Optex Systems Holdings, Inc. — FY2019 Form 10-K Summary
Reporting period: Fiscal year ended September 29, 2019, comprising 52 weeks. The filing is an annual Form 10-K, not a standalone fourth-quarter filing. Comparative period was the 52 weeks ended September 30, 2018.
Business context
Optex manufactures optical sighting systems, periscopes, surveillance and night-vision assemblies, optical filters, windows and related products, primarily for U.S. Department of Defense applications. Products support Abrams, Bradley, Stryker and other military vehicles and are sold directly to government agencies, defense prime contractors, foreign military customers and selected commercial customers. Operations comprise the Richardson, Texas facility and the Applied Optics Center in Dallas.
Approximately 87% of fiscal 2019 business supported U.S. military products. Revenue concentration remained high: U.S. government agencies represented 60% of revenue, one major defense contractor 22%, and one commercial customer 7%. Approximately 95% of revenue was domestic and 5% was from Canada.
Financial performance and liquidity
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Revenue | $24.530 million | $20.853 million | +17.6% |
| Gross margin | $6.253 million | $4.515 million | +38.5% |
| Gross margin percentage | 25.5% | 21.7% | +3.8 points |
| Operating income | $3.197 million | $1.486 million | +115.1% |
| Operating margin | 13.0% | 7.1% | +5.9 points |
| Income before taxes | $4.518 million | $1.561 million | +189.4% |
| Net income | $5.668 million | $1.394 million | +306.5% |
| Net income applicable to common shareholders | $3.800 million | $0.930 million | +308.6% |
| Basic and diluted EPS | $0.45 | $0.11 | + $0.34 |
| Adjusted EBITDA | $3.680 million | $1.996 million | +84.4% |
| Net cash from operating activities | $0.160 million | $1.039 million | Down $0.879 million |
Revenue growth was led by Richardson, which increased external revenue 27.3% to $16.219 million. Applied Optics Center external revenue increased 2.4% to $8.311 million. Periscope revenue rose 32.0% to $9.9 million and other products rose 212.5% to $5.0 million, while sighting-system revenue declined 63.9% to $1.3 million following completion of the DDAN program in the first quarter of fiscal 2019.
Net income benefited from a $1.344 million non-cash gain from the change in fair value of warrant liabilities, compared with a $95 thousand gain in fiscal 2018, and a $1.414 million release of deferred-tax valuation allowance. Adjusted EBITDA excludes the warrant gain and other non-operating or non-cash items.
At September 29, 2019, cash was $1.068 million, working capital was $11.7 million, accounts receivable was $3.066 million and inventory was $10.535 million. Inventory increased $2.896 million to support expected fiscal 2020 deliveries. The company generated only $160 thousand of operating cash flow despite $5.668 million of net income, primarily because of inventory, receivables and deferred-tax movements.
The Avidbank revolving credit facility permits borrowings of up to $2.2 million against eligible receivables. The outstanding balance was $250 thousand, down from $300 thousand, and the facility matures April 21, 2020. Interest is payable at prime plus 2.5%, subject to a minimum interest payment. The company also has approximately $1.328 million of remaining minimum lease and estimated common-area-maintenance payments under its facility leases.
Backlog and material changes
- Backlog increased 5.1% to $24.6 million from $23.4 million at the prior year-end. Approximately $20.0 million was scheduled for delivery during fiscal 2020 and $4.6 million thereafter.
- Fiscal 2019 new orders declined 9.6% to $25.8 million from $28.5 million, primarily because of lower MRS collimator assembly orders. Approximately $22.1 million of fiscal 2019 orders remained for delivery in fiscal 2020 and later.
- Periscope backlog increased 24.1% to $10.3 million; sighting-system backlog increased 46.4% to $4.1 million; other-product backlog declined 30.4% to $3.9 million; and Applied Optics Center backlog declined 6.0% to $6.3 million.
- Gross-margin improvement reflected higher volume, product mix and cost-efficiency improvements at the Applied Optics Center. General and administrative expense was essentially stable at $3.056 million versus $3.029 million.
- Warrant liabilities declined to $2.036 million from $3.500 million, reflecting exercises, a repurchase and a lower estimated fair value. There were 4.125 million warrants outstanding at year-end, exercisable at $1.50 per share through August 2021.
- The company repurchased and cancelled 88,081 warrants for approximately $75 thousand. No common-stock repurchases or dividends occurred in fiscal 2019.
- Effective fiscal 2019, the company adopted ASC 606; management reported no material effect on the financial statements.
Guidance, outlook, risks and unusual items
Management expected positive operating cash flow and net income during the next twelve months, supported by higher projected revenue, increased backlog, improved gross margins and productivity initiatives. Management also viewed higher U.S. defense procurement spending, the lifting of sequestration limits and continued foreign military sales as favorable demand factors. No formal revenue or earnings guidance was provided.
Management cautioned that increased orders could strain working capital through higher inventory, labor and production requirements. Uneven delivery schedules, first-article inspection requirements, program delays or insufficient credit availability could create a working-capital shortfall. The company stated that it may need additional capital in the future to service debt and fund working capital.
- Customer concentration is significant, with approximately 89% of revenue from three customers and approximately 85% of accounts receivable from four customers.
- Most government contracts are fixed-price and approximately 85% contain termination-for-convenience clauses. The company was not aware of pending terminations and had no accrued loss provisions for loss contracts or cost overruns.
- Approximately 5% of material requirements were single-sourced across seven suppliers. Certain specialized components could require four to six months or longer to qualify alternative sources.
- Defense spending, government procurement timing, budget changes, foreign military sales, competitive pricing, technology shifts and labor availability could materially affect results.
- The company had 4.125 million warrants outstanding, 25,000 vested options and 216,500 unvested restricted stock units, creating potential dilution.
- Adoption of ASC 842 leases beginning September 30, 2019 was expected to add approximately $1.7 million of right-of-use assets and lease liabilities, with no material expected effect on expenses or cash flows.
- The company reported no material pending legal proceedings, no pending defective-pricing claims, and compliance with applicable government-contract regulations.
Subsequent to year-end, the company reconstituted its board with three new independent directors. The board also approved December 2019 bonuses of $75 thousand for the CEO and $54 thousand for the CFO. A later announced shared IDIQ award for Improved Commander Weapon System periscopes had a maximum value of $35 million, but Optex’s share depends on pricing and performance and is not a firm order value.
Important facts for investors to verify
- Whether the $24.6 million backlog converts to revenue on the stated fiscal 2020 delivery schedule and whether new orders recover from the fiscal 2019 decline.
- Whether operating cash flow improves as the company converts its $10.535 million inventory and collects $3.066 million of receivables.
- The availability, covenant compliance and renewal terms of the $2.2 million Avidbank facility before its April 2020 maturity.
- The sustainability of the 25.5% gross margin after product mix changes and completion of the DDAN program.
- The extent to which reported net income depends on the non-cash warrant fair-value gain and the $1.414 million deferred-tax benefit.
- Customer concentration, fixed-price contract exposure, termination provisions and dependence on U.S. defense budgets.
- Potential dilution from warrants, options and restricted stock units, including 4.125 million warrants exercisable at $1.50 per share.
- The effect of ASC 842 lease recognition and whether additional capital will be required to support backlog growth.