EDGAR 10-K Filing

Company CIK: 1397016
Filing Year: 2021
Filename: 1397016_10-K_2021_0001493152-21-032028.json

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ITEM 1. BUSINESS
Item 1 Description of Business
Background
Current Line of Business
We manufacture optical sighting systems and assemblies, primarily for Department of Defense applications. Our 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. We also manufacture and deliver numerous periscope configurations, rifle and surveillance sights and night vision optical assemblies. Our 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 us.
We continue to field new product opportunities from both domestic and international customers. We believe that given continuing unrest in multiple global hot spots, the need for precision optics continues to increase. Most of these requirements are for observation and situational awareness applications; however, we continue to see requests for higher magnification and custom reticles in various product modifications. The basic need to protect the soldier while providing information about the mission environment continues to be the primary driver for these requirements.
Recent Events
Amended and Restated Employment Agreement for Danny Schoening
The Company entered into an amended and restated employment agreement with Danny Schoening dated December 1, 2021. The term of the agreement commenced as of December 1, 2021 and the current term ends on November 30, 2022. Mr. Schoening’s base salary is $296,031 per annum. Mr. Schoening will be eligible for a performance bonus based upon a rolling three-year operating plan adopted by the Company’s Board of Directors (the “Board”). The bonus will be based on operating metrics decided annually by our Board and tied to such three-year plan. The target bonus equates to 30% of Mr. Schoening’s base salary. Our Board will have discretion in good faith to alter the performance bonus upward or downward by 20%. The amended and restated employment agreement also served to amend Mr. Schoening’s Restricted Stock Unit (“RSU”) Agreement, dated January 2, 2019, by changing the third and final vesting date for the restricted stock units granted under such agreement. For additional information on the amended and restated employment agreement, please see “Item 11. Executive Compensation - Employment Agreements - Danny Schoening,” which disclosure is incorporated by reference herein.
Renewal of Employment Agreement for Karen Hawkins
On February 1, 2021, the employment agreement for Karen Hawkins, CFO, auto-renewed for an additional 18-month period, expiring on June 30, 2022. The contract automatically renews for subsequent 18-month periods unless Ms. Hawkins or the Company give notice of termination at least 90 days before the end of the term then in effect.
Stock & Warrant Repurchases
On June 8, 2020 the Company announced authorization for a $1 million stock repurchase program. As of September 27, 2020 there were 105,733 shares held in treasury purchased under the June 2020 stock repurchase program. The Company purchased a total of 519,266 shares under 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.
During the twelve months ended October 3, 2021, there were 449,088 common shares repurchased through the repurchase programs 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 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.
July 2021 Ransomware Attack
On July 13, 2021, the Company experienced a ransomware attack. Information regarding the attack was communicated to the appropriate U.S. government officials. The Company isolated the source of the attack and restored normal operations with no material day-to-day impact to the Company or the Company’s ability to access its data. As part of our normal disaster recovery procedures, we were able to restore our systems with clean back-ups. Sensitive data may have been breached, but we did not uncover any evidence of comprised data. We did not communicate with the attackers and engaged a third-party recovery and monitoring service to assist with the investigation and prevention of future attacks. Subsequent to the event, we have enhanced our IT security to minimize future occurrences.
Recent Orders
● On January 11, 2021, the Company announced a contract for Laser Protected Periscopes for a base period of three years plus two one-year option years, not to exceed $14.4 million pursuant to an Indefinite Delivery - Indefinite Quantity (IDIQ) contract.
● On August 2, 2021, the Company announced a contract award of $8.4 million as part of a twenty-four-month purchase order for laser filters manufactured at the (AOC) Division of Optex Systems, Inc.
● On September 21, 2021, the Company announced a $3 million order to be delivered over the next twelve months as part of a multi-year strategic supplier agreement with a domestic commercial manufacturer of premium optical devices. The products will be manufactured at the (AOC) Division of Optex Systems, Inc.
● On September 27, 2021, the Company announced an initial $1.4 million order against a 5 Year Indefinite Delivery Indefinite Quantity contract for laser protected periscopes from a U.S. Defense agency customer with deliveries starting in 2022 and concluding in 2023 for this initial release.
Products
Our products are installed on various types of U.S. military land vehicles, such as the Abrams and Bradley, and Stryker families of fighting vehicles, as well as light armored and armored security vehicles. We also manufacture and deliver numerous periscope configurations, rifle and surveillance sights and night vision optical assemblies. We deliver our products both directly to the federal government and to prime contractors.
On August 31, 2020, the Company announced it is now offering mil-spec quality High Efficiency Anti-Reflective Coatings for Infrared applications in both the military and commercial markets. These coatings are manufactured at the Applied Optics Center (AOC) Division of Optex Systems, Inc. in Dallas, Texas. During the twelve months ended October 3, 2021, AOC booked new orders of $199 thousand for the new products and an additional order of $52 thousand during October 2021. We anticipate continued revenue growth from the new offering in the current fiscal year.
We deliver high volume products, under multi-year contracts, to large defense contractors and government customers. Increased emphasis in the past several years has been on new opportunities to promote and deliver our products in foreign military sales, where U.S.-manufactured, combat and wheeled vehicles, are supplied (and upgraded) in cooperation with the U.S. Department of Defense. We have a reputation for quality and credibility with our customers as a strategic supplier. We also anticipate the opportunity to integrate some of our night vision and optical sights products into commercial applications.
Specific product categories by product line include:
Product Line
Product Category
Periscopes
Laser & Non-Laser Protected Plastic & Glass Periscopes, Electronic M17 Day/Thermal Periscopes, Vision Blocks
Sighting Systems
Back Up Sights, Digital Day and Night Sighting Systems (DDAN), M36 Thermal Periscope, Unity Mirrors, Optical Weapon System Support and Maintenance, Commander Weapon Station Sight (CWSS)
Howitzers
M137 Telescope, M187 Mount, M119 Aiming Device, XM10 Aiming Circle
Other
Muzzle Reference Systems (MRS), Binoculars, Collimators, Optical Lenses & Elements, Windows
Applied Optics Center
Laser Interference Filter, Optical Assemblies, Laser Filter Units, Day Windows, Binoculars, Specialty Thin Film Coatings.
Contracts
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.
Our government contracts allow for Federal Acquisition Regulation 52.243-1 which entitles the contractor to an “equitable adjustment” for contract or statement of work changes effecting cost or time of performance. In essence, an equitable price adjustment request is a request for a contract price modification (generally an increase) that allows for the contractor to be “made whole” for additional costs incurred which were necessitated by some modification of the contract effort. This modification may come from an overt change in U.S. Government requirements or scope, or it may come from a change in the conditions surrounding the contract (e.g., differing site conditions or late delivery of U.S. Government-furnished property) which result in statement of work additions, deletions, part substitutions, schedule or other changes to the contract which impact the contractor’s overall cost to complete.
Each contract with our customers has specific quantities of material that need to be purchased, assembled, and then shipped. Prior to bidding for a contract, we contact potential sources of material and receive qualified quotations for each material. In some cases, the entire volume is given to a single supplier and in other cases, the volume might be split between several suppliers. If a contract has a single source supplier and that supplier fails to meet their obligations (e.g., quality, delivery), then we would attempt to find an acceptable alternate supplier, and if successful, we would then renegotiate contractual deliverables (e.g., specifications, delivery or price). As of November 22, 2021, approximately 1% of our material requirements are single-sourced across 9 suppliers representing approximately 8% of our active supplier order values. Single-sourced component requirements span across all of our major product lines. Of these single sourced components, we have material contracts (purchase orders) with firm pricing and delivery schedules in place with each of the suppliers to supply the parts necessary to satisfy our current contractual needs. See “Item 1.A. Risk Factors - Risks Relating 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 certain supplier risks we face, which description is incorporated herein by reference.
Approximately 83% of our contracts contain termination clauses for convenience. In the event these clauses should be invoked by our customer, future revenues against these contracts could be affected, however these clauses allow for a full recovery of any incurred contract costs plus a reasonable fee up through and as a result of the contract termination. We are currently unaware of any pending terminations on our existing contracts.
In some cases, contract awards may be issued that are subject to renegotiation at a date (up to 180 days) subsequent to the initial award date. Generally, these subsequent negotiations have had an immaterial impact (zero to 5%) on the contract price of the affected contracts. Currently, none of our awarded contracts are subject to renegotiation.
We are subject to, and must comply with, various governmental regulations that impact, among other things, our revenue, operating costs, profit margins and the internal organization and operation of our business. The material regulations affecting our U.S. government business are summarized in the table below.
Regulation
Summary
Federal Acquisition Regulation (FAR)
The principal set of rules in the Federal Acquisition Regulation System. This system consists of sets of regulations issued by agencies of the federal government of the United States to govern what is called the “acquisition process,” which is the process through which the government acquires goods and services. That process consists of three phases: (1) need recognition and acquisition planning, (2) contract formation, and (3) contract administration. This system regulates the activities of government personnel in carrying out that process. It does not regulate the purchasing activities of private sector firms, except to the extent that those activities involve government solicitations and contracts by reference.
International Traffic in Arms Regulations (ITAR)
United States government regulations that control the export and import of defense-related articles and services on the United States Munitions List. These regulations implement the provisions of the Arms Export Control Act.
Truth in Negotiations Act (TINA)
A public law enacted for the purpose of providing for full and fair disclosure by contractors in the conduct of negotiations with the government. The most significant provision included is the requirement that contractors submit certified cost and pricing data for negotiated procurements above a defined threshold of $2 million for contracts entered into after June, 30, 2018. The law requires contractors to provide the government with an extremely broad range of cost or pricing information relevant to the expected costs of contract performance, and it requires contractors and subcontractors to submit cost or pricing data to the government and to certify that, to the best of their knowledge and belief, the data are current, accurate, and complete. A contracting officer may still request cost or price data, if necessary, without certification, to determine whether the proposed cost or price is fair and reasonable for contracts which are below the threshold.
We are responsible for full compliance with the Federal Acquisition Regulation (FAR). Upon award, the contract may identify certain regulations that we need to meet. For example, a contract may allow progress billing pursuant to specific FAR clauses incorporated into the contract. Other contracts may call for specific first article acceptance and testing requirements. The FAR will identify the specific regulations that we must follow based on the type of contract awarded and contains guidelines and regulations for managing a contract after award, including conditions under which contracts may be terminated, in whole or in part, at the government’s convenience or for default. These regulations also subject us to financial audits and other reviews by the government of our costs, performance, accounting and general business practices relating to our government contracts, which may result in adjustment of our contract-related costs and fees and, among other things and impose accounting rules that define allowable and unallowable costs governing our right to reimbursement under certain contracts.
First Article Testing and Acceptance requirements consist of specific steps which could be comprehensive and time consuming. The dimensions and material specifications of each piece of the assembly must be verified, and some products may have in excess of 100 assembled parts. Once the individual piece parts are verified to be compliant to the specification, the assembly processes are documented and verified. A sample of the production (typically three units) is verified to meet final performance specifications. Once the units meet the final performance specification, they are then subjected to accelerated life testing, a series of tests which simulate the lifetime use of the product in the field. This consists of exposing the units to thermal extremes, humidity, mechanical shock, vibration, and other physical exposure tests. Once completed, the units undergo a final verification process to ensure that no damage has occurred as a result of the testing and that they continue to meet the performance specification. All of the information and data is recorded into a final first article inspection and test report and submitted to the customer along with the test units for final approval. First Article Acceptance and Testing is generally required on new contracts/product awards but may also be required on existing products or contracts where there has been a significant gap in production, or where the product has undergone significant manufacturing process, material, tooling, equipment or product configuration changes.
We are also subject to laws, regulations and executive orders restricting the use and dissemination of information deemed classified for national security purposes and the exportation of certain products and technical data as covered by the International Traffic in Arms Regulation (ITAR). In order to import or export items listed on the U.S. Munitions List, we are required to be registered with the Directorate of Defense Trade Controls office. The registration is valid for one year, and the registration fees are established based on the number of license applications submitted the previous year. We currently have an approved and current registration on file with the Directorate of Defense Trade Controls office. Once the registration is approved, each import/export license must be filed separately. License approval requires the company to provide proof of need, such as a valid contract or purchase order requirement for the specific product or technical data requested on the license and requires a detailed listing of the items requested for export/import, the end-user, the end-user statement, the value of the items, consignees/freight forwarders and a copy of a valid contract or purchase order from the end-user. The approval process for the license can vary from several weeks to six months or more. The licenses we currently use are the Department of State licenses: DSP-5 (permanent export), DSP-6 (license revisions) and DSP-73 (temporary export) and Department of Commerce: BIS-711 (export).
The aforementioned licenses are valid for 48 months from date that each license is issued. A summary of our active ITAR licenses is presented below (updated as of November 17, 2021):
Fiscal Year Number of Total Contract
Value of
Active ITAR Licenses of Expiration Licenses Licenses
DSP-5
Issued 2018 2,742,658
Issued 2019 20,934,845
Issued 2020 51,365
Issued 2021 _3 232,630
Total DSP-5 Licenses
$ 23,961,498
DSP-6 (no active licenses) N/A - $ -
DSP-73
Issued in 2019 $ 4,000
Total DSP-73 Licenses
$ 4,000
BIS-711
Issued in 2018 $ 113,907
Issued in 2019 3,416
Issued in 2020 92,554
Issued in 2021 323,911
Total BIS-711 Licenses
$ 533,788
Total All Licenses
$ 24,499,286
These licenses are subject to termination if a licensee is found to be in violation of the Arms Export Control Act or the ITAR requirements. If a licensee is found to be in violation, in addition to a termination of its licenses, it can be subject to fines and penalties by the government.
Our contracts may also be governed by the Truth in Negotiation Act (TINA) requirements where certain of our contracts or proposals exceed the TINA threshold ($2 million for awards after June 30, 2018), and/or are deemed as sole source, or non-competitive awards, covered under this act. For these contracts, we must provide a vast array of cost and pricing data in addition to certification that our pricing data and disclosure materials are current, accurate and complete upon conclusion of the negotiation. Due to the additional disclosure and certification requirements, if a post contract award audit were to uncover that the pricing data provided was in any way not current, accurate or complete as of the certification date, we could be subjected to a defective pricing claim adjustment with accrued interest. We have no history of defective pricing claim adjustments and have no outstanding defective pricing claims pending. Additionally, as a result of this requirement, contract price negotiations may span from two to six months and can result in undefinitized or not to exceed ceiling priced contracts subject to future downward negotiations and price adjustments. Currently, we do not have any undefinitized contracts subject to further price negotiation.
Our failure to comply with applicable regulations, rules and approvals or misconduct by any of our employees could result in the imposition of fines and penalties, the loss of security clearances, the loss of our U.S. government contracts or our suspension or debarment from contracting with the U.S. government generally, any of which could have a material adverse effect our business, financial condition, results of operations and cash flows. We are currently in compliance with all applicable regulations and do not have any pending claims as a result of noncompliance.
The terms of our material contracts as of November 17, 2021, are as follows:
Customer Contract Total Award
Value(2) Remaining
Value(3) Delivery
Customer PO/Contract Type(1) (millions) (millions) Period
US Prime Contractor(1) Subcontract FFPQ $ 1.6 $ 0.1 Dec 2017- Feb 2022
Periscopes PO 35506523
US Prime Contractor(2) Subcontract FFPQ $ 3 $ 1.1 Oct 2017- Mar 2024
Sighting Systems PO 35515590
DLA Land and Maritime(3) Prime IDIQ $ 0.9 $ 0.4 Feb 2020 - Jun 2022
Periscopes SPE7LX-18-D-0108
US Prime Contractor(4) Subcontract FFPQ $ 2.6 $ 0.3 Aug 2017- Feb 2022
Day Windows (AOC) PO 40269398
DLA Land and Maritime(5) Prime IDIQ $ 0.2 $ 0.1 Feb 2021 - Apr 2022
Periscopes SPE7LX-19-D-0089
DLA Land and Maritime(6) Prime IDIQ $ 0.6 $ 0.4 Dec 2021 - July 2022
Periscopes SPE7LX-20-D-0020
DLA Land and Maritime(7) Prime/Shared IDIQ $ - $ - No task awards have
Glass Periscopes SPE7MX-20-D-0012
been released
DLA Land and Maritime(8) Prime IDIQ $ - $ - No task awards as of
Periscopes SPE7MX-20-D-0028
current date
DLA Land and Maritime(9) Prime IDIQ $ - $ - No task awards as of
Periscopes SPE7MX-20-D-0032
current date
U.S. Prime Contractor(10)
XM10 Aiming Circles Subcontract
PO 63659 FFPQ $ 2.3 $ 2.3 Jul 2021- Oct 2023
DLA Land and Maritime(11) Prime IDIQ $ 0.8 $ 0.4 Sept 2021 - Jan 2022
Periscopes SPE7LX-21-D-0057
U.S. Prime Contractor(12)
Laser Filter Units (AOC) Subcontract
PO 631537 FFPQ $ 8.4 $ 8.3 Aug 2021 - Oct 2023
Commercial Customer(13)
Optical Assemblies (AOC) Subcontract
PO26071, 26077 FFPQ $ 3 $ 3 Dec 2021 - June 2022
US Prime Contractor(14)
Periscopes Subcontract
PO 40389248,40389250 FFPQ $ 1.4 $ 1.4 Feb 2022 - Mar 2023
(1) Contract quantity awarded on December 2, 2016 for laser protected periscopes installed on Light Armored Vehicles in the Middle East.
(2) The original three-year contract was awarded on September 11, 2017 to provide LAV 6.0 optimized weapon system support for Optex’s Commander Sighting System. The contract includes option years to extend the period of performance through 2035 if awarded. The current contract option extends the in-service support through March 2024 for their existing fleet of Light Armored Vehicles.
