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

Good afternoon, and welcome to the Precision Optics Reports First Quarter Fiscal Year 2024 Financial Results 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.

All right. Thank you, Anthony, and thank you to everyone joining the call today. As the operator mentioned, on today's call, we will discuss Precision Optics' First quarter fiscal year 2024 financial results for the period ended September 30, 2023. With us on the call representing the company today are: Dr. Joe Forkey, Precision Optics' President and Chief Executive Officer; and Wayne Coll, the company's Chief Financial Officer. At the conclusion of today's prepared remarks, we'll open the call for a question-and-answer session. Today's conference call is also being webcast with the replay capabilities available both through the webcast as well as through 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 as 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, 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 our call today to discuss our first quarter fiscal year 2024 financial results. At a high level, the results of the quarter were in line with the expectations we discussed at the end of September. As anticipated, revenue declined due to timing differences between the pause or exit of certain mature customer programs and the transition of significant new customer programs into production. Revenue was also impacted by lower order volumes of optical components from our Ross Optical operation. We expect that the net results of these in and out transitions will be a higher run rate of quarterly revenue when the transitions are complete, and we expect first quarter revenue levels to be the low point of the fiscal year. The markets we serve continue to be robust. The medical device market continues to show strong continuous growth, fueled by the ongoing efforts to develop updated and new medical procedures by leveraging new technology, including robotics and digital imaging. These new technologies enhance the abilities of surgeons in the case of robotics by allowing for more precise and complex movements with reduced chance of surgeon fatigue. And in the case of digital imaging by allowing for the augmentation of traditional visual perception of the surgeon with computer-aided recognition of physiological features. Digital Imaging also has enabled the economic feasibility of single-use imaging devices, a segment of the market that continues to grow at 2x to 3x that of the overall medical device market. Financial markets for medical device start-ups have been challenging, but the larger well-capitalized companies are driving forward with innovation in areas that place high value on POC's unique technical capabilities, particularly in micro-optics and digital imaging. We see no signs of the growth of the medical device market slowing. This is directly apparent in the quantity of opportunities we have for new projects entering our engineering pipeline, a number of which we expect to announce in the next few weeks. It is also important to remember that our long-term success with customers' production programs is tied directly to the success of those programs in the market. The more those customers sell, the more we must produce. There has been an increasing profile shift of our customers to establish in highly capitalized companies and away from smaller start-ups with questionable time lines or funding. Given the high threshold of market opportunity of the larger industry competitors, it should be no surprise that we are extremely enthusiastic about the market opportunities for products we are working on. Some involve single-use replacement of existing reusable devices, giving us high confidence of quick market adoption and future volumes. Others are attempting new therapies in very attractive large markets. Again, our confidence in our customers' programs is fueling our confidence in our revenue acceleration as we progress through this fiscal year. Recently, we announced receipt of initial production orders for 2 of the programs we expected would move to commercial production, one for a new defense aerospace product, and the other for a complex subassembly used in a robotic laparoscopy system. We expect these programs to begin to contribute to revenue in the current second quarter, but to increase substantially in the third and fourth quarters. We also expect other programs to transition to commercial production this fiscal year, including our 2 single-use programs that we have discussed previously. Our Ross Optical operations have already begun to see increases in order and delivery volumes, which are contributing to a recovery of revenue levels more quickly than we had anticipated. In September, we indicated that Ross Optical revenues would be $0.5 million lower than recent historical levels for both Q1 and Q2 of this fiscal year. We now believe that Ross Optical revenues will begin to recover in the second quarter and will be essentially fully recovered to its previous quarterly run rate in the second half of the fiscal year. The main driver of the anticipated recovery in revenue and of our long-term growth potential, ultimately is our engineering pipeline, which remains as robust as ever and continues to grow. During the quarter, engineering revenue was up 16% compared to the same quarter a year ago and was within 5% of the previous quarter's record level. These ongoing high levels of engineering work not only contribute to overall revenue, but more importantly, are a strong indicator of future potential revenue growth as programs move from the engineering pipeline to long-term commercial production. As a result of the lower Q1 revenue, our adjusted EBITDA came in at negative $245,000 during the first quarter compared to positive $26,000 for the same quarter last year. We expect the recovery and acceleration of revenue growth in the current quarter and back half of the year to drive adjusted EBITDA positive once again. We are managing costs appropriately and have not stopped investing in our business for future growth. Our goal is to reach