Precision Optics Q4 2024 Earnings Report

Precision Optics EPS Results

• Actual EPS: -$0.23
• Consensus EPS: N/A
• Beat/Miss: N/A
• One Year Ago EPS: N/A

Precision Optics Revenue Results

• Actual Revenue: $4.72 million
• Expected Revenue: N/A
• Beat/Miss: N/A
• YoY Revenue Growth: N/A

Precision Optics Announcement Details

• Quarter: Q4 2024
• Date: 9/30/2024
• Time: After Market Closes
• Conference Call Date: Monday, September 30, 2024
• Conference Call Time: 5:00PM ET

Precision Optics (NASDAQ:POCI) Corporation, Inc. designs, develops, manufactures, and sells specialized optical and illumination systems and related components primarily in the United States and the European Economic Area. It offers medical instrumentation products, including endoscopes and endocouplers, as well as other custom imaging and illumination products, such as Microprecision lenses and micro medical cameras, and 3D endoscopes for use in minimally invasive surgical procedures by hospitals and physicians. The company also provides components and assemblies for industrial and military use. It markets its products to medical device companies. The company was incorporated in 1982 and is based in Gardner, Massachusetts.

Precision Optics Q4 2024 Earnings Call Transcript

Key Takeaways

• FY24 revenue was $19.1 million, slightly above pre-announced guidance but down from FY23 due to approximately $7 million of discontinued or delayed programs and a $1.5 million slowdown in the Ross Optical division.
• The company rebuilt its revenue base by transitioning several R&D projects into production—highlighted by a record $9 million order—and grew its product development pipeline by 24% year-over-year.
• Ramp-up challenges in Q4 and Q1—namely a temporary hold on a defense-aerospace program, yield variability on a robotic laparoscopy product, and customer-requested shipment reductions on an otoscopy line—combined to reduce quarterly revenue by about $500K in Q4 and $900K in Q1.
• Precision Optics forecasts a significant revenue step-up beginning in Q2 FY25, driven by resumed defense production, increased single-use endoscope deliveries targeting $3.6 million for the year, and continued strength in its medical imaging pipeline.
• Operational investments—including a new ERP system, manufacturing consolidation in Massachusetts, expanded engineering hires, and the launch of a platform product offering pre-qualified hardware/software modules—are designed to accelerate time-to-market and improve margins.

Presentation

[Operator]

Please note, this event is being recorded. I would now like to turn the conference over to Robert Blum with Lytham Partners. Please go ahead.

[Robert Blum, Managing Partner at Lytham Partners]

Thank you very much, Gary, and everyone joining the call today. As the operator mentioned, on today's call, we will discuss Precision Optics' Fourth Quarter and Fiscal Year 2024 Financial Results for the Period Ending June 30th, 2024. With us on the call representing the company today is Dr. Joe Forkey, Precision Optics' Chief Executive Officer, and Mr. Wayne Coll, the company's

[Robert Blum, Managing Partner at Lytham Partners]

Chief Financial Officer. At the conclusion of today's prepared remarks, we'll open the call for a question-and-answer session. If you dialed into the call through the traditional teleconference line, as the operator indicated, please press star, then one to ask a question. If you are listening through the webcast portal and would like to ask a question, you can submit your question through the Ask a Question feature in the webcast player.

[Robert Blum, Managing Partner at Lytham Partners]

We'll do our best to get to as many of the questions as possible. Before we begin with prepared remarks, we submit for the record the following statement.

[Robert Blum, Managing Partner at Lytham Partners]

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 Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 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.

[Robert Blum, Managing Partner at Lytham Partners]

Forward-looking statements describe future expectations, plans, results, or strategies and are generally preceded by words such as may, future, plan or planned, will or should, expected, anticipates, draft, eventually, or projected.

[Robert Blum, Managing Partner at Lytham Partners]

Listeners are cautioned that such statements are subject to a multitude of risks and uncertainties that could cause future circumstances, events, or results to differ materially from those projected in the forward-looking statements, including the risks that actual results may differ materially from those projected in 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.

[Robert Blum, Managing Partner at Lytham Partners]

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. The 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, or otherwise.

[Robert Blum, Managing Partner at Lytham Partners]

With that said, let me turn the call over to Dr. Joe Forkey, Chief Executive Officer, Precision Optics.

