The accompanying notes are an integral part of these consolidated interim financial statements.

PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWSSTOCKHOLDERS’ EQUITY

FOR THE SIXTHREE MONTHS ENDED

December 31, 2017SEPTEMBER 30, 2020 AND 20162019

(UNAUDITED)

The accompanying notes are an integral part of these consolidated interim financial statements.

PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED

SEPTEMBER 30, 2020 AND 2019

(UNAUDITED)

The accompanying notes are an integral part of these consolidated interim financial statements.

PRECISION OPTICS CORPORATION, INC.

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)

Principles of Consolidation and Operations

The accompanying consolidated financial statements include the accounts of Precision Optics Corporation, Inc. and its wholly-ownedwholly owned subsidiaries (the “Company”). All significant intercompany accounts and transactions have been eliminated in consolidation.

These consolidated financial statements have been prepared by the Company, without audit, and reflect normal recurring adjustments which, in the opinion of management, are necessary for a fair statement of the results of the secondfirst quarter and six months of the Company’s fiscal year 2018.2021. These consolidated financial statements do not include all disclosures associated with annual consolidated financial statements and, accordingly, should be read in conjunction with footnotes contained in the Company’s consolidated financial statements for the year ended June 30, 2017,2020, together with the Report of Independent Registered Public Accounting Firm filed under cover of the Company’s 20172020 Annual Report on Form 10-K, filed with the Securities and Exchange Commission on September 28, 2017.24, 2020.

Use of Estimates

The preparation of these consolidated 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.estimates.

Reclassification

Certain balance sheet items in the prior period financial statements have been reclassified to conform to the presentation of the current period financial statements. This reclassification had no effect on the previously reported net loss.

Income (Loss) Per Share

Basic income (loss) per share is computed by dividing net income or net loss by the weighted average number of shares of common stock outstanding during the period. Diluted income (loss) per share is computed by dividing net income or net loss(loss) by the weighted average number of shares of common stock outstanding during the period, plus the number of potentially dilutive securities outstanding during the period such as stock options and warrants.options. For the three and six months ended December 31, 2017 and 2016,September 30, 2019, the effect of such securities was antidilutive and not included in the fully diluted calculation because of the net loss generated in these periods.that period.

The following is the calculation of lossincome (loss) per share for the three and six months ended December 31, 2017September 30, 2020 and 2016:2019:

The number of shares issuable upon the exercise of outstanding stock options and warrants that were excluded from the computation as their effect was antidilutive was approximately 1,708,867893,200 and 5,113,2242,007,000 for the three months ended December 31, 2017September 30, 2020 and 2016, respectively, and approximately 4,739,960 and 5,113,224 for the six months ended December 31, 2017 and 2016,2019, respectively.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards.carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

In assessing the likelihood of utilization of existing deferred tax assets, management has considered historical results of operations and the current operating environment. Based on this evaluation, a full valuation reserve has been provided for the deferred tax assets.

Recently Issued Accounting PronouncementsGoodwill and Patents

In May 2014,Long-lived assets such as goodwill and patents are capitalized when acquired and reviewed for impairment whenever events or changes in circumstances indicate that the Financial Accounting Standards Board (FASB) issued ASU No. 2014-09, Revenue from Contracts with Customers which requires an entity to recognizebook value of the amountasset may not be recoverable. Impairment of revenue to which it expectsthe carrying value of long-lived assets such as goodwill and patents would be indicated if the best estimate of future undiscounted cash flows expected to be entitled forgenerated by the transfer of promised goodsasset grouping is less than its carrying value. If an impairment is indicated, any loss is measured as the difference between estimated fair value and carrying value and is recognized in operating income or services to customers. The ASU guidance requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which an entity expectsloss. Assets to be entitled in exchange for those goodsdisposed of are reported at the lower of the carrying amount or services. The guidance also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required regarding customer contracts, significant judgments and changes in judgments, and assets recognized from thefair value less costs to obtainsell. No such impairments of goodwill or fulfill a contract. The standard will be effective for the Company for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. The Company is reviewing the financial statement effect, if any,patents have been estimated by management as of implementing ASU No. 2014-09, that will go into effect on July 1, 2018.September 30, 2020.

