Precision Optics Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
February 14, 2024

There are 5 speakers on the call.

Operator

Good afternoon, and welcome to the Precision Optics 2nd Quarter Fiscal Year 20 24 Financial Results Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Robert Blum of Lytham Partners. Please go ahead.

Speaker 1

All right. Thank you, Andrea, and to everyone as well for joining the call today. As the operator mentioned on today's call, we will discuss Precision Optics' 2nd quarter fiscal year 2024 financial results for the period ended December 31, 2023. With us on the call representing the company today are Doctor. Joe Forkey, Precision Optics' Chief Executive Officer and Wayne Cole, the company's Chief Financial Officer.

Speaker 1

At the conclusion of today's prepared remarks, we will open the call for a question and answer session. Today's conference call is also being webcast with replay capabilities available through both the webcast as well as through the dial in instructions. The details of both were included in today's press release. Before we begin with prepared remarks, we submit for the record the following statement. Statements made by the management team of Precision Optics during the course of this conference call may contain forward looking statements within the meaning of Section 27A of the Act 1933 as amended and Section 21E of the Securities Exchange Act 1934 as amended and such forward looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Speaker 1

Forward looking statements describe future expectations, plans, results strategies and are generally preceded by words such as may, future, plan or planned, will or should, expected, anticipates, draft eventually or projected. Listeners are cautioned that such statements are subject to a multitude of risks and uncertainties that could cause future circumstances, Events or results should differ materially from those projected in the forward looking statements, including the risks that actual results may differ materially from those projected and the forward looking statements as a result of various factors and other risks identified in the company's filings with the Securities and Exchange Commission. All forward looking statements contained during this conference call speak only as of the date in which they were made and are based on management's assumptions and estimates as of such date. Company does not undertake any obligation to publicly update any forward looking statements, whether as a result of the receipt of new information, the occurrence of future events With that said, let me turn the call over to Doctor. Joe Forke, Chief Executive Officer, Precision Optics.

Speaker 1

Joe, please proceed.

Speaker 2

Thank you, Robert, and thank you all for joining our call today to discuss our Q2 fiscal year 2024 financial results. Revenue for the Q2 was $4,800,000 As we anticipated and discussed on recent calls, This is down year over year due to timing differences between reorders for ongoing production, the exit of certain mature customer programs and the introduction of new customer programs. Also consistent with our recent discussions, however, was the 12% quarter over quarter increase in 2nd quarter revenue compared to the 1st quarter. This is in line with our expectations that as we continue to expand our engineering pipeline and as new programs move from engineering to production, we will see higher overall revenues and profitability in the second half of the year with record quarterly run rates expected by the end of the fiscal year. Production revenue for the quarter was $2,600,000 up 6% over 1st quarter production revenue, an increase driven mainly by the introduction of a new defense aerospace program to production.

Speaker 2

Engineering revenue for the quarter was $2,300,000 up 33% compared to the same quarter a year ago and up 19% sequentially. This increase in engineering revenue for the quarter was supported in part by the addition of 2 senior engineers who started during the Q2. We continue to recruit aggressively to grow our technical team to take advantage of the high demand for our engineering services. Gross margins decreased from Q1 to Q2, resulting in an adjusted EBITDA loss relatively close to that of Q1, despite the increase in revenue in Q2. As Wayne will discuss in more detail, we understand the underlying causes of the reduced margin in the quarter and are confident we have taken appropriate steps to recover gross margin in the second half of fiscal twenty twenty four.

Speaker 2

Overall, we continue to anticipate strong engineering revenues and growing production revenues for the remainder of the fiscal year. As we have pointed out before, our strong engineering pipeline is a good indicator of potential future production revenue. These anticipated increases in revenue combined with expected improvements in gross margin supports our optimism for positive EBITDA in the second half fiscal 2024 and beyond. I want to take a couple of minutes to talk about some of our major programs, a few that have moved or will move to production this year that will drive the sequential revenue growth that we expect for the 3rd and 4th quarters. I also want to put these programs into the context of the market segments that they are a part of.

