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Operator
Good day and welcome to the Precision Optics Report's first quarter of fiscal year 2022 financial results conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Robert Bloom with Lippin Partners. Please go ahead.
Robert Bloom
All right. Thank you very much, Betsy. And thank you all for joining us today, as Betsy mentioned, to discuss the financial results for Precision Optics for the first quarter of fiscal year 2022, ended September 30th, 2021. With us on the call representing the company today are Dr. Joe Forkey, Precision Optics Chief Executive Officer and Dan Hebegger, the company's chief financial officer. At the conclusion of today's prepared remarks, we'll open the call for a question and answer session. Today's conference call is also being webcast with replay capabilities available, both 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 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 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 the 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 of Precision Optics. Joe, please proceed.
Betsy
Thank you, Robert. And thank you all for joining our call today to discuss our first quarter fiscal year 2022 financial results. This is our third investor conference call in the last month and a half. Following our year-end call in late September, in our Lighthouse Acquisition Call in early October, so I want to thank all of you for your continued interest and participation. During the call today, I will review the results of the first quarter, but perhaps more importantly, I want to provide an outlook for the remainder of fiscal 2022 and beyond. It is an exciting time for us. In the near term, we see significant opportunities in the pipeline projects nearing production, a list that has grown substantially with the acquisition of Lighthouse Imaging. And in the longer term, the combination of capabilities available at POC and Ross Optical with those of Lighthouse positions us very well to respond to the needs of our customers. I'll start with a summary of the first quarter results. While our overall revenue for the quarter was down year over year, our production revenue was the highest it has been in the last four quarters, coming in at nearly $2 million compared to $1.9 million in the most recent sequential fourth quarter and $2.2 million in the first quarter a year ago. The year-over-year change is consistent with what we have experienced the last few quarters as the pandemic has reduced our production revenue for released products by slowing or postponing production on three of our major programs. One of these three programs, for which reorders had been delayed, is our main defense production program. I'm pleased to report today that we finally received the reorder for this product, the first since before the start of the pandemic. I will provide more details on this in just a moment. On the engineering side, revenue for the first quarter was the lowest it has been in the last five quarters. This was due in part to delays in reaching specific invoiceable milestones for our single-use ophthalmology program, as well as delays in receipt of some new development orders from customers. Associated with the ophthalmology program delays, engineering resources were used to complete work that was outside the scope of current purchase orders and therefore did not contribute to revenue this quarter, but was necessary to support the long-term success of the program. We are in the process of resolving these issues, so we expect engineering revenues for the historical business that is, not including Lighthouse's contributions, to rebound in the second quarter and beyond. To reduce the revenue risks associated with out of scope engineering work and milestone delays in future pipeline projects, we have changed our proposal process for nearly all of our newer projects to a time and materials model. With this approach, most additional costs are covered by our customers and revenue for engineering work is recognized in the quarters in which it is performed. This is an approach we started using on projects about a year or so ago, and it is also the approach that has been used by Lighthouse for many years. Because our acquisition of Lighthouse didn't close until October 4th, with an effective date of October 1st, their first quarter results are not included in the results we reported today. In December, we will release historical pro forma financials for the combined company. We expect pro forma first quarter fiscal 2022 revenue for the combined company to be between $3.5 and $3.8 million. At our next earnings call in February, we will announce second quarter fiscal 2022 numbers for the combined company and I will discuss future expectations in more detail at that time. Considering the expected recovery of POC's revenue in the second quarter and the overall growth of Lighthouse's operations, we do expect revenue for the combined company in the second quarter to be higher than the first quarter pro forma levels. Although it has only been a month and a half since we closed on the Lighthouse acquisition, we have already begun to take steps to realize the underlying value of the combination. As we discussed during the conference call on October 5th, the real value of the combination of these two companies lies in the complementarity of their technical capabilities. Combining POC's expertise in micro-optics, 3D optics, and supply chain management with Lighthouse's expertise in imaging electronics and systems integration puts the combined company in an excellent position to respond to customer requirements for complete imaging solutions. This is particularly