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Part
1. Financial Information
Item
1. Unaudited Condensed Consolidated Financial Statements
OPTEX
SYSTEMS HOLDINGS, INC.
UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS
OF JANUARY 1, 2023
Optex
Systems Holdings, Inc.
Condensed
Consolidated Balance Sheets
The
accompanying notes are an integral part of these condensed consolidated financial statements
Optex
Systems Holdings, Inc.
Condensed
Consolidated Statements of Operations
(Unaudited)
The
accompanying notes are an integral part of these condensed consolidated financial statements
Optex
Systems Holdings, Inc.
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
The
accompanying notes are an integral part of these condensed consolidated financial statements
Optex
Systems Holdings, Inc.
Condensed
Consolidated Statement of Stockholders’ Equity
(Unaudited)
(Thousands,
except share data)
| |
Three
months ended January 2, 2022 | |
| |
Common | | |
| | |
| | |
| | |
Additional | | |
| | |
Total | |
| |
Shares | | |
Treasury | | |
Common | | |
Treasury | | |
Paid
in | | |
Retained | | |
Stockholders | |
| |
Issued | | |
Shares | | |
Stock | | |
Stock | | |
Capital | | |
Earnings | | |
Equity | |
Balance
at October 3, 2021 | |
| 8,523,704 | | |
| 35,555 | | |
$ | 9 | | |
$ | (69 | ) | |
$ | 25,752 | | |
$ | (9,978 | ) | |
$ | 15,714 | |
Stock
Compensation Expense | |
| - | | |
| - | | |
| - | | |
| - | | |
| 57 | | |
| - | | |
| 57 | |
Common
Stock Repurchase(1) | |
| - | | |
| 37,238 | | |
| - | | |
| (74 | ) | |
| - | | |
| - | | |
| (74 | ) |
Vested
Restricted Stock Units, net of withheld taxes | |
| 23,216 | | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | |
Net
income | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| 29 | | |
| 29 | |
Net
income (loss) | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| 29 | | |
| 29 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Balance
at January 2, 2022 | |
| 8,546,920 | | |
| 72,793 | | |
$ | 9 | | |
$ | (143 | ) | |
$ | 25,809 | | |
$ | (9,949 | ) | |
$ | 15,726 | |
Ending balance | |
| 8,546,920 | | |
| 72,793 | | |
$ | 9 | | |
$ | (143 | ) | |
$ | 25,809 | | |
$ | (9,949 | ) | |
$ | 15,726 | |
|
(1) |
Common
shares repurchased in the open market during the three months ended January 2, 2022. The shares were held as treasury stock using
the cost method and subsequently cancelled as of October 2, 2022. |
The
accompanying notes are an integral part of these condensed consolidated financial statements
Note
1 - Organization and Operations
Optex
Systems Holdings, Inc. (the “Company”) manufactures optical sighting systems and assemblies for the U.S. Department of Defense,
foreign military applications and commercial markets. Its products are installed on a variety of U.S. military land vehicles, such as
the Abrams and Bradley fighting vehicles, light armored and advanced security vehicles, and have been selected for installation on the
Stryker family of vehicles. The Company also manufactures and delivers numerous periscope configurations, rifle and surveillance sights
and night vision optical assemblies. Optex Systems Holdings’ products consist primarily of build to customer print products that
are delivered both directly to the military and to other defense prime contractors or commercial customers. The Company’s consolidated
revenues for the three months ended January 1, 2023 were derived from the U.S. government (22%), one major U.S. defense contractor (14%),
one major commercial customer (37%), and all other customers (27%). Approximately 95% of the total company revenue is generated from
domestic customers and 5% is derived from foreign customers, primarily in Canada. Optex Systems Holdings’ operations are based
in Dallas and Richardson, Texas in leased facilities comprising 93,967 square feet. As of January 1, 2023, Optex Systems Holdings operated
with 92 full-time equivalent employees.
Note
2 - Accounting Policies
Basis
of Presentation
Principles
of Consolidation: The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary,
Optex Systems, Inc. All significant inter-company balances and transactions have been eliminated in consolidation.
The
condensed consolidated financial statements of Optex Systems Holdings included herein have been prepared by Optex Systems Holdings, without
audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote
disclosures normally included in financial statements prepared in conjunction with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make
the information presented not misleading.
These
condensed consolidated financial statements should be read in conjunction with the annual audited consolidated financial statements and
the notes thereto included in the Optex Systems Holdings’ Form 10-K for the year ended October 2, 2022 and other reports filed
with the SEC.
The
accompanying unaudited interim condensed consolidated financial statements reflect all adjustments of a normal and recurring nature which
are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows of Optex
Systems Holdings for the interim periods presented. The results of operations for these periods are not necessarily comparable to, or
indicative of, results of any other interim period or for the fiscal year taken as a whole. Certain information that is not required
for interim financial reporting purposes has been omitted.
Inventory:
As of January 1, 2023, and October 2, 2022, inventory included:
Schedule of Inventory
| |
January
1, 2023 | | |
October
2, 2022 | |
| |
(Thousands) | |
| |
January
1, 2023 | | |
October
2, 2022 | |
Raw
Materials | |
$ | 6,240 | | |
$ | 6,953 | |
Work
in Process | |
| 4,822 | | |
| 2,722 | |
Finished
Goods | |
| 547 | | |
| 348 | |
Gross
Inventory | |
$ | 11,609 | | |
$ | 10,023 | |
Less:
Inventory Reserves | |
| (811 | ) | |
| (811 | ) |
Net
Inventory | |
$ | 10,798 | | |
$ | 9,212 | |
Concentration
of Credit Risk: Optex Systems Holdings’ accounts receivables as of January 1, 2023 consist of U.S. government agencies
(30%), three major U.S. defense contractors (12%, 12% and 7%, respectively), one major commercial customer (32%) and all other customers
(7%). The Company does not believe that this concentration results in undue credit risk because of the financial strength of the customers
and the Company’s long history with these customers.
Accrued
Warranties: Optex Systems Holdings accrues product warranty liabilities based on the historical return rate against period shipments
as they occur and reviews and adjusts these accruals quarterly for any significant changes in estimated costs or return rates. The accrued
warranty liability includes estimated costs to repair or replace returned warranty backlog units currently in-house plus estimated costs
for future warranty returns that may be incurred against warranty covered products previously shipped as of the period end date. As of
January 1, 2023, and October 2, 2022, the Company had warranty reserve balances of $229 thousand and $169 thousand, respectively.
Schedule of Warranty Reserves
| |
Three
months ended | |
| |
January
1, 2023 | | |
January
2, 2022 | |
Beginning
balance | |
$ | 169 | | |
$ | 78 | |
| |
| | | |
| | |
Incurred
costs for warranties satisfied during the period | |
| - | | |
| (2 | ) |
| |
| | | |
| | |
Warranty
expenses for new product shipped during the period(1) | |
| 60 | | |
| 46 | |
| |
| | | |
| | |
Ending
balance | |
$ | 229 | | |
$ | 122 | |
(1) |
Warranty
expenses accrued to cost of sales (based on current period shipments and historical warranty return rate). |
Use
of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial statement and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from the estimates.
Fair
Value of Financial Instruments: Fair value estimates discussed herein are based upon certain market assumptions and pertinent
information available to management as of the financial statement presentation date.
The
carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, are carried at, or approximate,
fair value as of the reporting date because of their short-term nature. The credit facility is reported at fair value as it bears market
rates of interest.
The
fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value and requires that assets and liabilities
carried at fair value be classified and disclosed in one of the following three categories:
Level
1: Quoted market prices in active markets for identical assets or liabilities.
Level
2: Observable market-based inputs or unobservable inputs that are corroborated by market data.
Level
3: Unobservable inputs reflecting the reporting entity’s own assumptions.
The
accounting guidance establishes a hierarchy which requires an entity to maximize the use of quoted market prices and minimize the use
of unobservable inputs. An asset or liability’s level is based on the lowest level of input that is significant to the fair value
measurement. Fair value estimates are reviewed at the origination date and again at each applicable measurement date and interim or annual
financial reporting dates, as applicable for the financial instrument, and are based upon certain market assumptions and pertinent information
available to management at those times.
Revenue
Recognition: The majority of the Company’s contracts and customer orders originate with fixed determinable unit prices
for each deliverable quantity of goods defined by the customer order line item (performance obligation) and include the specific due
date for the transfer of control and title of each of those deliverables to the customer at pre-established payment terms, which are
generally within thirty to sixty days from the transfer of title and control. We have elected to account for shipping and handling costs
as fulfillment costs after the customer obtains control of the goods. In addition, the Company has one ongoing service contract which
relates to optimized weapon system support (OWSS) and includes ongoing program maintenance, repairs and spare inventory support for the
customer’s existing fleet units in service during the duration of the contract. Revenue recognition for this program has been recorded
by the Company, and compensated by the customer, at fixed monthly increments over time, consistent with the defined contract maintenance
period. During the three months ended January 1, 2023 and January 2, 2022, there was $112 thousand and $120 thousand in service contract
revenue recognized over time.
During
the three-month periods ended January 1, 2023 and January 2, 2022, there was $29 thousand and zero of revenue recognized, respectively,
from customer deposit liabilities (deferred contract revenue). As of January 1, 2023, there were $326 thousand in customer deposit liabilities.
For
the three months ended January 1, 2023, there were $336 thousand in accrued selling expenses and $336 thousand in contract assets
related to a new $3.4 million contract booked in November 2022. The costs will be amortized against the revenue for the contract deliveries
expected to begin in April 2023 and extend through the following 10-15 months into fiscal year 2024.
Contract
Loss Reserves: The Company records loss provisions in the event that the current estimated total revenue against a
contract and the total estimated cost remaining to fulfill the contract indicate a loss upon completion. When the estimated costs
indicate a loss, we record the entire value of the loss against the contract loss reserve in the period the determination is made.
