Earnings Call Transcript - POCI Q4 2025

Operator, Operator

Good day, and welcome to the Precision Optics Reports Fourth Quarter and Fiscal Year 2025 Financial Results Conference Call. Please note that this event is being recorded. I would now like to turn the conference over to Mr. Robert Blum with Lytham Partners. Please go ahead.

Robert Blum, Presenter

All right. Thank you very much, operator, and thank you to everyone joining the call today. As the operator mentioned, on today's call, we will discuss Precision Optics' fourth quarter and fiscal year 2025 financial results for the period ended June 30, 2025. With us on the call representing the company today is Dr. Joe Forkey, Precision Optics' Chief Executive Officer; and Mr. 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. 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 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 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. All right. With that said, let me turn the call over to Dr. Joe Forkey, Chief Executive Officer of Precision Optics. Joe, please proceed.

Joseph Forkey, CEO

Thank you, Robert, and thank you all for joining our call today. Let me start by saying we certainly have a lot to be excited about at Precision Optics. We just finished the fiscal year with the highest quarterly revenue in our company's history. The $6.2 million fourth quarter puts us at an annualized run rate of approximately $25 million and the underlying drivers of this increase are sustainable into the foreseeable future. Our production business has grown substantially, and we expect that trend to continue. While we've experienced gross margin challenges in Q3 and Q4 of fiscal 2025, we understand these challenges and are aggressively taking steps to resolve them. With ongoing higher top line revenue, the growing engineering pipeline and improving gross margins, we believe we are now operating at a new level for Precision Optics and expect the gains we have made in revenue increases in fiscal '25 will increasingly flow through to the bottom line throughout fiscal '26 and beyond. The key driver to the achievement of these record revenues is the advancement of two major programs, which transitioned over the past year or so from our development pipeline into production. And while the benefits of the recent transition of these two major programs haven't flowed through to the bottom line yet, the increase in top line revenue provides the foundation upon which Precision Optics will grow to become a much larger and more profitable company. These two programs, one with a top-tier aerospace company and the other with a surgical robotics company focused on transformative solutions in urology carry long-term contracts with minimum annual commitments. These production contracts, along with additional programs in our development pipeline that are expected to move to production over the next 12 to 36 months, provide increased visibility and confidence into the future outlook for POC. With the growth that we anticipate, we have recently invested in our facilities to support the company's growth, not only for fiscal 2025 and 2026, but for years to come. In September, we moved our headquarters and corporate offices from Gardner, Massachusetts to Littleton, Massachusetts. This move opens up space at our existing facilities in Gardner for the consolidation and expansion of dedicated production resources. The new facility in Littleton, which is less than an hour from Boston, along with the new facility in South Portland, Maine, which we moved into in August, also allows us access to a broader engineering talent pool to support the company's growing product development pipeline. I believe we will look back at fiscal 2025 a few years from now as a critical inflection point in the company's history. When we advanced multiple products from our pipeline into production, began to refine operating processes to efficiently manufacture at higher scales, made the necessary investments in our facilities to sustainably support growth and build a strong backlog of programs through the launch of the Unity platform, all of which has provided us the foundation for substantial growth and greater visibility into the future. Today, I'll focus my remarks on the following items. First, updates on our two major production programs. Second, gross margin challenges in fiscal 2025. Third, steps we've taken to improve gross margin in fiscal 2026 and beyond. And finally, guidance for fiscal 2026. With that high-level overview, let me provide some more details, starting with our large production contract with a top-tier aerospace company. This is a highly complex and specific assembly we are producing, and it is essential for our customers' product and revenue forecast. We continue to increase production to meet the ever-growing demand from this customer with revenues increasing sequentially every quarter throughout the year and increases expected to continue throughout fiscal 2026. For perspective, Q1 revenue for this program was $300,000, Q2 revenue was $600,000, Q3 was $900,000 and in Q4 of fiscal 2025, revenue for this program was just under $2 million. We are now operating at record daily production revenues with the month of June contributing more than $900,000 alone. That's 3x what we shipped in the entire first quarter. We continue to take steps to further increase production capacity and we have commitments from our customers to accept deliveries at rates approximately double the average rate of Q4. We also have received significant additional production orders so that our current backlog for this program alone now stands at a record of nearly $9 million. We estimate our gross margin, specifically on this program is in the mid-30% range, so the ongoing increase in shipments will help to improve overall gross margin. Also, our customer for this product has agreed to reimburse us for tariff costs, and we are finalizing arrangements for these reimbursements now. Production revenue for our single-use cystoscope also hit a record level in Q4 of nearly $800,000, continuing the trend of increasing revenue each of the four quarters since production began. With the introduction of a partial second production line in August of this year and ongoing increases in demand from our customer and the end-user market, we expect revenue levels from this program to continue to increase throughout fiscal 2026. While we are certainly pleased with this continuing revenue growth for this program, it has not been without its challenges as we've communicated in recent quarters. Compared to our aerospace customer, this is a lower-priced, higher-volume single-use production program. For this program, in particular, we have run into challenges with production yield, more than anticipated labor touch time and substantial tariff increases. Considering the impact of all these issues together, we believe this product was operating at zero gross margin or a slight loss during the fourth quarter of fiscal 2025 and significantly pulled down our overall corporate gross margin. In the first quarter of fiscal 2026, we have already taken several steps to increase the profitability of this product. We have identified opportunities for yield improvement through design updates and touch time