Speaker 2

This is important to justify our confidence not only in the likely success of these new products, but also in the potential for us to capture new programs from the same market segments to support long term growth. The otoscopy program that recently restarted production after a pandemic induced hold, the new complex imaging sub assembly used robotic laparoscopy that will begin production in the Q3 as well as other otoscopy, sinoscopy and Endoscopy programs currently in our engineering pipeline are good examples of endoscopes that utilize POC's proprietary digital imaging and micro optics technology. The otoscopy program was restarted by us a few quarters ago, but has been limited by issues associated with one supplier's inability to restart their production of a highly complex critical component. We have worked with this supplier over the last 6 months and believe we have now resolved the underlying issues. With this supply chain issue resolved, we expect revenue from this customer to increase from a few $100,000 in the first half of the year to over $600,000 in the second half of the year, with much of this coming in the Q4.

Speaker 2

We believe this program will ultimately settle into a run rate of approximately $400,000 to $500,000

Speaker 1

per quarter.

Speaker 2

The second program in this category is a high level sub assembly that we build for a robotic laparoscopy system. We announced the receipt of the first production order for this product in November and transitioned the program from engineering to production during the Q2. This product is expected to begin contributing to production revenue in the 3rd quarter at a run rate of approximately $200,000 to $250,000 per quarter. Both of these programs are great examples of the migration over the last 5 to 10 years of complex endoscopes from designs utilizing more traditional technologies that incorporated rod lens relays or coherent fiber bundles enlarged cameras external to the endoscope system, to the use of small CMOS image sensors incorporated into the body of the endoscope itself. The combined capabilities at POC in the areas of optical design, particularly at small and micro sizes required for endoscopes, along with the electrical engineering capability required to design and manufacture digital imaging systems, positions us well to in the part of the medical device market that requires next generation CMOS based endoscopes.

Speaker 2

The overall endoscope market is fairly mature with an annual growth rate of 5% to 10% and dominated by procedures such as colonoscopy, traditional non robotic laparoscopy and arthroscopy. The medical disciplines that POC's digital and micro optics technology is ideally suited for are areas that historically were more difficult to approach endoscopically because of the extremely small sizes required for access to the relevant parts of the body. POC's technology is well suited for complex imaging products required for robotic systems that need custom complex optical, electronic and mechanical interfaces as well as the use of CMOS imagers embedded in the endoscope. Since the advances in CMOS sensors and micro optics allow more innovation in these areas today, we believe that the overall growth rate of these segments of the market is considerably higher than that of endoscopy in general and solidly in the double digits. The level of demand we have seen recently for new engineering programs in this area supports this conclusion.

Speaker 2

Today, we have more opportunities than we can satisfy with our current team. An additional segment of the endoscope market that requires the use of CMOS sensors and micro optics is the area of single use endoscopy. 2 of the programs that are scheduled to move from our engineering pipeline to production in the latter half of this fiscal year fall into this category. As we have discussed on earlier calls, single use endoscopes have many benefits over traditional reusable endoscopes, including ease of inventory control by the hospital, guarantee of brand new image quality for the surgeon in every procedure and importantly, The virtual elimination of the possibility of cross contamination from one patient to another. Over the last few years, The number of inquiries we have received from customers for new single use programs has grown dramatically, and we have a number of opportunities in this area that we are currently evaluating.

Speaker 2

This is consistent with overall market trends, which indicate single use endoscopy is growing at annual growth rates between 15% 20%, significantly higher than that of the endoscopy market in general. We have discussed our 2 single use programs on earlier calls, So I won't go into detail here, but I do want to provide a brief update. The first of these programs is for an ophthalmic application. This program has moved through the transfer phase and is essentially ready for POC to start production. Due to delays in our customers' submission of their 510 to the FDA, we now expect production to begin in the Q4 of this fiscal year or Q1 of fiscal 2025.

