Precision Optics Corporation, Inc.

Good day and welcome to the Precision Optics Report's third quarter fiscal year 2025 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. And 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 Mr. Robert Bloom with Lithum Partners. Please go ahead, sir.

Thank you, operator, and to everyone joining the call today. As the operator mentioned, on today's call we will discuss Precision Optics third quarter fiscal year 2025 financial results, and this is for the period ended March 31, 2025. With us on the call representing the company today are Dr. Joe Forkey, Precision Optics Chief Executive Officer, and Wayne Cole, 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. As the operator indicated, if you dial through the traditional teleconference line, 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. 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 that 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 Exchange Commission. All forward-looking statements contained during this conference call speak only as of the date on which they are 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, Precision Optics. Joe, please proceed. Thank you, Robert. And thank you all for joining our call today. Let's start right at the top with the challenges we encountered during the quarter in some of our production programs that led to significantly lower revenue and margins than we expected. Having rolled out a number of programs from product development into rapidly ramping production over the last 12 months, we sometimes discover process fixture or personnel limitations that can result in low yields, delivery delays, and reduced efficiency. These types of issues resulted in lower shipments than planned this quarter, underutilization of resources, greater scrap, and substantial negative adjusted EBITDA. There were also the indirect impacts of management's time and attention and direction of engineering resources to support the production line in addressing these issues. While we are disappointed by these results for the quarter, our confidence and excitement for the future remain undiminished. We have made significant progress on resolving the third quarter issues, and we have the largest production backlog in over 20 years. With a positive response to the launch of our Unity platform in Q3, we believe the underlying fundamentals of our strategy for business growth remain strong, and we look forward to recovering that growth in Q4 and beyond. Today, I'll focus my remarks on the following items. First, the operational challenges we face in Q3. Second, how we resolve these challenges. Third, the exciting sales pipeline we see as we look forward. Fourth, the Unity program rollout. And finally, our two new board members. One of the major programs driving our production growth is the single-use cystoscope. In mid-January, daily yields on this product line dropped precipitously to less than 50%. This is well below our historical and expected yields of around 90%. As a result, we stopped manufacturing while we performed a root cause investigation. By mid-February, we had identified the source of the low yields, made corrections, and restarted production. The restart was successful, but the ramp back to previous unit production levels took longer than we anticipated, mainly due to challenges we experienced in recruiting, retaining, and training adequate numbers of assembly technicians, particularly for a second shift. While POC has manufactured products for many years, the particular requirements associated with running higher volume lines with multiple shifts led to some challenges that we had to overcome. The good news is that we have made significant progress, both in improving production yield and in staffing both the first and second shifts. And while we continue to improve in both of these areas, the endoscope line throughput is currently double what it was before the shutdown, and we expect this line to contribute significantly more revenue in Q4 than it did in Q3. Moreover, the customer for this product was supportive of the yield analysis we performed and solutions we implemented, and has now asked us to expand our output further by adding a second production line, which we expect to begin producing product in the first half of fiscal 2026. The result of production challenges like this and the distraction of engineering resources away from product development work to resolve these issues resulted in a shortfall of approximately $600,000 in Q3. Separately and incrementally, about $300,000 of product development revenue was pushed out of Q3 due to a customer-imposed delay in one program and a single delayed milestone, which will be delivered in Q4, in one other project. Despite these issues, overall systems production revenue, which includes products launched in the last year as well as some legacy products, continued its upward growth, increasing over 20% quarter over quarter and more than doubling year over year. We had expected greater growth in the quarter, but our confidence and excitement for the future remain undiminished, and the demand remains unchanged. We have made significant progress resolving third quarter issues, and we have a large production backlog