OPTEX SYSTEMS HOLDINGS, INC 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 endedOctober 2, 2022 , prepared in accordance withU.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
BackgroundOptex Systems, Inc. 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 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 byOptex Systems, Inc. (Delaware ). 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 NAMSA and South American countries and as a subcontractor for several largeU.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 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. 29
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 onOptex 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 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 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 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 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. 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 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.
30 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 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 (to which we refer below as theOptex Systems segment orOptex Systems ), and the Applied Optics Center,Dallas plant, which was acquired onNovember 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 endedOctober 2, 2022 andOctober 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 Applied Applied Other Optics Other Optics (non-allocated Optex Center (non-allocated costs Optex Center costs and Richardson Dallas and eliminations) Consolidated Richardson Dallas eliminations) Consolidated
Revenue from External Customers
- $ 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 %
31
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.
32
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)
Twelve months Twelve months
ended ended
October 2, October 3,
Product Line 2022 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 inAugust 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 withU.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
(Millions)
Q1 Q2 Q3 Q4 2023 2024+ Total Backlog Total Backlog
Product Line 2023 2023 2023 2023 Delivery Delivery 10/2/2022 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 %
33
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
Sighting Systems and Howitzer product line backlog remained flat during the twelve months endedOctober 2, 2022 as compared to the prior year end backlog at$1.7 million and$2.3 million , respectively. The Howitzer contract awarded inJuly 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 endedOctober 2, 2022 , primarily for muzzle reference systems for a majorU.S. defense contractor.
Applied Optics Center -
The Applied Optics Center backlog increased by
Backlog for our optical assemblies increased by
Laser filter backlog decreased by
Day window backlog increased by
Other backlog increased by
Twelve month period ended
Revenues
The table below details the revenue changes by segment and product line for the
year ended
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 0.6 120.0Applied Optics Center - Dallas 12.9 6.4
6.5 101.6
Total Revenue $ 22.4 $ 18.2 $ 4.2 23.1
34
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
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 ourAiming 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 -
Revenue on optical assemblies increased by$3.0 million , or 157.9%, during the twelve months endedOctober 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
Revenues on our day windows remained flat at
Applied Optics Center revenue for other product lines increased by$0.6 million , or 120.0%, during the twelve months endedOctober 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 endedOctober 2, 2022 was 21.9% of revenue as compared to a gross margin of 13.8% of revenue for the year endedOctober 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 endedOctober 2, 2022 andOctober 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 endedOctober 2, 2022 , we recorded an operating income of$1.6 million as compared to operating loss of$(0.5) million during the year endedOctober 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. 35
Net income applicable to common shareholders. During the year endedOctober 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 endedOctober 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 endedOctober 2, 2022 andOctober 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 endedOctober 2, 2022 as compared to$0.0 million during the twelve months endedOctober 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 ofOctober 2, 2022 ,Optex Systems Holdings had working capital of$10.0 million , as compared to$12.9 million as ofOctober 3, 2021 . During the twelve months endedOctober 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
36 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. AtOctober 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 ofOctober 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. 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 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. 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. 37 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 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 ofSeptember 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). OnSeptember 22, 2021 the Company announced authorization for an additional$1 million stock repurchase program. During the twelve months endedOctober 2, 2022 , the Company purchased 190,954 common shares under theSeptember 2021 stock repurchase plan at a cost of$371 thousand . As ofOctober 2, 2022 , there were zero shares held in treasury. As ofOctober 2, 2022 , there was an authorized balance of$560 thousand remaining to be spent against the repurchase program. During the twelve months endedOctober 2, 2022 the Company declared and paid no dividends. As ofOctober 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 .
38
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.
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