Optex Systems Holdings, Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended June 30, 2019, compared with July 1, 2018; balance sheet compared with September 30, 2018. Financial statements are unaudited. The company manufactures optical sighting systems, periscopes, rifle and surveillance sights, and night-vision optical assemblies for U.S. government, defense contractor, foreign military, and commercial customers.
Financial Results and Position
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Revenue | $5.347 million | $6.124 million | $18.325 million | $15.451 million |
| Gross margin | $1.073 million; 20.1% | $1.496 million; 24.4% | $4.496 million; 24.5% | $3.605 million; 23.3% |
| Operating income | $0.265 million | $0.723 million | $2.146 million | $1.273 million |
| Net income | $0.376 million | $0.586 million | $1.428 million | $3.123 million |
| Net income applicable to common shareholders | $0.252 million | $0.389 million | $0.957 million | $2.066 million |
| Basic EPS | $0.03 | $0.05 | $0.11 | $0.24 |
| Adjusted EBITDA | $0.385 million | $0.847 million | $2.508 million | $1.653 million |
Liquidity and leverage: Cash was $0.896 million at June 30, 2019, versus $1.133 million at September 30, 2018. Working capital was $10.6 million, compared with $8.5 million at fiscal year-end. The Avidbank credit facility had $0.250 million outstanding against a borrowing capacity of up to approximately $2.2 million, subject to borrowing-base availability. Total liabilities were $6.212 million, including a $3.845 million warrant liability.
Cash flow: Nine-month operating cash flow was negative $15 thousand, compared with positive $1.006 million in the prior-year period. Inventory increased by $1.793 million and was the principal working-capital use. Investing cash flow was negative $132 thousand, primarily for equipment purchases. Financing cash flow was negative $90 thousand, including $50 thousand of credit-facility repayments, $75 thousand for warrant repurchases, and $72 thousand of warrant-exercise proceeds.
Material Changes Versus Prior Comparable Period
- Third-quarter revenue declined 12.7%, primarily because prior DDAN sighting-system spare contracts were substantially completed and commercial optical-assembly demand weakened.
- Third-quarter gross margin fell to 20.1% from 24.4%, driven by lower volume, product mix, and higher periscope rework and labor costs associated with supplier-quality issues, employee turnover, and temporary labor reliance.
- Nine-month revenue increased 18.6%, led by a 38.2% increase in periscope revenue and a $2.5 million increase in other Richardson products. Sighting-system revenue declined 61.0%.
- Nine-month gross margin improved to 24.5% from 23.3%, reflecting higher volume, improved product mix, and manufacturing-yield improvements at Applied Optics Center.
- Nine-month operating income increased by $0.9 million, but net income declined by $1.7 million because the prior year included a $2.010 million warrant fair-value gain, while 2019 included a $0.465 million warrant fair-value loss.
- Backlog increased 13.3% to $26.4 million from $23.3 million at September 30, 2018. Approximately $6.7 million was expected for delivery in fiscal 2019 fourth quarter and $19.7 million thereafter.
Outlook, Risks, and Unusual Items
- Management expected a strong fiscal 2019 fourth quarter, with revenue and gross margin exceeding the prior-year fourth quarter. Expectations included higher Richardson “other” product shipments, periscope revenue approximately 10%–12% above the 2018 fourth-quarter level, and increased Applied Optics Center revenue.
- Management projected greater periscope growth in the first half of fiscal 2020 as supplier diversification, reduced rework, and productivity initiatives mature.
- The company identified working-capital risk from higher inventory and production requirements, uneven customer delivery schedules, first-article inspections, and program delays.
- Customer concentration is significant: approximately 60% of revenue came from the U.S. government, 24% from one major U.S. defense contractor, and 8% from one commercial customer. Approximately 94% of revenue was domestic.
- The company had $9.578 million of net inventory at June 30, 2019, up from $7.639 million at September 30, 2018. Inventory reserves were $1.527 million.
- Warrant liabilities are Level 3 fair-value measurements and are sensitive to stock price, volatility, interest rates, and remaining term. There were 4.125 million warrants outstanding with a $3.845 million fair value at June 30, 2019.
- The company expects adoption of ASC 842 lease accounting on September 30, 2019 to add approximately $1.7 million of right-of-use assets and lease liabilities, with no expected material effect on expenses or cash flows.
- Remaining non-cancellable lease and estimated common-area-maintenance payments totaled approximately $1.453 million as of June 30, 2019.
- No material litigation was reported, and management stated that there were no material changes to previously disclosed risk factors.
Investor Verification Checklist
- Verify conversion of the $26.4 million backlog into revenue, particularly the timing of periscope and Applied Optics Center deliveries.
- Assess whether supplier-quality, rework, labor, and productivity issues improve sufficiently to restore third-quarter margin levels.
- Monitor inventory growth, operating cash conversion, and availability under the Avidbank borrowing base.
- Separate recurring operating performance from non-cash Level 3 warrant fair-value gains and losses.
- Evaluate customer and government-contract concentration, including potential delivery delays, contract modifications, or termination provisions.
- Confirm the impact of ASC 842 adoption and the expected approximately $1.7 million lease liability.
- Review dilution from 4.125 million outstanding warrants and 216,500 unvested restricted stock units.