PRECISION OPTICS CORPORATION, INC. 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis should be read in conjunction with the Financial Statements and Notes thereto, and other financial information included elsewhere in this Annual Report on Form 10-K. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains descriptions of our expectations regarding future trends affecting our business. The following discussion sets forth certain factors we believe could cause actual results to differ materially from those contemplated by the forward-looking statements. Critical Accounting Policies and Estimates Allowance for Credit Losses We are subject to credit risk primarily in our trade accounts receivable. We generally do not require collateral or other security as a condition of sale, rather we rely on credit approval, balance limitation and monitoring procedures to control credit risk in trade account financial instruments. Our customer base includes many large medical device and defense/aerospace companies, as well as newly incorporated entities pursuing emerging technologies. In those cases when we cannot determine the creditworthiness of our customer, we obtain prepayments and deposits that we judge will be sufficient to mitigate the risk of a significant financial loss. We establish reserves against losses that include both a review of specific account balances and current payment characteristics which are monitored contemporaneously to determine the adequacy of our reserve. Nevertheless, our customers may be adversely impacted by economic factors beyond our understanding and control, and which are difficult to foresee or estimate. A 1% increase in the accounts receivable reserve would increase our costs by approximately $44,000. We recognized bad debt expenses of $38,000 and $202,000 for the years ending June 30, 2025, and June 30, 2024, respectively. 18 Reserve for Excess and Obsolete Inventory Inventories, consisting of raw materials, work in process and finished goods, are primarily accounted for using the first-in first-out method, and are valued at the lower of cost and net realizable value. This valuation requires us to make judgments, based on currently available information, regarding product demand and the potential for a future financial loss resulting from the liquidation and disposal of unusable or unsaleable inventory. These assumptions about the future disposition of inventory are inherently uncertain, and changes in our estimates and assumptions may require us to realize write-downs. In addition, we enter into binding supplier commitments which are based on forecasted customer demand. If our customers reduce their forecasts, we may incur additional costs. An increase in the calculation of the reserve for excess and obsolete inventory equivalent to 1% of gross inventory value would increase our costs by approximately $39,000. Other significant accounting policies are included in the Notes to our Financial Statements contained elsewhere in this Annual Report on Form 10-K. Results of Operations for the Fiscal Year Ended June 30, 2025 as Compared to the Fiscal Year Ended June 30, 2024 Revenue Year Ended June 30, 2025 Percent of Sales 2024 Percent of Sales Increase (Decrease) Percent Change Engineering Design Services 4,938,158 25.9 8,519,130 44.6 (3,580,972 ) (42.0 ) Systems Manufacturing 8,290,225 43.4 3,731,754 19.5 4,558,471 122.2 MicroOptics Lab 2,135,562 11.2 2,720,925 14.3 (585,363 ) (21.5 ) Ross Optical Industries 3,727,324 19.5 4,132,541 21.6 (405,217 ) (9.8 ) Total Revenues 19,091,269 100.0 19,104,350 100.0 (13,081 ) (0.1 ) Total revenues for the fiscal year ended June 30, 2025 were $19,091,269, as compared to $19,104,350 for the same period in the prior year, a decrease of $13,081, or 0.1%. Revenue from Engineering Design Services decreased 42.0% during the year ending June 30, 2025 from the prior year ending June 30, 2024. Revenue decreases in the engineering category resulted from decreased demand for services, primarily from the transfer of our single-use cystoscope program from development (Engineering Design Services) to production (Systems Manufacturing), and increases in internal research and development. Engineering revenue in the year 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 Systems Manufacturing increased 122.2% during the year ending June 30, 2025 from the prior year ending June 30, 2024. Revenue increases in this category resulted from increased demand for manufacturing services as design services engagements concluded and progressed to manufacturing. Revenue from the MicroOptics Lab decreased 21.5% during the year ending June 30, 2025 from the prior year ending June 30, 2024, primarily due to reorder timing. Revenue from Ross Optical Industries decreased 9.8% for the year ending June 30, 2025 from the prior year ending June 30, 2024. We believe the decrease continues to be attributable to a general, industry-wide slowdown, coupled with uncertainty driven by evolving tariff costs, which has led customers to postpone deliveries. 