The
Company accounts for its stock-based compensation using the intrinsic value
method provided for under Accounting Principles Board Opinion (“APB”) No. 25,
Accounting
for Stock Issued to Employees and
related interpretations. Under APB No. 25 and related interpretations,
compensation cost is recognized based on the difference, if any, on the date of
grant between the fair value of the Company’s stock and the amount an employee
must pay to acquire the stock. Statement of Financial Accounting Standards
(“SFAS”) No. 123, Accounting
for Stock-Based Compensation,
establishes a fair-value-based method of accounting for stock-based compensation
plans. The Company has adopted the disclosure-only alternative under SFAS No.
123, which requires the disclosure of the pro forma effects on net loss and net
loss per share as if the fair value accounting prescribed by SFAS No. 123 had
been adopted.
No
stock-based employee compensation cost is reflected in net loss, as all options
granted had an exercise price equal to the market value of the underlying common
stock on the date of grant. The following table illustrates the effect on net
loss and net loss per share if the Company had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee compensation:
| |
|
Three
Months Ended
March
31, |
|
Nine
Months Ended
March
31, |
|
| |
|
2005 |
|
2004 |
|
2005 |
|
2004 |
|
|
Net
loss, as reported |
|
$ |
(819,916 |
) |
$ |
(1,017,312 |
) |
$ |
(2,574,253 |
) |
$ |
(2,672,551 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Add:
Total stock-based employee compensation expense determined under
fair-value-based method for all awards |
|
|
(7,100 |
) |
|
(9,448 |
) |
|
(38,412 |
) |
|
(52,383 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro
forma net loss |
|
$ |
(827,016 |
) |
$ |
(1,026,760 |
) |
$ |
(2,612,665 |
) |
$ |
(2,724,934 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss per share:
As
reported - basic and diluted |
|
$ |
(0.12 |
) |
$ |
(0.58 |
) |
$ |
(0.39 |
) |
$ |
(1.53 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro
forma - basic and diluted |
|
$ |
(0.12 |
) |
$ |
(0.59 |
) |
$ |
(0.39 |
) |
$ |
(1.56 |
) |
In July
2004, the Company completed a rights offering to stockholders of record on June
7, 2004 by issuing 5,256,159 shares of common stock at a price of $1.00 per
share. Net cash proceeds to the Company (after offering costs of $222,176) were
$5,033,983.
The costs
of the rights offering estimated to have been incurred through June 30, 2004 of
$171,885, have been deferred and are included in deferred financing costs in the
accompanying consolidated balance sheets as of June 30, 2004. The actual
offering costs of $222,176 have been charged against additional paid-in capital
in the accompanying consolidated balance sheets as of December 31,
2004.
| 5. |
RECENTLY
ISSUED ACCOUNTING PRONOUNCEMENTS |
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123R, Share-Based
Payment: an amendment of FASB Statements No. 123
and
95 (SFAS
123R), which requires companies to measure and recognize compensation expense
for all stock-based payments at fair value. SFAS 123R is effective for all
annual periods beginning after December 15, 2005 and thus, will be effective for
the Company beginning with the first quarter of fiscal year 2007 (July 1, 2006).
Early adoption is encouraged and retroactive application of the provisions of
SFAS 123R to the beginning of the fiscal year that includes the effective date
is permitted, but not required. The Company is currently evaluating the impact
of SFAS 123R on its financial position and results of operations. See Note 3 for
information related to the pro forma effects on the Company’s reported net loss
and net loss per share of applying the fair value recognition provisions of the
previous SFAS 123 to stock-based employee compensation.
Item
2
PRECISION
OPTICS CORPORATION, INC. AND SUBSIDIARIES
Management's
Discussion and Analysis of Financial
Condition
and Results of Operations
Important
Factors Regarding Forward-Looking Statements
When used
in this discussion, the words "believes", "anticipates", "intends to", and
similar expressions are intended to identify forward-looking statements. Such
statements are subject to certain risks and uncertainties which could cause
actual results to differ materially from those projected. These risks and
uncertainties, many of which are not within the Company’s control, include, but
are not limited to, uncertainty of future demand for the Company’s products; the
uncertainty and timing of the successful development of the Company’s new
products; the risks associated with reliance on a few key customers; the
Company’s ability to maintain compliance with requirements for continued listing
on the Nasdaq SmallCap Market; the Company’s ability to attract and retain
personnel with the necessary scientific and technical skills; the timing and
completion of significant orders; the timing and amount of the Company’s
research and development expenditures; the timing and level of market acceptance
of customers’ products for which the Company supplies components; the level of
market acceptance of competitors’ products; the ability of the Company to
control costs associated with performance under fixed price contracts; the
performance and reliability of the Company’s vendors; and the continued
availability to the Company of essential supplies, materials and services; which
are described further in Exhibit 99.1 to the Company’s Annual Report on Form
10-KSB for the fiscal year ended June 30, 2004. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date hereof. The Company undertakes no obligation to publicly release the
result of any revision to these forward-looking statements which may be made to
reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
Overview
Precision
Optics Corporation, a developer and manufacturer of advanced optical instruments
since 1982, designs and produces high-quality optical thin film coatings,
medical instruments, and other advanced optical systems. The Company’s medical
instrumentation line includes laparoscopes, arthroscopes and endocouplers and a
world-class product line of 3-D endoscopes for use in minimally invasive
surgical procedures.
