Optex Systems Holdings Inc quarterly report, Q1 FY2016

Optex Systems Holdings, Inc. — Form 10-Q Summary

Business Context and Reporting Period

Unaudited quarterly report for the three months ended December 27, 2015, compared with the three months ended December 28, 2014. Optex manufactures optical sighting systems, periscopes, surveillance and night-vision assemblies, and thin-film optical components primarily for U.S. and foreign military customers and defense contractors. The company operates through the Richardson, Texas, Optex Systems segment and the Dallas, Texas, Applied Optics Center segment, acquired from L-3 in November 2014.

Financial Highlights

Metric	Q1 FY2016	Q1 FY2015	Change
Revenue	$3.213 million	$2.098 million	+53.1%
Gross profit	$467 thousand	$379 thousand	+23.2%
Gross margin	15.6%	19.1%	Down 3.5 percentage points
Operating loss	$(227) thousand	$(308) thousand	Improved $81 thousand
Net loss	$(245) thousand	$(2.830) million	Improved $2.585 million
Basic and diluted loss per share	$(0.75)	$(9.10)	Improved
Cash flow from operations	$1.215 million	$269 thousand	+ $946 thousand

Revenue growth was led by periscopes, which increased 102.4% to $1.595 million, and Applied Optics Center revenue, which increased 205.8% to $1.046 million. Sighting systems revenue declined 60.9% to $276 thousand because of software and video-controller delivery delays affecting M36 DDAN units.

General and administrative expense was approximately $694 thousand, essentially unchanged from the prior-year quarter. The prior-year results included a $2.110 million bargain-purchase gain and substantial convertible-note-related interest and derivative valuation items. Those nonrecurring items did not recur in the current quarter.

Cash, Liquidity, Debt and Balance Sheet

Cash and cash equivalents increased to $1.405 million from $683 thousand at September 27, 2015.
Working capital was approximately $5.9 million at December 27, 2015, compared with $6.1 million at fiscal year-end.
Accounts receivable declined to $1.230 million from $2.866 million, while net inventory increased to $5.863 million from $5.713 million to support higher revenue.
Total assets were $10.783 million and total liabilities were $2.846 million at quarter-end.
The Avidbank revolving credit facility had $310 thousand outstanding, down from $817 thousand at September 27, 2015. The facility provides up to $1 million against eligible receivables, matures May 21, 2016, and carries interest at the greater of 7.0% or prime plus 2.5%. The company reported compliance with its debt covenants.
Operating cash flow of $1.215 million primarily reflected $1.636 million of collections of accounts receivable, partly offset by the operating loss and increased inventory.
Investing activities provided $7 thousand; financing activities used $500 thousand, primarily for repayment of the credit facility.

Material Changes Versus the Prior Comparable Period

Revenue increased $1.115 million, or 53.1%, primarily from higher periscope shipments and growth at Applied Optics Center.
Gross margin declined because of product mix, despite higher gross profit.
Operating loss narrowed modestly, while net loss improved substantially because the prior-year quarter included a $2.110 million acquisition gain, $5.479 million of interest expense, and an $847 thousand derivative valuation gain.
Backlog increased to $12.4 million from $11.2 million, an 11% increase. Periscope backlog rose 127% to $3.4 million, while sighting-system backlog fell 25% to $4.4 million. Applied Optics Center backlog increased 29% to $4.4 million.
The company completed a 1-for-1,000 reverse stock split on October 7, 2015. Common shares outstanding increased from 314,867 at September 27, 2015 to 331,145 at December 27, 2015, primarily from Series B preferred-stock conversions and rounding adjustments.
The $1.560 million convertible notes issued in November 2014 had been converted into 1,000 shares of Series B preferred stock by March 2015; no convertible-note balance or related derivative liability remained at quarter-end.

Guidance, Outlook, Risks and Unusual Items

Management expected net losses to continue into the first half of fiscal 2016, but stated that existing backlog supports higher revenue in the second through fourth quarters. During the quarter, the company received $3.9 million of new orders; it reported an additional $2.7 million of orders during the first six weeks of the following quarter.

Demand was increasing for laser-protected periscopes supporting U.S. combat-vehicle maintenance and foreign military programs, including Saudi Arabia, Morocco and Brazil.
Sighting-system shipments were expected to resume at a higher pace in the second fiscal quarter as software and video-controller issues were resolved.
The Applied Optics Center had a Nightforce supply agreement with stated minimum order values of $3.0 million for calendar 2015 and $3.9 million for calendar 2016, subject to agreed production and delivery schedules.
A June 2015 U.S. military base contract for 11,200 ACOG laser-filter units was valued at $1.3 million, with an option for an additional 11,200 units and potential total value of $2.6 million.
Liquidity remains dependent on continued collections, revenue growth and successful execution of the backlog. Management warned that uneven customer delivery demands, first-article inspection requirements or program delays could create a working-capital shortfall.
Defense spending reductions and sequestration remain industry risks. Government contracts may be terminated for convenience or default; the company reported no known pending terminations and no outstanding equitable-adjustment requests.
The Form S-1 primary offering was withdrawn after market conditions prevented completion of an underwritten offering.
The company had approximately $2.135 million of remaining minimum lease and estimated common-area-maintenance payments under its non-cancellable facility leases, net of the disclosed Applied Optics Center sublease.
Subsequent to quarter-end, management approved a 10% base-salary increase for the CEO and CFO, a $7.5 thousand bonus for the CFO, and a $10 thousand monthly director fee for the chairman effective in 2016.

Most Important Facts for Investors to Verify

Whether the $12.4 million backlog converts to revenue and cash as scheduled, particularly the $5.2 million expected in the second fiscal quarter.
Whether periscope growth and Applied Optics Center orders offset the decline and delivery delays in sighting systems.
Whether gross margins recover from 15.6% as product mix changes.
Whether operating cash flow remains positive and provides sufficient liquidity when the Avidbank facility matures in May 2016.
The terms, renewal status and collateral requirements of the Avidbank credit facility.
The potential dilution from 1,001 Series A preferred shares, 969 Series B preferred shares, 62,847 stock options and 1,000 warrants outstanding at quarter-end.
The company’s ability to achieve profitability after management’s expectation of continued losses into the first half of fiscal 2016.
Exposure to U.S. defense-budget reductions, government contract termination rights, customer concentration and program delays.