The Company has several long-term fixed price contracts that are currently indicative of a loss condition due to recent inflationary
pressures on material and labor, combined with increased manufacturing overhead costs. Some of these long-term contracts have option
year ordering periods ending in February 2025 with deliveries that may extend into February 2026. As of the three months ended
January 1, 2023 and October 2, 2022, the accrued contract loss reserves were $282 thousand
and $289 thousand, respectively.
During the three months ended January 1, 2023, the Company recognized additional expenses for contract loss reserves of $51
thousand on new task awards against the long-term fixed contracts and applied $58
thousand of the reserves against revenues booked during the period.
Income
Tax/Deferred Tax: As of January 1, 2023 and October 2, 2022, Optex Systems, Inc. has a deferred tax asset valuation allowance
of ($0.8) million against deferred tax assets of $1.8 million. The valuation allowance has been established due to historical losses
resulting in a Net Operating Loss Carryforward for each of the fiscal years 2011 through 2016 which may not be fully recognized due to
an IRS Section 382 limitation related to a change in control. During the three months ended January 1, 2023, our deferred tax assets
increased by $59 thousand related to temporary tax adjustments.
Earnings
per Share: Basic earnings per share is computed by dividing income available for common shareholders (the numerator) by the weighted
average number of common shares outstanding (the denominator) for the period. Diluted earnings per share reflect the potential dilution
that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
The
Company has potentially dilutive securities outstanding which include unvested restricted stock units and stock options. The Company
uses the Treasury Stock Method to compute the dilutive effect of any dilutive shares. Unvested restricted stock units and stock options
that are anti-dilutive are excluded from the calculation of diluted earnings per common share.
For
the three months ended January 1, 2023, 120,000 unvested shares of restricted stock (which convert to an aggregate of 36,045 incremental
shares) were excluded from the diluted earnings per share calculation as antidilutive due to the net loss for the period. For the three
months ended January 2, 2022, 66,000 unvested restricted stock units and 180,000 shares of unvested restricted stock (which convert to
an aggregate of 52,861 incremental shares) were included in the diluted earnings per share calculation.
Note
3 - Segment Reporting
The
Company’s reportable segments are strategic businesses offering similar products to similar markets and customers; however, the
companies are operated and managed separately due to differences in manufacturing technology, equipment, geographic location, and specific
product mix. Applied Optics Center was acquired as a unit, and the management at the time of the acquisition was retained. Both the Applied
Optics Center and Optex Systems – Richardson operate as reportable segments under the Optex Systems, Inc. corporate umbrella.
The
Applied Optics Center segment also serves as the key supplier of laser coated filters used in the production of periscope assemblies
for the Optex Systems-Richardson (“Optex Systems”) segment. Intersegment sales and transfers are accounted for at annually
agreed to pricing rates based on estimated segment product cost, which includes segment direct manufacturing and general and administrative
costs, but exclude profits that would apply to third party external customers.
Optex
Systems (OPX) – Richardson, Texas
Optex
Systems revenues are primarily in support of prime and subcontracted military customers. Approximately 86%
of the Optex Systems segment revenue is comprised of domestic military customers, 12%
is comprised of foreign military customers and 2%
is comprised of commercial customers. Optex Systems segment revenue is derived from the U.S. government, representing 19%,
and one major U.S. defense contractor representing 14%
of the Company’s consolidated revenue.
Optex
Systems is located in Richardson Texas, with leased premises consisting of approximately 49,100 square feet. As of January 1, 2023, the
Richardson facility operated with 50 full time equivalent employees in a single shift operation. Optex Systems, Richardson serves as
the home office for both the Optex Systems and Applied Optics Center segments.
Applied
Optics Center (AOC) – Dallas, Texas
The
Applied Optics Center serves primarily domestic U.S. customers. Sales to commercial customers represent 65% and military sales to prime
and subcontracted customers represent 35% of the total segment revenue. Approximately 95% of the AOC revenue is derived from external
customers and approximately 5% is related to intersegment sales to Optex Systems in support of military contracts. For the three months
ended January 1, 2023, the AOC segment revenue from one major commercial customer represents approximately 37% of the Company’s
consolidated revenue.
The
Applied Optics Center is located in Dallas, Texas with leased premises consisting of approximately 44,867 square feet of space. As of
January 1, 2023, AOC operated with 42 full time equivalent employees in a single shift operation.
The
financial tables below present information on the reportable segments’ profit or loss for each period, as well as segment assets
as of each period end. The Company does not allocate interest expense, income taxes or unusual items to segments.
Schedule of Segment Reporting Information
| |
Reportable
Segment Financial Information (thousands) | |
| |
As
of and for the three months ended January 1, 2023 | |
| |
Optex
Systems Richardson | | |
Applied
Optics Center Dallas | | |
Other
(non-allocated costs and intersegment eliminations) | | |
Consolidated
Total | |
| |
| | |
| | |
| | |
| |
Revenues
from external customers | |
$ | 1,619 | | |
$ | 2,421 | | |
$ | - | | |
$ | 4,040 | |
Intersegment
revenues | |
| - | | |
| 116 | | |
| (116 | ) | |
| - | |
Total
Revenue | |
$ | 1,619 | | |
$ | 2,537 | | |
$ | (116 | ) | |
$ | 4,040 | |
| |
| | | |
| | | |
| | | |
| | |
Depreciation
and Amortization | |
$ | 11 | | |
$ | 70 | | |
$ | - | | |
$ | 81 | |
| |
| | | |
| | | |
| | | |
| | |
(Loss) income before taxes | |
$ | ) | |
$ | | |
$ | ) | |
$ | ) |
| |
| | | |
| | | |
| | | |
| | |
Other
significant noncash items: | |
| | | |
| | | |
| | | |
| | |
Allocated
home office expense | |
$ | (280 | ) | |
$ | 280 | | |
$ | - | | |
$ | - | |
Stock
compensation expense | |
$ | - | | |
$ | - | | |
$ | 35 | | |
$ | 35 | |
Warranty
expense | |
$ | - | | |
$ | 60 | | |
$ | - | | |
$ | 60 | |
| |
| | | |
| | | |
| | | |
| | |
Segment
Assets | |
$ | 11,745 | | |
$ | 7,628 | | |
$ | - | | |
$ | 19,373 | |
Expenditures
for segment assets | |
$ | 23 | | |
$ | 67 | | |
$ | - | | |
$ | 90 | |
| |
Reportable
Segment Financial Information (thousands) | |
| |
As
of and for the three months ended January 2, 2022 | |
| |
Optex
Systems Richardson | | |
Applied
Optics Center Dallas | | |
Other
(non-allocated costs and intersegment eliminations) | | |
Consolidated
Total | |
| |
| | |
| | |
| | |
| |
Revenues
from external customers | |
$ | 1,857 | | |
$ | 2,483 | | |
$ | - | | |
$ | 4,340 | |
Intersegment
revenues | |
| - | | |
| 180 | | |
| (180 | ) | |
| - | |
Total
Revenue | |
$ | 1,857 | | |
$ | 2,663 | | |
$ | (180 | ) | |
$ | 4,340 | |
| |
| | | |
| | | |
| | | |
| | |
Depreciation
and Amortization | |
$ | 10 | | |
$ | 62 | | |
$ | - | | |
$ | 72 | |
| |
| | | |
| | | |
| | | |
| | |
Income
(loss) before taxes | |
$ | ) | |
$ | | |
$ | ) | |
$ | |
| |
| | | |
| | | |
| | | |
| | |
Other
significant noncash items: | |
| | | |
| | | |
| | | |
| | |
Allocated
home office expense | |
$ | (236 | ) | |
$ | 236 | | |
$ | - | | |
$ | - | |
Stock
compensation expense | |
$ | - | | |
$ | - | | |
$ | 57 | | |
$ | 57 | |
Warranty
expense | |
$ | - | | |
$ | 46 | | |
$ | - | | |
$ | 46 | |
| |
| | | |
| | | |
| | | |
| | |
Segment
Assets | |
$ | 14,267 | | |
$ | 7,088 | | |
$ | - | | |
$ | 21,355 | |
Expenditures
for segment assets | |
$ | 25 | | |
$ | 65 | | |
$ | - | | |
$ | 90 | |
Note
4 - Commitments and Contingencies
Non-cancellable
Operating Leases
Optex
Systems Holdings leases its office and manufacturing facilities for the Optex Systems, Inc. Richardson location and the Applied Optics
Center Dallas location. The Company also leases certain office equipment under non-cancellable operating leases.
The
leased facility under Optex Systems Inc. located at 1420 Presidential Drive, Richardson, Texas consists of 49,100 square feet of space
at the premises. The previous lease term for this location expired March 31, 2021 and the monthly base rent was $24.6 thousand through
March 31, 2021. On January 11, 2021 the Company executed a sixth amendment extending the terms of the lease for eighty-six (86) months,
commencing on April 1, 2021 and ending on May 31, 2028. The initial base rent is set at $25.3 thousand and escalates 3% on April 1 each
year thereafter. The initial term included 2 months of rent abatement for April and May of 2021. The monthly rent includes approximately
$11.9 thousand for additional Common Area Maintenance fees and taxes (“CAM”), to be adjusted annually based on actual expenses
incurred by the landlord.
The
leased facility under the Applied Optics Center located at 9839 and 9827 Chartwell Drive, Dallas, Texas, consists of 44,867 square feet
of space at the premises. The previous lease term for this location expired on October 31, 2021 and the monthly base rent was $21.9 thousand
through the end of the lease. On January 11, 2021 the Company executed a first amendment extending the terms of the lease for eighty-six
(86) months, commencing on November 1, 2021 and ending on December 31, 2028. The initial base rent is set at $23.6 thousand as of January
1, 2022 and escalates 2.75% on January 1 each year thereafter. The initial term included 2 months of rent abatement for November and
December of 2021. The amendment provides for a five-year renewal option at the end of the lease term at the greater of the then “prevailing
rental rate” or the then current base rental rate. Our obligations to make payments under the lease are secured by a $125,000 standby
letter of credit. The monthly rent includes approximately $8.6 thousand for additional CAM, to be adjusted annually based on actual expenses
incurred by the landlord.