(3) Contract awarded September 5, 2018. This is a long-term, Indefinite Delivery Indefinite Quantity (IDIQ) Contract with firm fixed pricing for the duration of a base period of three (3) years plus two (2) firm fixed priced option years for a potential total of (5) five years.
(4) Contract awarded February 6, 2017 with an additional quantity executed on January 24, 2019. This is a Firm Fixed Price order for Day Windows manufactured at the Applied Optics Center for delivery through March 2022.
(5) Contract awarded March 4, 2019. This is a long-term, Indefinite Delivery Indefinite Quantity (IDIQ) Contract with firm fixed pricing for the duration of a base period of three (3) years plus two (2) firm fixed priced option years for a potential total of (5) five years.
(6) Contract awarded on November 12, 2019. This is a long-term, Indefinite Delivery Indefinite Quantity (IDIQ) Contract with firm fixed pricing for the duration of a base period of three (3) years plus two (2) firm fixed priced option years for a potential total of (5) five years for periscopes valued up to $2.3 million.
(7) Contract awarded on December 5, 2019. This is a shared long-term, Indefinite Delivery Indefinite Quantity (IDIQ) Contract with firm fixed pricing for the duration of a base period of three (3) years plus two (2) firm fixed priced option years for a potential total of (5) five years and a maximum of value $35 million for Improved Commander Weapon System (ICWS) periscopes. As of October 3, 2021, there have been no task orders released against the base contract award.
(8) Contract awarded on January 24, 2020. This is a long-term, Indefinite Delivery Indefinite Quantity (IDIQ) Contract with firm fixed pricing for the duration of a base period of three (3) years plus two (2) firm fixed priced option years for a potential total of (5) five years for periscopes valued up to $3.6 million. As of October 3, 2021, there have been no task orders released against the base contract award.
(9) Contract awarded on February 12, 2020. This is a long-term, Indefinite Delivery Indefinite Quantity (IDIQ) Contract with firm fixed pricing for the duration of a base period of three (3) years plus two (2) firm fixed priced option years for a potential total of (5) five years for periscopes valued up to $9.2 million. As of October 3, 2021, there have been no task orders released against the base contract award.
(10) Purchase Order by a U.S. prime contractor in support of government contract W15QKN-16-D-0055 for Aiming Circle optical subassemblies. The purchase order was awarded on July 30, 2020 for $2 million and amended to $2.3 million on 9/14/2020 and includes non-recurring engineering and first article testing during fiscal year 2021, with production deliveries from November 2021 through October 2023.
(11) Contract awarded on January 6, 2021. This is a long-term, Indefinite Delivery Indefinite Quantity (IDIQ) Contract with firm fixed pricing for the duration of a base period of three (3) years plus two (2) firm fixed priced option years for a potential total of (5) five years for periscopes valued up to $14.4 million.
(12) Purchase Order awarded August 3, 2021 by a U.S. prime contractor in support of U.S. government contracts. Award includes first article inspection in August 2021 and production deliveries commencing in September 2021 through October 2023.
(13) Purchase Orders awarded September 8, 2021 and September 21, 2021 by a commercial customer.
(14) Purchase Orders awarded September 24, 2021 by a U.S. prime contractor in support of U.S. government contracts.
Market Opportunity - U.S. Military
During the twelve months ended October 3, 2021, approximately 86% of our business was in support of U.S. military products. The chart below was derived from public government spending sources and depicts total U.S. military spending from 2011 through 2020 and estimated spending through 2026. The purpose of including this chart is to provide the reader with historical trend data and projected U.S. military defense and procurement spending over time. For fiscal year 2022, the total projected military spending is estimated at $729.5 billion, an overall increase of 1.7% over estimated 2021 spending. The chart below also depicts increased spending through 2026 of 9.0% from the current estimated fiscal year 2021 level. Military procurement spending, a subset of total military spending, depicts an overall decline of 13.3 billion, or 9.7% in fiscal year 2022 as compared to the estimated spending in fiscal year 2021.
Military spending was negatively impacted by the Budget Control Act of 2011 (BCA 2011), which was passed in August 2011. The BCA 2011 mandated a $917.0 billion reduction in discretionary spending over the succeeding decade, and $1.2 trillion in automatic spending cuts over a nine-year period to be split between defense and non-defense programs beginning in January 2013. During the years 2015-2019 Congress enacted additional legislative budget measures which eased the strict spending caps set forth in sequestration of the BCA 2011 through the 2021 fiscal budget year.
On February 9, 2018, Congress enacted the Bipartisan Budget Act of 2018 (BBA 2018), a budget stop gap resolution which lifted the sequestration limits on military spending by $165 billion through fiscal year 2019. On August 2, 2019, the Bipartisan Budget Act of 2019 (BBA 2019) was signed into law. The BBA 2019 raises the budget caps for both defense and nondefense for fiscal year 2020 and fiscal year 2021, the final two years of the BCA 2011 discretionary cap period. The 2019 bill increases the defense base budget by $171 billion over the BCA 2011 and sets limits on the Overseas Contingency Operations (OCO) Emergency Funding of $141 billion over the two-year period. Under the current law, there are no caps on defense and nondefense discretionary spending for fiscal year 2022 and beyond.
As of December 14, 2021, the National Defense Authorization Act for Fiscal Year 2022 (2022 NDAA) has not yet been passed by Congress. The Chart below depicts the estimated funding levels from the U.S. Department of Defense based on the FY2022 budget request.
Source: Government Publishing Office, U.S. Budget Historical Tables, FY 2022, Table 3.2 Outlays by function and sub function, 1962-2026.
The table below depicts the U.S. Department of Defense budget request for fiscal year 2022 for major ground system programs. The total fiscal year 2022 budget request for major ground system programs decreased by 14.2% from the fiscal year 2021 levels and by 16.3% from the fiscal year 2020 levels. Although it is difficult to directly tie the budget request to specific components provided by Optex Systems, we provide periscopes, collimator assemblies, vision blocks and laser interface filters to the U.S. armed forces on almost all of the ground system platforms categorized below.
Major Weapon System Summary
($ in Millions) FY 2020 FY 2021 FY 2022
Ground Systems - Joint Service
JLTV Joint Light Tactical Vehicle $ 1,716.5 $ 1,401.9 $ 1,055.3
Ground Systems - USA
M-1 Abrams Tank Modification/Upgrades 2,186.0 1,404.2 1,031.7
AMPV Armored Multi-Purpose Vehicle 525.2 139.1 140.3
PIM Paladin Integrated Management 744.5 681.4 659.7
FMTV Family of Medium Tactical Vehicles 141.4 207.8 54.1
FHTV Family Of Heavy Tactical Vehicles 50.8 28.8 95.9
NGSW Next Generation Squad Weapon 86.2 124.4 165.0
Stryker Stryker 953.2 1,186.3 1,036.0
Ground Systems - USMC
ACV Amphibious Combat Vehicle 349.3 478.6 613.1
Total Ground System Vehicles $ 6,753.1 $ 5,652.5 $ 4,851.1
Source: Office of the Under Secretary of Defense (Comptroller)/Chief Financial Officer, “Program Acquisition Cost by Weapon System, United States Department of Defense, Fiscal Year 2022 Budget Request”, May 2021.
The 2022 Department of Defense Budget indicates an overall decrease in ground system vehicle program spending in the fiscal year 2021 and the 2022 appropriation budget years. There is generally a six to eighteen-month delay between U.S. defense budget requests and program delivery orders related to our products from government agencies and our prime defense customers. In addition, DoD budget requests are often changed throughout the congressional NDAA Budgeting and Budget appropriations process. The DoD budget requests exclude any foreign military sales as they are funded separately from the annual NDAA budgets. We are carefully watching the projected trends in both DoD military spending and FMS as defense allocation priorities change, as well as challenges which are presented from the current pandemic, global recession, and changes in political climate to ascertain any potential impact to the company’s future revenue.
The Applied Optics Center supports numerous other military platforms outside of the ground system vehicles budget such as infantry rifle scopes, night vision monoculars, infantry and navy binoculars, night goggles, and infrared aircraft filters. The Applied Optics Center has seen a substantial increase in orders from new and existing customers in support of the other platforms, which we expect to offset the impact of the ground systems reductions to their base revenue.
Market Opportunity - Foreign Military
Our products directly support FMS combat vehicles globally, including Canada, the Kingdom of Saudi Arabia, Kuwait, Morocco, Egypt, South America, and Israel. We have increased efforts to promote our proven military products, as well as newly improved product solutions directly to foreign military representatives and domestic defense contractors supporting the FMS initiatives.
In addition, we have partnered with G&H for the supply of acrylic-based sighting system technology to meet European customer requirements for a total package single-technology source supply. Some foreign customers desire the reduced weight and cost savings provided by acrylic based periscopes when compared directly to glass-based periscopes. Our partnership will allow us to deliver this technology through ITAR licenses directly to them or their customers. G&H designs and manufactures periscopes and sighting systems for armored fighting vehicles under the Kent Periscopes brand. With a strong footprint in Europe and Asia, G&H supplies glass-based products for both periscope external viewing and system sensor-based imaging by commanders, drivers, and gunners.
We are currently under contract with the Israeli Ministry of Defense (IMOD) to refurbish a small quantity of their Night Vision Rifle Scopes. If this initial quantity meets their requirements, we expect substantial follow on orders to refurbish a major portion of their current inventory.
We are also exploring possibilities to adapt some of our products for commercial use in those markets that demonstrate potential for solid revenue growth, both domestically and internationally.
Market Opportunity - Commercial
Our products are currently sold to military and related government markets. We believe there may be opportunities to commercialize various products we presently manufacture to address other markets. Our initial focus will be directed in three product areas.
● Big Eye Binoculars - While the military application we produce is based on mature military designs, we own all castings, tooling and glass technology. These large fixed mount binoculars could be sold to cruise ships, personal yachts and cities/municipalities. The binoculars are also applicable to fixed, land-based outposts for private commercial security as well as border patrols and regional law enforcement.
● Thin Film Coatings - The acquisition of the Applied Optics Center (AOC) also creates a new sector of opportunity for commercial products for us. Globally, commercial optical products use thin film coatings to create product differentiation. These coatings can be used for redirecting light (mirrors), blocking light (laser protection), absorbing select light (desired wavelengths), and many other combinations. They are used in telescopes, rifle scopes, binoculars, microscopes, range finders, protective eyewear, photography, etc. Given this broad potential, the commercial applications are a key opportunity going forward.
● Optical Assemblies - Through the Applied Optics Center, we are utilizing our experience in military sighting systems to pursue commercial opportunities associated with products that incorporate multi-lens optical cell assemblies, bonded optical elements and mechanical assemblies. There are a wide variety of products in the medical, machine vision, automotive and outdoor recreation fields that can benefit from our capabilities. Support to domestic customers for these type products has driven significant increases in overall sales during the last five years.
Customer Base
We serve customers in four primary categories: as prime defense contractor (Defense Logistics Agency (DLA) Land and Maritime, DLA Warren, DLA Aviation, U.S. Army, Navy and Marine Corps), as defense subcontractor (General Dynamics, L-3 Communications, Elbit Systems, BAE, Sig Sauer, and ADS Inc.), as a military supplier to foreign governments (Israel, Australia, South America and Canada) and also as a commercial optical assembly supplier (Nightforce Optics, Cabela’s, Amazon). During the twelve months ended October 3, 2021, we derived approximately 86% of our gross business revenue from six major customers: U.S. government agencies (28%), four major defense contractors, (27%, 11%, 5%, and 5%), and one commercial customer (10%). We have approximately 98 discrete contracts for items that are utilized in vehicles, optical product lines and as spare parts. Due to the high percentage of prime and subcontracted U.S. defense revenues, large customer size and the fact that there are multiple contracts with each entity, which are not interdependent, we are of the opinion that this provides us with a fairly well diversified revenue pool.
Marketing Plan
We believe we are well positioned to service both U.S. and foreign military needs by our focus on delivering products that satisfy the following factors important to the U.S. military:
● Product reliability - failure can cost lives
● Speed to delivery and adherence to delivery schedule
● System life cycle extension
● Low cost/best value
● Visual aids for successful execution of mission objectives
● Mission critical products specifically related to soldier safety.
Potential Entrants - Low Risk to us. In order to enter this market, potential competitors must overcome several barriers to entry. The first hurdle is that an entrant would need to prove to the government agency in question the existence of a government approved accounting system for larger contracts. Second, the entrant would need to develop the processes required to produce the product. Third, the entrant would then need to produce the product and submit successful test requirements (many of which require lengthy government consultation for completion). Finally, in many cases, the customer has an immediate need and therefore cannot wait for this qualification cycle and therefore must issue the contracts to existing suppliers. Given the expense of development and qualification testing, the barrier to entry is high for new competitors.
Buyers - Medium Risk to us. In most cases the buyers (usually government agencies or defense contractors) have two fairly strong suppliers. It is in their best interest to keep at least two, and therefore, in some cases, the contracts are split between suppliers. In the case of larger contracts, the customer can request an open book policy on costs and expects a reasonable margin to have been applied.
Substitutes - Low Risk to us. We have both new vehicle contracts and replacement part contracts for the same product. Three combat vehicles have a long history of service in the U.S. Army. The first M-1 Abrams Tank entered service with the Army in 1980; the M-2/M-3 Bradley Fighting Vehicle in 1981; and the Stryker Combat Vehicle in 2001. Under current Army modernization plans, the Army envisions all three vehicles in service with Active and National Guard forces beyond FY2028. Optex Systems provides periscopes and optical sighting systems in support of all three vehicle platforms. Since the early 2010s, the U.S. Army has been upgrading its outdated Bradley design with the Operation Desert Storm-Situational Awareness model and since 2012, upgrading the underbelly armor to improve mine and improvised explosive device resistance. Since it was first fielded in 1980, the Abrams tank has undergone near-continuous upgrades and improvements. The Abrams is the principal battle tank of the United States Army and Marine Corps, and the armies of Egypt, Kuwait, Saudi Arabia, Iraq, and since 2007, Australia. On average, there has been a new improvement package every seven years. The Army is currently upgrading the Abrams with a System Enhancement Package Version 3 (SEPv3), with additional upgrades in development. Additionally, the US Army has announced contracts to produce 742 Stryker DVH vehicles, redesigned (dual v-hulled vehicles) to be more resistant to land mines, as retrofits and as new production vehicles. The Abrams, Bradley and Striker vehicles are the only production tanks currently in production by the government. We believe that this, in conjunction with the 30-year life span, supports our expectation that they will continue to be used through 2040.
Suppliers - Low to Medium Risk to Optex Systems Holdings. The suppliers of standard processes (e.g., casting, machining and plating) need to be very competitive to gain and/or maintain contracts. Those suppliers of products that use top secret clearance processes have a slight advantage; however, there continues to be multiple avenues of supply and therefore only moderate power.
Consistent with our marketing plan and business model, the AOC acquisition strengthened our overall position by decreasing the bargaining power of their suppliers through the backwards integration of a key supplier and created additional barriers of entry for potential competitors.
The following matrix reflects the current focus of our four basic approaches for sales and development:
1) Sell existing products to existing customers.
2) Sell existing products to new customers.
3) Develop new products to meet the needs of our existing customers.
4) Develop new products to meet the needs of new customers.
Existing Customers
New Customers
New Products
Chile M17 Day/Thermal
USACC Binoculars
Brazil M17 Day/Thermal
GDLS DDAN, OWSS
Israel M17 Day/Thermal, OWSS
U.S. Prime Contractor - XM10 Aiming Circle
Commercial Optical Lens
Commercial: Optical Lens, Spotting Scopes, Monocular Lens
Existing Products
USACC Periscopes, Back Up Sights,
Marines Sighting Systems
Binoculars, Vision Blocks,
Laser Filter Units
Commercial: Optical Lens, Spotting
GDLS Periscopes, Collimators
Scopes, Monocular Lens
BAE Periscopes
L3- Laser Interface Filters
U.S. Prime Contractor - Laser Filter Units
DLA Optical Elements
Operations Plan
Our operations plan can be broken down into three distinct areas: material management, manufacturing space planning and efficiencies associated with economies of scale.
Materials Management
The largest portion of our costs is materials. We have completed the following activities in order to demonstrate continuous improvement:
- Successful completion of annual surveillance audit for ISO 9001:2008 certificate, with no major nonconformance issues
- Weekly cycle counts on inventory items
- Weekly material review board meeting on non-moving piece parts
- Kanban kitting on products with consistent ship weekly ship quantities
- Daily cross functional floor meetings focused on delivery, yields and labor savings
- Redesigned floor layout using tenant improvement funds
- Daily review of yields and product velocity
- Bill of material reviews prior to work order release
Future continuous improvement opportunities include installation and training of shop floor control module within the ERP system and organizational efficiencies of common procurement techniques among buyers.
Manufacturing Space Planning
We currently lease 93,967 square feet of manufacturing space (see “Properties”). Our current facilities are sufficient to meet our immediate production needs without excess capacity. As our processes are primarily labor driven, we are able to easily adapt to changes in customer demand by adjusting headcounts, overtime schedules and shifts in line with production needs. In the event additional floor space is required to accommodate new contracts, Optex has the option to lease adjacent floor space at the current negotiated lease cost per square foot. Consistent with the space planning, we will drive economies of scale to reduce support costs on a percentage of sales basis. These cost reductions can then be either passed through directly to the bottom line or used for business investment.
