OPTEX SYSTEMS HOLDINGS, INC This Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to supplement and complement our audited consolidated financial statements and notes thereto for the fiscal year endedOctober 2, 2022 and our unaudited condensed consolidated financial statements and notes thereto for the quarter endedJanuary 1, 2023 , prepared in accordance withU.S. generally accepted accounting principles (GAAP). You are encouraged to review our condensed consolidated financial statements in conjunction with your review of this MD&A. The financial information in this MD&A has been prepared in accordance with GAAP, unless otherwise indicated. In addition, we use non-GAAP financial measures as supplemental indicators of our operating performance and financial position. We use these non-GAAP financial measures internally for comparing actual results from one period to another, as well as for planning purposes. We will also report non-GAAP financial results as supplemental information, as we believe their use provides more insight into our performance. When a non-GAAP measure is used in this MD&A, it is clearly identified as a non-GAAP measure and reconciled to the most closely corresponding GAAP measure.
The following discussion highlights the principal factors that have affected our financial condition and results of operations as well as our liquidity and capital resources for the periods described. The operating results for the periods presented were not significantly affected by inflation.
Cautionary Note Regarding Forward-Looking Information
This Quarterly Report on Form 10-Q, in particular the MD&A, contains certain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Any statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact may be deemed to be forward-looking statements. When used in this Quarterly Report on Form 10-Q and other reports, statements, and information we have filed with theSecurities and Exchange Commission ("Commission" or "SEC"), in our press releases, presentations to securities analysts or investors, or in oral statements made by or with the approval of an executive officer, the words or phrases "believes," "may," "will," "expects," "should," "continue," "anticipates," "intends," "will likely result," "estimates," "projects" or similar expressions and variations thereof are intended to identify such forward-looking statements. These forward-looking statements represent our expectations, beliefs, intentions or strategies concerning future events, including, but not limited to, any statements regarding growth strategy; product and development programs; financial performance (including revenue and net income); backlog; expected timing of shipments; increases in the cost of materials and labor; labor shortages; follow-on orders; the impact of the COVID-19 pandemic; supply chain challenges; the continuation of historical trends; the sufficiency of our cash balances for future liquidity and capital resource needs; the expected impact of changes in accounting policies on our results of operations, financial condition or cash flows; anticipated problems and our plans for future operations; and the economy in general or the future of the defense industry. We caution that these statements by their nature involve risks and uncertainties, certain of which are beyond our control, and actual results may differ materially depending on a variety of important factors. Some of these risks and uncertainties are identified in this Management's Discussion and Analysis of Financial Condition and Results of Operations and the section "Risk Factors" in our Annual Report on Form 10-K and you are urged to review those sections. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete list of all potential risks or uncertainties. We do not assume the obligation to update any forward-looking statement. You should carefully evaluate such statements in light of factors described in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K. BackgroundOptex Systems, Inc. (Delaware ) manufactures optical sighting systems and assemblies, primarily forDepartment of Defense applications. Its products are installed on various types ofU.S. military land vehicles, such as the Abrams and Bradley fighting vehicles, light armored and armored security vehicles and have been selected for installation on the Stryker family of vehicles.Optex Systems, Inc. (Delaware ) also manufactures and delivers numerous periscope configurations, rifle and surveillance sights and night vision optical assemblies.Optex Systems, Inc. (Delaware ) products consist primarily of build-to-customer print products that are delivered both directly to the armed services and to other defense prime contractors. Less than 1% of today's revenue is related to the resale of products substantially manufactured by others. In this case, the product would likely be a simple replacement part of a larger system previously produced byOptex Systems, Inc. (Delaware ). 3