The
Company had one non-cancellable office equipment lease with a commencement date of October 1, 2018 and a term of 39 months. The lease
cost for the equipment was $1.5 thousand per month from October 1, 2018 through December 31, 2021. The lease was renewed on November
18, 2021 for an additional 48 months at a cost of $1.2 thousand per month. The start of the lease was delayed until April 2022 due to
temporary equipment shortages. The lease renewal resulted in the recognition of an additional right of use asset and a lease liability
of $51 thousand, respectively during the twelve months ended October 2, 2022.
As
of January 1, 2023, the remaining minimum lease and estimated CAM payments under the non-cancelable facility space leases are as follows:
Schedule
of Non-cancellable Operating Leases Minimum Payments
Non-cancellable
Operating Leases Minimum Payments
Fiscal
Year | |
| Facility
Lease Payments | | |
| Facility
Lease Payments | | |
| Lease
Payments | | |
| Total
Lease Payments | | |
| Total
Variable CAM Estimate | |
| |
(Thousands) | |
| |
Optex
Richardson | | |
Applied
Optics Center | | |
Office
Equipment | | |
Consolidated | |
Fiscal
Year | |
| Facility
Lease Payments | | |
| Facility
Lease Payments | | |
| Lease
Payments | | |
| Total
Lease Payments | | |
| Total
Variable CAM Estimate | |
2023
Base year lease | |
$ | 239 | | |
$ | 218 | | |
$ | 11 | | |
$ | 468 | | |
$ | 188 | |
2024
Base year lease | |
| 327 | | |
| 296 | | |
| 15 | | |
| 638 | | |
| 256 | |
2025
Base year lease | |
| 336 | | |
| 305 | | |
| 15 | | |
| 656 | | |
| 261 | |
2026
Base year lease | |
| 346 | | |
| 313 | | |
| 3 | | |
| 662 | | |
| 266 | |
2027
Base year lease | |
| 357 | | |
| 322 | | |
| - | | |
| 679 | | |
| 272 | |
2028
Base year lease | |
| 242 | | |
| 330 | | |
| - | | |
| 572 | | |
| 198 | |
2029
Base year lease | |
| - | | |
| 83 | | |
| - | | |
| 83 | | |
| 30 | |
Total
base lease payments | |
$ | 1,847 | | |
$ | 1,867 | | |
$ | 44 | | |
$ | 3,758 | | |
$ | 1,471 | |
Imputed
interest on lease payments (1) | |
| (238 | ) | |
| (263 | ) | |
| (3 | ) | |
| (504 | ) | |
| | |
Total
Operating Lease Liability(3) | |
$ | 1,609 | | |
$ | 1,604 | | |
$ | 41 | | |
$ | 3,254 | | |
| | |
| |
| | | |
| | | |
| | | |
| | | |
| | |
Right-of-use
Asset(2) | |
$ | 1,527 | | |
$ | 1,536 | | |
$ | 41 | | |
$ | 3,104 | | |
| | |
(1) |
|
Assumes
a discount borrowing rate of 5.0% on the new lease amendments effective as of January 11, 2021. |
(2) |
|
Includes
$150 thousand of unamortized deferred rent. |
(3) |
|
Short-term
and Long-term portion of Operating Lease Liability is $608 thousand and $2,646 thousand, respectively. |
Total
facilities rental and CAM expense for both facility lease agreements as of the three months ended January 1, 2023 and January 2, 2022
was $214 thousand and $209 thousand, respectively.
Total
office equipment rentals included in operating expenses was $5 and $4 thousand for the three months ended January 1, 2023 and January
2, 2022, respectively.
Note
5 - Debt Financing
Credit
Facility — PNC Bank (formerly BBVA, USA)
On
April 16, 2020, the Company terminated its facility with Avidbank and entered into a new facility with BBVA USA.
On
April 16, 2020, Optex Systems Holdings, Inc. and its subsidiary, Optex Systems, Inc. (collectively, the “Borrower”) entered
into a line of credit facility (the “Facility”) with BBVA, USA. In June 2021, PNC Bank completed its acquisition of BBVA,
USA and the bank name changed to PNC Bank (“PNC”). The substantive terms are as follows:
|
● |
The
principal amount of the Facility was $2.25 million. The Facility matured on April 15, 2022. The interest rate was variable based
on PNC’s Prime Rate plus a margin of -0.250%, initially set at 3% at loan origination, and all accrued and unpaid interest
was payable monthly in arrears starting on May 15, 2020; and the principal amount was due in full with all accrued and unpaid interest
and any other fees on April 15, 2022. |
|
|
|
|
● |
There
were commercially standard covenants including, but not limited to, covenants regarding maintenance of corporate existence, not incurring
other indebtedness except trade debt, not changing more than 25% stock ownership of Borrower, and a Fixed Charge Coverage Ratio of
1.25:1, with the Fixed Charge Coverage Ratio defined as (earnings before taxes, amortization, depreciation, amortization and rent
expense less cash taxes, distribution, dividends and fair value of warrants) divided by (current maturities on long term debt plus
interest expense plus rent expense). |
|
|
|
|
● |
The
Facility contained commercially standard events of default including, but not limited to, not making payments when due; incurring
a judgment of $10,000 or more not covered by insurance; not maintaining collateral and the like. |
|
|
|
|
● |
The
Facility was secured by a first lien on all of the assets of Borrower. |
On
April 12, 2022, the Company and its subsidiary, Optex Systems, Inc. (collectively with the Company, the “Borrowers”),
entered into an Amended and Restated Loan Agreement (the “Loan Agreement”) with PNC Bank, National Association,
successor to BBVA USA (the “Lender”), pursuant to which the Borrowers’ existing revolving line of credit facility
was decreased from $2.25
million to $1.125
million, and the
maturity date was extended from April 15, 2022 to April 15, 2023. The Company intends to replace or renew the Loan Agreement by April 15, 2023.
The
Loan Agreement requires the Borrowers to maintain a fixed charge coverage ratio of at least 1.25:1.
On
November 21, 2022, the Borrowers issued an Amended and Restated Revolving Line of Credit Note (the “Line of Credit Note”)
to the Lender in connection with an increase of the Borrowers’ revolving line of credit facility under the Loan Agreement from
$1.125 million to $2.0 million. The maturity date remains April 15, 2023. Obligations outstanding under the credit facility will accrue
interest at a rate equal to the Lender’s prime rate minus 0.25%.
The
Line of Credit Note and Loan Agreement contain customary events of default and negative covenants, including but not limited to those
governing indebtedness, liens, fundamental changes, investments, and restricted payments. The credit facility is secured by substantially
all of the operating assets of the Borrowers as collateral. The Borrowers’ obligations under the credit facility are subject to
acceleration upon the occurrence of an event of default as defined in the Line of Credit Note and Loan Agreement.
The
outstanding balance on the facility was zero as of January 1, 2023 and October 2, 2022. For the three months ended January 1, 2023 and
January 2, 2022, the total interest expense against the outstanding line of credit balance was zero.
Note
6-Stock Based Compensation
Stock
Options issued to Employees, Officers and Directors
The
Optex Systems Holdings 2009 Stock Option Plan provides for the issuance of up to 75,000 shares to the Company’s officers, directors,
employees and to independent contractors who provide services to Optex Systems Holdings as either incentive or non-statutory stock options
determined at the time of grant. There were no new grants of stock options during the three months ended January 1, 2023. As of January
1, 2023, there are zero stock options outstanding.
Restricted
Stock and Restricted Stock Units issued to Officers and Employees
The
following table summarizes the status of Optex Systems Holdings’ aggregate non-vested restricted stock and restricted stock units,
with the latter granted under the Company’s 2016 Restricted Stock Unit Plan:
Schedule
of Aggregate Non-vested Restricted Stock and Restricted Stock Units Granted
| |
Restricted
Stock Units | | |
Weighted
Average Grant Date Fair Value | | |
Restricted
Shares | | |
Weighted
Average Grant Date Fair Value | |
Outstanding
at October 3, 2021 | |
| 99,000 | | |
$ | 1.59 | | |
| | |
$ | 1.75 | |
Granted | |
| - | | |
| - | | |
| - | | |
| - | |
Vested | |
| (33,000 | ) | |
$ | 1.73 | | |
| (60,000 | ) | |
$ | 1.75 | |
Forfeited | |
| - | | |
| - | | |
| - | | |
| - | |
Outstanding
at October 2, 2022 | |
| 66,000 | | |
$ | 1.52 | | |
| 180,000 | | |
$ | 1.75 | |
Granted | |
| - | | |
| - | | |
| - | | |
| - | |
Vested | |
| (66,000 | ) | |
$ | 1.52 | | |
| (60,000 | ) | |
$ | 1.75 | |
Forfeited | |
| - | | |
| - | | |
| - | | |
| - | |
Outstanding
at January 1, 2023 | |
| - | | |
$ | - | | |
| 120,000 | | |
$ | 1.75 | |
On
January 2, 2019, the Company granted 150,000 and 50,000 restricted stock units with a January 2, 2019 grant date to Danny Schoening and
Karen Hawkins, respectively, vesting as of January 1 each year subsequent to the grant date over a three-year period at a rate of 34%
in year one, and 33% each year thereafter. The stock price at grant date was $1.32 per share. Effective December 1, 2021, the vesting
terms of Danny Schoening’s Restricted Stock Unit (RSU) grant from January 2019 were revised as described below. The Company amortizes
the grant date fair value of $264 thousand to stock compensation expense on a straight-line basis across the three-year vesting period
beginning on January 2, 2019. As of January 1, 2023, there was no unrecognized compensation cost relating to this award.