[Robert Blum, Managing Partner at Lytham Partners]

Joe, please proceed.

[Joe Forkey, CEO at Precision Optics]

Thank you, Robert, and thank you all for joining our call today to discuss our Fourth Quarter and Fiscal Year 2024 Results. As most of you know, on August 14th, we pre-announced revenue expectations for the year to be in a range of $18.5-$18.9 million. Our final revenue numbers that we reported today were $19.1 million for the year and $4.7 million for the fourth quarter.

[Joe Forkey, CEO at Precision Optics]

These revenue levels were slightly above the range we pre-announced in August, but somewhat lower than we anticipated at the time of our last conference call in May. These lower levels were driven by specific delays in a few key programs in the latter half of the fourth quarter.

[Joe Forkey, CEO at Precision Optics]

I will explain the causes of these delays in more detail in a minute, but let me emphasize right from the top, the customer relationships in each case remain strong, and the market potential of each product is intact, so our long-term outlook for these programs and overall business growth remains high. We always have a lot to cover on our Q4 calls, since we have just about completed our Q1 and have a preview of Q2.

[Joe Forkey, CEO at Precision Optics]

Let me first take a step back and discuss some of the challenges and successes of fiscal year 2024. As we communicated over the past year, when we exited our record-setting fiscal 2023, we were facing the loss or pullback of a few significant programs that were not moving forward in fiscal 2024.

[Joe Forkey, CEO at Precision Optics]

This included two production products and two product development programs that were discontinued, one defense aerospace program that was redesigned by our customer, and our longtime spinal surgery product, for which our customer had built up excess inventory that they need to burn through before placing additional orders. These programs represented approximately $5.6 million in revenue in fiscal 2023.

[Joe Forkey, CEO at Precision Optics]

In addition, our Ross Optical division saw a sharp drop in revenue caused by an overall slowdown in the optics components industry, starting in the first quarter of fiscal 2024. This represented a year-over-year reduction in revenue of approximately $1.5 million. All told, these situations had a starting fiscal 2024, with a reduction of over $7 million in fiscal 2023 base business.

[Joe Forkey, CEO at Precision Optics]

While this certainly made for a challenging fiscal 2024, we succeeded in rebuilding the revenue base by moving a number of programs from our product development pipeline into production and successfully bringing on new programs into our product development pipeline.

[Joe Forkey, CEO at Precision Optics]

This progress was punctuated by the record-breaking $9 million production order that we announced in May, and record product development revenue, with this segment of our business growing by nearly 24% year-over-year. I am happy to report that we are starting fiscal 2025 in a much stronger position. Of all programs that contributed significantly to our fiscal 2024 revenue, we have only one, which contributed about $400,000, that will not continue into fiscal 2025.

[Joe Forkey, CEO at Precision Optics]

This year, we are building on a strong base of business that will allow us to reach record levels of revenue in fiscal 2025. While the first quarter of fiscal 2025 will still have suppressed revenue levels due to some specific ramp-up challenges, we expect to see a step increase in revenue beginning in the second quarter.

[Joe Forkey, CEO at Precision Optics]

Beyond the recovery of top-line revenue during fiscal 2024, we also continued to strengthen our team and invest in operational infrastructure to support a larger business. To support the ongoing increase in interest from the medical device market and our product development capabilities, we have added engineering talent and begun a rollout of our new platform product that draws on our many years of experience in developing new digital imaging systems.

[Joe Forkey, CEO at Precision Optics]

This effort, along with management of our overall sales and marketing team, is now being led by our new VP of Sales and Marketing, Clay Schwabe. Clay has extensive experience in the medical device space, with previous positions in small, growing companies, as well as some of the industry's largest, Boston Scientific and Medtronic.

[Joe Forkey, CEO at Precision Optics]

Clay has taken over management of sales and marketing from our former Senior Vice President, Jeff DiRubio, who managed our team for more than 10 years. I want to take this opportunity to recognize the critical role Jeff has played in our company, helping us to increase sales by over 700% during his tenure. With significant growth expected in production, we have also updated the infrastructure of our manufacturing team and implemented a new ERP system.

[Joe Forkey, CEO at Precision Optics]

As part of the integration of the Lighthouse Imaging business, we made the decision last year to consolidate all optical systems manufacturing in our Massachusetts location, while maintaining an office in Maine to house our engineering and digital imaging center of excellence. We now have all but one of our production programs running in Massachusetts, and we expect this final product to transition in the next couple of months.