true in the medical device space where next generation products will require integration of the highest quality optical design and manufacture coupled with state-of-the-art image processing. The migration of the medical device market to systems that incorporate smaller optics, CMOS imaging sensors, and LED light sources, along with our customers' desire to find a single partner to provide the entire system design and manufacturing, including robust and cost-effective supply chain management, further enhances our combined company's competitive advantage in the medical device marketplace. The integration of the activities of the two companies has begun in earnest. We have now had numerous visits of employees from each division to the other and virtually all senior managers have met with their counterparts to discuss similarities and differences in operating procedures and to share information on best practices. In particular, The engineering teams at the two companies are now working together to find best solutions for specific aspects of five existing customer development programs, three that came from Lighthouse and two that came from Precision Optics. I am really encouraged to see these discussions progressing so quickly and smoothly, especially because they are being driven in large part by individual engineers who, I believe, already recognize the benefits of having the two technical groups working together as one team. As we anticipated, the cultures of the two companies and the alignment and motivation of the technical groups to use cutting-edge technology to solve problems for customers has really driven the technical discussions from the ground up. I believe this is a strong indicator of the likely long-term success of our technical groups working together. From a sales and marketing standpoint, we are already making joint sales calls and participating in industry conferences as an integrated company. In October, we attended our first conference together, and we have now put together plans for a single booth at all conferences we plan to attend next calendar year, with sales and technical staff manning these booths and representing the combined capabilities of all three company divisions, Precision Optics, Ross Optical, and Lighthouse Imaging. Finally, the response from our customers, both precision optics and lighthouses, has been really positive. Across the board, our customers have expressed a quick understanding of the benefits created by the merger. In some cases, customers even told us that they were hesitant to engage both precision optics and lighthouse in the past because they thought we would consider each other competitors and therefore wouldn't work together. In one case, An existing Precision Optics customer has asked us to extend our contract to add work by the Lighthouse group. And in two other cases, we have customers who are asking us to provide proposals that include work based on capabilities of both the Precision Optics and Lighthouse divisions. It is clear that our customers understand the benefits of POC and Lighthouse working together. All in all, I am very happy with how well the two organizations have begun to work together and with the future opportunities this creates for the combined company. I'll now comment briefly on our existing production programs and then provide a quick update on some of our engineering pipeline projects. As I already mentioned, I am really pleased that we have finally received an $875,000 follow-on order for our lead defense product. This is an order we have been waiting for since before the start of the pandemic. We expect to see about $60,000 in revenue from this project during the second quarter, with the remainder of the order spread out over the next four quarters. Based on discussions with this customer, we expect to see additional follow-on orders for this program when this one is completed. As we reported throughout much of fiscal 2021, we continue to see reduced production levels from the cardiac program. As the pandemic reduced the number of surgical procedures last year, our customers' inventory of the endoscope that we make increased, and so we throttled back on our production rates. We continue to hear from this customer that they are seeing increases in demand. While it is difficult to predict the timing of this product's full recovery, all indications are that over the long term, it will return to levels as high as or higher than they were before the pandemic. Production of our otoscopy product remains on hold pending better end market visibility for the product as our customer works through the excess inventory they have built up during the pandemic. While our customer continues to sell product and the market volume is beginning to show some early signs of recovery, the timing and extent of future order requirements are still uncertain. Despite this, our relationship with this customer continues to be very strong. As I mentioned last quarter, they've engaged us to help them evaluate some design options on another program for an ophthalmic product. This engagement is continuing to grow, and we believe it is likely to become a long-term engineering pipeline program with significant potential for engineering development work this year and production work next year. As we continue through fiscal 2022, we expect overall growth in revenue from our commercialized products to increase nominally. even while some of the products continue to be impacted by the pandemic. Longer term, over the next 12 months or so, we expect all of these products to recover to pre-pandemic or higher production levels. As I've mentioned in the past, our engineering pipeline is as large and robust as