Precision Optics Corporation, Inc. (OTCQB:PEYE) Q4 2020 Earnings Conference Call September 24, 2020 5:00 PM ET
Robert Blum – Lytham Partners
Joe Forkey – Chief Executive Officer
Conference Call Participants
Good afternoon, and welcome to the Precision Optics Fourth Quarter Fiscal Year 2020 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.
Hi. Thank you very much, Gary. And thank you all for joining us today to discuss the financial results of Precision Optics for the fourth quarter and fiscal year-end 2020 ended June 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 I began 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 and 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.
Thank you Robert, and thank you all for joining our call today to discuss our fourth quarter and fiscal year 2020 financial results.
Let me first summarize a few key events of the quarter and year. I will then provide some deeper commentary on the numbers, including some added context based on what we are seeing for the first quarter of fiscal 2021. And then finally, I’ll talk a bit about the status of our commercialized programs and pipeline.
As you can see from the preliminary revenue numbers that we announced in mid-August and our full financials that we released today, the overall results reflect the positive contributions from our Ross Optical acquisition that was completed at the very beginning of fiscal year 2020 offset by some impacts to certain aspects of our operations from COVID-19.
For the fourth quarter, which ended June 30, 2020, overall revenue was down about $150,000 compared to both the previous year, as well as the most recent third quarter. Our adjusted EBITDA, however, improved by more than $150,000 from the third quarter due to a decrease in our operating expenses.
As you may recall from our conversation in May, both of our operations in Massachusetts and Texas were deemed essential businesses and were therefore able to continue operations throughout the pandemic. However, the impact of COVID did create disruptions in a few key areas.
First, there was a delay for one component that we use in the building of our otoscopy product. This component delay ultimately led to a decrease in completed products, which impacted revenue by approximately $100,000 or so in Q4. However, in Q1 we are now back on schedule with no lingering effects.
Second, and as we talked about in May, we were notified by one of our major customers for whom we make an endoscope that goes into a cardiac ablation device of the need to significantly reduce deliveries through February, 2021, due to the impact of COVID-19 on their operations. This impacted revenue by about $200,000 during the fourth quarter.
Based on recent conversations, the attitude by the customer is much more positive than it was a few months ago as they begin to see hospitals resumed procedures that use their product. And we are optimistic about a return to normalize levels in the beginning of the next calendar year.
And third, gross margins were impacted by overall operational inefficiencies due to the adoption of certain workplace safety guidelines. As I stated last quarter, while all of our employees worked diligently to limit the impact of these new policies, we simply are not operating in completely normalized conditions and don’t have complete freedom to manage for production efficiency. With a return to pre-COVID shift schedules in the beginning of August, we have begun to reduce these impacts. And while it will take some time to recover pre-COVID efficiencies completely, we expect to see improvements in the first quarter of fiscal 2021.
Despite these impacts due to COVID, other parts of our business have been quite resilient. Our Ross Optical operations continued with similar revenue levels in Q3 and Q4, as they had earlier in the year. Other than the specific issues I mentioned above with two products, production customers continued to accept previously scheduled deliveries and to place follow on orders. And while we saw a drop-off in nearly all discussions about new development projects in the February/March/April timeframe, these discussions have now rebounded with current activity level similar to those we experienced pre-COVID.
The robustness of these parts of our business bolsters our belief that medical devices and the defense and aerospace industry, our two primary markets, are among the most economically resilient and vibrant industries to be selling into these days.
All-in-all, we believe the disruptions that we experienced in the third and fourth quarters of fiscal 2020 have begun to subside, and it is our expectation that we will see improvements in revenue and gross margins in the first quarter of fiscal 2021, as compared to the fourth quarter of fiscal 2020. In today’s environment, things can change quickly, but we are confident that we’re making progress.
One final point before I jump into the financials. Our balance sheet is in very good shape. We ended the fourth quarter and fiscal year with $1.1 million in cash, reflecting cash management initiatives, coupled with proceeds from an equity financing in April, 2020 and receipt of funding under the payroll protection program.