[Joe Forkey, CEO at Precision Optics]

We have updated our management structure in this area, moving some folks from Maine to Massachusetts, redefining roles for some senior employees, and hiring additional resources, particularly in Manufacturing Engineering. All told, we are well-positioned to support the growth we expect during fiscal 2025 and beyond.

[Joe Forkey, CEO at Precision Optics]

Let me take a few minutes now to discuss in more detail what happened with the programs that impacted revenue in the latter part of Q4 and in Q1, and where we see things going in Q2 of fiscal 2025 and beyond. We manage our business in four separate revenue streams: product development, optical systems production, Ross Optical, and our Micro Optics Laboratory.

[Joe Forkey, CEO at Precision Optics]

At the Micro Optics Lab, we started Q4 coming off a particularly strong revenue contribution of $1.2 million in Q3 from a highly complex optical assembly we have manufactured for a top-tier defense customer for many years. In April, we announced the follow-on order from this customer. Given the nature of the production process, this order starts with lower revenue rates that grow larger as we move through the order.

[Joe Forkey, CEO at Precision Optics]

Q4 revenue from this program was therefore about $260,000, almost $1 million lower than that of Q3. For the first and second quarters of fiscal 2025, we expect revenue of approximately $360,000 and $370,000 for this order. Within optical systems production, we expected and achieved significant revenue growth from Q3 to Q4 from three programs.

[Joe Forkey, CEO at Precision Optics]

Two of these are programs that transitioned from our product development pipeline to production in the last twelve months, and the third is our otoscopy program, which has continued to recover from the complete shutdown during the pandemic. The output from these three production programs nearly doubled, increasing from approximately $500,000 in Q3 to nearly $1 million in Q4.

[Joe Forkey, CEO at Precision Optics]

All three were running well in the early part of the fourth quarter, and we expected they would continue to ramp through Q4 and beyond. While all indicators still point to significant increases in these programs in the next couple of quarters, we've experienced some challenges as they have ramped up. The first of these is our new Defense Aerospace program that went into production in the second quarter of fiscal 2024.

[Joe Forkey, CEO at Precision Optics]

We had been ramping steadily until the middle of Q4, when we began to saturate the existing production line. Duplicating tools and fixtures and training additional operators took longer than expected during Q4, but we resolved these issues and continued shipping in Q1.

[Joe Forkey, CEO at Precision Optics]

In August of this year, however, our customer identified a potential specification failure, later determined to be the measurement technique used in acceptance testing by our customer and not a problem with the product itself. This is an indication of the extremely tight tolerances we are building to, tolerances that can only be measured with some of the most sophisticated measuring equipment available today.

[Joe Forkey, CEO at Precision Optics]

Unfortunately, the customer ordered a temporary production stop during the investigation, which reduced Q1 revenue by approximately $500,000. The good news, however, is that we restarted production on the line last week and fully expect this product to contribute to revenue at a higher level of approximately $850,000 starting in Q2. Importantly, our customer had the confidence to give us new follow-on orders for deliveries later this year, even while production was stopped during Q1.

[Joe Forkey, CEO at Precision Optics]

The second new program that went into production last year, but stalled a bit in Q4, was the robotic laparoscopy product. Production began in January, and while we have delivered a significant number of units, we have also experienced variable yield from lot to lot. This resulted in lower shipments than expected, both in Q4 and in Q1.

[Joe Forkey, CEO at Precision Optics]

Originally, we believed we would improve yield with experience, but we recently began a more thorough review of the build process to identify the root cause of the variable yield. Based on preliminary findings, we are confident we will be able to increase yields in Q2 and beyond. We restarted deliveries of the otoscopy product a little over a year ago.

[Joe Forkey, CEO at Precision Optics]

While restarting the line, we experienced some supply chain and yield issues, which were largely resolved by the fourth quarter of fiscal 2024, and we recognized approximately $400,000 in revenue that quarter. However, our customer requested we reduce shipments in the first quarter to match their demand, as they were dealing with the discontinuation of an electronic component, which has now been replaced.

[Joe Forkey, CEO at Precision Optics]

As a result, we were not able to deliver all of the units we produced in Q1. We expect shipments to be more regular in Q2 and beyond at a run rate of approximately $250,000 per quarter, with expectations that this may increase significantly by the end of fiscal 2025, depending on market penetration.

