Item
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The
following discussion should be read in conjunction with the consolidated financial statements and the related notes that are set forth
in our financial statements elsewhere in this Annual Report.
This
management’s discussion and analysis reflects information known to management as of our fiscal year end, October 2, 2022, and the
date of filing. This MD&A is intended to supplement and complement our audited financial statements and notes thereto for the year
ended October 2, 2022, prepared in accordance with U.S. generally accepted accounting principles (GAAP). You are encouraged to read our
financial statements in conjunction with 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
measures 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. This discussion contains forward-looking statements. Please see “Special
cautionary statement concerning forward-looking statements” and “Risk factors” for a discussion of the uncertainties,
risks and assumptions associated with these forward-looking statements. The operating results for the periods presented were not significantly
affected by inflation.
All
references in the following section to 2021 or 2022 with respect to our financial position and results of operations are to our fiscal
years ended October 3, 2021 or October 2, 2022, respectively.
Background
Optex
Systems, Inc. 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 our 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 NAMSA and South American countries and as a subcontractor for several large U.S. defense companies
serving foreign governments.
By
way of background, 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”. 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 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 and Material Trends
Refer
to “Item 1. Business – Market Opportunity: U.S. Military” 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.
Refer
to “Item 1A. Risk Factors – Risks Related to Our Business - Certain of our products are dependent on specialized
sources of supply potentially subject to disruption which could have a material, adverse impact on our business” for a description
of recent supply chain disruptions, which 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.
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 to date 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 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.
We
expect the combination of these issues to negatively impact our revenue during the first three months of
fiscal year 2023. Our first quarter revenue projection is expected to be approximately 8-9% below the 2022 first quarter level.
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 revenue and working capital in the second half of fiscal year 2023 to
increase significantly from the first six months with a full 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.
Refer
to “Item 1. Business – Recent Events” of this report for recent material events affecting the Company.
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. 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 (to which we refer
below as the Optex Systems segment or Optex Systems), and the Applied Optics Center, Dallas plant, which was acquired on November 3,
2014 (to which we refer below as the Applied Optics Center segment or Applied Optics Center), 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 years ended October 2, 2022 and October 3, 2021 reconciled to the Audited Consolidated Results of Operations as presented
in Item 8, “Financial Statements and Supplementary Data”.
Results
of Operations Selective Financial Info
(Thousands)
| |
Twelve
months ended | |
| |
October
2, 2022 | | |
October
3, 2021 | |
| |
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 | |
$ | 9,533 | | |
$ | 12,850 | | |
$ | - | | |
$ | 22,383 | | |
$ | 11,827 | | |
$ | 6,395 | | |
$ | - | | |
$ | 18,222 | |
Intersegment
Revenues | |
| - | | |
| 879 | | |
| (879 | ) | |
| - | | |
| - | | |
| 1,056 | | |
| (1,056 | ) | |
| - | |
Total
Segment Revenue | |
| 9,533 | | |
| 13,729 | | |
| (879 | ) | |
| 22,383 | | |
| 11,827 | | |
| 7,451 | | |
| (1,056 | ) | |
| 18,222 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Total
Cost of Sales | |
| 8,441 | | |
| 9,924 | | |
| (879 | ) | |
| 17,486 | | |
| 9,934 | | |
| 6,824 | | |
| (1,056 | ) | |
| 15,702 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Gross
Margin | |
| 1,092 | | |
| 3,805 | | |
| - | | |
| 4,897 | | |
| 1,893 | | |
| 627 | | |
| - | | |
| 2,520 | |
Gross
Margin % | |
| 11.5 | % | |
| 27.7 | % | |
| - | | |
| 21.9 | % | |
| 16.0 | % | |
| 8.4 | % | |
| - | | |
| 13.8 | % |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
General
and Administrative Expense | |
| 2,613 | | |
| 475 | | |
| 162 | | |
| 3,250 | | |
| 2,319 | | |
| 467 | | |
| 228 | | |
| 3,014 | |
Segment
Allocated G&A Expense | |
| (1,141 | ) | |
| 1,141 | | |
| - | | |
| - | | |
| (677 | ) | |
| 677 | | |
| - | | |
| - | |
Net
General & Administrative Expense | |
| 1,472 | | |
| 1,616 | | |
| 162 | | |
| 3,250 | | |
| 1,642 | | |
| 1,144 | | |
| 228 | | |
| 3,014 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Operating
Income (Loss) | |
| (380 | ) | |
| 2,189 | | |
| (162 | ) | |
| 1,647 | | |
| 251 | | |
| (517 | ) | |
| (228 | ) | |
| (494 | ) |
Operating
Income (Loss) % | |
| (4.0 | )% | |
| 15.9 | % | |
| - | | |
| 7.4 | % | |
| 2.1 | % | |
| (6.9 | %) | |
| - | | |
| (2.7 | )% |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Gain
(Loss) on Change in Fair Value of Warrants | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| 2,535 | | |
| 2,535 | ) |
Interest
Expense | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| (11 | ) | |
| (11 | ) |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Income
(Loss) before taxes | |
$ | (380 | ) | |
| 2,189 | | |
| (162 | ) | |
| 1,647 | | |
$ | 251 | | |
$ | (517 | ) | |
$ | 2,296 | | |
$ | 2,030 | |
Income
(loss) before taxes % | |
| (4.0 | )% | |
| 15.9 | % | |
| - | | |
| 7.4 | % | |
| 2.1 | % | |
| (6.9 | %) | |
| - | | |
| 11.1 | % |
Our
total external sales revenues increased by $4.2 million in the fiscal year 2022, or 23.1% compared to the 2021 fiscal year. The Optex
Systems segment realized a $2.3 million decrease and the Applied Optics Center segment realized an increase of $6.5 million in external
revenue compared to the prior year period. Intersegment revenues decreased by $0.2 million to $0.9 million in 2022 from $1.1 million
in 2021. Intersegment revenues relate primarily to coated filters provided by the Applied Optics Center to Optex Systems in support of
the Optex Systems periscope line.
Gross
margin increased $2.4 million and the gross margin percentage increased by 8.1 points from 13.8% in the 2021 fiscal year to 21.9% in
the 2022 fiscal year. The Optex Systems gross margin decreased by $0.8 million and the gross margin percentage decreased to 11.5% as
compared to 16.0% in the prior year period on lower revenue. The Applied Optics Center gross margin increased by $3.2 million and the
gross margin percentage increased by 19.3 points to 27.7% as compared to the prior year period of 8.4%. The increase in the consolidated
gross margin is primarily attributable to a significant shift in revenue from the Optex-Richardson segment to higher margin products
in the Applied Optics segment combined with higher absorption of the Applied Optics segment fixed overhead cost base associated with
higher production levels.
During
the years ended 2022 and 2021, Applied Optics Center absorbed $1.1 million and $0.7 million of fixed general and administrative costs
incurred by Optex Systems for support services. The increase in allocated general and administrative expenses during the 2022 year is
directly attributable to the shift in revenue volume between segments. These expenses cover accounting, executive, human resources, information
technology, board fees and other corporate expenses paid by Optex Systems and shared across both operating segments.
Operating
income increased by $2.1 million in the year ended October 2, 2022 to an income of $1.6 million as compared to the prior year operating
loss of $(0.5) million. The increase in operating income is primarily attributable to increased revenue and gross margin at the Applied
Optics Center segment.
Income
before taxes decreased $0.4 million, to $1.6 million in the 2022 fiscal year from a prior year income before taxes of $2.0 million. The
decrease in income before taxes year over year is primarily due to the expiration of the warrants in 2021 which generated a gain on change
in fair valuation of warrants of $2.5 million in the prior year and which is partially offset by the higher operating profit in 2022.
Backlog
During
the twelve months ended October 2, 2022, the Company booked $28.0 million in new orders, representing a 4.1% decrease from the prior
year period orders of $29.2 million. The orders for the most recently completed twelve months consist of $13.5 million for our Optex
Richardson segment and $14.5 million attributable to the Applied Optics Center segment.
The
following table depicts the new customer orders for the twelve months ending October 2, 2022 as compared to the prior year period in
millions of dollars:
| |
(Millions) | |
Product Line | |
Twelve months ended October 2, 2022 | | |
Twelve months ended October 3, 2021 | | |
Variance | | |
% Chg | |
Periscopes | |
$ | 9.2 | | |
$ | 7.6 | | |
$ | 1.6 | | |
| 21.1 | % |
Sighting Systems | |
| 0.7 | | |
| 1.2 | | |
| (0.5 | ) | |
| (41.7 | )% |
Howitzer | |
| - | | |
| - | | |
| - | | |
| - | % |
Other | |
| 3.6 | | |
| 0.8 | | |
| 2.8 | | |
| 350.0 | % |
Optex Systems – Richardson | |
| 13.5 | | |
| 9.6 | | |
| 3.9 | | |
| 40.6 | % |
Optical Assemblies | |
| 6.7 | | |
| 6.1 | | |
| 0.6 | | |
| 9.8 | % |
Laser Filters | |
| 4.7 | | |
| 11.9 | | |
| (7.2 | ) | |
| (60.5 | )% |
Day Windows | |
| 1.9 | | |
| 0.7 | | |
| 1.2 | | |
| 171.4 | % |
Other | |
| 1.2 | | |
| 0.9 | | |
| 0.3 | | |
| 33.3 | % |
Applied Optics Center – Dallas | |
| 14.5 | | |
| 19.6 | | |
| (5.1 | ) | |
| (26.0 | )% |
Total Customer Orders | |
$ | 28.0 | | |
$ | 29.2 | | |
$ | (1.2 | ) | |
| (4.1 | )% |
The
primary reason for the decline in orders in 2022 as compared to 2021 relates to the $8.4 million order awarded in August 2021 for laser
filters which was deliverable over twenty-four months. We anticipate future awards against this program as we near completion of the
current contract. In addition, in 2021 we received a $0.4 million award for sighting systems which are deliverable in 2023.