Inventories are stated at the lower of cost (first-in, first-out) or marketand net realizable value and consisted of the following:

The Company executed an unsecured Promissory Note with a bank on May 6, 2020 and received $808,962 of loan proceeds pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The Promissory Note bears interest at a fixed rate of 1% per annum, with principal and interest payments commencing on November 6, 2020. However, if the Small Business Administration confirms forgiveness of the Company’s loan and reimburses the bank for the total outstanding balance of principal and interest, the Company’s obligations under the Promissory Note will be deemed fully satisfied and paid in full. The Company has begun the loan forgiveness application process and expects that it will ultimately qualify for full forgiveness. Any portion of the Company’s CARES Act loan that is not forgiven shall be converted to a term loan with the bank with monthly payments bearing interest at no more than 1% per annum and a maturity date two years from the Promissory Note date, or May 6, 2022.

The Company entered into a five-year capital lease obligation in January 2016 for the acquisition of manufacturing equipment totaling $51,252. In January 2020 the Company entered into a five-year capital lease and a twelve-month capital lease in the amounts of $47,750 and $65,463 respectively, for manufacturing equipment. The net book value of fixed assets under capital lease obligations as of September 30, 2020 is $99,597.

On July 1, 2019 the Company entered into a three-year operating lease for its facility in El Paso, Texas with total remaining minimum lease payments of $109,156 at September 30, 2020. Total rent expense including base rent and common area expenses was $15,445 and $17,089 during the three months ended September 30, 2020 and 2019, respectively. Included in the accompanying balance sheet at September 30, 2020 is a right-of-use asset of $104,380 and current and long-term right-of-use operating lease liabilities of $58,136 and $46,244, respectively.

At December 31, 2017,September 30, 2020, future minimum lease payments under the capital lease obligationand operating lease obligations are as follows:

The Company’s operating leases for its three Gardner, Massachusetts office, production and storage spaces plus an equipment lease have expired and are continuing on a month to month tenant at will basis. Rent expense on these operating leases was $41,616 and $36,414 for the three months ended September 30, 2020 and 2019, respectively. 

The following table summarizes stock-based compensation expense for the three and six months ended December 31, 2017September 30, 2020 and 2016:2019:

No compensation has been capitalized because such amounts would have been immaterial.

The following tables summarize stock option activity for the sixthree months ended December 31, 2017:September 30, 2020:

Information related to the stock options outstanding as of December 31, 2017September 30, 2020 is as follows:

The aggregate intrinsic value of the Company’s “in-the-money” outstanding and exercisable options as of December 31, 2017 was $5,750 and $5,650, respectively.

As ofthe three months ended September 30, 2017, there were warrants outstanding for the issuance of an aggregate of 666,667 shares of common stock, $0.01 par value, at a purchase price of $0.01 per share. All warrants for 666,667 shares were exercised on or before October 16, 2017, by payment to the Company for the aggregate purchase price of $6,667. There are no warrants for the purchase of the Company’s stock outstanding as of December 31, 2017.2020 was $435,520.

On August 22, 2017,July 1, 2018, the Company entered into agreementsadopted ASU 2014-09 Revenue from Contracts with accredited investorsCustomers (ASC 606) using the modified retrospective method for contracts that were not completed as of July 1, 2018, whereby revenues are recognized as the performance obligations to deliver products or services are satisfied and are recorded based on the amount of consideration the Company expects to receive in exchange for satisfying the performance obligations. Most of the Company’s products and services are marketed to medical device companies almost exclusively in the United States. Products and services are primarily transferred to customers at a point in time based upon when services are performed or product is shipped.

Revenues represent the amount of consideration the Company expects to receive from customers in exchange for transferring products and services. Other selling costs to obtain and fulfill contracts are expensed as incurred due to the short-term nature of a majority of its revenues. The Company extends terms of payment to its customers based on commercially reasonable terms for the sale and purchase of 466,668 unregistered sharesmarkets of its common stock, $0.01 par value at a purchase price of $0.45 per share. The Company received $210,001customers, while also considering their credit quality. Shipping and handling costs charged to customers are included in gross proceeds from the offering. The Company is using the net proceeds from this placement for general working capital purposes.revenues.