[Joe Forkey, CEO at Precision Optics]

The overall impact of the challenges in these three programs reduced our Q4 revenue by approximately $500,000 and will negatively impact Q1 revenue by approximately $900,000, resulting in expected Q1 revenue between $4.2 million and $4.4 million.

[Joe Forkey, CEO at Precision Optics]

The other major program that just transitioned from product development to production in the last few months is the record $9 million production order for a single-use endoscopic imaging assembly that we announced in May. When we received this order, we anticipated fiscal 2025 revenue would be approximately $2.2 million. With our customer already increasing their demand and pulling in their forecasts, we have been ramping up deliveries.

[Joe Forkey, CEO at Precision Optics]

We are now delivering at a rate of approximately $600,000 per quarter and are currently standing up a second production line to achieve our updated estimate of $3.6 million in revenue for fiscal 2025. Based on the strong market dynamics of our customer's end-use market, we expect the demand could continue to grow in the future.

[Joe Forkey, CEO at Precision Optics]

We hope to be able to provide more details on this program soon. This order provides the impetus for ongoing POC investments in single-use endoscope manufacturing at scale, with high technical performance and at price points consistent with the single-use endoscope market. This will ultimately result in an efficient manufacturing platform that will provide ongoing strategic advantage.

[Joe Forkey, CEO at Precision Optics]

In summary, we are exiting Q1 with the optical systems production programs in far better shape and running at production levels, supporting expectations that will contribute at much higher levels for Q2 and beyond.

[Joe Forkey, CEO at Precision Optics]

As we start fiscal 2025 our product development pipeline is as robust as ever, and we continue to add new opportunities on a regular basis. This is a strong indicator of the overall strength of the medical device imaging market, which is growing at 5-10% per year, and the even stronger single-use segment, which is growing two to three times faster. We are continuing to recruit for engineering talent as we believe we have more opportunities than we can support with the existing team.

[Joe Forkey, CEO at Precision Optics]

As I mentioned on our last call, we have now developed a concept to provide an existing family of baseline designs to new customers coming into our product development pipeline. We call this our platform product, because the baseline designs, which draw from our many years of experience, act as a starting point for POC's design of a customer's new product.

[Joe Forkey, CEO at Precision Optics]

Customers may choose from a pre-existing set of hardware and software components that then can be engineered specifically to their specification. This platform gives us a competitive advantage in the marketplace, as these well-qualified baseline systems can offer an accelerated path to market and reduce development risk to our customers. Financially, this provides a high margin offering that will utilize less engineering resource to entice customers into development programs.

[Joe Forkey, CEO at Precision Optics]

The limited launch of this product to a few select customers has been very well received, and we already have three new customers based on this approach. We expect to proceed with a more formal launch in the coming months. Ultimately, we believe this approach will help us to become the provider of choice for next generation medical device digital imaging systems.

[Joe Forkey, CEO at Precision Optics]

Finally, our Ross Optical division is still feeling the impact of the industry-wide slowdown in optical component sales. Although we are just now beginning to see some customers who have delayed deliveries for many months starting to accept product into place, follow-on orders. This is consistent with the general attitude in the industry that business will begin to pick up again in the beginning of calendar 2025.

[Joe Forkey, CEO at Precision Optics]

We are increasing our marketing budget for Ross Optical in order to accelerate and hopefully magnify its rebound in fiscal 2025. To summarize, we believe production issues that depressed Q4 and Q1 revenue from three ongoing problem programs are largely resolved. We expect production deliveries against the $9 million order for the single-use endoscope imaging assembly to continue to ramp.

[Joe Forkey, CEO at Precision Optics]

We expect product development pipeline revenue to continue at near record levels, and we expect our Ross Optical division to continue at similar or slightly higher revenue rates compared to recent quarters. Taken together, these expectations support our strong confidence that we will see a sharp increase in revenue in Q2, with record quarterly revenues before the end of fiscal 2025. I'll now turn the call over to Wayne to review the financials.

[Wayne Coll, CFO at Precision Optics]

Thank you, Joe. Let me expand on some of Joe's comments on the financial results, starting with revenue. For the year, revenue was $19.1 million, a decrease of $1.9 million from last year. Last year's results included $600,000 of one-time technology license revenue. Excluding this, fiscal 2024 revenue was down 6.6% compared to fiscal 2023.