The
Company is currently developing specialty instruments incorporating its
patent-pending LENSLOCKTM technology, which we believe may result in lower cost,
easier repairability and enhanced durability, as well as ultra-small instruments
(some with lenses less than one millimeter in diameter) utilizing patent-pending
micro-precisionTM lens technology. The Company is also exploring new initiatives
in single-molecule technology and nanotechnology for biomedical and other
applications.
Precision
Optics Corporation is certified to the ISO 9001 Quality Standard, and complies
with the FDA Good Manufacturing Practices and the European Union Medical Device
Directive for CE Marking of its medical products. The Company’s Internet Website
is www.poci.com.
The areas
in which the Company does business are highly competitive and include both
foreign and domestic competitors. Many of the Company’s competitors are larger
and have substantially greater resources than the Company. Furthermore, other
domestic or foreign companies, some with greater experience in the optics
industry and greater financial resources than the Company, may seek to produce
products or services that compete with those of the Company. The Company uses
production facilities overseas to produce key components for the Company’s
business, such as lenses. The Company believes that the cost savings from such
production is essential to the Company’s ability to compete on a price basis in
the medical products area particularly and to the Company’s profitability
generally.
The
Company believes that competition for sales of its medical products and
services, which have been principally sold to Original Equipment Manufacturer
(OEM) customers, is based on performance and other technical features, as well
as other factors, such as scheduling and reliability, in addition to competitive
price.
The
Company believes that its future success depends to a large degree on its
ability to continue to conceive and to develop new optical products and services
to enhance the performance characteristics and methods of manufacture of
existing products. Accordingly, it expects to continue to seek to obtain
product-related design and development contracts with customers and to invest
its own funds on research and development, to the extent funds are available.
The
Company relies, in part, upon patents, trade secrets and proprietary knowledge
as well as personnel policies and employee confidentiality agreements concerning
inventions and other creative efforts to develop and to maintain its competitive
position. The Company does not believe that its business is dependent upon any
particular patent, patent pending, or license, although it believes that trade
secrets and confidential know-how may be important to the Company’s scientific
and commercial success.
The
Company conducts its domestic operations at two leased facilities in Gardner,
Massachusetts. The Company rents office space in Hong Kong for sales, marketing
and supplier quality control and liaison activities of its Hong Kong subsidiary.
The Company believes these facilities are adequate for its current operations.
Significant increases in production or the addition of significant equipment or
manufacturing capabilities in connection with the production for the Company’s
line of endoscopes, optical thin films, and other products may, however, require
the acquisition or lease of additional facilities.
Critical
Accounting Policies and Estimates
General
Management’s
discussion and analysis of financial condition and results of operations are
based upon the Company’s consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America (“U.S. GAAP”). The preparation of these financial
statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses. The Company
bases its 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 under different assumptions or conditions.
The
Company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements.
Revenue
Recognition
The
Company recognizes revenue in accordance with U.S. GAAP and SEC Staff Accounting
Bulletin (“SAB”) No. 104, Revenue
Recognition. SAB No.
104 requires that four basic criteria must be met before revenue can be
recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has
occurred or services have been rendered; (3) the price to the buyer is fixed and
determinable; and (4) collectibility is reasonably assured.
Sales
price of products and services sold is fixed and determinable after receipt and
acceptance of a customer’s purchase order or properly executed sales contract,
typically before any work is performed. Management reviews each customer
purchase order or sales contract to determine that the work to be performed is
specified and there are no unusual terms and conditions which would raise
questions as to whether the sales price is fixed or determinable. The Company
assesses credit worthiness of customers based upon prior history with the
customer and assessment of financial condition. The Company’s shipping terms are
customarily FOB shipping point. The Company’s revenue transactions typically
contain neither multiple deliverable elements or future performance obligations
to customers, other than a standard one-year warranty on materials and
workmanship, the estimated costs for which are provided for at the time revenue
is recognized.
