Precision Optics Corporation, Inc. (OTCQB:PEYE) Q1 2021 Earnings Conference Call November 13, 2020 5:00 PM ET

Company Participants

Robert Blum – Lytham Partners

Joe Forkey – Chief Executive Officer

Operator

Good evening and welcome to the Precision Optics Reports First Quarter Fiscal Year 2021 Financial Results Conference Call. All participants will be in a listen-only mode. [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.

Robert Blum

Hi. Thank you very much, Grant. And thank you all for joining us today to discuss the financial results of Precision Optics for the first quarter of fiscal year 2021 ended September 30, 2020.

With us on the call representing the company today are, Dr. Joe Forkey, Precision Optics Chief Executive Officer; Mr. 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 27 A of the Securities Act of 1933 as amended and Section 21 E 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 subscribe 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 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 risk that actual results may differ materially from those projected in the forward-looking statements as a result of various factors and other risks identified the company’s filings with the Securities Exchange Commission. All forward-looking statements contained in this conference called speaking only of to 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 current and future events or otherwise.

With that said, let me turn the call over to Dr. Joe Forkey, Chief Executive Officer, Precision Optics. Joe, please proceed.

Joe Forkey

Thank you, Robert. And thank you all for joining our call today to discuss our first quarter fiscal year 2021 financial results, where we showed improvement in nearly every key metric of the business over the most recent quarter. To lay out the agenda for today’s call, I will first summarize a few key events of the quarter including some brief commentary on the financial results. Then I’ll talk a bit about the status of our commercialized programs and pipeline. My goal is to keep my comments a bit more brief compared to recent calls, especially since our last call was only a month and a half ago.

One additional comment I want to make before we begin, please note that we have now consolidated our financial reporting in these earnings calls into two areas, production and engineering. As our business becomes more integrated, including Ross Optical, which has been on board for more than a year now, we felt the timing was appropriate as we start the new fiscal year to discuss the business in its integrated state, which is really how we are operating it.

As I mentioned at the onset, I am pleased with the performance during the first quarter. As we predicted during our year-end conference call in September, we saw improvements in company performance in Q1 in nearly all operating metrics. That included strong revenue growth both sequentially, where we were up 23% compared to the fourth quarter of fiscal 2020 and up 10% year-over-year, as we saw a recovery in shipments on orders that had been delayed due to issues surrounding COVID-19.

Further, our gross margin and bottom line results improved dramatically. And we are pleased to report a slight bottom line net profit with positive adjusted EBITDA of more than $100,000. Importantly, our balance sheet remains with approximately $900,000 in cash, with our net working capital position improving quarter-over-quarter. All in all, I am pleased with our operating performance in the first quarter.

Let me spend a few minutes reviewing the status of our commercialization programs and our pipeline in a bit more detail. First, on our cardiac program, there has been little change since our call in September. Based on recent conversations, we will remain at reduced delivery levels until early calendar 2021. As our customer works through the impact on end market deliveries caused by COVID. Our customer continues to believe the long-term prospects for their product in the market remain positive. We expect to begin to ramp back to historical production levels early in calendar 2021.

Second, on our otoscopy program, we had strong deliveries in the first quarter of fiscal 2021. This accounted for some of the sequential growth during the quarter, both in revenue and in gross margin as our production resources were finally able to restart and run at the capacity they were set up for before the delays caused by COVID. We are finishing deliveries for the current purchase order and are in discussions with the customer for a follow-on order. At this point we are uncertain on when that follow on order may occur as the customer assesses their inventory balances and outlook given the impacts of COVID-19. However, the long-term outlook for the program remains strong and we fully expect a reorder.

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During the first quarter, we have continued deliveries to our largest defense customer at a reduced rate as we round out the end of an existing order. But based on recent discussions with this customer, we anticipate a more substantial reorder by the end of this calendar year. This is consistent with the recent order they placed with us to pre-purchase the raw material for their products in order to guarantee the supply and to reduce the uncertainty on lead time for the next production order. Our really relationship with this customer remains very good.