Our manufacturing process is driven by the use of six sigma techniques and process standardization. Initial activities in this area have been the successful six sigma projects in several production areas which have led to improved output and customer approval on the aesthetics of the work environment. In addition, we use many tools including 5S programs, six sigma processes, and define, measure, analyze, improve, control (DMAIC) problem solving techniques to identify bottlenecks within the process flow, reduce cost and improve product yields. Successful results can then be replicated across the production floor and drive operational improvements.
Economies of Scale
Plant efficiencies fluctuate as a function of program longevity, complexity and overall production volume. Our internal processes are primarily direct labor intensive and can be more easily adapted to meet fluctuations in customer demand; however, our material purchases, subcontracted operations and manufacturing support costs are extremely sensitive to changes in volume. As our volume increases, our support labor, material and scrap costs decline as a percentage of revenue as we are able to obtain better material pricing, and scrap, start up and support labor (fixed) costs and they are spread across a higher volume base. On the contrary, as production volumes decline, our labor and material costs per unit of production generally increase. Additional factors that contribute to economies of scale relate to the longevity of the program. Long running, less complex programs (e.g., periscopes) do not experience as significant of an impact on labor costs as production volumes change, as the associated workforce is generally less skilled and can be ramped quickly as headcounts shift. Our more complex thin laser filter coatings, Howitzer and thermal day/night programs are more significantly impacted by volume changes as they require a more highly-skilled workforce and ramp time is longer as the training is more complex. We continually monitor customer demand over a rolling twelve-month window and in order to anticipate any changes in necessary manpower and material which allows us to capitalize on any benefits associated with increased volume and minimize any negative impact associated with potential declines in product quantities.
Intellectual Property
We utilize several highly specialized and unique processes in the manufacture of our products. While we believe that these trade secrets have value, it is probable that our future success will depend primarily on the innovation, technical expertise, manufacturing and marketing abilities of our personnel. We cannot assure you that we will be able to maintain the confidentiality of our trade secrets or that our non-disclosure agreements will provide meaningful protection of our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or other disclosure. The confidentiality agreements that are designed to protect our trade secrets could be breached, and we might not have adequate remedies for the breach. Additionally, our trade secrets and proprietary know-how might otherwise become known or be independently discovered by others. We possess three utility patents and two design patents.
Our competitors, many of which have substantially greater resources, may have applied for or obtained, or may in the future apply for and obtain, patents that will prevent, limit or interfere with our ability to make and sell some of our products. Although we believe that our products do not infringe on the patents or other proprietary rights of third parties, we cannot assure you that third parties will not assert infringement claims against us or that such claims will not be successful.
The following patents generally expire 20 years after issuance.
On July 13, 2021, we filed for a new patent, currently under review with the United States Patent and Trademark Office.
On June 18, 2019 we were issued U.S. Patent No. 10,324,298 titled “Offset Image Wedge with Dual Capability and Alignment Technique”. The invention relates to an offset image wedge for use on a bore-sighted rifle mounted directly onto the scope via a clamp mounting device. The wedge allows for a dual image which can be aligned in the field and provides the user with a choice of either a bore-sighted image or an offset image without removing the wedge.
On July 11, 2017, we were issued U.S. Patent No. D791,852 S, for our Red Tail Digital Spotting Scope. We have a retail sales relationship with Cabela’s Inc. and Amazon, to distribute these scopes. They are currently the only digital spotting scope offered by Cabela’s. Our Red Tail Digital Spotting Scopes also received a favorable review from Trigger Magazine in 2017.
In May 2015, we announced the issuance to us of U.S. Patent No. 13,792,297 titled “ICWS Periscope”. This invention improves previously accepted levels of periscope performance that, in turn, improve soldier’s safety.
In December 2013, Optex Systems, Inc. was issued U.S. Patent No. 23,357,802 titled “Multiple Spectral Single Image Sighting System Using Single Objective Lens Set.” The technology platform, designed for our DDAN program, is applicable to all ground combat vehicles used by the US and foreign militaries. This invention presents a single image to both day and night sensors using precision optics, which in turn allows the user to individually observe day, night, or day and night simultaneously. In addition, it has proven to be especially useful in light transition points experienced at dusk and dawn. We are in production and currently delivering sighting systems with this advanced technology, a significant upgrade in the goal of supporting our customers as they modernize the worldwide inventory of aging armored vehicles. This technology is applicable to many sighting systems, and it has already been designed for implementation on the Light Armored Vehicles, the Armored Security Vehicle, the Amphibious Assault Vehicle, and the M60 Main Battle Tank. Digital Day and Night technology has advanced the capabilities of these installed weapon systems and is the first in a series of patents we have applied for to protect our Intellectual Property portfolio in support of the warfighters who use these systems.
In May 2012, we purchased a perpetual, non-exclusive license, with a single up-front license fee of $200,000 to use Patent 7,880,792 “Optical and Infrared Periscope with Display Monitor” owned by Synergy International Optronics, LLC. We believe the purchase of the license agreement may allow us to extend and expand our market potential for the M113APC vehicle type which has the highest number of commonly used armored vehicles in the world. The current estimated active M113 APC worldwide inventory is over 80,000 units. This licensing of this patent allows us to develop additional products for this vehicle type, including the M17 Day/Thermal and M17 Day/Night periscopes. We are actively marketing the new periscopes internationally and completed our first international shipment utilizing this technology in March 2014. We continue to prototype these products and demonstrate them to potential customers.
Competition
The markets for our products are competitive. We compete primarily on the basis of our ability to design and engineer products to meet performance specifications set by our customers. Our customers include military and government end users as well as prime contractors that purchase component parts or subassemblies, which they incorporate into their end products. Product pricing, quality, customer support, experience, reputation and financial stability are also important competitive factors.
There are a limited number of competitors in each of the markets for the various types of products that we design, manufacture and sell. At this time, we consider our primary competitors for the Optex, Richardson site to be Kent Periscopes and Synergy International Optronics, LLC. The Applied Optics Center thin film and laser coatings products compete primarily with Materion-Barr, Artemis and Alluxa.
Our competitors are often well entrenched, particularly in the defense markets. Some of these competitors have substantially greater resources than we do. While we believe that the quality of our technologies and product offerings provides us with a competitive advantage over certain manufacturers, some of our competitors have significantly more financial and other resources than we do to spend on the research and development of their technologies and for funding the construction and operation of commercial scale plants.
We expect our competitors to continue to improve the design and performance of their products. We cannot assure investors that our competitors will not develop enhancements to, or future generations of, competitive products that will offer superior price or performance features, or that new technology or processes will not emerge that render our products less competitive or obsolete. Increased competitive pressure could lead to lower prices for our products, thereby adversely affecting our business, financial condition and results of operations. Also, competitive pressures may force us to implement new technologies at a substantial cost, and we may not be able to successfully develop or expend the financial resources necessary to acquire new technology. We cannot assure you that we will be able to compete successfully in the future.
Employees and Human Capital
We had 84 full time equivalent employees as of October 3, 2021 and 87 employees as of December 13, 2021, which include a small temporary work force to handle peak loads as needed. We are in compliance with local prevailing wage, contractor licensing and insurance regulations, and have good relations with our employees, who are not currently unionized. We use outside consultants for various services. We have not experienced any work stoppages and are not a party to a collective bargaining agreement. Management considers labor relations to be good.
We are dedicated to preserving operational excellence and remaining an employer of choice. We provide and maintain a work environment that is designed to attract, develop and retain top talent through offering our employees an engaging work experience that contributes to their career development. We recognize that our success is based on the collective talents and dedication of those we employ, and we are highly invested in their success. We value our employees and believe that employee loyalty and enthusiasm are key elements of our operating performance.
Internet Address
The Company maintains an internet website at the following address: www.optexsys.com. The information on the Company’s website is not incorporated by reference in this Annual Report on Form 10-K.

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ITEM 1A. RISK FACTORS
Item 1A Risk Factors
Investing in our common stock involves a high degree of risk. Prospective investors should carefully consider the risks described below, together with all of the other information included or referred to in this Annual Report, before purchasing shares of our common stock. There are numerous and varied risks, known and unknown, that may prevent us from achieving our goals. The risks described below are not the only risks we face. If any of these risks actually materializes, our business, financial condition or results of operations may be materially adversely affected. In such case, the trading price of our common stock could decline and investors in our common stock could lose all or part of their investment. The risks and uncertainties described below are not exclusive and are intended to reflect the material risks that are specific to us, our industry and companies that have securities trading on an over-the-counter market.
Risks Related to our Business
Low unemployment and tight labor markets may adversely affect our labor costs and our ability to hire and retain a sufficient workforce required to meet the backlog and customer demands. If we are not able to maintain a sufficient workforce and attract and retain additional personnel as required, we may not be able to implement our business plan and our results of operations could be materially and adversely affected.
We compete with several other large defense contractors, as well as homebuilding, industrial manufacturing and warehousing industries within the immediate area of our manufacturing facilities for both lower and higher skill level manufacturing employees. The limited supply of available workers for hire, combined with increasing competition among other local industries may result in increased production costs associated with higher wages, employee bonuses, overtime premiums and enhanced employee benefits in addition to cost increases associated with employee recruitment, employee turnover, training and learning curve inefficiencies. We may be unable to fill the labor positions required to meet our customer demands in a timely or cost-effective manner which would impede our ability to meet current or increasing production levels in line with our customer expectations and adversely affect our ability to grow revenue or maintain our current margin levels.
Our ability to fulfill our backlog may have an effect on our long-term ability to procure contracts and fulfill current contracts.
Our ability to fulfill our backlog may be limited by our ability to devote sufficient financial and human capital resources and limited by available material supplies. Disruptions in our supply chain driven by Covid-19, transportation delays, combined with inflationary pressures and tight labor market conditions could impede our ability to meet customer requirements. If we do not fulfill our backlog in a timely manner, we may experience delays in product delivery which would postpone receipt of revenue from those delayed deliveries. Additionally, if we are consistently unable to fulfill our backlog, this may be a disincentive to customers to award large contracts to us in the future until they are comfortable that we can effectively manage our backlog.
Our historical operations depend on government contracts and subcontracts. We face risks related to contracting with the federal government, including federal budget issues and fixed price contracts.
Future general political and economic conditions, which cannot be accurately predicted, may directly and indirectly affect the quantity and allocation of expenditures by federal agencies. Even the timing of incremental funding commitments to existing, but partially funded, contracts can be affected by these factors. Therefore, cutbacks or re-allocations in the federal budget could have a material adverse impact on our results of operations. Obtaining government contracts may also involve long purchase and payment cycles, competitive bidding, qualification requirements, delays or changes in funding, budgetary constraints, political agendas, extensive specification development, price negotiations and milestone requirements. In addition, our government contracts are primarily fixed price contracts, which may prevent us from recovering costs incurred in excess of budgeted costs. Fixed price contracts require us to estimate the total project cost based on preliminary projections of the project’s requirements. The financial viability of any given project depends in large part on our ability to estimate such costs accurately and complete the project on a timely basis. Some of those contracts are for products that are new to our business and are thus subject to unanticipated impacts to manufacturing costs. Even if our estimates are reasonable at the time made, prices of materials are subject to unanticipated adverse fluctuation. In the event our actual costs exceed fixed contractual costs of our product contracts, we will not be able to recover the excess costs which could have a material adverse effect on our business and results of operations. We examine these contracts on a regular basis and accrue for anticipated losses on these contracts, if necessary. As of October 3, 2021, there was $51 thousand in accrued loss provisions for loss contracts or cost overruns.
Approximately 83% of our contracts contain termination clauses for convenience. In the event these clauses should be invoked by our customer, future revenues against these contracts could be affected, however these clauses allow for a full recovery of any incurred contract costs plus a reasonable fee up through and as a result of the contract termination. We are currently unaware of any pending terminations on our existing contracts.
In some cases, contract awards may be issued that are subject to renegotiation at a date (up to 180 days) subsequent to the initial award date. Generally, these subsequent negotiations have had an immaterial impact (zero to 5%) on the contract price of the affected contracts. Currently, none of our awarded contracts are subject to renegotiation.
We have sought to minimize the adverse impact from the slower pace of U.S. military orders on our results of operations by seeking to obtain foreign military orders, expanding our customer base as well as seeking new commercial business. We do not expect these markets to completely mitigate the negative impact of lower U.S. defense spending.
If we fail to scale our operations appropriately in response changes in demand, we may be unable to meet competitive challenges or exploit potential market opportunities, and our business could be materially and adversely affected.
Significant fluctuations in customer demand place a significant strain on our management personnel, infrastructure and resources. To implement our current business and product plans, we need to appropriately manage our cost base, as well as train, manage and motivate our workforce, while continuing to maintain our critical operational and financial systems and our manufacturing and service capabilities. All of these endeavors require substantial management effort and potential capital. If we are unable to effectively manage our operations to our customer demand levels, we may be unable to scale our business quickly enough to meet competitive challenges or exploit potential market opportunities, and our current or future business could be materially and adversely affected.
We do not have employment agreements with our key personnel, other than our Chief Executive and Financial Officers, and our management has minimal unencumbered equity ownership in us. If we are not able to retain our key personnel or attract additional key personnel as required, we may not be able to implement our business plan and our results of operations could be materially and adversely affected.
We depend to a large extent on the abilities and continued participation of our executive officers and other key employees. The loss of any key employee could have a material adverse effect on our business. We currently have only two employment agreements, with our Chief Executive Officer which renews on an annual basis and currently expires on November 30, 2022, and our Chief Financial Officer which expires on June 30, 2022, with renewable terms each 18 months thereafter. We do not presently maintain “key man” insurance on any other key employees. Our management also has minimal unencumbered ownership interest in us, thus limiting their direct stake in our outcome. We believe that experienced personnel will continue to be required to implement our business plan. Competition for such personnel is intense, and we cannot assure you that they will be available when required, or that we will have the ability to attract and retain them. In addition, due to our small size, we do not presently have depth of staffing in our executive, operational and financial management areas in order to have an effective succession plan should the need arise. Thus, in the event of the loss of one or more of our management employees, our results of operations could be vulnerable to challenges associated with recruiting additional key personnel, if such recruiting efforts are not successful in a timely manner.
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.
We expect recent supply chain disruptions driven by the pandemic, combined with raw material shortages, labor shortages, transportation delays and inflationary pressures, to continue throughout 2022. These conditions 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 selectively single-sourced some of our material components in order to mitigate excess procurement costs associated with significant tooling and startup costs. Furthermore, because of the nature of government contracts, we are often required to purchase selected items from U.S. government approved suppliers, which may further limit our ability to utilize multiple supply sources for these key components.
To the extent any of these single sourced or government approved suppliers may have disruptions in deliveries due to production, quality, or other issues, we may also experience related production delays or unfavorable cost increases associated with retooling and qualifying alternate suppliers. The impact of delays resulting from disruptions in supply for these items could negatively impact our revenue, our reputation with our customers, and our results of operations. In addition, significant price increases from single-source suppliers could have a negative impact on our profitability to the extent that we are unable to recover these cost increases on our fixed price contracts.
Each contract has a specific quantity of material which needs to be purchased, assembled, and shipped. Prior to bidding on a contract, we contact potential sources of material and receive qualified quotations for this material. In some cases, the entire volume is given to a single supplier and in other cases; the volume might be split between several suppliers. If a contract has a single source supplier and that supplier fails to meet their obligations (e.g., quality, delivery), then we would seek to find an alternate supplier and bring this information back to the final customer. Contractual deliverables would then generally be re-negotiated (e.g., specifications, delivery, price. As of November 22, 2021, approximately 1% of our material requirements are single-sourced across 9 suppliers representing approximately 8% of our active supplier order value. Single-sourced component requirements span across all of our major product lines.
We consider it a material financial or schedule risk if we believe it will take us at least three months to identify and qualify a suitable replacement for specialized single source suppliers. In the table below, we identify those specialized single source suppliers with respect to which we face such a material risk and the product lines supported by those materials utilized by us as of November 22, 2021.
Product Line
Supply Item
Risk
Purchase Orders
Sighting Systems M36 DDAN
Digital camera system
Alternative source would take in excess of six months to qualify
This supplier is the designated replacement for Raytheon for the video system boards. One P.O. is currently in place to drive the transfer from Raytheon.
Periscopes
Die-cast housings
All die cast tooling is consolidated at this supplier. It would take approximately six months to move tooling and re-qualify a new supplier.
Current firm fixed price & quantity purchase orders are in place with the supplier to meet all contractual requirements. Supplier is on schedule.
Periscopes
Steel castings
Alternative supplier source would take six months to qualify.
Current firm fixed price & quantity purchase orders are in place with the supplier to meet all contractual requirements.
Vision Blocks
MIL Spec welded housings for vision blocks
Would take approximately 8-10 months to re-qualify a new supplier source.
Currently on Last Time Buy with current supplier vendor and trying to qualify a new vendor
Vision Blocks
Large/Small/Customs Blocks
Would take approximately 4-6 months to re-qualify a new supplier source.
Currently working with single source for purchasing material on a forecast projection basis
MRS
AL Castings for Housing
Would take approximately 8-12 months to re-qualify a new supplier source.
Currently, ordering for a single source, new casting tool and FAT will be required to qulify a new source
Short/Long Drivers
Mirrors
Would take approximately 8-12 months to re-qualify a new supplier source.
Currently working with single source for purchasing material on a forecast projection basis
Big Eye
Sand castings for big eye binocular parts
Would take approximately 4-6 months to re-qualify a new supplier source
Current firm fixed price & quantity purchase orders are in place with the supplier to meet all contractual requirements.
Applied Optics Center
M22/M24 Binocular
Spare Components
Only approved source due to proprietary rights. Alternate source cannot be developed.
Current firm fixed price and quantity purchase orders are in place with the supplier to meet all contractual requirements. Supplier is on schedule.
