Optex Systems Holdings, Inc. — Form 10-Q Summary
Reporting period: Fiscal quarter and nine months ended July 3, 2011, compared primarily with the three and nine months ended June 27, 2010. Financial statements are unaudited and presented in thousands unless otherwise noted.
Business Context
Optex manufactures optical sighting systems, periscopes, rifle and surveillance sights, and night-vision optical assemblies, primarily for U.S. Department of Defense applications and defense prime contractors. Operations are based in Richardson, Texas, with 79 full-time equivalent employees and a 49,100-square-foot leased facility. The company had 139,444,940 common shares outstanding as of August 15, 2011.
Financial Performance and Position
| Metric | Three months ended July 3, 2011 | Three months ended June 27, 2010 | Nine months ended July 3, 2011 | Nine months ended June 27, 2010 |
|---|---|---|---|---|
| Revenue | $3.231 million | $5.905 million | $11.971 million | $18.139 million |
| Gross profit | $0.550 million | $0.407 million | $1.805 million | $1.894 million |
| Gross margin | 17.0% | 6.9% | 15.1% | 10.4% |
| Operating income (loss) | $(0.042) million | $(0.352) million | $0.064 million | $(0.297) million |
| Net income (loss) after taxes | $(0.035) million | $(0.210) million | $(0.002) million | $(0.120) million |
| Net loss applicable to common shareholders | $(0.139) million | $(0.308) million | $(0.309) million | $(0.410) million |
Reported basic and diluted loss per share was approximately $0.00 for all presented periods because of the company’s large share count. Management reported non-GAAP EBITDA of approximately $0.11 million for the nine months ended July 3, 2011, versus $0.50 million for the comparable prior-year period.
- Cash flow: Operating activities provided $0.384 million during the nine months, compared with $1.087 million used in the prior-year period. Investing activities used $0.025 million, primarily for property and equipment. Financing activities used $0.707 million, reflecting repayment of the revolving credit facility.
- Cash and liquidity: Cash declined to $0.682 million at July 3, 2011 from $1.030 million at October 3, 2010. Management stated that working capital was sufficient to fund current operations for at least the next 12 months, but acknowledged that future growth could require additional capital.
- Working capital: Current assets were $8.762 million, including $6.143 million of net inventory and $1.887 million of accounts receivable. Current liabilities were $2.574 million.
- Debt: The Peninsula Bank revolving credit facility had a $0.400 million balance at July 3, 2011, with a $175,000 borrowing base and maturity extended to March 15, 2012. The company stated it was in compliance with loan covenants. The balance was reported as zero on August 15, 2011, and management intended to maintain a zero balance for 30 consecutive days to satisfy a facility requirement.
- Equity and preferred obligations: Stockholders’ equity was $7.095 million. The company recorded $0.307 million of preferred dividends during the nine months, with $0.884 million in dividends in arrears at July 3, 2011. Preferred shareholders agreed to waive accrued and future dividends subject to effectiveness of the Form S-1 registration statement.
Material Changes Versus the Prior Comparable Period
- Revenue declined 45.3% in the quarter and 34.0% for the nine months, primarily because of lower Howitzer, periscope, sighting-system and other product deliveries.
- Despite lower revenue, gross margin improved to approximately 17.0% in the quarter and 15.1% year to date, versus approximately 6.9% and 10.4%, respectively, in the prior-year periods. Improvements reflected cost reductions, product mix and the absence of intangible-asset amortization following the 2010 impairment.
- General and administrative expense decreased 25.0% in the quarter and 22.8% year to date, aided by lower spending and the elimination of intangible amortization.
- The company moved from a nine-month operating loss of $0.297 million to operating income of $0.064 million, while the net loss applicable to common shareholders narrowed by $0.101 million.
- Backlog declined to $13.5 million at July 3, 2011 from $18.1 million at June 27, 2010. Nine-month new orders totaled $6.4 million, including $5.1 million of foreign and domestic periscope orders.
- The company completed one major Howitzer program in March 2011 and reduced its workforce by eight employees in connection with that wind-down. Total workforce reductions over the prior 21 months represented approximately 26.2% of the workforce.
Guidance, Outlook, Risks and Unusual Items
- Management cited reduced federal funding, anticipated defense-spending pressure and slower ordering for Abrams, Bradley and Stryker-related programs as continuing risks. The company does not expect a material rebound in these programs based on information available at the filing date.
- Management expected periscope deliveries to increase 12% to 15% in the remaining fiscal 2011 quarters compared with the corresponding prior-year quarters, although the filing also stated that year-to-date periscope revenue and expected remaining-period deliveries were under pressure.
- A July 2011 contract modification shifted approximately $2.2 million of Howitzer deliveries from fiscal 2011 into the first three fiscal quarters of fiscal 2012, representing an approximately 35% shift of Howitzer revenue between fiscal years.
- The company had $2.9 million of remaining Howitzer backlog subject to contract losses and a $0.7 million accrued contract-loss reserve. It was negotiating an equitable adjustment related to design and technical-data issues, but stated that recovery was not assured.
- One Howitzer line was paused because of delayed specialty glass supplied by the customer; production was expected to resume by September 2011. Two remaining loss-making Howitzer contracts were expected to be completed by April 2012.
- Progress billing was temporarily suspended pending a Defense Contract Audit Agency review. The progress billing audit was completed in July 2011, and a $1.3 million payment was received on August 3, 2011. The company anticipated seeking an additional approximately $0.3 million payment after completion of the accounting-systems review.
- Approximately 95% of contracts contain government termination-for-convenience clauses. The company was not aware of pending terminations, litigation or threatened litigation at the filing date.
- The company filed a Form S-1 covering a proposed sale of up to 25 million common shares, anticipated at $0.01 per share. Effectiveness could trigger adjustments to the preferred-stock conversion price and certain warrant exercise prices, creating potential dilution.
- Outstanding potential dilution included 2.538 million stock options and 9.949 million warrants, all excluded from diluted earnings per share as anti-dilutive.
Investor Verification Items
- Verify the subsequent effectiveness and terms of the Form S-1, including the proposed equity issuance, preferred-stock dividend waiver, conversion-price ratchet and warrant repricing.
- Confirm collection of the $1.3 million progress payment and the status of the anticipated additional approximately $0.3 million payment.
- Monitor the Peninsula Bank facility balance, the required 30-day zero-balance condition, borrowing-base availability and covenant compliance through the March 15, 2012 maturity.
- Assess whether the $13.5 million backlog converts into revenue on schedule, particularly the $2.9 million of Howitzer backlog and the delayed deliveries shifted into fiscal 2012.
- Track the outcome of the requested Howitzer equitable adjustment and whether the $0.7 million loss reserve remains adequate.
- Evaluate the company’s ability to replace reduced U.S. defense demand with foreign, commercial or new product-line orders while maintaining positive operating cash flow.
- Reconcile the filing’s reported cash-flow net loss and other historical comparative references against the accompanying financial statements before relying on period-to-period calculations.