Revenues
for industrial and medical products sold in the normal course of business are
recognized upon shipment when delivery terms are FOB shipping point and all
other revenue recognition criteria have been met. Services that the Company
provides to customers, which amounted to approximately 8% of total Company
revenues in each of the quarter and nine months ended March 31, 2005, consist of
repairs and engineering design and development. Recognition of service revenue
occurs (assuming all other revenue recognition criteria have been met) upon
delivery to the customer of the repaired product, or in the case of engineering
design and development services, when the design or a prototype instrument has
been delivered to the customer. Contract revenues where the period of
performance extends beyond six months, including revenues from
customer-sponsored research and development contracts, are recognized under the
percentage-of-completion method. The percentage of completion is determined by
computing the percentage of the actual cost of work performed to the anticipated
total contract costs, or on the basis of units shipped. When the estimate of a
contract indicates a loss, the Company’s policy is to record the entire
estimated loss in the current period.
Bad
Debt
The
Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments.
Allowances for doubtful accounts are established based upon review of specific
account balances and historical experience. If the financial condition of the
Company’s customers were to deteriorate, resulting in an impairment of their
ability to make future payments, additional allowances may be
required.
Inventories
The
Company provides for estimated obsolescence on unmarketable inventory based upon
assumptions about future demand and market conditions. If actual demand and
market conditions are less favorable than those projected by management,
additional inventory write downs may be required. Inventory, once written down,
is not subsequently written back up, as these adjustments are considered
permanent adjustments to the carrying value of the inventory.
Impairment
of Long-Lived Assets and Long-Lived Assets to be Disposed of
In
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,
Accounting
for the Impairment or Disposal of Long-Lived Assets, the
Company assesses impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to undiscounted
future net cash flows expected to be generated by the asset. Estimating the
future cash flows expected to be generated by the asset is dependent upon
significant judgments made by management. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets.
Results
of Operations
Total
revenues for the quarter ended March 31, 2005 increased by $12,574, or 4.0%,
from the same period in the prior year. Revenues for the quarter decreased 17.9%
sequentially from the preceding quarter. Total revenues for the nine months
ended March 31, 2005 decreased by $191,784, or 16.3% from the same period in the
prior year.
The
increase in revenues for the quarter was due primarily to higher sales of
medical products (up by $8,210, or 3.8%) and higher sales of non-medical
products (up by $4,364, or 4.6%). Sales of medical products were higher due
primarily to higher shipments of beamsplitters, micro optic lenses and micro
couplers. Sales of non-medical products were higher due primarily to higher
shipments of industrial lenses, couplers and thin film coatings.
The
revenue decrease from the prior year for the nine months ended March 31, 2005
was due to lower sales of medical products (down by $258,624, or 25.5%)
partially offset by higher sales of non-medical products (up by $66,840 or
40.7%). Sales of medical products were lower due primarily to one-time shipments
last year to a customer of specialty endoscopes used for cardiac surgical
applications. Non-medical product sales were higher due primarily to higher
sales of industrial lenses, couplers and thin film coatings.
Revenues
from the Company’s largest customers, as a percentage of total revenues for the
nine months ended March 31, 2005 and 2004, were as follows:
| |
|
2005 |
|
2004 |
|
|
Customer
A |
|
|
22 |
|
|
20 |
|
|
Customer
B |
|
|
11 |
|
|
5 |
|
|
Customer
C |
|
|
- |
|
|
27 |
|
|
All
Others |
|
|
67 |
|
|
48 |
|
| |
|
|
100 |
% |
|
100 |
% |
No other
customer accounted for more than 10% of the Company’s revenues during those
periods.
At March
31, 2005, receivables from the Company’s three largest customers were
approximately 17%, 14% and 12%, respectively, of the total accounts receivable.
At June 30, 2004, receivables from the Company’s four largest customers were
approximately 47%, 18%, 13%, and 12%, respectively, of the total accounts
receivable. No other customer accounted for more than 10% of the Company’s
receivables as of March 31, 2005 and June 30, 2004.