The
Company entered into an amended and restated employment agreement with Danny Schoening dated December 1, 2021. The updated employment
agreement also served to amend Mr. Schoening’s RSU Agreement, dated January 2, 2019, by changing the third and final vesting date
for the restricted stock units granted under such agreement from January 1, 2022 to the “change of control date,” that being
the first of the following to occur with respect to the Company: (i) any “Person,” as that term is defined in Sections 13(d)
and 14(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with certain exclusions, is or becomes
the “Beneficial Owner” (as that term is defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities
of the Company representing fifty percent (50%) or more of the combined voting power of the Company’s then outstanding securities;
or (ii) the Company is merged or consolidated with any other corporation or other entity, other than: (A) a merger or consolidation which
would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining
outstanding or by being converted into voting securities of the surviving entity) more than fifty percent (50%) of the combined voting
power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation; or
(B) the Company engages in a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction)
in which no “Person” (as defined above) acquires fifty percent (50%) or more of the combined voting power of the Company’s
then outstanding securities. The amended RSU Agreement contains certain exceptions to the definition of change of control.
As
of the December 1, 2021 modification date related to the third and final vesting date of the 49,500 unvested restricted stock units held
by Danny Schoening, there was no change in the fair value of the modified award as compared to the original award immediately prior to
the modification date. The restricted stock units initially were certain to vest on January 1, 2022, but due to the modification, they
were less certain to vest, contingent on a “change in control” occurring, which change in control, in case Mr. Schoening
is terminated by the Company without cause or he resigns with good reason prior to such change in control, was required to occur prior
to March 13, 2023. As of the modification date, there was $5 thousand of unrecognized compensation cost associated with the original
award. As a matter of expediency, the unrecognized compensation expense as of the modification date was fully expensed through January
1, 2022. There is no additional compensation expense associated with the modification of the restricted stock unit agreement.
On
November 28, 2022, the Company entered into a new employment agreement with Danny Schoening which amended Mr. Schoening’s RSU Agreement,
dated January 2, 2019, which had been previously amended as of December 1, 2021, by changing the third and final vesting date for the
restricted stock units granted under such agreement from the “change of control date” to January 1, 2023.
On
February 17, 2020, the Company granted 50,000 restricted stock units to Bill Bates, General Manager of the Applied Optics Center. The
restricted stock units vest as of January 1 each year subsequent to the grant date over a three-year period at a rate of 34% in year
one, and 33% each year thereafter. The stock price at grant date was $2.13 per share. The Company will amortize the grant date fair value
of $107 thousand to stock compensation expense on a straight-line basis across the three-year vesting period beginning on February 17,
2020.
On
April 30, 2020, the Optex Systems Holdings, Inc. Board of Directors held a meeting and voted to increase the annual board compensation
for the three independent directors from $22,000 to $36,000 with an effective date of January 1, 2020, in addition to granting 100,000
restricted shares to each independent director which shall vest at a rate of 20% per year (20,000 shares) each January 1st,
over the next five years, through January 1, 2025. The total market value for the 300,000 shares is $525 thousand based on the stock
price of $1.75 as of April 30, 2020. The Company amortizes the grant date fair value to stock compensation expense on a straight-line
basis across the five-year vesting period beginning on April 30, 2020. On each of January 1, 2021, January 1, 2022, and January 1, 2023,
60,000 of the restricted director shares vested. As of January 1, 2023, there were 120,000 unvested restricted shares.
On
January 4, 2022, the Company issued 23,216 common shares to Karen Hawkins, CFO and Bill Bates (AOC GM), net of tax withholding of $19 thousand, in
settlement of 33,000 restricted stock units which vested on January 1, 2022.
On
January 4, 2023, the Company issued 46,432 common shares to Danny Schoening, CEO, and Bill Bates (AOC GM), net of tax withholding of $15 thousand, in
settlement of 66,000 restricted stock units which vested on January 1, 2023. As of January 1, 2023, there are zero unvested restricted
stock units outstanding.
Stock
Based Compensation Expense
Equity
compensation is amortized based on a straight-line basis across the vesting or service period as applicable. The recorded compensation
costs for options and shares granted and restricted stock units awarded as well as the unrecognized compensation costs are summarized
in the table below:
Schedule of Unrecognized Compensation Costs
| |
Stock
Compensation | |
| |
(thousands) | |
| |
Recognized
Compensation Expense | | |
Unrecognized
Compensation Expense | |
| |
Three
months ended | | |
As
of | |
| |
January
1, 2023 | | |
January
2, 2022 | | |
January
1, 2023 | | |
October
2, 2022 | |
| |
| | |
| | |
| | |
| |
Restricted
Shares | |
$ | 26 | | |
$ | 26 | | |
$ | 210 | | |
$ | 236 | |
Restricted
Stock Units | |
| 9 | | |
| 31 | | |
| - | | |
| 9 | |
Total
Stock Compensation | |
$ | 35 | | |
$ | 57 | | |
$ | 210 | | |
$ | 245 | |
Note
7 - Stockholders’ Equity
Dividends
As
of the three months ended January 1, 2023 and the twelve months ended October 2, 2022, there were no declared or outstanding dividends
payable.
Common
stock
On
June 8, 2020 the Company announced authorization for a $1 million stock repurchase program. As of September 27, 2020 there were 105,733
shares held in treasury purchased under the June 2020 stock repurchase program. The Company purchased a total of 519,266 common shares
against the program through April 2021, which were subsequently cancelled in June 2021.
On
September 22, 2021 the Company announced authorization for an additional $1 million stock repurchase program. The shares authorized to
be repurchased under the repurchase program may be purchased from time to time at prevailing market prices, through open market transactions
or in negotiated transactions, depending upon market conditions and subject to Rule 10b-18 as promulgated by the SEC.
During
the three months ended January 1, 2023, there were zero common shares repurchased under the program. All shares purchased have been
cancelled. A summary of the purchases under the program follows:
Summary of Purchases Under Plan
Fiscal
Period | |
Total
number of
shares purchased | | |
Total
purchase
cost | | |
Average
price paid
per share (with
commission) | | |
Maximum
dollar value
that may yet
be purchased under
the plan | |
| |
| | |
| | |
| | |
| |
| |
| | |
| | |
| | |
| |
October
4, 2021 through October 31, 2021 | |
| 18,265 | | |
$ | 37 | | |
$ | 2.01 | | |
$ | 894 | |
November
1, 2021 through November 28, 2021 | |
| 4,415 | | |
| 9 | | |
| 2.04 | | |
| 885 | |
November
29, 2021 through January 2, 2022 | |
| 14,558 | | |
| 28 | | |
| 1.93 | | |
| 857 | |
January
3, 2022 through January 30, 2022 | |
| 15,585 | | |
| 29 | | |
| 1.89 | | |
| 828 | |
January
31, 2022 through February 27, 2022 | |
| 27,618 | | |
| 49 | | |
| 1.75 | | |
| 779 | |
February
28, 2022 through April 3, 2022 | |
| 35,530 | | |
| 70 | | |
| 1.98 | | |
| 709 | |
April
4, 2022 through May 1, 2022 | |
| 12,304 | | |
| 27 | | |
| 2.22 | | |
| 682 | |
May
2, 2022 through May 29, 2022 | |
| 10,482 | | |
| 22 | | |
| 2.11 | | |
| 660 | |
May
30, 2022 through July 3, 2022 | |
| 49,657 | | |
| 95 | | |
| 1.90 | | |
| 565 | |
July
4, 2022 through July 25,2022 | |
| 610 | | |
| 1 | | |
| 2.10 | | |
| 564 | |
July
26, 2022 through August 13, 2022 | |
| 1,930 | | |
| 4 | | |
| 2.09 | | |
| 560 | |
Total
shares repurchased for twelve months ended October 2, 2022 | |
| 190,954 | | |
$ | 371 | | |
$ | 1.94 | | |
$ | 560 | |
Furthermore,
on August 18, 2022, the Company announced the commencement of a tender offer to purchase up to $4.25 million in value of shares of its
common stock. On September 15, 2022, the Company’s “modified Dutch auction” tender offer expired. In accordance with
the terms and conditions of the tender offer, the Company accepted for purchase 1,603,773 shares of common stock at a price of $2.65
per share, for an aggregate cost of approximately $4.25 million, excluding fees and expenses relating to the tender offer. The transaction
cost associated with the tender offer was $111 thousand. The shares were immediately cancelled upon completion of the transaction.
As
of October 2, 2022, and January 1, 2023, the total issued and outstanding common shares were 6,716,638 and 6,763,070, respectively. As
of October 2, 2022, and January 1, 2023 there were zero shares held in Treasury.
Note
8 - Subsequent Events
None.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This
Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to supplement and
complement our audited consolidated financial statements and notes thereto for the fiscal year ended October 2, 2022 and our
unaudited condensed consolidated financial statements and notes thereto for the quarter ended January 1, 2023, prepared in
accordance with U.S. generally accepted accounting principles (GAAP). You are encouraged to review our condensed consolidated
financial statements in conjunction with your review of this MD&A. The financial information in this MD&A has been prepared
in accordance with GAAP, unless otherwise indicated. In addition, we use non-GAAP financial measures as supplemental indicators of
our operating performance and financial position. We use these non-GAAP financial measures internally for comparing actual results
from one period to another, as well as for planning purposes. We will also report non-GAAP financial results as supplemental
information, as we believe their use provides more insight into our performance. When a non-GAAP measure is used in this MD&A,
it is clearly identified as a non-GAAP measure and reconciled to the most closely corresponding GAAP measure.
The
following discussion highlights the principal factors that have affected our financial condition and results of operations as well as
our liquidity and capital resources for the periods described. The operating results for the periods presented were not significantly
affected by inflation.