19 Gross Profit Gross margin decreased to 17.8% during the year ended June 30, 2025, compared to 30.3% for the year ended June 30, 2024. Gross profit decreased to $3,404,433 during the year ended June 30, 2025, compared to $5,797,777 for the year ended June 30, 2024, primarily driven by yield issues associated with new manufacturing lines, lower utilization of billable engineering resources, and the decreases in revenue discussed above. Research & Development R&D expenses increased $176,182 to $1,157,963 during the year ended June 30, 2025, compared to $981,781 during the year ended June 30, 2024. R&D expenses for the period primarily 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 $257,432, or 3.4% to $7,797,761 during the year ended June 30, 2025, compared to $7,540,329 during the year ended June 30, 2024. The increase in SG&A for the year was primarily due to increased personnel costs, most related to stock-based compensation and recruiting expense. 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 year ended June 30, 2025, net cash used in operating activities totaled $3,547,400 as compared to $2,683,012 during the year ended June 30, 2024. The increase in net cash used in operating activities was primarily due to the increase in net loss, accounts receivable and inventory during the year ended June 30, 2025, partially offset by the increase in accounts payable and customer advances during such period. Net Cash Used in Investing Activities During the year ended June 30, 2025, net cash used in investing activities was $233,473, consisting of purchases of property and equipment net of adjustments in patent costs. During the year ended June 30, 2024, net cash used in investing activities was $293,883, consisting of purchases of property and equipment and patent costs. Net Cash Provided by Financing Activities During the year ended June 30, 2025, we made payments of $321,554 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 year ended June 30, 2024, we made payments of $556,468 on term notes and capital leases offset by borrowings on the line of credit of $1,000,000. On October 4, 2021, the Company entered into a Loan Agreement with Main Street Bank of Marlborough, Massachusetts (the “Lender”), which provided for a $2,600,000 Term Loan and a $250,000 Revolving Line of Credit Loan Facility (the “Revolver”), which was increased to $500,000 effective May 17, 2022, and $1,250,000 effective June 2, 2023. Borrowings under the Revolver are limited by the borrowing base comprised of a percentage of accounts receivable and inventory and secured by all assets of the Company. Borrowings under the Revolver will bear interest payable monthly at the prime lending rate plus 1.5% per annum and shall not be less than 4.75% per annum. Borrowings under the Revolver are due upon demand. There were no borrowings under the Revolver at June 30, 2025. 20 The Company’s Loan Agreement with the Lender contains a minimum annual debt service coverage ratio covenant of 1.2x. As the Company did not meet this annual debt service coverage ratio for the fiscal year ended June 30, 2024, the Company’s Lender had agreed to waive compliance with such debt service ratio covenant for the period ending June 30, 2024. In addition to such waiver, the Lender and the Company entered into an amendment dated September 30, 2024 to that certain Term Loan dated October 4, 2021, as amended and that certain Promissory Note dated June 2, 2023 (collectively, the “Notes”) which amendments provide for a six month period of interest only payments from October 15, 2024 through March 15, 2025 for the Notes. The Company commenced payments of 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 ending 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 the Company satisfied 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 which the company was not in compliance with as of June 30, 2025. 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 approximately $1.2 million. Contractual cash commitments for the fiscal periods subsequent to June 30, 2025, are summarized as follows: Fiscal Year 2026 Thereafter Total Capital lease for equipment, including interest $ 28,004 $ – $ 28,004 Minimum operating lease payments $ 60,619 $ 98,687 $ 159,306 We have contractual cash commitments related to open purchase orders as of June 30, 2025, of approximately $6,260,000. 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 7A. 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 not required to provide the information requested by this Item. 21