PRECISION OPTICS CORPORATION, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and notes to those statements included elsewhere in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2021 and with our audited consolidated financial statements for the year ended June 30, 2021 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on September 28, 2021. This Quarterly Report on Form 10-Q contains forward-looking statements. When used in this report, the words “anticipate,” “suggest,” “estimate,” “plan,” “project,” “continue,” “ongoing,” “potential,” “expect,” “predict,” “believe,” “intend,” “may,” “will,” “should,” “could,” “would” and similar expressions are intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described in this report, the risks described in our Annual Report on Form 10-K for the year ended June 30, 2021 and other reports we file with the Securities and Exchange Commission. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made. We do not intend to update any of the forward-looking statements after the date of this report to conform these statements to actual results or to changes in our expectations, except as required by law. Overview We have been a developer and manufacturer of advanced optical instruments since 1982. Our medical instrumentation line includes traditional endoscopes and endocouplers as well as other custom imaging and illumination products for use in minimally invasive surgical procedures. Much of our recent development efforts have been targeted at the development of next generation endoscopes. We selectively execute internal research and development programs to develop next generation capabilities for designing and manufacturing 3D endoscopes and very small Microprecision™ lenses, anticipating future requirements as the surgical community continues to demand smaller and more enhanced imaging systems for minimally invasive surgery. As Ross Optical Industries of El Paso, Texas we also operate as a supplier of custom optical components and assemblies for military and defense, medical and various other industrial applications. All products sold by us under the Ross Optical name include a custom or catalog optic, which is sourced through our extensive domestic and worldwide network of optical fabrication companies. Most systems make use of optical lenses, prisms, mirrors and windows and range from individual optical components to complex mechano-optical assemblies. Products often include thin film optical coatings that are applied using our in-house coating department. As Lighthouse Imaging of Windham, Maine we also operate as a manufacturer of advanced optical imaging systems and accessories. We have a strong expertise in electrical engineering and development of end to end medical visualization devices. Product development competencies at Lighthouse Imaging include Systems, Optical, Mechanical, Electrical and Process Development Engineering. Our product development team has extensive experience developing visualization systems that are used in a variety of clinical applications. Lighthouse Imaging is an industry leader in chip on tip visualization systems. Approximately 87% of our business during the three months ended September 30, 2021 is from the design and manufacture of high-quality medical devices. Approximately 8% of our revenue during the same period is from the design, manufacture and resale of optical products for military and defense, and 5% is from other industrial, non-medical products. Our proprietary medical instrumentation line and unique custom design and manufacturing capabilities include traditional endoscopes and endocouplers as well as other custom imaging and illumination products for use in minimally invasive surgical procedures. We design and manufacture 3D endoscopes and very small Microprecision™ lenses, assemblies and complete medical devices to meet the surgical community’s continuing demand for smaller, disposable, and more enhanced imaging systems for minimally invasive surgery. We are registered to the ISO 9001:2015 and ISO 13485:2016 Quality Standards and comply with the FDA Good Manufacturing Practices and the European Union Medical Device Directive for CE marking of our medical products. Our internet websites are www.poci.com and www.rossoptical.com. Information on our websites is not intended to be integrated into this report. Investors and others should note that we announce material financial information using our company websites (www.poci.com; www.rossoptical.com), our investor relations website, SEC filings, press releases, public conference calls and webcasts. Information about Precision Optics, our business, and our results of operations may also be announced by social media posts on our Ross Optical LinkedIn page (www.linkedin.com/company/ross-optical-industries/) and Twitter feed (http://twitter.com/rossoptical). 13 The information that we post on these social media channels could be deemed to be material information. Therefore, we encourage investors, the media, and others interested in Precision Optics to review the information that we post on these social media channels. These social media channels may be updated from time to time on Precision Optics’ investor relations website. The information on, or accessible through, our websites and social media channels is not incorporated by reference in this Quarterly Report on Form 10-Q. The markets in which we do business are highly competitive and include both foreign and domestic competitors. Many of our competitors are larger and have substantially greater resources than we do. Furthermore, other domestic or foreign companies, some with greater financial resources than we have, may seek to produce products or services that compete with ours. We routinely outsource specialized production efforts as required to obtain the most cost-effective production. Over the years we have developed extensive experience collaborating with other optical specialists worldwide. We believe that our future success depends to a large degree on our ability to develop new optical