The
Optex Systems Richardson segment currently has seven open US Government IDIQ type military contracts for periscopes with unspent funding
which covers government base year and option year requirement periods into 2025. We anticipate additional orders throughout the next
three years for these contracts.
Optex
Systems Holdings continues to pursue new international and commercial opportunities in addition to maintaining its current footprint
with U.S. military vehicle manufacturers, with existing as well as new product lines. We are also reviewing potential products, outside
our traditional product lines, which could be manufactured using our current production facilities in order to capitalize on our existing
capacity. Further, we continue to look for strategic businesses to acquire that will strengthen our existing product line, expand our
operations, and enter new markets.
Backlog
as of October 2, 2022 was $32.9 million as compared to a backlog of $27.3 million as of October 3, 2021, representing an increase of
20.5%. The following table depicts the current expected delivery by quarter of all contracts awarded as of October 2, 2022.
(Millions)
Product Line | |
Q1 2023 | | |
Q2 2023 | | |
Q3 2023 | | |
Q4 2023 | | |
2023 Delivery | | |
2024+ Delivery | | |
Total Backlog 10/2/2022 | | |
Total Backlog 10/3/2021 | | |
Variance | | |
% Chg | |
Periscopes | |
$ | 1.4 | | |
$ | 2.6 | | |
$ | 1.9 | | |
$ | 0.1 | | |
$ | 6.0 | | |
$ | 1.6 | | |
$ | 7.6 | | |
$ | 5.6 | | |
$ | 2.0 | | |
| 35.7 | % |
Sighting Systems | |
| 0.2 | | |
| 0.6 | | |
| 0.1 | | |
| 0.1 | | |
| 1.0 | | |
| 0.7 | | |
| 1.7 | | |
| 1.7 | | |
| - | | |
| - | % |
Howitzer | |
| - | | |
| - | | |
| 0.1 | | |
| 0.3 | | |
| 0.4 | | |
| 1.9 | | |
| 2.3 | | |
| 2.3 | | |
| - | | |
| - | % |
Other | |
| 0.1 | | |
| 0.9 | | |
| 0.3 | | |
| 0.9 | | |
| 2.2 | | |
| 1.2 | | |
| 3.4 | | |
| 1.4 | | |
| 2.0 | | |
| 142.9 | % |
Optex Systems – Richardson | |
| 1.7 | | |
| 4.1 | | |
| 2.4 | | |
| 1.4 | | |
| 9.6 | | |
| 5.4 | | |
| 15.0 | | |
| 11.0 | | |
| 4.0 | | |
| 36.4 | % |
Optical Assemblies | |
| 1.3 | | |
| 2.1 | | |
| 1.3 | | |
| 1.0 | | |
| 5.7 | | |
| 1.1 | | |
| 6.8 | | |
| 5.0 | | |
| 1.8 | | |
| 36.0 | |
Laser Filters | |
| 0.4 | | |
| 1.2 | | |
| 2.4 | | |
| 1.4 | | |
| 5.4 | | |
| 3.3 | | |
| 8.7 | | |
| 9.9 | | |
| (1.2 | ) | |
| (12.1 | ) |
Day Windows | |
| 0.2 | | |
| 0.1 | | |
| 0.2 | | |
| 0.1 | | |
| 0.6 | | |
| 1.4 | | |
| 2.0 | | |
| 1.1 | | |
| 0.9 | | |
| 81.8 | |
Other | |
| 0.3 | | |
| - | | |
| - | | |
| - | | |
| 0.3 | | |
| 0.1 | | |
| 0.4 | | |
| 0.3 | | |
| 0.1 | | |
| 33.3 | |
Applied Optics Center – Dallas | |
| 2.2 | | |
| 3.4 | | |
| 3.9 | | |
| 2.5 | | |
| 12.0 | | |
| 5.9 | | |
| 17.9 | | |
| 16.3 | | |
| 1.6 | | |
| 9.8 | % |
Total Backlog | |
$ | 3.9 | | |
$ | 7.5 | | |
$ | 6.3 | | |
$ | 3.9 | | |
$ | 21.6 | | |
$ | 11.3 | | |
$ | 32.9 | | |
$ | 27.3 | | |
$ | 5.6 | | |
| 20.5 | % |
Optex
Systems - Richardson
During
the twelve months ended October 2, 2022, backlog for our Optex Richardson segment increased by 36.4%, or 4.0 million to $15.0 million,
as compared to the prior year ending backlog of $11.0 million.
Backlog
for our periscope product line has increased 35.7% or $2.0 million to $7.6 million, from our 2021 fiscal year end level of $5.6 million.
Sighting
Systems and Howitzer product line backlog remained flat during the twelve months ended October 2, 2022 as compared to the prior year
end backlog at $1.7 million and $2.3 million, respectively. The Howitzer contract awarded in July 2020 continues to experience customer
driven delays related to customer furnished materials. We expect to complete the first article testing during the third fiscal quarter
and to begin production deliveries during the fourth fiscal quarter of 2023.
Our
backlog in other product groups increased by $2.0 million or 142.9% from $1.4 million in 2021 to $3.4 million in 2022 on new orders booked
during the twelve months ended October 2, 2022, primarily for muzzle reference systems for a major U.S. defense contractor.
Applied
Optics Center – Dallas
The
Applied Optics Center backlog increased by $1.6 million, or 9.8%, for the year ended October 2, 2022, from $16.3 million in 2021 to $17.9
million in 2022.
Backlog
for our optical assemblies increased by $1.8 million, or 36.0%, as compared to the prior year on new orders from one of our commercial
customers.
Laser
filter backlog decreased by $1.2 million, or 12.1%, during the year due to shipments against our long term laser filter unit contract.
Day
window backlog increased by $0.9 million during the period as compared to the prior year on new orders from a major U.S. defense contractor.
Other
backlog increased by $0.1 million, or 33.3% for the year ended October 2, 2022, on new orders booked during the period for specialty
coatings.
Twelve
month period ended October 2, 2022 compared to the twelve month period ended October 3, 2021
Revenues
The
table below details the revenue changes by segment and product line for the year ended October 2, 2022 as compared to the year ended
October 3, 2021.
Twelve months ended
(Millions)
Product Line | |
October
2, 2022 | | |
October 3, 2021 | | |
Variance | | |
% Chg | |
Periscopes | |
$ | 7.2 | | |
$ | 7.2 | | |
$ | - | | |
| - | |
Sighting Systems | |
| 0.8 | | |
| 2.3 | | |
| (1.5 | ) | |
| (65.2 | ) |
Howitzers | |
| - | | |
| 0.2 | | |
| (0.2 | ) | |
| (100.0 | ) |
Other | |
| 1.5 | | |
| 2.1 | | |
| (0.6 | ) | |
| (28.6 | ) |
Optex Systems – Richardson | |
| 9.5 | | |
| 11.8 | | |
| (2.3 | ) | |
| (19.5 | ) |
Optical Assemblies | |
| 4.9 | | |
| 1.9 | | |
| 3.0 | | |
| 157.9 | |
Laser Filters | |
| 5.9 | | |
| 3.0 | | |
| 2.9 | | |
| 96.7 | |
Day Windows | |
| 1.0 | | |
| 1.0 | | |
| - | | |
| - | |
Other | |
| 1.1 | | |
| 0.5 | | |
| 0.6 | | |
| 120.0 | |
Applied Optics Center – Dallas | |
| 12.9 | | |
| 6.4 | | |
| 6.5 | | |
| 101.6 | |
Total Revenue | |
$ | 22.4 | | |
$ | 18.2 | | |
$ | 4.2 | | |
| 23.1 | |
Our
total revenues increased by $4.2 million, or 23.1% in fiscal year 2022 compared to fiscal year 2021. The Optex Systems Richardson segment
realized a $2.3 million, or 19.5%, decrease in revenue and the Applied Optics Center segment realized an increase of $6.5 million, or
101.6%, in revenue compared to the prior year period.
Optex
Systems - Richardson
Revenues
on our periscope line remained flat at $7.2 million during the twelve months ended October 2, 2022 and October 3, 2021.
Revenues
on sighting systems decreased by $1.5 million, or 65.2% from the prior year period due to completion of the Commander Weapon Sighting
Systems in the prior year with no follow-on order for the current year period, combined with lower revenue on the DDAN and OWSS repair
units during the current year as compared to the prior year. Lower revenue during the year is attributable to reductions in US spending
for military ground systems.
Revenue
on Howitzers decreased by $0.2 million, to zero, compared to revenues of $0.2 million in the prior fiscal year due to customer driven
delays against our Aiming Circle XM10 optical assemblies contract awarded in 2020.
Optex
Systems-Richardson revenue on other product lines decreased by $0.6 million, or 28.6%, compared to revenues in the prior year due to
lower contract demand on MRS collimators and cell assemblies attributable to reductions in US spending for military ground systems.
Applied
Optics Center - Dallas
Revenue
on optical assemblies increased by $3.0 million, or 157.9%, during the twelve months ended October 2, 2022 as compared to the prior twelve-month
period on significantly higher demand on several rifle scope assemblies from one of our major commercial customers.
Laser
filter revenue increased by $2.9 million, or 96.7%, during the twelve months ended October 2, 2022 as compared to the prior twelve-month
period on significantly higher demand for laser filter units from multiple defense contract customers.
Revenues
on our day windows remained flat at $1.0 million during the twelve months ended October 2, 2022 and October 3, 2021 as we continue to
ship against our existing contracts.
Applied
Optics Center revenue for other product lines increased by $0.6 million, or 120.0%, during the twelve months ended October 2, 2022 as
compared to the prior twelve-month period on increased revenue for unity mirrors and specialty coatings.
Gross
Margin. The gross margin for the year ended October 2, 2022 was 21.9% of revenue as compared to a gross margin of 13.8% of revenue
for the year ended October 3, 2021. Cost of sales increased by $1.8 million to $17.5 million for 2022 compared to $15.7 million for 2022.