Concurrently withThe Company disaggregates revenues by product and service types as it believes it best depicts how the placement,nature, amount, timing and uncertainty of revenues and cash flows are affected by economic factors. Revenues are comprised of the Company entered into an agreement with an investorfollowing for the salethree months ended September 30, 2020 and 2019:

Contract Assets and Liabilities

The nature of 88,888 unregistered sharesthe Company’s products and services does not generally give rise to contract assets as it typically does not incur costs to fulfill a contract before a product or service is provided to a customer. The Company’s costs to obtain contracts are typically in the form of its common stocksales commissions paid to employees. The Company has elected to expense sales commissions associated with obtaining a contract as incurred as the amortization period is generally less than one year. These costs have been recorded in selling, general and administrative expenses. As of September 30, 2020, there were no contract assets recorded in the Company’s Consolidated Balance Sheets.

The Company’s contract liabilities arise as a result of unearned revenue received from customers at inception of contracts or where the timing of billing for services provided toprecedes satisfaction of our performance obligations. The Company generally satisfies performance obligations within one year from the Company at a price of $0.45 per share.contract inception date.

In connection with the placement, the Company also entered into a registration rights agreement with the investors, whereby the Company was obligated to file a registration statement with the Securities Exchange Commission on or before 90 calendar days after August 22, 2017 to register the resale by the investors of 555,556 shares of our common stock purchasedContract liabilities, which were recorded as customer advances in the placement. The registration statement was filed withCompany’s Consolidated Balance Sheets, and unearned revenue are comprised of the Securities and Exchange Commission on November 20, 2017 and became effective on December 13, 2017.following:

On December 22, 2017,The world-wide COVID-19 pandemic that began during the Tax Cuts and Jobs Act was signed into law. The Tax Cuts and Jobs Act will significantly change the taxation of U.S.-based multinational corporations, by, among other things, reducing the U.S. corporate income tax rate, adopting elements of a territorial tax system, affecting the deductibility of capital expenditures, assessing a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, continuing the moratorium on Medical Device Excise Tax,quarter ended March 31, 2020 and the creationdomestic and international impact of new taxespolicy decisions being made in major countries around the world has had, and is expected to have, an adverse impact on certain foreign-sourced earnings. The legislation is unclear in some respectsthe Company’s sources of supply, current and will require interpretationsfuture orders from the Company’s customers, ability of Company to travel to and implementing regulations byattend marketing conferences and visit customer facilities, collection of amounts owed to it from its customers, the Internal Revenue Service, as well as state tax authorities,Company’s internal operating procedures, and the legislation could be subjectCompany’s overall financial condition. While the Company and many of its medical device and defense contracting customers continue to operate as essential businesses, the Company has taken various actions to augment its operating and human resource policies and procedures to guard against the potential amendmentshealth hazards of COVID-19. These augmented procedures can have a negative impact on the Company’s operational efficiencies. The Company sources various components from overseas suppliers throughout Asia, including China. The Company has experienced supply disruptions and technical corrections, any ofcustomer delays, which could lessen or increase certain adverse impactsit believes were the result of the legislation. TheCOVID-19 pandemic and related economic slow-down. Given the uncertainty surrounding the continuation of economic slow-downs domestically and abroad, the Company iscannot predict with certainty at this time what the future impact of COVID-19 and resulting business and economic policies in the process of determining what, if any, effect those provisionsUS and abroad will havebe on its financialupcoming quarterly fiscal operating results.

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 and sixthree months ended December 31, 2017September 30, 2020 and with our audited consolidated financial statements for the year ended June 30, 20172020 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on September 28, 2017.24, 2020.

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, 20172020 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 developinga developer and manufacturingmanufacturer of advanced optical instruments since 1982. Today, the vast majority of our business is the design and manufacture of high-quality medical devices and less than 10% of our business is the design and manufacture of military and industrial products. 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. Over the last ten years, we have fundedWe selectively execute internal research and development programs to develop next generation capabilities for designing and manufacturing 3D endoscopes and very small Microprecision™ lenses, anticipating future requirements as the surgical community continues to demand smaller and more enhanced imaging systems for minimally invasive surgery.

