Precision Optics Corporation, Inc. (POCI) Earnings Call Transcript & Summary

Good afternoon and welcome to the Precision Optics Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Robert Blum with Lytham Partners. Please go ahead.

Thank you very much, Gary. Good afternoon, everyone, and thank you for joining us today to discuss Precision Optics acquisition of Lighthouse Imaging. With us on the call representing the company today are Dr. Joe Forkey, Precision Optics' Chief Executive Officer; and Dan Habhegger, the company's Chief Financial Officer. At the conclusion of today's prepared remarks, we will open the call for a question-and-answer session. Today's conference call is also being webcast with replay capabilities available both through the webcast as well as through the dial-in instructions. The details of both were included in today's press release. Before we begin with prepared remarks, we submit for the record the following statement. Statements made by the management team of Precision Optics during the course of this conference call may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended, and such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements describe future expectations, plans, results or strategies and are generally preceded by words such as may, future, plan or planned, will or should, expected, anticipates, draft, eventually or projected. Listeners are cautioned that such statements are subject to a multitude of risks and uncertainties that could cause future circumstances, events or results to differ materially from those projected in the forward-looking statements, including the risks that actual results may differ materially from those projected in the forward-looking statements as a result of various factors and other risks identified in our filings with the Securities and Exchange Commission. All forward-looking statements contained during this conference call speak only of the date in which they were made and are based on management's assumptions and estimates as of such date. The company does not undertake any obligation to publicly update any forward-looking statements whether as a result of the receipt of new information, the occurrence of future events or otherwise. With that said, let me turn the call over to Dr. Joe Forkey, Chief Executive Officer of Precision Optics. Joe, please proceed.

