PRECISION OPTICS CORPORATION, INC. 10-Q

Item 1. Financial Statements. PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) September 30, June 30, 2022 2022 ASSETS Current Assets: Cash and cash equivalents $ 673,502 $ 605,749 Accounts receivable, net of allowance for doubtful accounts of $ 50,114 at September 30, 2022 and $ 44,135 at June 30, 2022 3,414,685 2,663,872 Inventories 2,755,660 3,022,147 Prepaid expenses 187,498 213,448 Total current assets 7,031,345 6,505,216 Fixed Assets: Machinery and equipment 3,222,406 3,215,412 Leasehold improvements 847,363 843,903 Furniture and fixtures 225,564 219,999 Total Fixed Assets 4,295,333 4,279,314 Less—Accumulated depreciation and amortization 3,704,254 3,651,843 Net fixed assets 591,079 627,471 Operating lease right-to-use asset 478,645 517,725 Patents, net 242,553 229,398 Goodwill 8,824,210 8,824,210 TOTAL ASSETS $ 17,167,832 $ 16,704,020 LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities: Current portion of capital lease obligation $ 41,318 $ 40,705 Current maturities of long-term debt 371,429 367,714 Current portion of acquisition earn out liability 166,667 166,667 Accounts payable 2,305,907 2,239,175 Customer advances 1,032,891 905,113 Accrued compensation and other 1,117,000 716,702 Operating lease liability 160,923 150,565 Total current liabilities 5,196,135 4,586,641 Capital lease obligation, net of current portion 101,128 111,691 Long-term debt, net of current maturities and debt issuance costs 1,865,498 1,961,141 Acquisition earn out liability, net of current portion 714,375 705,892 Operating lease liability, net of current portion 317,722 367,160 Stockholders’ Equity: Common stock, $ 0.01 par value: 50,000,000 shares authorized; issued and outstanding – 16,915,089 shares at September 30, 2022 and June 30, 2022 169,150 169,150 Additional paid-in capital 56,971,729 56,896,739 Accumulated deficit ( 48,167,905 ) ( 48,094,394 ) Total stockholders’ equity 8,972,974 8,971,495 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 17,167,832 $ 16,704,020 The accompanying notes are an integral part of these consolidated interim financial statements. 3 PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2022 AND 2021 (UNAUDITED) Three Months Ended September 30, 2022 2021 Revenues $ 5,085,301 $ 2,336,344 Cost of Goods Sold 3,360,647 1,697,312 Gross Profit 1,724,654 639,032 Research and Development Expenses, net 245,477 105,186 Selling, General and Administrative Expenses 1,495,766 933,624 Business acquisition expenses – 172,174 Total Operating Expenses 1,741,243 1,210,984 Operating Loss ( 16,589 ) ( 571,952 ) Interest Expense ( 56,922 ) ( 4,849 ) Net Loss $ ( 73,511 ) $ ( 576,801 ) Loss Per Share: Basic and Fully Diluted $ ( 0.00 ) $ ( 0.04 ) Weighted Average Common Shares Outstanding: Basic 16,915,089 13,282,476 Fully Diluted 16,915,089 13,282,476 The accompanying notes are an integral part of these consolidated interim financial statements. 4 PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE THREE MONTHS ENDED SEPTEMBER 30 , 2022 AND 2021 (UNAUDITED) Three Month Period Ended September 30, 2022 Number of Shares Common Stock Additional Paid-in Capital Common Stock Subscribed Accumulated Deficit Total Stockholders’ Equity Balance, July 1, 2022 16,915,089 $ 169,150 $ 56,896,739 $ – $ ( 48,094,394 ) $ 8,971,495 Stock-based compensation – – 74,990 – – 74,990 Net loss – – – – ( 73,511 ) ( 73,511 ) Balance, September 30, 2022 16,915,089 $ 169,150 $ 56,971,729 $ – $ ( 48,167,905 ) $ 8,972,974 Three Month Period Ended September 30, 2021 Number of Shares Common Stock Additional Paid-in Capital Common Stock Subscribed Accumulated Deficit Total Stockholders’ Equity Balance, July 1, 2021 13,282,476 $ 132,825 $ 50,464,280 $ – $ ( 47,165,978 ) $ 3,431,127 Stock-based compensation – – 160,071 – – 160,071 Proceeds from private placement of common stock subscribed, net of estimated issuance costs of $ 10,000 – – ( 10,000 ) 1,030,000 – 1,020,000 Net loss – – – – ( 576,801 ) ( 576,801 ) Balance, September 30, 2021 13,282,476 $ 132,825 $ 50,614,351 $ 1,030,000 $ ( 47,742,779 ) $ 4,034,397 The accompanying notes are an integral part of these consolidated interim financial statements. 