The following discussion and analysis should be read in conjunction with the
Financial Statements and Notes thereto, and other financial information included
elsewhere in this Annual Report on Form 10-K. This Management's Discussion and
Analysis of Financial Condition and Results of Operations contains descriptions
of our expectations regarding future trends affecting our business. The
following discussion sets forth certain factors we believe could cause actual
results to differ materially from those contemplated by the forward-looking
statements.
Overview
Effective June 1, 2019 we acquired the operating assets of Ross Optical
Industries, Inc. of El Paso, Texas, which we began operating as a division of
our Company beginning on that date. The accompanying financial statements
include the results of operations of the Ross Optical division for the entire
fiscal year ended June 30, 2020 and the assets and liabilities of the division
as of June 30, 2019 and 2020. The acquisition of the assets of Ross Optical
Industries effective June 1, 2019 expands our optics components and assemblies
business. All products supplied by Ross Optical include a custom or catalog
optic, which is sourced through Ross Optical's 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 the in-house coating department. Approximately
73% of Ross Optical revenues are from customers in the United States, 7% from
Western Europe and 8% from Canada during the fiscal year ended June 30, 2020.
Ross Optical's sales are mostly resale of specialized optical components with
the remainder being assemblies. Ross Optical does not perform revenue generating
engineering services or internal research and development. The majority of Ross
Optical sales are for industrial applications with the remainder split between
military and medical device products.
The Management Discussion and Analysis which follows is based on the financial
condition and results of operations of our Company including the operating
results for the fiscal year ended June 30, 2020 and the month of June 2019 and
the balance sheet as of June 30, 2020 and 2019 of our new division Ross Optical.
Approximately 8% of our non-Ross Optical division revenue in fiscal year 2020 is
from the design, manufacture and resale of optical products for military and
defense and 2% for other industrial, non-medical products and approximately
32-34% of our revenues in each of the fiscal years 2018, 2019 and 2020 were
derived from engineering and design services we performed for our customers to
incorporate our technologies and capabilities into their medical device
products. Approximately 64-79% of our total revenues in fiscal years 2018, 2019
and 2020 were derived from the assembly and manufacture of endoscopic medical
devises, sub-assemblies and optical components ordered by our customers and
usually developed from the engineering and design services we perform for them.
We expect sales revenue increases to come from the orders from our customers to
manufacture the products we help them engineer and design.
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 websites are
www.poci.com and www.rossoptical.com. Information contained on our websites does
not constitute part of this report.
17
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 and through the acquisition of the Ross Optical
division in June 2019, we have achieved extensive experience collaborating with
other optical specialists worldwide.
We believe that competition for sales of our medical products and services,
which have been principally sold to original equipment manufacturers, or OEM,
customers, is based on our ability to design and produce technical features,
performance, engineering service and production scheduling, on-time delivery,
quality control and product reliability, and competitive pricing.
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 Microprecision™ optics, micro medical
cameras, illumination, and 3D endoscopes.
The Ross Optical division sales are primarily optical components and assemblies
for industrial applications in addition to medical and military uses. By
combining the unique capabilities of our Company with the Ross Optical division
we believe there are opportunities for expanded sales of each division's
products and services throughout the combined customer base. For example, we
believe that our extensive engineering and design services may benefit Ross'
customer base and that Ross' expanded worldwide vendor relationships may benefit
our traditional efforts to source materials at competitive prices for our
development projects and manufacturing activities.
During the fiscal year ended June 30, 2020, we sold products and services to 646
different customers and no single customer represented 10% or more of
consolidated sales. We expect this trend to continue since consolidated sales
now include those of the Ross Optical.
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. Our Ross Optical division markets through existing
customers and trade shows, in addition to proactive online marketing strategies
executed primarily through its website. We believe there are opportunities to
expand the reach of sales activities of our business and that of our new
division, Ross Optical, through the gradual integration of some of the sales and
marketing resources of the two operations.
Critical Accounting Policies and Estimates
Our critical accounting policies are included in the Notes to our Financial
Statements contained in this Annual Report on Form 10-K.
