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Earnings Recap - Precision Optics (PEYE)


We are long Precision Optics Corporation (ticker: PEYE), which on February 13th issued its earnings report for the 2nd quarter (12/31/19) of its fiscal 2020 (link here). PEYE is a leading developer and manufacturer of advanced optical instruments since 1982. Using proprietary optical technologies, PEYE designs and produces next generation medical instruments, Microprecision™ micro-optics with characteristic dimensions less than 1 millimeter, and other advanced optical systems for a broad range of customers including some of the largest global medical device companies. PEYE's innovative medical instrumentation line includes state-of-the-art endoscopes and endocouplers as well as custom illumination and imaging products for use in minimally invasive surgical procedures. We covered the thesis underlying this investment in a prior writeup (please see our 9/12/19 writeup in our Research section); PEYE's share price is up 13.4% since the issuance of this long thesis:

The quarter produced mixed results, with a large increase in revenues (mainly due to its acquisition of Ross Optical) but a concomitant increase in net loss (during 1H FY2020 PEYE experienced a $491,322 increase in compensation to existing and newly hired employees in its non-Ross operations). Below is the meat of the earnings PR:

Gross margins were higher due to the fact that Ross Optical's margins are typically in the 48-50% range, much higher than legacy Precision Optics. While PEYE's revenues for the 1st half of FY2020 were +77%, most of this was due to the Ross acquisition; on a pro forma organic basis (giving effect to the acquisition for the relevant periods), revenues still rose a respectable 7.5%. Provided PEYE can continue to find good acquisition targets while avoiding unnecessary dilution of its shareholders and taking on onerous debt, our original PEYE long thesis holds. The Ross acquisition increased PEYE's revenues about 70%, yet PEYE's shares outstanding only increased approximately 7% and the deal was not reliant on debt. One would, however, certain hope to see PEYE's losses decrease as a percentage of revenue over time (evidencing operating leverage in the business model).

At a current equity valuation of approximately 2 times sales ($21 million market cap [with minimal debt, just a $500K potential earnout liability] versus $10.6MM revenue runrate for 1H FY2020), PEYE seems fairly reasonably valued by the market. In comparison, the S&P 500 trades at 2.4X P/S (PEYE probably deserves a bit of discount to the overall market due to its microcap status).

One important note of caution concerns the outbreak of the coronavirus in China and its effect on PEYE's supply chain--the following is from PEYE's most recent Form 10-Q filing:

We depend on the availability of certain key supplies and services that are available from only a few sources and we may experience difficulty with certain suppliers due to the recent coronavirus outbreak in China and we may have difficulty finding alternative sources of these supplies or services.

We source certain key supplies to develop and manufacture our products, particularly our precision grade optical glass, which is available from only a few sources, in China. Due to the recent coronavirus outbreak in China in December 2019, we may experience difficulties with certain suppliers. Our business could be affected if we become unable to procure these essential materials and services in adequate quantities and at acceptable prices. We are always evaluating our suppliers and alternative sources. If we experience a shortage of certain supplies and are unable to find an alternative source, our financial condition and results of operations could be adversely affected.

DISCLOSURE: Long PEYE.

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