reduction through fixture and process improvements. We are working with our customer who is in agreement with these steps we've taken and is generally extremely supportive. There is a mutual understanding of the complexity of the assembly and the attitude that we must get this working right. These are robust long-term solutions and are not out of the ordinary for a production line recently started and used for a highly complex product like this one. While we are confident these modifications will bring the profitability of this product in line with our original expectations, they will take some months to implement. In the meantime, we have renegotiated pricing with our customer to account for lower yields and higher touch time costs in the near term. The renegotiated near-term price is approximately 24% higher than the price at the end of the fourth quarter of fiscal 2025. In addition, our customer has agreed to cover tariffs associated with this product, which represents approximately 20% of the price at the end of the fourth quarter. We believe these design and production changes, along with pricing updates for the near term will result in steadily increasing profitability for this product beginning in the first quarter of fiscal 2026 and continuing throughout the year. In addition to the two large programs, there are a number of other continuing programs that round out our production forecast for fiscal 2026. Summarizing our systems manufacturing business, while we are experienced in growing teams of a very small business, I am excited that production is growing to a size that will begin to reflect scaling and efficiencies as we move through the new fiscal year. We expect our systems manufacturing business to grow at least 75% in fiscal 2026. Beyond our production programs, our product development pipeline is recovering from the dip caused by the transfer of the single-use cystoscope to production. We continue to expect two to three programs to transfer to production in each of the next two years, and we are quickly gaining momentum with a number of new customers based on the Unity platform that we discussed in recent calls. Our business development team is working aggressively to reach new customers through increased outreach, including our first-ever panel webinar, which I will host this coming Wednesday to discuss current trends in medical device imaging. For anyone interested in this event, registration is on our website. So while revenue for fiscal 2026 will largely be driven by our two largest programs, there is a host of other programs right behind those that will continue growth into the future. With strong confidence in our ability to maintain revenue at the higher levels seen in the fourth quarter of fiscal 2025, let me turn now to a few comments on gross margin. A number of issues pulled down gross margins in Q3 and Q4 of fiscal 2025. And while Q4 gross margin was slightly higher than that of Q3, we expect margins to recover substantially more in fiscal 2026. Because our single-use cystoscope program occupied so much of our engineering team's efforts prior to fiscal 2025, its transition this past year to production led to a reduction in product development revenue for the first time in over 6 years. Because product development revenue tends to have higher margins than production, overall gross margin suffered from this shift in product mix. In fiscal 2025, this issue was exacerbated by the need to pull design engineers into troubleshooting on the single-use cystoscope line, reducing the amount of engineering resources available for billable product development work. As I already mentioned, we have a clear path now to improve the single-use cystoscope production line, which will reduce the requirement for engineering support. Also, we are already beginning to see a recovery of the product development pipeline and expect steady increases throughout fiscal 2026. In the fourth quarter of fiscal 2025, about $0.5 million of product development revenue was for tooling and fixtures for additional production lines, which carries a margin just under 10%. Because these revenues are mainly for low-risk pass-through materials purchases that still contribute to the bottom line, we welcome orders like these, but they do pull down overall gross margin percentage. While we expect materials revenues such as this to continue, we expect it will be a smaller percentage of total revenue, and therefore, should be much less impactful as production programs grow. Finally, the impact of the tariff increases in Q3 and particularly in Q4 was substantial. Total tariff costs in Q4 alone were approximately $180,000, representing about 3% of gross margin. We have worked aggressively on this issue. As I already mentioned, we are close to having agreements on tariff reimbursement with our two major production customers, at least one of which we expect will be retroactive to July 1, and we now have a policy requiring tariff reimbursement on virtually all new orders. We are investing in the business through the operational steps I described already, but also by strengthening our overall operations team. In the first quarter of fiscal 2026, we recruited and hired our first manufacturing and quality engineers. We just recently hired a new Director of Quality and Regulatory Affairs, and I am really pleased to announce today that we have just come to an agreement with Joe Traut who will start as our new Chief Operating Officer on October 1. Joe is an industry veteran with over 30 years of experience in medical device production, much of it focused on bringing up new production lines, transferring production lines from one location to another and overall improving manufacturing efficiency and performance. Joe has consulted to us for the last two months. He's already familiar with the issues we need to tackle, and I'm really thrilled that he has agreed to come on full time to help us drive the performance of our operations to higher levels. Joe will be replacing Mahesh Lawande, who has been in the COO position for about two years. These were two critical years for our operations as we launched our aerospace and single-use cystoscope production programs. I want to thank Mahesh for his tireless efforts and dedication during this time. For fiscal 2026, we expect revenue of approximately $25 million which compares to $19 million in 2025, an increase of over 30%. This will be driven largely by our systems manufacturing business, which is forecasted to increase by more than 75% as our two large production programs continue to expand. We expect fiscal 2026 gross margins of approximately 30%, which favorably compares to 18% in 2025. Improved manufacturing yields, better pass-through of tariffs and elimination of some low-margin revenue are all key factors to the improvement. Our long-term margin goal remains 40% with significant increases in revenue and gross margins. We expect to recover positive adjusted EBITDA in the range of $0.5 million for fiscal 2026. We believe there is substantial operating leverage to drive significant bottom line profit as revenues continue to increase. With that, let me turn it over to Wayne to review the financials in more detail. I will then provide some closing comments and then open the call to questions. Wayne?