With that high level overview, let’s get into some of the details of the financial results after which I will follow-up with an overview of some of our key business drivers. Revenue during the fourth quarter ended June 30 was $2,240,000, a decrease of 6% compared to revenue of $2,380,000 in the fourth quarter of last year, and a decrease of 6% also compared to $2,370,000 in the most recent third quarter.
As I already mentioned, there was approximately $100,000 or so impact from supply chain issues for the otoscopy product and $200,000 related to reduce deliveries of product in the cardiac program, both caused by COVID.
Unrelated to COVID, but as we discussed previously, we continue to see a quarterly reduction of about $175,000 related to our defense product. We believe our customer is finalizing plans for a ramp back up in production and hope to get back to normal levels by early next calendar year.
Our Ross Optical operations had another nice quarter with revenue of $1,130,000. For the fiscal year ended June 30 revenue was $9.9 million, an increase of $3.1 million compared to fiscal 2019. This improvement was the result of a $3.9 million increase due to the acquisition of Ross Optical, which contributed to revenue for the entire year as compared to one month of contribution in fiscal 2019, offset by an $800,000 decrease in our historical POC operations mainly due to the items I mentioned above.
As I mentioned earlier, with the otoscopy product back to normal and with improvements in other areas, we are expecting first quarter fiscal 2021 revenue to be up compared to the fourth quarter.
Our gross margin was 29% for the fourth quarter compared to 36% in the previous year’s fourth quarter and 34% in the most recent third quarter. Ross Optical margins were down slightly, mainly due to the impact of an accrual adjustment related to vacation expense. And the POC margins continued to be hampered by COVID-related inefficiencies that I already mentioned, and by the negative impact of a single engineering engagement that depressed margin throughout the year.
As these issues appear to be subsiding and with Ross Optical margins expected to return to a more typical level in the first quarter, we are expecting gross margins in the first quarter of fiscal 2021 to be up compared to the most recent fourth quarter.
For the fiscal year ended June 30, gross margins were 34% compared to 31% in fiscal 2019. Again, Ross Optical being on board for the full year was the main driver of this improvement with a partial negative offset due to cost overruns in one engineering project and overall COVID-related inefficiencies.
Operating expenses were $973,000 during the fourth quarter of fiscal 2020 as compared to $1,282,000 during the immediately preceding third quarter and compare it to $956,000 in the fourth quarter a year ago. Roughly half of the quarter-to-quarter reduction from Q3 to Q4 was due to limitations in activities, particularly in the area of sales and marketing travel due to our response to the pandemic. The other half is made up of non-COVID-related items that we expect in the near-term will continue at the lower levels of Q4.
For the fiscal year ended June 30, operating expenses were $4.8 million compared to $2.7 million in fiscal 2019. A little over $1.1 million of the $2.1 million increase in expenses is attributable to the addition of the Ross Optical operations, while the remaining increase was due to strategic investments we have made during the year to position the company for future growth.
We have concentrated our investments in our four areas of strategic focus as we have described on previous calls. Expanding our sales and marketing team to reach more customers, investing in proprietary technology and products to boost revenue and gross margins, investing in automation for high volume product opportunities and exploring additional merger and acquisition opportunities.
On the sales and marketing side, we added personnel to increase customer coverage, company visibility and communication efficiency. We have also added an external marketing firm, revamped our website and begun to run our efforts for digital customer engagement. And we have implemented a CRM system so that we can be more efficient in how we manage existing customer engagements and prospect for new ones.
On the research and development side, we have added engineering personnel to work on a mix of design development for a specific customer projects along with internal R&D efforts to generate proprietary intellectual property. I believe this investment in IP is critical to the long-term success of the business, and is one of the reasons why we continue to see strong interest in new pipeline projects.
We continue to explore ways to produce high volume products and we see that long awaited market for single use products beginning to materialize. On the M&A front, things have been quiet as many small business owners have been heads down writing out the COVID storm. We hope to see opportunities in this area come back to life in the new fiscal year.