The defense technology supply industry is subject to technological change and if we are not able to keep up with our competitors and/or they develop advanced technology as response to our products, we may be at a competitive disadvantage.
The market for our products is generally characterized by technological developments, evolving industry standards, changes in customer requirements, frequent new product introductions and enhancements, short product life cycles and severe price competition. Our competitors could also develop new, more advanced technologies in reaction to our products. Currently accepted industry standards may change. Our success depends substantially on our ability, on a cost-effective and timely basis, to continue to enhance our existing products and to develop and introduce new products that take advantage of technological advances and adhere to evolving industry standards. An unexpected change in one or more of the technologies related to our products, in market demand for products based on a particular technology or of accepted industry standards could materially and adversely affect our business. We may or may not be able to develop new products in a timely and satisfactory manner to address new industry standards and technological changes, or to respond to new product announcements by others. In addition, new products may or may not achieve market acceptance.
Unexpected warranty and product liability claims could adversely affect our business and results of operations.
The possibility of future product failures could cause us to incur substantial expense to repair or replace defective products. We warrant the quality of our products to meet customer requirements and be free of defects for twelve months subsequent to delivery. We establish reserves for warranty claims based on our historical rate of returned shipments against these contracts. There can be no assurance that this reserve will be sufficient if we were to experience an unexpectedly high incidence of problems with our products. Significant increases in the incidence of such claims may adversely affect our sales and our reputation with consumers. Costs associated with warranty and product liability claims could materially affect our financial condition and results of operations.
We rely on the proper function, availability and security of information technology systems to operate our business and a cyber-attack or other breach of these systems could have a material adverse effect on our business, financial condition or results of operations.
We rely on information technology systems to process, transmit, and store electronic information in our day-to-day operations. Similar to other companies, the size and complexity of our information technology systems makes them vulnerable to a cyber-attack, malicious intrusion, breakdown, destruction, loss of data privacy, or other significant disruption. Our information systems require an ongoing commitment of significant resources to maintain, protect, and enhance existing systems and develop new systems to keep pace with continuing changes in information processing technology, evolving systems and regulatory standards.
On July 13, 2021, we experienced a ransomware attack. While we do not expect that attack to have material adverse consequences, similar attacks, if not caught and effectively addressed in a timely manner, could have a material adverse effect on our business, financial condition and results of operations.
Any failure by us to maintain or protect our information technology systems and data integrity, including from cyber-attacks, intrusions or other breaches, could result in the unauthorized access to personally identifiable information, theft of intellectual property or other misappropriation of assets, or otherwise compromise our confidential or proprietary information and disrupt our operations. Any of these events may cause us to have difficulty preventing, detecting, and controlling fraud, be subject to legal claims and liability, have regulatory sanctions or penalties imposed, have increases in operating expenses, incur expenses or lose revenues as a result of a data privacy breach or theft of intellectual property, or suffer other adverse consequences, any of which could have a material adverse effect on our business, financial condition or results of operations.
We may face risks as a result of the ongoing COVID-19 pandemic.
We may be at risk as a result of the current COVID-19 pandemic. Risks that could affect our business include the duration and scope of the COVID-19 pandemic and the impact on the demand for our products; actions by governments, businesses and individuals taken in response to the pandemic; the length of time of the COVID-19 pandemic and the possibility of its reoccurrence; the timing required to develop and implement effective treatments and achieve acceptable vaccination rates in the event of future outbreaks; the eventual impact of the pandemic and actions taken in response to the pandemic on global and regional economies; and the pace of recovery when the COVID-19 pandemic subsides.
The pandemic has caused several program delays throughout the defense supply chain as a result of plant shutdowns, employee illnesses, travel restrictions, remote work arrangements and similar supplier issues. Due to the significant level of uncertainty surrounding the pandemic and its impact to our customers and the defense supply chain, we are unable to ascertain the impact further delays in contract awards and customer orders may have on our fiscal year 2022 revenues.
We derive almost all of our revenue from a small number of customers and the loss of any of these customers could have a material adverse effect on our revenues.
For the year ended October 3, 2021, the Company’s consolidated revenues were derived from U.S. government agencies (28%), four U.S. defense contractors (27%, 11%, 5%, and 5%), one major commercial customer (10%) and all other customers (14%). Approximately 90% of total Company revenue is generated from domestic customers and 10% is derived from foreign customers, primarily Canada. In particular, a decision by one of our major defense contract customers, U.S. government agencies, or major commercial customers to cease issuing contracts to us could have a significant material impact on our business and results of operations given that they represent over 86% of our gross business revenue. There can be no assurance that we could replace these customers on a timely basis or at all.
We have approximately 81 discrete contracts with major defense contractors and the U.S. Government (primarily Defense Logistics Agencies (DLA)), and other prime U.S. defense contractors. If they choose to terminate these contracts, we are entitled to fully recover all contractual costs and reasonable profits incurred up to or as a result of the terminated contract.
We only possess five patents and rely primarily on trade secrets to protect our intellectual property.
We utilize several highly specialized and unique processes in the manufacture of our products, for which we rely solely on trade secrets to protect our innovations. We cannot assure you that we will be able to maintain the confidentiality of our trade secrets or that our non-disclosure agreements will provide meaningful protection of our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or other disclosure. The non-disclosure agreements that are designed to protect our trade secrets could be breached, and we might not have adequate remedies for the breach.
It is also possible that our trade secrets will otherwise become known or independently developed by our competitors, many of which have substantially greater resources than us, and these competitors may have applied for or obtained, or may in the future apply for or obtain, patents that will prevent, limit or interfere with our ability to make and sell some of our products. Although based upon our general knowledge (and we have not conducted patent searches), we believe that our products do not infringe on the patents or other proprietary rights of third parties; however, we cannot assure you that third parties will not assert infringement claims against us or that such claims will not be successful.
We anticipate that we may need to raise additional capital in the future beyond any cash flow from our existing business; additional funds may not be available on terms that are acceptable to us, or at all.
We anticipate we may have to raise additional capital in the future to finance our future working capital needs. We cannot assure you that any additional capital will be available on a timely basis, on acceptable terms, or at all. Future equity or debt financings may be difficult to obtain. If we are not able to obtain additional capital as may be required, our business, financial condition and results of operations could be materially and adversely affected.
We anticipate that our capital requirements will depend on many factors, including:
● our ability to fulfill backlog;
● our ability to procure additional production contracts;
● our ability to control costs;
● the timing of payments and reimbursements from government and other contracts, including but not limited to changes in federal government military spending and the federal government procurement process;
● increased sales and marketing expenses;
● technological advancements and competitors’ response to our products;
● capital improvements to new and existing facilities;
● our relationships with customers and suppliers; and
● general economic conditions including the effects of future economic slowdowns, acts of war or terrorism and the current international conflicts.
Even if available, financings may involve significant costs and expenses, such as legal and accounting fees, diversion of management’s time and efforts, and substantial transaction costs. 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.
Risks Related to Our Stock
Our common stock is currently quoted on an Over-The-Counter Market, which affects the liquidity of our common stock and may affect its stock price.
Our common stock is quoted on OTCQB under the trading symbol “OPXS”. Trading in our common stock has been very limited and we cannot make any assurances that the trading volume will increase, or, if and when it increases, that it will be sustained at any level. Over-the-counter markets are generally considered to be less efficient than, and not as broad as, a stock exchange.
Our share price could decrease as a result of this limited liquidity or otherwise, and our share price is likely to be highly volatile. Specifically, stockholders may have difficulties reselling significant numbers of shares of common stock at any particular time, and may not be able to resell their shares of common stock at or above the price paid for such shares. As a result, stockholders may be required to hold shares of common stock for an indefinite period of time. In addition, sales of substantial amounts of common stock could lower the prevailing market price of our common stock.
Furthermore, our ability to raise additional capital is impaired because of the less liquid nature of the over-the-counter markets. We may not be able to complete an equity financing on acceptable terms, or at all. In that context, investors should consider that not having the common stock listed on a national securities exchange makes us ineligible to use shorter and less costly filings, such as Form S-3, to register our securities for sale. While we may use Form S-1 to register a sale of our stock to raise capital or complete acquisitions, doing so would cause us to incur higher transaction costs and adversely impact our ability to raise capital or complete acquisitions of other companies in a timely manner. In addition, if we are able to complete equity financings, the dilution from any equity financing while our shares are quoted on an over-the-counter market could be greater than if we were to complete a financing while our common stock were listed on a national securities exchange.
Finally, if we cease to qualify for quotation on OTCQB, our common stock may be forced to trade on the “pink sheets,” and the market for resale of our common stock would be extremely limited. In that case, holders of our common stock may find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock, and the market value of our common stock may decline as a result.
We are subject to penny stock rules, which discourages broker-dealers from effecting transactions in our common stock.
The SEC has adopted a number of rules to regulate “penny stock” that restricts transactions involving our shares of common stock. Such rules include Rules 3a51-1, 15g-1, 15g-2, 15g-3, 15g-4, 15g-5, 15g-6, 15g-7, and 15g-9 under the Exchange Act. These rules may have the effect of reducing the liquidity of penny stocks. “Penny stocks” generally are equity securities with a price of less than $5.00 per share, subject to certain exclusions. As long as we are not listed on a securities exchange or Nasdaq, our shares of common stock constitute “penny stock” within the meaning of the rules. The additional sales practice and disclosure requirements imposed upon U.S. broker-dealers in connection with effecting transactions in “penny stocks” may discourage such broker-dealers from effecting transactions in shares of our common stock, which could severely limit the market liquidity of such shares and impede their sale in the secondary market.
A U.S. broker-dealer selling penny stock to anyone other than an established customer or “accredited investor” must make a special suitability determination for the purchaser and must receive the purchaser’s written consent to the transaction prior to sale, unless the broker-dealer or the transaction is otherwise exempt. In addition, the penny stock regulations require the U.S. broker-dealer to deliver, prior to any transaction involving a penny stock, a disclosure schedule prepared in accordance with SEC standards relating to the penny stock market, unless the broker-dealer or the transaction is otherwise exempt. A U.S. broker-dealer is also required to disclose commissions payable to the U.S. broker-dealer and the registered representative and current quotations for the securities. Finally, a U.S. broker-dealer is required to submit monthly statements disclosing recent price information with respect to the penny stock held in a customer’s account and information with respect to the limited market in penny stocks.
In addition to the “penny stock” rules described above, FINRA has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. The FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock and have an adverse effect on the market for our shares.
Furthermore, transfers of our common stock may require broker-dealers to submit notice filings and pay fees in certain states, which may discourage broker-dealers from effecting transactions in our common stock.
You should also be aware that, according to the SEC, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include (i) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; (ii) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; (iii) “boiler room” practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (iv) excessive and undisclosed bid-ask differentials and markups by selling broker-dealers; and (v) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, resulting in investor losses.
General Risk Factors
Changes in current economic conditions may adversely affect our ability to continue operations.
Changes in current economic conditions may cause a decline in business, consumer and defense spending and capital market performance, which could adversely affect our business and financial performance. Our ability to raise funds, which could be required for business continuity or expansion of our operations, may be adversely affected by current and future economic conditions, such as a reduction in the availability of credit, financial market volatility and economic recession.
In the future, we may look to acquire other businesses in our industry and the acquisitions will require us to use substantial resources.
In the future, we may decide to pursue acquisitions of other businesses in our industry. In order to successfully acquire other businesses, we would be forced to spend significant resources for both acquisition and transactional costs, which could divert substantial resources in terms of both financial and personnel capital from our current operations. Additionally, we might assume liabilities of the acquired business, and the repayment of those liabilities could have a material adverse impact on our cash flow. Furthermore, when a new business is integrated into our ongoing business, it is possible that there would be a period of integration and adjustment required which could divert resources from ongoing business operations.
The elimination of monetary liability against our directors, officers and employees under Delaware law and the existence of indemnification rights to our directors, officers and employees may result in substantial expenditures by us and may discourage lawsuits against our directors, officers and employees.
We provide indemnification to our directors and officers to the extent provided by Delaware law. The foregoing indemnification obligation could result in our incurring substantial expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup. These provisions and resultant costs may also discourage us from bringing a lawsuit against directors and officers for breaches of their fiduciary duties and may similarly discourage the filing of derivative litigation by our stockholders against our directors and officers even though such actions, if successful, might otherwise benefit us and our stockholders.
Our stock price is speculative, and there is a risk of litigation.
The trading price of our common stock has in the past and may in the future be subject to wide fluctuations in response to factors such as the following:
● revenue or results of operations in any quarter failing to meet the expectations, published or otherwise, of the investment community;
● speculation in the press or investment community;
● wide fluctuations in stock prices, particularly with respect to the stock prices for other defense industry companies;
● announcements of technological innovations by us or our competitors;
● new products or the acquisition of significant customers by us or our competitors;
● changes in investors’ beliefs as to the appropriate price-earnings ratios for us and our competitors;
● changes in management;
● sales of common stock by directors and executive officers;
● rumors or dissemination of false or misleading information, particularly through Internet chat rooms, instant messaging, and other rapid-dissemination methods;
● conditions and trends in the defense industry generally;
● the announcement of acquisitions or other significant transactions by us or our competitors;
● adoption of new accounting standards affecting our industry;
● general market conditions;
● domestic or international terrorism and other factors; and
● other factors as described in this section.
Fluctuations in the price of our common stock may expose us to the risk of securities class action lawsuits. Although no such lawsuits are currently pending against us and we are not aware that any such lawsuit is threatened to be filed in the future, there is no assurance that we will not be sued based on fluctuations in the price of our common stock. Defending against such suits could result in substantial cost and divert management’s attention and resources. In addition, any settlement or adverse determination of such lawsuits could subject us to significant liability.

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ITEM 1B. UNRESOLVED STAFF COMMENTS

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ITEM 2. PROPERTIES
Item 2 Properties
We are headquartered in Richardson, TX and lease approximately 93,967 combined square feet of facilities between Richardson, Texas and Dallas, Texas. We operate with a single shift, and capacity could be expanded by adding a second shift.
We renewed the lease on our 49,100 square foot, Richardson, Texas facility, effective as of January 11, 2021, for eighty-six (86) months, commencing on April 1, 2021 and ending on May 31, 2028. Our Applied Optics Center, is located in Dallas, Texas with leased premises consisting of approximately 44,867 square feet of space. The Applied Optics Center lease was renewed on January 11, 2021 for eighty-six (86) months, commencing on November 1, 2021 and ending on December 31, 2028. The Applied Optics Center 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 rent rate.

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ITEM 3. LEGAL PROCEEDINGS
Item 3 Legal Proceedings
From time to time, we are involved in lawsuits, claims, investigations and proceedings, including pending opposition proceedings involving patents that arise in the ordinary course of business. There are no matters pending that we expect to have a material adverse impact on our business, results of operations, financial condition or cash flows.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4 Mine Safety Disclosures
None.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market information
Our common stock is currently quoted on the OTCQB Marketplace under the symbol “OPXS”. Trading in our common stock has historically lacked consistent volume, and the market price has been volatile. Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
On December 13, 2021, the closing price for our common stock as reported on the OTCQB was $1.89 per share.
Securities outstanding and holders of record
On December 13, 2021, there were approximately 80 shareholders of record for our common stock and 8,523,704 shares of our common stock issued and 8,462,310 common shares outstanding.
Dividends
We have in the past paid dividends but we have no plans to do so in the foreseeable future.
Unregistered Sales of Equity Securities
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. The issuance was made pursuant to the exemption from registration afforded by Rule 506(b) under the Securities Act as an issuance to accredited investors.
Issuer Purchases of Equity Securities
The table below sets forth information with respect to purchases made by or on behalf of the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) of its common shares during the three months ended October 3, 2021.
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(1)
September 23, 2021 to October 3, 2021
35,555 $ 68,546 $ 1.93 $ 931,454
(1) On September 22, 2021 the Company announced authorization for an additional $1 million stock repurchase program. As of October 3, 2021, there were 35,555 shares held in treasury purchased under the September 2021 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.

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ITEM 6. SELECTED FINANCIAL DATA
Item 6. Reserved

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
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 3, 2021, 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 3, 2021, 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 2020 or 2021 with respect to our financial position and results of operations are to our fiscal years ended September 27, 2020 or October 3, 2021, 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, all of which is incorporated herein by reference.
Refer to Item 1.A. 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.
Refer to “Item 1. Business Recent Events” of this report for updated information on new orders, board changes, executive and board compensation and stock and warrant repurchases.