Cautionary
Note Regarding Forward-Looking Information
This
Quarterly Report on Form 10-Q, in particular the MD&A, contains certain “forward-looking statements” within the meaning
of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange
Act of 1934, as amended (the “Exchange Act”). Any statements contained in this Quarterly Report on Form 10-Q that are not
statements of historical fact may be deemed to be forward-looking statements. When used in this Quarterly Report on Form 10-Q and other
reports, statements, and information we have filed with the Securities and Exchange Commission (“Commission” or “SEC”),
in our press releases, presentations to securities analysts or investors, or in oral statements made by or with the approval of an executive
officer, the words or phrases “believes,” “may,” “will,” “expects,” “should,”
“continue,” “anticipates,” “intends,” “will likely result,” “estimates,”
“projects” or similar expressions and variations thereof are intended to identify such forward-looking statements.
These
forward-looking statements represent our expectations, beliefs, intentions or strategies concerning future events, including, but
not limited to, any statements regarding growth strategy; product and development programs; financial performance (including revenue
and net income); backlog; expected timing of shipments; increases in the cost of materials and labor; labor shortages; follow-on
orders; the impact of the COVID-19 pandemic; supply chain challenges; the continuation of historical trends; the sufficiency of our
cash balances for future liquidity and capital resource needs; the expected impact of changes in accounting policies on our results
of operations, financial condition or cash flows; anticipated problems and our plans for future operations; and the economy in
general or the future of the defense industry.
We
caution that these statements by their nature involve risks and uncertainties, certain of which are beyond our control, and actual
results may differ materially depending on a variety of important factors. Some of these risks and uncertainties are identified in
this Management’s Discussion and Analysis of Financial Condition and Results of Operations and the section “Risk
Factors” in our Annual Report on Form 10-K and you are urged to review those sections.
You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider any
such list to be a complete list of all potential risks or uncertainties.
We
do not assume the obligation to update any forward-looking statement. You should carefully evaluate such statements in light of factors
described in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K.
Background
Optex
Systems, Inc. (Delaware) manufactures optical sighting systems and assemblies, primarily for Department of Defense applications. Its
products are installed on various types of U.S. military land vehicles, such as the Abrams and Bradley fighting vehicles, light armored
and armored security vehicles and have been selected for installation on the Stryker family of vehicles. Optex Systems, Inc. (Delaware)
also manufactures and delivers numerous periscope configurations, rifle and surveillance sights and night vision optical assemblies.
Optex Systems, Inc. (Delaware) products consist primarily of build-to-customer print products that are delivered both directly to the
armed services and to other defense prime contractors. Less than 1% of today’s revenue is related to the resale of products substantially
manufactured by others. In this case, the product would likely be a simple replacement part of a larger system previously produced by
Optex Systems, Inc. (Delaware).
We
are both a prime and sub-prime contractor to the Department of Defense. Sub-prime contracts are typically issued through major defense
contractors such as General Dynamics Land Systems, Raytheon Corp., BAE, ADS Inc. and others. We are also a military supplier to foreign
governments such as Israel, Australia and South American countries and as a subcontractor for several large U.S. defense companies
serving foreign governments.
The Federal Acquisition Regulation is the principal set of regulations that govern the acquisition process of government
agencies and contracts with the U.S. government. In general, parts of the Federal Acquisition Regulation are incorporated into government
solicitations and contracts by reference as terms and conditions effecting contract awards and pricing solicitations.
Many
of our contracts are prime or subcontracted directly with the Federal government and, as such, are subject to Federal Acquisition Regulation
Subpart 49.5, “Contract Termination Clauses” and more specifically Federal Acquisition Regulation clauses 52.249-2 “Termination
for Convenience of the Government (Fixed-Price)”, and 49.504 “Termination of fixed-price contracts for default”. These
clauses are standard clauses on our prime military contracts and generally apply to us as subcontractors. It has been our experience
that the termination for convenience is rarely invoked, except where it is mutually beneficial for both parties. We are currently not
aware of any pending terminations for convenience or for default on our existing contracts.
In
the event a termination for convenience were to occur, Federal Acquisition Regulation clause 52.249-2 provides for full recovery of all
contractual costs and profits reasonably occurred up to and as a result of the terminated contract. In the event a termination for default
were to occur, we could be liable for any excess cost incurred by the government to acquire supplies from another supplier similar to
those terminated from us. We would not be liable for any excess costs if the failure to perform the contract arises from causes beyond
the control and without the fault or negligence of the Company as defined by Federal Acquisition Regulation clause 52.249-8.
In
addition, some of our contracts allow for government contract financing in the form of contract progress payments pursuant to Federal
Acquisition Regulation 52.232-16, “Progress Payments”. As a small business, and subject to certain limitations, this clause
provides for government payment of up to 90% of incurred program costs prior to product delivery. To the extent our contracts allow for
progress payments, we intend to utilize this benefit, thereby minimizing the working capital impact on Optex Systems Holdings for materials
and labor required to complete the contracts.
Recent
Developments
NASDAQ
Listing Application
On
December 7, 2022 the Company submitted an application to list its common stock on the NASDAQ Capital Market. There are no assurances
(1) that the Company will continue to meet the initial listing criteria throughout the pendency of the application (including with respect
to its share price), (2) that NASDAQ will approve the application or (3) relating to the timing of any such approval. If and when listed
on NASDAQ, there are no assurances that the Company will continue to meet NASDAQ’s continued listing requirements.
Amended
and Restated Employment Agreement for Danny Schoening
On
November 28, 2022, the Company entered into a new employment agreement with Danny Schoening. Pursuant to the agreement, which is dated
as of December 1, 2022, Mr. Schoening will continue to serve as the Company’s President and Chief Executive Officer through November
30, 2025. Mr. Schoening’s base salary initially is $304,912 per annum, and will be increased to $314,060 on December 1, 2023 and
$323,481 on December 1, 2024. Mr. Schoening will be eligible for a performance bonus based on a one-year operating plan adopted by the
Company’s Board of Directors (the “Board”). The bonus will be based on financial and/or operating metrics decided annually
by the Board or the Compensation Committee and tied to such one-year plan. The target bonus will equate to 30% of Mr. Schoening’s
base salary. The Board will have discretion in good faith to alter the performance bonus upward or downward by 20%.
The
updated employment agreement also served to amend Mr. Schoening’s RSU Agreement, dated January 2, 2019, which had been previously
amended as of December 1, 2021, by changing the third and final vesting date for the restricted stock units granted under such agreement
from the “change of control date” to January 1, 2023.
The
employment agreement events of termination consist of: (i) death or permanent disability of Mr. Schoening; (ii) termination by the Company
for cause (including conviction of a felony, commission of fraudulent, illegal or dishonest acts, certain willful misconduct or gross
negligence by Mr. Schoening, continued failure to perform material duties or cure material breach after written notice, violation of
securities laws and material breach of the employment agreement), (iii) termination by the Company without cause and (iv) termination
by Mr. Schoening for good reason (including continued breach by the Company of its material obligations under the agreement after written
notice, the requirement for Mr. Schoening to move more than 100 miles away for his employment without consent, and merger or consolidation
that results in more than 66% of the combined voting power of the Company’s then outstanding securities or those of its successor
changing ownership or a sale of all or substantially all of its assets, without the surviving entity assuming the obligations under the
agreement). For a termination by the Company for cause or upon death or permanent disability of Mr. Schoening, Mr. Schoening will be
paid accrued and unpaid salary and any bonus earned through the date of termination. For a termination by the Company without cause or
by Mr. Schoening with good reason, Mr. Schoening will also be paid six months’ base salary in effect.
New
Loan Agreement
On
April 12, 2022, the Company and its subsidiary, Optex Systems, Inc. (collectively with the Company, the “Borrowers”), entered
into an Amended and Restated Loan Agreement (the “Loan Agreement”) with PNC Bank, National Association, successor to BBVA
USA (the “Lender”), pursuant to which the Borrowers’ existing revolving line of credit facility was decreased from
$2.25 million to $1.125 million, and the maturity date was extended from April 15, 2022 to April 15, 2023.
The
Loan Agreement requires the Borrowers to maintain a fixed charge coverage ratio of at least 1.25:1.
On
November 21, 2022, the Borrowers issued an Amended and Restated Revolving Line of Credit Note (the “Line of Credit Note”)
to the Lender in connection with an increase of the Borrowers’ revolving line of credit facility under the Loan Agreement from
$1.125 million to $2.0 million. The maturity date remains April 15, 2023. Obligations outstanding under the credit facility will accrue
interest at a rate equal to the Lender’s prime rate minus 0.25%.
The
Line of Credit Note and Loan Agreement contain customary events of default and negative covenants, including but not limited to those
governing indebtedness, liens, fundamental changes, investments, and restricted payments. The credit facility is secured by substantially
all of the operating assets of the Borrowers as collateral. The Borrowers’ obligations under the credit facility are subject to
acceleration upon the occurrence of an event of default as defined in the Line of Credit Note and Loan Agreement.
Election
of New Director
On
October 19, 2022, the Board of Directors of the Company expanded the size of the Board from four to five members and elected Mr. Dayton
Judd as a director, to hold office until the Company’s next annual meeting of shareholders and until his successor has been elected
and qualified.
Material
Trends
Recent
supply chain disruptions have strained our suppliers and extended supplier delivery lead times, affecting their ability to sustain operations.
We anticipate market wide material shortages for paint and resin products as well as critical epoxies and chemicals used in our manufacturing
process. In addition, we are seeing substantial increases in the costs of aluminum, steel and acrylic commodities, which has affected our net income in the first three months of fiscal year 2023 and is expected to continue to
have a negative effect on our long-term fixed contracts over the next three years.
We
have experienced significant material shortages during the three months ended October 2, 2022 and extending into the first three
months of fiscal year 2023 from two significant suppliers of our periscope covers and housings. These shortages affect several of
our periscope products at the Optex Richardson segment. The delays in key components, combined with labor shortages during the first
quarter of fiscal year 2023 have negatively impacted our production levels and have pushed the expected delivery dates into the
second and third quarters of fiscal year 2023. We are aggressively seeking alternative sources for these components as well as
increasing employee recruitment initiatives and overtime to attempt to mitigate any continuing risks to the periscope line. In
addition, one of our major customers for the Applied Optics Center has requested a significant schedule delay pushing their laser
filter unit delivery schedules from the first half into the second half of fiscal year 2023.