[Wayne Coll, CFO at Precision Optics]

This is a significant accomplishment as we started the year with a loss of previous year programs and revenue, representing about $7 million, or 34% of fiscal 2023 revenue. A major contributor to that recovery was the product development or engineering pipeline segment of our business, which posted revenue at a record level of $8.3 million, representing a year-over-year increase of 24%.

[Wayne Coll, CFO at Precision Optics]

Looking specifically at the fourth quarter, revenue was $4.7 million compared to $5 million last year, a decrease of 6%. Joe has already commented on the key drivers here. With the pullback in revenue for the year, we saw less absorption of certain fixed costs in production, which impacted our overall gross margins.

[Wayne Coll, CFO at Precision Optics]

Lower revenues related specifically to Ross Optical, reduced revenue by $1.5 million and gross margin by $1 million. For the year, gross margins were 30% compared to 38% last year. Excluding the license revenue, last year's gross margins would have been in the mid-35% range. For the fourth quarter of fiscal 2024, gross margins were 22% compared to 39% in last year's fourth quarter.

[Wayne Coll, CFO at Precision Optics]

The fourth quarter was particularly impacted by the ramp-up challenges Joe summarized, which led not only to lower revenue, but also significantly reduced gross margin. We also recognized unfavorable charges to COGS in the fourth quarter, resulting from one-time adjustments in the carrying value of our raw materials inventories. We do expect gross margin to recover quickly as production processes stabilize and revenues increase.

[Wayne Coll, CFO at Precision Optics]

Operating expenses for the year were $8.5 million, compared to $8.4 million last year, and for Q4, they were $2.4 million, compared to $2.5 million last year. There are also a few costs in Q4 that were new compared to a year ago. First, as Joe mentioned, we have put a focus on recruiting this past year, and during the fourth quarter, we had approximately $200,000 in one-time personnel-related expenses.

[Wayne Coll, CFO at Precision Optics]

Beyond this specific expense, there's the cost of new people, engineers especially, getting up to speed and achieving target utilization. These are investments in our long-term growth. Second, with the anticipated rollout of our new platform product, we incurred significant internal R&D expenses that were higher compared to earlier quarters and years, but also represent a strong investment in the platform product that we believe will have positive sales impacts in the near term.

[Wayne Coll, CFO at Precision Optics]

Third, with the increase in production volume, we have been exploring the possible expansion of our manufacturing facilities. We have not yet concluded on how best to balance our growth needs with investment costs, but we did incur approximately $50,000 in expenses in this area during the fourth quarter.

[Wayne Coll, CFO at Precision Optics]

As a result of the lower revenue, our net loss was $3 million during fiscal 2024, compared to a $145,000 loss last year. For the fourth quarter, the net loss was $1.4 million, compared to a $96,000 loss in last year's fourth quarter.

[Wayne Coll, CFO at Precision Optics]

Adjusted EBITDA, which excludes stock-based compensation, interest expense, depreciation, and amortization, was negative $1.6 million in fiscal 2024, compared to a positive adjusted EBITDA of $491,000 last year.

[Wayne Coll, CFO at Precision Optics]

For the fourth quarter, we had negative $1.1 million adjusted EBITDA, compared to negative $410,000 last year. Again, the biggest driver here was the lower revenue and largely fixed manufacturing and operating expenses, along with one-time operating expenses that hit in the fourth quarter.

[Wayne Coll, CFO at Precision Optics]

As we look to achieve our goals for the upcoming year, we expect Adjusted EBITDA breakeven quarterly revenue levels to be approximately $5.5 million, which is aligned with our revenue expectations for the second quarter and beyond. Our cash balance at June 30, 2024, was $405,000.

[Wayne Coll, CFO at Precision Optics]

After the close of the year, this past August, we completed a $1.4 million registered direct offering of common stock, which included participation from directors and officers to supplement our working capital.

[Wayne Coll, CFO at Precision Optics]

As we alluded to earlier, we are evaluating alternatives for the consolidation, expansion, and relocation of our physical facilities to support the growth and efficiencies that are key in our drive to scale. We believe the long-term financial model of the production business is very attractive, and will result in a high return on invested capital.