Our unique proprietary technology inAs 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 areasRoss Optical name include a custom or catalog optic, which is sourced through our extensive domestic and worldwide network of microoptical fabrication companies. Most systems make use of optical lenses, prisms, mirrors and prisms, microwindows 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.

Approximately 60% of our business during the three months ended September 30, 2020 is from the design and manufacture of high-quality medical fiberdevices. Approximately 9% of our revenue during the same period is from the design, manufacture and CMOS based cameras,resale of optical products for military and defense, and 31% is from other industrial, non-medical products. Our proprietary medical instrumentation line and unique custom design ofand manufacturing capabilities include traditional endoscopes and endocouplers as well as other custom imaging and illumination products for use in minimally invasive surgical procedures. We design and manufacture 3D endoscopes and very small Microprecision™ lenses, assemblies and complete medical grade instruments, combined with recent developments indevices to meet the areas of 3D displays, has allowed us to begin commercialization of related productsurgical community’s continuing demand for smaller, disposable, and service offerings to a widening group of customers addressing various medical device, defense and aerospace applications. Thus, a portion of our revenues are now derived from engineering and design services we performed for our customers to incorporate our technologies and capabilities into their medical device products. We believe that new products based on these technologies providemore enhanced imaging systems for existing surgical procedures and can enable development of many new medical device products and related medical procedures.minimally invasive surgery.

We are registered to the ISO 9001:20082015 and ISO 13485:20032016 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 website is www.poci.com.websites are www.poci.com and www.rossoptical.com. Information on our websitewebsites 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), 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 LinkedIn page (www.linkedin.com/company/ross-optical-industries/) and Twitter feed (http://twitter.com/rossoptical).

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 effectivecost-effective production.

We believe that competition for sales of our medical products and services, which Over the years we 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.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 Microprecision™ optics, micro medical cameras, illumination, single-use endoscopes and 3D endoscopes.

ForOur largest customer during the sixthree months ended December 31, 2017, approximately 75%September 30, 2020 accounted for 11.3% of our sales were made to seven customers. Of these, four were medium to large, international, medicaland represented production revenue for an ENT scanning device companiesincorporating our Microprecision™ technologies as an enabling design feature. During the fiscal quarter ended September 30, 2020 we had revenue from another one-hundred fifty-eight customers, and one was a large defense contractor. Eachnone of thesethose customers has beenaccounted for more than 10% of our customer for numerous years. The other two customers were early-stage companies developing endoscopic products that incorporate our unique design capabilities. Sales to these seven customers included both products we developed over five years ago and products we are currently developing which rely heavily on our unique, proprietary Microprecision™ lens technology and optical visualization system expertise.total sales.

Current sales and marketing activities are intended to broaden awareness of the benefits of our new technology platforms which we believe are ready for generaland our successful application of these new technologies to medical device projects requiring surgery-grade visualization from sub-millimeter sized devices and 3D endoscopy.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 including Medical Design and Manufacturing West and MD&M East, and periodically 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.

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 under different assumptions or conditions.

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, 20172020 filed with the Securities and Exchange Commission on September 28, 2017.24, 2020.

Results of Operations

Our total revenues for the quarter ended December 31, 2017,September 30, 2020, were $812,773,$2,757,901, as compared to $601,590$2,514,984 for the same period in the prior year, an increase of $211,183,$242,917, or 35.1%9.7%. Revenues increasedWe believe sales to certain customers were negatively impacted by the COVID-19 pandemic during the quarter ended December 31, 2017 compared toSeptember 30, 2020, however, the mix of engineering service, production and component sales were similar between the first quarter of fiscal year 2021 and the same quarter of the prior year in the engineering services and production categories by 75% and 16%, respectively. The majority of our revenues are derived from engineering design and manufacturing services related to products marketed or under development by our OEM customers. Therefore, our revenues are subject to fluctuations on a product by product basis from period to period. The increase in productionfiscal year. Engineering revenue during the quarter ended December 31, 2017 whenSeptember 30, 2020 increased approximately $180,000 compared to the same quarter of the prior year resulted primarily from an increase in sales of a traditional product to a long-standing customer. Engineering service revenue during the quarter ended December 31, 2017, when compared to the same quarter of the prior year included a similar number of projects, but increases in revenue from two specific customers, one of which is now transitioning from the engineering to production phase. We believe most engineering design projects have the potential to generate production revenues when our customers achieve commercialization of the products under design.