an appropriate level of EBITDA for a small but fast-growing company while simultaneously investing in the company to continue that high growth rate. Earlier this year, we added a new Chief Operating Officer position and hired a new CFO. It has been very valuable having these 2 very skilled and experienced executives onboard. We have reevaluated procedures and processes, all while planning to deliver the growing book of business we see coming. We have implemented new tools to safeguard against project cost overruns, for example, and we are progressing in the implementation of a new ERP system to help manage the entire organization, which we expect to complete early in calendar 2024. We are making other investments in our business, including the addition of a new sales resource, and we are consistently recruiting for additional engineering capacity to increase the size of our product development capability, which continues to run at high utilization rates. As we've discussed previously, our business model relies on us engaging with our customers early in their design process and utilizing our product development group to design their product, making use of our enabling proprietary technology. This puts us in an ideal position to become the manufacturer of our customers' product for many years once the product is released commercially. Growing the size of our engineering team increases the number of programs we can support in our development pipeline. Ultimately, this increases the number of products in commercial production, which in turn, fuels our long-term growth. A great example of this development and production life cycle is the program for which we announced initial production orders just last week. This product is a highly complex optical subassembly that will be used in our customers' new robotic laparoscopy system. This program progressed through the development pipeline over a number of years, initially at Lighthouse imaging and after our acquisition of Lighthouse was continued by our combined team of engineers. We are excited to see a major customer program that came to us through Lighthouse begin production. Our customer, in this case, is a well-funded start-up that is in the final stages of receiving FDA clearance and expects to launch their product in calendar 2024. We expect this product will contribute to increased revenue this fiscal year and that we will receive follow-on orders after this one is complete. There are a number of other medical device programs we expect to transition to commercial production this fiscal year. Two of these are the single-use programs we have discussed on recent calls. Both of these programs are currently going through the transition phase of the development process, where we are manufacturing many hundreds of units to verify and validate the design and the production process. While these assemblies are built by a combination of manufacturing and engineering resources, they are categorized as engineering revenue and have contributed to the record engineering revenue levels in the last 2 quarters. Both of these products rely heavily on our micro optics and digital imaging technologies. We expect both of these products to enter commercial production in the second half of the fiscal year. We continue to see evidence that single-use devices are gaining market share. Given our experience with our 2 initial single-use programs, we are updating our sales and marketing efforts to pursue additional opportunities in this quickly growing market segment. As part of this effort, we are exhibiting this week at the MEDICA exhibit in Germany, which is one of the largest medical device trade shows in the world. This year, we will exhibit in OmniVision's booth. As we've discussed before, OmniVision is one of the largest CMOS sensor manufacturers in the world and a close partner to POC in digital imaging and particularly in single-use endoscope projects. Within the aerospace and defense market, our opportunities continue to grow. Anything for which weight is an issue, need smaller size optics. This includes any device that is carried by a soldier, that flies through the air or is launched into space. This key denominator of weight fits perfectly into POC's micro-optics specialty. Combining small size with our expertise in digital imaging creates a broad offering for defense/aerospace applications. We have begun an effort to better understand the details of the defense/aerospace market and to identify specific segments where our technology can be most competitive. We have experience with 3 significant programs in the defense and aerospace market. Last month, we announced the receipt of $680,000 in initial production orders from a top-tier defense/aerospace company, addressing a new commercial application that leverages our manufacturing IP developed for high-precision microoptics technology. This product is a high-level subassembly. It is a very complicated product that has required much effort from our talented engineering group to design a robust and cost-effective manufacturing process. Although we have had other defense and aerospace programs more centered on component procurement, this one should be a very profitable and consistent opportunity for us with the customer already discussing significant follow-on production orders. The large number of programs slated to transition from development to production during this fiscal year is a direct result of the strong engineering pipeline we have discussed for some time now. Importantly, we have been busy bringing in new programs to the development pipeline even while other programs are transitioning to production. This is critical as it ensures that the growth we anticipate in fiscal 2024 will be sustainable with additional programs moving through the pipeline for production starts in fiscal 2025 and beyond. At our size, the timing of specific programs moving in and out of production can cause some ups and downs in quarterly revenues, but the clear trend is toward increasing revenue in fiscal 2024 and beyond. With that, let me turn it over to Wayne to review the financials in more detail.

