Item 2. Management’s Discussion and Analysis of Financial
Condition and Results of Operations.
The following discussion of our financial condition
and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and notes to those
statements included elsewhere in this Quarterly Report on Form 10-Q for the quarter ended December 31, 2022 and with our audited consolidated
financial statements for the year ended June 30, 2022 included in our Annual Report on Form 10-K, filed with the Securities and Exchange
Commission on September 27, 2022.
This Quarterly Report on Form 10-Q contains
forward-looking statements. When used in this report, the words anticipate, suggest, estimate, plan, project, continue, ongoing, potential,
expect, predict, believe, intend, may, will, should, could, would and similar expressions are intended to identify forward-looking statements.
You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated
in the forward-looking statements for many reasons, including the risks described in this report, the risks described in our Annual Report
on Form 10-K for the year ended June 30, 2022 and other reports we file with the Securities and Exchange Commission. Although we believe
the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of
the date on which the statements are made. We do not intend to update any of the forward-looking statements after the date of this report
to conform these statements to actual results or to changes in our expectations, except as required by law.
Overview
We have been a developer and manufacturer of advanced
optical instruments since 1982. Our medical instrumentation line includes traditional endoscopes and endocouplers as well as other custom
imaging and illumination products for use in minimally invasive surgical procedures. Much of our recent development efforts have been
targeted at the development of next generation endoscopes. We selectively execute internal research and development programs to develop
next generation capabilities for designing and manufacturing 3D endoscopes and very small MicroprecisionTM lenses, anticipating
future requirements as the surgical community continues to demand smaller and more enhanced imaging systems for minimally invasive surgery.
As Ross Optical Industries of El Paso, Texas we
also operate as a supplier of custom optical components and assemblies for military and defense, medical and various other industrial
applications. All products sold by us under the Ross Optical name include a custom or catalog optic, which is sourced through our extensive
domestic and worldwide network of optical fabrication companies. Most systems make use of optical lenses, prisms, mirrors and windows
and range from individual optical components to complex mechano-optical assemblies. Products often include thin film optical coatings
that are applied using our in-house coating department.
As Lighthouse Imaging of Windham, Maine we also
operate as a manufacturer of advanced optical imaging systems and accessories. We have a strong expertise in electrical engineering and
development of end-to-end medical visualization devices. Product development competencies at Lighthouse Imaging include Systems, Optical,
Mechanical, Electrical and Process Development Engineering. Our product development team has extensive experience developing visualization
systems that are used in a variety of clinical applications. Lighthouse Imaging is an industry leader in chip on tip visualization systems.
Approximately 31% our business during the six
months ended December 31, 2022 is from engineering services (primarily relating to the design of medical device optical assemblies), 48%
from the sale of both internally manufactured and purchased optical components, and 16% from the manufacture of optical assemblies and
sub-assemblies (primarily for medical device instrument applications). Our proprietary medical instrumentation line, unique custom design
and manufacturing capabilities, and expert electrical engineering and development services have generated orders for traditional proprietary
endoscopes and endocouplers as well as for custom imaging and illumination products for use in minimally invasive surgical procedures.
We design and manufacture 3D endoscopes and very small MicroprecisionTM lenses, assemblies and complete medical devices to
meet the surgical community’s continuing demand for smaller, disposable, and more enhanced imaging systems for minimally invasive
surgery.
We are registered to the ISO 9001:2015 and ISO
13485:2016 Quality Standards and comply with the FDA Good Manufacturing Practices and the European Union Medical Device Directive for
CE marking of our medical products.
Our internet websites are www.poci.com, www.rossoptical.com,
and www.lighthouseoptics.com. Information on our websites is not intended to be integrated into this report. Investors and others should
note that we announce material financial information using our company websites (www.poci.com; www.rossoptical.com; www.lighthouseoptics.com),
our investor relations website, SEC filings, press releases, public conference calls and webcasts. Information about Precision Optics,
our business, and our results of operations may also be announced by social media posts on our Ross Optical and Lighthouse LinkedIn pages
(www.linkedin.com/company/ross-optical-industries/) (https://www.linkedin.com/company/lighthouse-imaging-corporation/) and Twitter feed
(http://twitter.com/rossoptical) and on our Lighthouse Facebook page (https://www.facebook.com/lighthouseoptics/).
The information that we post on these social media
channels could be deemed to be material information. Therefore, we encourage investors, the media, and others interested in Precision
Optics to review the information that we post on these social media channels. These social media channels may be updated from time to
time on Precision Optics’ investor relations website. The information on, or accessible through, our websites and social media channels
is not incorporated by reference in this Quarterly Report on Form 10-Q.