5 PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED SEPTEMBER 30 , 2022 AND 2021 (UNAUDITED) Three Months Ended September 30, 2022 2021 Cash Flows from Operating Activities: Net Loss $ ( 73,511 ) $ ( 576,801 ) Adjustments to reconcile net loss to net cash used in by operating activities - Depreciation and amortization 52,411 42,280 Stock-based compensation expense 74,990 160,071 Non-cash interest expense 9,412 – Changes in operating assets and liabilities - Accounts receivable, net ( 750,813 ) 167,563 Inventories, net 266,487 ( 235,495 ) Prepaid expenses 25,950 8,309 Accounts payable 66,732 81,091 Customer advances 127,778 ( 113,512 ) Accrued compensation and other 400,298 284,154 Net cash provided by (used in) operating activities 199,734 ( 182,340 ) Cash Flows from Investing Activities: Purchases of fixed assets ( 16,019 ) ( 24,325 ) Additional patent costs ( 13,155 ) ( 6,041 ) Net cash used in investing activities ( 29,174 ) ( 30,366 ) Cash Flows from Financing Activities: Payment of capital lease obligation ( 9,950 ) ( 9,375 ) Payments of long-term debt ( 92,857 ) – Gross Proceeds from private placement of common stock subscribed – 1,030,000 Net cash (used in) provided by financing activities ( 102,807 ) 1,020,625 Net increase in cash and cash equivalents 67,753 807,919 Cash and cash equivalents, beginning of period 605,749 861,650 Cash and cash equivalents, end of period $ 673,502 $ 1,669,569 Supplemental disclosure of non-cash financing activities: Offering costs included in accrued compensation and other $ – $ 10,000 The accompanying notes are an integral part of these consolidated interim financial statements. 6 PRECISION OPTICS CORPORATION, INC. NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation and Operations The accompanying consolidated financial statements include the accounts of Precision Optics Corporation, Inc. and its wholly-owned subsidiaries (the “Company”). All significant intercompany accounts and transactions have been eliminated in consolidation. These consolidated financial statements have been prepared by the Company, without audit, and reflect normal recurring adjustments which, in the opinion of management, are necessary for a fair statement of the results of the first quarter of the Company’s fiscal year 2023. These consolidated financial statements do not include all disclosures associated with annual consolidated financial statements and, accordingly, should be read in conjunction with footnotes contained in the Company’s consolidated financial statements for the year ended June 30, 2022, together with the Report of Independent Registered Public Accounting Firm filed under cover of the Company’s 2022 Annual Report on Form 10-K, filed with the Securities and Exchange Commission on September 27, 2022. Use of Estimates The preparation of these consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The Company bases its 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. Income (Loss) Per Share Basic income (loss) per share is computed by dividing net income or net loss by the weighted average number of shares of common stock outstanding during the period. Diluted income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period, plus the number of potentially dilutive securities outstanding during the period such as stock options. For the three months ended September 30, 2022, the effect of such securities was antidilutive and not included in the fully diluted calculation because of the net loss generated during those periods. The following is the calculation of income (loss) per share for the three months ended September 30, 2022 and 2021: Schedule of earnings per share Three Months Ended September 30, 2022 2021 Net Income (Loss) Basic and Fully Diluted $ ( 73,511 ) $ ( 576,801 ) Weighted Average Shares Outstanding Basic and Fully Diluted 16,915,089 13,282,476 Loss Per Share - Basic and Fully Diluted $ ( 0.00 ) $ ( 0.04 ) The number of shares issuable upon the exercise of outstanding stock options that were excluded from the computation as their effect was antidilutive was approximately 2,714,000 and 2,563,200 for the three months ended September 30, 2022 and 2021, respectively. 