Speaker 2

We expect to continue production for a year or so, after which we believe production may transfer to one of our customers' facilities. If production is transferred, we would then receive royalties on units manufactured and sold by our customer. The second of these programs, the single use cystoscope, has moved in the opposite direction with our customer pushing us to be ready to launch production in the Q4 of this fiscal year, more than 6 months earlier than we had previously expected. This program has been our largest engineering pipeline project for the last couple of quarters And we expect that after it launches, it will quickly become our largest production program. This product is a replacement product for a reusable device within a larger robotic system.

Speaker 2

Therefore, we have good reason for optimism that this product may drive substantial growth for us in coming years. The experience our sales and engineering team has gained through the support of these 2 single use programs, combined with the strong and accelerating market growth, gives us confidence that single use products will continue to be a major source of ongoing growth for many years to come. In October, we announced the receipt of orders for a new defense aerospace program, which began production in the second quarter. Since that announcement, we have received follow on orders to continue production at least through the Q4 of this fiscal year And we are in discussions with the customer for additional orders to extend deliveries at least through an additional 12 months. This program contributed approximately $200,000 to 2nd quarter production revenue and we expect this program to ramp to approximately $500,000 per quarter by the end of this fiscal year.

Speaker 2

Our historic Defense Aerospace program also contributed to 2nd quarter revenue and is expected to increase in revenue for the Q3. Our customer for this program has indicated we should expect follow on orders in the coming months to support a steady state production rate on the order of $2,000,000 per year. As we've discussed on recent calls, we have been investing significantly in our sales resources. I'm happy to report that in the Q2, we added 2 new sales reps. And while our main focus today is still in the medical device market, both of these new reps have some experience in the defense aerospace market as well.

Speaker 2

Given our success with a few defense aerospace programs, we have initiated an effort to better understand the size and growth of different segments of this market and to identify those areas in which POC's unique technology would have the greatest value. We have hired an outside consultant and created an internal working group to evaluate the most promising submarkets to consider. To expand further, while the overall growth rate of traditional optical targeting systems is in the 5% to 10% range, POC's capabilities are better suited to segments that are still developing and that rely on next generation technology. We have already identified 3 segments that require micro optics and or high precision alignment, some of which are represented by our current production programs. They are unmanned aerial vehicles or drones, directed energy weapons or laser weapons, and satellite communications, especially among satellite constellations.

Speaker 2

Each of these segments is expanding at double digit annual growth rates, making them ideal targets for future POC sales and marketing efforts. While we are just starting to approach the defense aerospace market in a more deliberate way, it is already clear that there are more that there are opportunities for POC's unique capabilities. I look forward to providing more updates on this initiative on future calls. With the large number of programs anticipated to move to production in the next few quarters, we have begun to critically evaluate our manufacturing infrastructure. We are considering various approaches to satisfy our requirements for manufacturing space, including a search for a potential new facility that will allow us to further expand and optimize manufacturing capacity to support both our near term and longer term growth objectives.

Speaker 2

We are also carefully considering the need to refill the engineering pipeline as programs move to production. Our experience in the marketplace confirms our belief that POC's unique technologies are ideally suited to segments of the medical device market that are experiencing high growth rates. With our increasing understanding of the defense aerospace market, we believe there are more opportunities in that industry as well. By continuing to support and expand our sales resources and given the high quality and quantity of potential new customers we have today, We are confident we will have plenty of opportunity to continue to grow our engineering pipeline even as programs move to production. At our size, the timing of specific programs moving in and out of production can cause some ups and downs in quarterly revenues, But the clear trend is toward increasing revenue in the remainder of fiscal 2024 and beyond.

Speaker 2

I'll now turn the call over to Wayne to review the financial results in more detail. I will then make a few closing comments before questions. Wayne? Thank you, Joe.