Finally, on the G&A side, we engage the new CFO midyear and started the process to implement a new financial software system to update and further integrate the POC and Ross Optical accounting software, all with the goal of managing the larger company accounting needs and being prepared for additional growth.
While we have made sizable investments over the last year, many of these investments will continue to benefit the company without the need to be duplicated in the near-term. So, while we don’t expect operating expenses to be as low in the first quarter of fiscal 2021 as they were in Q4 of fiscal 2020, we do believe they will continue to be lower than the higher levels of Q2 and Q3 of fiscal 2020.
As I mentioned earlier, it is our expectation that revenue levels and margins will recover from the various issues that hampered the third and fourth quarter, and we feel good about the new projects that are coming up.
Also on the net income line, we reported a GAAP net loss of $323,000 during the fourth quarter, including $75,000 of stock-based compensation. Backing out the stock-based compensation, as well as depreciation, amortization, and interest, our adjusted EBITDA for the quarter was a loss of $207,000. This compared to a $360,000 adjusted EBITDA loss in Q3 and a profit of $162,000 in the fourth quarter a year ago. The improvement compared to Q3 was driven by the decrease in operating expenses I mentioned a moment ago, offset by a slight decrease in revenue and margin.
For the fiscal year ended June 30, net loss was $1.4 million compared to $615,000 in fiscal 2019. Adjusted EBITDA for the year was a $763,000 loss compared to a $37,000 profit for the previous year. Without the impact of COVID, we believe adjusted EBITDA would have been much closer to breakeven.
With revenues and margins expected to be up while holding operating expenses down, we believe we will see an improvement in adjusted EBITDA in the first quarter of fiscal 2021 compared to Q4 of fiscal 2020.
Turning now to our balance sheet. I mentioned earlier, our cash balance at June 30, 2020 was $1.1 million, which compared to $632,000 at the end of March. The increase in cash is due to the $250,000 private placement completed on April 14 and the receipt of the PPP loan of $809,000 on May 6, partially offset by a significant paydown of accounts payable to catch up on the extremely aggressive cash management we instituted during February and March at the beginning of the pandemic.
Also, the balance sheet shows a new liability for $809,000, which is labeled note payable to bank. That entry relates to the PPP note. We expect that the note will be forgiven based on the criteria of the program, but until it is, it will continue to show up as a liability.
As we work to recover from some of the impacts of the COVID-19 pandemic, we are prepared to take steps to reduce expenses if necessary, but our goal is to bring revenues from existing and new products back in line as quickly as possible, and to continue our strategic plan for growth without delay. Our cash balance at the end of the fourth quarter positions us well to execute on that plan.
The release of our financial results for fiscal year 2020 represents a milestone as we conclude the first year of Ross Optical and Precision Optics working together as one company. I hope it’s apparent from my comments today that the integration process has proceeded smoothly and that we have achieved a level of cooperation between divisions and employees that truly has us working as a single company.
While there are always opportunities to improve the operations of a company with facilities in different geographic locations, today we are more focused on leveraging the value of our combined operations then on onboarding a new division to the company. Therefore, in fiscal 2021, we may cease to report numbers for Ross Optical as its own business unit. In any case, we will continue to provide investors inappropriate amounts of detail.
I’d like to spend a few minutes now reviewing the status of our commercialization programs and our pipeline with a bit more detail. There has essentially been no change in our three commercialized programs since our conference call in May. Deliveries in our otoscopy program remained solid. The issues we had that affected delivery of product during the third and fourth quarters have been resolved, and we are on track for strong deliveries in the first quarter of fiscal 2021.
We will soon finish deliveries for the current purchase order, and are already in discussions with the customer for a follow on order. Most importantly, the product is being well received in the market, which should hopefully bode well for increases in volumes in the future.
Our cardiac program will remain at reduced levels until February, 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, and they have begun to see a recovery of demand as hospitals moved beyond early moratoriums on non-emergency surgical procedures. We and they expect to be back to historical production levels midway through the third quarter of fiscal 2021.