Gross
profit (loss) for the quarter ended March 31, 2005 reflected a favorable change
of $110,520 compared to the quarter ended March 31, 2004. Gross profit (loss) as
a percentage of revenues improved from a negative 48.9% in the quarter ended
March 31, 2005 to a negative 13.2% in the quarter ended March 31, 2005. The
favorable change in gross profit was due primarily to a lower manufacturing cost
structure resulting from restructuring measures implemented in fiscal year 2004,
and by lower provisions for slow-moving and obsolete inventories recorded in the
quarter ended March 31, 2005 of $38,650 compared to $124,700, recorded in the
quarter ended March 31, 2004.
Gross
profit (loss) for the nine months ended March 31, 2005 reflected a favorable
change of $24,995 compared to the nine months ended March 31, 2004. Gross profit
as a percentage of revenues changed from a negative 28.5% last year to a
negative 31.4% this year. The change in gross profit was due to the lower
provisions for slow-moving and obsolete inventories recorded in the nine month
period ended March 31, 2005 ($187,650 this year compared to $308,800 last year)
and by a lower manufacturing cost structure referred to above, partially offset
by lower sales volume this year.
Research
and development expenses decreased by $48,775, or 12.9%, for the quarter ended
March 31, 2005, and by $70,476, or 7.2%, for the nine months ended March 31,
2005 compared to the corresponding periods of the prior year. The decrease
reflects a shift in certain resources to customer-sponsored development efforts
(the costs of which are included in cost of goods sold), resulting in initial
shipments of new products to several customers.
Selling,
general and administrative expenses increased by $22,618, or 5.2%, for the
quarter ended March 31, 2005, and increased by $73,126, or 5.5%, for the nine
months ended March 31, 2005 compared to the corresponding periods of the prior
year. The increase is due primarily to higher bid and proposal expenses and
professional services expenses, partially offset by lower insurance expense.
The
provision for asset impairment and restructuring of $52,208 in the quarter and
nine months ended March 31, 2004, consists of a provision for severance benefits
paid in the quarter ended March 31, 2004 related to a workforce reduction in
January 2004 of 15%, or five employees.
Interest
income increased by $8,511 for the quarter and by $23,696 for the nine months
ended March 31, 2005 compared to the corresponding periods of the prior year.
The increase was due to the higher base of cash and cash equivalents because of
proceeds received from the rights offering in July 2004.
No income
tax provision was recorded in the first, second or third quarters of fiscal year
2005 or 2004 because of the losses generated in those periods.
Liquidity
and Capital Resources
For the
nine months ended March 31, 2005, the Company’s cash and cash equivalents
increased by $2,694,661 from $343,260 at June 30, 2004 to $3,037,921. The
increase in cash and cash equivalents was due to receipt of gross proceeds from
the rights offering of $5,256,159 less payment of offering costs of $203,598,
partially offset by cash used by operating activities of $2,287,385, capital
expenditures of $28,813, and an increase in other assets of $41,702.
The
Company’s current sources of liquidity consist of its cash and cash equivalents
and accounts receivable. At March 31, 2005, the Company had $3,037,921 in cash
and cash equivalents and $137,606 in accounts receivable.
The
Company believes, based on its operating and strategic plans and the net
proceeds received in July 2004 from its rights offering to stockholders, that it
will have sufficient funds to conduct operations at least through March 31,
2006.
Contractual
cash commitments for the fiscal years subsequent to March 31, 2005 are
summarized as follows:
| |
|
2005 |
|
2006 |
|
Thereafter |
|
Total |
|
| |
|
|
|
|
|
|
|
|
|
|
Operating
leases |
|
$ |
6,030 |
|
$ |
741 |
|
$ |
1,853 |
|
$ |
8,624 |
|
|
Total |
|
$ |
6,030 |
|
$ |
741 |
|
$ |
1,853 |
|
$ |
8,624 |
|
The
Company provides a standard one-year warranty on materials and workmanship to
its customers. The Company provides for estimated warranty costs at the time
product revenue is recognized. Warranty costs are included as a component of
cost of goods sold in the accompanying consolidated statements of operations.
For the nine month periods ended March 31, 2005 and 2004, warranty costs were
not significant.
For the
quarter ended March 31, 2005, the Company’s cash used in operating activities
was $779,329, compared to $753,564 for the preceding quarter ended December 31,
2004. The increase was due primarily to the lower revenues in the quarter ended
March 31, 2005 compared to the quarter ended December 31, 2004.
Capital
equipment expenditures during the nine months ended March 31, 2005 were $28,813,
down 9.4% from the same period in 2004. Future capital expenditures will depend
on future sales and the success of ongoing research and development
efforts.