products and services to enhance the performance characteristics and methods of manufacture of existing products. Accordingly, we expect to continue to seek and obtain product-related design and development contracts with customers and to selectively invest our own funds on research and development, particularly in the areas of Microprecision™ optics, micro medical cameras, illumination, single-use endoscopes and 3D endoscopes. Our largest customer during the three months ended September 30, 2021 accounted for 9.7% of our revenue and represented assembly revenues for a medical diagnostic system. During the three months ended September 30, 2021 we had revenue from another one hundred sixty-five customers, and none of those customers accounted for more than 10% of our total revenue. Current sales and marketing activities are intended to broaden awareness of the benefits of our new technology platforms and our successful application of these new technologies to medical device projects requiring surgery-grade visualization from sub-millimeter sized devices and 3D endoscopy, including single-use products and assemblies. We market directly to established medical device companies primarily in the United States that we believe could benefit from our advanced endoscopy visualization systems. Through this direct marketing, referrals, attendance at trade shows and a presence in online professional association websites, we have expanded our on-going pipeline of projects to significant medical device companies as well as well-funded emerging technology companies. We expect our customer pipeline to continue to expand as development projects transition to production orders and new customer projects enter the development phase. Our Ross Optical division markets through existing customers and trade shows, in addition to proactive online marketing strategies executed primarily through its website. General This management’s discussion and analysis of financial condition and results of operations is based upon our unaudited consolidated financial statements, which have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. There have been no significant changes in our critical accounting policies as disclosed in the Notes to our Financial Statements contained in our Annual Report on Form 10-K for the year ended June 30, 2021 filed with the Securities and Exchange Commission on September 28, 2021. 14 Results of Operations Our total revenues for the quarter ended September 30, 2021, were $2,336,344, as compared to $2,757,901 for the same period in the prior year, a decrease of $421,557, or 15.3%. Engineering revenue during the quarter ended September 30, 2021 decreased approximately $216,000 compared to the same fiscal quarter of the prior year due primarily to the change in mix of engineering projects. Production revenue had a decrease year-over-year of approximately $268,000 due primarily to COVID-19 related slow-downs instituted by our existing customers. Other revenue changes between the quarter ended September 30, 2021 and the same period of the prior year were considered customary fluctuations with existing customers and project progressions. We generated revenues from 166 unique customers during the quarter ended September 30, 2021, and no single customer accounted for 10% or more of our revenue for the quarter ended September 30, 2021 or the fiscal years ended June 30, 2021, or 2020. The COVID-19 world-wide pandemic that began during the quarter ended March 31, 2020 and the domestic and international impact of policy decisions being made in major countries around the world has had, and could continue to have, an adverse impact on our sources of supply, current and future orders from our customers, collection of amounts owed to us from our customers, our internal operating procedures, and our overall financial condition. Given the uncertainty surrounding the continuation of economic impacts both domestically and abroad, we cannot predict with certainty at this time what the future impact of COVID-19 and resulting business and economic policies in the US and abroad will be on our up-coming quarterly fiscal operating results. Gross profit for the quarter ended September 30, 2021 was $639,032, compared to $975,178 for the same period in the prior year, reflecting a decrease of $336,146. Gross profit for the quarter ended September 30, 2021 as a percentage of our revenues was 27.4%, a decrease from the gross profit percentage of 35.4% for the same period in the prior year. Quarterly gross profit and gross profit percentage depend on a number of factors, including overall sales volume, facility utilization, product sales mix, the costs of engineering services, and production start-up costs and challenges in connection with new products, the effects of COVID-19 pandemic policy decisions on various economies and our suppliers and customers, as well as the effects on production efficiencies due to the augmented policies we have incorporated into our operations as a result of the COVID-19 pandemic. Our gross margin on individual engineering projects is dependent on a number of factors and is expected to fluctuate from quarter to quarter based on the nature and status of engineering projects, unanticipated cost over-runs, design challenges and changes, start-up production activities or other customer-imposed project changes or delays. Our decrease in gross margin from 35.4% to 27.4% during the fiscal quarter ended September 30, 2021 compared to 2020 was primarily the result of a gross margin decrease in one engineering project due to cost over-runs, plus a decrease in higher margin production revenues with customers due to COVID-19 factors. The remainder of our production, engineering and component revenues resulted in margins within our targeted range with reasonably expected fluctuations. Research and development expenses were $105,186 for the quarter ended September 30, 2021, compared to $151,576 for the same period in the prior year, a decrease of $46,390, or 30.6%. In-house research and development and certain