Business context and reporting period
Precision Optics Corporation, Inc. designs and manufactures optical instruments, with most business in medical devices; approximately 5% of its business is military and industrial products. This unaudited Form 10-Q covers the first quarter of fiscal 2017, the three months ended September 30, 2016, and compares results with the same quarter of 2015.
Financial results and liquidity
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Revenue | $849,548 | $858,427 | Down $8,879 (1.0%) |
| Gross profit / margin | $167,051 / 19.7% | $132,338 / 15.4% | Profit up $34,713; margin up 4.3 percentage points |
| Research and development | $116,992 | $150,768 | Down 22.4% |
| Selling, general and administrative | $343,782 | $365,026 | Down 5.8% |
| Net loss / loss per share | $(293,408) / $(0.04) | $(381,890) / $(0.06) | Loss narrowed $88,482 |
| Cash from (used in) operations | $157,788 | $(125,084) | Improved $282,872 |
- Cash and cash equivalents were $202,406 at September 30, 2016, versus $50,059 at June 30, 2016. Operating cash generation benefited from reductions in receivables and inventory and increases in accounts payable; it does not represent positive earnings.
- Current assets were $1.84 million and current liabilities $1.56 million, leaving working capital of approximately $287,000. Cash alone was materially below current liabilities.
- Reported debt consisted of capital lease obligations of $37,896, including $7,987 current; no other debt balance is reported in the supplied filing text. Future minimum lease payments total $43,564. Open purchase-order commitments were approximately $175,000.
- Capital expenditures were $3,500. No income tax provision was recorded; the company maintains a full valuation reserve against deferred tax assets.
Material changes and management commentary
- Revenue was nearly flat, but management reported engineering-service revenue increased 68%, driven by CMOS and Microprecision projects. Lower production revenue offset that growth, including decreases in laryngoscopes, a CMOS camera assembly, and optical components. Management cited one lost production contract and described other production variations as consistent with customer purchasing patterns.
- Management attributed improved gross margin mainly to higher manufacturing margins and lower stock-based compensation charged to cost of goods sold, partly offset by lower engineering-revenue margins. Lower R&D expense reflected labor costs charged to engineering activity and reduced stock-based compensation; lower SG&A reflected reduced consulting, advertising, and legal costs.
- Management views higher engineering activity as a potential source of future production opportunities and says it expects the customer pipeline to expand as development projects move to production. The filing provides no quantified revenue or earnings guidance and cautions that actual results may differ materially from forward-looking statements.
- The company reports recurring losses over several years, including a $1.06 million net loss and $876,298 of operating cash use in FY2016. Management says additional capital may be needed until breakeven and profitable results are sustained; financing may be unavailable or unacceptable, and equity financing would dilute shareholders. If capital or positive cash flow cannot be secured, the company may reduce R&D and other costs, with potential consequences for operations and its ability to continue as a going concern.
- Customer concentration is significant: four customers accounted for 49% of quarterly revenue (Customer A 20%, B 18%, C 11%; Customer D had no reported share), compared with 52% from the four named customers in the prior-year quarter. For FY2016, approximately 62% of sales came from seven customers.
- Management concluded disclosure controls and internal control over financial reporting were ineffective at September 30, 2016. The filing identifies material weaknesses in segregation of accounting duties and inventory valuation; remediation efforts are described, but management cannot guarantee remediation. No material change in internal control occurred during the quarter.
- No material changes to the risk factors in the FY2016 Form 10-K were reported. Management was not aware of pending or threatened litigation expected to have a material impact.
Important facts for investors to verify
- Whether engineering projects convert into recurring production orders and offset the lost contract and lower production sales.
- Whether operating cash generation is sustainable, given ongoing losses, limited cash relative to current liabilities, and working-capital dependence.
- The timing, availability, and dilution or covenant implications of any financing required to fund operations and product development.
- Progress in remediating the two material control weaknesses, particularly inventory valuation and segregation of duties.
- Exposure to concentrated customers, product mix, and quarterly margin variability.