Precision Optics Corporation, Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended June 30, 2019, compared with fiscal 2018. Although the request identifies “2018 Q4,” this filing reports FY2019 annual results, not a standalone quarter.
Business context
Precision Optics designs and manufactures optical products, principally medical endoscopes, imaging systems and components, and provides customer engineering and design services. It is developing Microprecision lenses, micro cameras and 3D endoscopes. Effective June 1, 2019, Ross Optical’s operations were included for June only; the asset acquisition closed July 1, 2019. Ross expands the company’s optical components and assemblies business.
Financial results and liquidity
| Metric | FY2019 | FY2018 |
|---|---|---|
| Revenue | $6.80 million | $4.04 million |
| Gross profit / margin | $2.12 million / 31.2% | $1.48 million / 36.7% |
| Operating loss | $613,000 | $349,000 |
| Net loss | $615,000 | $351,000 |
| Operating cash flow | $(1.03) million | $101,000 |
Revenue rose 68.5%; production revenue increased 99.3% and engineering-services revenue 2.3%. FY2019 included $656,000 of June Ross Optical revenue. Medical-device products and assemblies contributed $3.67 million, optical components $1.82 million, and engineering design services $1.31 million.
Gross margin declined because of production ramp-up costs and inefficiencies, plus overruns on a large engineering project. Management said it believed the issues were temporary and that corrective solutions were being developed. SG&A rose 52.9% to $2.10 million, including higher stock-based compensation, personnel and acquisition-related costs. Research and development expense increased 10.7% to $505,000. Acquisition expenses were $128,000.
At June 30, 2019, cash was $2.29 million, working capital $2.76 million, current assets $6.37 million and current liabilities $3.61 million. Current liabilities included $1.44 million due for the Ross acquisition, reported as paid in July 2019, and $450,000 in customer advances. Total assets were $7.49 million; stockholders’ equity was $3.38 million. Debt was limited: capital lease obligations totaled approximately $14,600, with no material bank debt disclosed.
Cash increased from $403,000 to $2.29 million, principally reflecting $2.93 million of gross private-placement proceeds and $54,000 from option exercises; operating activities used $1.03 million. The company reported recurring losses and an accumulated deficit of $45.64 million. It stated that additional financing might be required if it cannot reach sustained break-even and profitability, and may not be available on acceptable terms.
Material changes, outlook and risks
- Ross Optical acquisition: Purchase price was up to $2.0 million, including $1.5 million at closing, subject to holdbacks, and a $500,000 contingent earn-out tied to three years of revenue and gross-margin targets. The purchase-price allocation was preliminary. Unaudited pro forma FY2019 results, assuming ownership from July 1, 2018, showed revenue of $10.54 million and net income of $122,000; these figures are not actual reported results or a forecast.
- Growth expectations: Management expects increased sales and believes Ross Optical and customer projects moving from development to production may support improved performance. The filing provides no quantified revenue, earnings or cash-flow guidance.
- Customer and execution exposure: Three customers represented approximately 41% of FY2019 sales. Fixed-price orders are a significant portion of revenue and may prove unprofitable. Customer purchasing patterns, project timing, production costs and customer creditworthiness can cause volatility.
- Funding and dilution: The company has a history of losses and operating cash outflows. It raised equity to support operations and the acquisition; additional financing could dilute shareholders. The July 2019 Ross-related share issuance added 760,000 shares, and 1.82 million options were outstanding at year-end.
- Other risks: Risks include integration of Ross Optical, reliance on key personnel and a limited number of suppliers, medical-device and defense-industry regulation, tariffs, intellectual-property disputes, competition and low trading liquidity on OTCQB.
- Controls and unusual matters: Management concluded disclosure controls and internal control over financial reporting were ineffective at June 30, 2019, citing material weaknesses in segregation of duties and inventory valuation. Management described remediation efforts but did not guarantee resolution. The independent auditor gave an unqualified opinion on the financial statements; it did not audit internal controls.
Investor verification priorities
- Confirm Ross Optical’s post-acquisition revenue, margins, integration progress and whether earn-out targets are being met.
- Track production ramp costs and the two projects management identified as depressing margins, including whether expected margin improvements materialize.
- Assess cash burn, collections, customer advances, acquisition-related payments and the need for additional capital.
- Review customer concentration and the collectability of receivables, including the continuing allowance for doubtful accounts.
- Monitor remediation of the reported material weaknesses and verify future filings’ internal-control conclusions.
- Reconcile post-year-end share issuance and outstanding options when assessing dilution and ownership.