Optex Systems Holdings, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Optex Systems manufactures optical sighting systems, periscopes, surveillance and night-vision assemblies, and thin-film optical components for U.S. and foreign military, defense-prime, and commercial customers. Operations comprise the Richardson, Texas, Optex Systems segment and the Dallas, Texas, Applied Optics Center segment. The unaudited quarter ended January 1, 2017 is compared with the three months ended December 27, 2015. The company had 90 full-time equivalent employees and 8,190,101 common shares outstanding as of February 20, 2017.
Financial Results and Position
| Metric | Quarter Ended January 1, 2017 | Comparable Period |
|---|---|---|
| Revenue | $3.512 million | $3.213 million |
| Gross profit | $0.772 million | $0.467 million |
| Gross margin | 22.0% | 14.5% |
| Operating loss | $(0.072) million | $(0.227) million |
| Net income applicable to common shareholders | $0.354 million | $(0.245) million |
| Basic earnings per share | $0.04 | $(0.75) |
| Cash flow from operations | $(0.369) million | $1.222 million provided |
Revenue increased 9.4%, primarily from a $0.5 million increase at Applied Optics Center, partially offset by lower Richardson revenue. Cost of sales remained approximately $2.7 million. Management attributed the margin improvement to higher volume, product mix, manufacturing efficiencies, improved labor and product yields, and lower overhead rates.
The $0.430 million gain from the change in fair value of warrant liabilities was the principal reason the company reported net income despite an operating loss. The gain was noncash and resulted from remeasurement of 4,125,200 warrants classified as Level 3 liabilities.
At January 1, 2017, cash and cash equivalents were $2.069 million, compared with $2.568 million at October 2, 2016. Working capital was approximately $8.4 million versus $8.6 million at fiscal year-end. Accounts receivable were $1.858 million and net inventory was $6.585 million, including a $0.371 million quarterly inventory increase to support expected deliveries.
Total liabilities were $4.888 million, including a $0.300 million balance on the Avidbank credit facility and a $2.688 million warrant liability. The Avidbank revolving facility was amended to $2.2 million, bears interest at prime plus 2.5%, and matures January 22, 2018. Separately, the related-party Sileas secured note balance was $15.1 million as of January 1, 2017.
Investing cash outflow was $0.130 million for equipment purchases, primarily a spectrophotometer. There was no financing cash flow during the quarter. Cash decreased by $0.499 million.
Material Changes Versus the Comparable Period
- Revenue increased $0.299 million, or 9.4%, to $3.512 million.
- Applied Optics Center revenue increased 50.0% to approximately $1.5 million, driven primarily by commercial Nightforce optical assembly deliveries.
- Richardson revenue declined 9.1% to approximately $2.0 million; sighting-system revenue fell 66.7% because DDAN deliveries were rescheduled.
- Gross profit increased $0.305 million, and consolidated gross margin improved 7.5 percentage points to 22.0%.
- General and administrative expense increased approximately $0.150 million to $0.844 million, reflecting executive bonuses, investor relations costs, board fees, and stock compensation.
- The operating loss narrowed by approximately $0.155 million, but the company remained operationally unprofitable.
- Backlog increased 26.7% to $15.2 million from $12.0 million at October 2, 2016. New orders totaled $6.7 million, versus $3.9 million in the comparable prior-year quarter.
- The company issued 75,000 common shares upon conversion of Series C preferred stock and cancelled 197,299 treasury shares returned by Sileas.
Guidance, Outlook, Risks, and Unusual Items
Management expects periscope revenue to increase in the following quarter as recently booked orders begin delivery. It expects optical assembly revenue to rise through fiscal 2017 and other product revenue to increase after first-article testing and production begin. Management also expects both segments’ gross margins and operating profits to improve during fiscal 2017, while anticipating continued net losses into the next quarter and net income in the second half of fiscal 2017.
Backlog includes $11.1 million for Richardson and $4.1 million for Applied Optics Center. Recent awards included a $0.8 million L-3 order, a $1.3 million commercial supplier agreement, a $1.5 million DLA order under a five-year $5.99 million IDIQ contract, and a $1.5 million defense-company purchase order.
Key risks include uneven customer delivery schedules, first-article inspections, qualification testing, export licensing, long-lead materials, dependence on defense and prime-contractor demand, and the possibility of a working-capital shortfall. The company stated that successful profitability depends on generating sufficient revenue to support its cost structure. It also disclosed that government contracts may contain termination-for-convenience and termination-for-default provisions.
The company filed an amended 2016 Form 10-K to correct the accounting for 4,125,200 warrants issued in the August 2016 public offering. Management expanded procedures for reviewing complex financial instruments. Disclosure controls were deemed effective, and no material litigation or material changes to previously reported risk factors were disclosed.
Subsequent to quarter-end, 45,799 common shares were issued in January 2017 related to vesting of restricted stock units, net of shares withheld for employee taxes.
Facts Investors Should Verify
- Whether the expected fiscal 2017 delivery schedule converts the $15.2 million backlog into revenue and operating cash flow as projected.
- Whether the company can achieve positive operating profitability without relying on noncash warrant-liability gains.
- The liquidity impact of negative operating cash flow, rising inventory, lease obligations, and the $15.1 million related-party note.
- The status of DDAN qualification testing, export licensing, long-lead materials, and delayed sighting-system deliveries.
- The valuation sensitivity of the $2.688 million Level 3 warrant liability and potential dilution from 4,125,200 warrants, Series C preferred stock, restricted stock units, and options.
- Whether commercial customer concentration at Applied Optics Center, including Nightforce, creates material customer or demand risk.