internal functions not directly related to customer engagements are classified as research and development expenses with the majority of our engineering, research and development activities being consumed in revenue generating engagements with our customers for the development of their products. During the quarter September 30, 2021 we had a greater amount of our engineering personnel time consumed in customer focused activities causing decreased research and development expense compared to the quarter ended September 30, 2020. Selling, general and administrative expenses were $933,624 for the quarter ended September 30, 2021, compared to $822,002 for the same period in the prior year, an increase of $111,622, or 13.6%. The increase in the three months ended September 30, 2021, compared to the same period of the prior fiscal year was due to increased stock compensation and marketing related expense. We also incurred $172,174 of business acquisition expenses related to the Lighthouse Imaging transaction during the quarter ended September 30, 2021. 15 Liquidity and Capital Resources We have sustained recurring net losses from operations for several years. During the year ended June 30, 2021, we incurred an operating loss of $905,583 and generated cash from operating activities of $46,550. During the three months ended September 30, 2021 we had a net loss of $576,801 and used cash in operating activities of $182,340. At September 30, 2021, cash was $1,669,569, accounts receivables were $1,711,192 and current liabilities were $2,758,416, including $336,572 of customer advances received for future order deliveries. We also raised $1,030,000 during the quarter ended September 30, 2021 in conjunction with the Lighthouse Imaging transaction. This amount was part of the full raise which was completed on October 4, 2021. For the full raise, we issued 937,500 shares of common stock at a purchase price of $1.60 per share to accredited investors in a private placement totaling $1,500,000. Although we have experienced improved financial performance in certain recent fiscal quarters, our operating expenses have also increased and we continue to experience pricing pressure from our customers and challenges in engineering projects and production orders that result in cost over-runs and depressed gross margins. We also experience added uncertainty related to our vendors ability to supply materials and our customers future order levels as a result of the economic impact the COVID-19 world-wide pandemic and related jurisdictional policies and regulations. Consequently, critical to our ability to maintain our financial condition is achieving and maintaining a level of quarterly revenues that generate break even or better financial performance as well as timely collection of accounts receivable from our customers. We believe profitable operating results can be achieved through a combination of revenue levels, realized gross margins and controlling operating expense increases, all of which are subject to periodic fluctuations resulting from sales mix and the stage of completion of varying engineering service projects as they progress towards and into production level revenues We have traditionally funded working capital needs through product sales, management of working capital components of our business, cash received from public and private offerings of our common stock, warrants to purchase shares of our common stock or convertible notes, manufacturing equipment leases, and by customer advances paid against purchase orders by our customers and recorded in the current liabilities section of the accompanying financial statements. We have incurred year to year and quarter to quarter operating losses during our efforts to develop current products including Microprecision™ optical elements, micro medical camera assemblies and 3D endoscopes. Our management believes that the opportunities represented by these technical capabilities and related products have the potential to generate sales increases to achieve breakeven and profitable results. On May 6, 2020, we received loan proceeds in the amount of $808,962 under the Paycheck Protection Program, or PPP, from Bank of America. The PPP, established as part of the Coronavirus Aid, Relief and Economic Security Act, or CARES Act, provides for loans to qualifying businesses that are forgivable provided the loan proceeds are used for eligible purposes, including payroll, benefits, rent and utilities. The unsecured loan dated May 6, 2020 was forgiven on March 30, 2021 by the Small Business Administration pursuant to the CARES Act. The forgiveness of the Promissory Note was recorded as other income in the Consolidated Statements of Operations for the quarter ended March 31, 2021. In October 2021 we acquired the assets of Lighthouse Imaging, LLC as described in note 8. Subsequent Event-Business Acquisition to the accompanying financial statements in this Form 10-Q. To finance that acquisition we entered into a $2,600,000 bank term loan, sold shares of our common stock for gross proceeds of $1,500,000, and secured a $250,000 bank line of credit. Capital equipment expenditures and additional patent costs during the three months ended September 30, 2021 were $30,366. Future capital equipment and patent expenditures will be dependent upon future sales and success of on-going research and development efforts. Contractual cash commitments for the fiscal periods subsequent to September 30, 2021, are summarized as follows: Fiscal 2022 Thereafter Total Capital lease for equipment, including interest $ 36,464 $ 169,161 $ 205,625 Minimum operating lease payments - Ross Optical division $ 47,116 $ 0 $ 47,116 We have contractual cash commitments related to open purchase orders as of September 30, 2021 of approximately $500,922. 16 Off-Balance Sheet Arrangements We currently have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. Item 3. Quantitative and Qualitative Disclosures About Market Risk. As a smaller reporting company, as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item.