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 3, 2021 and September 27, 2020 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 3, 2021 September 27, 2020
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 $ 11,827 $ 6,395 $ - $ 18,222 $ 17,233 $ 8,657 $ - $ 25,890
Intersegment Revenues - 1,056 (1,056 ) - - 1,689 (1,689 ) -
Total Segment Revenue 11,827 7,451 (1,056 ) 18,222 17,233 10,346 (1,689 ) 25,890
Total Cost of Sales 9,934 6,824 (1,056 ) 15,702 13,517 7,974 (1,689 ) 19,802
Gross Margin 1,893 - 2,520 3,716 2,372 - 6,088
Gross Margin % 16.0 % 8.4 % - 13.8 % 21.6 % 22.9 % - 23.5 %
General and Administrative Expense 2,319 3,014 2,439 3,205
Segment Allocated G&A Expense (677 ) - - (673 ) - -
Net General & Administrative Expense 1,642 1,144 3,014 1,766 1,242 3,205
Operating Income (Loss) (517 ) (228 ) (494 ) 1,950 1,130 (197 ) 2,883
Operating Income (Loss) % 2.1 % (6.9 %) - (2.7 %) 11.3 % 10.9 % - 11.1 %
Gain (Loss) on Change in Fair Value of Warrants - - 2,535 2,535 - - (508 ) (508 )
Interest Expense - - (11 ) (11 ) - - (19 ) (19 )
Income (Loss) before taxes $ 251 $ (517 ) $ 2,296 $ 2,030 $ 1,950 $ 1,130 $ (724 ) $ 2,356
Income (loss) before taxes % 2.1 % (6.9 %) - 11.1 % 11.3 % 10.9 % - 9.1 %
Our total external sales revenues decreased by $7.7 million in 2021, or 29.6% compared to 2020 revenue levels. The Optex Systems segment realized a $5.4 million decrease and the Applied Optics Center segment realized a decrease of $2.3 million in external revenue compared to the prior year period. Intersegment revenues decreased by $0.6 million to $1.1 million in 2021 from $1.7 million in 2020. 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 decreased $3.6 million and the gross margin percentage decreased by 9.7 points from 23.5% in 2020 to 13.8% in 2021. The Optex Systems gross margin decreased by $1.8 million in 2021 compared to 2020 and the gross margin percentage decreased to 16.0% in 2021 as compared to a gross margin percentage of 21.6% in 2020. The Applied Optics Center gross margin decreased by $1.7 million and the gross margin percentage decreased by 14.5 points from 22.9% in 2020 to 8.4% in 2021. The erosion in the gross margin percentage between years is primarily driven by lower revenue across both segments, changes in product mix toward less profitable product groups, and unfavorable manufacturing overhead adjustments on reduced production volume.
During the years ended 2021 and 2020, Applied Optics Center absorbed $0.7 million of fixed general and administrative costs incurred by Optex Systems for support services. 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 decreased by $3.4 million, in 2021 to a loss of $(0.5) million, as compared to the prior year operating income of $2.9 million. The decrease in operating income is primarily attributable to lower revenue and lower gross margin during the year partially offset by slightly lower general and administrative costs of $0.2 million as compared to the prior year.
Income before taxes decreased $0.3 million, to $2.0 million in 2021 from a prior year income before taxes of $2.4 million. The decrease in income before taxes year over year is primarily due to decreased operating income of $3.4 million, offset by an increase in income for non-cash related changes to the fair value of warrants of $3.0 million.
Backlog
Backlog as of October 3, 2021 was $27.3 million as compared to a backlog of $16.3 million as of September 27, 2020, representing an increase of 67.5%. The following table depicts the current expected delivery by quarter of all contracts awarded as of October 3, 2021. The increased backlog was primarily within our Applied Optics Center segment.
(Millions)
Product Line Q1
Q2
Q3
Q4
Delivery 2023+
Delivery Total Backlog
10/3/2021 Total Backlog
9/27/2020 Variance % Chg
Periscopes $ 1.0 $ 0.9 $ 1.8 $ 0.7 $ 4.4 $ 1.2 $ 5.6 $ 5.3 $ 0.3 5.7 %
Sighting Systems 0.3 0.1 0.1 0.1 0.6 1.1 1.7 2.9 (1.2 ) (41.4 )%
Howitzer - - 0.1 0.2 0.3 2.0 2.3 2.5 (0.2 ) (8.0 )%
Other 0.4 0.5 0.1 0.2 1.1 0.3 1.4 2.5 (1.1 ) (44.0 )%
Optex Systems - Richardson 1.7 1.5 2.1 1.2 6.4 4.6 11.0 13.2 (2.2 ) (16.7 )%
Applied Optics Center - Dallas 2.4 3.1 2.5 2.8 10.9 5.4 16.3 3.1 13.2 425.8 %
Total Backlog $ 4.1 $ 4.6 $ 4.6 $ 4.0 $ 17.3 $ 10.0 $ 27.3 $ 16.3 $ 11.0 67.5 %
During fiscal year 2021, Optex Systems Holdings received new orders totaling $29.2 million, a 65.9% increase, as compared to new orders of $17.6 million during the prior year. The 2021 orders consist of $7.6 million in support of our periscope product line, $19.6 million attributable to the Applied Optics Center and $1.2 million attributable to sighting systems and support, and $0.8 million in other products.
During the eighteen months through October 3, 2021, we experienced a reduction in new orders and ending customer backlog in our Optex Richardson segment. We attribute the lower orders to a combination of factors including a COVID-19 driven slow-down of contract awards for both U.S. military sales and foreign military sales (FMS), primarily during the second half of fiscal year 2020, combined with significant shifting in defense spending budget allocations in US military sales and FMS away from Army ground system vehicles toward other military agency applications. In addition, the pandemic has caused several program delays throughout the defense supply chain as a result of plant shutdowns, employee illnesses, travel restrictions, remote work arrangements and similar supplier chain issues. Our Applied Optics Center segment experienced a significant decline in orders during the second half of fiscal year 2020, however during the last twelve months, the segment has seen a sizable increase in new orders as a result of increased military spending in Army infantry optical equipment and an increased customer base.
Optex Systems - Richardson:
During the twelve months ended October 3, 2021, backlog for our Optex Richardson segment decreased by 16.7%, or 2.2 million to $11.0 million, as compared to the prior year ending backlog of $13.2 million.
Backlog for our periscope product line has increased 5.7% or $0.3 million to $5.6 million, from our 2020 fiscal year end level of $5.3 million. Our total periscope contract awards for fiscal 2021 totaled $7.6 million as compared to $6.2 million in the fiscal year 2020, an increase of $1.4 million, or 22.6% from the prior year.
Sighting Systems backlog decreased by $1.2 million or 41.4% from $2.9 million in fiscal year 2020 to $1.7 million as of the end of fiscal year 2021. The decrease in backlog is primarily attributable shipments against several of our long running Commander Weapon Sighting Systems “CWSS”, Digital Day and Night Sighting Systems “DDAN” contracts awarded during the prior years. During 2021, we booked $1.2 million in new orders, an increase of $0.2 million from the prior year orders of $1.0 million.
Howitzer backlog decreased by $0.2 million, or 8.0%, from $2.5 million to $2.3 million, on shipments against our Aiming Circle XM10 contract for optical assemblies which was awarded in fiscal year 2020. During the year, there were no new orders for howitzer assemblies as compared to $2.3 million in the prior year.
Our backlog in other product groups decreased by $1.1 million or 44.0% from $2.5 million in 2020 to $1.4 million in 2021 on shipments against our long running Muzzle Reference Sensor Collimator Assembly “MRS” contracts. During 2021, we booked new orders of $0.8 million as compared to the prior year orders of $2.7 million.
The Optex Systems Richardson segment, currently has seven open US Government IDIQ type military contracts for periscopes with substantial unspent funding which covers government base year and option year requirement periods into 2025, in addition to a significant pricing proposal in process for sighting system support with an expected award during the next six months.
Applied Optics Center - Dallas
The Applied Optics Center backlog increased by $13.2 million, or 425.8%, for the year ended October 3, 2021, from $3.1 million in 2020 to $16.3 million in 2021. New orders for the Applied Optics Center during the 2021 fiscal year were $19.6 million as compared to the fiscal year 2020 orders of $5.4 million, an increase of $14.2 million or 263.0%. We are seeing increases in demand and proposal activity for both laser coated filters and optical assemblies and anticipate additional order bookings for both our commercial and military products for deliveries beginning in fiscal year 2022. On August 2, 2021, the Company announced a contract award of $8.4 million with a new customer as part of a twenty-four-month purchase order for laser filter units and on September 21, 2021, the Company announced a $3 million commercial order for optical devices.
Optex Systems Holdings continues to pursue new international and commercial opportunities in addition to maintaining its current footprint with U.S. military vehicle manufactures, 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.
Twelve month period ended October 3, 2021 compared to the twelve month period ended September 27, 2020
Revenues:
The table below details the revenue changes by segment and product line for the year ended October 3, 2021 as compared to the year ended September 27, 2020.
Twelve months ended
(Millions)
Product Line October 3,
September 27,
Variance % Chg
Periscopes $ 7.2 $ 11.3 $ (4.1 ) (36.3 )
Sighting Systems 2.3 2.2 0.1 4.5
Howitzers 0.2 - 0.2 -
Other 2.1 3.7 (1.6 ) (43.2 )
Optical Systems - Richardson 11.8 17.2 (5.4 ) (31.4 )
Applied Optics Center - Dallas 6.4 8.7 (2.3 ) (26.4 )
Total Revenue $ 18.2 $ 25.9 $ (7.7 ) (29.7 )
Our total revenues decreased by $7.7 million, or 29.7% in 2021 compared to 2020 revenue levels. The Optex Systems Richardson segment realized a $5.4 million, or 31.4%, decrease in revenue and the Applied Optics Center segment realized a decrease of $2.3 million, or 26.4%, in revenue compared to the prior year period.
Revenues decreased by $4.1 million or 36.3% on our periscope line during the twelve months ended October 3, 2021 as compared to the twelve months ended September 27, 2020 based on lower customer demand between the respective periods.
Revenues on sighting systems increased by $0.1 million, or 4.5% from the prior year period due to shipments of Commander Weapon Sighting Systems against existing prior year contracts.
Revenue on Howitzers increased by $0.2 million, compared to revenues of zero in the prior year due to shipments against our Aiming Circle XM10 optical assemblies contract awarded in 2020.
Revenue on other product lines decreased by $1.6 million, or 43.2%, compared to revenues in the prior year due to lower contract demand on MRS collimators and cell assemblies.
The Applied Optics Center external revenue decreased by $2.3 million, or 26.4%, during 2021 as compared to the prior year period. The lower revenue was primarily driven by lower customer orders across coated filter and optical assembly lines. We expect revenue for the Applied Optics Center to increase in the next year consistent with recent increases in customer demand for optical assemblies and laser filter units.
Gross Margin. The gross margin for the year ended October 3, 2021 was 13.8% of revenue as compared to a gross margin of 23.5% of revenue for the year ended September 27, 2020. Cost of sales decreased by $4.1 million to $15.7 million for 2021 compared to $19.8 million for 2020 on reduced revenue. The gross margin decreased by $3.6 million to $2.5 million in 2021 as compared to $6.1 million in 2020. The erosion in the gross margin is primarily due to lower revenue across both segments, unfavorable manufacturing overhead adjustments on reduced production volume and some shifts in product mix toward less profitable product groups.
G&A Expenses. For the years ended October 3, 2021 and September 27, 2020, we recorded operating expenses of $3.0 million and $3.2 million, respectively. General and administrative cost decreases of $0.2 million, or 6.3%, during 2021 are primarily attributable to decreased salaries and office expenses.
Operating Income. For the year ended October 3, 2021, we recorded an operating loss $0.5 million as compared to operating income of $2.9 million during the year ended September 27, 2020. The $3.4 million decrease in operating income in the current year over the prior year is primarily due to decreased revenue and gross margin, offset by slightly lower general and administrative spending in the current year as compared to the prior year period.
Other (Expense) Income. During the year ended October 3, 2021, we recognized a $2.5 million gain on change in the fair value of warrants as compared to a $0.5 million loss in the year ended September 27, 2020. The $3.0 million change in the fair value of warrants is primarily due to the expiration of outstanding warrants as of August 26, 2021. Additional information related to the change in valuation is discussed under Item 1, “Consolidated Financial Statements, Note 12 - Warrant Liabilities”.
Net income applicable to common shareholders. During the year ended October 3, 2021, we recorded net income applicable to common shareholders of $1.5 million as compared to net income applicable to common shareholders of $1.2 million during the year ended September 27, 2020. The increase of net income of $0.3 million is primarily attributable to decreased operating income of ($3.4) million offset by changes in the fair value of warrants of $3.0 million and a change in income taxes of $0.6 million as compared to the year ended 2020.
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 3, 2021 and September 27, 2020, in terms of both the GAAP net income measure and the non-GAAP Adjusted EBITDA measure.
(Thousands)
Twelve months ended
October 3,
September 27,
Net Income - GAAP $ 2,131 $ 1,825
Add:
(Gain) Loss on Change in Fair Value of Warrants (2,535 )
Federal Income Tax (Benefit) Expense (101 )
Depreciation
Stock Compensation
Interest Expense
Adjusted EBITDA - Non GAAP $ (3 ) $ 3,328
Our Adjusted EBITDA decreased by $3.3 million to $0.0 million during the twelve months ended October 3, 2021 as compared to $3.3 million during the twelve months ended September 27, 2020. The decrease in EBITDA is primarily driven by a decrease in revenue of $7.7 million resulting in lower operating profit of $3.4 million and other changes of ($0.1) million. Operating segment performance is discussed in greater detail throughout the previous sections.
Liquidity and Capital Resources
As of October 3, 2021, Optex Systems Holdings had working capital of $12.9 million, as compared to $11.7 million as of September 27, 2020. 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.
Backlog as of October 3, 2021 was $27.3 million as compared to a backlog of $16.3 million as of September 27, 2020, representing an increase of 67.5%.
The Company has historically funded its operations through 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 3, 2021, the Company had approximately $3.9 million in cash and an outstanding payable balance of zero against our working line of credit. The line of credit allows for borrowing up to a maximum of $2.3 million. As of October 3, 2021, our outstanding accounts receivable was $3.2 million. We expect the accounts to be collected during the first quarter of fiscal 2022. 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 June 8, 2020 the Company announced authorization for a $1 million stock repurchase program. The shares authorized to be repurchased under the new 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 September 27, 2020, there were 105,733 common shares repurchased through the program at a cost of $200 thousand. The Company purchased a total of 519,266 shares against the program through April 2021 at a total cost of $1.0 million, which were subsequently cancelled in June 2021.
On September 22, 2021 the Company announced authorization for an additional $1 million stock repurchase program. As of October 3, 2021, there were 35,555 shares held in treasury which were purchased under the September 2021 stock repurchase plan at a cost of $69 thousand. During the twelve months ended October 3, 2021, there was a combined total of 449,088 common shares repurchased through both repurchase programs at a total cost of $869 thousand.
During the twelve months ending October 3, 2021, we generated operating cash flow of $0.5 million, received proceeds from the exercise of warrants of $0.3 million, paid down our line of credit by ($0.4) million, and spent ($0.9) million for the purchase of shares against our previously announced stock repurchase plans and ($0.3) million on acquisitions of property and equipment.
We intend to renew or replace our current $2.3 million facilities line of credit which expires on April 15, 2022. 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 August 26, 2021, 3,936,391 outstanding warrants expired worthless, resulting in a $2.5 million gain on change in fair value of warrants and the elimination of the balance sheet warrant liability.
During the twelve months ended October 3, 2021 the Company declared and paid no dividends. As of October 3, 2021, there are no outstanding declared and unpaid dividends.
Critical Accounting Policies
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 $479 thousand for the twelve months ended October 3, 2021 and $451 thousand for the twelve months ended September 27, 2020.
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 3, 2021, there was $1 thousand of revenue recognized during the period from customer deposit liabilities (deferred contract revenue). During the twelve months ended September 27, 2020 there was $3 thousand of revenue recognized during the period from customer deposit liabilities (deferred contract revenue. As of the twelve months ended October 3, 2021 and September 27, 2020, there are no significant deferred contract costs such as sales commissions.
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 3, 2021, Optex Systems Inc. has a net carrying value of $1.3 million in deferred tax assets represented by deferred tax assets of $2.1 million and a deferred tax asset valuation allowance of ($0.8) 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. Due to historical losses, our valuation allowance reserve was set at 100% of the deferred tax asset for the years 2014 through 2018 for a net carrying value of zero. As of October 3, 2021, and September 27, 2020, 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 3, 2021, we recognized and additional $0.04 million in tax benefits from the 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.
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. Adoption of ASC Topic 842 resulted in the balance sheet recognition of a right-of-use asset of $1.9 million and corresponding operating lease liabilities of approximately $1.8 million as of the beginning of the fiscal year ended on September 27, 2020, representing the present value of future lease payments as of the beginning of the year, for the term of the equipment lease and both segment facility leases and which assumed the exercise of a five-year renewal option at the Applied Optics Center as of November 1, 2021. 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 on January 11, 2021 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.
As of period ended September 27, 2021, the Company has recognized a $1.4 million in right-of-use-asset and corresponding operating lease liabilities of $1.5 million. As of period ended October 3, 2021, the Company has recognized a $3.6 million in right-of-use-asset and corresponding operating lease liabilities of $3.7 million.
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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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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 3, 2021 and September 27, 2020, 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 3, 2021 and September 27, 2020, 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 3, 2021, the Company has a net carrying value of $1.3 million in deferred tax assets represented by deferred tax assets of $2.1 million and a deferred tax asset valuation allowance of $0.8 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.
We have served as the Company’s auditor since 2017.
Fort Worth, Texas
December 20, 2021
Optex Systems Holdings, Inc.
Consolidated Balance Sheets
(Thousands, except share and
per share data)
October 3, 2021 September 27, 2020
ASSETS
Cash and Cash Equivalents $ 3,900 $ 4,700
Accounts Receivable, Net 3,183 2,953
Inventory, Net 7,583 8,791
Prepaid Expenses
Current Assets 14,928 16,673
Property and Equipment, Net 1,017 1,006
Other Assets
Deferred Tax Asset 1,288 1,227
Right-of-use Asset 3,599 1,416
Security Deposits
Other Assets 4,910 2,666
Total Assets $ 20,855 $ 20,345
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts Payable $ 551 $ 833
Operating Lease Liability
Accrued Expenses 1,077
Warrant Liability - 2,544
Accrued Warranty Costs
Customer Advance Deposits -
Current Liabilities 2,008 4,955
Other Liabilities
Credit Facility -
Operating Lease Liability, net of current portion 3,133 1,037
Other Liabilities 3,133 1,414
Total Liabilities 5,141 6,369
Commitments and Contingencies -
Stockholders’ Equity
Common Stock - ($0.001 par, 2,000,000,000 authorized, 8,523,704 and 8,795,869 shares issued, and 8,488,149 and 8,690,136 outstanding, respectively)
Treasury Stock (at cost, 35,555 and 105,733 shares held, respectively) (69 ) (200 )
Additional Paid in capital 25,752 26,276
Accumulated Deficit (9,978 ) (12,109 )
Stockholders’ Equity 15,714 13,976
Total Liabilities and Stockholders’ Equity $ 20,855 $ 20,345
The accompanying notes are an integral part of these financial statements.