[Wayne Coll, CFO at Precision Optics]

This is supported by the high degree of recurring revenue as a result of our single-use focus, as well as the high likelihood of strong customer retention, as our technologies are embedded in the products and will have been included in FDA submissions of our customers.

[Wayne Coll, CFO at Precision Optics]

Based on our growth expectations, we will, over time, invest in both physical capacity as well as methods for manufacturing efficiencies. We are confident the attractiveness of the business model will afford us multiple financing alternatives for appropriate investments. I will now turn the call back over to Joe for some final comments.

[Joe Forkey, CEO at Precision Optics]

Thank you, Wayne. To summarize, fiscal 2024 was certainly a challenging year, and while we made substantial progress rebuilding our revenue base during the year, revenue in the fourth quarter came in a bit lower than our initial expectations.

[Joe Forkey, CEO at Precision Optics]

This was caused by a few program delays that impacted fourth quarter revenue by about $500,000-$600,000. Some of these issues will also impact first quarter fiscal 2025 revenue, which we expect to be in the range of $4.2 million-$4.4 million. But as of today, most of these issues have been resolved.

[Joe Forkey, CEO at Precision Optics]

We now have strong visibility and confidence that with our production single-use program starting to grow in Q2, the re-ramp of our Defense Aerospace program that was put on a temporary hold, starting up again last week, coupled with a number of other growing programs, we will see significantly higher revenues in Q2 and record quarterly revenues before the end of fiscal 2025.

[Joe Forkey, CEO at Precision Optics]

This should also improve profitability due to the leverage of fixed costs in our business model. All in all, we are very optimistic that we will see substantial growth, both in top line and bottom line performance in fiscal 2025. Before I turn it over to questions, I want to mention that we will be participating in the Lytham Partners Fall 2024 Investor Conference tomorrow.

[Joe Forkey, CEO at Precision Optics]

If you would like to schedule a one-on-one meeting, please reach out to Robert Blum to coordinate. To all of you on the call, I thank you for your continued support of Precision Optics. We'd be happy to take any questions at this time.

[Operator]

We will now begin the question-and-answer session. To ask a question, you may press star and one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Again, if you have a question, please press star then one.

[Robert Blum, Managing Partner at Lytham Partners]

All right. Hey, Gary, this is Robert Blum. I guess while we wait to see if anyone comes in on the live call, I've got some webcast submissions here. So Joe and Wayne, if you have, let's walk through a couple of these.

[Robert Blum, Managing Partner at Lytham Partners]

First question here is: On previous calls, mentioned we would complete a $1.2 million Defense order by August of 2024, and follow-on orders were expected. Was it completed, and have we seen any follow-up discussion or orders?

[Joe Forkey, CEO at Precision Optics]

Yeah, so that was the new Defense Aerospace program that we commented on during the comments here. This is the program that was put on a hold by the customer for almost a couple of months, and so because of that hold, it reduced the time that it will take to finish the orders that this question is referring to.

[Joe Forkey, CEO at Precision Optics]

The good news, as I mentioned in the script here, was that the customer has allowed us to restart shipping, and so we're quite confident that this program is going to contribute significantly to Q2 and beyond. As for the second part of the question, the customer has given us new orders. In fact, this is one of the things I mentioned in my remarks.

[Joe Forkey, CEO at Precision Optics]

The customer gave us new orders even while they had us on a production hold, because they were confident that we would be able to sort out with them what the issues were. So, the answer, the answer to the question is: We have not finished the deliveries, but that's because our customer put us on hold. We expect to finish the deliveries now in the next quarter, and we do have follow-on orders that'll continue after that.

[Robert Blum, Managing Partner at Lytham Partners]

All right, great. Again, as a reminder, you can submit questions either through the webcast portal there or online here by press or over the telephone by pressing star, then one. Our next question, Joe", is: Can you walk through what you believe your contribution margin is on the various programs? Is there a target contribution margin you look for?"

[Joe Forkey, CEO at Precision Optics]

I'm going to let Wayne answer this one.

[Wayne Coll, CFO at Precision Optics]

Yeah. So depending on the lines of business, the margin tends to differ. When you take, for instance, the Defense Aerospace work we do with the Micro Optics Lab, those margins are probably some of the highest that the company experiences, in excess of 50%.

