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 March 31, 2025 and with our audited consolidated financial statements for the year ended June 30, 2024 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on September 30, 2024 , as amended by that certain Amendment No. 1 on Form 10-K/A filed with the Securities and Exchange Commission on October 28, 2024. 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, 2024 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. 14 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, ear, 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. 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 among 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 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 and related disclosures. 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 under different assumptions or conditions and any such differences may be material. 15 Critical Accounting Policies and 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, 2024 filed with the Securities and Exchange Commission on September 30, 2024. Results of Operations Revenue Three Months Ended March 31, 2025 Percent of Sales 2024 Percent of Sales Increase (Decrease) Percent Change Engineering Design Services $ 924,792 22.1 $ 2,274,679 43.4 $ (1,349,887 ) (59.3 ) Optical Components 2,934,999 70.1 2,402,622 45.8 532,377 22.2 Finished Products and Assemblies 326,177 7.8 565,278 10.8 (239,101 ) (42.3 ) Total Revenues $ 4,185,968 100.0 $ 5,242,579 100.0 $ (1,056,611 ) (20.2 ) Nine Months Ended March 31, 2025 Percent of Sales 2024 Percent of Sales Increase (Decrease) Percent Change Engineering Design Services $ 3,980,155 30.8 $ 6,440,895 44.8 $ (2,460,740 ) (38.2 ) Optical Components 8,000,344 62.0 6,285,808 43.7 1,714,536 27.3 Finished Products and Assemblies 929,429 7.2 1,661,420 11.5 (731,991 ) (44.1 ) Total Revenues $ 12,909,928 100.0 $ 14,388,123 100.0 $ (1,478,195 ) (10.3 ) Total revenues for the quarter ended March 31, 2025 were $4,185,968, as compared to $5,242,579 for the same period in the prior year, a decrease of $1,056,611 or 20.2% and for the nine months ended March 31, 2025 was $12,909,928 as compared to $14,388,123 for the same period in the prior year, a decrease of $1,478,195, or 10.3%. Revenue from Engineering Design Services decreased 59.3% and 38.2% during the three- and nine-month periods ending March 31, 2025 from the same periods in the prior fiscal year. Revenue decreases in the engineering category resulted from decreased demand for services, increases in internal research and development, and delays related to milestone completion. Engineering revenue in the quarter was reduced due to unplanned increases in non-billable sustaining engineering activity to support manufacturing scale up along with delayed revenue opportunities within the product development pipeline. Revenue from Optical Components increased 22.2% and 27.3% during the three- and nine-month periods ending March 31, 2025 from the same periods in the prior fiscal year due to the introduction of new defense/aerospace and medical device programs. Revenue from Finished Products and Assemblies decreased 42.3% and 44.1% during the three- and nine-month periods ending March 31, 2025 from the same periods in the prior fiscal year. The decreases in Finished Products and Assemblies were attributable to lower demand for certain production programs and the timing of order fulfillment. 16 Gross Profit Gross margin decreased to 10.0% during the quarter ending March 31, 2025, compared to 35.5% for the quarter ending March 31, 2024. Gross profit decreased to $417,975 during the three months ending March 31, 2025, compared to $1,858,737 for the three months ended March 31, 2024, primarily driven by yield issues associated with new manufacturing lines, lower utilization of billable engineering resources, and the decreases in revenue discussed above. Gross margin decreased to 20.2% during the nine months ending March 31, 2025, compared to 33.2% for the nine months ending March 31, 2024. Gross profit decreased to $2,605,247 during the nine months ending March 31, 2025, compared to $4,773,324 for the nine months ending March 31, 2024. Research & Development R&D expenses increased $18,469 to $211,242 during the quarter ending March 31, 2025, compared to $192,773 during the quarter ending March 31, 2024. R&D expenses increased $302,389 to $929,648 during the nine months ending March 31, 2025, compared to $627,259 during the nine months ending March 31, 2024. R&D expenses for the period represent employee-related expenses to support product improvements, the development of new technologies and standardized approaches to address the opportunities for an evolving single-use medical device environment. Selling, General and Administrative Expenses SG&A expenses increased $320,527, or 16.7% to $2,245,018 during the three months ending March 31, 2025, compared to $1,924,491 during the three months ending March 31, 2024. The increase in SG&A for the three-month period was primarily due to increased personnel