Optex Systems Holdings, Inc.
Consolidated Statements of Income
(Thousands, except share and per share data)
Twelve months ended
October 3, 2021 September 27, 2020
Revenue $ 18,222 $ 25,890
Cost of Sales 15,702 19,802
Gross Margin 2,520 6,088
General and Administrative Expense 3,014 3,205
Operating Income (Loss) (494 ) 2,883
Gain (Loss) on Change in Fair Value of Warrants 2,535 (508 )
Interest Expense (11 ) (19 )
Other Income (Expense) 2,524 (527 )
Income Before Taxes 2,030 2,356
Income Tax Expense (Benefit), net (101 )
Net Income $ 2,131 $ 1,825
Deemed dividends on participating securities (660 ) (598 )
Net income applicable to common shareholders $ 1,471 $ 1,227
Basic income per share $ 0.18 $ 0.14
Weighted Average Common Shares Outstanding - basic 8,241,021 8,464,572
Diluted income per share $ 0.18 $ 0.14
Weighted Average Common Shares Outstanding - diluted 8,323,809 8,589,919
The accompanying notes are an integral part of these financial statements.
Optex Systems Holdings, Inc.
Consolidated Statements of Cash Flows
(Thousands)
Twelve months ended
October 3, 2021 September 27, 2020
Cash Flows from Operating Activities:
Net Income $ 2,131 $ 1,825
Adjustments to Reconcile Net Income to Net Cash provided by Operating Activities:
Depreciation and Amortization
(Gain) Loss on Change in Fair Value of Warrants (2,535 )
Stock Compensation Expense
Deferred Tax (60 )
Accounts Receivable (230 )
Inventory 1,208 1,744
Prepaid Expenses (33 )
Leases
Accounts Payable and Accrued Expenses (510 ) (1,103 )
Accrued Warranty Costs (4 )
Customer Advance Deposits (1 ) (2 )
Increase (Decrease) In Accrued Estimated Loss On Contracts - -
Total Adjustments (1,650 ) 2,086
Net Cash provided by Operating Activities 3,911
Cash Flows used in Investing Activities
Purchases of Property and Equipment (274 ) (152 )
Net Cash used in Investing Activities (274 ) (152 )
Cash Flows used in Financing Activities
Cash Paid for Taxes Withheld On Net Settled Restricted Stock Unit Share Issue (44 ) (54 )
Payments (to) Borrowings from Credit Facility (377 )
Proceeds from Warrant Exercise -
Stock Repurchase (869 ) (200 )
Net Cash used in Financing Activities (1,007 ) (127 )
Net (Decrease) Increase in Cash and Cash Equivalents (800 ) 3,632
Cash and Cash Equivalents at Beginning of Period 4,700 1,068
Cash and Cash Equivalents at End of Period $ 3,900 $ 4,700
Supplemental Cash Flow Information:
Non Cash Transactions:
Right-of-Use Asset $ 3,688 $ 1,811
Operating Lease Liabilities (3,688 ) (1,894 )
Treasury stock retired (1,000 ) -
Cash Transactions:
Cash Paid for Taxes
Cash Paid for Interest
The accompanying notes are an integral part of these financial statements.
Optex Systems Holdings, Inc.
Consolidated Statement of Stockholders’ Equity
4
(Thousands, except share data)
Common
Additional
Total
Shares Treasury Common Treasury Paid in Retained Stockholders
Issued Shares Stock Stock Capital Earnings Equity
Balance at September 29, 2019 8,436,422 - $ 8 $ - $ 26,134 $ (13,934 ) $ 12,208
Stock Compensation Expense - - - - -
Vested restricted stock units issued net of tax withholding 59,447 - - - (54 ) - (54 )
Restricted Board Shares Issued (1) (1) 300,000 - - (1 ) - -
Common Stock Repurchase (2) (2) - 105,733 - (200 ) - - (200 )
Exercise of Warrants
Exercise of Warrants, shares
Common Stock Purchase and Cancellation
Common Stock Purchase and Cancellation, shares
Cancellation of Treasury Shares
Cancellation of Treasury Shares, shares
Net income - - - - - 1,825 1,825
Balance at September 27, 2020 8,795,869 105,733 $ 9 $ (200 ) $ 26,276 $ (12,109 ) $ 13,976
Stock Compensation Expense - - - - -
Vested restricted stock units issued net of tax withholding 58,392 - - - (44 ) - (44 )
Common Stock Repurchase (2) (2) - 449,088 - (869 ) - - (869 )
Exercise of Warrants (3) (3) 188,809 - - - -
Common Stock Purchase and Cancellation (100 ) - - - - - -
Cancellation of Treasury Shares (2) (2) (519,266 ) (519,266 ) - 1,000 (1,000 ) - -
Net income - - - - - 2,131 2,131
Balance at October 3, 2021 8,523,704 35,555 $ 9 $ (69 ) $ 25,752 $ (9,978 ) $ 15,714
(1) 100,000 restricted common shares issued to each of the Independent Board of Directors (Rimmy Malhotra, Dale Lehman, Larry Hagenbuch) on April 30, 2020 with 20% vesting as of each January 1 each year over a five-year period. The value of the shares at issue date is $525,000 for 300,000 shares to be amortized over the vesting period. As of October 3, 2021, 60,000 of the director shares were vested, and 240,000 were unvested.
(2) Common shares repurchased in the open market between June 11, 2020 and October 3, 2021. On June 14, 2021, 519,266 of the repurchased shares were cancelled, and as of October 3, 2021, 35,555 shares were held in treasury stock using the cost method.
(3) 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.
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 3, 2021, 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 2021 ended on October 3, 2021 and included 53 weeks. Fiscal year 2020 ended on September 27, 2020 and included 52 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 $3.9 million in cash on deposit with our banks. Only a portion of the cash, currently $500 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 3, 2021 are derived from sales to U.S. government agencies (28%), four U.S. defense contractors (27%, 11%, 5%, and 5%), one major commercial customer (10%) and all other customers (14%). The Company’s revenues for fiscal year ended September 27, 2020 are derived from sales to U.S. government agencies (50%), three major U.S. defense contractors (19%, 6% and 5%), one major commercial customer (9%) and all other customers (11%). 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 3, 2021, and September 27, 2020, 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 2021 we recognized zero in bad debt expenses associated with uncollectible accounts. In the fiscal year 2020 we recognized $1 thousand in bad debt expenses associated with uncollectible accounts.
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%, a commercial customer, 16%, and a foreign military customer, 7%. As of September 27, 2020, 89% of the accounts receivable balance was comprised of five customers: the U.S. government, 29%, three major defense contractors, 39%, 8% and 7%, and a commercial customer, 6%.
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 3, 2021, and September 27, 2020 inventory included:
Schedule of Inventory
(Thousands)
As of
October 3, 2021 As of
September 27, 2020
Raw Materials $ 4,926 $ 5,506
Work in Process 2,664 3,214
Finished Goods
Gross Inventory 8,219 9,358
Less: Inventory Reserves (636 ) (567 )
Net Inventory $ 7,583 $ 8,791
In the twelve months ended October 3, 2021 Optex Systems recorded $69 thousand of obsolete and excess inventory reserves. Net Inventory decreased by $1.2 million in support of deliveries against several long running contracts during the 2021 fiscal year.
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 3, 2021, and September 27, 2020, the existing warranty reserve balances of $78 thousand and $83 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 3, 2021 and September 27, 2020.
Schedule of Warranty Reserves
Years ended
Beginning balance $ 83 $ 46
Incurred costs for warranties satisfied during the period (80 ) (39 )
Warranty Expenses:
Warranties reserved for new product shipped during the period(1)
Change in estimate for pre-existing warranty liabilities (2) (30 )
Warranty Expense
Ending balance $ 78 $ 83
(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.
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. Adoption of ASC Topic 842 resulted in the balance sheet recognition of a right-of-use asset of $1.9 million and corresponding operating lease liabilities of approximately $1.8 million as of the beginning of the fiscal year ended on September 27, 2020, representing the present value of future lease payments as of the beginning of the year, for the term of the equipment lease and both segment facility leases and which assumed the exercise of a five-year renewal option at the Applied Optics Center as of November 1, 2021. 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 on January 11, 2021 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.
As of period ended September 27, 2021, the Company has recognized a $1.4 million in right-of-use-asset and corresponding operating lease liabilities of $1.5 million. As of period ended October 3, 2021, the Company has recognized a $3.6 million in right-of-use-asset and corresponding operating lease liabilities of $3.7 million. 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 $479 thousand for the twelve months ended October 3, 2021 and $451 thousand for the twelve months ended September 27, 2020.
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 3, 2021, there was $1 thousand of revenue recognized during the period from customer deposit liabilities (deferred contract revenue). During the twelve months ended September 27, 2020 there was $3 thousand of revenue recognized during the period from customer deposit liabilities (deferred contract revenue. As of the twelve months ended October 3, 2021 and September 27, 2020, 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 3, 2021, and September 27, 2020, Optex Systems, Inc. had a balance of zero and $1 thousand, respectively, in customer advance deposits.
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 3, 2021, Optex Systems Inc. has a net carrying value of $1.3 million in deferred tax assets represented by deferred tax assets of $2.1 million and a deferred tax asset valuation allowance of ($0.8) 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. Due to historical losses, our valuation allowance reserve was set at 100% of the deferred tax asset for the years 2014 through 2018 for a net carrying value of zero. As of October 3, 2021, and September 27, 2020, 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 3, 2021, we recognized an additional $0.04 million in tax benefits from the 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.
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 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. For the twelve months ended September 27, 2020, 182,000 unvested restricted stock units and 300,000 restricted unvested shares (which converts to 125,347 incremental dilutive shares) were included in the diluted earnings per share calculation as dilutive, and 4,125,200 warrants were excluded.
Our outstanding warrants during the twelve months ended October 3, 2021 and September 27, 2020 are participating securities which share dividend distributions and the allocation of any undistributed earnings (deemed dividends) with our common shareholders. During the twelve months ended October 3, 2021 and September 27, 2020, there were no declared dividends and allocated undistributed earnings of $0.7 million and $0.6 million attributable to the participating warrants, respectively.
Note 3 - Recent Accounting Pronouncements
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). ASU 2018-13 modifies the disclosure requirements on recurring and nonrecurring fair value measurements in Topic 820. The amendments in the update are effective for all entities for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019. As such, Optex Systems Holdings adopted these provisions as of the fiscal year beginning on September 28, 2020. There was no material impact on our financial statement disclosures as a result of the amendment adoption.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (“ASU 2016-13”). ASU 2016-13 changes the impairment model for most financial assets and certain other instruments, including trade and other receivables, held-to-maturity debt securities and loans, and requires entities to use a new forward-looking expected loss model that will result in the earlier recognition of allowance for losses. This update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. As such, Optex Systems Holdings adopted these provisions as of the fiscal year beginning on September 28, 2020. There was no material impact on our consolidated financial statements and results of operations as a result of adopting ASU 2016-13.
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 and one equipment lease which extends beyond twelve months and fall under the guidance of ASC Topic 842. Adoption of ASC Topic 842 resulted in the balance sheet recognition of a right-of-use asset of $1.8 million and corresponding operating lease liabilities of approximately $1.9 million as of September 30, 2019, representing the present value of future lease payments as of the beginning of the year, for the term of the equipment lease and both segment facility leases. See also Note 7.
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 85% of the Optex Systems segment revenue is comprised of domestic military customers, and 15% is comprised of foreign military customers. Optex Systems segment revenue is derived from the U.S. government, 28%, and two major U.S. defense contractors representing 21% and 11%, 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 3, 2021, the Richardson facility operated with 47 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 35% and military sales to prime and subcontracted customers represent 65% of the total segment revenue. Approximately 86% of the AOC revenue is derived from external customers and approximately 14% is related to intersegment sales to Optex Systems in support of military contracts. For the twelve months ended October 3, 2021, the AOC segment revenue from the U.S. government, one major commercial customer, and two major defense contractors represent approximately 10%, 7% 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 3, 2021, AOC operated with 37 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 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 (loss) before taxes $ 251 $ (517 ) $ 2,296 $ 2,030
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
Reportable Segment Financial Information
(thousands)
Twelve months ended September 27, 2020
Optex Systems
Richardson Applied Optics Center
Dallas Other
(non-allocated costs and intersegment eliminations) Consolidated
Total
Revenues from external customers $ 17,233 $ 8,657 $ - $ 25,890
Intersegment revenues - 1,689 (1,689 ) -
Total Revenue $ 17,233 $ 10,346 $ (1,689 ) $ 25,890
Interest expense $ - $ - $ 19 $ 19
Depreciation and Amortization $ 36 $ 212 $ - $ 248
Income before taxes $ 1,950 $ 1,130 $ (724 ) $ 2,356
Other significant noncash items:
Allocated home office expense $ (673 ) $ 673 $ - $ -
Loss on change in fair value of warrants $ - $ - $ 508 $ 508
Stock option compensation expense $ - $ - $ 197 $ 197
Warranty Expense $ - $ 76 $ - $ 76
Segment Assets $ 14,642 $ 5,703 $ - $ 20,345
Expenditures for segment assets $ 102 $ 50 $ - $ 152
Note 5 - Property and Equipment
A summary of property and equipment at October 3, 2021 and September 27, 2020 is as follows:
Schedule of Property and Equipment
(Thousands)
Estimated
Useful Life Year Ended
October 3, 2021 Year Ended
September 27, 2020
Property and Equipment
Furniture and Fixtures 3-5 yrs $ 398 $ 398
Machinery and Equipment 5 yrs 4,035 3,782
Leasehold Improvements 7 yrs
Less: Accumulated Depreciation
(3,712 ) (3,450 )
Net Property & Equipment
$ 1,017 $ 1,006
Depreciation Expense
$ 263 $ 248
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. During the twelve months ended September 27, 2020, Optex Systems Holdings’ purchased $20 thousand in new furniture and fixtures and $132 thousand in machinery and equipment. During the twelve months ended September 27, 2020, there were no sales or retirements of fixed assets.
Note 6 - Accrued Expenses
The components of accrued liabilities for the years ended October 3, 2021 and September 27, 2020 are summarized below:
Schedule of Accrued Liabilities
(Thousands)
Year Ended Year Ended
October 3, 2021 September 27, 2020
Contract Loss Reserves $ 51 $ -
Accrued Vacation
Property Taxes
Operating Expenses
Payroll & Payroll Related
Total Accrued Expenses $ 851 $ 1,077
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 $11.6 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 $7.8 thousand for additional CAM, to be adjusted annually based on actual expenses incurred by the landlord.
The Company has 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 is $1.5 thousand per month from October 1, 2018 through December 31, 2021.
Optex Systems Holdings adopted the provisions of ASC Topic 842 “Leases” as of the fiscal year beginning on September 30, 2019. Optex Systems Holdings has two significant operating facilities leases and one equipment lease which extend beyond twelve months and fall under the guidance of ASC Topic 842. Adoption of ASC Topic 842 resulted in the balance sheet recognition of a right-of-use asset of $1.8 million and corresponding operating lease liabilities of approximately $1.9 million as of September 30, 2019, which represented the present value of future lease payments for the term of the equipment lease and both segment facility leases and which assumed the exercise of a five-year renewal option at the Applied Optics Center as of November 1, 2021. Execution of the new lease amendments for the Dallas and Richardson facilities on January 11, 2021 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 twelve months ended October 3, 2021.
As of October 3, 2021, 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:
Schedule of Non-cancellable Operating Leases Minimum Payments
Non-cancellable Operating Leases Minimum Payments
Fiscal Year Facility
Lease
Payments Facility
Lease
Payments Lease
Payments
Total Lease Payments Total Variable CAM Estimate
(Thousands)
Optex Richardson Applied Optics Center Office Equipment Consolidated
Fiscal Year Facility
Lease
Payments Facility
Lease
Payments Lease
Payments
Total Lease Payments Total Variable CAM Estimate
2022 Base year lease 546
2023 Base year lease
2024 Base year lease
2025 Base year lease
2026 Base year lease
2027 Base year lease
2028 Base year lease
2029 Base year lease -
Total base lease payments 2,232 $ 2,171 $ 4 4,407 $ 1,695
Imputed interest on lease payments (1) (1) (339 ) (407 ) - (746 )
Total Operating Lease Liability(2) (2) $ 1,893 $ 1,764 $ 4 $ 3,661
Right-of-use Asset(3) (3) $ 1,831 $ 1,764 $ 4 $ 3,599
(1) Assumes a discount borrowing rate of 5.0% on the new lease amendments effective as of January 11, 2021 and 7.5% on the remaining lease term for the Applied Optics Dallas facility through October 31, 2021.
(2) Includes $62 thousand of unamortized deferred rent.
(3) Short-term and Long-term portion of Operating Lease Liability is $528 thousand and $3,133 thousand, respectively.
Total expense under both facility lease agreements for the twelve months ended October 3, 2021 was $769 thousand. Total expense under both facility lease agreements as of the twelve months ended September 27, 2020 was $735 thousand.
