Good day. And welcome to the Precision Optics Reports Fourth Quarter Fiscal Year 2022 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Mr. Robert Blum. Please go ahead, sir..

All right. Thank you all for joining us today for the Precision Optics fourth quarter and fiscal year 2022 conference call for the period ended June 30, 2022. With us on the call representing the company today are Dr. Joe Forkey, Precision Optics’ Chief Executive Officer; and Dan Habhegger, the company’s Chief Financial Officer.

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 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 statements.

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.

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.

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 risk 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 our filings with the Securities 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.

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. So, with that said, let me turn the call over to Dr. Joe Forkey, Chief Executive Officer of Precision Optics. Joe, please proceed..

Thank you, Robert. And thank you all for joining our call today to discuss our fourth quarter and fiscal year 2022 financial results. Fiscal 2022 was clearly a transformational year for Precision Optics.

We advanced a number of programs from our pipeline to production, resulting in strong organic growth for the year and for the fourth quarter in particular, and we completed the acquisition of Lighthouse Imaging to combine two of the industry’s leaders in micro-optics and digital imaging.

We have talked for some time about our business strategy based on the idea of engaging with customers at the very early stages of the product development cycle to use our cutting-edge technological capabilities to enable their product requirements.

This approach in many cases provides ongoing manufacturing revenue for many years once the product has transitioned from development into production.

We have now demonstrated the success of this business strategy with products that are currently in production and range from next-generation cardiovascular endoscopes to otoscopy and spinal surgery devices, as well as defense and aerospace programs. The markets for our products continue to be robust.

The impact of pandemic-related restrictions on medical device inventories has largely been resolved and we see existing customers moving back to pre-pandemic sales levels. We also are experiencing a significant increase in the number and size of new program opportunities.

We believe this is due in part to the overall growth of the minimally invasive surgical market, but also due to the recognition by potential customers that the breadth and depth of our technical capabilities with POC and Lighthouse now combined as one company is unique and really unmatched in the industry.

With a burgeoning production portfolio and a large pipeline that continues to move projects through the development process, I believe we are in a great position to continue the acceleration of organic growth in fiscal 2022 into the future. As usual, I will talk about a few of the most pertinent programs contributing to our growth.

But first, I’ll start with a quick recap of the numbers we reported today. Total revenue for the year was $15.7 million, an increase of 47% compared to fiscal year 2021. Excluding the revenue attributable to Lighthouse, organic revenue was up 11% for the year, with production revenue up 19%.

Looking specifically at the fourth quarter, revenue was up 79%, and again, excluding Lighthouse, organic revenue growth in the fourth quarter was up 27%. Gross margins for the quarter and year were 30% and 31%, respectively, and excluding Lighthouse would have been 35% for both periods, up year-over-year from 29% and 32%, respectively.

Clearly, we have made significant progress in growing revenues organically and we are beginning to see the effects of higher utilization on gross margins. As we continue to integrate Lighthouse and move more products into production, we expect to see ongoing growth in both revenue and gross margin.

In the new fiscal year, we will also be more focused on demonstrating our ability to see our gross profit flow through to the bottomline. Given our ongoing growth, we still believe it is the right time for us to uplift our stock to the NASDAQ capital market.

As most of you are aware, we successfully received approval from shareholders at our annual meeting in April to affect the reverse split if needed, to satisfy the NASDAQ minimum share price requirement.

We have needed to take steps to be sure we comply with certain other technical requirements of NASDAQ, such as our unrestricted market cap and number of round lot shareholders. While it has taken longer than we originally anticipated, we now believe that the company has satisfied all of these requirements.

We are awaiting confirmation or further comment from NASDAQ. With a positive response, we anticipate the process of listing shares on NASDAQ to be completed in the next few weeks. Overall production revenue was $10.3 million during fiscal 2022 versus $7.9 million in fiscal 2021, an increase of $2.4 million or 30% year-over-year.