Our total revenues for the six months ended December 31, 2017 were $1,841,519, as compared to $1,451,138 for the same period in the prior year, an increase of $390,381, or 26.9%. The increase in revenues for the six month period ended December 31, 2017 compared to the same period of the prior year resulted from increases in engineering and production revenues of 41% and 18%, respectively. The engineering revenue increase during the quarter ended December 31, 2017 compared to the same period of the prior year resulted primarily from two large customer projects, one of which is now transitioning to production. These increases were partially offset by the previously mentioned loss of a customer’s Microprecision™ technology product in fiscal 2017. Production revenues increased during the quarter ended December 31, 2017 compared to the same period of the prior year due to the addition of an optical component projectprojects with two new customers, which was partially offset by a typical and anticipated reduction in revenue to a cyclicalcustomer progressing through the development stage. Production revenue had a slight increase in traditional laryngoscopes.quarter-over-quarter revenue due to an increase in production revenue for the ENT scanning device product, which was partially offset by a reduction in production revenue for the cardiovascular product, which both incorporate our Microprecision™ CMOS technology.

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. While we and many of our medical device and defense contracting customers continued to operate as essential businesses, we took 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 had supply disruptions and customer delays 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 impacts both 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 quarterly fiscal operating results.

Gross profit for the quarter ended December 31, 2017September 30, 2020 was $300,222,$975,178, compared to $148,407$974,117 for the same period in the prior year, reflecting an increase of $151,815, or 102.3%.$1,061. Gross profit for the quarter ended December 31, 2017September 30, 2020 as a percentage of our revenues was 36.9%35.4%, an increasea decrease from the gross profit percentage of 24.7% for the same period in the prior year. Gross profit for the six months ended December 31, 2017 was $686,964, as compared to $315,458 for the same period in the prior year, which reflects an increase of $371,506 or 117.8%. Gross profit for the six months ended December 31, 2017 as a percentage of our revenues was 37.3%, an increase from the gross profit percentage of 21.7%38.7% 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, and the costs of engineering services, and initial production start-up costs, challenges in connection with new products. The improvementproducts, 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 margin 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 decrease in our gross profit performancemargin from 38.7% to 35.4% during the fiscal quarter and six month periods ended December 31, 2017 resultedending September 30, 2019 compared to 2020 was primarily the result of a gross margin decrease in one engineering project due to cost over-runs, plus a decrease in production revenue gross margin resulting from increased revenues absorbingtwo production products. One production product with a higher percentage of fixed manufacturing costs, and lower fixed compensation expense during the quarter. Management expects compensation costs togross margin experienced an increase since new hires for these or similar positions are planned. Additionally, targeted or better margins were realized on most engineering and production projectsin quarter-over-quarter sales during the quarter ended December 31, 2017, including the larger revenue projectsSeptember 30, 2020, while another production product with a higher gross margin experienced a decrease in each category, due to experienced related efficienciesquarter-over-quarter sales. The remainder of our production, engineering and component revenues resulted in producing traditional products and engineering development activities associatedmargins within our targeted range with Microprecision™ technologies.reasonably expected fluctuations.

Research and development expenses were $90,031$151,576 for the quarter ended December 31, 2017,September 30, 2020, compared to $119,215a similar amount of $152,154 for the same period in the prior year, a decrease of $29,184, or 24.5%. Research and development expenses were $208,458 for the six months ended December 31, 2017, compared to $236,207 for the same period in the prior year, a decrease of $27,749, or 11.7%. The decrease in research and development expenses during the quarter and six months ended December 31, 2017, compared to the same periods of the prior year, resulted from a temporary reduction in engineering department staffing and a higher percentage of available engineering resources being consumed in revenue generating engagements with our customers for the development of their products.year. In-house research and development and certain internal functions not directly related to customer engagements are classified as research and development expenses.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 quarter ended September 30, 2020 we achieved an increased amount of engineering revenue by utilizing a similar amount of engineering labor as compared to the same quarter of the prior year. Consequently, a similar amount of engineering resources were consumed in internal research and development activities during the quarters ended September 30, 2020 and 2019, respectively.