Speaker 3

Let me expand on some of Joe's comments on the financial results, starting with revenue. Last year, we recognized $600,000 in one time revenue pertaining to a technology rights agreement in the 2nd quarter, which makes year over year comparisons to this year's Q2 a bit challenging. For the Q2 of fiscal 2024, Total revenue was $4,800,000 a decrease of 18% compared to $5,900,000 in last year's Q2. However, net of the technology rights revenue, the year over year decline for the quarter was 8.8% or $463,000 Engineering revenue was a record $2,300,000 compared to $1,700,000 last year, an increase of 33%. However, revenue from optical components was down $600,000 for the quarter compared to the same quarter last year, primarily due to reduced demand at Ross Optical, which While improving in the 2nd quarter compared to the first, it's still down compared to the prior year.

Speaker 3

Finished products and assemblies was down approximately $400,000 year over year due to the elimination of certain products from our customers' portfolios and a pause in the manufacture of 1 product until the beginning of our next fiscal year, while our customer sells through their existing inventory. However, as Joe touched on, we expect this category to be a source of significant revenue growth during the second half of this fiscal year. Compared to the Q1, revenues grew by $500,000 due primarily to increasing engineering revenues, improvements in order volumes at Ross and the production start of the new defense aerospace program that Joe mentioned earlier. We have taken proactive measures within our Ross Optical operation to continue revenue growth, including the onboarding of a new technical salesperson in 2nd quarter in a revitalized digital marketing program. For the 2nd quarter, our gross margin was 30.1% compared to 44.2% in the same quarter last year.

Speaker 3

Excluding the technology rights revenue I gross margin for the Q2 a year ago would have been 37.8%. The biggest driver of the gross margin decrease is reduced overall sales and lower utilization of facilities. Additionally, while engineering revenues continue their trajectory of growing sales, we had 34% of our sales in the 2nd quarter in the materials component of engineering sales compared to a more typical 24% of sales in the Q1. Since the margin on materials is only 20%, This factor serves to dampen overall margins. We also recorded a one time increase to our excess an obsolete inventory reserve in the amount of $75,000 after a thorough analysis, driven by preparations for our new ERP system, which we are excited to say will go live at the end of this month after the lengthy and dedicated efforts of our team.

Speaker 3

Finally, gross margin was negatively impacted by startup inefficiencies associated with programs Transitioning to or restarting production during the Q2. We have already addressed these inefficiencies, mainly embodied in low start up yields and margins for these programs to recover nicely in the Q3 and beyond. Total operating expenses in the 2nd quarter were $2,160,000 compared to $2,030,000 in Q2 of last year or an increase of about $125,000 Increases in travel expenses and the allowance for doubtful accounts as well as an increase in stock based compensation expense during the quarter were the main drivers here. Despite the anticipated increases in revenue for the second half of 2024, we expect quarterly operating expenses to remain substantially constant. As a result of the year over year decline in revenue and gross margin, net loss during the 2nd quarter was $759,000 compared to a net income of $508,000 in last year's Q2, which of course includes the $600,000 technology rights revenue.

Speaker 3

Adjusted EBITDA, which excludes stock based compensation, interest expense, Depreciation and amortization was negative $269,000 for the Q2 of fiscal 2024 compared to positive adjusted EBITDA of $866,000 in the Q2 of last year. Again, the key driver here was the decrease in production revenue and the technology rights agreements included in last financials. Our cash balance at December 31, 2023 was nearly $1,000,000 compared to $1,400,000 at September 30, 2023. The change in cash is consistent with our EBITDA loss and normal debt repayments in Q2. As a reminder, we continue to maintain full availability on our $1,250,000 working capital line of credit with our bank.

Speaker 3

As we look to the Q3 of fiscal 2024, we expect to see sequential quarterly revenue growth Similar to the growth from the 1st to second quarter due to key production deliveries against existing customer orders and a continuation of strong engineering revenue. We believe these higher revenues along with improved margins will result in higher profitability and positive adjusted EBITDA. I will now turn the call back over to Joe for some final comments.

Speaker 2

Thank you, Wayne. I'd like to summarize a few key points before we take questions. 1st, our engineering pipeline is as large and robust as it has ever been, with record engineering revenue in the Q2. We believe this is a key leading indicator of future production revenue increases. While total second quarter revenue was down year over year, we grew revenue sequentially from Q1 to Q2 and expect to see continued growth in Q3 and Q4 of this year.