Of this increase, approximately $870,000 came from Lighthouse, which implies a 19% growth in organic production revenue. For the fourth quarter, production revenue was $3.1 million, compared to $1.9 million in Q4 of fiscal 2021, an increase of more than 60%.

Lighthouse contributed $364,000 of the fourth quarter production revenue, which implies a 43% year-over-year organic production revenue growth.

The key drivers here were the increase in production orders for our spinal product for a major long-time customer, which we announced in March, our new defense/aerospace production contract, which we announced in February, the transition to production of Lighthouse’s next-generation otoscope device, which we announced in May, and a nice pickup in our older lead defense/aerospace product, which came back following a delay during the pandemic.

Let me expand on these four key drivers of production revenue. We have talked on recent calls about the large new defense/aerospace order that is now in full production. In February, we announced initial production orders for approximately $1.5 million.

In May, we received additional orders totaling approximately $800,000 and we expect additional orders soon to support ongoing deliveries for the indefinite future.

During the fourth quarter, we delivered approximately $400,000 against this order and we expect deliveries to increase in the next couple of quarters to reach the $3 million annual run rate we announced previously. In addition, we continue to work with this customer on additional products, some of which are going through prototype testing now.

Our ongoing defense/aerospace program also contributed to revenue increases for the fourth quarter and fiscal year. You may recall that this program was delayed due to the pandemic, but is now back underway. We received the latest follow-on order in November of last year for $875,000 or a bit more than $200,000 per quarter.

We are working to fulfill this order now. And based on discussions with this customer, we expect to see additional follow-on orders for this program when this one is completed.

On the medical device side, we reported in March 2022 that we had received production orders totaling approximately $2.5 million for a spinal surgery product that we have been delivering to a large medical device customer for over 10 years.

We delivered nearly $0.5 million in product to them in each of the third and fourth quarters, and expect to continue shipments at nominally the same level for the next couple of quarters. This is a great example of the value to our company of medical device products once they transfer to production.

With very little ongoing investment, this product has continued to contribute to production revenue and now more than 10 years out from initial production, volumes have grown substantially.

Because of regulatory requirements and an aversion to risk associated with changing suppliers, these types of products tend to stay with us once they transition to production, often contributing to ongoing revenue for many years.

Finally, and as we talked about last quarter, the first program from our Lighthouse acquisition to transition to production occurred during the fourth quarter.

This product is a highly complex optical and electronic otoscope used for imaging in the ENT space, and we are currently delivering against the $600,000 initial production order that will continue for the next six months to nine months with follow-on orders expected.

Production of this product represents the first successful transfer of a Lighthouse pipeline product since the acquisition and is a great indicator of the likely success of other pipeline programs nearing production. Overall, we continue to see a nice recovery of other mature products that were delayed due to the pandemic.

In particular, our otoscopy and cardiac devices continue to experience improved market pull-through, which we believe will lead to an increase in production for both programs as we enter fiscal 2023.

As I have said in the last couple earnings calls, our product development pipeline and the volume and size of new opportunities, especially as a combined company, continues to be as large as it has ever been. So we are able to replenish our pipeline as soon as programs transition to production.

Our engineering revenue was $5.4 million for the year, an increase of 94% compared to the previous year. Lighthouse contributed about $3.0 million of this revenue. We have integrated the two engineering teams and are finding the combined resource to be much more scalable.

Most programs, even those that came into the merger from one company or the other, are routinely worked on by engineers sitting in both locations. It is a testament to the early successes of our integration efforts that the combined engineering team is working so well together.

As I mentioned last quarter, I’m really excited that we recently received the development program from the first customer we engaged as an integrated company.

We spoke to this company -- this customer soon after the acquisition, began dedicated discussions about their project in December and received an order for the first stages of the development program in April. We expect this program to convert soon to a full development program.

