Optex Systems Holdings, Inc. — Fiscal 2016 Form 10-K Summary
Reporting period: Fiscal year ended October 2, 2016, consisting of 53 weeks. The filing is an annual report, not a standalone fiscal fourth-quarter report. The comparable fiscal year ended September 27, 2015 consisted of 52 weeks.
Business context
Optex manufactures optical sighting systems, periscopes, night-vision assemblies, laser-protected optics and related components primarily for U.S. and foreign military applications. The company operates through the Richardson, Texas optical systems segment and the Applied Optics Center in Dallas, acquired from L-3 in November 2014. Commercial optical assemblies, including products supplied to Nightforce Optics, are an expanding business area.
Approximately 64% of fiscal 2016 business supported U.S. military products. The four largest customers represented approximately 84% of gross revenue: U.S. government agencies 45%, General Dynamics 18%, Nightforce Optics 15% and Exelis 6%.
Financial performance and liquidity
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Revenue | $17.279 million | $13.003 million | Up 33.1% |
| Cost of sales | $14.228 million | $11.617 million | Up $2.611 million |
| Gross margin | $3.051 million | $1.386 million | Up $1.665 million |
| Gross margin percentage | 17.7% | 10.7% | Up 7.0 percentage points |
| General and administrative expense | $3.251 million | $2.826 million | Up 17.9% |
| Operating income (loss) | $(0.200) million | $(1.440) million | Improved $1.240 million |
| Income (loss) before taxes | $(0.236) million | $0.491 million | Declined $0.727 million |
| Net income (loss) | $(0.236) million | $0.491 million | Declined $0.727 million |
| Loss applicable to common shareholders | $(0.997) million | $(5.950) million | Improved $4.953 million |
| Basic and diluted loss per share | $(0.64) | $(19.06) | Improved |
The company reported no current or deferred income tax expense because its deferred tax assets were fully offset by a valuation allowance. The $0.997 million loss attributable to common shareholders included a $0.761 million preferred-stock beneficial-conversion dividend.
Revenue growth was led by periscopes, which increased 80.0% to $8.1 million, and Applied Optics Center revenue, which increased 29.2% to $6.2 million. Sighting-system revenue declined 18.2% to $1.8 million, while Howitzer/Aiming Circle revenue fell to zero following the nonrecurring prior-year contract settlement.
Cash and cash equivalents were $2.568 million at year-end versus $0.683 million in the prior year. Working capital increased to $8.6 million from $6.1 million. Operating activities provided $0.171 million of cash, investing activities used $0.030 million, and financing activities provided $1.744 million. Net inventory was $6.214 million and accounts receivable were $2.095 million.
The Avidbank revolving facility had a $2.2 million maximum commitment after an October 2016 amendment, subject to eligible receivables and covenants. The outstanding balance was $0.300 million at fiscal year-end. The facility bears interest at prime plus 2.5%, is secured by company assets and matures January 22, 2018. A $17.8 million Sileas-related note balance was not a direct consolidated liability of Optex; it was associated with the company’s majority shareholder.
Material changes versus the prior comparable period
- Revenue increased $4.3 million, supported by higher defense orders, foreign military sales and commercial optical assemblies.
- Gross margin improved substantially because of higher production volumes, product mix and manufacturing efficiencies. The prior year also included approximately $0.3 million of Applied Optics Center intangible amortization.
- Operating loss narrowed from $1.4 million to $0.2 million, although G&A increased by $0.5 million due partly to suspended capital-raise costs, investor-relations expense and higher director fees.
- The prior year included a $2.1 million bargain-purchase gain from the Applied Optics Center acquisition and a $0.9 million government settlement related to a completed Howitzer Aiming Circle contract. These unusual items did not recur in fiscal 2016.
- Loss attributable to common shareholders improved primarily because fiscal 2015 included approximately $6.4 million of preferred-stock beneficial-conversion charges; fiscal 2016 included $0.761 million.
- New orders increased 26.6% to $17.6 million from $13.9 million. Backlog increased 2.6% to $12.0 million from $11.7 million.
- The company completed an August 2016 public offering with gross proceeds of approximately $4.75 million and net proceeds of approximately $4.25 million. Proceeds funded preferred-stock redemptions, offering costs and working capital.
- The company effected a 1-for-1,000 reverse stock split on October 7, 2015, followed by substantial preferred-stock conversions and new equity issuance.
Guidance, outlook, risks and unusual items
Management expected fiscal 2017 orders to meet or exceed fiscal 2016 orders and expected approximately 45% to 50% of fiscal 2017 orders to be deliverable during fiscal 2017. Management also expected losses to continue through the first half of fiscal 2017 but anticipated fiscal 2017 profitability based on projected revenue growth. These are forward-looking statements and are not guarantees.
Subsequent to year-end, the company reported $6.2 million of additional orders through December 14, 2016, including $3.5 million of periscopes, $0.5 million of other Optex products and $2.2 million of Applied Optics Center products. It also reported a $1.5 million December purchase order for laser-protected periscopes and an October 2016 $1.3 million commercial optical-assembly award.
- Revenue remains concentrated among a small number of defense and commercial customers, with approximately 84% from four customers.
- U.S. defense budgets, government procurement timing, contract funding and foreign military sales materially affect results.
- Most government contracts are fixed-price, exposing the company to material, labor, delivery and production-cost overruns.
- Approximately 85% of contracts contain termination-for-convenience clauses. Management reported no known pending terminations and no accrued loss provisions at October 2, 2016.
- Approximately 17% of material requirements were single-sourced across 10 suppliers. Certain specialized components could require four to six months or more to qualify from alternate suppliers.
- The company expects to require sufficient cash flow and financing to support working capital and debt obligations; uneven deliveries or inspection delays could create a working-capital shortfall.
- Applied Optics Center has a relatively fixed, specialized cost base and is sensitive to workforce retention, production volume and energy costs.
- At year-end, 360 Series C preferred shares remained outstanding, convertible into approximately 1.425 million common shares. In addition, 4.125 million warrants and vested options were outstanding, creating potential dilution.
- The company had a $4.7 million deferred tax asset fully offset by a valuation allowance and a $6.6 million net operating loss carryforward.
- The filing reported no material pending legal proceedings, no pending defective-pricing claims and no material internal-control weaknesses.
Most important facts for an investor to verify
- Whether the anticipated fiscal 2017 profitability and order growth materialized.
- Conversion of the $12.0 million backlog into revenue, including timing of delayed sighting-system deliveries.
- Cash generation, inventory levels and borrowing-base availability under the Avidbank facility.
- Customer concentration and renewal, funding and termination status of major government and General Dynamics contracts.
- Actual margins and cash contribution from the Applied Optics Center’s commercial optical-assembly business.
- Potential dilution from Series C preferred shares, 4.125 million warrants, options and restricted stock units.
- The economic substance and repayment or conversion status of the $15.1 million post-year-end Sileas-related note balance.
- Whether single-source suppliers, fixed-price contracts or government procurement delays create material cost or delivery exposure.