dominated by products for customers who will take delivery as fast as we can build. The underlying fundamentals of our strategy are robust, and we look forward to posting solid revenue growth in Q4 and beyond. Production levels from our aerospace program in particular have continued to ramp as anticipated from approximately $300,000 in Q1 to $600,000 in Q2 to just under $900,000 in Q3. Near the end of Q3, we doubled the line capacity by expanding our ISO class seven clean room and building additional tools and fixtures. We expect production for this program to set another new record in the fourth quarter as we strive to double output quarter over quarter. In April, after many months of negotiation, we finalized the main purchase agreement, which will govern our ongoing manufacturing work with this customer. The agreement highlights the commitment between the companies to expand production of this product that leverages POC's proprietary manufacturing technology. Under the terms of the new agreement, the customer has agreed to minimum annual purchase commitments of nearly $4 million for 2025 and 2026. This commitment, along with the backlog greater than $6 million today, provides us with a level of predictability and visibility to our growing production schedule, which will help us better forecast and execute production revenues. In Q3, we also started production of two additional programs transitioning from product development. One is our second single-use program to go into production, a microendoscope used for an ophthalmic procedure, and the second is a complex subassembly used for retinal imaging. Each of these programs is now running at a $100,000 to $200,000 per quarter level. Finally, there are still many product development programs that continue to move forward which meet our standard benchmarks for production revenue potential. In particular, a couple programs that were delayed due to work our customers needed to do before continuing their work for us have now started to move forward again. A good example of this is a program that uses a very small single-use endoscope for a specialty arthroscopic procedure that has been on hold for over a year as our customer evaluated updates and market conditions before deciding to move forward. Earlier this month, we received a purchase order to complete product validation, and we now expect this project to move to production near the end of calendar 2025. The single-use ophthalmic endoscope that started production in the third quarter and the single-use arthroscope that just restarted in our product development pipeline along with our single-use cystoscope already in production, all represent good examples of the way POC's unique capabilities in micro-optics and CMOS-based digital imaging are enabling next-generation endoscopic systems that support the fast-growing single-use endoscope market. As we've discussed on recent calls, this segment of the endoscope market is growing at annual rates estimated to be as high as 20%. and is being driven by the lower cost and superior performance of these scopes. The lower cost comes from the use of photolithography computer chip technology to fabricate CMOS sensors, combined with the positioning of the CMOS sensor at the distal tip of an endoscope. This eliminates the high-cost elements in more traditional endoscopes required to carry the image from the distal to proximal ends of the endoscope. Along with lower cost, the CMOS-based scopes generally have better image quality than those based on older imaging technologies. With single-use endoscopes, surgeons always get brand-new scope image quality. Hospitals don't need to track scopes through reprocessing procedures, and perhaps most importantly, the possibility of cross-contamination from one patient to another is eliminated. Now that CMOS sensors have been available for medical devices for a number of years, And with early adopters demonstrating that single-use endoscopes are technically, clinically, and economically viable, the entire endoscope market is moving in this direction. With POC's long-term strategic focus on developing technology, infrastructure, and partnerships, particularly with OmniVision, a market leader in producing CMOS sensors, we are well-positioned to become the supplier of choice for digital endoscopes and, more specifically, for single-use endoscopes. Our Unity platform, which we launched in late January, further aligns our offerings to this target market. As we discussed at length in our last call, the Unity platform is designed to utilize standard baseline designs with a library of modular subsystems that can be quickly updated and customized to satisfy specific customer product requirements. At a high level, Unity is expected to revolutionize the way new endoscopic systems are developed by combining the best technology with the best design process. This approach reduces risk, cost, and most importantly, time to market. The response to the launch of Unity at shows in late January and early February, along with the demonstration exhibit and session presentation at the device talk show in May, has been very positive. We have seen a steady increase in website traffic flow with April levels more than 15% greater than January. And today we are in