7 Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In assessing the likelihood of utilization of existing deferred tax assets, management has considered historical results of operations and the current operating environment. Based on this evaluation, a full valuation reserve has been provided for the deferred tax assets. Goodwill and Patents Long-lived assets such as goodwill and patents are capitalized when acquired and reviewed for impairment whenever events or changes in circumstances indicate that the book value of the asset may not be recoverable. Impairment of the carrying value of long-lived assets such as goodwill and patents would be indicated if the best estimate of future undiscounted cash flows expected to be generated by the asset grouping is less than its carrying value. If an impairment is indicated, any loss is measured as the difference between estimated fair value and carrying value and is recognized in operating income or loss. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. No such impairments of goodwill or patents have been estimated by management as of September 30, 2022. 2. BUSINESS ACQUISITION On October 4, 2021, the Company acquired substantially all of the assets of Lighthouse Imaging, LLC, of Windham, Maine, a medical optics and digital imaging business operating as a designer and manufacturer of advanced optical imaging systems and accessories with a strong expertise in electrical engineering and development of end-to-end medical visualization devices. The actual results of operations of the Lighthouse division are included in the accompanying consolidated financial statements as of, and for the three months ended, September 30, 2022. The purchase price for Lighthouse Imaging included $ 1,500,000 as potential earn-out consideration over the subsequent two year period, contingent on the Lighthouse division meeting specified annual gross profit targets. The Lighthouse division did not meet the target for the first $ 750,000 portion of the earn-out, and the contingent liability associated with that portion was reversed and recognized as other income in the fiscal quarter ended June 30, 2022. The second $ 750,000 portion of the earn-out contingent liability will be paid if the target level of gross profit is earned by the Lighthouse division for the period from October 1, 2022 through September 30, 2023. Consolidated unaudited pro forma results of operations for the Company are presented below assuming that the acquisition of the Lighthouse division had occurred on July 1, 2021. Pro forma operating results include net adjustments resulting from the acquisition transaction during the three months ended September 30, 2021. Schedule of consolidated pro forma results Three Months Ended September 30, 2022 2021 (Actual) (Pro Forma) Revenues $ 5,085,301 $ 3,780,681 Net Loss $ ( 73,511 ) $ ( 519,506 ) Loss per Share Basic and diluted $ ( 0.00 ) $ ( 0.03 ) Pro forma financial information is not necessarily indicative of the Company’s actual results of operations if the acquisition had been completed at the date indicated, nor is it necessarily an indication of future operating results. Amounts do not include any operating efficiencies or cost saving that the Company believes may be achievable. 8 3. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out) or market and consisted of the following: Schedule of inventory September 30, 2022 June 30, 2022 Raw Materials $ 1,075,948 $ 1,414,996 Work-In-Progress 469,647 460,460 Finished Goods 1,210,065 1,146,691 Total Inventories $ 2,755,660 $ 3,022,147 4. BANK FINANCING ACTIVITIES Bank Line of Credit On October 4, 2021, the Company entered into a Loan Agreement with Main Street Bank of Marlborough, Massachusetts, which provided for a $ 2,600,000 Term Loan and a $ 250,000 Revolving Line of Credit Loan Facility, which was increased to $500,000 effective May 17, 2022. The $ 500,000 line of credit is due on demand and had no borrowings outstanding at September 30, 2022. Borrowings under the line of credit bear interest payable monthly at the prime lending rate plus 1.5% per annum, or 7.75 % as of September 30, 2022, and shall not be less than 4.75% per annum. Borrowings under the line of credit are limited to the borrowing base comprised of a percentage of accounts receivable and inventory and are secured by all the assets of the Company. Long-Term Debt Long-term debt consists of the following at September 30, 2022: Schedule of long-term debt Amount Term Loan Note payable to Main Street Bank with monthly principal payments of $ 30,952 .38 plus interest at the