Finally, our defense program has continued at reduced levels, but based on discussions with the customer, we anticipate a reorder by the end of this calendar year. Due to the nature of this business sector, we continue to have limited visibility into the program itself, but our relationship with the customer is very good and we have been introduced by this group to a number of other projects within their company.
We have seen this expansion of our relationship with this defense customer, as well as communications with other customers, many of which are customers of Ross Optical, as indicators that there are additional opportunities for our technologies in the defense and aerospace marketplace.
As many of you are aware, we made the strategic decision a few years ago to focus our efforts broadly within the medical device market, and more specifically where we can bring innovation to the table through our micro optics and 3D capabilities. This focus never prohibited us from pursuing projects within the defense and aerospace market if they came to us, but we were not proactive in finding them.
That changed, however, with the acquisition of Ross Optical and with the expansion of our sales and marketing resources, which as I mentioned above, has been a key area of investment over the past year. With these initiatives, we have been able to expand our efforts in this area and are already beginning to see some results.
Recently, we received a prototype order from a large defense aerospace company that has the potential to be a rather large near term opportunity and we have already begun to deliver these prototypes. I want to caution everyone that we are still working through the process, and there is no guarantee that this engagement will result in a production order. But the fact that we were chosen to provide prototypes for this program is a strong indicator of the success of the integration of Ross Optical into POC and of the expansion of our overall sales and marketing capabilities.
Capturing this prototype order required a deeply cooperative effort between multiple departments in our integrated company, including our new west coast sales rep who joined the company a little over a year ago. The President of Ross Optical, who joined us with the acquisition of Ross Optical a year ago, our new VP of Engineering who joined the company last February, along with the General Manager of our Optics Lab, VP of Sales and Marketing, Directors of Quality and Operations at POC and at Ross Optical and other members of POC and Ross Optical’s engineering and accounting teams. This was truly a team effort. And it’s clear that neither POC nor Ross Optical on their own could have captured this project.
While we don’t know — while we won’t know for some time whether this prototype order will ultimately result in new production work, the successful way in which our integrated company presented itself to this customer bodes very well for future opportunities in the defense and aerospace marketplace.
Beyond this new program, a number of our other pipeline projects are progressing well. Our colonoscope pipeline program that relies on Precision Optics micro camera enabling technology is poised to receive 510(k) approval any day now. And we expect a new order from this customer as soon as tomorrow or early next week.
The single use ophthalmoscope program is continuing to progress nicely as we successfully meet key milestones. While there is still work to be done, we are expecting regulatory filing in mid-2021 and a commercial launch in early 2022. This timing is a slight delay from our earlier expectations, but it’s still in line with our general experience for a project of this size and complexity.
In Q4, we reached some critical milestones in our 3D endoscope development program. Nonetheless, we were notified by our customer in early July that they were putting this project on indefinite hold.
We are confident that the investments we made in the technology underlying this program will provide value to POC and to our other customers in the future. To that point, we have already begun discussions with very large medical device company about development of a 3D endoscope for their robotic surgery system. In addition, we recently received early stage prototype orders for two new projects, both in the medical device market. One of which is in the single use space.
As I mentioned above, the number of business discussions about new projects like these slowed dramatically earlier this year, when COVID first came on the scene, but as indicated by these new orders, the overall interest in development projects that utilize POC is unique capabilities has recovered well and we are confident that this will continue into the future.
Overall, I am incredibly proud of our entire team, which has continued to band together to maintain a safe overall workplace for our employees and strive to meet the expectations and demands of our customers.
As I said earlier, we are expecting sequential quarterly growth in the first quarter of fiscal 2021. I think it’s important to point out that this has been accomplished during a time when our largest customer has essentially put a hold on receiving orders. In other words, we have refilled that gap with new and expanding customers and so have built in topline growth in fiscal 2021 as that large customer comes back online.