The gross margin increased by $2.4 million to $4.9 million in 2022 as compared to $2.5 million in 2021. The increase is primarily due
to higher revenue and shifts between segments and product lines combined with higher fixed cost absorption at the Applied Optics Center
segment related to increased production volume.
G&A
Expenses. For the years ended October 2, 2022 and October 3, 2021, we recorded operating expenses of $3.3 million and $3.0 million,
respectively. General and administrative cost increases of $0.3 million, or 10%, during fiscal year 2022 are primarily attributable to
increased labor and expenses based on labor, increased office expenses and higher selling expenses as compared to the prior year.
Operating
Income. For the year ended October 2, 2022, we recorded an operating income of $1.6 million as compared to operating loss of $(0.5)
million during the year ended October 3, 2021. The $2.1 million increase in operating income in the current year over the prior year
is primarily due to higher revenue and gross margin, partially offset by increased general and administrative expenses.
Net
income applicable to common shareholders. During the year ended October 2, 2022, we recorded net income applicable to common shareholders
of $1.3 million as compared to net income applicable to common shareholders of $1.5 million during the year ended October 3, 2021. The
decrease of net income of $0.2 million is primarily attributable to the elimination of the warrants which expired in 2021 and resulted
in a $2.5 million gain during the prior year twelve-month period, and a change in tax expenses of $0.5 million as compared to 2021. The
change in income due to the warrants and taxes is partially offset by higher revenue and operating income of $2.1 million in the current
year as compared to the prior year period and elimination of the deemed dividends of $0.7 million associated with the warrants which
expired in 2021.
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 twelve-month operating results for the periods ended October 2, 2022 and October 3, 2021, in terms of both
the GAAP net income measure and the non-GAAP Adjusted EBITDA measure.
| |
(Thousands) Twelve months ended | |
| |
October
2, 2022 | | |
October
3, 2021 | |
| |
| | |
| |
Net Income — GAAP | |
$ | 1,283 | | |
$ | 2,131 | |
Add: | |
| | | |
| | |
Gain on Change in Fair Value of Warrants | |
| - | | |
| (2,535 | ) |
Federal Income Tax Expense (Benefit) | |
| 364 | | |
| (101 | ) |
Depreciation | |
| 307 | | |
| 263 | |
Stock Compensation | |
| 162 | | |
| 228 | |
Interest Expense | |
| - | | |
| 11 | |
Adjusted EBITDA - Non GAAP | |
$ | 2,116 | | |
$ | (3 | ) |
Our
Adjusted EBITDA increased by $2.1 million to $2.1 million during the twelve months ended October 2, 2022 as compared to $0.0 million
during the twelve months ended October 3, 2021. The increase in EBITDA is primarily driven by increased revenue and operating profit
during the current year as compared to the prior year twelve-month period. Operating segment performance is discussed in greater detail
throughout the previous sections.
Liquidity
and Capital Resources
As
of October 2, 2022, Optex Systems Holdings had working capital of $10.0 million, as compared to $12.9 million as of October 3, 2021.
During the twelve months ended October 2, 2022, we generated operating cash flow of $2.0 million and spent ($4.7) million for the purchase
of shares against our stock repurchase plan and common stock tender offer and ($0.25) million on acquisitions of property and equipment.
Backlog
as of October 2, 2022 was $32.9 million as compared to a backlog of $27.3 million as of October 3, 3021, representing an increase of
20.5%.
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 October 2, 2022, the Company had approximately $0.9 million in cash and
an outstanding payable balance of zero against its then $1.125 million line of credit (which has since been increased to $2.0 million).
As of October 2, 2022, our outstanding accounts receivable was $2.9 million. We expect the accounts to be collected during the first
quarter of fiscal 2023.
Recently
experienced supplier delays, labor shortages, and customer schedule changes are expected to negatively impact our revenue during the
first three months 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. We anticipate revenues, and working capital, in
the second half of fiscal year 2023 to increase significantly from the first six months with a full recovery expected by fiscal year
end 2023.
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 twelve 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.
Some
of our contracts may allow for government contract financing in the form of contract 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.
The
Company expects to generate net income and positive cash flow from operating activities over the next twelve months. To remain profitable,
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 facilities line of credit during the next twelve 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 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 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. These shares represented approximately
19.3% of its shares of common stock outstanding as of September 15, 2022. Because the tender offer was oversubscribed, the Company accepted
for payment only a pro-rated portion of the shares of common stock properly tendered by each tendering stockholder (other than “odd
lot” holders whose shares were purchased on a priority basis).
On
September 22, 2021 the Company announced authorization for an additional $1 million stock repurchase program. During the twelve months
ended October 2, 2022, the Company purchased 190,954 common shares under the September 2021 stock repurchase plan at a cost of $371 thousand.
As of October 2, 2022, there were zero shares held in treasury. As of October 2, 2022, there was an authorized balance of $560 thousand
remaining to be spent against the repurchase program.
During
the twelve months ended October 2, 2022 the Company declared and paid no dividends. As of October 2, 2022, there are no outstanding declared
and unpaid dividends.
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 “Summary of Significant Accounting Policies” of Item 8 “Financial Statements and Supplementary
Data” of this report.
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 in-house 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 October 2, 2022, the Company had
accrued warranty costs of $169 thousand, as compared to $78 thousand as of October 3, 2021. The primary reason for the $91 thousand increase
in reserve balances relates to higher revenue on warrantied product being sold during the twelve months ended October 2, 2022, combined
with an increase in customer returned backlog pending repair or replacement to our customer as compared to the warranty backlog as of
October 3, 2021.
As
of October 2, 2022 and October 3, 2021, we had $289 thousand, and $51 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. During the twelve months
ended October 2, 2022, there accrued contract losses increased by $238 thousand on new awards against the active IDIQ contracts. There
is no way to reasonably estimate future inflationary impacts, or customer awards on the existing loss contracts. We continue to monitor
these contracts throughout the year for any significant changes in addition to seeking potential cost saving strategies to mitigate risk.
As
of October 2, 2022 and October 3, 2021, Optex Systems Inc. had a net carrying value of $0.9 million and $1.3 million, respectively in
deferred tax assets. Net deferred tax assets as October 2 2022 and October 3, 2021 consisted of deferred tax assets of $ 1.8 million
and $2.1 million, and valuation reserves of $0.9 million and $0.8 million, respectively. During the twelve-month period ended October
2, 2022, we collected $0.3 million in tax refunds related to the prior year net operating loss carryback in deferred tax assets. 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.
Recent
Accounting Pronouncements
Recent
Accounting Pronouncements are detailed under Note 3 of Item 8 “Financial Statements and Supplementary Data” of this report.
Item
8. Financial Statements and Supplementary Data
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the Board of Directors and Stockholders
Optex
Systems Holdings, Inc.
Opinion
on the Financial Statements
We
have audited the accompanying consolidated balance sheets of Optex Systems Holdings, Inc. and subsidiaries (the
“Company”) as of October 2, 2022 and October 3, 2021, and the related consolidated statements of income,
stockholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the
“financial statements”). In our opinion, the financial statements present fairly, in all material respects, the
financial position of the Company as of October 2, 2022 and October 3, 2021, and the results of their operations and their cash
flows for the years then ended, in conformity with accounting principles generally accepted in the United States of
America.
Basis
for Opinion
These
financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial
statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United
States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities
laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We
conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company
is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits
we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion
on the effectiveness of the entity’s internal control over financial reporting. Accordingly, we express no such opinion.
Our
audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding
the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant
estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits
provide a reasonable basis for our opinion.
Critical
Audit Matter
The
critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was
communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are
material to the financial statements and (2) involved especially challenging, subjective, or complex judgments. The communication of
the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by
communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or
disclosures to which it relates.
Deferred
Taxes
Critical
Audit Matter Description
As
described in notes 2 and 13 to the consolidated financial statements, deferred tax assets and liabilities are determined based on
differing treatment of items for financial reporting and income tax reporting purposes. A valuation allowance is provided for
certain deferred tax assets if it is more likely than not that the Company will not realize tax assets through future operations.
When assessing the recoverability of deferred tax assets, management considers the scheduled reversal of deferred tax liabilities,
projected future taxable income and tax planning strategies, and results of recent operations. Management has determined that a
portion of the deferred tax assets may not be realized and has established a valuation allowance against the deferred tax asset
balance. For the year ended October 2, 2022, the Company has a net carrying value of $0.9 million in deferred tax assets represented
by deferred tax assets of $1.8 million and a deferred tax asset valuation allowance of $0.9 million against those assets.
We
identified the evaluation of the deferred taxes as a critical audit matter because of the significant estimates and assumptions management
used in calculating the deferred tax assets and liabilities as well as the valuation allowance. Performing audit procedures to evaluate
the reasonableness of these estimates and assumptions required a high degree of auditor judgment. Additionally, the audit procedures
performed on deferred taxes required increased audit effort and involved the use of professionals with specialized skill and knowledge.
How
the Critical Audit Matter Was Addressed in the Audit
Our
audit procedures consisted of the following:
| ● | Testing
management’s process for developing the accounting estimate for deferred taxes including
the valuation allowance. |
| ● | Evaluating
the appropriateness of the significant estimates and assumptions used by management, including
the scheduled reversal of deferred tax liabilities, projected future taxable income, and
results of recent operations. We considered the current and past performance of the entity,
the industry in which the Company operates, and whether audit evidence obtained from other
audit procedures resulted in any disconfirming evidence. |
| ● | Testing
the completeness and accuracy of underlying data used in calculating deferred taxes and the
related valuation allowance. |
| | |
| ● | Utilizing
professionals with specialized skill and knowledge to assist in the evaluation of the reasonableness
of deferred taxes and the related valuation allowance. |
/s/
Whitley Penn LLP
We
have served as the Company’s auditor since 2017.
Fort
Worth, Texas
December
19, 2022
PCAOB
ID: 726
Optex
Systems Holdings, Inc.
Consolidated
Balance Sheets
The
accompanying notes are an integral part of these financial statements.