We are both a prime and sub-prime contractor to theDepartment of Defense . Sub-prime contracts are typically issued through major defense contractors such asGeneral Dynamics Land Systems ,Raytheon Corp. , BAE,ADS Inc. and others. We are also a military supplier to foreign governments such asIsrael ,Australia and South American countries and as a subcontractor for several largeU.S. defense companies serving foreign governments. The Federal Acquisition Regulation is the principal set of regulations that govern the acquisition process of government agencies and contracts with theU.S. government. In general, parts of the Federal Acquisition Regulation are incorporated into government solicitations and contracts by reference as terms and conditions effecting contract awards and pricing solicitations. Many of our contracts are prime or subcontracted directly with the Federal government and, as such, are subject to Federal Acquisition Regulation Subpart 49.5, "Contract Termination Clauses" and more specifically Federal Acquisition Regulation clauses 52.249-2 "Termination for Convenience of the Government (Fixed-Price)", and 49.504 "Termination of fixed-price contracts for default". These clauses are standard clauses on our prime military contracts and generally apply to us as subcontractors. It has been our experience that the termination for convenience is rarely invoked, except where it is mutually beneficial for both parties. We are currently not aware of any pending terminations for convenience or for default on our existing contracts. In the event a termination for convenience were to occur, Federal Acquisition Regulation clause 52.249-2 provides for full recovery of all contractual costs and profits reasonably occurred up to and as a result of the terminated contract. In the event a termination for default were to occur, we could be liable for any excess cost incurred by the government to acquire supplies from another supplier similar to those terminated from us. We would not be liable for any excess costs if the failure to perform the contract arises from causes beyond the control and without the fault or negligence of the Company as defined by Federal Acquisition Regulation clause 52.249-8. In addition, some of our contracts allow for government contract financing in the form of contract progress payments pursuant to Federal Acquisition Regulation 52.232-16, "Progress Payments". As a small business, and subject to certain limitations, this clause provides for government payment of up to 90% of incurred program costs prior to product delivery. To the extent our contracts allow for progress payments, we intend to utilize this benefit, thereby minimizing the working capital impact onOptex Systems Holdings for materials and labor required to complete the contracts. Recent Developments NASDAQ Listing Application
OnDecember 7, 2022 the Company submitted an application to list its common stock on the NASDAQ Capital Market. There are no assurances (1) that the Company will continue to meet the initial listing criteria throughout the pendency of the application (including with respect to its share price), (2) that NASDAQ will approve the application or (3) relating to the timing of any such approval. If and when listed on NASDAQ, there are no assurances that the Company will continue to meet NASDAQ's continued listing requirements.
Amended and Restated Employment Agreement for
OnNovember 28, 2022 , the Company entered into a new employment agreement withDanny Schoening . Pursuant to the agreement, which is dated as ofDecember 1, 2022 ,Mr. Schoening will continue to serve as the Company's President and Chief Executive Officer throughNovember 30, 2025 .Mr. Schoening's base salary initially is$304,912 per annum, and will be increased to$314,060 onDecember 1, 2023 and$323,481 onDecember 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% ofMr. Schoening's base salary. The Board will have discretion in good faith to alter the performance bonus upward or downward by 20%. 4
The updated employment agreement also served to amend
The employment agreement events of termination consist of: (i) death or permanent disability ofMr. Schoening ; (ii) termination by the Company for cause (including conviction of a felony, commission of fraudulent, illegal or dishonest acts, certain willful misconduct or gross negligence byMr. Schoening , continued failure to perform material duties or cure material breach after written notice, violation of securities laws and material breach of the employment agreement), (iii) termination by the Company without cause and (iv) termination byMr. Schoening for good reason (including continued breach by the Company of its material obligations under the agreement after written notice, the requirement forMr. Schoening to move more than 100 miles away for his employment without consent, and merger or consolidation that results in more than 66% of the combined voting power of the Company's then outstanding securities or those of its successor changing ownership or a sale of all or substantially all of its assets, without the surviving entity assuming the obligations under the agreement). For a termination by the Company for cause or upon death or permanent disability ofMr. Schoening ,Mr. Schoening will be paid accrued and unpaid salary and any bonus earned through the date of termination. For a termination by the Company without cause or byMr. Schoening with good reason,Mr. Schoening will also be paid six months' base salary in effect.