it has been at any time in recent history, and it has grown even more with the addition of Lighthouse. A number of these programs are targeted by our customers for release into production in the next 12 months. Combined with Lighthouse, we now have development projects in the medical device areas of otoscopy, colonoscopy, arthroscopy, ophthalmology, laparoscopy, abdominal surgery, ear, nose, and throat, cardiology, and urology. We also have a number of projects we are working on in the defense and aerospace market. While there isn't time for me to comment on all of these pipeline projects, I will give a brief update on some of the ones we have discussed on previous calls. Our customer for the multi-camera colonoscope, which is enabled by the custom micro cameras we provide, believes that this device is very close to receiving 510 clearance from the FDA. He recently told us that the FDA required one additional clinical trial that has now been completed. While we and our customer wait for the FDA, they have developed a robust go-to-market plan with a sales force in place, demo systems, and production facility. We remain confident that soon after they receive clearance, we will see additional production orders for our cameras. The project with the large defense and aerospace company that we have discussed the last few quarters continues to move forward nicely. We delivered some of what we believe will be final prototypes at the end of September and early October. Also, I visited this customer in person in early October with our sales team. They spent an entire day with us and shared with us many details of their rollout plans for the program that uses our product. We left the meeting further encouraged that our partnership with this customer remains strong and that we are well positioned to receive production orders, perhaps before the end of this quarter. Within our single-use ophthalmology program, we continue to move through design and process validation, having now completed the assembly of approximately 500 design validation units. We continue to anticipate that this product will go through regulatory approval in the next few months and move into production by mid next year. Similar to recent quarters, due to the complexity of the program, we incurred costs in the first quarter that were higher than we originally anticipated and that were not covered by revenue from this customer. This is the program that I referred to earlier as the major reason for our reduced revenue and margin for the first quarter. Despite the cost overruns, I believe, as I have stated in the past, that this is the right program for us to make these investments in. In addition to the potential long-term production revenue, This program will be our first single-use project that will go to production. The experience and understanding we are gaining about single-use products, as well as the tangible IP and somewhat intangible know-how, will allow us to better develop a long-term strategy to address the large and rapidly growing single-use segment of the medical device market. In addition to these few specific pipeline projects that I have commented on before, Lighthouse brings to us four additional programs, which we will discuss on our next earnings call, that we believe could move to production in the next 12 months. And combined, we have many additional programs that are beyond the early feasibility stage and firmly contributing to the size and strength of our engineering pipeline. To meet this strong demand, we continue to expand our combined engineering teams. As another indication of the efforts to integrate activities of the two technical teams, we have already begun joint interviews of new prospective engineering candidates. Let me now turn to summarize and comment on some of the specific elements of our income statement and balance sheet. On the top line, as I've already mentioned, revenue during the first quarter of fiscal year 2022 was $2.3 million. Production revenue was nearly $2.0 million, while engineering revenue was about $373,000. As I've already discussed, this was the highest production revenue in the last four quarters, but the lowest engineering revenue over that time period. Engineering revenue was impacted mainly by one specific program and delays in some new orders. As we work on correcting both of these issues, we expect engineering revenue, and therefore total revenue, to rebound in the second quarter and beyond. As I mentioned, on a pro forma basis, including lighthouse operations, first quarter revenue would have been between $3.5 and $3.8 million. I don't want to provide specific guidance for the second quarter results, which will include Lighthouse, but it is our expectation that revenues will be at this level or higher with future growth dependent on the exact timing of the production launch of some of the many pipeline projects of the combined company. Our gross margin was 27% for the first quarter compared to 29% in the previous quarter and 35% in the first quarter a year ago. We estimate that cost overruns allocated to the single-use product were on the order of a couple hundred thousand dollars without any associated revenue, which reduced our gross margin by about 10 percentage points. Another way to think about this is that if those costs had been allocated to R&D instead of cost of goods sold, gross margin would have been approximately 38% during the first quarter. As we have discussed on previous calls, much of our engineering work on pipeline projects represents an investment in technology and know-how, which has payoffs far beyond each current quarter's gross margin. We believe that correcting the cost overruns with the One Engineering