Selling, general and administrative expenses were $270,035$822,002 for the quarter ended December 31, 2017,September 30, 2020, compared to $342,487$907,845 for the same period in the prior year, a decrease of $72,452,$85,843, or 21.2%9.5%. Selling, general and administrative expenses were $566,619 for the six months ended December 31, 2017, compared to $686,269 for the same period in the prior year, a decrease of $119,650, or 17.4%.TheThe decrease in the quarter and six months ended December 31, 2017,September 30, 2020, compared to the same periods inquarter of the prior fiscal year was primarily due to reduceddecreased recruiting, shareholder relations, stock based compensation expense relating to stock options and stock accrued for consulting services, plus reduced wages resulting from the retirement of a sales person in January 2017 and a temporarily vacated administrative position which has since been filled. The expense reductions were partiallytravel costs offset by a $25,000 increaseincreases in the reserve for doubtful accounts receivable relating to one specific customerconsulting, professional accounting and increased sales commissions for a lesser amount.

No income tax provision was recorded in the quarter and six month periods ended December, 2017 and 2016 because of the losses generated in those periods.insurance expenses. 

Liquidity and Capital Resources

We have sustained recurring net losses for several years. During the quarter and six month periods ended December 31, 2017, we incurred net losses of $60,326 and $89,111, respectively. We also incurred net losses of $1,006,457 and $1,034,765 during the fiscal yearsyear ended June 30, 2017 and 2016, respectively,2020 we incurred a net loss of 1,426,150 and used cash in operating activities of $667,434$592,492. During the three months ended September 30, 2020 we had net income of $793 and $876,298 during the same fiscal periods, respectively. Asused cash in operating activities of December 31, 2017,$172,636. At September 30, 2020 cash and cash equivalentswas $900,510, accounts receivables were $381,752, accounts receivable were $753,152,$1,585,001 and current liabilities were $1,529,694. Our working capital was $671,433$2,875,003, including $206,665 of customer advances received for future order deliveries.

Although our sales levels have increased and $479,604 at December 31, 2017our financial performance has shown signs of periodic improvement during certain recent fiscal quarters, our operating expenses have also increased and June 30, 2017, respectively.we continue to experience pricing pressure from our customers and challenges in engineering projects and production orders that result in cost over-runs and lower gross margins. 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, and by cash received from public and private offerings of our common stock, warrants to purchase shares of our common stock or convertible notes. We have incurred quarter to quarter operating losses during our efforts to developnotes, and by customer advances paid against purchase orders and recorded in the current products including Microprecision™ optical elements, micro medical camera assemblies and 3D endoscopes.liabilities section of the accompanying financial statements. Our management believes that the opportunities represented by these productsour current production projects and engineering pipeline of Microprecision™ optical projects have the potential to generate sales increases to achieve sustained breakevenincreasing revenues and profitable results. However, our current financial condition may raise doubt regarding our abilityresults.

On May 6, 2020, we received loan proceeds in the amount of $808,962 under the Paycheck Protection Program, or PPP, from Bank of America. The PPP, established as part of the Coronavirus Aid, Relief and Economic Security Act, or CARES Act, provides for loans to continuequalifying businesses that are forgivable provided the loan proceeds are used for eligible purposes, including payroll, benefits, rent and utilities. The unsecured loan, which is in the form of a note dated May 6, 2020 and recorded as a going concern, as referenced by the Report of our Independent Registered Public Accounting Firm on ourcurrent liability in accompanying financial statements, matures on May 6, 2022 and bears interest at a rate of 1% per annum, payable monthly commencing on December 6, 2020. While we currently believe that our use of the loan proceeds meets the conditions for forgiveness of the year ended June 30, 2017, included in our Annual Report on Form 10-K.

We recognize thatloan, we have begun the working capital described aboveforgiveness application process and our cash and accounts receivable as of December 31, 2017 is low considering the level of cash historically used in our operations at our current sales levels. Our accounts receivable and cash balances are subject to significant fluctuations based on the timing and amount of customer billings and accounts receivable collections as well as the terms of vendor payment obligations. If quarterly sales revenues do not increase and maintain near or above cash breakeven levels in the next six to nine months, we may be required to obtain cash for operations from non-working capital sources, which may not be available, in which case we would have to significantly decrease or cease operations.