In
November 2022, we increased our line of credit to $2.0 million from $1.125 million to facilitate our working capital requirements due
to the delays and increased backlog. As supplier issues and labor shortages abate, we anticipate increased revenue beginning in the second
quarter and increased working capital during the second half of fiscal year 2023 with a recovery expected by fiscal year end
2023. Based on our current backlog, we anticipate an overall increase for fiscal year 2023 revenues as compared to the 2022 levels.
We
refer also to “Item 1. Business – Market Opportunity: U.S. Military” in our annual report on Form 10-K for the
year ended October 2, 2022 for a description of current trends in U.S. government military spending and its potential impact on Optex,
which may be material, including particularly the tables included in that section and disclosure on the significant reduction in spending
for U.S ground system military programs, which has a direct impact on the Optex Systems Richardson segment revenue, all of which is incorporated
herein by reference.
Results of Operations
Segment
Information
We
have presented the operating results by segment to provide investors with an additional tool to evaluate our operating results and to
have a better understanding of the overall performance of each business segment. Management of Optex Systems Holdings uses the selected
financial measures by segment internally to evaluate its ongoing segment operations and to allocate resources within the organization
accordingly. Segments are determined based on differences in products, location, internal reporting and how operational decisions are
made. Management has determined that the Optex Systems, Richardson plant and the Applied Optics Center, Dallas plant are separately managed,
organized, and internally reported as separate business segments. The table below provides a summary of selective statement of operations
data by operating segment for the three months ended January 1, 2023 and January 2, 2022 reconciled to the Condensed Consolidated Results
of Operations as presented in Item 1, “Condensed Consolidated Financial Statements.”
Results
of Operations Selective Financial Information
(Thousands)
| |
Three
months ended | |
| |
January
1, 2023 | | |
January
2, 2022 | |
| |
Optex Richardson | | |
Applied
Optics Center Dallas | | |
Other
(non-allocated costs and eliminations) | | |
Consolidated | | |
Optex
Richardson | | |
Applied
Optics Center Dallas | | |
Other
(non-allocated costs and eliminations) | | |
Consolidated | |
| |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| |
Revenue
from External Customers | |
$ | 1,619 | | |
$ | 2,421 | | |
$ | - | | |
$ | 4,040 | | |
$ | 1,857 | | |
$ | 2,483 | | |
$ | - | | |
$ | 4,340 | |
Intersegment
Revenues | |
| - | | |
| 116 | | |
| (116 | ) | |
| - | | |
| - | | |
| 180 | | |
| (180 | ) | |
| - | |
Total
Segment Revenue | |
| 1,619 | | |
| 2,537 | | |
| (116 | ) | |
| 4,040 | | |
| 1,857 | | |
| 2,663 | | |
| (180 | ) | |
| 4,340 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Total
Cost of Sales | |
| 1,460 | | |
| 1,979 | | |
| (116 | ) | |
| 3,323 | | |
| 1,667 | | |
| 2,030 | | |
| (180 | ) | |
| 3,517 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Gross
Profit | |
| 159 | | |
| 558 | | |
| - | | |
| 717 | | |
| 190 | | |
| 633 | | |
| - | | |
| 823 | |
Gross
Margin % | |
| 9.8 | % | |
| 22.0 | % | |
| - | | |
| 17.7 | % | |
| 10.2 | % | |
| 23.8 | % | |
| - | | |
| 19.0 | % |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
General
and Administrative Expense | |
| 863 | | |
| 101 | | |
| 35 | | |
| 999 | | |
| 642 | | |
| 109 | | |
| 57 | | |
| 808 | |
Segment
Allocated G&A Expense | |
| (280 | ) | |
| 280 | | |
| - | | |
| - | | |
| (236 | ) | |
| 236 | | |
| - | | |
| - | |
Net
General & Administrative Expense | |
| 583 | | |
| 381 | | |
| 35 | | |
| 999 | | |
| 406 | | |
| 345 | | |
| 57 | | |
| 808 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Operating
(Loss) Income | |
| (424 | ) | |
| 177 | | |
| (35 | ) | |
| (282 | ) | |
| (216 | ) | |
| 288 | | |
| (57 | ) | |
| 15 | |
Operating
(Loss) Income % | |
| (26.2 | )% | |
| 7.0 | % | |
| - | | |
| (7.0 | )% | |
| (11.6 | )% | |
| 10.8 | % | |
| - | | |
| 0.3 | % |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Net
(Loss) Income before taxes | |
$ | (424 | ) | |
$ | 177 | | |
$ | (35 | ) | |
$ | (282 | ) | |
$ | 213 | | |
$ | (77 | ) | |
$ | 967 | | |
$ | 1,103 | |
Net
(Loss) Income before taxes % | |
| (26.2 | )% | |
| 7.0 | % | |
| - | | |
| (7.0 | )% | |
| (11.6 | )% | |
| 10.8 | % | |
| - | | |
| 0.3 | % |
Our
total revenues decreased by $300 thousand, or 6.9%, comparing the three months ended January 1, 2023 with the three months ended January
2, 2022. The decrease in revenue was primarily driven by a $238 thousand decrease in external revenue at the Optex Richardson segment
and a $62 thousand decrease in external revenue at the Applied Optics Center segment, respectively, over the prior year period. The
decrease in revenue was due to supply chain issues, labor shortage and customer schedule delays across the segments.
Consolidated
gross profit for the three months ended January 1, 2023 decreased by $106 thousand, or 12.9%, compared to the prior year period. The
decrease in profit was primarily attributable to a decrease in consolidated revenue across a relatively fixed overhead cost base, changes
in revenue mix between the segments, and inflationary material and labor pressure against our long-term fixed price contracts.
Our
operating income for the three months ended January 1, 2023 decreased by $297 thousand to a loss of $282 thousand, as compared to the
prior year period operating income of $15 thousand. The decrease in operating income was primarily driven by lower gross profit combined
with an increase in general and administrative spending.
Non-GAAP
Adjusted EBITDA
We
use adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) as an additional measure for evaluating the performance
of our business as “net income” includes the significant impact of noncash valuation gains and losses on warrant liabilities,
noncash compensation expenses related to equity stock issues, as well as depreciation, amortization, interest expenses and federal income
taxes. We believe that Adjusted EBITDA is a meaningful indicator of our operating performance because it permits period-over-period comparisons
of our ongoing core operations before the excluded items, which we do not consider relevant to our operations. Adjusted EBITDA is a financial
measure not required by, or presented in accordance with, U.S. generally accepted accounting principles (“GAAP”).
Adjusted
EBITDA has limitations and should not be considered in isolation or a substitute for performance measures calculated under GAAP. This
non-GAAP measure excludes certain cash expenses that we are obligated to make. In addition, other companies in our industry may calculate
Adjusted EBITDA differently than we do or may not calculate it at all, which limits the usefulness of Adjusted EBITDA as a comparative
measure.
The
table below summarizes our three-month operating results for the periods ended January 1, 2023 and January 2, 2022, in terms of both
the GAAP net income measure and the non-GAAP Adjusted EBITDA measure. We believe that including both measures allows the reader better
to evaluate our overall performance.
| |
Three months ended (thousands) | |
| |
January 1, 2023 | | |
January 2, 2022 | |
| |
| | |
| |
Net (Loss) Income (GAAP) | |
$ | (223 | ) | |
$ | 29 | |
Add: | |
| | | |
| | |
Depreciation and Amortization | |
| 81 | | |
| 72 | |
Federal Income Tax Benefit | |
| (59 | ) | |
| (14 | ) |
Stock Compensation | |
| 35 | | |
| 57 | |
Adjusted EBITDA – Non-GAAP | |
$ | (166 | ) | |
$ | 144 | |
Our
net income decreased by $252 thousand to a loss of $223 thousand for the three months ended January 1, 2023, as compared to income
of $29 thousand for the three months ended January 2, 2022. Our adjusted EBITDA decreased by $310 thousand to a loss of $166
thousand for the three months ended January 1, 2023, as compared to income of $144 thousand for the three months ended January 2,
2022. The decrease in the three-month period ended January 1, 2023 is primarily driven by lower revenue and operating profit as
compared to the prior year. Operating segment performance is discussed in greater detail throughout the previous and following
sections.
Backlog
During the three months ended
January 1, 2023 the Company booked $11.2 million in new orders, representing a 220.0% increase over the prior year period new orders of
$3.5 million. Both segments experienced a sizeable growth in orders as compared to the prior year period.
The
orders for the most recently completed quarter consist of $8.6 million for our Optex Richardson segment and $2.6 million attributable
to the Applied Optics Center. The following table depicts the new customer orders for the three months ending January 1, 2023 as compared
to the three-month period ending January 2, 2022 in millions of dollars:
| |
(Millions) | | |
| |
Product
Line | |
Q1
2023 | | |
Q1
2022 | | |
Variance | | |
%
Chg | |
Periscopes | |
$ | 3.7 | | |
$ | 2.2 | | |
$ | 1.5 | | |
| 68.2 | % |
Sighting
Systems | |
| 3.4 | | |
| 0.1 | | |
| 3.3 | | |
| 3300.0 | % |
Howitzer | |
| - | | |
| - | | |
| - | | |
| - | % |
Other | |
| 1.5 | | |
| 0.3 | | |
| 1.2 | | |
| 400.0 | % |
Optex
Systems – Richardson | |
| 8.6 | | |
| 2.6 | | |
| 6.0 | | |
| 230.8 | % |
Optical
Assemblies | |
| 1.2 | | |
| 0.2 | | |
| 1.0 | | |
| 500.0 | % |
Laser
Filters | |
| 1.3 | | |
| - | | |
| 1.3 | | |
| 100.0 | % |
Day
Windows | |
| - | | |
| - | | |
| - | | |
| - | % |
Other | |
| 0.1 | | |
| 0.7 | | |
| (0.6 | ) | |
| (85.7 | )% |
Applied
Optics Center – Dallas | |
| 2.6 | | |
| 0.9 | | |
| 1.7 | | |
| 188.9 | % |
Total
Customer Orders | |
$ | 11.2 | | |
$ | 3.5 | | |
$ | 7.7 | | |
| 220.0 | % |
The Company has seen significant increases in orders for many of its defense and commercial products during the first
three months of fiscal year 2023 inclusive of two new customers for our sighting systems and filter programs. On November 1, 2022, the
Company announced it has been awarded a $3.4 million order to repair and refurbish night vision equipment for the Government of Israel.