For the
quarter ended March 31, 2005, research and development expenses were $330,743,
down 12.9% from $379,518 a year earlier. The decrease reflects a shift in
certain resources to customer-sponsored development efforts in the quarter (the
costs of which are included in cost of goods sold), resulting in initial
shipments of new products to several customers. The level of future quarterly
R&D expenses will ultimately depend on the Company’s assessment of new
product opportunities.
During
the quarter and nine months ended March 31, 2005, the Company’s revenues
included initial shipments to several new customers of optical lenses and
instruments which utilize the Company’s patent-pending micro-precision lens
technology and encompass a variety of innovative techniques involving minimally
invasive surgery. The Company also delivered prototypes to a new customer of
specialized lens systems for use in advanced night vision applications and
provided thin film coatings to two other new customers for use in environmental
monitoring and advanced laser instrumentation applications. These new
initiatives accounted for approximately 15% of total Company revenues in each of
the quarter and nine months ended March 31, 2005.
Trends
and Uncertainties That May Affect Future Results
The
Company expects its recent pattern of quarter-to-quarter revenue fluctuations to
continue, due to the uncertain timing or orders from customers and their size in
relation to total revenues. The Company continues to move forward with new
products and technical innovations, in particular, the development of a new
prototype 2.7 mm endoscope, and new instruments utilizing the Company’s new
micro-precisionTM lens technology (patent pending) for endoscopes under 1 mm.
The Company continues to explore potential applications of single-molecule
technology and nanotechnology, as well as potential near-term applications of
the Company’s existing technologies in non-medical markets.
The
Company believes that the recent introduction of several new products, along
with new and ongoing customer relationships, may generate additional revenues,
which are required in order for the Company to achieve profitability. If these
additional revenues are not achieved on a timely basis, the Company will be
required and is prepared to implement further cost reduction measures, as
necessary.
Section
404 of the Sarbanes-Oxley Act of 2002, requiring companies and their public
accounting firms to report on the effectiveness of the company’s internal
controls over financial reporting, will first apply to the Company’s Annual
Report on Form 10-KSB for the fiscal year ending June 30, 2007. The Company
expects its operating expenses will increase as a result of the costs associated
with the implementation of and maintaining compliance with Section
404.
Item
3 Controls
and Procedures
As of the
end of the period covered by this quarterly report, the Company’s Chief
Executive Officer and Principal Financial Officer have conducted an evaluation
of the Company’s disclosure controls and procedures. Based on their evaluation,
the Company’s Chief Executive Officer and Principal Financial Officer have
concluded that the Company’s disclosure controls and procedures are effective to
ensure that information required to be disclosed by the Company in reports that
it files or submits under the Securities Exchange Act of 1934 is (i) recorded,
processed, summarized and reported within the time periods specified in the
applicable Securities and Exchange Commission rules and forms and (ii)
accumulated and communicated to the Company’s management, including the
Company’s Chief Executive Officer and the Company’s Principal Financial Officer,
as appropriate to allow timely decisions regarding required
disclosure.
There was
no change in the Company’s internal control over financial reporting during the
Company’s
most recently completed fiscal quarter that has materially affected, or is
reasonably
likely to materially affect, the Company’s internal control over
financial reporting.
PART
II. OTHER
INFORMATION
|
Items
1-5 |
Not
Applicable. |
Exhibit
31.1 – Certifications of the Company’s Chief Executive
Officer
required by Rule 13a-14(a)/15d-14(a)
Exhibit
31.2 – Certification of the Company’s Chief Financial
Officer
required by Rule 13a-14(a)/15d-14(a)
Exhibit
32.1 – Certifications of the Company’s Chief Executive
Officer
and Chief Financial Officer required by Rule 13a-14(b) and
18 U.S.
C. 1350.
In
accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
| |
|
|
| |
PRECISION OPTICS
CORPORATION, INC. |
|
|
|
| DATE: May 10, 2005 |
By: |
/s/ JACK P.
DREIMILLER |
| |
Jack
P. Dreimiller
Senior
Vice President, Finance,
Chief
Financial Officer and Clerk |
| |
|
EXHIBIT
INDEX
Exhibit
31.1 – Certifications of the Company’s Chief Executive
Officer
required by Rule 13a-14(a)/15d-14(a)
Exhibit
31.2 – Certification of the Company’s Chief Financial
Officer
required by Rule 13a-14(a)/15d-14(a)
Exhibit
32.1 – Certifications of the Company’s Chief Executive
Officer
and Chief Financial Officer required by Rule 13a-14(b) and
18 U.S.
C. 1350