Wayne Coll, CFO

Thank you, Joe. Let me expand on some of Joe's comments on the financial results, starting with revenue. For the fourth quarter, revenue was $6.2 million compared to $4.2 million in the prior sequential quarter and $4.7 million in the year-ago fourth quarter of fiscal 2024. Breaking it down, production revenue was $5.1 million compared to $3.3 million in the prior sequential quarter and $2.8 million in the year-ago quarter, while engineering revenue was $1.1 million compared to $1.9 million in the year-ago quarter. For the year, revenue was flat compared to the prior year at $19.1 million. This, on the surface, masks the trend in the transformation of our more engineering-focused business to a more rapidly scaling manufacturing enterprise. On the product development side, our engineering pipeline continues to strengthen in response to marketing around the Unity platform, coupled with an expanding outreach that is focused on broadening our customer base. We now project fiscal 2026 revenues to reach $25 million. This growth is being driven by continued expansion of our systems manufacturing business as our backlog and production demand continues to increase, driven by recent purchase commitments for the aerospace and single-use programs. Growth of 75% is expected in this area from approximately $8.3 million in fiscal 2025 to $14.5 million in fiscal 2026. This continues the trend from fiscal 2025, where revenue from this business segment nearly tripled from $1.2 million in Q1 to $3.4 million in Q4. Conservatively, we are currently forecasting a modest recovery in product development going from $4.9 million in fiscal 2025 to $5.6 million in 2026. Revenue from our micro-optics labs is expected to drop from $2.1 million in fiscal 2025 to $1.3 million in fiscal 2026 due entirely to the timing of that division's large defense customer reorder. And our Ross Optical operations are expected to be essentially flat at $3.7 million to $3.8 million. For the quarter ending June 30, 2025, gross margins were 13% compared to 10% in the prior sequential quarter and 22% in the fourth quarter of a year ago. Although we continue to scale production of our single-use cystoscope following the production costs incurred during the previous sequential quarter, we continue to recognize suboptimal yields. We expect those yields to improve and normalize toward target levels in the third quarter of fiscal 2026 for all the reasons Joe covered. The under-absorption of engineering resources was a contributing factor here as well. For the year, gross margins were 18% compared to 30% in the prior year. We expect gross margin to continue to recover as production revenues increase. We are expecting a blended gross margin of approximately 30% for fiscal 2026 with much of the improvement occurring in the second half of the fiscal year. We decreased R&D spending in the quarter from $355,000 to $228,000 compared to the quarter ending June 30, 2024. R&D spending in the current fiscal year increased approximately $180,000 to $1.2 million compared to $982,000 during the year ending June 30, 2024, primarily due to our investment in Unity. Selling, general and administrative expenses increased $2 million during the three months ended June 30, 2025 compared to $1.9 million during the three months ending June 30, 2024. For the year, SG&A increased from $7.5 million to $7.8 million primarily due to increased personnel costs, primarily stock-based compensation and recruiting expenses. As a result of the factors I've discussed, our net loss was $1.4 million for the quarter as it was for the same quarter last year. Our net loss for the year was $5.8 million compared to $3 million in the prior year. Adjusted EBITDA, which excludes stock-based compensation, interest expense, depreciation and amortization was negative $856,000 in the fourth quarter of 2025 compared to negative $1.3 million in the previous sequential quarter and negative $1.1 million in the year-ago quarter. For fiscal 2025, adjusted EBITDA was negative $3.7 million compared to negative $1.6 million in fiscal 2024. Cash at the end of June was approximately $1.8 million and debt was below $1.9 million. Accordingly, we are working to increase the availability of debt capital to fund our continued business expansion.

Joseph Forkey, CEO

Thank you, Wayne. Let me finish by summarizing a few key points. First, we are very optimistic about the future, given the high growth expectations of our production business and the high degree of confidence and visibility into these programs. Second, we believe that these new higher revenue levels of roughly $6 million per quarter or $25 million per year are sustainable given our significant production backlog. And finally, we are investing in the team to quickly address all operations challenges, including those associated with a small and rapidly growing production business. We are maturing as a company. We may not get everything perfect the first time, but we're building our internal capacity to take on challenges and deliver strong long-term business results. To all of you on the call, I thank you for your continued support of Precision Optics. We will be participating in the Lytham Partners Fall Investor Conference with one-on-one meetings tomorrow. Please contact Robert for more information. With that, we'd be happy to take any questions.

Operator, Operator

And your first question today will come from Chris Bechowski, Private Investor.