Total office equipment rentals included in operating expenses was $22 thousand for the twelve months ended October 3, 2021 and for the twelve months ended September 27, 2020.
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 are as follows:
● The principal amount of the Facility is $2.25 million. The Facility matures on April 15, 2022. The interest rate is 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 is payable monthly in arrears starting on May 15, 2020; and the principal amount is due in full with all accrued and unpaid interest and any other fees on April 15, 2022.
● There are 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). As of October 3, 2021, the Company was in compliance with the covenants.
● The Facility contains 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 is secured by a first lien on all of the assets of Borrower.
The outstanding balance on the credit facility was zero and $377 thousand as of October 3, 2021 and September 27, 2020, respectively. For the years ended October 3, 2021 and September 27, 2020, the total interest expense against the outstanding line of credit balance was $11 thousand and $19 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. During the twelve months ended September 27, 2020, all of the 25,000 outstanding stock options were repurchased at $0.01 per option for a total transaction of $250. There were no new grants of stock options during the twelve months ended October 3, 2021. As of October 3, 2021, there are zero stock options outstanding.
Restricted Stock Units issued to Officers and Employees
On June 14, 2016, the Compensation Committee (“Committee”) of the Board of Directors of Optex Systems Holdings, Inc. approved the Company’s 2016 Restricted Stock Unit Plan (the “Plan”). The Plan provides for the issuance of restricted stock units (“RSU”) for up to 1,000,000 shares of the Company’s common stock to Optex Systems Holdings officers and employees. Each RSU constitutes a right to receive one share of the Company’s common stock, subject to vesting, which unless otherwise stated in an RSU agreement, shall vest in equal amounts on the first, second and third anniversary of the grant date. Shares of the Company’s common stock underlying the number of vested RSUs will be delivered as soon as practicable after vesting. During the period between grant and vesting, the RSUs may not be transferred, and the grantee has no rights as a shareholder until vesting has occurred. If the grantee’s employment is terminated for any reason (other than following a change in control of the Company or a termination of an officer other than for cause), then any unvested RSUs under the award will automatically terminate and be forfeited. If an officer grantee’s employment is terminated by the Company without cause or by the grantee for good reason, then, provided that the RSUs have not been previously forfeited, the remaining unvested portion of the RSUs will immediately vest as of the officer grantee’s termination date. In the event of a change in control, the Company’s obligations regarding outstanding RSUs shall, on such terms as may be approved by the Committee prior to such event, immediately vest, be assumed by the surviving or continuing company or cancelled in exchange for property (including cash).
On January 7, 2020, the Company issued 59,447 common shares to one director and two officers, net of tax withholding of $54 thousand, in settlement of 84,500 restricted stock units which vested on January 1, 2020.
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 market 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 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.
Effective December 1, 2021, the vesting terms of Danny Schoening’s RSU grant from January 2019 were revised as described in “Item 11. Executive Compensation - Employment Agreements - Danny Schoening,” which disclosure is incorporated by reference herein.
Restricted Shares Issued to Independent Board Members
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 will amortize the fair market value to stock compensation expense on a straight-line basis across the five-year vesting period beginning on April 30, 2020. On January 1, 2021, 60,000 of the restricted director shares vested.
There were no new grants of restricted stock units during the twelve months ended October 3, 2021.
The following table summarizes the status of Optex Systems Holdings’ aggregate non-vested restricted stock units and restricted shares granted as of October 3, 2021:
Schedule of Aggregate Non-vested Restricted Stock Units Granted
Restricted
Stock Units
Weighted
Average
Grant Date
Fair Value
Restricted
Shares
Weighted
Average
Grant Date
Fair Value
Outstanding at September 29, 2019 216,500 $ 1.29 - -
Granted 50,000 $ 2.13 300,000 $ 1.75
Vested (84,500 ) $ 1.25 - -
Forfeited - - - -
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
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 3, 2021 September 27, 2020 October 3, 2021 September 27, 2020
Restricted Shares $ 105 $ 79 $ 341 $ 446
Restricted Stock Units 188
Total Stock Compensation $ 228 $ 197 $ 407 $ 634
The unrecognized compensation expense for restricted shares and restricted stock units is expected to be recognized over a weighted-average period of 3.25 years and 0.92 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 3, 2021 and September 27, 2020, 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 3, 2021 and September 27, 2020 were $158 thousand and $165 thousand, respectively.
Note 11 - Stockholders’ Equity
Dividends
There were no dividends declared or paid during the twelve months ended October 3, 2021 and September 27, 2020.
Common stock
During the twelve months ended September 27, 2020, there were 59,447 common shares issued, net of tax withholding, in settlement of 84,500 restricted stock units which vested on January 1 2020. On April 30, 2020, there were 300,000 restricted shares issued to independent board members. There were no other issuances of common stock during the twelve months ended September 27, 2020.
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.
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 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 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. As of October 3, 2021, there were 35,555 shares held in treasury purchased under the September 2021 stock repurchase plan. 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 3, 2021, there were 449,088 common shares repurchased through the program at a cost of $869 thousand. During the twelve months ended September 27, 2020, there were 105,733 common shares repurchased through the program at a cost of $200 thousand. 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
May 24, 2020 through June 28, 2020 34,243 $ 63 $ 1.84 $ 937
Stock Buyback Plan initiated May 2020 ($1,000,000)
May 24, 2020 through June 28, 2020 34,243 $ 63 $ 1.84 $ 937
June 29, 2020 through July 26, 2020 6,806 1.89
July 27, 2020 through August 23, 2020 10,688 1.96
August 23, 2020 through September 27, 2020 53,996 1.90
September 28, 2020 through October 25, 2020 20,948 2.01
October 26, 2020 through November 22, 2020 129,245 2.05
November 23, 2020 through December 27, 2020 58,399 1.86
December 28, 2020 through January 24, 2021 40,362 1.80
January 25, 2021 through February 21, 2021 52,180 1.94
February 22, 2021 through March 28, 2021 73,800 1.90
March 29, 2021 through April 19, 2021 38,599 1.82 -
Total shares repurchased and cancelled 519,266 $ 1,000 $ 1.93 $ -
Stock Buyback Plan initiated September 2021 ($1,000,000)
September 23, 2021 through October 1, 2021 35,555 $ 69 $ 1.93 $ 931
Total shares repurched for the twelve months ended September 27, 2020 105,733 $ 200 $ 1.89
Total shares repurched for the twelve months ended October 3, 2021 449,088 1.93
Total shares repurchased as of October 3, 2021 554,821 $ 1,069 $ 1.93 $ 931
As of October 3, 2021, and September 27, 2020, the total outstanding common shares were 8,488,149 and 8,690,136, 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, 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) 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 9/29/2019 4,125,200 $ 0.49 $ 2,036
Loss on Change in Fair Value of Warrant Liability
(Gain) Loss on Change in Fair Value of Warrant Liability, Outstanding
Reclassification to additional paid in capital on exercise of warrants
Reclassification to additional paid in capital on exercise of warrants, Outstanding
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 3, 2021 and September 27, 2020 include the following:
Schedule of Income Tax Provision
(Thousands)
Current income tax expense:
Current year federal income tax $ - $ 403
Prior year tax adjustment (62 ) (59 )
Current income tax expense (62 )
Deferred income tax provision (benefit):
Federal (39 )
Provision for (Benefit from) income taxes, net $ (101 ) $ 531
As of October 3, 2021, Optex Systems Inc. has a net carrying value of $1.3 million in deferred tax assets represented by deferred tax assets of $2.1 million and a deferred tax asset valuation allowance of ($0.8) 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 3, 2021, and September 27, 2020, 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 3, 2021. During the twelve months ended October 3, 2021, the Company recognized ($0.04) million in tax benefits to deferred tax assets. During the twelve months ended September 27, 2020, the Company recognized $0.2 million in tax expenses from 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 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
% %
Tax provision (benefit) at statutory federal rate $ 426 $ 495
Nondeductible expenses (531 ) (26)
Other temporary adjustments 1
Prior year federal income tax adjustment (62 ) (3) (59 ) (2)
Change in deferred tax valuation allowance (155 ) (8) (48 ) (2)
Provision for (benefit from) income taxes, net $ (101 ) (5) $ 531
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
(Thousands)
Deferred Tax Asset
As of
October 3, 2021 As of
September 27, 2020
Stock Compensation $ 73 $ 64
Inventory Reserve
Unicap
Deferred Compensation -
Fixed assets (226 ) (18 )
Goodwill Amortization
Intangible Asset Amortization
Net Operating Losses 1,657 1,362
Other
Subtotal $ 2,096 $ 2,190
Valuation allowance (808 ) (963 )
Net deferred asset $ 1,288 $ 1,227
The Company has a net loss carryforward of $7.9 million as of October 3, 2021 as compared to a net loss carryforward of $6.5 million as of September 27, 2020. 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 $4.0 million of the current net operating loss carryforward for a net tax benefit of $0.8 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 is not subject to the IRS section 382 limitation and is available for a tax loss carryback up to five years.
The Company applied FASB ASC 740-10 and has no unrecognized tax benefits. By statute, the tax years ended October 3, 2021, September 27, 2020 and September 29, 2019 are open to examination by the major taxing jurisdictions to which the Optex Systems Holdings is subject.
During the twelve months ended October 3, 2021 the Company paid $48 thousand in income taxes, and has a net tax refund due related to the fiscal year 2021 tax year of ($48) thousand included in prepaid expenses. During the twelve months ended September 27, 2020 the Company paid $289 thousand in income taxes, and had a net tax refund due related to the fiscal year 2020 tax year of ($20) thousand included in prepaid expenses. There were additional tax benefit adjustments of $40 thousand due to changes from the provisional 2020 rates as compared to the federal income tax report associated with research and development tax credits and other adjustments.
Note 14 - Subsequent Events
The Company entered into an amended and restated employment agreement with Danny Schoening dated December 1, 2021. The term of the agreement commenced as of December 1, 2021 and the current term ends on November 30, 2022. Mr. Schoening’s base salary is $296,031 per annum. Mr. Schoening will be eligible for a performance bonus based upon a rolling three-year operating plan adopted by the Company’s Board of Directors (the “Board”). The bonus will be based on operating metrics decided annually by our Board and tied to such three-year plan. The target bonus equates to 30% of Mr. Schoening’s base salary. Our 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, by changing the third and final vesting date for the restricted stock units granted under such agreement from January 2, 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.
The employment agreement events of termination consist of: (i) death or permanent disability of Mr. Schoening; (ii) termination by the Company for cause (including conviction of a felony, commission of fraudulent acts, willful misconduct by Mr. Schoening, continued failure to perform duties after written notice, violation of securities laws and breach of the employment agreement), (iii) termination by the Company without cause and (iv) termination by Mr. Schoening for good reason (including breach by the Company of its obligations under the agreement, the requirement for Mr. Schoening to move more than 100 miles away for his employment without consent, and merger or consolidation that results in more than 66% of the combined voting power of the Company’s then outstanding securities or those of its successor changing ownership or a sale of all or substantially all of its assets, without the surviving entity assuming the obligations under the agreement). For a termination by the Company for cause or upon death or permanent disability of Mr. Schoening, Mr. Schoening will be paid salary and for a termination due to his death or permanent disability, also any bonus earned through the date of termination. For a termination by the Company without cause or by Mr. Schoening with good reason, Mr. Schoening will also be paid six months’ base salary in effect and, if such termination occurs prior to a change of control, Mr. Schoening will not forfeit the unvested RSUs until and unless the change of control does not occur by March 13, 2023.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.

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ITEM 9A. CONTROLS AND PROCEDURES
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of October 3, 2021, management performed, with the participation of our Principal Executive Officer and Principal Financial Officer, an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the report we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s forms, and that such information is accumulated and communicated to our management including our Principal Executive Officer and our Principal Financial Officer, to allow timely decisions regarding required disclosures. Based on the evaluation, our Principal Executive Officer and our Principal Financial Officer concluded that, as of October 3, 2021, our disclosure controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
During the quarter ended October 3, 2021, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projection of any evaluation of effectiveness to future periods is subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has conducted, with the participation of our Principal Executive Officer and our Principal Financial Officer, an assessment, including testing of the effectiveness, of our internal control over financial reporting as of October 3, 2021. Management’s assessment of internal control over financial reporting was conducted using the criteria in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. In connection with our management’s assessment of our internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act of 2002, we have not identified any material weaknesses in our internal control over financial reporting as of October 3, 2021. We have thus concluded that our internal control over financial reporting was effective as of October 3, 2021.
Item 9.B. Other Information
None.
PART III

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ITEM 9B. OTHER INFORMATION

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10 Directors, Executive Officers and Corporate Governance
Our board of directors directs the management of the business and affairs of our company as provided in our certificate of incorporation, our by-laws and the General Corporation Law of Delaware. Members of our board of directors keep informed about our business through discussions with senior management, by reviewing analyses and reports sent to them, and by participating in regularly scheduled board and committee meetings.
Our Company is led by Danny Schoening, who has served as COO since 2009, was appointed CEO and Director in 2013, and became Chairman in 2017.
As of October 3, 2021, our board of directors consists of four directors, which includes three independent directors and one non-independent director as discussed below.
Our board leadership structure is used by other smaller public companies in the United States, and we believe that this leadership structure is effective for us. We believe that our directors provide effective oversight of the risk management function, especially through dialogue between the full board and our management. Our directors serve for a one-year term and until their successors are elected and duly qualify.
Due to our small size, the priority has been in attracting qualified directors, with some consideration toward board diversity.
Directors and Executive Officers
The following table sets forth information regarding the members of our board of directors and our executive officers and other significant employees.
The following table sets forth certain information with respect to our directors and executive officers:
Name
Age
Position
Danny Schoening
Chairman and Director, Chief Executive Officer, Chief Operating Officer
Karen L. Hawkins
Chief Financial Officer
Larry Hagenbuch
Director, Audit Committee Chair (appointed November 4, 2019)
Dale Lehmann
Director, Nominating Committee Chair (appointed November 4, 2019)
Rimmy Malhotra
Director, Compensation Committee Chair (appointed November 4, 2019)
Billy Bates(2)
General Manager, Applied Optics Center
Danny R. Schoening (57). Mr. Schoening joined Optex Systems, Inc. (Texas) in January 2008. Upon the acquisition of the assets of Optex Systems, Inc. (Texas) by Optex Systems, Inc. (Delaware), Danny became the COO of Optex Systems, Inc. (Delaware) (as of September 28, 2008) and he commenced service with Optex Systems Holdings as its Chief Operating Officer as of the date of the reorganization, March 30, 2009 and was appointed Chief Executive Officer and as a Director in 2013. He has been instrumental in establishing the systems and infrastructure required to continue Optex System’s rapid growth. This activity was rewarded with Optex System’s recent ISO 9001:2000 Certification. From February 2004 to January 2008, Danny was the Vice President of Operations for The Finisar Corporation AOC Division for 4 years where he led a team of up to 200 employees to produce vertical cavity lasers for the data communications industry at production rates of hundreds of thousands of units per week. Prior to Finisar, Danny was the Director of Operations for multiple divisions of Honeywell International. Serving the Automotive, Medical, Aerospace, and Consumer Commercial Markets. During this 17-year period, Danny was recognized with Honeywell’s Lund Award, their highest award for developing employee resources. Danny has a broad experience level in the following technologies: Mechanical Assembly Processes, Micro-Electronic Assembly Processes, Laser Manufacturing, Plastic Molding, Metal Machining, Plating, Thick Film Printing, Surface Mount Technology, Hall Effect Technology and MEMS based Pressure Devices. Danny received a Bachelor’s of Science in Manufacturing Engineering Technology from the University of Nebraska, an MBA from Southern Methodist University, and holds three U.S. patents. The Board of Directors has determined that Danny is suited to sit on our Board because of his industry experience and as he is the CEO.
Karen L. Hawkins (56). On November 19, 2014, Karen Hawkins was appointed as our Chief Financial Officer. Ms. Hawkins had previously served as our Vice President, Finance and Controller, since the date of the reorganization, March 30, 2009 and was the controller of Optex Systems, Inc. (Delaware), effective September 28, 2009. She began her employment with Optex Systems, Inc. (Texas) in April 2007. Ms. Hawkins has over 30 years’ experience in Financial Accounting and Management, primarily focused in the Defense and Transportation Industries. She has a strong background in both Financial & Cost Accounting, with extensive Government Pricing, Financial Analysis, and Internal Auditing experience. Her past history also includes Program Management, Materials Management and Business Development. She brings over 25 years’ direct experience in Government Contracting with a strong knowledge of Cost Accounting Standards Board and Federal Acquisition Regulation. Her previous employment includes General Dynamics - Ordinance and Tactical Division, Garland (formerly known as Intercontinental Manufacturing) for over 13 years from November, 1994 through March, 2007. During her tenure there she served in the roles of Controller (Accounting & IT), Program Manager over a $250M 3-year Army Indefinite Delivery/Indefinite Quantity (Indefinite Delivery/Indefinite Quantity) type contract, as well as Materials Manager with oversight of Purchasing, Production Control & Warehousing functions. Prior to her employment at General Dynamics, Ms. Hawkins served in various finance and accounting positions at Luminator, a Mark IV Industries Co, and Johnson Controls, Battery Division - Garland. Karen received her Bachelor’s Degree in Business Administration in Accounting from Stephen F. Austin State University in Texas in 1986 and became a Certified Public Accountant in 1992.
Bill Bates (59). Mr. Bates joined the Company in 2014. He has thirty-five years of experience related to optical component and system manufacturing. He is currently the General Manager of the Applied Optics Center in Dallas, Texas where he oversees the Thin-film Coating and Optical Assembly Operations where he has served since November of 2014. He has held various positions throughout his thirty-five years of experience within Litton Industries, Northrop Grumman Corporation, and L-3 Communications. He previously served as Vice President and General Manager within the Warrior Systems Division of L-3 Communications. Mr. Bates received a Bachelor of Science of Business Administration from DeVry University and an MBA from the University of Texas at Dallas.