The order represents a significant increase in our Optex Richardson sighting systems business base for a new customer and includes an
additional potential award value with a 100% optional award quantity clause. In October 2023 the Company booked a $0.9 million award for
Applied Optics Center laser interface filters for a new defense customer in addition to increased purchase orders for our commercial optical
assemblies for our existing customer.
Backlog
as of January 1, 2023, was $40.1 million as compared to a backlog of $26.5 million as of January 2, 2022, representing an increase of
$13.6 million or 51.3%. Backlog as compared to October 2, 2022 increased by $7.2 million, or 21.9% from $32.9 million.
The following table depicts the current expected delivery by period of all contracts awarded as of January 1, 2023 in millions of dollars:
| |
(Millions) | |
Product
Line | |
Q2
2023 | | |
Q3
2023 | | |
Q4
2023 | | |
2023
Delivery | | |
2024+
Delivery | | |
Total
Backlog 1/1/2023 | | |
Total
Backlog 1/2/2022 | | |
Variance | | |
%
Chg | |
Periscopes | |
$ | 2.7 | | |
$ | 2.8 | | |
$ | 1.1 | | |
$ | 6.7 | | |
$ | 3.3 | | |
$ | 10.0 | | |
$ | 6.9 | | |
$ | 3.1 | | |
| 44.9 | % |
Sighting
Systems | |
| 0.2 | | |
| 1.2 | | |
| 0.9 | | |
| 2.3 | | |
| 2.6 | | |
| 4.9 | | |
| 1.5 | | |
| 3.4 | | |
| 226.7 | % |
Howitzer | |
| - | | |
| 0.1 | | |
| 0.1 | | |
| 0.2 | | |
| 2.1 | | |
| 2.3 | | |
| 2.3 | | |
| - | | |
| - | % |
Other | |
| 1.2 | | |
| 0.6 | | |
| 0.9 | | |
| 2.7 | | |
| 2.1 | | |
| 4.8 | | |
| 1.0 | | |
| 3.8 | | |
| 380.0 | % |
Optex
Systems - Richardson | |
| 4.1 | | |
| 4.7 | | |
| 3.0 | | |
| 11.9 | | |
| 10.1 | | |
| 22.0 | | |
| 11.7 | | |
| 10.3 | | |
| 88.0 | % |
Optical
Assemblies | |
| 1.6 | | |
| 1.6 | | |
| 1.5 | | |
| 4.7 | | |
| 1.8 | | |
| 6.5 | | |
| 4.1 | | |
| 2.4 | | |
| 58.5 | % |
Laser
Filters | |
| 1.2 | | |
| 2.4 | | |
| 3.1 | | |
| 6.8 | | |
| 2.6 | | |
| 9.4 | | |
| 9.0 | | |
| 0.4 | | |
| 4.4 | % |
Day
Windows | |
| 0.1 | | |
| 0.2 | | |
| 0.1 | | |
| 0.4 | | |
| 1.4 | | |
| 1.8 | | |
| 0.9 | | |
| 0.9 | | |
| 100.0 | % |
Other | |
| 0.3 | | |
| 0.1 | | |
| 0.1 | | |
| 0.3 | | |
| 0.1 | | |
| 0.4 | | |
| 0.8 | | |
| (0.4 | ) | |
| (50.0 | )% |
Applied
Optics Center - Dallas | |
| 3.2 | | |
| 4.3 | | |
| 4.8 | | |
| 12.2 | | |
| 5.9 | | |
| 18.1 | | |
| 14.8 | | |
| 3.3 | | |
| 22.3 | % |
Total
Backlog | |
$ | 7.3 | | |
$ | 9.0 | | |
$ | 7.8 | | |
$ | 24.1 | | |
$ | 16.0 | | |
$ | 40.1 | | |
$ | 26.5 | | |
$ | 13.6 | | |
| 51.3 | % |
Optex
Systems Richardson backlog as of January 1, 2023, was $22.0 million as compared to a backlog of $11.7 million as of January 2, 2022,
representing an increase of $10.3 million or 88.0%.
Applied
Optics Center backlog as of January 1, 2023, was $18.1 million as compared to a backlog of $14.8 million as of January 2, 2022, representing
an increase of $3.3 million, or 22.3%.
Please
refer to “Material Trends” above or “Liquidity and Capital Resources” below for more information
on recent developments and trends with respect to our orders and backlog, which information is incorporated herein by reference.
The
Company continues to aggressively pursue international and commercial opportunities in addition to maintaining its current footprint
with U.S. vehicle manufactures, with existing as well as new product lines. We continue to review and seek potential products, outside
our traditional product lines, which could be manufactured using our current production facilities in order to capitalize on our existing
excess capacity.
Three
Months Ended January 1, 2023 Compared to Three Months Ended January 2, 2022
Revenues.
For the three months ended January 1, 2023, revenues decreased by $300 thousand or 6.9% compared to the prior year period as set forth
in the table below:
| |
Three
months ended | |
| |
(Thousands) | |
Product
Line | |
January
1, 2023 | | |
January
2, 2022 | | |
Variance | | |
%
Chg | |
Periscopes | |
$ | 1,325 | | |
$ | 1,065 | | |
$ | 260 | | |
| 24.4 | |
Sighting
Systems | |
| 189 | | |
| 274 | | |
| (85 | ) | |
| (31.0 | ) |
Howitzers | |
| - | | |
| - | | |
| - | | |
| - | |
Other | |
| 105 | | |
| 518 | | |
| (413 | ) | |
| (79.7 | ) |
Optex
Systems – Richardson | |
| 1,619 | | |
| 1,857 | | |
| (238 | ) | |
| (12.8 | ) |
Optical
Assemblies | |
| 1,508 | | |
| 1,145 | | |
| 363 | | |
| 31.7 | |
Laser
Filters | |
| 557 | | |
| 937 | | |
| (380 | ) | |
| (40.6 | ) |
Day
Windows | |
| 161 | | |
| 220 | | |
| (59 | ) | |
| (26.8 | ) |
Other | |
| 195 | | |
| 181 | | |
| 14 | | |
| 7.7 | |
Applied
Optics Center – Dallas | |
| 2,421 | | |
| 2,483 | | |
| (62 | ) | |
| (2.5 | ) |
Total
Revenue | |
$ | 4,040 | | |
$ | 4,340 | | |
$ | (300 | ) | |
| (6.9 | ) |
Optex
Systems Richardson revenue decreased by $238 thousand or 12.8% for the three months ended January 1, 2023 as compared to the three months
ended January 2, 2022 on lower customer demand for sighting system repairs and muzzle reference systems (other) as compared to the prior
year period. In addition, shipments against existing periscope orders have been delayed into the next quarter due to supplier and manpower
shortages. We anticipate higher revenue beginning during the second quarter and increasing through the second half of fiscal year 2023
as the supplier and labor shortages are resolved and the backlog has significantly increased on new orders. We anticipate additional
periscope orders for delivery in the last fiscal quarter of 2023.
Applied
Optics Center revenue decreased by $62 thousand or 2.5% for the three months ended January 1, 2023 as compared to the three months ended
January 2, 2022. The revenue decrease is primarily attributable to customer requested shipment delays for our laser filter units for
a large defense contractor to accommodate their ongoing facility move. Based on current backlog and the post-move adjusted customer delivery
schedule, we are anticipating revenue to begin increasing during the next quarter with more significant increases occurring during the
second half of the fiscal year.
Gross
Profit. The gross margin during the three-month period ended January 1, 2023 was 17.7% of revenue as compared to a gross margin of
19.0% of revenue for the period ended January 2, 2022. The gross profit decreased by $106 thousand to $717 thousand for the three months
ended January 1, 2023 as compared to $823 thousand in the prior year three months. The decrease in gross profit is primarily attributable
to lower revenue spread across a relatively fixed cost base, changes in mix between products and operating segments and material and
labor inflationary pressure on our long-term contracts. Cost of sales decreased to $3.3 million for the current period as compared to
the prior year period of $3.5 million on lower period revenue and increased cost.
G&A
Expenses. During the three months ended January 1, 2023 and January 2, 2022, we recorded operating expenses of $999 thousand and
$808 thousand, respectively. Operating expenses increased by 23.6% between the respective periods primarily due to increased labor costs,
office expenses, legal and audit fees.
Operating
(Loss) Income. During the three months ended January 1, 2023, we recorded an operating loss of ($282) thousand, as compared to operating
income of $15 thousand during the three months ended January 2, 2022. The $297 thousand decrease in operating income for the current
year period from the prior year period is primarily due to lower gross profit and increased general and administrative costs in the current
year quarter as compared to the prior year quarter.
Net
(Loss) Income applicable to common shareholders. During the three months ended January 1, 2023, we recorded a net loss applicable
to common shareholders of ($223) thousand as compared to a net income applicable to common shareholders of $29 thousand during the three
months ended January 2, 2022. The change in net income of $252 thousand is primarily attributable to lower revenue and gross profit combined
with increased general and administrative costs.
Liquidity
and Capital Resources
As
of January 1, 2023, the Company had working capital of $9.7 million, as compared to $10.0 million as of October 2, 2022.