[Wayne Coll, CFO at Precision Optics]

And you compare that to manufacturing margins, particularly related to the manufacturing of the single-use product and so forth, and those margins tend to be more in the 30% range at the moment. And then in between that, you've got the Ross Optical business, which, you know, that full utilization, again, is in that higher, you know, almost 50% type of margin profile. With lower revenues, it's got a lower margin profile.

[Wayne Coll, CFO at Precision Optics]

And then on the product development side, that tends to be, again, in the mid-forties. The margins tend to be in the low to mid-forties. Taking into account both the labor elements, the non-recurring engineering revenues, and material revenues that are part of that segment.

[Robert Blum, Managing Partner at Lytham Partners]

Okay, great. Next question here, and I know you touched on this a little bit. For the aerospace defense program that was put on hold but is now back up and running, can you expand on what some of the factors were that forced the hold? Was any of this related to POC, or was this unrelated?

[Joe Forkey, CEO at Precision Optics]

Yeah, sure. I can comment a little more on this. The assembly that we provide is used to transmit a laser beam, and so there are some measurements of the laser beam that have to be made when we finish the production here, and we do the inspections, and then there are similar measurements that are made by our customer at their facility.

[Joe Forkey, CEO at Precision Optics]

The way the measurements are made is very complicated and requires some fairly sophisticated equipment. And ultimately, the measurements that are being made can be impacted by the motion of some of the components that we assemble that are as small as, you know, maybe even 10 microns. I mean, it's very, very sensitive.

[Joe Forkey, CEO at Precision Optics]

And so what happened was we were making measurements here, we were shipping, and then it was taking our customers some time for them to make measurements on their end. When they started making measurements, they saw differences in what compared to what we had measured, and so there was a concern that there may have been a drift because the measurements are so sensitive to even, you know, tens of microns of movement.

[Joe Forkey, CEO at Precision Optics]

So, they asked us to stop production while we collectively worked to sort out what was the ultimate cause. Ultimately, the belief now is that it was not a motion of the parts we were assembling, but instead a sensitivity issue with the two highly sensitive devices, one that we were using and one that they were using.

[Joe Forkey, CEO at Precision Optics]

And so they asked us to do some troubleshooting, some test measurements, some test assemblies, and then we, you know, sent them back and forth to test and align our QC measurements. And based on all of that, they've agreed, and we've agreed that it likely was a measurement issue, and so they've allowed us to restart production.

[Joe Forkey, CEO at Precision Optics]

As we've done that, we've added a little bit to the measurements that we make in order to just further confirm that the conclusion that we came to collectively was the right one. So all in all, there's no indication that there was a problem with what POC was doing or making or producing.

[Joe Forkey, CEO at Precision Optics]

But because this is such a highly sensitive and tightly specified part, it really was a measurement error caused by the particular devices that were being used to make the measurements.

[Robert Blum, Managing Partner at Lytham Partners]

Okay, great. Our next question here is: "For the single-use program, you mentioned revenue expectations have increased. Can you provide any commentary on the dynamics leading to the increase?"

[Joe Forkey, CEO at Precision Optics]

Yeah, sure. So of course, with non-disclosures in place and such, we're limited as to how much detail we can give on what's happening. But I can give a couple of comments that are sort of general that I hope will... I think will help everyone understand what's going on here.

[Joe Forkey, CEO at Precision Optics]

So the product that we're making, the single-use product that we're making for our customer, is going into a system that's replacing an existing product that they have on the market today. It recently received clearance from the FDA, and so they now are actually in the market.

[Joe Forkey, CEO at Precision Optics]

The market risk associated with a new product going on the market is relatively low in this case because they already have a product on the market, so they're, you know, they're cannibalizing their own market. And really, they put together this new product to expand the market that they already were doing very well in with the product that they had.

[Joe Forkey, CEO at Precision Optics]

So once the product actually got out there, and even though it's still in a limited release mode, once it got out there, and they were able to confirm with some of the folks in the market, some of the surgeons, that the benefits that they believed would come with it were actually realized in the field by the surgeons. The...

[Joe Forkey, CEO at Precision Optics]

Their marketing group's expectations for deliveries of their product, I think, has gone up, and so that, of course, comes back to us and increases the rate at which they want product from us. So that's what's happening. I think it's a very good dynamic, and I think there, as we said in the script, there are opportunities for this to continue to grow as they continue to go out in the market and get more positive feedback.