The markets in which we do business are highly
competitive and include both foreign and domestic competitors. Many of our competitors are larger and have substantially greater resources
than we do. Furthermore, other domestic or foreign companies, some with greater financial resources than we have, may seek to produce
products or services that compete with ours. We routinely outsource specialized production efforts as required to obtain the most cost-effective
production. Over the years we have developed extensive experience collaborating with other optical specialists worldwide.
We believe that our future success depends to
a large degree on our ability to develop new optical products and services to enhance the performance characteristics and methods of manufacture
of existing products. Accordingly, we expect to continue to seek and obtain product-related design and development contracts with customers
and to selectively invest our own funds on research and development, particularly in the areas of MicroprecisionTM optics,
micro medical cameras, illumination, single-use endoscopes and 3D endoscopes.
Current sales and marketing activities are intended
to broaden awareness of the benefits of our new technology platforms and our successful application of these new technologies to medical
device projects requiring surgery-grade visualization from sub-millimeter sized devices and 3D endoscopy, including single-use products
and assemblies. We market directly to established medical device companies primarily in the United States that we believe could benefit
from our advanced endoscopy visualization systems. Through this direct marketing, referrals, attendance at trade shows and a presence
in online professional association websites, we have expanded our on-going pipeline of projects to significant medical device companies
as well as well-funded emerging technology companies. We expect our customer pipeline to continue to expand as development projects transition
to production orders and new customer projects enter the development phase.
General
This management’s discussion and analysis
of financial condition and results of operations is based upon our unaudited consolidated financial statements, which have been prepared
without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. The preparation of these consolidated
financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and
expenses. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these estimates.
There have been no significant changes in our
critical accounting policies as disclosed in the Notes to our Financial Statements contained in our Annual Report on Form 10-K for
the year ended June 30, 2022 filed with the Securities and Exchange Commission on September 27, 2022.
Results of Operations
Our total revenues for the quarter ended December
31, 2022, were $5,886,961, as compared to $3,897,041 for the same period in the prior year, an increase of $1,989,920, or 51.1%, primarily
due to an increase in component revenue to a large defense contractor, and a $600,000 one-time sale of technology rights relating to a
medical device instrument developed for a customer.
Our total revenues for the six months ended December 31,
2022 were $10,972,262, as compared to $6,233,385 for the same period in the prior year, an increase of $4,738,877, or 76.0% due in part
to the inclusion of the Lighthouse division since its acquisition on October 4, 2021, increases in component sales in the El Paso and
Gardner locations, an increase in engineering revenues, and one-time technology rights revenue in the quarter ended December 31, 2022.
Our two largest customers accounted for 14.2%
and 18.1% of our revenue during the quarter ended December 31, 2022, and 15.3% and 11.8% of our revenue during the six months ended December
31, 2022. One of our two largest customers is a defense/aerospace company and the other is developing a medical device instrument. We
generated revenues from 207 unique customers during the six months ended December 31, 2022, and no other customer represented over 10%
of our revenue during the three and six months ended December 31, 2022.
The COVID-19 world-wide pandemic that began during
the quarter ended March 31, 2020 and the domestic and international impact of policy decisions being made in major countries around the
world has had, and could continue to have, an adverse impact on our sources of supply, current and future orders from our customers, collection
of amounts owed to us from our customers, our internal operating procedures, and our overall financial condition.
Gross profit for the quarter ended December
31, 2022 was $2,725,224, compared to $1,119,582 for the same period in the prior year, an increase of $1,605,642, or 143%. Gross
profit for the quarter ended December 31, 2022 as a percentage of our revenues was 46.3%, an increase from the gross profit
percentage of 28.7% for the same period in the prior year. Gross profit for the six months ended December 31, 2022 was $4,449,878,
as compared to $1,758,614 for the same period in the prior year, an increase of $2,691,264 or 153%. Gross profit for the six months
ended December 31, 2022 as a percentage of our revenues was 40.6%, an increase from the gross profit percentage of 28.2% for
the same period in the prior year. Quarterly gross profit and gross profit percentage depend on a number of factors, including
overall sales volume, facility utilization, product sales mix, the costs of engineering services, and production start-up costs and
challenges in connection with new products, the effects of COVID-19 pandemic policy decisions on various economies and our suppliers
and customers, as well as the effects on production efficiencies due to the augmented policies we have incorporated into our
operations as a result of the COVID-19 pandemic.
Our gross profit on individual engineering projects
is dependent on a number of factors and is expected to fluctuate from quarter to quarter based on the nature and status of engineering
projects, unanticipated cost over-runs, design challenges and changes, start-up production activities, or other customer-imposed project
changes or delays. Our increase in gross profit dollars and margin during three and six months ended December 31, 2022 compared to the
same periods in the previous years was due to inclusion of the Lighthouse division since its acquisition on October 4, 2021, increases
in engineering, component and production revenues, greater production and personnel utilization, and recognition of technology rights
revenue with no associated direct incremental costs.