active discussions with five potential customers motivated by their interest in Unity. This response bolsters our confidence that Unity will help us bring new programs into our development pipeline in the near term. Before I turn the call over to Wayne, I want to make a couple comments on the recent changes to our board. I want to start by thanking and acknowledging Dr. Richard Miles for his dedication to POC. Dick retired from the board in March after serving as a director for nearly 20 years. During that time, he has been a steadfast supporter and contributor to POC. Peter Anania, who joined us following the acquisition of Lighthouse Imaging in 2021, also retired from the board in March. He was a great resource of experience and advice and has been a strong contributor during his entire time on the board. We are fortunate to have two highly respected individuals with great experience in areas relevant to POC's current operations joining our board, Buell Duncan and JJ Pellegrino. Many of you may know JJ from his role as CFO at LaMaitre Vascular, a NASDAQ-listed company in the medical space. JJ's record of success in helping to build a company from early beginnings to significant scale and shareholder appreciation are directly relevant to Precision Optics, especially since much of LaMaitre's growth was driven by scaling production of medical devices in Massachusetts facilities. Similarly, Buell Duncan brings decades of executive leadership and strategic expertise, further strengthening our commitment to innovation and growth. having been a marketing and general management executive at IBM for nearly three decades. Buell's experience building and leading sales and marketing teams and in general corporate management will be valuable to us as we work to capitalize on sizable market opportunities. With that, let me turn it over to Wayne to review the financials in more detail. I will then provide some closing comments and open the call to questions. Wayne? Thank you, Joe.

Let me expand on some of Joe's comments on the financial results, starting with revenue. For the third quarter, revenue was $4.2 million compared to $5.2 million in the third quarter of fiscal 2024. Breaking it down, production revenue was $3.2 million compared to $3 million in the year-ago quarter, while engineering revenue was $924,000 compared to $2.3 million in the year-ago quarter. As Joe mentioned, low yields forced us to pause production of our single-use cystoscope, resulting in unplanned increases in non-billable, sustaining engineering activities to support manufacturing scale of programs and conduct a root cause analysis. Our efforts, while ultimately successful, consumed engineering time and resources in these non-billable activities. With the launch of our Unity platform, a customizable solution that encompasses our design approach and the interest generated by our presentations at three of the four major trade shows we will attend this year, we've seen the pace of engineering pipeline opportunities increasing. We also recognize the comparative impact of the full absorption of our engineering team's efforts to bring the single-use cystoscopy product to launch when we compare current results to the year-ago quarter. We expect to finish our fiscal year strongly with $6 million in sales in the next quarter. Our backlog and demand for production remains strong, driven by the aerospace and single-use programs. Turning to gross margin, for the quarter ended March 31, 2025, gross margins were 10% compared to 35% in the year-ago third quarter. As we mentioned, the low yields and one month shutdown of the line and the under absorption of engineering resources were contributing factors here. We expect gross margin to recover as manufacturing continues to scale and revenues increase, particularly in the fourth quarter. We increased R&D spending in the quarter from 193,000 to 211,000 compared to the quarter ending March 31, 2024. R&D spending in the current fiscal year increased $302,000 to $930,000 compared to $627,000 during the nine months ended March 31, 2024, primarily due to our investment in Unity. Selling general and administrative expenses, or SG&A, increased $321,000 to $2.2 million during the three months ending March 31, 2025, compared to $1.9 million during the three months ending March 31, 2024. The increase was primarily due to increased personnel costs, primarily stock-based compensation and recruiting expenses. Similarly, SG&A spending in the current fiscal year increased $357,000 to $5.9 million compared to $5.5 million during the nine months ended March 31, 2024. As a result of the lower revenue and associated lower gross profit, our net loss was $2.1 million for the quarter compared to $317,000 net loss for the same quarter last year. Adjusted EBITDA, which excludes stock-based compensation, interest expense, depreciation and amortization, was negative $1.3 million in the third quarter of 2025, compared to a positive adjusted EBITDA of $52,000 in the same quarter last year. Cash at the end of March was in excess of $2.5 million. During the quarter, we raised approximately $5 million, paid down our revolving line of credit, and deployed working capital. I will now turn the call back over to Joe for some final comments.