Thank you, Robert, and thank you all for joining us today on short notice to discuss this morning's announcement of Precision Optics acquisition of Lighthouse Imaging. Needless to say, we are extremely excited about this announcement and the opportunity it presents to our customers, employees and our shareholders. During the course of this call, I would like to present and discuss some additional details, including the following: first, I'd like to give you an overview of Lighthouse Imaging and their differentiated capabilities, particularly in the area of imaging electronics and systems and the synergies that come from the combination of these 2 businesses. Second, I will talk a bit about Lighthouse's business model, which happens to be very similar to our own. They work with customers at an early engineering stage to help them develop innovative products and then transition these products into ongoing production. Third, I'll comment briefly on the highly complementary corporate cultures. As was the case in our Ross Optical acquisition, confidence that the individuals in the 2 companies will be able to work well together is extremely important to the overall success of this merger. And finally, I will talk about the financial aspects of the transaction and the strong alignment of interests between all parties involved. As we stated in the press release, this merger combines 2 of the industry's leaders in medical optics and digital imaging, leveraging Precision Optics' next-generation capabilities in micro-optics, 3D imaging and optical systems and efficient supply chain production through our Ross Optical division with Lighthouse Imaging's advanced capabilities and strong reputation in leading-edge optical imaging electronics and associated systems. Over the last several years, the market for optical imaging systems, especially in healthcare, has changed dramatically as a result of the development of CMOS imaging sensors and LED illumination sources. These new electronic components have allowed for a reduction in size and increase in performance of medical devices. Most next-generation medical devices today include components that require highly advanced optics in both illumination and imaging systems. They also, however, require highly advanced electronic designs to drive newer LED-based illumination sources and to capture and process electronic images received by CMOS image sensors. This evolution is disrupting the minimally invasive medical device market in large part by displacing fiber optic-based and rod lens-based endoscopy systems. This is also driving the increased need for specialization in electronics and the marrying of electrical and optical engineering in this space. That, in a nutshell, drove the desire to combine Lighthouse Imaging with Precision Optics. Both Precision Optics and Lighthouse Imaging provide engineering services as well as manufacturing of complete system-level medical devices. As a consequence, we know each other well and we have been what I like to describe as friendly competitors. Recognizing the particular focus of Precision Optics on the optical side of things and Lighthouse Imaging on the electronic side of things, we have in the past, even while competing on some projects, developed proposals jointly as partners for some others. The reasons that drove us to consider a partnership, even while competing in other areas, are the same reasons that now bring us together as one merged company. Combined, we believe we will have one of the premier engineering departments in the entire industry, offering customers a one-stop shop for optical imaging-based medical device design and production. Because we both have long-standing excellent reputations in the medical device marketplace, I am confident that our customers will see this combination as extremely positive. This is consistent with the feedback we have received even today as we have started to reach out to existing customers with the news. Similar to us, Lighthouse Imaging has benefited from the robust market for unique optical imaging capabilities, including 3D imaging, that has created a large funnel of engineering projects for both us and them. First, to provide some context. For the 12-month period ended June 30, 2021, Lighthouse had revenues of $4.5 million. Approximately 66% of its revenue came from engineering services, with the remainder attributable to production activities. However, we believe these ratios will shift a bit in the coming months as the number of products have moved through the engineering pipeline and are scheduled to move into production. This is very similar to where Precision Optics was a few years ago when we rolled out our first engineering pipeline projects into production and pushed beyond breakeven. For Lighthouse Imaging, and now for our combined company, the movement of these projects from the engineering pipeline into production, provides an exciting opportunity for future growth. We can already begin to see the effects of this shift in Lighthouse's EBITDA numbers. For the 12-month period ended June 30, 2021, Lighthouse's EBITDA was $232,000. But importantly, their EBITDA for the first 6 months of that time period was only $6,000, while EBITDA for the second 6 months was $226,000. As Lighthouse continues to execute on the transition of products from design to production, we expect this increase in EBITDA to continue also. Given the importance of the development and production pipeline, let me spend a few minutes describing some of the products Lighthouse is working on. On the production side, Lighthouse currently has 2 legacy products categories. The first is a series of test and measurement products that are used to measure the performance of endoscopic systems. There is a limited market for these, but Lighthouse has been supplying them for many, many years. It's a mature product with good margins and straightforward high-yield manufacturing. The second product family is a laryngoscope assembly. This is manufactured for a large medical device company who acquired Lighthouse's original customer a couple of years ago. This product has the potential for future growth and is also produced with a mature design and manufacturing process. All told, the existing production activities at Lighthouse account for approximately $1.5 million in annual revenue. Except for some limited slowdowns due to COVID-related excess inventory, we expect this part of their business to remain relatively constant in the coming months and years as the products are well established in the market with no signs of near-term reductions. On the engineering side, their pipeline is extremely robust and growing similar to Precision Optics, with 4 products set to move from development pipeline to production in the next 12 months. The 4 products span a range of applications and disciplines within the medical device market, including arthroscopy, robotic laparoscopy, ophthalmology and otoscopy. In some cases, these products have already achieved regulatory clearance while others have a clear pathway to clearance in the next 3 quarters. In all cases, however, prototypes have been completed and customer evaluations have been successful. These customers have provided time lines for launch and are working with Lighthouse now on the transition from development to production. Similar to Precision Optics, the general criteria for taking on a project, other than