New Loan Agreement OnApril 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") withPNC Bank, National Association , successor toBBVA 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 fromApril 15, 2022 toApril 15, 2023 .
The Loan Agreement requires the Borrowers to maintain a fixed charge coverage ratio of at least 1.25:1.
OnNovember 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 remainsApril 15, 2023 . Obligations outstanding under the credit facility will accrue interest at a rate equal to the Lender's prime rate minus 0.25%. The Line of Credit Note and Loan Agreement contain customary events of default and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes, investments, and restricted payments. The credit facility is secured by substantially all of the operating assets of the Borrowers as collateral. The Borrowers' obligations under the credit facility are subject to acceleration upon the occurrence of an event of default as defined in the Line of Credit Note and Loan Agreement. Election of New Director OnOctober 19, 2022 , the Board of Directors of the Company expanded the size of the Board from four to five members and elected Mr.Dayton Judd as a director, to hold office until the Company's next annual meeting of shareholders and until his successor has been elected and qualified. 5 Material Trends Recent supply chain disruptions have strained our suppliers and extended supplier delivery lead times, affecting their ability to sustain operations. We anticipate market wide material shortages for paint and resin products as well as critical epoxies and chemicals used in our manufacturing process. In addition, we are seeing substantial increases in the costs of aluminum, steel and acrylic commodities, which has affected our net income in the first three months of fiscal year 2023 and is expected to continue to have a negative effect on our long-term fixed contracts over the next three years. We have experienced significant material shortages during the three months endedOctober 2, 2022 and extending into the first three months of fiscal year 2023 from two significant suppliers of our periscope covers and housings. These shortages affect several of our periscope products at the Optex Richardson segment. The delays in key components, combined with labor shortages during the first quarter of fiscal year 2023 have negatively impacted our production levels and have pushed the expected delivery dates into the second and third quarters of fiscal year 2023. We are aggressively seeking alternative sources for these components as well as increasing employee recruitment initiatives and overtime to attempt to mitigate any continuing risks to the periscope line. In addition, one of our major customers for the Applied Optics Center has requested a significant schedule delay pushing their laser filter unit delivery schedules from the first half into the second half of fiscal year 2023. InNovember 2022 , we increased our line of credit to$2.0 million from$1.125 million to facilitate our working capital requirements due to the delays and increased backlog. As supplier issues and labor shortages abate, we anticipate increased revenue beginning in the second quarter and increased working capital during the second half of fiscal year 2023 with a recovery expected by fiscal year end 2023. Based on our current backlog, we anticipate an overall increase for fiscal year 2023 revenues as compared to the 2022 levels. We refer also to "Item 1. Business - Market Opportunity:U.S. Military" in our annual report on Form 10-K for the year endedOctober 2, 2022 for a description of current trends inU.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 forU.S ground system military programs, which has a direct impact on theOptex Systems Richardson segment revenue, all of which is incorporated herein by reference. 6 Results of Operations Segment Information We have presented the operating results by segment to provide investors with an additional tool to evaluate our operating results and to have a better understanding of the overall performance of each business segment. Management ofOptex 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 theOptex Systems ,Richardson plant and the Applied Optics Center,Dallas plant are separately managed, organized, and internally reported as separate business segments. The table below provides a summary of selective statement of operations data by operating segment for the three months endedJanuary 1, 2023 andJanuary 2, 2022 reconciled to the Condensed Consolidated Results of Operations as presented in Item 1, "Condensed Consolidated Financial Statements." Results of Operations Selective Financial Information (Thousands) Three months ended January 1, 2023 January 2, 2022 Applied Other Applied Other Optics (non-allocated
