Precision Optics Corporation, Inc. (NASDAQ:POCI) Q2 2024 Earnings Call Transcript

Precision Optics Corporation, Inc. (NASDAQ:POCI) Q2 2024 Earnings Call Transcript February 14, 2024

Precision Optics Corporation, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, and welcome to the Precision Optics Second Quarter Fiscal Year 2024 Financial Results conference call. All participants will be in listen-only mode. [Operator Instructions]. 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.

Robert Blum: 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’ second quarter fiscal year 2024 financial results for the period ended December 31, 2023. With us on the call representing the company today are Dr. Joe Forkey, Precision Optics’ Chief Executive Officer; and Wayne Coll, 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 both the webcast as well as through the dial-in instructions. The details of both are included in today’s press release.

A close-up of eyeglasses on display at a Vista Optical shop.

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

All forward-looking statements contained during this conference call speak only as of the date on 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. With that said, let me turn the call over to Dr. Joe Forkey, Chief Executive Officer, Precision Optics. Joe, please proceed.

Joe Forkey: Thank you, Robert, and thank you all for joining our call today to discuss our second quarter fiscal year 2024 financial results. Revenue for the second quarter was $4.8 million. 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 second quarter revenue compared to the first 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.

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Q&A Session

Production revenue for the quarter was $2.6 million, up 6% over first quarter production revenue — an increased driven mainly by the introduction of a new defense aerospace program to production. Engineering revenue for the quarter was $2.3 million, 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 two senior engineers who started during the second quarter. We continued 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 second quarter and are confident we have taken appropriate steps to recover gross margin in the second half of fiscal 2024. 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 the expected improvement in gross margin, supports our optimism for positive EBITDA in the second half of fiscal 2024 and beyond. I wanted to take a couple of minutes to talk about some of our major programs, quite a few that have moved or will move to production this year, that will drive the sequential revenue growth that we expect for the third and fourth quarters.

I also want to put these programs into the context of the market segments that they are part of. 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 subassembly used for robotic laparoscopy that will begin production in the third quarter; as well as other otoscopy, sinoscopy, and cystoscopy 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 six 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 hundred thousand dollars 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 fourth quarter. We believe this program will ultimately settle into a run rate of approximately $400,000 to $500,000 per quarter. The second program in this category is a high-level subassembly 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 second quarter.

This product is expected to begin contributing to production revenue in the third 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 five to 10 years of complex endoscopes from designs utilizing more traditional technologies that incorporated rod lens relays or coherent fiber bundles and large 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 of 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 compete in the part of the medical device market that requires next-generation CMOS-based endoscopes.

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 POCs 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 also 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. 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. Two 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 in 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. This is consistent with overall market trends, which indicate single-use endoscopy is growing at annual growth rates between 15% and 20% — significantly higher than that of the endoscopy market in general. We have discussed our two 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(k) to the FDA, we now expect production to begin in the fourth quarter of this fiscal year, or first quarter of fiscal 2025.

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 fourth quarter of this fiscal year, more than six 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.

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 that have gained through the support of these two 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 fourth quarter 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 second quarter production revenue, and we expect this program to ramp to approximately $0.5 million per quarter by the end of this fiscal year. Our historic defense aerospace program also contributed to second quarter revenue, and is expected to increase in revenue for the third quarter. 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 million 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 second quarter, we added two 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.

Given our success with a few defense aerospace programs, we have initiated an effort to better understand the size and growth potential 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 three 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. 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 opportunities for POC’s unique capabilities.I look forward to providing more updates on this initiative on future calls. With a 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.