And as I mentioned before, we have been introduced by this group to a number of other projects within their company, and recently received prototype orders in support of one of these new projects. Our expectation is that the existing projects will ramp back up to production levels of a year ago, and that significant opportunities exist for future growth with this customer. The volume of our traditional products including complex endocouplers, specialized endoscopes, custom spinal surgery products along with the components supplied by Ross Optical continues to remain stable.

Finally, engineering services had a very nice revenue quarter. As I have stated numerous times over the years, the timing and recognition of revenue within engineering can fluctuate based on delivery of milestones. Projects may run with ongoing consistent work levels, but the timing of milestone achievements as compared to quarter end can cause revenue to be up or down in any particular quarter. I do believe, however, that we are beginning to see the impact of our investments in the expansion of our engineering group within this segment. As we discussed about a year ago, we made investments in key aspects of our development functions to increase our engineering capacity and speed of project execution.

The number of projects that are moving through our engineering group not only increases engineering revenue, but also increases the pipeline of candidates for commercial production. The new pipeline project with the large defense aerospace company that we discussed last quarter, for which we received the prototype order, continues to move forward. During the first quarter, we delivered the first of the prototypes and worked closely with this customer to address normal engineering issues that arise during a prototype stage production effort for parts like these that are technically very challenging.

We feel really good about the productivity and tone of these interactions, which resulted in adjustments of some of their specifications to better accommodate our production methods and adjustments of some of our production methods to better accommodate their requirements. This kind of give and take with a customer of this size is indicative of the development of a strong long-term working relationship. We expect to have further clarity on the next phases of this project in the coming months.

Our multi camera colonoscope pipeline program that relies on Precision Optics’ micro camera enabling technology is continuing to move closer to commercialization. Our customer tells us that they expect 510(k) approval to be coming imminently and that they expect to place a new order for product from us any day now. On the single use ophthalmoscope program, there has been no change in timing since our last call, as it is continuing to progress nicely in engineering. We and the customer are expecting regulatory filing in mid-2021, and a potential commercial launch in early 2022.

In addition to these few well established engineering pipeline programs we are simultaneously working on several other developing pipeline projects that are at varying stages, each of which has the potential to be a significant long-term opportunity for the company. Even with the increase in engineering resources, our engineering group is running near capacity as we continue to evaluate and add new opportunities. A number of factors are contributing to the largest number of opportunities we are seeing. Across the board, we are observing an increase in business activity as compared to the early part of this year, when virtually all new business inquiry is ground to a halt as the world was learning how to deal with the COVID pandemic and its impact on operations, supply chain, medical device markets, et cetera.

On our September call, I commented that we were seeing some of this activity coming back. Today, the rate of inquiries has recovered to a rate similar to if not exceeding the levels we experienced before the pandemic. In the area of small CMOS based endoscopes, the market is expanding rapidly as the rate of introduction of new image sensors by OmniVision, the market leader in medical sensor fabrication continues to increase. We have a very good working relationship with OmniVision, and they have shared with us their product roadmap, which shows a sustained and an increasing rate of new product introduction for the next couple years.

These new sensors support smaller and higher resolution performance, which allows their use in more and more endoscopic and medical device applications. Many customers are coming to us now with requests for custom lenses and new endoscope designs based on this expansion of available sensor options. A significant subset of the overall CMOS endoscope market is the single use market which we have talked about before. The early successes of Ambu in Boston Scientific have now been noticed by other major players, as well as VC backed startups and POC is well positioned to respond to the need of these customers as they pursue new single use endoscope applications.

In addition to the existing single use ophthalmoscope pipeline project, we are working on early design work in proof of concept prototypes for two additional customers that came to us in the last six months, who are interested in single use products. One is a well-funded startup; the other is one of the largest medical device companies in the world. Given all of the investments we have made in the development of CMOS in single use endoscope technology, we are well positioned to respond to the increasing demand for CMOS based endoscopes in general, in single use versions in particular, which are driving growth in this market.

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In the defense and aerospace market, the growth and opportunities for POC is coming from our efforts to make inroads into this market by leveraging POC’s and Ross Optical’s existing relationships, as well as the broader product offering available from our integrated company. We also believe that opportunities for our micro precision optics technology continue to increase as companies in this space work to redesign systems in an effort to optimize size, weight in power.