Optics (non-allocated
Optex Center costs and Center costs and
Richardson Dallas
eliminations) Consolidated Optex Richardson
Revenue from External Customers
$ -$ 4,040 $ 1,857$ 2,483 $ -$ 4,340 Intersegment Revenues - 116 (116 ) - - 180 (180 ) - Total Segment Revenue 1,619 2,537 (116 ) 4,040 1,857 2,663 (180 ) 4,340 Total Cost of Sales 1,460 1,979 (116 ) 3,323 1,667 2,030 (180 ) 3,517 Gross Profit 159 558 - 717 190 633 - 823 Gross Margin % 9.8 % 22.0 % - 17.7 % 10.2 % 23.8 % - 19.0 %
General and Administrative Expense 863 101
35 999 642 109 57 808
Segment Allocated G&A Expense (280 ) 280 - - (236 ) 236 - -Net General & Administrative Expense 583 381 35 999 406 345 57 808 Operating (Loss) Income (424 ) 177 (35 ) (282 ) (216 ) 288 (57 ) 15 Operating (Loss) Income % (26.2 )% 7.0 % - (7.0 )% (11.6 )% 10.8 % - 0.3 % Net (Loss) Income before taxes$ (424 ) $ 177 $ (35 )$ (282 ) $ 213$ (77 ) $ 967$ 1,103 Net (Loss) Income before taxes % (26.2 )% 7.0 %
- (7.0 )% (11.6 )% 10.8 % - 0.3 %
7
Our total revenues decreased by$300 thousand , or 6.9%, comparing the three months endedJanuary 1, 2023 with the three months endedJanuary 2, 2022 . The decrease in revenue was primarily driven by a$238 thousand decrease in external revenue at the Optex Richardson segment and a$62 thousand decrease in external revenue at the Applied Optics Center segment, respectively, over the prior year period. The decrease in revenue was due to supply chain issues, labor shortage and customer schedule delays across the segments. Consolidated gross profit for the three months endedJanuary 1, 2023 decreased by$106 thousand , or 12.9%, compared to the prior year period. The decrease in profit was primarily attributable to a decrease in consolidated revenue across a relatively fixed overhead cost base, changes in revenue mix between the segments, and inflationary material and labor pressure against our long-term fixed price contracts. Our operating income for the three months endedJanuary 1, 2023 decreased by$297 thousand to a loss of$282 thousand , as compared to the prior year period operating income of$15 thousand . The decrease in operating income was primarily driven by lower gross profit combined with an increase in general and administrative spending. Non-GAAP Adjusted EBITDA We use adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) as an additional measure for evaluating the performance of our business as "net income" includes the significant impact of noncash valuation gains and losses on warrant liabilities, noncash compensation expenses related to equity stock issues, as well as depreciation, amortization, interest expenses and federal income taxes. We believe that Adjusted EBITDA is a meaningful indicator of our operating performance because it permits period-over-period comparisons of our ongoing core operations before the excluded items, which we do not consider relevant to our operations. Adjusted EBITDA is a financial measure not required by, or presented in accordance with,U.S. generally accepted accounting principles ("GAAP"). Adjusted EBITDA has limitations and should not be considered in isolation or a substitute for performance measures calculated under GAAP. This non-GAAP measure excludes certain cash expenses that we are obligated to make. In addition, other companies in our industry may calculate Adjusted EBITDA differently than we do or may not calculate it at all, which limits the usefulness of Adjusted EBITDA as a comparative measure. The table below summarizes our three-month operating results for the periods endedJanuary 1, 2023 andJanuary 2, 2022 , in terms of both the GAAP net income measure and the non-GAAP Adjusted EBITDA measure. We believe that