While there maybe some ups-and-downs due to timing of new orders and production runs, the overall revenue picture remain strong. All this is happening with an expected improvement in margins and an expanding pipeline that should continue to provide ample opportunities for sustainable long-term growth. Our balance sheet is strong and we are able to invest in growth and to take advantage of new opportunities as they arise.
One final note. With travel restrictions limiting our ability to meet with investors in person, I will be participating in a virtual investor conference hosted by the team at Lytham Partners. This will include a presentation on October 7, as well as virtual one-on-one meeting. Please contact Robert Blum for additional information.
And now, I’d be happy to take any questions.
And we do have a question from Veselin Mahalav [ph], a Private Investor. Please go ahead.
Hi, Joe. Thanks for taking my question.
So, Joe, what are the opportunities to increase gross margins going forward to an acquisition? When Ross Optical was brought online, it had a 10% operating margin and I forgot what the gross margin was, but we were all hoping that the company will become sustainably profitable probably 5% to 10% operating margin level. I’m talking about myself and expand from there. And so now we’re hit with the delays and with the — with COVID.
So, with that being said, you said that you are looking at acquisitions that people are hunkered down, but they’re burning money just like Precision Optics has been losing money a little bit at a time and burning cash as well. So, sooner or later, there may be an opportunity. Do you see any companies out there with 40% — 50% or higher gross margin opportunities, such that if you’re bring them into the family so to speak, we can see immediately accretive results here because it’s been — we’ve been at this for 10 years now, micro lens, new technologies. We had sustainable pick up in sales starting 2017, I believe. And a profitable company brought under the umbrella, Ross Optical and we’re still not there.
But what about an acquisition that — or two or three with high gross margins, I’m not looking for you guys to buy some company with 10% gross margin and burning cash. I’m looking for you guys to bring in some 40%, 50% gross margin companies such that the combined company can finally sustainably become profitable at the operating level and cash-flow positive? Your comments please.
Yeah. Sure. So, let’s see. There’s a couple of things there that — so the first thing with regards to other potential acquisition candidates. We are pretty confident that there are other small optics companies out there that run at profitable margins like you were talking about. But we don’t know of any today that we are actively engaged with.
I think our attitude was, we needed to get this first acquisition under our belt. I think it’s gone quite successfully. I think as I talked about the companies that are working well together. And I think we probably would have started looking more aggressively a little sooner than now had it not been for COVID. But that obviously did slow things down. There were one or two sort of preliminary discussions with a couple of companies, but they were extremely preliminary and then they sort of got put on hold.
So, I do think it’s a — it’s an area that we will look towards in the future. But as I’ve said in the past, I don’t think we absolutely have to do more acquisitions, but we certainly are open to that. And we will be making a concerted effort to start looking more deliberately as we get farther into this fiscal year.
In terms of the other part of your question in terms of getting beyond profitability again, I think, from a high level — the way I look at this, as we made some strategic decisions about a year ago to make some investments, which I talked about, and those investments are starting to pay-off now, were not for COVID, I think that we would be very close to breakeven now, because the investments that we made in the cash-flow from Ross Optical were pretty well matched.
And as you pointed out, we had some new production orders under our belt and we were starting to see some improvements. So, I do think that COVID — I’m hesitant to blame COVID for everything. That certainly is not the case. But it certainly did have an impact in, and effectively it has slowed down the plans that we had by some six, eight, 10 months.
But I do think that the deliveries will come back for this one big customer. The benefit of the investments that we’ve made like this new defense, aerospace prototype order that we’re getting now, I think we’ll continue to see those starting to grow. So, I do think that there’s an opportunity for growth even without acquisitions. But certainly, the optics industry is still highly fragmented and we do believe there are other small companies out there that would be prime candidates for other acquisitions.
This concludes our question-and-answer session. I would like to turn the conference back over to Joe Forkey 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 again during our virtual presentation and one-on-one meetings and I hope we can all visit face to face again in the near future. Thank you all. Have a good evening and stay safe.
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.