costs, chiefly stock-based compensation and recruiting expense, SG&A expenses increased $356,799, or 6.5% to $5,870,846 during the nine months ending March 31, 2025, compared to $5,514,047 during the nine months ending March 31, 2024. Liquidity and Capital Resources Based on our current plans and business conditions, management believes that the Company’s available cash and cash equivalents, the cash generated from operations, availability on our line of credit, and our ability to raise funds in the capital markets will be sufficient to provide for the Company’s working capital and capital expenditure requirements for at least 12 months from the date of this filing. However, our cash on hand and cash generated solely from operations may be insufficient to meet working capital needs for such period and we may be required to raise external financing in the short-term. Net Cash Used in Operating Activities During the nine months ending March 31, 2025, net cash used in operating activities totaled $2,978,165 as compared to $1,706,998 during the nine months ending March 31, 2024. The increase in net cash used in operating activities was primarily due to the increase in net loss and inventory during the nine months ending March 31, 2025, partially offset by the increase in accounts payable and customer advances during such period. Net Cash Used in Investing Activities During the nine months ending March 31, 2025, net cash used in investing activities was $149,837, consisting of purchases of property and equipment net of adjustments in patent costs. During the nine months ending March 31, 2024, net cash used in investing activities was $282,078, consisting of purchases of property and equipment and patent costs. Net Cash Provided by Financing Activities During the nine months ending March 31, 2025, we made payments of $196,487 on term notes and capital leases and repaid $1,000,000 on our revolving line of credit. We raised a net of $6,270,136 from two registered direct offerings made in August 2024 and February 2025 pursuant to our shelf registration statement. During the nine months ending March 31, 2024, we made payments of $417,109 on term notes and capital leases offset by borrowings on the line of credit of $400,000. 17 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. There were no borrowings under the Revolver at March 31, 2025. Our loan agreement contains a minimum annual debt service coverage ratio covenant of 1.2x. We did not meet this annual debt service coverage ratio as of June 30, 2024. Our lender has agreed to waive compliance with the debt service ratio covenant for the period ending June 30, 2024. In addition to the waiver, we have entered into amendments dated September 30, 2024 with our lender to both term loans which provide for a six-month period of interest only payments from October 15, 2024 through March 15, 2025. We will begin to pay principal and interest under the Notes beginning with the payments due on April 15, 2025, with a new amortization schedule for the remaining term for such Notes through their maturity date. On February 14, 2025 the lender agreed to waive compliance with the annual debt service coverage ratio covenant for the fiscal year ended June 30, 2025 subject to a $30,000 waiver fee and the completion of an equity raise of at least $4,500,000 by February 24, 2025, which we completed on February 21, 2025. Any future advances are contingent on the Company achieving a minimum Debt Service Coverage ratio of 1.20x based on quarterly testing. There were no other changes to or modifications to the Loan Agreement or the Notes. On August 14. 2024 we entered into securities purchase agreements with institutional and accredited investors in addition to certain directors and officers of the Company for the purchase and sale of 265,868 shares of the Company’s common stock resulting in gross proceeds of approximately $1.4 million before deducting placement agent commissions and other estimated offering expenses. Net proceeds were $1,204,542. On February 19, 2025 the Company entered into securities purchase agreements with institutional and accredited investors for the sale of $1,272,500 shares of the Company’s common stock in a registered direct offering at a purchase price of $4.00 per share. The offering closed on February 21, 2025 with net proceeds after transaction costs of $5,053,000. Capital equipment expenditures and additional patent costs during the nine months ended March 31, 2025 and in the same period in the prior year were $7,484 and $282,078, respectively. Contractual cash commitments for the fiscal periods subsequent to March 31, 2025, are summarized as follows: Fiscal 2025 Thereafter Total Capital lease for equipment, including interest $ 9,335 $ 28,004 $ 37,339 Minimum operating lease payments $ 45,944 $ 11,477 $ 57,421 We have contractual cash commitments related to open purchase orders as of March 31, 2025 of approximately $5,740,000. 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. 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. 18