including both measures allows the reader better to evaluate our overall performance. Three months ended (thousands) January 1, 2023 January 2, 2022 Net (Loss) Income (GAAP) $ (223 ) $ 29 Add: Depreciation and Amortization 81 72 Federal Income Tax Benefit (59 ) (14 ) Stock Compensation 35 57 Adjusted EBITDA - Non-GAAP $ (166 ) $ 144 8 Our net income decreased by$252 thousand to a loss of$223 thousand for the three months endedJanuary 1, 2023 , as compared to income of$29 thousand for the three months endedJanuary 2, 2022 . Our adjusted EBITDA decreased by$310 thousand to a loss of$166 thousand for the three months endedJanuary 1, 2023 , as compared to income of$144 thousand for the three months endedJanuary 2, 2022 . The decrease in the three-month period endedJanuary 1, 2023 is primarily driven by lower revenue and operating profit as compared to the prior year. Operating segment performance is discussed in greater detail throughout the previous and following sections. Backlog During the three months endedJanuary 1, 2023 the Company booked$11.2 million in new orders, representing a 220.0% increase over the prior year period new orders of$3.5 million . Both segments experienced a sizeable growth in orders as compared to the prior year period. The orders for the most recently completed quarter consist of$8.6 million for our Optex Richardson segment and$2.6 million attributable to the Applied Optics Center. The following table depicts the new customer orders for the three months endingJanuary 1, 2023 as compared to the three-month period ending January
2,
2022 in millions of dollars:
(Millions)
Q1 Q1
Product Line 2023 2022 Variance % Chg
Periscopes $ 3.7 $ 2.2 $ 1.5 68.2 %
Sighting Systems 3.4 0.1 3.3 3300.0 %
Howitzer - - - - %
Other 1.5 0.3 1.2 400.0 %
Optex Systems - Richardson 8.6 2.6 6.0 230.8 %
Optical Assemblies 1.2 0.2 1.0 500.0 %
Laser Filters 1.3 - 1.3 100.0 %
Day Windows - - - - %
Other 0.1 0.7 (0.6 ) (85.7 )%
Applied Optics Center - Dallas 2.6 0.9 1.7 188.9 %
Total Customer Orders $ 11.2 $ 3.5 $ 7.7 220.0 %
9
The Company has seen significant increases in orders for many of its defense and
commercial products during the first three months of fiscal year 2023 inclusive
of two new customers for our sighting systems and filter programs. On November
1, 2022 , the Company announced it has been awarded a $3.4 million order to
repair and refurbish night vision equipment for the Government of Israel . The
order represents a significant increase in our Optex Richardson sighting systems
business base for a new customer and includes an additional potential award
value with a 100% optional award quantity clause. In October 2023 the Company
booked a $0.9 million award for Applied Optics Center laser interface filters
for a new defense customer in addition to increased purchase orders for our
commercial optical assemblies for our existing customer.
Backlog as of January 1, 2023 , was $40.1 million as compared to a backlog of
$26.5 million as of January 2, 2022 , representing an increase of $13.6 million
or 51.3%. Backlog as compared to October 2, 2022 increased by $7.2 million , or
21.9% from $32.9 million . The following table depicts the current expected
delivery by period of all contracts awarded as of January 1, 2023 in millions of
dollars:
(Millions)
Q2 Q3 Q4 2023 2024+ Total Backlog Total Backlog
Product Line 2023 2023 2023 Delivery Delivery 1/1/2023 1/2/2022 Variance % Chg
Periscopes $ 2.7 $ 2.8 $ 1.1 $ 6.7 $ 3.3 $ 10.0 $ 6.9 $ 3.1 44.9 %
Sighting Systems 0.2 1.2 0.9 2.3 2.6 4.9 1.5 3.4 226.7 %
Howitzer - 0.1 0.1 0.2 2.1 2.3 2.3 - - %
Other 1.2 0.6 0.9 2.7 2.1 4.8 1.0 3.8 380.0 %
Optex Systems - Richardson 4.1 4.7 3.0 11.9 10.1 22.0 11.7 10.3 88.0 %
Optical Assemblies 1.6 1.6 1.5 4.7 1.8 6.5 4.1 2.4 58.5 %
Laser Filters 1.2 2.4 3.1 6.8 2.6 9.4 9.0 0.4 4.4 %
Day Windows 0.1 0.2 0.1 0.4 1.4 1.8 0.9 0.9 100.0 %
Other 0.3 0.1 0.1 0.3 0.1 0.4 0.8 (0.4 ) (50.0 )%Applied Optics Center - Dallas 3.2 4.3 4.8 12.2
5.9 18.1 14.8 3.3 22.3 %
Total Backlog $ 7.3 $ 9.0 $ 7.8 $ 24.1 $ 16.0 $ 40.1 $ 26.5 $ 13.6 51.3 %
Optex Systems Richardson backlog as of January 1, 2023 , was $22.0 million as
compared to a backlog of $11.7 million as of January 2, 2022 , representing an
increase of $10.3 million or 88.0%.
