 81% of quarterly sales came from seven customers, creating material customer-concentration exposure. The company competes with larger, better-resourced domestic and foreign competitors, and revenue can fluctuate with customer product and project timing.
Risks, controls, and other notable items
- Management identified disclosure controls and internal control over financial reporting as ineffective at September 30, 2017, citing material weaknesses in segregation of duties and inventory valuation. The segregation issue reflects limited accounting staff; the inventory weakness has required prior-period audit adjustments. Management described review and inventory-control procedures but did not state that the weaknesses were remediated.
- Deferred tax assets have a full valuation allowance; no income tax provision was recorded for either quarter because of losses.
- The filing states there was no known pending or threatened litigation expected to have a material impact. It reports no off-balance-sheet arrangements and no material change to other previously disclosed risk factors, apart from the added cash runway risk.
Important facts for investors to verify
- Cash runway, collections and customer billing timing, and whether sales can approach cash breakeven within management’s six-to-nine-month timeframe.
- Availability, terms, and dilution effects of any further financing; also the post-quarter warrant exercise and resulting share count.
- Whether revenue growth and improved gross margins persist as customer development projects transition to production, given concentration in seven customers.
- Progress in remediating the material weaknesses in financial reporting controls, particularly inventory valuation and segregation of duties.
- The accuracy and timing of the approximately $235,000 purchase-order commitment estimate and the company’s ability to meet obligations.