Optex
Systems Holdings, Inc.
Consolidated
Statements of Income
The
accompanying notes are an integral part of these financial statements.
Optex
Systems Holdings, Inc.
Consolidated
Statements of Cash Flows
The
accompanying notes are an integral part of these financial statements.
Optex
Systems Holdings, Inc.
Consolidated
Statement of Stockholders’ Equity
(1) |
Common
shares repurchased in the open market during the twelve months ended October 3, 2021 and October 2, 2022. Shares were held in treasury
using the cost method. As of October 3, 2021, there were 35,555 shares held in treasury at a cost of $69 thousand. As of October
2, 2022, all of the treasury shares have been cancelled. |
|
|
(2) |
Exercise
of warrants for common shares at $1.50 for gross proceeds of $283 thousand and a fair market value of $9 thousand as of the exercise
dates. |
|
|
(3) |
Common
shares repurchased pursuant to the tender offer that closed on September 15, 2022. Total tendered shares of 1,603,773 at $2.65, or
$4.25 million, plus transaction costs of $111 thousand. Repurchased shares were immediately cancelled. |
The
accompanying notes are an integral part of these 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. Optex Systems Holdings 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. Optex Systems Holdings’
operations are based in Dallas and Richardson, Texas in leased facilities comprising 93,967 square feet. As of October 2, 2022, the Company
operated with 84 full-time equivalent employees.
Note
2 — Summary of Significant Accounting Policies
Basis
of Presentation
Principles
of Consolidation: The consolidated financial statements include the accounts of Optex Systems Holdings and its wholly-owned subsidiary,
Optex Systems, Inc. All significant inter-company balances and transactions have been eliminated in consolidation.
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.
Segment
Reporting: FASB ASC 280 requires that a public business enterprise report financial and descriptive information about its reportable
operating segments. Operating segments are components of an enterprise about which separate financial information is available and evaluated
regularly by the chief operating decision maker in decisions regarding resource allocations and performance assessments. Generally, financial
information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to
allocate resources to segments. Segments are determined based on differences in products, 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 FASB ASC 280 requires that a public business enterprise
report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets. It requires reconciliations
of total segment revenues, total segment profit or loss, total segment assets, and other amounts disclosed for segments to corresponding
amounts in the enterprise’s general-purpose financial statements.
Fiscal
Year: Optex System Holdings’ fiscal year ends on the Sunday nearest September 30. Fiscal year 2022 ended on October 2,
2022 and included 52 weeks. Fiscal year 2021 ended on October 3, 2021 and included 53 weeks.
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, 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. Fair values for the Company’s warrant liabilities and derivatives are estimated by utilizing valuation models
that consider current and expected stock prices, volatility, dividends, market interest rates, forward yield curves and discount rates.
Besides the Company’s warrant liabilities, such amounts and the recognition of such amounts are subject to significant estimates
that may change in the future.
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.
Each
of the measurements is considered a Level 3 measurement based on the availability of market data and inputs and the significance of any
unobservable inputs as of the measurement date. The methods and significant inputs and assumptions utilized in estimating the fair value
of the warrant liabilities, as well as the respective hierarchy designations are discussed further in Note 12 “Warrant Liabilities”.
Cash
and Cash Equivalents: For financial statement presentation purposes, Optex Systems Holdings considers those short-term, highly
liquid investments with original maturities of three months or less to be cash or cash equivalents. Optex Systems Holdings has $0.9 million
in cash on deposit with our banks. Only a portion of the cash, currently $250 thousand, would be covered by federal deposit insurance
and the uninsured balances are substantially greater than the insured amounts.
Concentration
of Credit Risk: The Company’s revenues for fiscal year ended October 2, 2022 are derived from sales to U.S. government
agencies (14%), three U.S. defense contractors (22%, 15%, and 7%), one major commercial customer 22%) and all other customers (20%).
The Company’s revenues for fiscal year ended October 3, 2021 are derived from sales to U.S. government agencies (28%), four major
U.S. defense contractors (27%, 11%, 5%, and 5%), one major commercial customer (10%) and all other customers (14%). Optex Systems Holdings
does not believe that this concentration results in undue credit risk because of the financial strength of the obligees.
Accounts
Receivable: Optex Systems Holdings records its accounts receivable at the original sales invoice amount less liquidations for
previously collected advance/progress bills and an allowance for doubtful accounts. An account receivable is considered to be past due
if any portion of the receivable balance is outstanding beyond its scheduled due date. On a quarterly basis, Optex Systems Holdings evaluates
its accounts receivable and establishes an allowance for doubtful accounts, based on its history of past write-offs and collections,
and current credit conditions. No interest is accrued on past due accounts receivable. As of October 2, 2022, and October 3, 2021, Optex
Systems Holdings had an allowance for doubtful accounts of $5 thousand, for non U.S. government account balances greater than 120 days.
As the customer base is primarily U.S. government and government prime contractors, Optex Systems Holdings allowance for doubtful accounts
is minimal. Optex Systems Holdings charges uncollectible accounts to bad debt expense in the period as they are first deemed uncollectible.
In the fiscal year 2022 we recognized $21 thousand in bad debt expenses associated with uncollectible accounts. In the fiscal year 2021
we recognized zero in bad debt expenses associated with uncollectible accounts.
As
of October 2, 2022, 89%
of the accounts receivable balance was comprised of eight customers: the U.S. government, 10%,
five major defense contractors, 14%, 12%, 9%, 8%
and 7%,
a commercial customer, 19%,
and a foreign military customer, 10%.
As of October 3, 2021, 87%
of the accounts receivable balance was comprised of six customers: the U.S. government, 34%,
three major defense contractors, 13%, 10%
and 7%,
and a commercial customer, 16%,
and a foreign military customer, 7%.
Inventory:
Inventory is recorded at the lower of cost or net realizable value, and adjusted as appropriate for decreases in valuation and
obsolescence. Adjustments to the valuation and obsolescence reserves are made after analyzing market conditions, current and projected
sales activity, inventory costs and inventory balances to determine appropriate reserve levels. Cost is determined using the first-in
first-out method. As of October 2, 2022, and October 3, 2021 inventory included:
Schedule of Inventory
| |
| | |
| |
| |
(Thousands) | |
| |
As of October 2, 2022 | | |
As of October 3, 2021 | |
Raw Materials | |
$ | 6,953 | | |
$ | 4,926 | |
Work in Process | |
| 2,722 | | |
| 2,664 | |
Finished Goods | |
| 348 | | |
| 629 | |
Gross Inventory | |
| 10,023 | | |
| 8,219 | |
Less: Inventory Reserves | |
| (811 | ) | |
| (636 | ) |
Net Inventory | |
$ | 9,212 | | |
$ | 7,583 | |
In
the twelve months ended October 2, 2022 Optex Systems recorded $175 thousand of obsolete and excess inventory reserves. Net Inventory
increased by $1.6 million in support of increased customer backlog and higher revenue.
Warranty
Costs: Some of Optex Systems Holdings’ customers require that the Company warrant the quality of its products to meet customer
requirements and be free of defects for up to twelve months subsequent to delivery. 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.
Throughout the year, warranty costs are expensed as incurred, and as of each year end, Optex Systems Holdings reviews the prior 12-month
warranty experience rate and may adjust the warranty accrual as required to cover any estimated warranty expenses associated the period
end backlog of returned customer units awaiting repair or replacement plus any estimated warranty expenses related to anticipated future
returns on previous deliveries. As of October 2, 2022 and October 3, 2021, the existing warranty reserve balances of $169 thousand and
$78 thousand, respectively, were reviewed and determined to be adequate to satisfy any future warranty claims that may have existed as
of the end of each fiscal year for shipments occurring in the prior 12 months. We have made numerous improvements to our supplier bases
and internal production process to reduce the return rate on future shipments but will continue to review and monitor the reserve balances
related to this product line against any existing warranty backlog and current trend data as we repair and replace our current warranty
backlog and process future warranty returns.
The
table below summarizes the warranty expenses and incurred warranty costs for the twelve months ended October 2, 2022 and October 3, 2021.
Schedule of Warranty Reserves
| |
2022 | | |
2021 | |
| |
Years ended | |
| |
2022 | | |
2021 | |
Beginning balance | |
$ | 78 | | |
$ | 83 | |
| |
| | | |
| | |
Incurred costs for warranties satisfied during the period | |
| (4 | ) | |
| (80 | ) |
| |
| | | |
| | |
Warranty Expenses: | |
| | | |
| | |
Warranties reserved for new product shipped during the period(1) | |
| 198 | | |
| 38 | |
Change in estimate for pre-existing warranty liabilities (2) | |
| (103 | ) | |
| 37 | |
Warranty Expense | |
| 95 | | |
| 75 | |
| |
| | | |
| | |
Ending balance | |
$ | 169 | | |
$ | 78 | |
|
(1) |
Warranty
expenses accrued to cost of sales (based on current year shipments and historical warranty return rate). |
|
(2) |
Changes
in estimated warranty liabilities recognized in cost of sales associated with: the period end customer returned warranty backlog,
or the actual costs of repaired/replaced warranty units which were shipped to the customer during the year. During the twelve months
ended October 2, 2022, the warranty return rate was significantly below historical levels resulting in a favorable change in estimate
during the period. |
Property
and Equipment: Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the
estimated useful lives of the assets, ranging from three to seven years. Expenditures for renewals and betterments are capitalized. Expenditures
for minor items, repairs and maintenance are charged to operations as incurred. Gain or loss upon sale or retirement due to obsolescence
is reflected in the operating results in the period the event takes place.
Leases:
In February 2016, FASB issued ASU 2016-02—Leases (Topic 842). The update is intended to increase transparency and
comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information
about leasing arrangements. The amendments in this update are effective for fiscal years beginning after December 15, 2018, including
interim periods within those fiscal years. As such, Optex Systems Holdings adopted these provisions as of the fiscal year beginning on
September 30, 2019. Optex Systems Holdings has two significant operating facilities leases which extend beyond twelve months and fall
under the guidance of ASC Topic 842.