Applied Optics Center backlog as of
Please refer to "Material Trends" above or "Liquidity and Capital Resources" below for more information on recent developments and trends with respect to our orders and backlog, which information is incorporated herein by reference. The Company continues to aggressively pursue international and commercial opportunities in addition to maintaining its current footprint withU.S. vehicle manufactures, with existing as well as new product lines. We continue to review and seek potential products, outside our traditional product lines, which could be manufactured using our current production facilities in order to capitalize on our existing excess capacity.
Three Months Ended
Revenues. For the three months endedJanuary 1, 2023 , revenues decreased by$300 thousand or 6.9% compared to the prior year period as set forth in the table below: Three months ended (Thousands) Product Line January 1, 2023 January 2, 2022 Variance % Chg Periscopes $ 1,325 $ 1,065$ 260 24.4 Sighting Systems 189 274 (85 ) (31.0 ) Howitzers - - - - Other 105 518 (413 ) (79.7 )
Optex Systems - Richardson 1,619 1,857
(238 ) (12.8 )
Optical Assemblies 1,508 1,145 363 31.7
Laser Filters 557 937 (380 ) (40.6 )
Day Windows 161 220 (59 ) (26.8 )
Other 195 181 14 7.7Applied Optics Center - Dallas 2,421 2,483
(62 ) (2.5 )
Total Revenue $ 4,040 $ 4,340 $ (300 ) (6.9 )
10
Optex Systems Richardson revenue decreased by $238 thousand or 12.8% for the
three months ended January 1, 2023 as compared to the three months ended January
2, 2022 on lower customer demand for sighting system repairs and muzzle
reference systems (other) as compared to the prior year period. In addition,
shipments against existing periscope orders have been delayed into the next
quarter due to supplier and manpower shortages. We anticipate higher revenue
beginning during the second quarter and increasing through the second half of
fiscal year 2023 as the supplier and labor shortages are resolved and the
backlog has significantly increased on new orders. We anticipate additional
periscope orders for delivery in the last fiscal quarter of 2023.
Applied Optics Center revenue decreased by $62 thousand or 2.5% for the three
months ended January 1, 2023 as compared to the three months ended January 2,
2022 . The revenue decrease is primarily attributable to customer requested
shipment delays for our laser filter units for a large defense contractor to
accommodate their ongoing facility move. Based on current backlog and the
post-move adjusted customer delivery schedule, we are anticipating revenue to
begin increasing during the next quarter with more significant increases
occurring during the second half of the fiscal year.
Gross Profit. The gross margin during the three-month period ended January 1,
2023 was 17.7% of revenue as compared to a gross margin of 19.0% of revenue for
the period ended January 2, 2022 . The gross profit decreased by $106 thousand to
$717 thousand for the three months ended January 1, 2023 as compared to $823
thousand in the prior year three months. The decrease in gross profit is
primarily attributable to lower revenue spread across a relatively fixed cost
base, changes in mix between products and operating segments and material and
labor inflationary pressure on our long-term contracts. Cost of sales decreased
to $3.3 million for the current period as compared to the prior year period of
$3.5 million on lower period revenue and increased cost.
G&A Expenses. During the three months ended January 1, 2023 and January 2, 2022 ,
we recorded operating expenses of $999 thousand and $808 thousand , respectively.
Operating expenses increased by 23.6% between the respective periods primarily
due to increased labor costs, office expenses, legal and audit fees.