rate of 7.00 % as of September 30, 2022. Secured by all assets of the Company, and subject to certain periodic reporting to the bank, an annual minimum EBITDA plus stock based compensation to debt service coverage ratio of 1.20:1 commencing with the fiscal year ending June 30, 2023, and other conditions. The Term Loan Note matures on October 15, 2028 . $ 2,259,524 Less current maturities ( 371,429 ) Less debt issuance costs, net of accumulated amortization of $ 929 ( 22,597 ) Long-term debt, net of current portion of debt issuance costs $ 1,865,498 9 At September 30, 2022 principal payments due on the Term Loan Note payable are as follows: Schedule of principal payments due term loan note payable Fiscal Year Ending June 30: 2023 $ 278,572 2024 371,429 2025 371,429 2026 371,429 2027 371,429 Thereafter 495,236 Total long term debt $ 2,259,524 5. LEASE OBLIGATIONS In March 2021 the Company entered into a five-year capital lease in the amount of $ 161,977 for manufacturing equipment. In January 2020, the Company entered into a five-year capital lease for $ 47,750 for manufacturing equipment. The net book value of fixed assets under capital lease obligations as of September 30, 2022 is $ 135,667 . On July 1, 2019 the Company entered into a three-year operating lease for its facility in El Paso, Texas, and in February 2022 the Company entered into an extension of the lease for an additional three years through June 2025. Remaining minimum lease payments at September 30, 2022 total $ 123,842 . Total rent expense including base rent and common area expenses was $ 11,630 and $ 13,997 during the fiscal quarters ended September 30, 2022 and 2021, respectively. On October 4, 2021 the Company assumed the remaining term of the Windham, Maine lease as part of the Lighthouse acquisition. The lease expires on July 31, 2025. Remaining minimum lease payments at September 30, 2022 total $ 390,229 . Total rent expense including base rent and common area expenses was $ 35,017 during the fiscal quarter ended September 30, 2022. Included in the accompanying balance sheet at September 30, 2022 is a right-of-use asset of $ 478,645 and current and long-term right-of-use operating lease liabilities of $ 160,924 and $ 317,722 , respectively. At September 30, 2022 future minimum lease payments under the capital lease and operating lease obligations are as follows: Future minimum lease payments Fiscal Year Ending June 30: Capital Leases Operating Lease 2023 $ 36,464 $ 136,167 2024 48,619 182,652 2025 43,917 183,775 2026 28,028 11,477 Total Minimum Payments 157,028 $ 514,071 Less: amount representing interest 14,582 Present value of minimum lease payments 142,446 Less: current portion 41,318 $ 101,128 The Company’s operating leases for its Gardner, Massachusetts office, production and storage spaces plus an equipment lease have expired and are continuing on a month-to-month tenant at will basis. Rent expense on these operating leases was $ 50,826 and $ 51,277 for the fiscal quarter ended September 30, 2022 and 2021, respectively. 10 6. STOCK-BASED COMPENSATION Stock Options The following table summarizes stock-based compensation expense for the three months ended September 30, 2022 and 2021: The share amounts and prices shown below do not reflect adjustment for a 1-for-3 reverse stock split that took effect after the close of business on November 1, 2022. Schedule of stock-based compensation expense Three Months Ended September 30, 2022 2021 Cost of Goods Sold $ 6,298 $ 28,415 Research and Development Expenses 30,756 43,489 Selling, General and Administrative Expenses 37,936 88,167 $ 74,990 $ 160,071 No compensation has been capitalized because such amounts would have been immaterial. The following tables summarize stock option activity for the three months ended September 30 2022: Schedule of stock option activity Options Outstanding Number of Shares Weighted Average Exercise Price Weighted Average Contractual Life Outstanding at June 30, 2022 2,714,000 $ 1.33 7.08 years Exercised, Granted and Cancelled – – – Outstanding at September 30, 2022 2,714,000 $ 1.33 6.83 years 11 Information related to the stock options outstanding as of September 30, 2022 is as follows: Schedule of stock options outstanding by exercise price range Range of Exercise Prices Number of Shares Weighted- Average Remaining