project, along with more complete utilization of manufacturing overhead through a rebound in growth and production revenue, will lead to higher margins in the future. As we look at the business going forward, including the lighthouse imaging operations, we believe gross margins will be in the 35 to 40% range. Operating expenses in Q1 were $1.2 million. This includes approximately $172,000 in one-time business acquisition expenses. Excluding these expenses gives quarterly operating expenses of just over $1.0 million. On a cash basis, excluding depreciation and amortization, as well as stock-based compensation, non-acquisition-related operating expenses were approximately $865,000. This is basically flat compared to the previous quarter and compared to the first quarter of a year ago, indicative of our ongoing efforts to prudently manage the business. All told, on the net income line, we reported a gap net loss of $577,000 during the first quarter, with an adjusted EBITDA loss of $197,000, which excludes acquisition costs, stock-based compensation, interest expense depreciation, and amortization. The issue with the one engineering project had the biggest impact here. Looking forward to the remainder of fiscal year 2022 and beyond, we still expect some amount of ups and downs in quarterly revenue due to timing of engineering as well as production project deliverables. But overall, we are anticipating continued growth in revenue and overall financial performance as new pipeline projects transition to production and the previously running defense production program comes back online. Adding Lighthouse's expected growth in revenues and profitability, there is good reason to expect positive growth for the combined company. Turning now to our balance sheet. Our cash balance at September 30, 2021 was $1,670,000. Approximately $1,030,000 was added to our balance sheet as proceeds received before September 30, from the private placement that we closed on October 4th. An additional $470,000 was received from the private placement after September 30th and will show up on the balance sheet for the second quarter. Approximately $400,000 to $500,000 of the financing proceeds were used in the purchase of Lighthouse Imaging and associated acquisition expenses. The remainder will bolster the balance sheet and be available for any integration expenses required, including those associated with some specific working capital items that Precision Optics acquired along with the Lighthouse operation. We believe that our cash balance at the end of the first quarter positions us well to manage the integration of Precision Optics and Lighthouse imaging and to execute on our overall plan going forward. Before I take questions, I always like to recap the major elements of our strategic plan that we put in place a couple years ago and have discussed on recent calls. First, grow our sales capabilities and capacity. Second, invest in our technical resources and develop our own intellectual property. Third, invest in and update our production capabilities, for example, to address the single-use market. And fourth, augment our own skills and programs via external partnerships or acquisitions. I believe we have been successful in recent quarters in all areas of this plan and that we are starting to see the positive results on our business. Obviously, the acquisition of Lighthouse Imaging fits squarely in the last element of this plan to explore and execute strategic acquisitions. But I am confident that, in fact, this acquisition will advance all four areas of this strategic plan. Overall, I am pleased with the current state of precision optics, as well as our position for future growth. We have created a strong capability in micro-optics and 3D imaging, particularly within the medical device and defense and aerospace markets, which allows visionary customers to leverage our capabilities to bring to market next-generation applications that they would otherwise be unable to accomplish on their own. With the addition of Lighthouse, I believe we will have one of the premier engineering groups in the entire industry, offering customers a one-stop shop for optical imaging-based medical device design and production. While I recognize that there is a lot of work ahead of us to realize the full potential of our combined company, I am very excited about the position Precision Optics is in today about the team that we have assembled, and about the opportunities that lay ahead of us. A couple final notes. We will be exhibiting at the Medical Design and Manufacturing East Show in New York City December 7th through the 9th, and I will be there in person on the 8th. Also, we will be participating in the Lithum Winter 2021 Investor Conference the following week on December 13th through 16th. For that event, I will be conducting a fireside chat to highlight our vision for 2022 and will be participating in virtual one-on-one meetings. I would welcome the opportunity to meet with any of you during either or both of these events. For anyone that is interested in meeting, please reach out to Robert and his team to coordinate. I thank you all for your attention today, and now I'd be happy to take any questions.
Operator
We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster.
Robert Bloom
Hey, Betsy, while we see if there are any questions, Joe, I've got a couple here I'd like to maybe see if you can address. You chatted a little bit about the single-use project, some of the know-how and some of the learnings that you've developed as a result of it. Without going into anything that you feel is proprietary, is there anything you can expand upon what some of those learnings may have been to this point?