18
Results of Operations for the Fiscal Year Ended June 30, 2020 as Compared to the
Fiscal Year Ended June 30, 2019
Total revenues for the fiscal year ended June 30, 2020 were $9,923,355, an
increase of $3,119,186, or 45.8%, from revenues for fiscal year 2019 of
$6,804,169. Included in fiscal year 2020 revenues is $4,583,653 from the Ross
Optical division compared to $656,232 in fiscal year 2019 realized for one month
subsequent to the acquisition of the Ross Optical division effective June 1,
2019. During fiscal year ended June 30, 2020, our non-Ross Optical division
revenues were $5,339,702, a decrease of $808,235, or 13.1%, from non-Ross
Optical division revenues of $6,147,937 in fiscal year 2019.
The 13.1% decrease in non-Ross Optical division revenues in fiscal year 2020
resulted primarily from reductions of sales to various production category
customers which we believe are the result of the COVID-19 pandemic described
below as well as cyclical sales patterns periodically experienced with certain
traditional product customers. Non-Ross Optical division engineering services
and component revenues were relatively unchanged from fiscal year 2019 to fiscal
year 2020 with 2% increases each in fiscal year 2020, however, in fiscal year
2020 a $419,423 decrease in engineering revenue from a 3D optical project
customer was offset by a $671,509 increase in engineering revenue from a new
Microprecision™ CMOS customer project. The 3D optical project has been cancelled
by the customer and we do not expect future engineering service or production
revenues relating to this project. Although fiscal revenues were consistent
between the years, the number of engineering projects we worked on in fiscal
year 2020 was less than the number of engineering projects worked on in fiscal
year 2019. The engineering projects range in type including CMOS,
Microprecision™ and illumination systems. We believe the quality of the
engineering projects continues to provide the opportunity for production
purchase orders from these customers as the products advance to clinical
evaluation and commercialization.
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 is expected to 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. While we and many of
our medical device and defense contracting customers continue to operate as
essential businesses, we have taken various actions to augment our operating and
human resource policies and procedures to guard against the potential health
hazards of COVID-19. These augmented procedures can have a negative impact on
our operational efficiencies. We source various components from overseas
suppliers throughout Asia including China. We have experienced supply
disruptions and customer delays from certain vendors and customers that we
believe were the result of the COVID-19 pandemic and related economic slow-down.
We continue to communicate as closely as possible with our suppliers and
customers to maintain a current perspective on the future effects of COVID-19 on
our business. Given the uncertainty surrounding the continuation of economic
slow-downs domestically and abroad, we cannot predict with certainty at this
time what the future impact of COVID-19 and resulting business and economic
policies in the US and abroad will be on our up-coming financial operating
results.
Revenues from our largest customers, as a percentage of total revenues, were as
follows:
Year Ended June, 30
2020 2019
Customer A 9% 18%
Customer B 7% 13%
Customer C 5% 11%
All Others 79% 58%
100% 100%
No other customer accounted for more than 10% of our revenues in fiscal years
2020 and 2019.
19
Gross profit for fiscal year ended June 30, 2020 of $3,362,576, reflected an
increase of $1,240,098, or 58.4%, as compared to gross profit for fiscal year
2019 of $2,122,478. Gross profit, as a percentage of revenues for fiscal year
2020, was 33.9% as compared to gross profit, as a percentage of revenues for
fiscal year 2019, of 31.2%. Gross profit and gross profit percentage for any
given fiscal period depend on a number of factors, including overall sales
volume, facility utilization, product sales mix, the costs of engineering
services, production start-up costs and challenges in connection with new
products, and 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.
The increase in gross profit dollars and gross profit percentage during the
fiscal year ended June 30, 2020 compared to fiscal year 2019 is primarily due to
the inclusion of the Ross Optical division revenue at a higher gross margin
percentage than we realize on non-Ross revenues. Ross Optical division revenues
generated a gross margin percentage of 47.6% during fiscal year 2020 while
non-Ross revenue margin was 22.1% for fiscal year 2020. The non-Ross gross
margin is dependent on a number of factors and is expected to fluctuate from
quarter to quarter. Specifically, fiscal year 2020 gross margins for the
non-Ross Optical division revenues were negatively impacted by below break-even
sales levels, unanticipated cost over-runs associated with engineering projects,
and the effects of COVID-19 pandemic policy decisions on various economies and
our suppliers and customers as well as the effects on production efficiencies of
the augmented policies we have incorporated into our operations as a result of
the COVID-19 pandemic. The cost over-runs resulted primarily from design
challenges encountered in a 3D engineering project having an estimated impact of
five percentage points on our consolidated gross margin for fiscal year 2020.