The sale of additional equity or convertible debt securities would result in additional dilution to our stockholders, and debt financing, if available, may involve restrictive covenants that could restrict our operations or finances. Financing, if necessary, may not be available in amounts or on terms acceptable to us, if at all. If we cannot raise funds on acceptable termsyet be assured that our $808,962 PPP loan will be eligible for forgiveness, in whole or achieve positive cash flow, we may not be able to continue to conduct operations, develop new products, grow market share, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, any of which would negatively impact our business, operating results and financial condition.in part.

Capital equipment expenditures and additional patent application related expenditurescosts during the sixthree months ended December 31, 2017 and 2016September 30, 2020 were $17,189 and $31,691, respectively.$40,609. Future capital equipment and patent application expenditures will be dependent upon the type and amount of future sales revenue and successthe needs of on-going research and development efforts.

We have contractual cash commitments related to open purchase orders as of December 31, 2017September 30, 2020 of approximately $338,000, including$656,850, plus a $27,828$74,119 commitment remaining under a five-yearthree capital lease obligationobligations for the acquisition of equipment and $109,156 commitment remaining under a three-year facility lease relating the Ross Optical division in El Paso, Texas (see Note 3. Capital Lease Obligation)Obligations). We have no other contractual cash commitments since other leased facilities are currently on a month-to-month basis.

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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

As a smaller reporting company, as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item.

Item 4. Controls and Procedures.

Management’s Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and our Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures, including internal control over financial reporting, were not effective, as of December 31, 2017,September 30, 2020, to ensure the information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934, as amended (i) is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our disclosure controls and procedures are intended to be designed to provide reasonable assurance that such information is accumulated and communicated to our management. Based on this evaluation, our management concluded that our internal control over financial reporting was not effective as of December 31, 2017.September 30, 2020.

The following is a description of two material weaknesses in our internal control over financial reporting:

Segregation of Duties: As previously disclosed in our Annual Reports on Form 10-K for the fiscal years ended June 30, 2008-2017,2008-2020, our management identified a control deficiency during the 2008 fiscal year because we lacked sufficient staff to segregate accounting duties. We believe the control deficiency resulted primarily because we have the equivalent of one and one-half persons performing all accounting-related on-site duties. As a result, we did not maintain adequate segregation of duties within our critical financial reporting applications, the related modules and financial reporting processes. This control deficiency could result in a misstatement of balance sheet and income statement accounts in our interim or annual consolidated financial statements that would not be detected. Accordingly, management has determined that this control deficiency constitutes a material weakness. During the period beginning with fiscal year 2008 through June 30, 2017,2020, no audit adjustments resulting from this condition were required.

To address and remediate the material weakness in internal control over financial reporting described above, beginning with the quarter ended September 30, 2008, we instituted a procedure whereby our Chief Executive Officer, our Chief Financial Officer and other members of our Board of Directors perform a higher level review of the quarterly and annual reports on Form 10-Q and Form 10-K prior to filing.

We believe that the step outlined above strengthens our internal control over financial reporting and mitigates the material weakness described above. As part of our assessment of internal control over financial reporting for the fiscal yearquarter ended JuneSeptember 30, 2017,2020, our management has evaluated this additional control and has determined that it is operating effectively.

Inventory Valuation: As previously disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017,2020, we reported a material weakness with respect to the valuation of our inventories. Specifically, the amounts used to value our inventory at June 30, 2009 with respect to overhead rates and purchased items were often inconsistent with the supporting documentation, due to year-to-year changes in overhead rates and costs of purchased items that were not properly reflected in inventory valuation. Accordingly, management had determined that this control deficiency constituted a material weakness as of June 30, 2009. AuditPeriodic fiscal year-end audit adjustments of approximately $58,000 and $41,000 to our audited financial statements as of June 30, 2011 and June 30, 2017, respectively, were$50,000 have been necessary as a result of this condition.