Betsy
Yeah, sure, Robert. So let me make this comment. So obviously, as a technical company, any of the engineering pipeline projects that we're working on has some technical aspects to it. And as we work to roll our capabilities into the specific requirements for our customers, we always are advancing the technological side of the things that we're doing. So So sort of obviously, we're improving our technical capabilities as we work on these single use projects. The obvious area is in the area of patentable inventions and those sorts of things. And in this case, there are three places where we have applied for patents that we think will be useful for other single use projects. But I think in this case, it's important to point out that a big part of what we are learning as we work through this particular project as our single-use project that has gone as far as this one has and has gotten as close to production as this one has, is the kinds of know-how that you can only get by running a program all the way through the process of going through the development and into production. And as I mentioned in my comments, we've already built 500 design validation units. Now, for a regular reusable production product, 500 units is basically one to two years' worth of production. And so in this case, we've built all of these units just as part of our development process. And the kinds of things that we are learning and that we are getting expertise in are things that are fairly specific to single-use requirements. And so these are things that have to do with the design for manufacture, the way that you set up production lines, the way that you design and the way that you incorporate tooling and fixturing. And the reason these things are so important or maybe a little different for single use is that for single use, every minute of touch time, literally every minute of touch time is important to the overall financial success of the program. Every $1 in the cost of goods is important for for the overall financial success of the program. Every half a percent of yield is important. And so there's a bit of a different mindset when you're going into a single-use project as opposed to a reusable project. If a reusable project has an extra dollar or two of cost of goods and you're selling it for $1,000, it's not going to make or break the product. For a single-use product, a couple dollars can make a big difference. And so there's really a mindset that's a little bit different, and our entire engineering team is really developing that mindset in a way that I believe will be applicable to future single-use projects. There is one other area that I just want to comment on that falls in the same category, and that has to do with our understanding of the overall single-use market, single-use device market. It's one thing to sit down and on a piece of paper lay out the financial aspects of making a single-use project successful. It's another thing to be engaged with suppliers and with a customer who is really looking at the long-term success of their program. And so we have gone through a process of evaluating the financial models associated with this single-use project. models that I believe will be useful for future projects, but also models that will help us to understand which part of this large and rapidly growing part of the medical device space, that is the single use space, models, financial models that will help us to evaluate which parts of that space we will be able to operate in and which parts of that space we will not be able to operate in.
Robert
So,
Betsy
To summarize, there are the standard technical applications or technical know-how that you would have in any kind of a project that is useful and that we're developing in this case. There are the things that are very specific to single use in terms of the way that you design a product, the way that you design fixtures, the way that you set up the workflow. And then there are the very specific things for single use around the financial models. All three of these areas are areas that we're making advancements in. as we move this particular project through the engineering pipeline.
Robert Bloom
All right, Joe, thank you for that. I do appreciate it. One other item here, and I'll turn it over if there are any other questions here. You chatted a little bit about the Lighthouse programs that are set to be in production over the next 12 months or so. I know you mentioned you might provide some additional details next quarter, but anything that might be important to add during this call here?
Betsy
Yeah, sure. So as you can imagine, a lot's been happening in the last couple months. And so I and the POC team are still getting all the details of some of these various projects, which is why I thought it made more sense for us to discuss them in some detail at the next earnings call. But let me just give everyone a little flavor for some of the things that Lighthouse is doing that we're pretty excited about. So I mentioned in my comments that there were four projects in particular that we expect could go into production in the next 12 months. Again, without going into lots of detail, I can tell you one of them is in the area of otoscopy. So it's basically an otoscope. One is in the area of an ophthalmic scanning system. One is in the area of small size arthroscopy for carpal tunnel procedures. And the fourth one is a laparoscope that would be used for robotic surgery. As you can tell, if you were listening carefully, some of those things are in similar areas that POC is working in, in terms of the disciplines. Some of them are in areas that we've talked about in the past, but haven't been talking about recently. Robotic surgery, for instance. So there's a nice match in terms of the commonality of the disciplines and the kinds of technologies that you need to address them between the things that Lighthouse is doing and the things that POC is doing. But there's also some things in that list that I just laid out that are a little different from some of the things that POC is doing, which helps us to expand the footprint of the company, if you like. Again, without going into lots of detail, what I can tell you is that For all four of these programs, they have gone through various levels of clinical trials and have had positive responses from their customers. Their customers are ready now to move to the next stage, which is to start pilot builds and to go through the regulatory process. One of the programs has already been cleared by the FDA and could have pilot builds as soon as this quarter. And if they don't come this quarter, they almost certainly will come next quarter. The other three of these projects, as I've already said, we expect the first production orders to come through in the next 12 months. So I know that's not as much detail as everyone would like, but maybe that will give people sort of a sense of what we see coming from the Lighthouse side of things.
Robert Bloom
No, that's perfect, Joe. Thank you very much. Betsy, if there are any questions, I'll turn it back over to you again. Thank you.
Operator
As a reminder, if you have a question, please press star then one to be joined into the question queue. Press star then one. This concludes our question and answer session. I would like to turn the conference back over to management for any closing remarks.
Betsy
Thank you, Betty, Betsy, and thanks everyone again for joining us on the call today. I do look forward to speaking with many of you during the MD&M show and during the LISM conference. Thanks, everyone. Have a good evening and stay safe. Bye-bye.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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