Thank you, Joe. Let me expand upon some of Joe's comments on the financial results, starting with revenue. For the quarter, total revenue was $4.3 million, a decrease of 15% compared to $5.1 million in last year's first quarter. Production revenue was $2.4 million compared to $3.4 million last year, a decrease of $1 million, while engineering revenue was $1.9 million compared to $1.6 million, an increase of $300,000. Of the $1 million decrease in production revenue, approximately $500,000 pertains to our Ross Optical operations as we saw lower order volumes as customers sought to rebalance their inventories, which have previously grown beyond sustainable levels due to increased ordering in response to concerns about supply chain disruptions. Our engineering business remains strong, however, and very highly utilized. We have implemented increased pricing as a reflection of the strong demand for our capabilities. For gross margins, in the first quarter, our gross margin was 33.9% compared to 32.2% in the same quarter last year. While there was improvement compared to the year ago period, gross margins were down as compared to the most recent sequential quarters due to lower overall sales volume and facility utilization. Long term, we remain focused on driving expansion in gross profit margins through improvement in our processes and procedures, coupled with higher absorption of our fixed overhead with increased production levels, as well as price increases where appropriate. Total operating expenses were $1.87 million compared to $1.74 million in Q1 of last year, roughly an increase of about $125,000. The change from the year ago first quarter was primarily due to increased marketing-related expenses, increased personnel costs and increased professional fees associated with public company expenses. On a sequential basis, we saw a decline in operating expenses. As Joe mentioned at the beginning, we remain focused on efficiently managing the business with a goal to drive profitability as revenues pick up back in the -- pickup in the second half of the fiscal year. As a result of the aforementioned decline in revenue and gross profit, net loss during the first quarter was $464,000 compared to a net loss of $159,000 in last year's first quarter. Adjusted EBITDA, which excludes stock-based compensation, interest, depreciation, amortization, other income and acquisition expenses, was negative $245,000 for Q1 of fiscal 2024 compared to positive EBITDA of $26,000 in Q1 of last year. Again, the key driver here was the decrease in production revenue. Our cash balance at September 30, 2023, was $1.4 million compared to $2.9 million at June 30, 2023. While cash funded and EBITDA loss and normal debt repayments in Q1, increases in accounts receivable and inventory, and decreases in accounts payable and accruals were primarily timing related, and we don't foresee a similar cash burn in Q2 as we expect earnings to recover with revenue levels and other elements of working capital having returned to normal levels. Also, we continue to maintain full availability on our $1.25 million working capital line of credit with our bank. So as we look to the second quarter of fiscal 2024 and as mentioned by Joe, we already see that Ross revenues have begun to recover, and we have visibility to a stronger quarter for production. Finally, we expect to continue to see strong performance on the engineering side and a return to $5 million and above quarterly revenue levels. I will now turn the call back over to Joe for some final comments.

Thanks, Wayne. To wrap things up, I want to remind everyone that companies ranging from the largest aerospace and defense contractors in the U.S. to top tier medical device companies, as well as well-funded start-ups pushing the envelope with new medical procedures are increasingly relying on Precision Optics to bring innovative new solutions to the market. We have a strong position in our specialized segment of the market, focusing on micro-optics, 3D and digital imaging. With new production orders set to be delivered in the coming quarters in a robust and growing pipeline, we look forward to continued revenue growth and improved profitability metrics in fiscal 2024. One final note, for those of you in the New York City area, Wayne and I will be on a [ non-DO ] roadshow in the week of December 4. If you'd like to meet in person, please contact Robert. To all of you on the call, I thank you for your continued support of Precision Optics, and we'd now be happy to take any questions.

[Operator Instructions]

Anthony, this is Robert Blum here. Let me jump in while we see if anyone queues up for a question. I've got a couple here for you, Joe and Wayne. Let's start with Ross Optical, help maybe listeners understand the nuances of what took place during this quarter. You talked about sort of rebalancing of inventories and things of that nature. But what are sort of the nuances that everything sort of came together this quarter? You're seeing a rebound, it sounds like here in Q2 and sort of back to more normalized levels in Q3. But is there anything you can expand upon as it relates specifically to the Ross operations?