We continue to expand our sales and marketing efforts in this area and are starting to see some initial success with additional requests for quote. In one specific case, we received the prototype order for components similar in nature to those we make for our current large defense customer from another multibillion-dollar defense contractor. While we don’t yet know the long-term potential, this is a good example of the progress we are making in targeting this large existing market for growth.

Internally, I feel really good about the work that the team at Precision Optics is doing. The investments we have made in expanding the business over the past few years, allowing for us to offer a broad set of optical capabilities all under one roof is raising the profile of the business within the industry and bringing more and more opportunities to the table. This vertical integration of capabilities which enables our company to uniquely apply customization requirements is something that others in the industry simply are unable to accomplish. This is one of our key differentiators in our success, helping clients bringing more and more products to the market will drive increases in our financial results.

Now I’ll summarize a few key items on the income statement and balance sheet. On the top line revenue during the first quarter was $2.8 million, an increase of 23% sequentially and up 10% compared to the first quarter a year ago. The breakdown was $2.2 million of production revenue during Q1 fiscal 2021, which compared to 1.9 million in the previous quarter and 2.1 million in the first quarter a year ago, increases of 12% and 3%, respectively. As I mentioned, the primary driver here was contributions from the otoscopy product.

Engineering Services revenue was $589,000 during the first quarter, which was a 102% increase from the previous quarter, and up 44% compared to the first quarter a year ago. Again, this primarily relates to timing of revenue recognition, but we are seeing a consistent level of higher demand for engineering. As I mentioned above, the increased number of projects being quoted and pursued is a result of both market trends and internal execution by our larger sales group, including contributors from Ross Optical.

Our gross margin was 35% for the first quarter compared to 29% in the previous quarter and 39% in the first quarter a year ago. Quarter-over-quarter margin improvement was driven by completion of one low margin engineering project, and the increase in total volume, better leveraging our fixed costs. Clearly, there is still room for improvement, much of which will come from better utilization of manufacturing overhead through growth in revenue. Our near-term goal continues to be getting back to the 40% plus gross margin range.

Operating expenses were $974,000 during the first quarter of fiscal 2021 as compared to $1.1 million during the first quarter a year ago and roughly flat compared to the most recent fourth quarter of fiscal 2020. The reduction in operating expenses year-over-year continues to come from overall careful management of all operating costs, as well as limitations in certain activities, particularly in the area of sales and marketing travel due to COVID-19. We expect this level of operating expenses to be relatively consistent for the next quarter or so.

All told, on the net income line we reported a GAAP net income of $793 during the first quarter, including $71,000 of stock-based compensation. Backing out the stock-based compensation, as well as depreciation, amortization and interest, our adjusted EBITDA for the quarter was positive $108,000. This compared to a $208,000 adjusted EBITDA loss in the previous quarter, and then adjusted EBITDA profit of $59,000 in the first quarter a year ago. Revenue growth, sequential improvement in gross margins, coupled with continued efficient management of expenses, all contributed to the profitability of the quarter.

Turning now to our balance sheet, our cash balance at September 30, 2020 was $901,000, which compared to $1.1 million at the end of June. This reduction in cash was accompanied by an increase in working capital of a little more than $60,000. The main change here was a $200,000 decrease in customer advances offset by about $100,000 change in accounts receivable.

We continue to show a liability for $809,000 on the balance sheet, which is labeled note payable to bank. That entry relates to our PPP loan. We expect that the loan will be forgiven based on the criteria of the program, but until it is it will continue to show up as a liability. We believe our cash balance at the end of the first quarter continues to position us well to execute on our plan. But as always, we are prepared to take steps to reduce expenses if necessary.

Before I take questions, let me recap briefly. As we predicted during our year-end conference call in September, we saw improvements in company performance in Q1 in nearly all operating metrics. We grew revenues, improved our gross margins and maintained strict discipline in managing our expenses, which resulted in profitability on a net income basis, as well as on an adjusted EBITDA basis. Importantly, our team continues to band together to maintain a safe overall workplace for our employees and we continue to meet the expectations and demands of our customers.

