Optex Systems Holdings, Inc. — Fiscal 2018 Form 10-K Summary
Business context and reporting period
Optex manufactures optical sighting systems, periscopes, rifle and surveillance sights, night-vision assemblies, laser filters and related optical products, primarily for U.S. Department of Defense applications. Operations are conducted through the Richardson, Texas facility and the Applied Optics Center in Dallas. The filing covers the 52-week fiscal year ended September 30, 2018; the comparable fiscal year ended October 1, 2017 included 53 weeks. The filing is an annual report rather than a standalone quarterly report.
Approximately 76% of fiscal 2018 business supported U.S. military products. Revenue concentration remained high: U.S. government agencies represented 38% of revenue, one major defense contractor 29%, and one commercial customer 20%. The company had 100 full-time equivalent employees at September 30, 2018 and leased approximately 93,967 square feet.
Financial performance and liquidity
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Revenue | $20.853 million | $18.547 million | +12.4% |
| Gross margin | $4.515 million; 21.7% | $3.414 million; 18.4% | +$1.101 million; +3.3 percentage points |
| Operating income | $1.486 million | $0.204 million | +$1.282 million |
| Net income | $1.394 million | $(0.304) million | Improved by $1.698 million |
| Net income applicable to common shareholders | $0.930 million; $0.11 per share | $(0.510) million; $(0.06) per share | Improved by $1.440 million |
| Adjusted EBITDA | $1.996 million | $0.791 million | +$1.205 million |
| Cash flow from operations | $1.039 million | $0.016 million | +$1.023 million |
| Cash and equivalents | $1.133 million | $1.682 million | $(0.549) million |
| Working capital | $8.5 million | $8.0 million | +$0.5 million |
| Backlog | $23.4 million | $15.7 million | +49.0% |
Revenue growth occurred in both operating segments: Richardson revenue increased 13.4% to $12.739 million and Applied Optics Center revenue increased 11.0% to $8.114 million. Sighting Systems revenue increased 227.3% to $3.6 million, while Periscopes increased 5.6% to $7.5 million and Other products declined 46.7% to $1.6 million.
Gross-margin improvement reflected higher volume, product mix and efficiency gains at Applied Optics Center. General and administrative expense declined 6.2% to $3.029 million. The fiscal 2018 net income included a $95 thousand non-cash gain from the change in fair value of warrant liabilities, compared with a $489 thousand non-cash loss in fiscal 2017.
At September 30, 2018, total assets were $12.687 million and stockholders’ equity was $6.344 million. Accounts receivable were $2.458 million and net inventory was $7.639 million. The company had $300 thousand outstanding under its Avidbank revolving credit facility, with borrowing capacity of up to $2.2 million subject to eligible receivables and covenants. The facility matures April 21, 2020 and bears interest at prime plus 2.5%.
Fiscal 2018 investing cash use was $167 thousand, primarily for property and equipment. Financing cash use was $1.421 million, including $784 thousand of dividends and $700 thousand of stock repurchases, partially offset by $93 thousand of warrant-exercise proceeds. The company declared no additional dividends after the April 12, 2018 record date.
Material changes versus the prior comparable period
- Revenue increased 12.4%, driven by growth in both segments and a significant recovery in Sighting Systems deliveries after prior configuration, material and export-license delays.
- Gross margin expanded from 18.4% to 21.7%, while operating margin increased from approximately 1.1% to 7.1%.
- The company returned to profitability, reporting $1.394 million of net income versus a $304 thousand net loss.
- New orders increased 27.8% to $28.5 million from $22.3 million, and backlog increased 49.0% to $23.4 million.
- Periscope backlog increased 69.4% to $8.3 million; Sighting Systems backlog declined 31.7% to $2.8 million; Other-product backlog increased to $5.6 million from $0.6 million; and Applied Optics Center backlog increased 9.8% to $6.7 million.
- Cash declined despite positive operating cash flow because of dividends, stock repurchases and capital expenditures.
- All Series C preferred shares were converted into common shares during fiscal 2018. The company ended the year with 8,333,353 common shares outstanding and no Series C preferred shares.
Guidance, outlook, risks and unusual items
Management expected fiscal 2019 orders to meet or exceed the fiscal 2018 level of $28.5 million. As of December 10, 2018, the company had booked an additional $5.6 million of fiscal 2019 orders. Management projected Periscope revenue growth of 20% to 25% in fiscal 2019 and expected Other-product revenue to increase by up to 300% based on current delivery schedules. Applied Optics Center revenue was expected to decline 8% to 9% in the first half of fiscal 2019 and increase 34% to 35% in the second half, with a shift toward military products.
Management viewed increased U.S. defense procurement budgets and the lifting of sequestration caps as favorable, but noted that sequestration relief could expire after fiscal 2019 and that future defense spending remains subject to congressional, political and budgetary uncertainty. The company expects positive operating cash flow and net income in fiscal 2019, but cautioned that higher inventory, labor and production requirements could create a working-capital shortfall.
Subsequent to year-end, the company announced a $0.9 million international DDAN order and a $1.9 million DLA order for laser-protected periscopes. The board also approved fiscal 2018 bonuses of $76 thousand for the CEO and $56 thousand for the CFO, 8% salary increases effective January 1, 2019, and new RSU grants totaling 200,000 shares.
- Customer concentration is material, with 87% of revenue generated by three customers.
- Government contracts are subject to funding changes, termination-for-convenience provisions and fixed-price execution risk. Approximately 76% of contracts contain termination clauses, although no pending terminations were known at filing.
- Approximately 16.2% of material requirements were single-sourced across 10 suppliers, creating potential delivery, qualification and cost risks.
- The company may need additional capital to fund debt service and working capital; financing may not be available on acceptable terms.
- Labor shortages and wage pressure could constrain production and margins as orders increase.
- The company had $4.261 million of warrants and options outstanding at year-end, including 4,260,785 warrants exercisable at $1.50 per share, creating potential dilution and non-cash earnings volatility.
- A $2.9 million deferred tax asset was fully offset by a valuation allowance. Management indicated that improved earnings could support a future partial release, but no release was recorded at year-end.
- The company reported no material pending legal proceedings, no loss-contract accruals, and no material long-lived-asset impairment.
Facts investors should verify
- Whether the $23.4 million backlog converts to revenue on the disclosed schedule and whether fiscal 2019 orders meet or exceed $28.5 million.
- Whether gross-margin improvement and positive operating cash flow are sustainable after product-mix changes and increased labor, inventory and production costs.
- Liquidity under the $2.2 million Avidbank facility, including borrowing-base availability, covenants and the April 2020 maturity.
- Exposure to the three major customers, U.S. defense appropriations and the potential reimposition of sequestration caps.
- Progress in qualifying alternate sources for single-sourced components and the effect of any supplier or labor disruptions.
- The potential dilution and valuation impact of 4,260,785 outstanding warrants, RSUs and future equity compensation.
- Whether improved profitability supports a future release of the $2.9 million deferred-tax valuation allowance.