On
January 11, 2021, the Company executed amendments extending the lease terms of both facilities for eighty-six months. Execution of the
new lease amendments for the Dallas and Richardson facilities resulted in the balance sheet recognition of a right-of-use asset of $3.7
million and corresponding operating lease liabilities of approximately $3.7 million during the period ended October 3, 2021. As of the
twelve months ended October 2, 2022, the Company has recognized $51 thousand in right-of-use-asset and corresponding operating lease
liabilities of $51 thousand for an office equipment lease expiring in December 2025. See also Note 7.
Revenue
Recognition: The Company has adopted FASB ASC 606—Revenue from Contracts with Customers which requires revenue recognition
based on a five-step model that includes: identifying the contract, identifying the performance obligations, determining the transaction
price, allocating the transaction price and recognizing the revenue. The standard results in the recognition of revenue depicting the
transfer of promised goods or services to customers in an amount reflecting the expected consideration to be received from the customer
for such goods and services, based on the satisfaction of performance obligations, occurring when the control of the goods or services
transfer to the customer. 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. The total revenue recognized over time related to the contract is $464 thousand for the twelve months ended October 2, 2022 and
$479 thousand for the twelve months ended October 3, 2021.
The
Company has on occasion, outside of the presented periods, received selective contract awards and modifications which included substantive
milestone performance obligations, contract modifications, negotiated settlements and financing arrangements which could fall within
the scope of FASB ASC 606 revenue recognition guidance on reoccurrence, and as such, the Company has expanded their contract review process
to ensure any new contract awards, changes, modifications, financing arrangements or potential negotiated settlements are recorded in
compliance to the new standard guidance.
During
the twelve months ended October 2, 2022, there was zero revenue recognized during the period from customer deposit liabilities (deferred
contract revenue). During the twelve months ended October 3, 2021 there was $1 thousand of revenue recognized from customer deposit liabilities
(deferred contract revenue). As October 2, 2022 and October 3, 2021, there are no significant deferred contract costs such as sales commissions.
Customer
Advance Deposits: Customer advance deposits represent amounts collected from customers in advance of shipment or revenue recognition
which relate to undelivered product due to non-substantive milestone payments or other cash in advance payment terms. As of October 2,
2022 and October 3, 2021, Optex Systems, Inc. had a balance of $311 thousand and zero, respectively, in customer advance deposits.
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. As of the twelve months ended October 2, 2022, the Company recognized contract loss reserves
of $289 which
have been separately itemized on the balance sheet. As of the twelve months ended October 3, 2021, the Company had contract loss reserves
of $51 thousand. In the prior year, the accrued contract losses were previously included in accrued expense and have been reclassed as
a separate line in the current year presentation. See also Note 6 “Accrued Expenses”.
Government
Contracts: Many of Optex Systems Holdings’ contracts are prime or subcontracted directly with the Federal government and
as such, are subject to Federal Acquisition Regulation (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 prime military contracts
and are required by the government to be “flowed down” by the prime contractor to any subcontractors used to perform work
or provide components against the award. It has been Optex Systems Holdings’ experience that the termination for convenience is
rarely invoked, except where it has been mutually beneficial for both parties. Optex Systems Holdings is not currently aware of any pending
terminations for convenience or default on its existing prime contracts or customer purchase orders.
Impairment
or Disposal of Long-Lived Assets: Optex Systems Holdings follows the provisions of FASB ASC 360-10, “Accounting for
the Impairment or Disposal of Long-lived Assets”. This standard requires, among other things, that long-lived assets be reviewed
for potential impairment whenever events or circumstances indicate that the carrying amounts may not be recoverable. The assessment of
possible impairment is based on the ability to recover the carrying value of the asset from the expected future pre-tax cash flows (undiscounted
and without interest charges) of the related operations. If these cash flows are less than the carrying value of such assets, an impairment
loss is recognized for the difference between estimated fair value and carrying value. The measurement of impairment requires management
to estimate future cash flows and the fair value of long-lived assets. No impairment of long-lived assets was recorded for the periods
presented.
Stock-Based
Compensation: FASB ASC 718 establishes standards for the accounting for transactions in which an entity exchanges its equity
instruments for goods or services, but primarily focuses on transactions whereby an entity obtains employee services for share-based
payments. FASB ASC 718 requires that the compensation cost relating to share-based payment transactions be recognized in the financial
statements. That cost will be measured based on the fair value of the equity or liability instruments issued. It also addresses transactions
in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity
instruments or that may be settled by the issuance of those equity instruments.
Income
Tax/Deferred Tax: FASB ASC 740 requires recognition of deferred tax assets and liabilities for the expected future tax consequences
of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities
are determined based on differing treatment of items for financial reporting and income tax reporting purposes. The deferred tax balances
are adjusted to reflect tax rates by tax jurisdiction, based on currently enacted tax laws, which will be in effect in the years in which
the temporary differences are expected to reverse. Under FASB ASC 740, the effect on deferred tax assets and liabilities of a change
in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for certain deferred
tax assets if it is more likely than not that Optex Systems Holdings will not realize tax assets through future operations. When assessing
the recoverability of deferred tax assets, management considers the scheduled reversal of deferred tax liabilities, projected future
taxable income and tax planning strategies and results of recent operations. Based on those estimates, management has determined that
a portion of the deferred tax assets may not be realized and has established a valuation allowance against the deferred tax asset balance.
We record uncertain tax positions in accordance with ASC 740 on the basis of a two-step process in which (1) we determine whether it
is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those
tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than
50 percent likely to be realized upon ultimate settlement with the related tax authority.
As
of October 2, 2022, Optex Systems Inc. has a net carrying value of $0.9 million in deferred tax assets represented by deferred tax assets
of $1.8 million and a deferred tax asset valuation allowance of ($0.9) million against those assets. The valuation allowance has been
established due to historical losses resulting in a Net Operating Loss Carryforward for each of the fiscal years 2010 through 2016 which
may not be fully recognized due to an IRS Section 382 limitation related to a change in control occurring in fiscal year 2018. As of
October 2, 2022 and October 3, 2021, we reviewed the deferred tax assets and determined it was more likely than not that we would be
able to utilize a substantial portion of the deferred tax asset balance against future earnings. Our assumptions were based on the previous
three years earnings trend as well as anticipated future earnings expected with the increases in U.S defense and Foreign Military market
spending. During the twelve months ended October 2, 2022, the Company recovered $0.3 million in cash for a tax refund related to a net
operating loss carryback from the prior year ended October 2, 2021, and recognized an income tax expense of $0.4 million. We will continue
to review the deferred tax assets and related valuation reserves in accordance with ASC 740 on an annual basis.
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
potentially dilutive securities that Optex Systems Holdings had outstanding were stock options and warrants. Optex Systems Holdings uses
the Treasury Stock Method to compute the dilutive effect of stock options and warrants. Stock options and warrants that are anti-dilutive
are excluded from the calculation of diluted earnings per common share.
For
the twelve months ended October 2, 2022, 66,000 unvested restricted stock units and 180,000 unvested restricted shares (which converts
to 91,045 incremental dilutive shares) were included in the diluted earnings per share calculation as dilutive. For the twelve months
ended October 3, 2021, 99,000 unvested restricted stock units and 240,000 restricted unvested shares (which converts to 82,788 incremental
dilutive shares) were included in the diluted earnings per share calculation as dilutive.
Our
outstanding warrants during the twelve months ended October 3, 2021 were participating securities which shared dividend distributions
and the allocation of any undistributed earnings (deemed dividends) with our common shareholders. During the twelve months ended October
3, 2021, there were no declared dividends and allocated undistributed earnings of $0.7 million attributable to the participating warrants.
There were no outstanding warrants or declared dividends during the twelve months ended October 2, 2022 as the warrants expired on August
21, 2021.
Note
3 — Recent Accounting Pronouncements
There
are no significant recent accounting pronouncements that effect the Company.
Note
4 — 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 84% of the Optex Systems segment
revenue is comprised of domestic military customers, and 16% is comprised of foreign military customers. Optex Systems segment revenue
is derived from the U.S. government, 13%, and two major U.S. defense contractors representing 17% and 8%, of the Company’s consolidated
revenue, respectively.
Optex
Systems is located in Richardson Texas, with leased premises consisting of approximately 49,100 square feet. As of October 2, 2022, the
Richardson facility operated with 46 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 41% and military sales to prime
and subcontracted customers represent 59% of the total segment revenue. Approximately 94% of the AOC revenue is derived from external
customers and approximately 6% is related to intersegment sales to Optex Systems in support of military contracts. For the twelve months
ended October 2, 2022, the AOC segment revenue from one major commercial customer, and two major defense contractors
represent approximately 22%, 15% and 5% of the Company’s consolidated revenue, respectively.
The
Applied Optics Center is located in Dallas, Texas with leased premises consisting of approximately 44,867 square feet of space. As of
October 2, 2022, AOC operated with 38 full time equivalent employees in a single shift operation.
The
financial table below presents the information for each of the reportable segments profit or loss as well as segment assets for each
year. The Company does not allocate interest expense, income taxes or unusual items to segments.
