Business Context and Reporting Period
Optex Systems Holdings, Inc. manufactures optical sighting systems, periscopes, rifle and surveillance sights, night-vision assemblies, and laser-coated filters for U.S. and foreign military, defense-prime, and commercial customers. The company operates through Optex Systems–Richardson and Applied Optics Center–Dallas, with 88 full-time-equivalent employees as of July 1, 2018.
This unaudited Form 10-Q covers the three and nine months ended July 1, 2018, compared with the periods ended July 2, 2017. The filing was signed August 13, 2018.
- Revenue concentration: U.S. government 39%, one major U.S. defense contractor 27%, one commercial customer 22%, and all other customers 12%.
- Geographic mix: approximately 83% domestic and 17% Canadian revenue.
- Backlog was $19.5 million at July 1, 2018, up from $15.7 million at October 1, 2017.
Financial Metrics
| Metric | Three Months Ended July 1, 2018 | Three Months Ended July 2, 2017 | Nine Months Ended July 1, 2018 | Nine Months Ended July 2, 2017 |
|---|---|---|---|---|
| Revenue | $6.124 million | $4.386 million | $15.451 million | $11.938 million |
| Gross margin | $1.496 million; 24.4% | $0.886 million; 20.2% | $3.605 million; 23.3% | $2.427 million; 20.3% |
| Operating income (loss) | $0.723 million | $0.065 million | $1.273 million | $(0.078) million |
| Net income (loss) applicable to common shareholders | $0.586 million | $(0.963) million | $3.123 million | $(0.758) million |
| Basic earnings (loss) per share | $0.07 | $(0.12) | $0.37 | $(0.09) |
| Adjusted EBITDA | $0.847 million | $0.202 million | $1.653 million | $0.368 million |
Cash and cash equivalents were $1.639 million at July 1, 2018, compared with $1.682 million at October 1, 2017. Working capital was approximately $9.0 million, compared with $8.0 million at fiscal year-end. Accounts receivable were $2.554 million and net inventory was $7.477 million.
- Operating cash flow for the nine-month period was $1.006 million, compared with $(0.335) million in the prior-year period.
- Investing cash flow was $(0.035) million, primarily for property and equipment purchases.
- Financing cash flow was $(1.014) million, including $0.784 million of dividends and $0.200 million of share repurchases.
- The Avidbank credit facility had $0.300 million outstanding at July 1, 2018, with borrowing capacity of up to $2.2 million subject to borrowing-base requirements. The facility maturity was extended to April 21, 2020.
- Total liabilities were $4.699 million and stockholders’ equity was $8.433 million at July 1, 2018.
Material Changes Versus the Prior Comparable Period
- Three-month revenue increased 41.9%, driven by higher Optex Richardson deliveries and Applied Optics Center sales. Nine-month revenue increased 30.3%.
- Three-month gross margin expanded to 24.4% from 20.2%; nine-month gross margin increased to 23.3% from 20.3%. Management attributed the improvement to increased volume, pricing, product mix, production efficiencies, and labor and yield improvements.
- General and administrative expense declined 5.8% for the quarter and 6.9% for the nine-month period.
- Operating income improved to $0.723 million for the quarter and $1.273 million for the nine-month period, versus $0.065 million and a $0.078 million operating loss, respectively, in the prior-year periods.
- Results benefited materially from non-cash warrant revaluation. The company recorded a $2.010 million gain for the nine months, versus a $0.666 million loss in the prior-year period. The warrant liability declined to $1.597 million from $3.607 million at October 1, 2017.
- The company changed its warrant valuation method from a binomial model to a Black-Scholes-Merton model and revised volatility assumptions. Management classified the measurement as Level 3, making reported income sensitive to stock price, volatility, interest rates, and other valuation inputs.
- Warranty expense was $0.273 million for the nine months, related to quality issues involving Applied Optics Center optical assemblies. The company stated that production improvements were implemented and that the warranty reserve was $0.163 million at July 1, 2018.
- During the nine months, 120 Series C preferred shares converted into 500,000 common shares, and the company repurchased 200,000 common shares for $0.200 million.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expected continued revenue growth, positive operating cash flow, increased adjusted EBITDA, and lower fiscal 2018 general and administrative spending. It expected fourth-quarter gross margins to remain near the nine-month rate and above fiscal 2017 levels.
- Management expected fourth-quarter revenue to approximate the prior year for periscopes and sighting systems, while Applied Optics Center and certain “other” product revenues could be lower because of delivery schedules and product mix.
- Backlog increased 24.2% to $19.5 million, including $5.3 million expected for fourth-quarter 2018 delivery and $14.2 million for 2019 and later. New orders during the nine months totaled $19.2 million.
- Management cited increased defense authorization and the lifting of sequestration spending limits as potentially favorable for U.S. military product demand. The filing does not provide formal quantitative revenue or earnings guidance.
- Management warned that uneven customer delivery requirements, first-article inspections, program delays, rising inventory and production costs, and insufficient revenue could create a working-capital shortfall.
- Customer concentration, dependence on defense spending and government procurement, international sales, contract timing, product quality and warranty claims, and reliance on a limited number of customers are significant operating risks.
- Remaining minimum facility lease and estimated common-area-maintenance payments totaled approximately $2.147 million as of July 1, 2018.
- The company reported no material pending or threatened litigation and no material changes to the risk factors disclosed in its Form 10-K.
- The board stated that no additional fiscal 2018 dividends were anticipated after the April 2018 payment. The filing contains an inconsistency: the balance sheet shows no dividends payable, while MD&A refers to approximately $0.262 million recorded for the April dividend; investors should verify the correct amount.
- Subsequent events included conversion of 48 additional Series C preferred shares into 200,000 common shares and a July 2018 repurchase of 500,000 common shares for $0.500 million. The filing reports 8,246,003 common shares outstanding as of August 13, 2018.
Important Facts for Investors to Verify
- Whether operating improvements and higher gross margins are sustainable after the reported delivery timing and product-mix benefits.
- The portion of the $19.5 million backlog that is funded, firm, and expected to convert to revenue during fiscal 2018 and 2019.
- The impact of customer concentration and defense procurement timing on future revenue and cash flow.
- The sensitivity of earnings and the $1.597 million warrant liability to changes in the company’s stock price and Level 3 valuation assumptions.
- The status of Applied Optics Center warranty claims, backlog, reserves, and quality remediation.
- Available borrowing capacity and compliance with the Avidbank facility’s borrowing-base and bank-account requirements.
- The final share count and cash impact of the July 2018 preferred conversions and common-stock repurchase.
- The discrepancy between the balance sheet and MD&A regarding dividends payable.