As I commented previously, based on conversations with this customer, I am completely convinced that neither POC nor Lighthouse would have received this order prior to the merger, because this program requires both the heavy-duty optical and electronics expertise that our combined company can now provide.

This is a great validation of the reasons for which we made this acquisition and it’s a strong indicator of the business opportunities before us. There are a number of programs in our product development pipeline that have the ability to transition to production in fiscal 2023.

This includes the single-use ophthalmoscope project that continues to move forward with urgency on the part of our customer, who now anticipates regulatory submission in early calendar 2023 and product launch next summer.

As I’ve stated before, this project has an added importance to Precision Optics since it is our first high-volume single-use product.

Our experience with this program has allowed us to better understand the business requirements of single-use products and has allowed us to develop tangible IP and intangible know-how related to single-use devices in general.

This experience positions us well to address the large and rapidly growing single-use segment of the medical device market, which by some estimates is growing at 2 times to 3 times the rate of the reusable device market.

As we look to the first quarter of fiscal 2023, we expect our run rate of overall revenue to be steady compared to Q4 and increasing as we progress through the year.

From a revenue standpoint, we are focused on ramping current production programs and converting development programs into production, so that we exit the fiscal year at a run rate much higher than our current quarterly revenue. While our growth is never linear, we expect solid organic growth in the range of 20% for this coming year.

Let me talk a bit now about some of the financial highlights. I’ve already mentioned revenue a few times, but to reiterate, revenue for the fiscal year and fourth quarter were $15.7 million and $4.8 million, respectively, both representing new records for annual and quarterly revenue.

The growth for both time periods was due to a combination of organic revenue growth, combined with new contributions from Lighthouse. Our gross margin was 30% for the fourth quarter, compared to 37% in the previous quarter and 30% in the fourth quarter a year ago. Excluding Lighthouse, Q4 margin would have been 35%.

For the year, gross margin was 31%, compared to 32% last year, and excluding Lighthouse, would have been again 35%. Gross margin related to organic revenue for the quarter and year of 35% is up 3% to 5% year-over-year and certainly moving in the right direction.

As we have long anticipated, gross margins associated with organic revenue have begun to rise as a result of improving production efficiencies along with higher utilization of production and engineering resources.

While we were generally pleased by the increase in margin, we also experienced some one-time expenses in the fourth quarter associated with production start-up costs for the new large defense/aerospace program, some integration costs related to the movement of Lighthouse’s inventory management system into POC and some charges related to a product we discontinued during the year.

Without these one-time charges, fourth quarter margin would have been approximately 33% and fourth quarter margin on organic revenues would have been approximately 39%, which is close to the 40% target we have talked about on previous calls.

All told, the general trends we have talked about in the past that will help us achieve our target gross margins of 40% and higher are still intact. We may see some fluctuations from quarter-to-quarter, but the overall expectation is that gross margins will continue to improve.

Operating expenses in the fourth quarter were $1.9 million, compared to approximately $1.8 million in the previous quarter. On a cash basis, excluding depreciation and amortization, as well as stock-based compensation, operating expenses were approximately $1.7 million, compared to approximately $1.5 million in the previous quarter.

The roughly $200,000 quarter-over-quarter increase is largely due to increased travel, trade shows, commissions and other general sales and marketing expenses that have increased with the end of the pandemic and with increasing revenues. I want to call your attention to the other income line, which includes an entry for $742,084.

This entry arises from the impairment of an earnout that was available to the previous owners of Lighthouse Imaging. The acquisition included earnout opportunities, the first of which was for $750,000 based on a gross margin target for the 12-month period following the acquisition.

It is now clear that the gross margin target will not be met in the first year, and therefore, POC will not be obligated to make the earnout payments.

While we are disappointed that the Lighthouse operation did not achieve these gross margin targets in the first year, we believe the underlying value of the Lighthouse operation and of the combination of POC and Lighthouse technical resources are still solidly positive.