[Robert Blum, Managing Partner at Lytham Partners]

Okay, great. Just a reminder to everyone, if you have a question, you can submit it online through the portal. The webcast portal, press star one if you are dialed in. We have a couple of questions here pertaining to the platform. I'll sort of bring these together.

[Robert Blum, Managing Partner at Lytham Partners]

"Will the new product you are researching and offering change the model of the company by increasing R&D expenses and increasing gross margins? Presumably now you can bill the R&D expenses for custom client products, but in the future, the clients will use your platform, which is not entirely custom, and you have to pay the R&D expenses by yourself. How will that affect gross margins, R&D expenses, profitability?"

[Robert Blum, Managing Partner at Lytham Partners]

Sort of adding to that, how does this platform sort of allow companies to transition from entry-level stage to a more established pipeline customer?" So I know I threw a lot out at you there. I can rephrase some of them if you need me to.

[Joe Forkey, CEO at Precision Optics]

No, no, that's fine. I think I get the sense of the question. It's a great question. So this is good because I want to clarify something on the platform product. And as I said in my remarks, we'll be doing more in terms of marketing and having a formal launch and such in the next few months.

[Joe Forkey, CEO at Precision Optics]

So I think this will become clearer and clearer as we provide more and more information to the market in general. But the idea here is that we do need to do a little bit of internal R&D in order to get the platform product going.

[Joe Forkey, CEO at Precision Optics]

But by and large, the R&D work for the platform product is all the work that we have done over the last three, five, seven years in developing these kinds of products for many of our customers. You'll recall that one of the key elements of our business model is that we maintain the ability to use the IP that we develop during the development process of these products.

[Joe Forkey, CEO at Precision Optics]

Now, we can't go and duplicate our customer's product and sell it to their direct competitor, but what we've discovered is that there are core elements of all of the products that we make, there are core design elements that are common to all of the different products.

[Joe Forkey, CEO at Precision Optics]

And so what we're doing is we're taking these core design elements and reconfiguring them in a way that we can provide a baseline model very quickly, which would be a, an initial prototype to our customers, very fast, almost off the shelf. And then we have various modular pieces, which are pieces that come from other products that we've made for other customers, that we can sort of bolt on.

[Joe Forkey, CEO at Precision Optics]

These are. Think of Lego, you know, Lego blocks that you can add on to the baseline design. So that's the first part of it. There's a little bit of R&D expense now that we need to incur in order to take all the different designs that we've done before and turn them into a common baseline design. So that's what we're doing right now.

[Joe Forkey, CEO at Precision Optics]

But this does not change the overall business model, which is one where we're going to customize what we have for our customer. What it does is, it allows us to give our customer a higher level base design than we were able to give them before, when we were simply showing them a technology.

[Joe Forkey, CEO at Precision Optics]

And so by giving them this higher level base design, it accelerates the time to market, but there's still a requirement to take the base design and wrap it in the outside configuration that our customer needs, and to decide which of the other modular pieces to bolt on. And our expectation is that for each customer, they're going to have a couple of unique custom pieces that also have to go on.

[Joe Forkey, CEO at Precision Optics]

So it does not remove the time and materials charge that we charge for our customers as they go through the product development process. It just accelerates that, and it allows us to charge our customers for this baseline designs, which will be the same for every customer.

[Joe Forkey, CEO at Precision Optics]

So from a margin standpoint, because we can charge for this baseline design, which, after this bit of R&D that we're incurring now, will be the same for everyone, that should help our gross margins on the product development side of things go up slightly.

[Joe Forkey, CEO at Precision Optics]

And it will continue to bring our customers into the product development pipeline, but it will add to our competitive advantage because of the reduced time to market and the reduced risk that comes from starting from scratch.

[Joe Forkey, CEO at Precision Optics]

So, I hope I think I answered most of the pieces of your question, Robert. Whoever asked the question, if there's a follow-up, I'm happy to take it.

[Robert Blum, Managing Partner at Lytham Partners]

All right, great. Well, I show no additional questions here, Joe, so I will turn it over to you for any closing remarks.

[Joe Forkey, CEO at Precision Optics]

Okay. Thank you, Robert. Thank you, everyone, for joining us on the call today. I look forward to speaking to all of you soon. Thanks very much. Have a good evening.

[Operator]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Participants

Executives

• Joe Forkey, CEO
• Wayne Coll, CFO

Analysts

• Robert Blum, Managing Partner at Lytham Partners