Operating (Loss) Income. During the three months ended January 1, 2023 , we
recorded an operating loss of ($282) thousand , as compared to operating income
of $15 thousand during the three months ended January 2, 2022 . The $297 thousand
decrease in operating income for the current year period from the prior year
period is primarily due to lower gross profit and increased general and
administrative costs in the current year quarter as compared to the prior year
quarter.
Net (Loss) Income applicable to common shareholders. During the three months
ended January 1, 2023 , we recorded a net loss applicable to common shareholders
of ($223) thousand as compared to a net income applicable to common shareholders
of $29 thousand during the three months ended January 2, 2022 . The change in net
income of $252 thousand is primarily attributable to lower revenue and gross
profit combined with increased general and administrative costs.
Liquidity and Capital Resources
As of
During the three months ended
11
The Company has capital commitments of
Backlog as of
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. AtJanuary 1, 2023 , the Company had approximately$1.3 million in cash and an outstanding payable balance of zero against its$2.0 million line of credit. As ofJanuary 1, 2023 , our outstanding accounts receivable was$1.6 million . We expect the accounts to be collected during the second quarter of fiscal 2023. Recently experienced supplier delays, labor shortages, and customer schedule changes negatively impacted our revenue during the three months endedJanuary 1, 2023 but are expected to abate during the second quarter of fiscal year 2023. As described in more detail below, inNovember 2022 , we increased our line of credit to$2.0 million from$1.125 million , to facilitate our working capital requirements due to the delays and increased backlog. We anticipate higher revenue beginning during the second quarter and increasing through the second half of fiscal year 2023 as the supplier and labor shortages combined with customer schedule delays are resolved and the backlog has significantly increased on new orders. In the short term, the Company plans to utilize its current cash, open line of credit and operating cash flow to fund inventory purchases in support of the backlog growth and higher anticipated revenue during the next nine months. Short term cash in excess of our working capital needs may be also be used to fund the purchase of property and equipment required to maintain or meet our growing backlog in addition to repurchasing common stock against our current stock repurchase plan. Longer term, excess cash beyond our operating needs may be used to fund new product development, company or product line acquisitions, or additional stock purchases as attractive opportunities present themselves. In some instances, new government contract awards may allow for contract financing in the form of progress payments pursuant to Federal Acquisition Regulation 52.232-16, "Progress Payments." Subject to certain limitations, this clause provides for government payment of up to 90% of incurred program costs prior to product delivery for small businesses like us. To the extent any contracts allow for progress payments and the respective contracts would result in significant preproduction cash requirements for design, process development, tooling, material or other resources which could exceed our current working capital or line of credit availability, we intend to utilize this benefit to minimize any potential negative impact on working capital prior to receipt of payment for the associated contract deliveries. Currently none of our existing contracts allow for progress payments. The Company expects to generate net income and positive cash flow from operating activities over the next nine months. To achieve and retain profitability, we need to maintain a level of revenue adequate to support our cost structure. Management intends to manage operations commensurate with its level of working capital and line of credit during the next nine months and beyond; however, uneven revenue levels driven by changes in customer delivery demands, first article inspection requirements or other program delays associated with the pandemic, labor shortages and supply chain issues could create a working capital shortfall. In the event the Company does not successfully implement its ultimate business plan, certain assets may not be recoverable. OnApril 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") withPNC Bank, National Association , successor toBBVA 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 fromApril 15, 2022 toApril 15, 2023 .
The Loan Agreement requires the Borrowers to maintain a fixed charge coverage ratio of at least 1.25:1.
OnNovember 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 remainsApril 15, 2023 . Obligations outstanding under the credit facility will accrue interest at a rate equal to the Lender's prime rate minus 0.25%. 12 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. OnSeptember 22, 2021 the Company announced authorization for an additional$1 million stock repurchase program. As ofJanuary 1, 2023 , there was an authorized balance of$560 thousand remaining to be spent against the repurchase program. During the three months endedJanuary 1, 2023 , there were no stock repurchases against the plan.