feasibility and pricing, is that the project has the potential to generate on the order of $1 million in production revenue in the first year of production. And we believe this will be the case for the projects transitioning to production in the next year. One thing I think is important to note out here -- point out here, in which we will provide full detailed pro forma breakdowns in the 8-K amendments we will file in the coming months, is that the gross margins have generally been in the range of 30% to 40% or higher. As more products move to mature production, we expect margins in general to move up as greater levels of production more fully absorb overhead costs. In addition to these 4 projects, Lighthouse's engineering pipeline is pretty full, and they are continuously bringing in new opportunities. They are confident, therefore, that they will be able to backfill their development pipeline as some projects move to production. In addition, both Lighthouse and Precision Optics anticipate that this merger may allow us to expand our engineering team and increase the total number of projects that the 2 groups combined will be able to support. This is very encouraging because today, both technical teams are close to saturation as a consequence of the recent increases we have both seen in the number of customers interested in our development services. Lighthouse Imaging and Precision Optics are similar in many ways. Both were founded by optical engineers in the 1980s. Both have maneuvered through ups and downs over the years. Both have worked in the medical device space now for many years, and both are technology companies that rely heavily on long-term relationships with customers and vendors, and most importantly, with their employees. These commonalities, not surprisingly, have led to similar cultures at the 2 organizations. At Lighthouse Imaging, CEO Tom Snyder, who has been there for over 2 years now, has done a great job building on the strong background developed by Dennis Leiner, the company Founder; and Robert Austring, the most recent CEO before Tom. Since arriving at Lighthouse, Tom has successfully led a process to focus on customer satisfaction and loyalty that has helped the company through what is always a challenging set of product development processes for multiple customers simultaneously. It is clear when I have talked with Tom and when I visited, that the entire Lighthouse team is motivated by a drive similar to that of employees at Precision Optics. To push the envelope of what is possible technically while fully satisfying the needs of the customer. The company culture has a palpable understanding that their work is important to many people as the devices they design and produce impact patient outcomes and people's lives. In short, they have a sense of mission, very similar to that of POC. Given all of these commonalities and given the really positive conversations I've had over the last few months with Tom and all of the leadership at Lighthouse Imaging, I'm confident that the Precision Optics, Ross Optical and Lighthouse Imaging teams will work very well together and present a common message about how we do business to existing and new prospective customers. For the past 11 years, Lighthouse Imaging has been owned by Anania & Associates Investment Company, a Maine-based private equity firm focused on supporting sustainable growth in its portfolio of companies. I'm very pleased that Peter Anania, its President and Chairman, will join the Precision Optics' Board of Directors. The total purchase price paid by Precision Optics for Lighthouse Imaging is comprised of $2.85 million in cash and 2.5 million shares in Precision Optics. Depending on the valuation of the stock, the total value of the cash and stock combined is somewhere between about $6.6 million and $7.9 million. In addition, Precision Optics will potentially make additional payments of up to $1.5 million subject to certain earn-out provisions. The earn-out requirements are based on gross profit targets over the next 2 years. Achievement of the earn-out requirements will result in levels of EBITDA large enough to fund the payment through cash generated by Lighthouse operations. Simultaneous with the transaction, we completed an equity capital raise of $1.5 million and entered into a $2.6 million term loan with Main Street Bank in Marlborough, Massachusetts. The variable term loan is at Prime plus 1.5% with a floor of 4.75% and matures in 2028. We are very comfortable with covenants associated with the term loan, and the first covenant test does not occur until 2023. We also entered into a $250,000 line of credit with Main Street Bank. We believe our ability to access the traditional debt bank markets to complete the acquisition is a significant step forward in the maturation of Precision Optics and highlights the confidence the bank has following intense due diligence of this transaction. I believe the debt terms are extremely favorable for Precision Optics and our shareholders, helping to limit dilution and provide further upside for our shareholders as we execute on our business plan and merge these 2 companies. Lighthouse Imaging had revenue of approximately $4.5 million in our last fiscal year ending June 2021. With the transition of products to production, we expect Lighthouse will have a significant rate of growth over the long term. Fiscal 2022 growth is largely coming from customers already identified or in-house, and we anticipate the growth rate could be as high as 25% or more. Combined, we believe we will be on a clear trajectory to reach $20 million in revenue. We believe that will be an important milestone that separates us from boutique firms in our space and provides the scale to continue to invest in capabilities, capacity and distribution. I have talked about several ways that Precision Optics and Lighthouse Imaging are stronger together. From a financial perspective, we are quite comfortable that the addition of Lighthouse's profitability will offset the dilutive effect of the additional shares we issued. In other words, we expect this to be an accretive transaction during the earn-out period and beyond. Also, as I mentioned, different than the Ross acquisition is the fact that Peter Anania will be joining the Board, and all of the owners of Lighthouse Imaging are taking a significant portion of the sale price in Precision Optics' equity and earn-outs. With more than 60% of the total acquisition price covered by equity and earn-outs, the interest of all parties in the combined company are firmly aligned, and we are excited to successfully move forward together. On one final note, we indicated in the press release that we intend to begin hosting annual meetings again. We have several near-term priorities, including the SEC documentation related to this transaction and execution of our ongoing business. But we do see Precision Optics maturing, and we view the annual meeting process as a logical next step for the company and its shareholders. Let me finish by thanking you all for taking the time to listen in today. If any of you would like to discuss this transaction or any other topics related to the business, I will be available for virtual one-on-one meetings at the Lytham Partners Fall 2021 Investor Conference over the next couple of days. As usual, please contact Robert Blum for additional information. And now I'll be happy to take any questions.