This led to successful deliveries on virtually all orders scheduled for Q1, following a backlog that had been created by COVID-19 issues, and to nice progress on pipeline projects that have the ability to be significant contributors to revenue over the next few quarters and years. We are still not out of the woods as it relates to the impacts from COVID on our business, as customers continue to work through excess inventory, and evaluate the velocity of sell through of their end products in the market.

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However, the increase we have seen in pipeline projects, as well as request for quotation for new projects gives me optimism that we can continue to mitigate some of the upcoming ups and downs due to the long tail of COVID disruptions on certain products, as our overall base of business continues to grow.

One final note, I have enjoyed the time that many of us have been able to spend during the most recent Lytham Partners conferences, and we’ll once again be available for virtual one-on-one meetings during their next event December 7 through 11. Please contact Robert Blum for additional information.

And now, I’d be happy to take any questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session.

Robert Blum

Grant this is Robert here. I’ll go ahead and jump in with a quick question here, again, if anyone wants to queue up, star and then one. Joe on that sort of final comment you made there talking about some of the backlog issues that were created from COVID. The progress you’re sort of making the pipeline. When you sort of look at the current and the anticipated impacts of what’s going on in the world in the business, sort of help us to sort of bring together the two sides of that there and maybe summarize it a little bit?

Joe Forkey

Yeah. Sure. So I think with regard to COVID, we’re – as I said, sort of towards the ends of the comments, we’re not out of the woods yet, but I think we’re in a different place than we were six months ago. I sort of think of it as the acute stage of the impact from COVID on our business, which was the first part of this calendar year, where there was a lot of uncertainty and that drove a lot of concern on the part of our customers, not knowing what to expect. And as we’ve talked about, there were one or two opportunities, in particular one pipeline opportunity that went away completely, really, because of the acute impact of the business landscape caused by the introduction of COVID in a pandemic.

I think we’re really in a different phase now. I don’t think that we’re out of the woods, as I say, but I think we’re more into what I would call the long tail of the impact of the pandemic. And clearly we can see already that there will be some longer term impact, I would say over the course of the next few months and the next few quarters, as our existing customers who continue to take delivery, some as you know, at reduced rates are sitting on some excess inventory, because the end use customers have not come back to the level that they were at pre-pandemic. There’s a – the good news is that I think, from our customer base, there’s a pretty strong belief that we will get out of this and when the pandemic is over that they will survive the pandemic and that they will work through the excess inventory that they have now, and that the products that they’re selling will continue to grow as they had before the pandemic started.

So from that standpoint, I don’t anticipate any sort of catastrophic loss of customers or catastrophic loss of product line. The real question is going to be how long does it take for them to get through the excess inventory? And how is that impacted by some of the sort of second wave that we’re seeing and things like that. We did talk with one customer not too long ago who told us that they were starting to see some pickup in the number of cases for their particular product in Europe. And now a lot of the hospitals in Europe are going back to a place where they are not performing any elective surgery. They haven’t seen that yet in the US, there is some talk, I think in the in the Midwestern states about that happening.

So it’s those kinds of on and off activities that will affect the timing and the length of this sort of, as I keep saying, the long tail of the impact. But again, the good news is that in the long run, we expect all of the commercialized programs to come back. And we see that these new projects that are coming through the pipeline are continuing to move forward. So in some sense, we – it’s a very positive thing from the standpoint of looking out a couple of quarters in the future when the commercialized programs come back and we layer on top of that some of these other programs, I think we’ll see that on average, the company will have grown as we go through the pandemic and come out the other side.

Robert Blum

All right, perfect, Joe. Well, as we have no further questions here, I’ll go ahead and turn it over for any closing remarks that you have.

Joe Forkey

Yeah, thanks Robert. I just want to thank everyone for joining us on the call today. I look forward to speaking with many of you again during our one-on-one meetings. I encourage you to sign up for those as early as possible. And I hope that soon we can all visit face-to-face again in the near future. Thank you everyone. Have a good evening and stay safe.

Operator

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



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