To address and remediate the material weakness in internal control over financial reporting described above, beginning in the quarter ended September 30, 2009 and continuing through the quarter ended September 30, 2020, we implemented processes to improve our inventory controls and documentation surrounding inventory valuation for overhead rates, and performed procedures to ensure that the pricing of inventory items was consistent with the supporting documentation. We believe that the step outlined above strengthens our internal control over financial reporting and mitigates the material weakness described above.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the first quarter of our fiscal year covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

To address and remediate the material weakness in internal control over financial reporting described above, beginning in the quarter ended September 30, 2009 and continuing through the quarter ended December 31, 2017, we implemented processes to improve our inventory controls and documentation surrounding inventory valuation for overhead rates, and performed procedures to ensure that the pricing of inventory items was consistent with the supporting documentation. We believe that the step outlined above strengthens our internal control over financial reporting and mitigates the material weakness described above.

We intend to continue to remediate material weaknesses and enhance our internal controls but cannot guarantee that our efforts will result in remediation of our material weaknesses or that new issues will not be exposed in this process.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

Our Company, on occasion, may be involved in legal matters arising in the ordinary course of our business. While management believes that such matters are currently insignificant, matters arising in the ordinary course of business for which we are or could become involved in litigation may have a material adverse effect on our business, financial condition or results of operations. We are not aware of any pending or threatened litigation against us or our officers and directors in their capacity as such that could have a material impact on our operations or finances.

Item 1A. Risk Factors.

Other than as described below, thereThere have been no material changes from the risk factors previously disclosed in our annual report on Form 10-K for the fiscal year ended June 30, 2017,2020, as filed with the Securities and Exchange Commission on September 28, 2017; and our quarterly report for the quarter ended September 30, 2017, as filed with the Securities and Exchange Commission on November 14, 2017.24, 2020.

As of December 31, 2017, we may not have sufficient cash to continue operations for the next six to nine months.

As of December 31, 2017, we had $381,752 in cash and cash equivalents, $753,152 in accounts receivable, and $1,529,694 in current liabilities. We incurred net losses of $89,111 and $1,006,457 during the six months ended December 31, 2017 and the fiscal year ended June 30, 2017, respectively. If quarterly sales revenues do not increase and maintain near or above cash breakeven levels in the next six to nine months, we may be required to obtain cash for operations from non-working capital sources, which may not be available, in which case we would have to significantly decrease or cease operations. The sale of additional equity or convertible debt securities would result in additional dilution to our stockholders, and debt financing, if available, may involve restrictive covenants that could restrict our operations or finances. Financing, if necessary, may not be available in amounts or on terms acceptable to us, if at all. If we cannot raise funds on acceptable terms or achieve positive cash flow, we may not be able to continue to conduct operations, develop new products, grow market share, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, any of which would negatively impact our business, operating results and financial condition.

The newly enacted Tax Cuts and Jobs Act may affect our financial results, including our net deferred tax asset, and we are in the process of evaluating its effects.

On December 22, 2017, the Tax Cuts and Jobs Act was signed into law. The Tax Cuts and Jobs Act will significantly change the taxation of U.S.-based multinational corporations, by, among other things, reducing the U.S. corporate income tax rate, adopting elements of a territorial tax system, affecting the deductibility of capital expenditures, assessing a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, continuing the moratorium on Medical Device Excise Tax, and the creation of new taxes on certain foreign-sourced earnings. The legislation is unclear in some respects and will require interpretations and implementing regulations by the Internal Revenue Service, as well as state tax authorities, and the legislation could be subject to potential amendments and technical corrections, any of which could lessen or increase certain adverse impacts of the legislation. We are in the process of determining what, if any, effect those provisions will have on our financial results, and there can be no assurance of whether such additional effects will be positive or negative.

The Tax Cuts and Jobs Act also reduces the federal corporate income tax rate from 35% to 21% effective January 1, 2018, which we expect will positively impact our future effective tax rate and after-tax earnings in the United States. As a result of the reduction in the corporate income tax rate, we are required to revalue our net deferred tax asset to account for the future impact of lower corporate tax rates on this deferred amount and record any change in the value of such asset as a one-time non-cash charge on our income statement.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

We did not issue any unregistered equity securities during the quarter ended December 31, 2017.None.

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

Copies of above exhibits not contained herein are available to any stockholder, upon written request to: Chief Financial Officer, Precision Optics Corporation, Inc., 22 East Broadway, Gardner, MA 01440.

SIGNATURES

Pursuant to 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.