Precision Optics Stock: Stage Set For Profitability (NASDAQ:POCI)

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Precision Optics Corporation, Inc. (NASDAQ:POCI) is a supplier of customized micro-precision optical and endoscopic digital imaging solutions for military and medical device manufacturers. The company implemented a strategy change about seven years ago, as I described in “Precision Optics Has A Game Plan That Isn’t Obvious At First Glance, published in June 2021.

This updated article restates my investment thesis and examines the underlying concerns that potential investors would likely have when evaluating POCI such as the lack of profitability, the weak cash position, the lack of liquidity in the stock, and potential supply chain problems.

Investment thesis

POCI’s products are highly complex and have a long sales cycle sometimes as long as five years as they proceed through engineered customized designing through FDA approval for medical devices or the government approval and funding process for military products. The products have a long shelf life once they reach the commercial stage and result in predictable annual revenue similar to recurring revenue.

The company’s new strategy is to build up the product pipeline to produce at least two new commercial products annually, with each having a revenue potential of at least $1 million per year. My investment thesis has been and remains that the company’s revenue will ramp up as products advance on the pipeline from engineering to production.

Profitability

POCI is on track to meet its stated goal as it announced earlier this year a $1.5 million order from an aerospace company and a $2.5 million contract from a medical device company. Going forward, the company is set to escalate beyond its goal as an otoscope device from recently acquired Lighthouse Imaging received an $800 K production order. The company’s product pipeline has five products in the pilot stage, which immediately precedes the full commercial stage.

Last week, the company reported year-over-year revenue growth of 118%. Organic growth was an impressive 61%, and gross margins improved from 30% to 34%. Minus the Lighthouse revenue, the gross margin was 42%. The bottom line was a loss of $74 K for the quarter. Close to profitability. What will it take for the company to turn a profit?

Lighthouse and the original POCI are now combined as one unit. As Lighthouse production becomes integrated with POCI, the gross margins will improve. The company has also raised its prices after many years of unchanged pricing. The margin improvement and new pricing will help, but scaling is the secret sauce for profitability. As the company has grown, losses have been reduced to where profitability is now possible.

Weak cash position

POCI has about $670K in cash, which is insufficient to fund payment of the interest due for the $2.6 million loan which provided funding for the Lighthouse acquisition and a $1.5 million earnout payment due to Lighthouse should it meet contractual goals. Four out of the five products currently in the pilot stage originate from Lighthouse. Per my conversation with CEO Joe Forkey, Lighthouse meeting its earn-out goal will result in more than sufficient funds for POCI to meet its financial obligations and substantially improve the company’s cash position. There is a similar earn-out payment arrangement with Ross Optical, which POCI acquired in June 2019. Should earnout goals not be met, the company has sufficient cash and credit to meet its financial responsibilities.

Lack of share liquidity

There are only about 6 million shares. Insiders and institutions own almost two-thirds of the shares, which have recently been uplisted to Nasdaq. In a previous conversation with Dr. Forkey, I inquired as to why not do a capital raise by issuing shares simultaneously with the uplisting in order to improve the cash position as well as liquidity. Dr. Forkey prefers to issue shares as needed for acquisitions. 2.5 million shares were created to partially fund the Lighthouse acquisition. Dr. Forkey believes that POCI is receiving a better value for its shares via acquisition funding than the company would receive in capital markets and expects that continuing the acquisition strategy along with the uplisting will result in improved liquidity.

I can see the wisdom in Dr. Forkey’s plan as capital markets have provided cash at brutal terms during this rising interest rate climate, and also the acceptance of POCI shares by an acquired company further validates the value of the shares.

Potential supply chain problems

I was concerned about how much titanium Precision uses for its components since a large portion of the world’s supply of titanium comes from Russia and Ukraine. Dr. Forkey said he is aware of the possible supply issues involving titanium but it isn’t a concern because Precision utilizes mostly stainless steel, but there could be a problem with specialty glass. Precision’s customers demand specialty glass from specific manufacturers, which generally tend to be either one German manufacturer or another company based in Japan. Dr. Forkey is concerned that Europe may have an energy problem this winter and curtail some manufacturing activity. Precision has built up its specialty glass inventory to last through the winter. Dr. Forkey also mentioned how the acquisition of Ross Optical, has been critically instrumental in circumventing supply chain issues through Ross’ ability to locate alternative parts or components when a supply issue arises.

Conclusion

POCI’s strategic shift is starting to pay dividends as the company is recording record profits and nears profitability. The acquisitions of Ross Optical and Lighthouse Imaging appear to be good fits as the company has expanded its pipeline and avoided supply chain issues. Scaling and margin improvement should result in profitability, and there is a plan in place to address the low cash position and share liquidity issues. My original investment thesis remains unchanged.

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