Schedule of Segment Reporting Information
| |
Reportable Segment Financial Information (thousands) | |
| |
Twelve months ended October 2, 2022 | |
| |
Optex
Systems
Richardson | | |
Applied
Optics
Center Dallas | | |
Other (non-
allocated
costs and
intersegment
eliminations) | | |
Consolidated Total | |
| |
| | |
| | |
| | |
| |
Revenues from external customers | |
$ | 9,533 | | |
$ | 12,850 | | |
$ | - | | |
$ | 22,383 | |
Intersegment revenues | |
| - | | |
| 879 | | |
| (879 | ) | |
| - | |
Total Revenue | |
$ | 9,533 | | |
$ | 13,729 | | |
$ | (879 | ) | |
$ | 22,383 | |
| |
| | | |
| | | |
| | | |
| | |
Interest expense | |
$ | - | | |
$ | - | | |
$ | - | | |
$ | - | |
| |
| | | |
| | | |
| | | |
| | |
Depreciation and Amortization | |
$ | 38 | | |
$ | 269 | | |
$ | - | | |
$ | 307 | |
| |
| | | |
| | | |
| | | |
| | |
Income (loss) before taxes | |
$ | ) | |
$ | | |
$ | ) | |
$ | |
| |
| | | |
| | | |
| | | |
| | |
Other significant noncash items: | |
| | | |
| | | |
| | | |
| | |
Allocated home office expense | |
$ | (1,141 | ) | |
$ | 1,141 | | |
$ | - | | |
$ | - | |
Stock compensation expense | |
$ | - | | |
$ | - | | |
$ | 162 | | |
$ | 162 | |
Warranty expense | |
$ | - | | |
$ | 95 | | |
$ | - | | |
$ | 95 | |
| |
| | | |
| | | |
| | | |
| | |
Segment Assets | |
$ | 11,286 | | |
$ | 7,251 | | |
$ | - | | |
$ | 18,537 | |
Expenditures for segment assets | |
$ | 64 | | |
$ | 193 | | |
$ | - | | |
$ | 257 | |
| |
Reportable Segment Financial Information (thousands) | |
| |
Twelve months ended October 3, 2021 | |
| |
Optex
Systems Richardson | | |
Applied
Optics
Center Dallas | | |
Other (non-
allocated
costs and
intersegment
eliminations) | | |
Consolidated Total | |
| |
| | |
| | |
| | |
| |
Revenues from external customers | |
$ | 11,827 | | |
$ | 6,395 | | |
$ | - | | |
$ | 18,222 | |
Intersegment revenues | |
| - | | |
| 1,056 | | |
| (1,056 | ) | |
| - | |
Total Revenue | |
$ | 11,827 | | |
$ | 7,451 | | |
$ | (1,056 | ) | |
$ | 18,222 | |
| |
| | | |
| | | |
| | | |
| | |
Interest expense | |
$ | - | | |
$ | - | | |
$ | 11 | | |
$ | 11 | |
| |
| | | |
| | | |
| | | |
| | |
Depreciation and Amortization | |
$ | 41 | | |
$ | 222 | | |
$ | - | | |
$ | 263 | |
| |
| | | |
| | | |
| | | |
| | |
Income before taxes | |
$ | | |
$ | ) | |
$ | | |
$ | |
| |
| | | |
| | | |
| | | |
| | |
Other significant noncash items: | |
| | | |
| | | |
| | | |
| | |
Allocated home office expense | |
$ | (677 | ) | |
$ | 677 | | |
$ | - | | |
$ | - | |
Gain on change in fair value of warrants | |
$ | - | | |
$ | - | | |
$ | (2,535 | ) | |
$ | (2,535 | ) |
Stock compensation expense | |
$ | - | | |
$ | - | | |
$ | 228 | | |
$ | 228 | |
Warranty Expense | |
$ | (15 | ) | |
$ | 90 | | |
$ | - | | |
$ | 75 | |
| |
| | | |
| | | |
| | | |
| | |
Segment Assets | |
$ | 14,010 | | |
$ | 6,845 | | |
$ | - | | |
$ | 20,855 | |
Expenditures for segment assets | |
$ | 20 | | |
$ | 254 | | |
$ | - | | |
$ | 274 | |
Note
5 — Property and Equipment
A
summary of property and equipment at October 2, 2022 and October 3, 2021 is as follows:
Schedule of Property and Equipment
| |
Estimated Useful Life | |
Year Ended October 2, 2022 | | |
Year Ended
October 3, 2021 | |
| |
| |
(Thousands) | |
| |
Estimated Useful Life | |
October 2, 2022 | | |
October 3, 2021 | |
Property and Equipment | |
| |
| | | |
| | |
Furniture and Fixtures | |
3-5 yrs | |
$ | 405 | | |
$ | 398 | |
Machinery and Equipment | |
5 yrs | |
| 4,231 | | |
| 4,035 | |
Leasehold Improvements | |
7 yrs | |
| 351 | | |
| 296 | |
Property and Equipment, gross | |
7 yrs | |
| 351 | | |
| 296 | |
Less: Accumulated Depreciation | |
| |
| (4,019 | ) | |
| (3,712 | ) |
Net Property & Equipment | |
| |
$ | 968 | | |
$ | 1,017 | |
| |
| |
| | | |
| | |
Depreciation Expense | |
| |
$ | 307 | | |
$ | 263 | |
During
the twelve months ended October 2, 2022, Optex Systems Holdings’ purchased $6 thousand in new furniture and fixtures, $196 thousand
in machinery and equipment and $55 thousand in leasehold improvements. During the twelve months ended October 2, 2022, there were no
sales or retirements of fixed assets. During the twelve months ended October 3, 2021, Optex Systems Holdings’ purchased $254 thousand
in new furniture and fixtures and $20 thousand in leasehold improvements. During the twelve months ended October 3, 2021, there were
no sales or retirements of fixed assets.
Note
6 — Accrued Expenses
The
components of accrued liabilities as of October 2, 2022 and October 3, 2021 are summarized below:
Schedule of Accrued Liabilities
| |
October 2, 2022 | | |
October 3, 2021(1) | |
| |
(Thousands) | |
| |
October 2, 2022 | | |
October 3, 2021(1) | |
Accrued Vacation | |
| 402 | | |
| 376 | |
Property Taxes | |
| 115 | | |
| 117 | |
Operating Expenses | |
| 213 | | |
| 99 | |
Payroll & Payroll Related | |
| 228 | | |
| 208 | |
Total Accrued Expenses | |
$ | 958 | | |
$ | 800 | |
| (1) | Accrued
Expenses at October 3, 2021, previously included $51
thousand in Contract Loss Reserves which has been presented as a separate balance sheet component as of the year ended October 2,
2022. See also Note 2 “Contract Loss Reserves”. |
Note
7 — Commitments and Contingencies
Rental
Payments under 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
$11.3 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 includes 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 $7.9 thousand for additional CAM, to be adjusted annually based on actual expenses
incurred by the landlord.
Execution
of the new lease amendments for the Dallas and Richardson facilities resulted in the balance sheet recognition of a right-of-use asset
of $3.7
million and corresponding operating lease liabilities
of approximately $3.7
million during the year ended October 3, 2021.
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 October 2, 2022, the remaining minimum base lease and estimated common area maintenance (CAM) payments under the non-cancellable office
equipment and facility space leases are as follows:
Non-cancellable
Operating Leases Minimum Payments
Schedule of Non-cancellable Operating Leases Minimum Payments
| |
1 | | |
| | |
| | |
|
|
|
|
| |
| |
(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 | |
$ | 317 | | |
$ | 288 | | |
$ | 15 | | |
$ | 620 | | |
$ | 235 | |
2024 Base year lease | |
| 327 | | |
| 296 | | |
| 15 | | |
| 638 | | |
| 240 | |
2025 Base year lease | |
| 336 | | |
| 305 | | |
| 15 | | |
| 656 | | |
| 245 | |
2026 Base year lease | |
| 346 | | |
| 313 | | |
| 3 | | |
| 662 | | |
| 249 | |
2027 Base year lease | |
| 357 | | |
| 322 | | |
| - | | |
| 679 | | |
| 254 | |
2028 Base year lease | |
| 242 | | |
| 330 | | |
| - | | |
| 572 | | |
| 184 | |
2029 Base year lease | |
| - | | |
| 83 | | |
| - | | |
| 83 | | |
| 27 | |
Total base lease payments | |
| 1,925 | | |
$ | 1,937 | | |
$ | 48 | | |
| 3,910 | | |
$ | 1,434 | |
Imputed
interest on lease payments (1) | |
| (258 | ) | |
| (283 | ) | |
| (4 | ) | |
| (545 | ) | |
| | |
Total
Operating Lease Liability | |
$ | 1,667 | | |
$ | 1,654 | | |
$ | 44 | | |
$ | 3,365 | | |
| | |
| |
| | | |
| | | |
| | | |
| | | |
| | |
Right-of-use
Asset(3) | |
$ | 1,587 | | |
$ | 1,591 | | |
$ | 44 | | |
$ | 3,222 | | |
| | |
(1) |
Assumes
a discount borrowing rate of 5.0% on the new lease amendments effective as of January 11, 2021. |
(2) |
Includes
$143 thousand of unamortized deferred rent. |
(3) |
Short-term
and Long-term portion of Operating Lease Liability is $604 thousand and $2,761 thousand, respectively. |
Total
expense under both facility lease agreements for the twelve months ended October 2, 2022 was $849 thousand. Total expense under both
facility lease agreements as of the twelve months ended October 3, 2021 was $769 thousand.
Total
office equipment rentals included in operating expenses was $22 thousand for the twelve months ended October 2, 2022 and for the twelve
months ended October 3, 2021.
Note
8 — 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. (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 were 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
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%.
See also Note 14 “Subsequent Events”.
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 credit facility was zero as of October 2, 2022 and October 3, 2021, respectively. For the years ended October
2, 2022 and October 3, 2021, the total interest expense against the outstanding line of credit balance was zero and $11 thousand, respectively.
Note
9 — 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 twelve months ended October 2, 2022. As of October
2, 2022, 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 September 27, 2020 | |
| 182,000 | | |
$ | 1.54 | | |
| 300,000 | | |
| 1.75 | |
Granted | |
| — | | |
| — | | |
| — | | |
| — | |
Vested | |
| (83,000 | ) | |
$ | 1.49 | | |
| (60,000 | ) | |
$ | 1.75 | |
Forfeited | |
| — | | |
| — | | |
| — | | |
| — | |
Outstanding at October 3, 2021 | |
| 99,000 | | |
$ | 1.59 | | |
| 240,000 | | |
$ | 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 | |
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 October 2, 2022, 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
are 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, must 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. See also Note 14
“Subsequent Events”.
