Optex Systems Holdings Inc annual report, FY2012

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

Reporting period: Fiscal year ended September 30, 2012, comprising 52 weeks; comparable fiscal year ended October 2, 2011. The filing was signed December 19, 2012. Optex manufactures optical sighting systems, periscopes, night-vision assemblies and related products for U.S. and foreign military vehicles and defense contractors.

Business Context

Products are sold primarily to General Dynamics Land Systems, U.S. government agencies and other defense contractors.
Approximately 97% of fiscal 2012 gross revenue came from three customers: General Dynamics Land Systems divisions, 83%; U.S. Government, primarily DLA, 10%; and BAE Systems, 4%.
The company operated a leased approximately 49,000-square-foot Richardson, Texas facility with 72 full-time equivalent employees at September 30, 2012.
Backlog increased to approximately $19.0 million at September 30, 2012 from $11.5 million at October 2, 2011, an increase of 65.2%.

Financial Performance and Position

Metric	FY 2012	FY 2011	Change
Revenue	$14.254 million	$16.227 million	Down 11.7%
Cost of sales	$11.849 million	$13.741 million	Down 13.9%
Gross margin	$2.405 million	$2.486 million	Down $0.081 million
Gross margin percentage	16.8%	15.4%	Up 1.4 percentage points
General and administrative expense	$2.706 million	$2.408 million	Up 12.5%
Operating income (loss)	$(0.301) million	$0.078 million	Declined $0.379 million
Net income (loss)	$(0.368) million	$0.591 million	Declined $0.959 million
Net income (loss) attributable to common shareholders	$(0.262) million	$0.178 million	Declined $0.440 million
Net cash provided by operating activities	$0.848 million	$1.114 million	Down $0.266 million

Revenue declines reflected reduced U.S. military and prime-contractor spending, delayed program funding and uncertainty regarding sequestration.
Howitzer revenue fell 59.5% to $1.7 million following completion of major programs. Periscope revenue was essentially flat at $10.8 million. Sighting-system revenue increased to $1.0 million from $0.2 million, primarily from M36 Digital Day and Night development revenue.
Cash and cash equivalents were $1.653 million at September 30, 2012, compared with $1.514 million at the prior year-end.
Net inventory increased to $7.094 million from $4.088 million, principally to support backlog and future deliveries.
Total assets were $12.198 million and total liabilities were $4.608 million at September 30, 2012. Stockholders’ equity was $7.590 million.
The Avidbank revolving facility provided up to $1.0 million against eligible receivables and was extended through July 2014. The balance was zero at year-end, compared with $0.507 million at the prior year-end.
Operating cash flow was supported by approximately $2.7 million of customer milestone deposits and collections, but was reduced by approximately $3.3 million of inventory investment.

Material Changes Versus the Prior Period

Revenue decreased $1.973 million, while gross margin percentage improved because of product mix, completion of loss-making Howitzer programs, operating efficiencies and cost reductions.
General and administrative expenses increased $0.298 million, including higher business-development, advertising, public-relations, legal, travel and exposition costs.
The company moved from operating income of $0.078 million to an operating loss of $0.301 million.
Net income changed to a loss primarily because of lower operating performance and a $0.635 million unfavorable change in deferred tax expense or benefit, partly offset by lower interest expense and a $0.519 million favorable change in preferred-stock dividend accounting.
Fiscal 2012 orders totaled approximately $21.8 million, including an $8.0 million five-year M36 contract with General Dynamics Land Systems–Canada, a $1.2 million DLA award and $12.6 million of additional orders, primarily for periscopes.
Common shares outstanding increased to 152.3 million from 139.4 million through equity issuance, warrant exercises and preferred-stock conversion. The company also had 48.5 million outstanding stock options at year-end.

Guidance, Outlook and Unusual Items

Management expected fiscal 2013 revenue to decline slightly or approximate fiscal 2012 levels based on existing backlog.
Management expected general and administrative spending to remain approximately $2.7 million in fiscal 2013.
Full production under the M36 Digital Day and Night program was expected to generate approximately $1.6 million of fiscal 2013 revenue and approximately $1.5 million annually thereafter through 2017.
The company expected approximately $1.2 million of additional fiscal 2013 revenue from the DLA Gunner’s Head Assembly award, with deliveries moved to May and June 2013 because of longer material lead times.
Approximately $2.7 million of customer advance deposits were recorded at September 30, 2012, including $0.8 million classified as short term and $1.9 million as long term. These amounts relate principally to the M36 contract and require future procurement and delivery obligations.
The company appealed the rejection of an equitable-adjustment claim related to a completed Howitzer program to the Armed Services Board of Contract Appeals. The filing states that the outcome cannot be predicted and that no future margin impact was expected because the losses had already been recognized.
Approximately 95% of contracts contain termination-for-convenience provisions. Management reported no known pending contract terminations, no current loss contracts requiring a provision and no pending defective-pricing claims.
Approximately 34% of material requirements were single-sourced across six suppliers. Several specialized components could require more than six months to qualify from alternate suppliers.

Principal Risks and Contingencies

High customer concentration and dependence on U.S. defense spending expose results to budget reductions, delayed orders, sequestration, contract cancellations and procurement delays.
Most contracts are fixed-price, creating exposure to material-cost increases, manufacturing inefficiencies, labor overruns and supply-chain disruptions.
The company stated that it may need additional capital in the future, although management believed current working capital was sufficient for at least the next 12 months.
Series A preferred stock was convertible into approximately 702.1 million common shares as of the filing date, creating substantial potential dilution and superior liquidation and voting rights.
Sileas Corporation’s approximately 85% ownership interest was pledged as collateral for a secured note with principal of approximately $13.8 million due February 20, 2014. The filing stated that a default could result in a change of control.
The company’s common stock traded on the OTCQB with limited liquidity and substantial volatility; no dividends were expected.
Approximately 83% of current contract deliveries were subject to warranties of up to 15 months. The warranty reserve was $25 thousand at year-end.
The company had no patents at filing, relied substantially on trade secrets and had pending patent applications for DDAN technology.
The independent auditor issued an unqualified opinion on the financial statements but did not audit or express an opinion on internal control over financial reporting, as permitted for the company’s smaller-reporting-company status.

Investor Verification Items

Reconcile the $19.0 million backlog to expected fiscal 2013 deliveries, customer purchase orders and remaining contract values.
Assess whether customer concentration, defense-budget reductions and sequestration could materially reduce future orders.
Review the quality and recoverability of the $7.1 million inventory balance and the company’s ability to convert customer advances into profitable deliveries.
Confirm terms, availability and collateral requirements of the Avidbank facility and evaluate future working-capital requirements.
Evaluate dilution from 702.1 million potentially issuable common shares under Series A preferred conversion, 48.5 million options and 4.5 million warrants.
Monitor the ASBCA equitable-adjustment appeal and the potential change-of-control consequences of the Sileas–Longview secured note.
Verify the assumptions supporting the $1.157 million net deferred tax asset and the absence of additional fixed-price contract losses.