Critical Accounting Estimates
A critical accounting estimate is an estimate that:
? is made in accordance with generally accepted accounting principles,
? involves a significant level of estimation uncertainty, and
? has had or is reasonably likely to have a material impact on the company's
financial condition or results of operation.
Our significant accounting policies are fundamental to understanding our results
of operations and financial condition. Some accounting policies require that we
use estimates and assumptions that may affect the value of our assets or
liabilities and financial results. These policies are described in Note 2
(Accounting Policies) to consolidated financial statements in our Annual Report
on Form 10-K for the year ended October 2, 2022 .
Our critical accounting estimates include warranty costs, contract losses and
the deferred tax asset valuation. Future warranty costs are based on the
estimated cost of replacement for expected returns based upon our most recent
experience rate of defects as a percentage of warranty covered sales. Our
warranty covered sales primarily include the Applied Optics Center optical
assemblies. While our warranty period is 12 months, our reserve balances assume
a general 90-day return period for optical assemblies previously delivered plus
any returned backlog inhouse that has not yet been repaired or replaced to our
customer. If our actual warranty returns should significantly exceed our
historical rates on new customer products, significant production changes, or
substantial customer changes to the 90-day turn-around times on returned goods,
the impact could be material to our operating profit. We have not experienced
any significant changes to our warranty trends in the preceding three years and
do not anticipate any significant impacts in the near term. We monitor the
actual warranty costs incurred to the expected values on a quarterly basis and
adjust our estimates accordingly. As of January 1, 2023 , the Company had accrued
warranty costs of $229 thousand , as compared to $169 thousand as of October 2,
2022 . The primary reason for the $60 thousand increase in reserve balances
relates to an increase in customer returned backlog pending repair or
replacement to our customer during the preceding three-month period.
As of January 1, 2023 and October 2, 2022 , we had $282 thousand , and $289
thousand , respectively, of contract loss reserves included in our balance sheet
accrued expenses. These loss contracts are related to some of our older legacy
periscope IDIQ contracts which were priced in 2018 through early 2020, prior to
COVID-19 and the significant downturn in defense spending on ground system
vehicles. Due to inflationary price increases on component parts and higher
internal manufacturing costs (as a result of escalating labor costs and higher
burden rates on reduced volume), some of these contracts are in a loss
condition, or at marginal profit rates. These contracts are typically three-year
IDIQ contracts with two optional award years, and as such, we are obligated to
accept new task awards against these contracts until the contract expiration.
Should contract costs continue to increase above the negotiated selling price,
or in the event the customer should release substantial quantities against these
existing loss contracts, the losses could be material. For contracts currently
in a loss status based on the estimated per unit contract costs, losses are
booked immediately on new task order awards. Some of these long-term contracts
have option year ordering periods ending in February 2025 with deliveries that
may extend into February 2026 . During the three months ended January 1, 2023 ,
the Company recognized additional expenses for contract loss reserves of $51
thousand on new task awards against the long-term fixed contracts and applied
$58 thousand of the reserves against revenues booked during the period. There is
no way to reasonably estimate future inflationary impacts, or customer awards on
the existing loss contracts.
13
As of January 1, 2023 and October 2, 2022 , our deferred tax assets consisted of
$1.8 million , partially offset by a valuation reserve of $0.8 million against
those assets for a net deferred tax asset of $1.0 million . The valuation
allowance covers certain deferred tax assets where we believe we will be
unlikely to recover those tax assets through future operations. The valuation
reserve includes assumptions related to future taxable income which would be
available to cover net operating loss carryforward amounts. Because of the
uncertainties of future income forecasts combined with the complexity of some of
the deferred assets, these forecasts are subject to change over time. While we
believe our current estimate to be reasonable, changing market conditions and
profitability, changes in equity structure and changes in tax regulations may
impact our estimated reserves in future periods.
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