Optex Systems Holdings Inc. — Form 10-Q Summary
Business context and reporting period
Optex Systems manufactures optical sighting systems, periscopes, rifle and surveillance sights, night-vision assemblies, and thin-film optical components for U.S. and foreign military customers, defense prime contractors, and commercial markets. Operations are conducted through Optex Systems in Richardson, Texas, and Applied Optics Center in Dallas, Texas. The filing covers the unaudited three months ended December 31, 2017, compared with the three months ended January 1, 2017. The company had 94 full-time equivalent employees at December 31, 2017.
Key financial metrics
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Revenue | $4.777 million | $3.512 million |
| Gross profit | $1.116 million | $0.772 million |
| Gross margin | 23.4% | 22.0% |
| General and administrative expense | $0.773 million | $0.844 million |
| Operating income (loss) | $0.343 million | $(0.072) million |
| Net income (loss) applicable to common shareholders | $(0.094) million | $0.354 million |
| Basic and diluted earnings per share | $(0.01) | $0.04 |
| Adjusted EBITDA | $0.475 million | $0.082 million |
| Cash flow from operating activities | $0.125 million | $(0.369) million |
At December 31, 2017, cash and cash equivalents were $1.546 million, accounts receivable were $2.424 million, net inventory was $7.702 million, and working capital was approximately $8.1 million. Total assets were $13.185 million and total liabilities were $7.551 million.
The company had $0.300 million outstanding under its Avidbank credit facility. The facility permits borrowings of up to $2.2 million, subject to borrowing-base availability. The balance sheet also included a $3.951 million warrant liability, measured using Level 3 valuation inputs. Total minimum remaining facility lease and estimated common-area-maintenance payments were $2.487 million.
Material changes versus the prior comparable period
- Revenue increased $1.265 million, or 37.1%, primarily from higher Richardson revenue of approximately $0.63 million and higher Applied Optics Center revenue of approximately $0.64 million.
- Gross profit increased $0.344 million, and gross margin improved 1.4 percentage points to 23.4%. Applied Optics Center margin improved to 21.1% from 13.4%, while Richardson margin declined to 22.3% from 25.1% because of product mix.
- Operating results improved from a $0.072 million loss to $0.343 million of operating income, helped by higher gross profit and a $0.071 million reduction in general and administrative expense.
- Net income declined to a $0.094 million loss because the company recorded a $0.344 million noncash loss on warrant fair value changes, compared with a $0.430 million gain in the prior-year quarter, and recognized $0.090 million of current income tax expense.
- Operating cash flow improved to $0.125 million from a use of $0.369 million, principally due to $0.701 million of collections of accounts receivable, partly offset by reductions in accounts payable and accrued expenses.
- Backlog decreased to $14.6 million from $15.7 million at October 1, 2017. Richardson backlog increased to $10.5 million, while Applied Optics Center backlog declined to $4.1 million.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected fiscal 2018 revenue to be consistent with or slightly above fiscal 2017 levels, with higher periscope shipments anticipated in the following quarter and increased Applied Optics Center deliveries during the year.
- Management expected gross margins and operating profits to improve during fiscal 2018 through higher revenue, better labor and product yields, productivity initiatives, and a more favorable product mix.
- Management expected fiscal 2018 general and administrative spending to approximate fiscal 2017 levels and expected positive operating cash flow and increased adjusted EBITDA during 2018.
- New orders totaled $3.6 million in the quarter, down from $6.7 million in the prior-year quarter. Management attributed the decline to government contract-award timing and delays in new optical-assembly orders from a major Applied Optics Center customer.
- The company reported $14.6 million of backlog, with expected deliveries of $5.7 million in the remainder of fiscal 2018, $4.8 million in 2019, and $4.1 million thereafter. Backlog is subject to customer delivery schedules, first-article testing, contract timing, and possible program delays.
- Warranty reserves increased to $0.251 million from $0.174 million because of quality issues involving Applied Optics Center optical assemblies. Management stated that production improvements should reduce future returns but will continue monitoring the warranty backlog and reserve.
- The company maintained a full valuation allowance against approximately $2.8 million of deferred tax assets. Management indicated that a future release of the allowance could be approximately $2.0 million if profitability provides sufficient positive evidence, but the timing and amount remain uncertain.
- The $3.951 million warrant liability is remeasured each reporting period and can create significant noncash earnings volatility. The warrants cover 4,125,200 shares, have a $1.50 exercise price, and expire August 26, 2021.
- A $0.02-per-share dividend was paid in January 2018, and a final scheduled quarterly dividend was expected in April 2018. The board stated it did not expect to authorize additional dividends beyond April 2018 for the foreseeable future.
- The Avidbank facility maturity was extended from January 22, 2018 to March 22, 2018; management intended to renew the line for an additional two years. Management cautioned that uneven customer demand, production and inventory requirements, or program delays could create a working-capital shortfall.
- No material litigation was reported, and management stated that there were no material changes to the risk factors disclosed in the prior Form 10-K. Disclosure controls were concluded to be effective.
Important facts for investors to verify
- Whether Applied Optics Center customer orders materialize as expected and whether its backlog recovers from the 32.8% sequential decline.
- Whether the company converts its $14.6 million backlog into revenue while maintaining or improving gross margins.
- The renewal and borrowing-base availability of the Avidbank credit facility after March 22, 2018.
- Warranty claim trends and the adequacy of the $0.251 million warranty reserve.
- The effect of stock-price and volatility changes on the Level 3 warrant liability and reported net income.
- Whether profitability supports a partial release of the deferred-tax valuation allowance.
- The company’s ability to fund dividends, inventory, production costs, leases, bonuses, and other obligations from operating cash flow and available liquidity.