This project has since been cancelled by the customer and cost over-runs will
not continue. The remainder of our production and engineering jobs resulted in
margins within our targeted range with reasonably expected fluctuations.
Research and development expenses were $886,129 for fiscal year 2020 as compared
to $505,300 for fiscal year 2019. The increase of $380,829, or 75.4%, in fiscal
year 2020 compared to fiscal year 2019 was due primarily to engineering
personnel added during the year and an increase in internal engineering related
development projects that we believe will enhance our technology platform of
capabilities and our overall competitiveness in providing unique optical and
illumination solutions for medical device endoscopes.
Selling, general and administrative expenses increased by $1,797,820, or 85.5%,
to $3,899,430 for fiscal year 2020 as compared to $2,101,610 for fiscal year
2019. The increase in SG&A expenses in fiscal year 2020 includes $1,207,046 of
Ross Optical division SG&A expenses compared to $140,635 in fiscal year 2019, in
addition to an increase in compensation to existing and newly hired sales and
administrative personnel of approximately $386,000, plus increases in
consulting, director, recruiting and legal fees, advertising and trade shows,
stock based compensation, and investor relations firm and other stock related
costs.
Business acquisition expenses were $128,111 in fiscal year 2019 and represent
direct costs relating to the acquisition of the Ross Optical division such as
audit and legal fees and travel costs.
The income tax provisions in fiscal years 2020 and 2019 represent the minimum
statutory state income tax liability.
Liquidity and Capital Resources
We have sustained recurring net losses for several years. During the years ended
June 30, 2020 and 2019 we incurred net losses of $1,426,150 and $614,871,
respectively, and used cash in operating activities of $592,491 and $1,031,693,
respectively. At June 30, 2020, our cash and cash equivalents were $1,134,697,
accounts receivable were $1,481,437, and current liabilities were $3,149,380,
including $417,059 of advances paid against open purchase orders by our
customers and a note payable to a bank for a PPP CARES Act loan amount of
$808,962 that we expect to be forgiven as planned pursuant to the terms of the
CARES Act enacted in response to the COVID-19 pandemic.
20
Although our sales revenue has increased and we have experienced improved
financial performance in certain recent fiscal quarters, 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
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. 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 margins 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, 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 Microprecision™ optical elements, micro medical camera
assemblies and 3D endoscopes. Our management believes that the opportunities
represented by these products have the potential to generate sales increases to
achieve breakeven and profitable results.
In May 2020 we received $808,962 cash for payment of payroll and rental expenses
in the form of an unsecured promissory note pursuant to the Paycheck Protection
Program under the Coronavirus Aid, Relief, and Economic Security Act, or the
CARES Act. Although our lender and the Small Business Administration have not
yet begun accepting applications for forgiveness of the CARES Act loans, we
expect that we will ultimately qualify for full forgiveness. Additionally, in
April 2020, we received $250,000 cash for general working capital needs in
return for 200,000 shares of our common stock. We believe our increased levels
of sales will continue and that the addition of the Ross Optical division will
enhance our financial performance such that our existing financial condition and
the prospect of increased sales from the opportunities our current products
offer will be sufficient to fund our operations on a profitable basis. However,
if we are not able to achieve sustained breakeven and profitable results using
our existing financial resources, we would be required to pursue additional
financing that may not be available at acceptable terms or may cause dilution to
our existing shareholders.
Capital equipment expenditures during fiscal year 2020 and fiscal year 2019 were
$232,365 and $140,038, respectively, $113,213 of which in fiscal 2020 were
funded by leasing agreements with monthly payment obligations. Patent
application expenditures during fiscal year 2020 and fiscal year 2019 were
$41,142 and $6,812, respectively. 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 years subsequent to June 30, 2020
are summarized as follows:
Fiscal 2021 Thereafter Total
Capital lease for equipment, including
interest $ 54,593 $ 40,420 $ 95,013
Minimum operating lease payments - Ross
Optical division $ 61,779 $ 62,822 $ 124,601
We have contractual cash commitments related to open purchase orders as of June
30, 2020 of approximately $714,398.
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Material Trends and Uncertainties
We currently have no material trends or uncertainties 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.
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.
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PRECISION OPTICS CORPORATION, INC. 
