Optex Systems Holdings, Inc. — Q2 FY2016 Form 10-Q Summary
Business context and reporting period
The unaudited Form 10-Q covers the three and six months ended March 27, 2016, compared with the periods ended March 29, 2015. Optex manufactures optical sighting systems, periscopes, rifle and surveillance sights, night-vision assemblies, and thin-film-coated optical components for U.S. and foreign military customers, defense primes, and selected commercial customers. Operations are conducted through the Richardson, Texas, Optex Systems segment and the Dallas, Texas, Applied Optics Center segment. The company had 95 full-time equivalent employees at quarter-end.
Financial performance and condition
| Metric | Three months ended Mar. 27, 2016 | Three months ended Mar. 29, 2015 | Six months ended Mar. 27, 2016 | Six months ended Mar. 29, 2015 |
|---|---|---|---|---|
| Revenue | $3.216 million | $3.403 million | $6.429 million | $5.501 million |
| Gross margin | $515 thousand; 16.0% | $(27) thousand; approximately (0.8%) | $981 thousand; 15.3% | $352 thousand; 6.4% |
| Operating loss | $(313) thousand | $(837) thousand | $(541) thousand | $(1.144) million |
| Net income (loss) | $(310) thousand | $3.642 million | $(556) thousand | $813 thousand |
| Net loss applicable to common shareholders | $(310) thousand | $(2.799) million | $(556) thousand | $(5.628) million |
| Basic and diluted loss per share | $(0.90) | $(9.00) | $(1.66) | $(18.10) |
Six-month revenue increased 16.9%, led by periscopes, which rose 46.3%, and Applied Optics Center revenue, which rose 25.8%. Sighting systems revenue declined 32.7% because of software and video-controller delivery delays. Second-quarter revenue declined 5.5%, primarily because Applied Optics Center revenue fell 15.7% after completion of prior-year military contracts.
Gross margin improved materially because of better labor efficiency, updated pricing, increased plant utilization, and lower Applied Optics Center intangible amortization. General and administrative expense was $828 thousand in the quarter and $1.522 million for the six months, broadly unchanged from the prior comparable periods.
Six-month operating cash flow was $(63) thousand, compared with $(527) thousand in the prior year. Inventory increased $1.484 million to $7.197 million to support anticipated second-half shipments, while accounts receivable declined $1.209 million to $1.658 million. Investing cash flow was $(4) thousand, versus $(2.079) million in the prior year, and financing cash flow was $(20) thousand, versus $2.036 million provided in the prior year.
Cash and cash equivalents were $596 thousand at March 27, 2016, compared with $683 thousand at September 27, 2015. Working capital was approximately $5.7 million, compared with $6.1 million at fiscal year-end. The Avidbank credit facility had $784 thousand outstanding at quarter-end and was secured by substantially all company assets. On April 20, 2016, the facility was increased from $1 million to $2 million and extended to January 22, 2018. The company stated that it was in compliance with debt covenants.
Material changes versus the prior comparable period
- Six-month revenue increased $927 thousand, while the second-quarter revenue decline was $187 thousand.
- Six-month gross margin percentage improved to 15.3% from 6.4%; second-quarter gross margin improved to 16.0% from a small gross loss.
- Six-month operating loss narrowed by $603 thousand to $541 thousand.
- Reported earnings comparisons were affected by prior-year nonrecurring items, including a $2.110 million bargain-purchase gain, a $6.441 million preferred-stock dividend or premium, and derivative-related valuation activity.
- Backlog increased to $15.2 million from $11.0 million, an increase of 38.2%. Richardson backlog increased 44.0% to $10.8 million, and Applied Optics Center backlog increased 25.7% to $4.4 million.
- On March 27, 2016, Sileas converted $3.125 million of Series A preferred stock into 1.25 million common shares. Common shares outstanding increased to 1,581,145 at quarter-end; 1,621,145 shares were outstanding as of May 10, 2016.
- The company completed a 1-for-1,000 reverse stock split on October 7, 2015. All share and per-share information was adjusted retroactively.
Guidance, outlook, risks and unusual items
Management expected revenue and profitability to improve in the second half of fiscal 2016, supported by backlog and planned shipments of periscopes, ACOG laser filter units, and other products. Management also expected sighting-system shipments to resume at a higher pace as software and video-controller issues were resolved. The filing does not provide formal numeric earnings or revenue guidance.
During the six months, the company received $9.9 million of new orders. Periscope backlog was $5.3 million, up 165.0% from the prior year, and the company reported an additional $1.7 million of periscope orders booked after the quarter began. The ACOG contract had a base value of approximately $1.3 million and an option for total potential value of approximately $2.6 million. The Nightforce supply agreement included minimum annual order values of $3.0 million for calendar 2015 and $3.9 million for calendar 2016.
Key risks include dependence on U.S. government and foreign military spending, defense-budget reductions, customer delivery timing, first-article inspections, contract and program delays, inventory requirements, and the need to achieve sufficient revenue to support the cost structure. Management warned that uneven delivery patterns could create a working-capital shortfall and that certain assets might not be recoverable if the business plan is not successfully implemented.
Government contracts generally contain termination-for-convenience and termination-for-default provisions. The company reported no known pending contract terminations, no outstanding requests for equitable adjustments, no material litigation, and no material changes to previously disclosed risk factors. The filing also disclosed approximately $1.914 million of remaining minimum lease and estimated common-area-maintenance payments under non-cancellable facility leases. An investor-relations agreement executed after quarter-end requires $7,500 monthly payments and 40,000 restricted common shares, which were issued on April 29, 2016.
Most important facts to verify
- Whether second-half shipments and the $15.2 million backlog convert into revenue and positive operating cash flow as projected.
- Whether gross-margin improvements from labor efficiency, pricing, and utilization are sustainable.
- The timing and financial impact of resolving sighting-system software and video-controller delays.
- Applied Optics Center performance, including ACOG deliveries, Nightforce orders, and renewal of its Dallas facility lease and sublease.
- Liquidity after the quarter-end credit-facility increase, including borrowing-base availability, covenant compliance, and cash needs to fund the $7.197 million inventory balance.
- The potential dilution and voting impact of outstanding Series A and Series B preferred stock, options, and future conversions.
- Execution of the company’s plan to reach profitability, given the continuing losses, limited cash balance, defense-spending exposure, and customer concentration.