Speaker 2

With growth in revenue will come increased utilization of our manufacturing capacity and thus improvement in gross margins and the bottom line. Our technological capabilities are highly sought after. We are one of only a few companies in the world that can deliver the type of micro optics in digital imaging that are supporting the next generation of medical devices. The segments of the medical device market that we operate in are growing quickly and we expect to benefit from this surge in new devices that are coming to the market in the coming years. With a number of production orders in hand that support sequential revenue growth in the back half of fiscal twenty twenty four, Coupled with continued strength in our engineering pipeline, we remain optimistic for a strong finish to fiscal 2024 and look forward to ongoing growth in future years.

Speaker 2

To all of you on the call, I thank you for your continued support of Precision Optics. We'd be happy to take questions at this time.

Operator

We will now begin the question and answer session. And our first question will come from Chris Vachowsky, a Private Investor. Please go ahead.

Speaker 4

Hello. Thanks for taking my question. You said a lot of Engineering revenue this quarter. Now does that is that all going to turn into Manufacturing revenue in future quarters? Or do you just do you sometimes just do engineering on contract?

Speaker 4

Or is everything something that you start producing in the future?

Speaker 2

Yes. So with very few exceptions, We only take programs into our engineering pipeline that we expect will go to production. Now that doesn't mean that 100 an engineering program and evaluate the programs with a high focus on the likelihood that they'll go to production. So the short answer is everything in the engineering pipeline we would we work on with an expectation that it will go to production.

Speaker 4

Okay. So this huge growth in engineering this large growth in engineering revenue is important for even Larger revenues in the production side. Okay. That program you mentioned that You expect for it to be the largest program and it's going to I think you said it's going to be in the Q4, it's going to start. Could you Tell a non medical professional exactly what it's going into?

Speaker 2

So I can tell you briefly, we're constrained a bit by the non disclosure agreements we have with our customer because they have not announced publicly what it is that we're doing for them. But it's a cystoscopy system, which means that it's used in the urinary tract. And it's a robotic type system. So it's It's a robotic system that has an endoscope that goes into the urinary tract to do various things.

Speaker 4

Okay. And is it one time use?

Speaker 2

It is. Yes.

Speaker 4

Okay. So you I guess you'll be making lots of them.

Speaker 2

Exactly. Yes.

Speaker 4

Okay. All right. This also seems very optimistic. Good luck and this is all from me. Thanks.

Speaker 2

Great. Thanks very much for the questions.

Speaker 1

Andrea, this is Robert Blum here. Before, while we see if there's any additional questions in the queue, Joe, a couple questions here on this side. As you mentioned sort of the pursuit of more dispense and aerospace projects, Give us an idea of how long it sort of takes to A, win these opportunities and B, sort of the conversion of them into revenue maybe in comparison to the medical device side?

Speaker 2

Yes. It's a great question. It's actually part of what we're looking at as we're digging into the various segments of the defense Aerospace market. But, I can use the 2 programs that we have running right now as good examples of sort of the extremes. And as you point out in comparison to medical device, let me just remind everyone, the medical device programs Because of the regulatory requirements and because we're typically working on a program from the very conception stage, typically take 2 or 3 years to get through the engineering process.

Speaker 2

Now in some cases, it will take even longer if it's A program that requires something more than a 510 or if there are multiple clinical trials that are required. But typically medical device program, we're looking at somewhere around 2 or 3 years to go through the engineering pipeline, sometimes a little faster, sometimes a little slower. Our experience with the defense aerospace programs is that it depends, critically on just how far the program is pushing the technological limits of what people have done before. So This new program that I commented on that came into production this year is a program for which the customer came to us with a set of prints and a fairly well defined design. And they came to us about a year ago.

