Optex Systems Holdings, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended April 1, 2018, compared with April 2, 2017. The financial statements are unaudited. Optex manufactures optical sighting systems, periscopes, rifle and surveillance sights, night-vision assemblies, and optical filters for U.S. and foreign military, defense-prime, and commercial customers. The company operated two segments: Optex Systems Richardson and Applied Optics Center Dallas.
Key Financial Metrics
Amounts below are in thousands, except per-share data and percentages.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $4,550 | $4,040 | $9,327 | $7,552 |
| Gross margin | $993 | $769 | $2,109 | $1,541 |
| Gross margin percentage | 21.8% | 19.0% | 22.6% | 20.4% |
| Operating income (loss) | $207 | $(71) | $550 | $(143) |
| Gain on warrant remeasurement | $2,350 | $(72) | $2,006 | $358 |
| Net income applicable to common shareholders | $2,631 | $(149) | $2,536 | $205 |
| Basic earnings (loss) per share | $0.31 | $(0.02) | $0.30 | $0.03 |
| Adjusted EBITDA | $331 | $87 | $807 | $169 |
Six-month operating margin was approximately 5.9%, compared with negative 1.9% in the prior-year period. Net income was materially affected by the noncash warrant gain; adjusted EBITDA provides a better view of operating performance.
Liquidity, Cash Flow, Debt, and Balance Sheet
- Cash and cash equivalents were $1.831 million at April 1, 2018, compared with $1.682 million at October 1, 2017.
- Working capital was approximately $8.2 million, compared with $8.0 million at fiscal year-end.
- Operating activities generated $718 thousand of cash during the first six months, versus $796 thousand used in the prior-year period. Cash generation primarily reflected $1.724 million of accounts-receivable collections, partly offset by reductions in accounts payable and accrued expenses.
- Investing cash outflow was $17 thousand. Management expects up to approximately $200 thousand of additional fixed-asset spending in the second half of fiscal 2018.
- Financing cash outflow was $552 thousand, primarily dividends and taxes withheld on restricted stock unit settlements.
- The Avidbank credit facility had $300 thousand outstanding at April 1, 2018. The facility permits borrowing of up to $2.2 million, subject to borrowing-base requirements. On April 5, 2018, the revolving maturity was extended to April 21, 2020, with a 0.5% annual facility fee and additional bank-account reporting requirements.
- Total assets were $12.690 million and total liabilities were $4.680 million. Inventory was $7.937 million, including a $1.617 million reserve.
Material Changes Versus Prior Comparable Period
- Revenue increased 15.0% in the quarter and 22.4% for the six months. Six-month growth was driven by a $1.2 million increase at Applied Optics Center and a $0.5 million increase at Richardson.
- Applied Optics Center revenue increased 37.5% in the quarter and 38.7% for the six months, supported by commercial optical assemblies and military laser filters.
- Six-month sighting-system revenue increased $1.1 million, partly reflecting the resumption of production after prior configuration and export-license delays.
- Other product revenue declined $0.5 million for the six months due primarily to lower component-spare orders. Periscope revenue declined modestly by $0.1 million.
- Gross margin improved by 280 basis points in the quarter and 220 basis points for the six months, reflecting higher volume, pricing, labor and yield efficiencies, and product mix.
- General and administrative expense declined 6.4% in the quarter and 7.4% for the six months, principally due to lower stock compensation, director fees, and investor-relations costs.
- Backlog increased to $18.6 million at April 1, 2018 from $15.7 million at October 1, 2017, an 18.5% increase. Approximately $5.6 million was expected for delivery in the third quarter and $4.3 million in the fourth quarter of fiscal 2018.
- The warrant liability declined from $3.607 million at October 1, 2017 to $1.601 million at April 1, 2018, producing a $2.006 million noncash gain. The company changed from a binomial valuation model to a Black-Scholes-Merton model and used a lower volatility assumption.
Guidance, Outlook, Risks, and Unusual Items
- Management expects strong third-quarter and second-half fiscal 2018 revenue, particularly from Richardson periscopes and sighting systems and Applied Optics military filters and commercial assemblies.
- Management expects second-half consolidated gross-margin rates to remain broadly consistent with first-half performance, with shifts by segment and product mix.
- Management expects lower fiscal 2018 general and administrative spending, continued positive operating cash flow, and higher adjusted EBITDA, but these expectations depend on adequate revenue and successful production execution.
- The company cited favorable defense-spending legislation and the lifting of sequestration limits as potential demand drivers. It also reported new multi-year IDIQ awards and a $1.62 million commercial strategic-supplier purchase order.
- Customer concentration is significant: approximately 34% of revenue came from the U.S. government, 24% from one major U.S. defense contractor, and 29% from one commercial customer. Approximately 87% of revenue was domestic and 13% was from Canada.
- Management warned that uneven customer delivery requirements, first-article inspections, program delays, higher inventory and production costs, or insufficient revenue could create a working-capital shortfall. Profitability depends on maintaining revenue sufficient to support the cost structure.
- Warranty expense was $134 thousand in the quarter and $211 thousand for the six months for Applied Optics optical assemblies, compared with no warranty expense in the prior-year periods. Management believes production improvements should reduce future returns but will continue monitoring the warranty backlog and reserve.
- The company has 4,125,200 outstanding warrants exercisable at $1.50 per share through August 26, 2021. The Level 3 fair-value liability is sensitive to stock price, volatility, interest rates, and valuation assumptions, and may cause substantial earnings volatility.
- The company paid the final scheduled $0.02-per-share dividend in April 2018 and does not anticipate additional fiscal 2018 dividends. No material litigation was reported, and management stated that there were no material changes to previously disclosed risk factors.
Important Facts for Investors to Verify
- Whether the $18.6 million backlog converts into revenue on the projected delivery schedule and whether the reported IDIQ awards produce expected orders.
- The sustainability of Applied Optics Center margin improvements and the expected recovery in Richardson periscope and sighting-system production.
- The impact of customer concentration, defense-budget changes, export licenses, first-article testing, and procurement timing on revenue and cash flow.
- Future changes in the Level 3 warrant liability and the resulting noncash gains or losses under the revised valuation model.
- Inventory reserve adequacy, warranty claims, and the potential working-capital impact of supporting the higher backlog.
- Availability and terms of the Avidbank facility, including borrowing-base capacity and compliance with the amended covenants.
- The company’s ability to sustain positive operating cash flow after dividends, planned capital expenditures, and other working-capital requirements.