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, 2023 and with our audited consolidated financial statements for the year ended June 30, 2023 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on September 28, 2023. 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, 2023 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 proprietary medical instrumentation line, unique custom design and manufacturing capabilities, and expert engineering and development has generated traditional proprietary endoscopes and endocouplers as well as other custom imaging and illumination products for our customers’ 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. Effective June 1, 2019 we acquired the operating assets of Ross Optical Industries, Inc. of El Paso, Texas. As Ross Optical Industries 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 suppliers. 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. Effective October 1, 2021 we acquired the operating assets of Lighthouse Imaging, LLC of Windham, Maine. Our Lighthouse Imaging division supplements our operations as a manufacturer of advanced optical imaging systems and accessories and has provided further 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. Since the purchase we have integrated these acquired engineering and operational capabilities to provide an expanded, unified offering to our customers. 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. 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. Over the years we have developed extensive experience collaborating with other optical specialists worldwide. The markets for our products have increasingly been driven by the demand for smaller and more enhanced imaging systems by the needs of the surgical community, including applications for the brain, eye, wear, urology, cardiology/angiography and the spine. 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. 12 We produce micro-precision optics, which are millimeter sized and smaller cameras with low manufacturing costs. The small size provides visualization for new procedures in new parts of the body and for existing procedures that are currently performed blind or with sub-optimal imaging, facilitating the development of new surgical procedures that are currently impractical. We use patented and patent-pending approaches to fabricating opto-mechanical and opto-electronic systems. We have developed and helped commercialize applications for numerous customers in the medical device and defense/aerospace industries. 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. Competition amongst medical device companies is increasing with multiple companies now pursuing less expensive, procedure specific robotic systems. 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 TM optics, micro medical cameras, illumination, single-use endoscopes, and 3D endoscopes. We are one of only a handful of companies in the world to design and provide 3D endoscopes. By designing systems with low manufacturing costs, we have also begun to penetrate the single-use endoscope market. Single-use endoscopes virtually eliminate the potential for patient cross-contamination and support a number of additional operational benefits for hospitals and surgeons. We estimate this segment of the overall minimally invasive surgical market is growing at two to three times the rate of the overall market. 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 are registered to the ISO 9001:2015 and ISO 13485:2016 Quality Standards and comply with the FDA Good Manufacturing Practices. Our websites are www.poci.com, www.rossoptical.com, and www.lighthouseoptics.com. The information contained on our websites does not constitute part of this report. 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, 2023 filed with the Securities and Exchange Commission on September 28, 2023. Results of Operations Total revenues for the quarter ended September 30, 2023 were $4,321,255, as compared to $5,085,301 for the same period in the prior year, a decrease of $764,046, or 15.0%. During the three months ended September 30, 2023, approximately 44% our business was from engineering services primarily relating to the design of medical device optical assemblies, 44% from the sale of both internally manufactured and purchased optical components, and 12% from the manufacture of optical assemblies and sub-assemblies primarily for medical device instrument. During the three months ended September 30, 2022, approximately 32% our business was from engineering services primarily relating to the design of medical device optical assemblies, 52% from the sale of both internally manufactured and purchased optical components, and 16% from the manufacture of optical assemblies and sub-assemblies primarily for medical device instrument applications. During the quarter ended September 30, 2023, compared to the same period in the prior year, optical component revenue decreased approximately $749,000, assembly production revenues decreased $273,000, while engineering revenue increased approximately $258,000 to $1,901,000 from $1,643,000. We believe the decreases in optical components were largely driven by lower order volumes as customers sought to rebalance their inventories, which had previously grown beyond sustainable levels due to increased ordering in response to concerns about supply chain disruptions. The decreases in medical device products and assemblies was attributable to timing differences between the exit of certain mature customer programs, reorders for ongoing products and the introduction of new customer programs, primarily in the areas of medical endoscopes, including single-use devices and new defense / aerospace commitments. Revenue increases in the engineering category were driven by efforts to complete design engagements on these very same products in preparation for commercial production later in our fiscal year. 13 Gross profit for the quarter ended September 30, 2023 of $1,463,611 reflected a decrease of $175,830, or 10.7%, as compared to gross profit for the same period in the prior year and was primarily driven by the decrease in revenue discussed above. Gross profit, as a percentage of revenues for the quarter ended September 30, 2023, was 33.9% as compared to gross profit, as a percentage of revenues for the same period in the prior year, of 32.2%, due in part to improved utilization of our engineering resources. Gross profit and the gross profit percentage for any given fiscal period depend on many factors, including overall sales volume, facility utilization, product sales mix, the nature and costs of engineering services, design challenges and changes, production start-up costs, customer-imposed project changes or delays, and the effects of COVID-19 pandemic policy decisions on various economies and our suppliers and customers. Research and development expenses were $212,758, or 4.9% of revenue for the quarter ended September 30, 2023, as compared to $245,477, or 4.8% of revenue for the same period in the prior year, a decrease of $32,719, or 13.3%. Selling, general and administrative expenses were $1,656,146 for the quarter ended September 30, 2023, compared to $1,495,766 for the same period in the prior year, an increase of $160,380 or 8.2%. The increase in selling, general and administrative expenses in the three months ended September 30, 2023 was primarily due to increased marketing-related expenses, increased personnel costs and increased professional fees associated with public company expenses. Liquidity and Capital Resources During the quarter ended September 30, 2023, cash on hand funded increases in accounts receivable of $625,719, offset by increased customer advances of $250,293, increases in inventory of $194,995, increases in prepaid expenses of $112,120, and a net decrease in accounts payable, accrued expenses and other of $390,720. During the quarter ended September 30, 2023 we also made payments of $138,876 on our term notes and capital leases. These items, in addition to the impact of the quarterly net loss, net of depreciation, amortization, stock-based compensation and other non-cash items, resulted in a decrease of $1,555,383 in our cash and cash equivalents at September 30 2023 from $2,925,852 at June 30, 2023 to $1,370,769 at September 30, 2023. In October 2021 we entered a $2,600,000 term loan with a commercial bank. In June 2023 we added a second term loan in the amount of $750,000. We secured a $250,000 line of credit from the same bank in October 2021 for working capital needs, which was increased to $500,000 in May 2022 and to $1,250,000 in June 2023. On June 20, 2023, we also raised $2,288,000, net of expenses, through a private placement of 420,000 shares of our common stock. There were no borrowings outstanding on the line of credit on September 30, 2023 and full availability in the amount of $1,250,000. Capital equipment expenditures and additional patent costs during the quarter ended September 30, 2023 and the same period in the prior year were $43,517 and $29,174, respectively. Contractual cash commitments for the fiscal periods subsequent to September 30, 2023, are summarized as follows: Fiscal 2024 Thereafter Total Capital lease for equipment, including interest $ 36,464 $ 71,923 $ 108,387 Minimum operating lease payments $ 136,989 $ 195,252 $ 332,241 We have contractual cash commitments related to open purchase orders as of September 30, 2023 of approximately $2,060,000. 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. 14 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.