Yes, sure. So the way I think about this is that this is really the long tail of COVID. And I know everyone's sick of hearing about COVID, but it still persists a little bit when it comes to some of the impacts on the business. The way we see this is the following, towards the end of COVID, when people started ordering things again, and we started to have some supply chain challenges, a number of our customers put in fairly significant orders in order to manage what they saw as supply chain issues that they thought would continue for a significant period of time. At the same time, as we came out of the pandemic, the demand for a lot of the optical systems that use our optical components started to grow very quickly. And everyone, I suppose, remembers that the economy and things started moving quite well after the pandemic until, of course, the Fed started increasing interest rates and then everything started to slow down. So we had 2 things happening at the same time. We had a supply chain that was challenged, and we had customers who were experiencing higher demand and had lower inventories because they had soft ordering during the pandemic. So all of those things combined led to customers placing fairly significant orders. What ended up happening then is that because of timing, they ended up getting a whole bunch of the material, then the Fed started raising interest rates, things started slowing down a little bit in the optics industry in general. It's not terrible, but it's not as -- things aren't moving as quickly as they were before. People are not ordering quite as much. So our customers then ended up with some excess inventory. We're pretty confident that this is the right interpretation because the things that caused the lower revenue in the first quarter, in large part were due to delayed orders. So customers who called and said, we have scheduled deliveries in the first quarter. We want to push those out by some period of time, right? And so I don't think we lost any orders. I think orders slowed -- new orders slowed down a little bit, but mostly it was delay of shipments of existing orders. What we've now seen is that the order rate has started to pick up in general, and some of those delays that customers that ask for, [ they push out to over ] Q3 or Q4, they're now asking us to pull those back into -- some into Q2 and into Q3. So on both sides of it, understanding what the underlying cause was for the very low performance in Q1 and the recovery that we're starting to see all fits together with that idea that it really was caused ultimately by the concerns over the supply chain the really strong performance of the optics industry coming out of the pandemic and then slowing down a little. So we're pretty sure that we understand what's going on. And as we said in our comments, we're starting to see things recover even in the current Q2. So we're pretty confident that things will come back and that this is not a long-term issue.

All right. Perfect, Joe. You talk a little -- maybe talk a little bit here about the process that you undergo when you transition a product into production and single-use in particular? And then maybe any potential inherent risks that sort of take place during that transition process?

Sure. So with any product, we go through a number of well-defined stages in the design process and the transfer to production. We go through what we call a minimal-viable prototype, and MVP is the very first prototype we do. Then we do an alpha prototype, which includes the basic functionality of what we expect the final design to be. We learn a lot of things through the alpha prototypes, and then we go with that information we learn and we go and build a beta prototype, which is intended to be the same as the production product. We take the beta prototype and we do some testing, if everything looks good, then we'll go through a transition period, a transition phase where we build a number of these beta prototypes in order to demonstrate 2 things. One is to demonstrate that we can build it reproducibly. And the second is that we'll have high yields and that the build procedures will fit the economics of the pricing that we have agreed to with the customer. That transition phase where we build a number of these final prototypes, which really could be called pilot units because they're the same as the production units. For a reusable device this typically where the volumes we're building every year are hundreds of thousands, that transition period process will generally require that we build some tens of units, 30, 40, 50 units, something like that. And then we do a detailed testing of all of those units and confirm that the build process is working well and that the products are performing as we expected. When we get to a single-use product, where we're talking about building tens of thousands or even higher 50,000, 100,000 units a year, the transition process, the transfer process from the beta prototype to full production takes on a much larger requirement because part of what we're validating there is the build process itself. One of the things that we need to do when we do single-use products is set things up, both the design and the manufacturing process so that we don't have to spend a lot of time or money doing quality measurements on every unit that comes off the line when we're in production. So we end up having to validate in a much more significant way the manufacturing process. And so that's why in my comments, I commented that for both of our single-use programs are in this transfer phase now, we're building many hundreds and hundreds of units. And by the time we're done, we will have built probably a couple of thousand units in each case of these transfer phase prototypes that are intended to be the exact same design and build process that we'll have for the commercial production. So in both cases, for reusable and for single use, there's always a possibility that as we go through this transfer phase that we may find that there's some issue with manufacturing. Now in the reusable case, that's much less likely because we're building fewer units, and we're measuring every unit when we get into production. In the single use case, because we're validating the process so that we don't have to do very much, if any, inspection when we get into full-blown production. We -- because we're building so many more units in we're looking so much more carefully at the process, there is a chance that we'll discover something as we go through that process that acts a little differently when we start building hundreds and hundreds of these, then perhaps [ acted ] when we were building a hand roll of 10 or 15 or 20 of the alpha prototypes or the beta prototypes. And I will say, in fact, in this case, in both of our single use cases, we did discover some things as we were going through those transfer phase validation builds. Now this is not entirely unusual. The risk, of course, is that one of these issues become significant enough that we have to back up and do a fairly significant redesign. Luckily, in our cases, none of the things that we found have resulted in that kind of delay. We have had to update some of our tooling and fixing and those sorts of things. But by and large, we have gotten through much of the transfer phase already without any major issues. And so I think, we'll -- we're pretty optimistic that we'll be able to get through those things in time to start production in just a couple of months. So that's the process we go through. It is much more substantial for single use. That's why it's been taking us a little longer to get these into production. But as I say, we're pretty far along in that transfer phase now, and we're pretty optimistic we'll be in production very soon.