[Operator Instructions]

Joe, while we're all waiting to see if anyone jumps in, I've got a couple of questions here, if you don't mind. The first one here is, what does this acquisition do in regards to maybe some of your efforts in the single-use market there?

Yes. Yes, it's a great question. So we've talked on earlier calls about how the single-use market for medical devices is developing. And one of the critical aspects of the single-use devices is that, in almost all cases, they use a CMOS sensor. And so you can understand very clearly and pretty immediately that having an electronics capability is critically important. Now there are other ways that we can satisfy that. We have a number of outside resources that we can work with. But one of the other critical requirements for single-use is that we keep the price points very low. So what this does in that regard is that it helps us in 2 ways: first, it brings the technical capability in-house for both of us, it brings the optical piece into Lighthouse, and it brings the electronics piece into Precision Optics. And therefore, helps us with the technology; but also importantly, removes the possibility or removes the situation where one or the other of us have to go outside and absorb or pass onto our customer the added costs associated with having sub-suppliers. And so this very clearly fits into the overall effort of reducing the overall costs of these products that is a critical requirement for single-use by putting the companies together and not having multiple markups with multiple margins in multiple organizations.

All right. And then just one more here. Maybe talk about some of the similarities and maybe some of the differences, if you can, between this acquisition and the Ross acquisition.

Yes. Sure. So in terms of the similarities, I would say, so as I harp on a lot, the cultures are very similar. That's important for small company acquisitions and mergers. The other way in which they're very similar is that it expands the core capabilities of Precision Optics. In the case of Ross Optical, giving us a very robust optical component business and small subassembly business. In the case of Lighthouse Imaging, getting us the capability for the electronic side of these medical device systems. So in that sense, it's broadening Precision Optics' capabilities, and for that matter, broadening Ross Optical's access to capabilities with POC, and Lighthouse's ability to access the capabilities of traditional POC. So in that way, the 2 acquisitions are similar. I think there are some differences, though. And I think most importantly, in the case of Ross Optical, we have done some joint marketing, but it really has been joint marketing of the added capabilities to the existing customers of each of the 2 organizations. POC and Ross Optical worked at sort of a different place in the supply chain for our customers. And so we came in by piggybacking on the relationships that each other already had. In the case of Lighthouse, it's very clear that we're already talking, in many cases, to the same customers. So I think we will see, in fact, we're already starting a much quicker and probably more extensive integration of the front-end sales and marketing and branding aspects of the business because what we're really doing with the Lighthouse acquisition is expanding the capabilities to the same marketplace that both of us are already acting in. So I think what you'll see is, as I say, quicker and more extensive integration of the sales and marketing message that comes out of the combined organization.

Perfect, Joe. Thank you for that. I appreciate it. Gary, I'll turn it back over to you if there are any questions.

There are no questions at this time. [Operator Instructions] Showing no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Thank you, operator, and thanks, everyone, for joining us on the call today. I look forward to speaking with many of you all again soon. Thanks and have a good evening.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.