Research and development expenses were $208,666
for the quarter ended December 31, 2022, compared to $113,164 for the same period in the prior year, an increase of $95,502, or 84.4%.
Research and development expenses were $454,143 for the six months ended December 31, 2022, compared to $218,350 for the same period
in the prior year, an increase of $235,793, or 108%. In-house research and development and certain internal functions not directly related
to customer engagements are classified as research and development expenses with the majority of our engineering, research and development
activities being consumed in revenue generating engagements with our customers for the development of their products. During the three
and six months ended December 31, 2022 compared to the same periods of the prior year we had an increase in personnel, and an increase
in research and development costs incurred in the development of internal research and development efforts and projects.
Selling, general and administrative expenses were
$1,819,741 for the quarter ended December 31, 2022, compared to $1,466,768 for the same period in the prior year, an increase of $352,973,
or 24.1%. Selling, general and administrative expenses were $3,315,507 for the six months ended December 31, 2022, compared to $2,400,392
for the same period in the prior year, an increase of $915,115, or 38.1%. The increase in selling, general and administrative expenses
in the six months ended December 31, 2022 compared to the same periods of the prior fiscal year was primarily due to inclusion of the
Lighthouse division since its acquisition in October, 2021, plus increased compensation due to expanded headcount, incentive bonuses and
sales commissions resulting from increased revenues, and marketing related expenses, offset by a decreased amount of stock-based compensation
expense.
Liquidity and Capital Resources
With the exception of the current period ended
December 31, 2022, during which net income was 560,909, which includes one-time technology rights revenue of $600,000, we have sustained
recurring net losses from operations for several years. During the years ended June 30, 2022 and 2021 we incurred operating losses of
$1,513,890 and $905,583, respectively. At December 31, 2022, cash was $381,318, accounts receivables were $4,032,522 and current liabilities
were $5,477,991, including $794,981 of customer advances received for future order deliveries.
Although our revenue and gross margin have increased,
our operating expenses have also increased, and we continue to experience pricing pressure from our customers and challenges in engineering
projects and production orders that can result in cost over-runs and depressed gross margins. We also experience added uncertainty related
to our vendors ability to supply materials and our customers future order levels as a result of the economic impact the COVID-19 world-wide
pandemic and related jurisdictional policies and regulations and lingering supply-chain issues. Consequently, critical to our ability
to maintain our financial condition is achieving and maintaining a level of quarterly revenues that generate break even or better financial
performance as well as timely collection of accounts receivable from our customers. We believe profitable operating results can be achieved
through a combination of revenue levels, realized gross profits and controlling operating expense increases, all of which are subject
to periodic fluctuations resulting from sales mix and the stage of completion of varying engineering service projects as they progress
towards and into production level revenues.
We have traditionally funded working capital needs
through product sales, management of working capital components of our business, cash received from public and private offerings of our
common stock, warrants to purchase shares of our common stock or convertible notes, manufacturing equipment leases, and by customer advances
paid against purchase orders by our customers and recorded in the current liabilities section of the accompanying financial statements.
We have incurred year to year and quarter to quarter operating losses during our efforts to develop current products including MicroprecisionTM
optical elements, micro medical camera assemblies and 3D endoscopes. Our management believes that the opportunities represented by these
technical capabilities and related products have the potential to generate sales increases to achieve breakeven and profitable results.
In connection with our October 2021 acquisition
of Lighthouse Imaging, we entered into a $2,600,000 bank term loan, and sold shares of our common stock for gross proceeds of $1,500,000.
We also secured a $250,000 bank line of credit from the same bank in October 2021 for working capital needs, which was increased to $500,000
in May 2022. There were no borrowings outstanding on the line of credit at December 31, 2022.
Capital equipment expenditures and additional
patent costs during the six months ended December 31, 2022 were $37,637. Future capital equipment and patent expenditures will be dependent
upon future sales and success of on-going research and development efforts.
Contractual cash commitments for the fiscal periods
subsequent to December 31, 2022, are summarized as follows:
| |
Fiscal 2023 | | |
Thereafter | | |
Total | |
Financing lease for equipment, including interest | |
$ | 24,285 | | |
$ | 120,564 | | |
$ | 144,849 | |
Minimum operating lease payments | |
$ | 90,778 | | |
$ | 377,904 | | |
$ | 468,682 | |
We have contractual cash commitments related to
open purchase orders as of December 31, 2022 of approximately $3,547,236.
Off-Balance Sheet Arrangements
We currently have no off-balance sheet arrangements
that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.