During
the three months ended January 1, 2023, we generated operating cash flow of $451 thousand and spent ($90) thousand on acquisitions of
property and equipment.
The Company has capital commitments
of $209 thousand for the purchase of property and equipment consisting of an ultrasonic aqueous system and a reflectometer device during
the next ninety days.
Backlog
as of January 1, 2023 was $40.1 million as compared to a backlog of $32.9 million and $26.5 million as of October 2, 2022 and January
2, 2022, respectively, and representing an increase of 21.9% and 51.3%, respectively.
The
Company has historically funded its operations through cash from operations, convertible notes, common and preferred stock offerings
and bank debt. The Company’s ability to generate positive cash flows depends on a variety of factors, including the continued development
and successful marketing of the Company’s products. At January 1, 2023, the Company had approximately $1.3 million in cash and
an outstanding payable balance of zero against its $2.0 million line of credit. As of January 1, 2023, our outstanding accounts receivable
was $1.6 million. We expect the accounts to be collected during the second quarter of fiscal 2023.
Recently
experienced supplier delays, labor shortages, and customer schedule changes negatively impacted our revenue during the three months ended
January 1, 2023 but are expected to abate during the second quarter of fiscal year 2023. As described in more detail below, in November
2022, we increased our line of credit to $2.0 million from $1.125 million, to facilitate our working capital requirements due to the
delays and increased backlog. We anticipate higher revenue beginning during the second quarter and increasing through the second half
of fiscal year 2023 as the supplier and labor shortages combined with customer schedule delays are resolved and the backlog has significantly
increased on new orders.
In
the short term, the Company plans to utilize its current cash, open line of credit and operating cash flow to fund inventory purchases
in support of the backlog growth and higher anticipated revenue during the next nine months. Short term cash in excess of our working
capital needs may be also be used to fund the purchase of property and equipment required to maintain or meet our growing backlog in
addition to repurchasing common stock against our current stock repurchase plan. Longer term, excess cash beyond our operating needs
may be used to fund new product development, company or product line acquisitions, or additional stock purchases as attractive opportunities
present themselves.
In
some instances, new government contract awards may allow for contract financing in the form of progress payments pursuant to Federal
Acquisition Regulation 52.232-16, “Progress Payments.” Subject to certain limitations, this clause provides for government
payment of up to 90% of incurred program costs prior to product delivery for small businesses like us. To the extent any contracts allow
for progress payments and the respective contracts would result in significant preproduction cash requirements for design, process development,
tooling, material or other resources which could exceed our current working capital or line of credit availability, we intend to utilize
this benefit to minimize any potential negative impact on working capital prior to receipt of payment for the associated contract deliveries.
Currently none of our existing contracts allow for progress payments.
The
Company expects to generate net income and positive cash flow from operating activities over the next nine months. To achieve and retain profitability,
we need to maintain a level of revenue adequate to support our cost structure. Management intends to manage operations commensurate with
its level of working capital and line of credit during the next nine months and beyond; however, uneven revenue levels driven by changes
in customer delivery demands, first article inspection requirements or other program delays associated with the pandemic, labor shortages
and supply chain issues could create a working capital shortfall. In the event the Company does not successfully implement its ultimate
business plan, certain assets may not be recoverable.
On
April 12, 2022, the Company and its subsidiary, Optex Systems, Inc. (collectively with the Company, the “Borrowers”), entered
into an Amended and Restated Loan Agreement (the “Loan Agreement”) with PNC Bank, National Association, successor to BBVA
USA (the “Lender”), pursuant to which the Borrowers’ existing revolving line of credit facility was decreased from
$2.25 million to $1.125 million, and the maturity date was extended from April 15, 2022 to April 15, 2023.
The
Loan Agreement requires the Borrowers to maintain a fixed charge coverage ratio of at least 1.25:1.
On
November 21, 2022, the Borrowers issued an Amended and Restated Revolving Line of Credit Note (the “Line of Credit Note”)
to the Lender in connection with an increase of the Borrowers’ revolving line of credit facility under the Loan Agreement from
$1.125 million to $2.0 million. The maturity date remains April 15, 2023. Obligations outstanding under the credit facility will accrue
interest at a rate equal to the Lender’s prime rate minus 0.25%.
The
Line of Credit Note and Loan Agreement contain customary events of default and negative covenants, including but not limited to those
governing indebtedness, liens, fundamental changes, investments, and restricted payments. The credit facility is secured by substantially
all of the operating assets of the Borrowers as collateral. The Borrowers’ obligations under the credit facility are subject to
acceleration upon the occurrence of an event of default as defined in the Line of Credit Note and Loan Agreement.
We
intend to renew or replace the line of credit facility. If adequate funds are not available on acceptable terms, or at all, we may be
unable to finance our operations, develop or enhance our products, expand our sales and marketing programs, take advantage of future
opportunities or respond to competitive pressures.
On
September 22, 2021 the Company announced authorization for an additional $1 million stock repurchase program. As of January 1, 2023,
there was an authorized balance of $560 thousand remaining to be spent against the repurchase program. During the three months ended
January 1, 2023, there were no stock repurchases against the plan.
Critical
Accounting Estimates
A
critical accounting estimate is an estimate that:
|
● |
is
made in accordance with generally accepted accounting principles, |
|
|
|
|
● |
involves
a significant level of estimation uncertainty, and |
|
|
|
|
● |
has
had or is reasonably likely to have a material impact on the company’s financial condition or results of operation. |
Our
significant accounting policies are fundamental to understanding our results of operations and financial condition. Some accounting policies
require that we use estimates and assumptions that may affect the value of our assets or liabilities and financial results. These policies
are described in Note 2 (Accounting Policies) to consolidated financial
statements in our Annual Report on Form 10-K for the year ended October 2, 2022.
Our
critical accounting estimates include warranty costs, contract losses and the deferred tax asset valuation. Future warranty costs are
based on the estimated cost of replacement for expected returns based upon our most recent experience rate of defects as a percentage
of warranty covered sales. Our warranty covered sales primarily include the Applied Optics Center optical assemblies. While our warranty
period is 12 months, our reserve balances assume a general 90-day return period for optical assemblies previously delivered plus any
returned backlog inhouse that has not yet been repaired or replaced to our customer. If our actual warranty returns should significantly
exceed our historical rates on new customer products, significant production changes, or substantial customer changes to the 90-day turn-around
times on returned goods, the impact could be material to our operating profit. We have not experienced any significant changes to our
warranty trends in the preceding three years and do not anticipate any significant impacts in the near term. We monitor the actual warranty
costs incurred to the expected values on a quarterly basis and adjust our estimates accordingly. As of January 1, 2023, the Company had
accrued warranty costs of $229 thousand, as compared to $169 thousand as of October 2, 2022. The primary reason for the $60 thousand
increase in reserve balances relates to an increase in customer returned backlog pending repair or replacement to our customer during
the preceding three-month period.
As
of January 1, 2023 and October 2, 2022, we had $282 thousand, and $289 thousand, respectively, of contract loss reserves included in
our balance sheet accrued expenses. These loss contracts are related to some of our older legacy periscope IDIQ contracts which were
priced in 2018 through early 2020, prior to COVID-19 and the significant downturn in defense spending on ground system vehicles. Due
to inflationary price increases on component parts and higher internal manufacturing costs (as a result of escalating labor costs and
higher burden rates on reduced volume), some of these contracts are in a loss condition, or at marginal profit rates. These contracts
are typically three-year IDIQ contracts with two optional award years, and as such, we are obligated to accept new task awards against
these contracts until the contract expiration. Should contract costs continue to increase above the negotiated selling price, or in the
event the customer should release substantial quantities against these existing loss contracts, the losses could be material. For contracts
currently in a loss status based on the estimated per unit contract costs, losses are booked immediately on new task order awards. Some of these long-term contracts have option year ordering periods ending
in February 2025 with deliveries that may extend into February 2026. During
the three months ended January 1, 2023, the Company recognized additional expenses for contract loss reserves of $51 thousand on new
task awards against the long-term fixed contracts and applied $58 thousand of the reserves against revenues booked during the period.
There is no way to reasonably estimate future inflationary impacts, or customer awards on the existing loss contracts.
As
of January 1, 2023 and October 2, 2022, our deferred tax assets consisted of $1.8 million, partially offset by a valuation reserve of
$0.8 million against those assets for a net deferred tax asset of $1.0 million. The valuation allowance covers certain deferred tax assets
where we believe we will be unlikely to recover those tax assets through future operations. The valuation reserve includes assumptions
related to future taxable income which would be available to cover net operating loss carryforward amounts. Because of the uncertainties
of future income forecasts combined with the complexity of some of the deferred assets, these forecasts are subject to change over time.
While we believe our current estimate to be reasonable, changing market conditions and profitability, changes in equity structure and
changes in tax regulations may impact our estimated reserves in future periods.
Item
3. Quantitative and Qualitative Disclosures about Market Risk.
Not
applicable.
Item
4. Controls and Procedures
Evaluation
of Disclosure Controls and Procedures
As
of the end of the period covered by our Quarterly Report on Form 10-Q for the quarter ended January 1, 2023, management performed, with
the participation of our Principal Executive Officer and Principal Financial Officer, an evaluation of the effectiveness of our disclosure
controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Our disclosure controls and procedures are designed
to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized,
and reported within the time periods specified in the SEC’s forms, and that such information is accumulated and communicated to
our management, including our Principal Executive Officer and our Principal Financial Officer, to allow timely decisions regarding required
disclosures. Based upon the evaluation described above, our Principal Executive Officer and our Principal Financial Officer concluded
that, as of January 1, 2023, our disclosure controls and procedures were effective.
Changes
in Internal Control Over Financial Reporting
During
the three months ended January 1, 2023, there were no changes in our internal control over financial reporting that have materially affected,
or are reasonably likely to materially affect, our internal control over financial reporting.