Okay. Great. That's helpful, hopefully, for everyone there. I've got one more question again then, operator, I'll turn it over if there's anyone else in the queue. I just want to Wayne, maybe on your side here, I want to confirm something there was obviously a little bit of an abnormal correlation, we call it between the cash -- the change in cash vis-a-vis the sort of operating adjusted EBITDA and traditional loan repayments. I think you mentioned, I just want to confirm that you said you don't sort of foresee something similar during the second quarter. Just maybe help people understand and maybe some more detail there, the cash and availability.

Yes, sure thing. Yes, I think a couple of items. One, we do expect we will see EBITDA recover in the second quarter, and that was a part of the use of cash. The debt repayments, we can expect those. That's -- those are on schedule. So that will be very similar. But I think on the case -- in the case of the working capital, uses of working capital, the expansion in receivables and inventory, my feeling is, they've arrived kind of at their normalized levels. They're going to be fairly stable. It's not sources of capital as we move forward. But we do expect the need for working capital. That's why we have a credit line in place specifically for the expansion of working capital for accounts receivable and inventory as we get these larger programs into production. At the same time, as a larger programs go in to production, the positive EBITDA is going to kind of also work to offset our working capital needs. So again, it was a bit of a -- I think, it was a bit of a low point. Q1 was a bit of a low point from a revenue and EBITDA standpoint and also from a use of working capital, but we expect those trends to turn around and reverse themselves as we move forward.

Okay. Perfect. Sounds good. Thanks for addressing those questions guys. Anthony, I will turn it back over to you if there's anyone that would like to key up for a question.

[Operator Instructions] It appears there are no questions. This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Hold on just a moment, Anthony. I believe we have perhaps one question just came in. Our next -- our question will come from [ Norman Kadajian ], a private investor.

Joe. Earlier this year, you've mentioned that we would have record quarterly revenues sometime this year. Do you still feel comfortable with that statement? And what product or products are the most important to reaching that goal?

Yes. So thanks for the question. The short answer to your question is, yes. We still expect record revenues to come in this year. There are a number of products that are going to help us get there. There are a couple that we just announced our first production orders for in the last month or so, and I talked a little bit about on the call. One is in defense/aerospace. The other one is a high-level subassembly for this robotic system that we're working on. The other 2 are the ones that we've been talking about for a while, which are the single-use programs. I think, importantly -- well, so let me also say there are 2 or 3 others that I think have a decent probability of coming in, in this fiscal year. We don't need all 3 of these other ones to come in. Even if one comes in, it's going to make a significant difference. So there's always a little bit of uncertainty in our forecasting. But with those 3 or 4 that I mentioned, along with a couple more that could come in, we're pretty confident that we're going to see some record levels. I think importantly, it's critical that we continue to see high revenue from our Ross Optical division, and we've talked a lot about that. And then, also that we continue to see high revenue levels from our engineering pipeline and we talked a lot about that in the script today. We've been doing a lot of work. We haven't talked a lot about it, but we've been doing a lot of work to make sure that we have new programs coming into the engineering pipeline even as these other programs are moving into production. So to be very specific to your question about which programs are the most important. It's really the 2 that we already announced, one in aerospace/defense that's already talking to us about follow-on orders, one in robotic laparoscopy, the subassembly we made there and then our 2 single-use programs. Those are the ones that are really going to drive us in the latter part of the year.

Okay. That concludes our question-and-answer session. I'd like to turn it 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 all of you soon.

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