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 and January 1, 2022, 60,000 of the restricted director shares vested. As of October 2, 2022, there
were 180,000 unvested restricted shares.
On
January 2, 2021, the Company issued 58,392 common shares to directors and officers, net of tax withholding of $44 thousand, in settlement
of 83,000 restricted stock units which vested on January 1, 2021.
On
January 4, 2022, the Company issued 23,216 common shares to officers, net of tax withholding of $19 thousand, in settlement of 33,000
restricted stock units which vested on January 1, 2022.
As
of October 2, 2022, there were 66,000 unvested restricted stock units consisting of 16,500 unvested restricted stock units for Bill Bates,
which will vest on January 1, 2023, and 49,500 unvested restricted stock units for Danny Schoening, vesting on January 1, 2023.
There
were no new grants of restricted stock or restricted stock units during the twelve months ended October 2, 2022.
Stock
Based Compensation Expense
Equity
compensation is amortized to general and administrative expenses based on a straight-line basis across the vesting or service period
as applicable. The recorded compensation costs for restricted 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 | |
| |
Twelve months ended | | |
As of year ended | |
| |
October 2,
2022 | | |
October 3,
2021 | | |
October 2,
2022 | | |
October 3,
2021 | |
Restricted Shares | |
$ | 105 | | |
$ | 105 | | |
$ | 236 | | |
$ | 341 | |
Restricted Stock Units | |
| 57 | | |
| 123 | | |
| 9 | | |
| 66 | |
Total Stock Compensation | |
$ | 162 | | |
$ | 228 | | |
$ | 245 | | |
$ | 407 | |
The
unrecognized compensation expense for restricted shares and restricted stock units as of October 2, 2022, is expected to be
recognized over a weighted-average period of 2.25
years and 0.25
years, respectively.
Note
10 — Defined Contribution Plan
The
Company sponsors a defined contribution pension plan under Section 401(k) of the Internal Revenue Code for all employees. Company contributions
are voluntary and are determined annually at the discretion of the Board of Directors at the beginning of each fiscal year. For the fiscal
years ended October 2, 2022 and October 3, 2021, the Company offered a qualified automatic contribution arrangement (QACA) with a 100%
match of the first 1% and 50% matching of the next 5% and a 2-year vesting requirement. The Company’s contribution expense for
the fiscal years ended October 2, 2022 and October 3, 2021 were $155 thousand and $158 thousand, respectively.
Note
11 — Stockholders’ Equity
Dividends
There
were no dividends declared or paid during the twelve months ended October 2, 2022 and October 3, 2021.
Common
stock
During
the twelve months ended October 3, 2021, there were 58,392 common shares issued, net of tax withholding, in settlement of 83,000 restricted
stock units which vested on January 1, 2021.
During
the twelve months ended October 2, 2022, there were 23,216
common shares issued to officers, net of tax withholding of $19
thousand, in settlement of 33,000
restricted stock units which vested on January 1, 2022.
On
August 10, 2021 and August 23, 2021, there were 148,300 and 40,509 warrants exercised, respectively, at $1.50 per common share at a total
transaction cost of $283 thousand. The total fair market value at the time of exercise was $292 thousand. There were no other issuances
of common stock during the twelve months ended October 3, 2021.
On
August 31, 2021, the Company repurchased 100
common shares from a private investor for a total transaction cost of $150
which were subsequently cancelled.
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 plan. 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 or in
negotiated transactions, depending upon market conditions and subject to Rule 10b-18 as promulgated by the SEC.
During
the twelve months ended October 2, 2022, there were 190,954 common shares repurchased through the program at a cost of $371 thousand.
During the twelve months ended October 3, 2021, there were 449,088 common shares repurchased through the program at a cost of $869 thousand.
As of October 3, 2021, there were 35,555 shares held in treasury purchased under the September 2021 stock repurchase plan. As of October
2, 2022, all of the repurchased shares had been cancelled. A summary of the purchases under the plan 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 | |
| |
| | |
| | |
| | |
| |
September 28, 2020 through October 25, 2020 | |
| 20,948 | | |
$ | 42 | | |
$ | 2.01 | | |
$ | 758 | |
October 26, 2020 through November 22, 2020 | |
| 129,245 | | |
| 265 | | |
| 2.05 | | |
| 493 | |
November 23, 2020 through December 27, 2020 | |
| 58,399 | | |
| 109 | | |
| 1.86 | | |
| 384 | |
December 28, 2020 through January 24, 2021 | |
| 40,362 | | |
| 73 | | |
| 1.80 | | |
| 311 | |
January 25, 2021 through February 21, 2021 | |
| 52,180 | | |
| 101 | | |
| 1.94 | | |
| 210 | |
February 22, 2021 through March 28, 2021 | |
| 73,800 | | |
| 140 | | |
| 1.90 | | |
| 70 | |
March 29, 2021 through April 19, 2021 | |
| 38,599 | | |
| 70 | | |
| 1.82 | | |
| - | |
September 23, 2021 through October 1, 2021 | |
| 35,555 | | |
$ | 69 | | |
$ | 1.93 | | |
$ | 931 | |
| |
| | | |
| | | |
| | | |
| | |
Total shares repurchased for year ended October 3, 2021 | |
| 449,088 | | |
$ | 869 | | |
$ | 1.93 | | |
$ | 931 | |
| |
| | | |
| | | |
| | | |
| | |
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 October 3, 2021, the total outstanding common shares were 6,716,638 and 8,488,149, respectively.
Warrants
On
August 26, 2016, Optex Systems Holdings Inc. issued 4,323,135 warrants to new shareholders and the underwriter, in connection with a
public share offering. The warrants entitled the holder to purchase one share of our common stock at an exercise price equal to $1.50
per share at any time on or after August 26, 2016 (the “Initial Exercise Date”) and on or prior to the close of business
on August 26, 2021 (the “Termination Date”).
Pursuant
to a warrant agreement between Optex Systems Inc. and Equity Stock Transfer, LLC, as warrant agent, the warrants were issued in book-entry
form and were initially represented only by one or more global warrants deposited with the warrant agent, as custodian on behalf of The
Depository Trust Company, or DTC, and registered in the name of Cede & Co., a nominee of DTC, or as otherwise directed by DTC.
The
exercise price and number of shares of common stock issuable upon exercise of the warrants could be adjusted in certain circumstances,
including in the event of a stock split, stock dividend, extraordinary dividend on or recapitalization, reorganization, merger or consolidation.
Under
the terms of the warrant agreement, Optex Systems Holdings Inc. agreed to use their best efforts to maintain the effectiveness of the
registration statement and current prospectus relating to common stock issuable upon exercise of the warrants until the expiration of
the warrants. During any period in which Optex failed to have an effective registration statement covering the shares underlying the
warrants, the warrant holder was permitted to exercise the warrants on a cashless basis. The warrant holders did not have the rights
or privileges of holders of common stock and any voting rights until they exercised their warrants and received shares of common stock,
except as set forth in the warrants. After the issuance of shares of common stock upon exercise of the warrants, each holder was entitled
to one vote for each share held of record on all matters to be voted on by stockholders.
Subject
to limited exceptions, a holder of warrants did have the right to exercise any portion of its warrants if the holder (together with such
holder’s affiliates, and any persons acting as a group together with such holder or any of such holder’s affiliates) would
beneficially own a number of shares of common stock in excess of 4.99% of the shares of our common stock then outstanding after giving
effect to such exercise (the “Beneficial Ownership Limitation”); provided, however, that, upon notice to the Company, the
holder could increase or decrease the Beneficial Ownership Limitation, provided that in no event could the Beneficial Ownership Limitation
have exceeded 9.99% and any increase in the Beneficial Ownership Limitation would not be effective until 61 days following notice of
such increase from the holder to us.
No
fractional shares of common stock would be issued upon exercise of the warrants. If, upon exercise of the warrants, a holder would be
entitled to receive a fractional interest in a share, Optex Systems Holdings Inc. would, upon exercise, round up to the nearest whole
number of shares of common stock to be issued to the warrant holder. If multiple warrants were exercised by the holder at the same time,
Optex Systems Holdings Inc. would aggregate the number of whole shares issuable upon exercise of all the warrants. There was no established
trading market for the warrants.
In
the event of a fundamental transaction (as defined in warrant), then the Company or any successor entity would pay at the holder’s
option, exercisable at any time concurrently with or within 30 days after the consummation of the fundamental transaction, an amount
of cash equal to the value of the remaining unexercised portion of the warrants on the date of consummation of the fundamental transaction
as determined in accordance with the Black Scholes option pricing model.
As
of September 27, 2020 there were 4,125,200 warrants outstanding. During the twelve months ended September 27, 2020, there were zero warrants
exercised or repurchased. During the twelve months ended October 3, 2021, 188,809 of the warrants were exercised and zero warrants repurchased.
On August 26, 2021, the remaining 3,936,391 warrants expired worthless. As of October 3, 2021 and October 2, 2022, there were zero outstanding
warrants remaining.
Note
12 — Warrant Liabilities
On
August 26, 2016, Optex Systems Holdings, Inc. issued 4,323,135 warrants to new shareholders and the underwriter, in connection with a
public share offering. The warrants entitle the holder to purchase one share of our common stock at an exercise price equal to $1.50
per share at any time on or after August 26, 2016, and on or prior to the close of business on August 26, 2021. The Company determined
that these warrants are free standing financial instruments that are legally detachable and separately exercisable from the common stock
included in the public share offering. Management also determined that the warrants are puttable for cash upon a fundamental transaction
at the option of the holder and as such required classification as a liability pursuant to ASC 480 “Distinguishing Liabilities
from Equity”. The Company had no plans to consummate a fundamental transaction and did not believe a fundamental transaction was
likely to occur during the remaining term of the outstanding warrants. In accordance with the accounting guidance, the outstanding warrants
were recognized as a warrant liability on the balance sheet and are measured at their inception date fair value and subsequently re-measured
at each reporting period with changes being recorded as a component of other income in the consolidated statement of income.