Contractual Life (years) Weighted- Average Exercise Price Exercisable Number of Shares Exercisable Weighted- Average Exercise Price $ 0.48 60,000 3.50 $ 0.48 60,000 $ 0.48 $ 0.50 80,000 3.72 $ 0.50 80,000 $ 0.50 $ 0.55 15,000 5.51 $ 0.55 15,000 $ 0.55 $ 0.70 100,000 5.84 $ 0.70 100,000 $ 0.70 $ 0.73 630,000 4.41 $ 0.73 630,000 $ 0.73 $ 0.85 6,000 0.26 $ 0.85 6,000 $ 0.85 $ 0.90 36,000 1.69 $ 0.90 36,000 $ 0.90 $ 1.25 45,000 7.47 $ 1.25 30,000 $ 1.25 $ 1.30 441,000 6.70 $ 1.30 431,500 $ 1.30 $ 1.40 70,000 8.13 $ 1.40 70,000 $ 1.40 $ 1.42 100,000 6.95 $ 1.42 100,000 $ 1.42 $ 1.45 5,000 8.44 $ 1.45 1,667 $ 1.45 $ 1.50 70,000 7.19 $ 1.50 70,000 $ 1.50 $ 1.68 540,000 8.68 $ 1.68 540,000 $ 1.68 $ 1.87 30,000 9.61 $ 1.87 – $ – $ 2.00 100,000 8.57 $ 2.00 10,000 $ 2.00 $ 2.09 246,000 9.36 $ 2.09 – $ – $ 2.26 140,000 9.14 $ 2.26 90,000 $ 2.26 $ 0.48 – 2.26 2,714,000 6.83 $ 1.33 2,270,167 $ 1.20 The aggregate intrinsic value of the Company’s in-the-money outstanding and exercisable options as of September 30, 2022 was $ 1,982,850 and $ 1,951,825 , respectively. 7. REVENUE RECOGNITION Revenues are recognized as the performance obligations to deliver products or services are satisfied and are recorded based on the amount of consideration the Company expects to receive in exchange for satisfying the performance obligations. Most of the Company’s products and services are marketed to medical device companies with approximately 85% of sales to customers in the United States. Products and services are primarily transferred to customers at a point in time based upon when services are performed or product is shipped. Other selling costs to obtain and fulfill contracts are expensed as incurred due to the short-term nature of a majority of its contracts. The Company extends terms of payment to its customers based on commercially reasonable terms for the markets of its customers, while also considering their credit quality. Shipping and handling costs charged to customers are included in revenues. 12 The Company disaggregates revenues by product and service types as it believes it best depicts how the nature, amount, timing and uncertainty of revenues and cash flows are affected by economic factors. Revenues are comprised of the following for the three months ended September 30, 2022 and 2021: Schedule of disaggregation of revenues Three Months Ended September 30, 2022 2021 Engineering Design Services $ 1,642,967 $ 373,316 Optical Components 2,652,681 1,538,932 Medical Device Products & Assemblies 789,653 424,096 $ 5,085,301 $ 2,336,344 Contract Assets and Liabilities The nature of the Company’s products and services does not generally give rise to contract assets as it typically does not incur costs to fulfill a contract before a product or service is provided to a customer. The Company’s costs to obtain contracts are typically in the form of sales commissions paid to employees. The Company has elected to expense sales commissions associated with obtaining a contract as incurred as the amortization period is generally less than one year. These costs have been recorded in selling, general and administrative expenses. As of September 30, 2022, there were no contract assets recorded in the Company’s Consolidated Balance Sheets. The Company’s contract liabilities arise from unearned revenue received from customers at inception of contracts or where the timing of billing for services precedes satisfaction of our performance obligations. The Company generally satisfies performance obligations within one year from the contract inception date. Contract liabilities, which were recorded as customer advances in the Company’s Consolidated Balance Sheets, and unearned revenue are comprised of the following: Schedule of contract liabilities Three Months Ended September 30, 2022 2021 Contract liabilities, beginning of period $ 905,113 $ 450,084 Unearned revenue received from customers 455,613 205,389 Revenue recognized ( 327,835 ) ( 318,901 ) Contract liabilities, end of period $ 1,032,891 $ 336,572 8. COVID-19 PANDEMIC 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 the Company’s sources of supply, current and future orders from its customers, collection of amounts owed to the Company from its customers, its internal operating procedures, and the Company’s overall financial condition. 13