The reason that Lighthouse did not satisfy the earnout targets was mostly due to delays in transitioning some of the pipeline programs to production. While we would have preferred that the programs transition sooner, we put the earnout structure in place largely because this timing is difficult to predict.

We are still confident that these programs will transition to production in the near-term and that they will be accompanied by profitable increases in revenue when they do. All told, net income for the fourth quarter was $269,000 and for the year was a loss of $928,000.

Adjusted EBITDA, which excludes stock-based compensation, interest expense, depreciation, amortization and the earnout impairment, was a loss of $191,000 for Q4 and a loss of $242,000 for the fiscal year. As we look forward to the coming year and beyond, it’s important to recognize that over the last few years, our business has grown several fold.

We have digested that growth and invested in our infrastructure, including sales, finance and accounting, human resources and IT. With our revenues and gross margin improving, a key priority in the new fiscal year will be to show a solidly profitable bottomline.

We will continue to invest in growth, but we have reached a maturity level where we must show the business is self-funding and generates a positive return. I believe we are well positioned to accomplish this in the coming year. One final note before I take questions.

We will be participating in the Lytham Fall 2022 Investor Conference over the next few days. I look forward to speaking with many of you then. But as always, please don’t hesitate to reach out to Robert Blum or to me directly to schedule a call for another time. I thank you for your time today and I’d now be happy to take any questions..

[Operator Instructions] The first question will come from Mr. Rick Teller, Investor [ph]. Please go ahead, sir..

Yeah. Hi, Joe.

A question for you, with the expansion of production on a lot of these new products, how are you doing in terms of lining up the right kind of production labor that you need?.

Yeah. Thanks, Rick. That’s a great question. So, generally speaking, everyone knows that the labor market is very tight. I would say that the locations that our operations are in are some locations where the labor market is not quite as tight as it is in other places. It’s still tight, to be sure.

But we’re located outside of the major metropolitan areas, although we’re close enough to get to the airports and to draw in technical talent and such, but not right in the middle of it, where the labor shortage is most acute. Having said that, we still do have to work and make an effort to find the right talent.

But one of the benefits that we have is that we train all of the assembly folks that join our company. So part of the development process that we go through when we’re going through the engineering process is the design and validation of tools and fixtures that make it a bit easier to manufacture the products that we generally make.

And while our technicians are highly talented, they don’t have to come in with specific capabilities or experience in order to be able to contribute to the production that we do. It takes them a week or two to get up to speed. For some things it takes longer. But we basically stage people so that they can start to contribute as quickly as they come in.

So all of those things combined has allowed us to be able to keep up with the labor needs that we need and I think we’ll be able to do that even as we move forward..

All right. Good. And one other production question, single-use products, by their nature, they have to be sold at a much lower price point, which presumes some kind of automation.

Are you -- to make those things, does that require, let’s call it, standard equipment that you can buy from outside vendors or do you have to kind of create your own equipment?.

Yeah. It’s a great comment and great observation and great question. So this is a big part of what I referred to in my comments about learning some of the unique aspects of what’s required to support a single-use program. It’s not solely technical.

It also has to do with the financials and economics of single-use, which, as you point out, Rick, have much more stringent price point pressures. So to answer your specific question, virtually all of the tools and fixtures that we use for the single-use programs are designed in-house and are built by us.

There may be components that we get off the self. But ultimately, the tools and fixtures are all put together by us, and we go through a very robust validation process to demonstrate that the yields using these tools and fixtures will be very, very high, because, again, with the higher volumes yield is particularly important..

Very good. Thank you..

Thanks, Rick..

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks. Please go ahead..

Thank you, Operator, and thanks again, everyone, for joining us on the call today. Once again, I will be available in the next couple of days at the Lytham Investor Conference. If folks have additional questions and I’d be happy to talk to everyone at any time. Look forward to speaking with you all soon. Thanks. Have a good night..

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