The
fair value of the warrant liabilities presented below were measured using either a BSM valuation model. Significant inputs into the respective
model at the inception and reporting period measurement dates are as follows:
Schedule of Warrant Liabilities Assumptions Used
| |
Issuance
date | | |
Period
ended | | |
Period
ended | | |
Period
ended | | |
Period
ended | | |
Expiration
date | |
Valuation Assumptions | |
August 26,
2016 | | |
October 1,
2017 | | |
September 30,
2018 | | |
September 29,
2019 | | |
September 27,
2020 | | |
August 26,
2021(5) | |
Exercise Price(1) | |
$ | 1.50 | | |
$ | 1.50 | | |
$ | 1.50 | | |
$ | 1.50 | | |
$ | 1.50 | | |
$ | 1.50 | |
Warrant Expiration Date (1) | |
| 8/26/2021 | | |
| 8/26/2021 | | |
| 8/26/2021 | | |
| 8/26/2021 | | |
| 8/26/2021 | | |
| 8/26/2021 | |
Stock Price (2) | |
$ | 0.95 | | |
$ | 0.98 | | |
$ | 1.71 | | |
$ | 1.56 | | |
$ | 1.96 | | |
$ | 1.49 | |
Interest Rate (annual) (3) | |
| 1.23 | % | |
| 1.62 | % | |
| 2.88 | % | |
| 1.63 | % | |
| 0.12 | % | |
| - | |
Volatility (annual) (4) | |
| 246.44 | % | |
| 179.36 | % | |
| 64.05 | % | |
| 53.66 | % | |
| 51.67 | % | |
| - | |
Time to Maturity (Years) | |
| 5 | | |
| 3.9 | | |
| 2.9 | | |
| 1.9 | | |
| 0.9 | | |
| Expired | |
Calculated fair value per share | |
$ | 0.93 | | |
$ | 0.87 | | |
$ | 0.82 | | |
$ | 0.49 | | |
$ | 0.62 | | |
$ | - | |
(1) |
Based
on the terms provided in the warrant agreement to purchase common stock of Optex Systems Holdings, Inc. dated August 26, 2016. |
(2) |
Based
on the trading value of common stock of Optex Systems Holdings, Inc. as of each presented period ending date. August 26, 2021 stock
price based on the volume weighted average price for 618,451 share trades on that date. Closing price was $1.55 based trades of 2,400
final shares traded. |
(3) |
Interest
rate for U.S. Treasury Bonds, as of each presented period ending date, as published by the U.S. Federal Reserve. |
(4) |
Based
on the historical daily volatility of Optex Systems Holdings, Inc. as of each presented period ending date. |
(5) |
Warrants
expired worthless without cashless exchange pursuant to the Warrant Agreement Section 2(c) determination that the August 26, 2021
VWAP calculation of $1.49 was below the exercise price of $1.50. |
The
warrants outstanding and fair values at each of the respective valuation dates are summarized below:
Summary of Warrants Outstanding and Fair Values
| |
Warrants | | |
Fair Value | | |
Fair Value | |
Warrant Liability | |
Outstanding | | |
per Share | | |
(000’s) | |
Fair Value as of period ended 9/27/2020 | |
| 4,125,200 | | |
$ | 0.62 | | |
$ | 2,544 | |
Reclassification to additional paid in capital on exercise of warrants (1) | |
| (188,809 | ) | |
| | | |
| (9 | ) |
Gain on Change in Fair Value of Warrant Liability (2) | |
| (3,936,391 | ) | |
| | | |
| (2,535 | ) |
Fair Value as of period ended 10/03/2021 | |
$ | - | | |
$ | - | | |
$ | - | |
(1) |
Exercise
of warrants for gross proceeds of $283 thousand and a warrant liability fair market value of $292 thousand as of the exercise date. |
(2) |
Expiration
of Warrants on August 26, 2021. |
The
warrant liabilities are considered Level 3 liabilities on the fair value hierarchy as the determination of fair value includes various
assumptions about of future activities and the Company’s stock prices and historical volatility as inputs.
Note
13 — Income Taxes
The
income tax provision for the years ended October 2, 2022 and October 3, 2021 include the following:
Schedule of Income Tax Provision
| |
2022 | | |
2021 | |
| |
(Thousands) | |
| |
2022 | | |
2021 | |
Current income tax expense: | |
| | | |
| | |
Current year federal income tax | |
$ | 331 | | |
$ | - | |
Prior year tax adjustment | |
| - | | |
| (62 | ) |
Current income tax expense | |
| 331 | | |
| (62 | ) |
Deferred income tax provision (benefit): | |
| | | |
| | |
Federal | |
| 33 | | |
| (39 | ) |
| |
| | | |
| | |
Provision for (Benefit from) income taxes, net | |
$ | 364 | | |
$ | (101 | ) |
As
of October 2, 2022, Optex Systems Inc. has a net carrying value of $0.9 million in deferred tax assets represented by deferred tax assets
of $1.8 million and a deferred tax asset valuation allowance of ($0.9) million against those assets. The valuation allowance has been
established due to historical losses resulting in a Net Operating Loss Carryforward for each of the fiscal years 2010 through 2016 which
may not be fully recognized due to an IRS Section 382 limitation related to a change in control occurring in fiscal year 2018. As of
October 2, 2022 and October 3, 2021, we reviewed the deferred tax assets and determined it was more likely than not that we would be
able to utilize a substantial portion of the deferred tax asset balance against future earnings. Our assumptions were based on the previous
three years earnings trend as well as anticipated future earnings expected with the recent orders and increased backlog as of October
2, 2022. During the twelve months ended October 2, 2022, the Company recognized $0.03 million in tax expenses to deferred tax assets.
During the twelve months ended October 3, 2021, the Company recognized ($0.04) million in tax benefits to deferred tax assets. We will
continue to review the deferred tax assets and related valuation reserves in accordance with ASC 740 on an annual basis.
The
income tax provision for Optex Systems as of October 2, 2022 and October 3, 2021 differs from those computed using the statutory
federal tax rate in the respective years due to the following permanent differences:
Schedule of Effective Income Tax Rate Reconciliation
| |
2022 | | |
% | | |
2021 | | |
% | |
| |
| | |
| | |
| | |
| |
Tax provision (benefit) at statutory federal rate | |
$ | 346 | | |
| 21 | | |
$ | 426 | | |
| 21 | |
Nondeductible expenses | |
| 1 | | |
| - | | |
| (531 | ) | |
| (26 | ) |
Other temporary adjustments | |
| (17 | ) | |
| (1 | ) | |
| 221 | | |
| 11 | |
Prior year federal income tax adjustment | |
| - | | |
| - | | |
| (62 | ) | |
| (3 | ) |
Change in deferred tax valuation allowance | |
| 34 | | |
| 2 | | |
| (155 | ) | |
| (8 | ) |
Provision for (benefit from) income taxes, net | |
$ | 364 | | |
| 22 | | |
$ | (101 | ) | |
| (5 | ) |
Deferred
income taxes recorded in the balance sheets result from differences between financial statement and tax reporting of income and deductions.
A summary of the composition of the deferred income tax assets (liabilities) follows:
Schedule of Deferred Income Taxes
| |
As of October 2, 2022 | | |
As of October 3, 2021 | |
| |
(Thousands) | |
| |
Deferred Tax Asset | |
| |
As of October 2, 2022 | | |
As of October 3, 2021 | |
| |
| | |
| |
Stock Compensation | |
$ | 76 | | |
$ | 73 | |
Inventory Reserve | |
| 170 | | |
| 134 | |
Unicap | |
| 34 | | |
| 27 | |
Deferred Compensation | |
| 29 | | |
| - | |
Fixed assets | |
| (219 | ) | |
| (226 | ) |
Goodwill Amortization | |
| 100 | | |
| 199 | |
Intangible Asset Amortization | |
| 57 | | |
| 113 | |
Contract Loss Reserve | |
| 61 | | |
| 11 | |
Accrued Paid Time Off | |
| 85 | | |
| 79 | |
Net Operating Losses | |
| 1,327 | | |
| 1,657 | |
Other | |
| 65 | | |
| 29 | |
Subtotal | |
$ | 1,785 | | |
$ | 2,096 | |
Valuation allowance | |
| (843 | ) | |
| (808 | ) |
Net deferred asset | |
$ | 942 | | |
$ | 1,288 | |
The
Company has a net loss carryforward of $6.3 million as of October 2, 2022 as compared to a net loss carryforward of $7.9 million as of
October 3, 2021. Due to an IRS section 382 change in control limitation which was effective during the fiscal year ended 2017, it is
anticipated that the Company may only realize $2.3 million of the current net operating loss carryforward for a net tax benefit of $0.5
million through fiscal year ending in 2037. For the year ended October 3, 2021, the Company realized a ($1.4) million net operating tax
loss which was not subject to the IRS section 382 limitation and was available for a tax loss carryback up to five years. During the
twelve months ended October 2, 2022, the Company recovered $0.3 million in cash for a tax refund related to the net operating loss carryback
from the prior October 3, 2021 year end.
The
Company applied FASB ASC 740-10 and has no unrecognized tax benefits. By statute, the tax years ended October 2, 2022, October 3, 2021
and September 27, 2020 are open to examination by the major taxing jurisdictions to which the Company is subject.
During
the twelve months ended October 2, 2022 the Company paid zero in income taxes, received a tax refund of $312 thousand for fiscal year
2021 operating loss carrybacks, and recorded a current year federal income tax liability of $331 thousand. During the twelve months ended
October 3, 2021 the Company paid $48 thousand in income taxes, and had a net tax refund due related to the fiscal year 2021 tax year
of ($48) thousand included in prepaid expenses.
Note
14 — Subsequent Events
On
November 21, 2022, the Company issued an Amended and Restated Revolving Line of Credit
Note to PNC Bank, National Association, in
connection with an increase of the Borrowers’ revolving line of credit facility from $1.125 million to $2.0 million under the Borrowers’
existing Amended and Restated Loan Agreement with the Lender. 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%.
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.