Speaker 2

So this one took about a year for us to develop the process to build it, which is really The key technology that we're contributing here, it's the manufacturing process, and the know how that we have in the manufacturing process. So Took us about a year to put that process together for their particular design that they came to us with and then to run through a couple of rounds of prototypes to demonstrate that we could do it. That was sort of the fastest that I would expect one of these programs would take is about a year. On the longer side, the historical defense aerospace program that we have that we've been producing for a number of years just before the pandemic started. That one actually took some 3 years or so, maybe even 4 years to go through a few rounds of prototypes.

Speaker 2

In that case, the customer was asking us to do something that they and we agreed was right on the edge of what was physically possible. And so while we don't know exactly what it's used for, we know that it's used for a very advanced technological device, whatever it is, that's pushing the limits in terms of what can be done with the micro optics that we're making. So In that case, while the customer had an initial design, we had to go through 3 or 4 design iterations to be able to satisfy both their environments and what could be done from a physical standpoint. So I expect that what we're going to find as we dig into these segments that have higher growth rate because there's a lot of technological development that's going on. I think what we're going to find is that, that range that we found these two programs between 1 year and 4 years is probably the typical timeline that we should expect for these new programs in the defense aerospace market.

Speaker 1

All right, perfect. That is helpful. Next question we have here is, you mentioned the introduction of a new ERP system. Some talk about how you expect the system to improve operations and financial results?

Speaker 2

Yes. So I should say Wayne and our new COO Mahesh really have spearheaded this effort, which has required the efforts of a lot of people in the company. They've done a great job of getting this ready to launch in the next month, as Wayne alluded to. So I'm going to let him answer this question. But I would just say from my standpoint, I expect I'll be able to get more detailed reports more often, which I think from my standpoint will help me to understand what's going on in the company on a more timely basis.

Speaker 2

But let me let Wayne talk about this in more detail.

Speaker 3

Thanks, Joe. Yes, I think my answer is similar. An integrated system will allow us to collect better information more quickly and productively so we can run the business more efficiently and it's really going to help us to scale with our existing headcount.

Speaker 1

All right, perfect. Sounds good. I think the last question here is, you're sort of How are you planning to manage sort of the significant growth in production you are expecting? And do you have the resources that you need?

Speaker 2

Yes. So that's a question we've been asking ourselves for quite some time. So of course, we've seen that This production ramp is coming for a little while now. In terms of planning for it, we've planned on a number of fronts. We did do a bit of a sort of mini reorganization of the company a few months ago in order to get people into the positions that we thought would be most effective, as the production starts to grow.

Speaker 2

The last of those positions that we sort of came out of this restructuring reorganization was a Senior Director of Operations for production. And that role has been filled by someone internally just about a week or 2 ago. So we've been working for some time to make sure that the organizational arrangement is ideally suited to the production that we see coming. In terms of the resources beyond that, there's obviously the direct labor resources that we'll need. And so while we can sort of pre position those folks, we can't do too much of that because then we'll have people sitting around and not being productive.

Speaker 2

So The direct labor for the assembly work and production work, we're pretty confident we can bring in when and as we need them for the growth that we see. The other sort of critical piece of resources is one that I alluded to in our comments and that is our production facilities. And while we're able to satisfy the requirements that we have today, we do believe that over the next few quarters, depending on exactly when various programs start to hit that we likely will outgrow the facility facilities that we have. So there are a couple of different ways that we could expand. And one of those ways, of course, is to look at a new facility.

Speaker 2

So we are looking at all potential ways of satisfying the facility requirements. And as we move forward, as the new programs come online, we'll be ready to have new facility capabilities as we need them in the most efficient way possible.

Speaker 1

All right, fantastic. That's all the questions we have here. Andrew, I'm going to go ahead and turn it back over to you if there's any additional questions or

Operator

There appear to be no questions on the line at this time. I will turn the conference over to management for any closing

Speaker 2

Thank you, Andrea, and thanks everyone for joining us on the call today. I look forward to speaking with everyone soon. Have a good night And stay safe.

Operator

The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.

Powered by Quartr
Earnings Conference Call
Precision Optics Q2 2024
00:00 / 00:00