Optex Systems Holdings Inc quarterly report, Q3 FY2020

Optex Systems Holdings, Inc. 10-Q Summary

Business Context and Reporting Period

Optex Systems Holdings manufactures optical sighting systems, periscopes, rifle and surveillance sights, night-vision assemblies, and related optical components for the U.S. Department of Defense, defense contractors, foreign military customers, and commercial markets. Operations are conducted through the Optex Systems Richardson and Applied Optics Center Dallas segments.

This unaudited Form 10-Q covers the three and nine months ended June 28, 2020, compared with the periods ended June 30, 2019. The filing was signed August 11, 2020. The company had 109 full-time equivalent employees and 8,761,626 common shares outstanding as of August 11, 2020.

Financial Highlights

Metric	Three Months Ended June 28, 2020	Three Months Ended June 30, 2019	Nine Months Ended June 28, 2020	Nine Months Ended June 30, 2019
Revenue	$5.849 million	$5.347 million	$18.682 million	$18.325 million
Gross margin	$1.481 million; 25.3%	$1.073 million; 20.1%	$4.568 million; 24.5%	$4.496 million; 24.5%
Operating income	$626 thousand	$265 thousand	$2.126 million	$2.146 million
Income before taxes	$36 thousand	$341 thousand	$1.605 million	$1.664 million
Net income applicable to common shareholders	$(95) thousand	$252 thousand	$798 thousand	$957 thousand
Basic earnings per share	$(0.01)	$0.03	$0.09	$0.11
Adjusted EBITDA	$750 thousand	$385 thousand	$2.431 million	$2.508 million

Quarterly revenue increased 9.4%, while nine-month revenue increased 1.9%. Quarterly operating income rose substantially because of higher revenue and gross margin. The quarterly net loss resulted primarily from a $585 thousand noncash loss on the fair value of warrants and $131 thousand of income tax expense.

Cash Flow, Liquidity, Debt and Balance Sheet

Cash and cash equivalents were $2.788 million at June 28, 2020, compared with $1.068 million at September 29, 2019.
Operating activities generated $1.861 million of cash during the nine months, compared with cash used of $15 thousand in the prior-year period.
Investing activities used $150 thousand, primarily for property and equipment purchases.
Financing activities provided $9 thousand, including $127 thousand of net credit-facility borrowings, offset by $64 thousand of stock repurchases and $54 thousand of tax withholding on share settlements.
Working capital was approximately $13.5 million at June 28, 2020, compared with $11.7 million at September 29, 2019.
The company replaced its Avidbank facility with a BBVA USA revolving credit facility on April 16, 2020. The facility has a $2.25 million principal limit, matures April 15, 2022, and had $377 thousand outstanding at quarter-end. The company was in compliance with its covenants.
Total liabilities were $6.744 million and stockholders’ equity was $13.380 million at June 28, 2020.
Adoption of ASC 842 resulted in recognition of a $1.517 million right-of-use asset and $1.568 million of operating lease liabilities at quarter-end.

Material Changes Versus the Prior Comparable Period

Applied Optics Center revenue increased 12.5% for the quarter and 7.8% for the nine-month period. Richardson revenue increased 7.8% for the quarter but declined 1.1% for the nine months.
Quarterly gross margin increased $408 thousand, supported by gold reclamation credits, higher production volume, and favorable manufacturing overhead adjustments at the Applied Optics Center.
Nine-month gross margin increased only $72 thousand, and the gross margin percentage remained 24.5% because of higher labor and manufacturing costs, particularly at Richardson.
General and administrative expense increased 5.8% for the quarter and 3.9% for the nine months, primarily due to board changes, increased board compensation, proxy costs, and the February 2020 shareholders meeting.
Backlog declined to $20.0 million from $24.6 million at September 29, 2019, a decrease of $4.6 million or 18.7%. New orders during the nine months were $14.0 million, compared with $21.4 million in the prior-year period.
The company authorized a $1.0 million stock repurchase program on June 8, 2020 and repurchased 34,243 shares for $64 thousand through quarter-end.
The company issued 300,000 restricted shares to three independent directors and granted 50,000 restricted stock units during the nine months. Stock compensation expense increased to $120 thousand from $84 thousand.
The warrant liability increased to $2.540 million from $2.036 million at fiscal year-end, producing a $504 thousand noncash loss during the nine months.

Outlook, Commentary, Risks and Unusual Items

Management stated that the company remained operational as an essential defense contractor during the COVID-19 pandemic and had experienced minimal disruption through the filing date.
Management identified potential risks from future illness, supply-chain interruptions, travel restrictions, customer delivery changes, slower government contracting activity, and possible reductions in future defense spending.
Management expected higher Richardson revenue in the fourth quarter from ICWS periscopes, CWSS units, and other deliveries, but expected lower Applied Optics Center revenue because some customer awards and deliveries were delayed into fiscal 2021.
A supplier quality issue and late delivery of a critical component delayed approximately $742 thousand of periscope deliveries into the fourth quarter. The supplier implemented corrective action and the component was subsequently delivered.
Management expected production-efficiency initiatives, lower scrap and rework, and higher yields to offset increased labor and manufacturing costs over the next twelve months.
The company reported several IDIQ and other contract awards, including potential awards with aggregate maximum values materially exceeding current backlog. IDIQ awards are included in backlog only when task orders are released, so maximum contract values should not be treated as committed revenue.
The company expected positive net income, adjusted EBITDA, and operating cash flow throughout 2020, but acknowledged that uneven customer demand, production delays, rising inventory and labor costs, or pandemic-related disruptions could create a working-capital shortfall.
No material litigation was reported, no material changes to previously disclosed risk factors were identified, and no subsequent events were reported.

Important Facts for Investors to Verify

Whether the $20.0 million backlog converts into revenue on the disclosed delivery schedule, particularly the $7.1 million expected in the fourth quarter of fiscal 2020.
Whether delayed ICWS periscope deliveries and expected fourth-quarter Richardson shipments occur as planned.
The timing and probability of pending proposals, DCAA audits, IDIQ task-order releases, and other awards that are not yet included in backlog.
The effect of COVID-19 on defense budgets, customer awards, supply chains, labor availability, and delivery schedules.
Compliance with the BBVA facility’s 1.25:1 fixed-charge coverage covenant and availability under the $2.25 million borrowing limit.
The valuation sensitivity of the $2.540 million Level 3 warrant liability and its potential effect on reported earnings.
Whether higher labor, overhead, warranty, and lease costs pressure margins or working capital.
The company’s use of cash for the authorized $1.0 million stock repurchase program while maintaining liquidity for growth and production requirements.