R. Rimmy Malhotra (46) joined the Board in November 2019 and holds the role of Compensation Committee Chair. Rimmy currently manages The Nicoya Fund, an investment partnership whose partners include, high net worth individuals, entrepreneurs and family offices and has acted in that capacity since 2013. He currently serves as Vice-Chairman of HireQuest, Inc., a NASDAQ listed staffing operator. He holds an MBA from The Wharton School in Finance, MA in International Affairs from The University of Pennsylvania and a Bachelor of Science in Computer Science from Johns Hopkins University. The Board of Directors has determined that Rimmy is suited to sit on our Board because of his experience with public equities and financial matters.
Lawrence F. Hagenbuch (55) joined the Board in November 2019 and holds the role of Audit Committee Chair. Larry is currently a Managing Director at Huron Consulting Group. Prior to that, Larry was the Chief Operating Officer and Chief Financial Officer for J. Hilburn, Inc., a custom clothier for men from December 2009 to May 2019. He served on the board of directors of Remy International (REMY) from November 2008 until that company’s sale to BorgWarner in November 2015, where he served on the audit and compensation committees. Larry also currently served on the board of director of Arotech (ARTX) prior to its sale to Greenrbiar Partners. Larry currently serves on the board of directors for HireQuest (HQI). Larry has served in senior management positions for SunTx Capital Partners, Alix Partners, GE / GE Capital, and American National Can Group, Inc. Larry began his professional career in the United States Navy. The Board of Directors has determined that Larry is suited to sit on our Board because of his operating experience at both large and growth-oriented companies, in addition to his experience as a director of other public companies.
Dale E. Lehmann (63) joined the Board in November 2019 as an industry expert having over 30 years of management, strategy, product development, delivery and operational experience in the electro-optical industry. Dale was the Director of Business Development & Strategy for General Dynamics Global Imaging Technologies Group from 2014 through 2017. Prior to that, Dale was the Senior Vice President & General Manager of the Infrared Products Group for L-3 Communications/Cincinnati Electronics from 1995 through 2014. Dale currently sits on the Board of Directors for Adimec USA, a provider of application specific imaging solutions. The Board of Directors has determined that Dale is suited to sit on our Board because of his experience with companies in similar industries.
Family Relationships
There are no family relationships among the officers and directors.
Corporate Governance
Our board of directors believes that sound governance practices and policies provide an important framework to assist them in fulfilling their duty to stockholders. Our board of directors actively supports management’s adoption and implementation of many “best practices” in the area of corporate governance, including annual review of internal control changes, compensation practices, executive management and auditor retention. In the year ended October 3, 2021, all directors attended a minimum of 75% of the meetings of the board of directors and of the committees on which they served.
Code of Ethics
Our board of directors has adopted a Code of Business Conduct and Ethics which has been distributed to all directors, and executive officers, and will be distributed to employees and will be given to new employees at the time of hire. The Financial Code of Ethics contains a number of provisions that apply principally to our Principal Executive Officer, Principal Financial Officer and other key accounting and financial personnel. A copy of our Code of Business Conduct and Ethics can be found under the “Investor Relations” section of our website (www.optexsys.com) under the section for corporate governance. We also intend to disclose any amendments or waivers of our Code on our website.
Board Meetings
We are incorporated under the laws of the State of Delaware. The interests of our stockholders are represented by the board of directors, which oversees our business and management.
The board of directors meets regularly during the year and holds special meetings and acts by unanimous written consent whenever circumstances require. The board held four meetings (including special meetings) and took action by unanimous written consent one time during our fiscal year ended October 3, 2021.
Board Independence
Our board of directors has determined that three of our directors (all except Mr. Schoening) would meet the independence requirements of the Nasdaq Capital Market, if such standards applied to the Company. In reaching its conclusions, the board of directors considered all relevant facts and circumstances with respect to any direct or indirect relationships between the Company and each of the directors.
Board Committees
The Company has a separately-designated audit committee, of which Larry Hagenbuch serves as the chair and the “audit committee financial expert.” The Company has a separately-designated compensation committee, of which Rimmy Malhotra serves as the chair. The Company has a separately-designated nominating committee, of which Dale Lehman serves as the chair. Each committee consists of independent directors Larry Hagenbuch, Rimmy Malhotra and Dale Lehmann.
Board Nominations
Stockholders wishing to bring a nomination for a director candidate before a stockholders meeting must give written notice to our Corporate Secretary, either by personal delivery or by United States mail, postage prepaid. The stockholder’s notice must be received by the Corporate Secretary not later than (a) with respect to an Annual Meeting of Stockholders, 90 days prior to the anniversary date of the immediately preceding annual meeting, and (b) with respect to a special meeting of stockholders for the election of directors, the close of business on the tenth day following the date on which notice of the meeting is first given to stockholders. The stockholder’s notice must set forth all information relating to each person whom the stockholder proposes to nominate that is required to be disclosed under applicable rules and regulations of the SEC, including the written consent of the person proposed to be nominated to being named in the proxy statement as a nominee and to serving as a director if elected. The stockholder’s notice must also set forth as to the stockholder making the nomination (i) the name and address of the stockholder, (ii) the number of shares held by the stockholder, (iii) a representation that the stockholder is a holder of record of stock of the Optex Systems Holdings, entitled to vote at the meeting and intends to appear in person or by proxy at the meeting to nominate the person named in the notice, and (iv) a description of all arrangements or understandings between the stockholder and each nominee.
Stockholder Communications with the Board of Directors
Stockholders may communicate directly with the board of directors or any board member by writing to them at Optex Systems Holdings, Inc., 1420 Presidential Drive, Richardson, TX 75081. The outside of the envelope should prominently indicate that the correspondence is intended for the board of directors or for a specific director. The secretary will forward all such written communications to the director to whom it is addressed or, if no director is specified, to the entire board of directors.
Director Attendance at Annual Meetings of Stockholders
Directors are encouraged to attend annual meetings, although such attendance is not required. All four directors attended the Company’s 2021 Annual Meeting of Shareholders.
Delinquent Section 16 Reports
Section 16(a) of the Exchange Act requires officers, directors and persons who own more than ten percent of a registered class of equity securities to, within specified time periods, file certain reports of ownership and changes in ownership with the SEC. Based solely on its review of the copies of such forms received by it, the Company believes that, during its most recently completed fiscal year ended on October 3, 2021, all Section 16(a) reports required to be filed by its officers, directors, and greater than ten percent beneficial owners were timely filed, except that (1) two reports were filed late by Dale Lehman, reporting seven late transactions, (2) one report was filed late by Rimmy Malhotra, reporting one late transaction and (3) one report was filed late by Ephraim Fields, reporting one late transaction.

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ITEM 11. EXECUTIVE COMPENSATION
Item 11 Executive Compensation
Summary Compensation Table
The following table sets forth, for the years indicated, all compensation paid, distributed or accrued for services, including salary and bonus amounts, rendered in all capacities by our principal executive officer, principal financial officer and all other executive officers who received or are entitled to receive remuneration in excess of $100,000 during the stated periods. These officers are referred to herein as the “named executive officers.” Except as provided below, none of our executive officers received annual compensation in excess of $100,000 during the last three fiscal years.
Name and Principal Position Fiscal Year Salary
($)
Non-Equity Incentive Compensation
($)
Stock
Awards
($) (1)
All Other Compensation
($) Total
($)
$ 271,515 $ - $ 65,340 $ 120 $ 336,975
Danny Schoening, 284,645 47,632 65,835 - 398,112
CEO, COO & Board Chairman 279,504 74,719 73,740 - 427,963
$ 199,500 $ - $ 21,780 $ 120 $ 221,400
Karen Hawkins 205,425 37,158 21,945 - 264,528
CFO 201,537 53,924 24,580 - 280,041
$ 149,002 $ - $ 35,411 $ 120 $ 184,533
Bill Bates 150,834 23,014 31,076 - 204,924
AOC General Manager 148,269 22,236 15,675 - 186,180
(1) On June 15, 2016, the Company issued 150,000 RSUs to its Chief Executive Officer, Danny Schoening, and 50,000 RSUs to its Chief Financial Officer, Karen Hawkins. The RSUs issued to Mr. Schoening and Ms. Hawkins vest as follows: 34% on January 1, 2017, 33% on January 1, 2018 and 33% on January 1, 2019. The total market value of the restricted stock units based on the share price of $1.85 as of June 15, 2016 is $372 thousand. The restricted stock units were fully vested on January 1, 2019. On June 15, 2017, the Company issued 50,000 RSUs to its General Manager (Applied Optical Products). The RSUs issued to Mr. Bates vest as follows: 34% on January 1, 2018, 33% on January 1, 2019 and 33% on January 1, 2020. The total market value of the restricted stock units granted to Mr. Bates based on the share price of $0.95 as of June 15, 2017 is $47.5 thousand. On January 2, 2019, the Company issued 150,000 RSUs to its Chief Executive Officer, Danny Schoening, and 50,000 RSUs to its Chief Financial Officer, Karen Hawkins. The RSUs issued to Mr. Schoening and Ms. Hawkins vest as follows: 34% on January 1, 2020, 33% on January 1, 2021 and 33% on January 1, 2022. The total market value of the restricted stock units based on the share price of $1.32 as of January 2, 2019 is $264 thousand. The cost of the shares is amortized on a straight-line basis across the vesting periods. On December 1, 2021 the Company executed an amended and restated twelve-month employment agreement for Danny Schoening, effective as of December 1, 2021 and expiring on November 30, 2022. The amended agreement modifies the Restricted Stock Unit (“RSU”) Agreement vesting requirements for his remaining 49,500 unvested units from January 1, 2022 to vesting upon a “Change of Control Date” as defined in the employment agreement. The amounts in the “Stock awards” column reflect the dollar amounts recognized as the executive portion of compensation expense for financial statement reporting purposes for each named executive officer, as required by FASB ASC 718, disregarding any estimates for forfeitures relating to service-based vesting conditions.
Employment Agreements
Danny Schoening
The Company entered into an amended and restated employment agreement with Danny Schoening dated December 1, 2021. The term of the agreement commenced as of December 1, 2021 and the current term ends on November 30, 2022. Mr. Schoening’s base salary is $296,031 per annum. Mr. Schoening will be eligible for a performance bonus based upon a rolling three-year operating plan adopted by the Company’s Board of Directors. The bonus will be based on operating metrics decided annually by our Board and tied to such three-year plan. The target bonus equates to 30% of Mr. Schoening’s base salary. Our 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, by changing the third and final vesting date for the restricted stock units granted under such agreement from January 2, 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.
The employment agreement events of termination consist of: (i) death or permanent disability of Mr. Schoening; (ii) termination by the Company for cause (including conviction of a felony, commission of fraudulent acts, willful misconduct by Mr. Schoening, continued failure to perform duties after written notice, violation of securities laws and breach of the employment agreement), (iii) termination by the Company without cause and (iv) termination by Mr. Schoening for good reason (including breach by the Company of its obligations under the agreement, the requirement for Mr. Schoening to move more than 100 miles away for his employment without consent, and merger or consolidation that results in more than 66% of the combined voting power of the Company’s then outstanding securities or those of its successor changing ownership or a sale of all or substantially all of its assets, without the surviving entity assuming the obligations under the agreement). For a termination by the Company for cause or upon death or permanent disability of Mr. Schoening, Mr. Schoening will be paid salary and for a termination due to his death or permanent disability, also any bonus earned through the date of termination. For a termination by the Company without cause or by Mr. Schoening with good reason, Mr. Schoening will also be paid six months’ base salary in effect and, if such termination occurs prior to a change of control, Mr. Schoening will not automatically forfeit the unvested RSUs until and unless the change of control does not occur by March 13, 2023.
● On December 15, 2020, the Company’s Board of Directors approved an executive bonus for Danny Schoening, CEO of $48 thousand to be paid January 2021.
● In January 2021 Danny Schoening agreed to a temporary salary reduction of 8% from February 20, 2021 through October 1, 2021.
Karen Hawkins
On August 4, 2016, our Board of Directors approved an employment agreement for Karen Hawkins, Chief Financial Officer, dated as of August 1, 2016. This agreement has the following salient terms:
The term of the agreement commenced on August 1, 2016, and the current term expires on June 30, 2022 and automatically renews for subsequent 18-month periods unless Ms. Hawkins or we give notice of termination at least 90 days before the end of the term then in effect.
On each subsequent renewal date of the commencement of employment, Ms. Hawkins’ base salary shall be reviewed by the Board and may be increased to such rate as the Board, in its sole discretion, may hereafter from time to time determine and Ms. Hawkins is entitled to annual bonuses of up to 30% of her base salary as approved by the Board.
Ms. Hawkins is entitled to 20 days’ vacation and all other benefits accorded to our other senior executives.
The employment agreement events of termination consist of: (i) death of Ms. Hawkins; (ii) termination by the Company for cause (including conviction of a felony, commission of fraudulent acts, willful misconduct by Ms. Hawkins, continued failure to perform duties after written notice, violation of securities laws and breach of the employment agreement), (iii) termination by the Company without cause and (iv) termination by Ms. Hawkins for good reason (including breach by the Company of its obligations under the agreement, the requirement for Ms. Hawkins to move more than 100 miles away for her 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 of Ms. Hawkins, Ms. Hawkins will be paid salary and bonus earned through the date of termination. For a termination by the Company without cause or by Ms. Hawkins with good reason, Ms. Hawkins will also be paid six months’ base salary in effect and all granted stock options shall remain exercisable for a period of two years after such termination, with all unvested stock options immediately vesting. The agreement contains a standard non-solicitation and non-compete agreement that extends for one year subsequent to termination thereof.
● On December 15, 2020, the Company’s Board of Directors approved an executive bonus for Karen Hawkins, CFO of $37 thousand to be paid in December 2020.
● In January 2021 Karen Hawkins agreed to a temporary salary reduction of 5% from February 20, 2021 through October 1, 2021 at which time her salary was reinstated to $205,425 per annum.
We do not have any other employment agreements with our executive officers.
Equity Compensation Plan Information
Option Compensation Plan
We currently have an option compensation plan covering the issuance of both incentive and non-statutory options, determined at the time of grant, for the purchase of up to 75,000 shares, which was increased from 50,000 shares on December 19, 2013. The purpose of the Plan is to assist us in attracting and retaining highly competent employees and to act as an incentive in motivating selected officers and other employees of us and our subsidiaries, and directors and consultants of us and our subsidiaries, to achieve long-term corporate objectives. On December 19, 2013, the Board of Directors authorized the grant of 20,000 options to three board members and a grant of 5,000 to an officer.
As of September 29, 2019, there were 25,000 fully vested stock options outstanding at an exercise price of $10 per share and an expiration date of December 18, 2020. During the twelve months ended September 27, 2020, all 25,000 outstanding stock options were repurchased at $0.01 per option for a total transaction of $250. There were no new grants of stock options during the twelve months ended October 3, 2021. As of October 3, 2021, there are zero stock options outstanding.
Restricted Stock Unit Plan
On June 14, 2016, the Compensation Committee (“Committee”) of the Board of Directors of Optex Systems Holdings, Inc. approved the Company’s 2016 Restricted Stock Unit Plan (the “Plan”). The Plan provides for the issuance of restricted stock units (“RSUs”) for up to 1,000,000 shares of the Company’s common stock to Optex Systems Holdings officers and employees. Each RSU constitutes a right to receive one share of the Company’s common stock, subject to vesting, which unless otherwise stated in an RSU agreement, shall vest in equal amounts on the first, second and third anniversary of the grant date. Shares of the Company’s common stock underlying the number of vested RSUs will be delivered as soon as practicable after vesting. During the period between grant and vesting, the RSUs may not be transferred, and the grantee has no rights as a shareholder until vesting has occurred. If the grantee’s employment is terminated for any reason (other than following a change in control of the Company or a termination of an officer other than for cause), then any unvested RSUs under the award will automatically terminate and be forfeited. If an officer grantee’s employment is terminated by the Company without cause or by the grantee for good reason, then, provided that the RSUs have not been previously forfeited, the remaining unvested portion of the RSUs will immediately vest as of the officer grantee’s termination date. In the event of a change in control, the Company’s obligations regarding outstanding RSUs shall, on such terms as may be approved by the Committee prior to such event, immediately vest, be assumed by the surviving or continuing company or cancelled in exchange for property (including cash).
Outstanding Equity Awards at Fiscal Year-End
The following table sets forth information regarding the outstanding equity awards held by the named executive officers at October 3, 2021 and market value as of December 13, 2021.
Option Awards Stock Awards
Number of
Securities
Underlying
Unexercised
Options
Exercisable
Number of
Securities
Underlying
Unexercised
Options
Unexercisable
Equity
Incentive
Plan Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
Option
Exercise
Price
Option
Expiration
Number of
Shares or
Units of
Stock that
have not
Vested
Market
Value of
Shares or
Units of
Stock that
have not
Vested
Equity
Incentive
Plan Awards:
Number of
Unearned
Shares,
Units or
Other
Rights that
have not
Vested
Equity
Incentive
Plan Awards: Market or
Payout
Value of
Unearned
Shares,
Units or
Other
Rights that
have not
Vested
Name (#) (#) (#) ($) Date (#) ($) (#) ($)
Danny Schoening(1) - - - - - 49,500 $ 93,555 - $ -
Karen Hawkins(2) - - - - - 16,500 $ 31,185 - $ -
Bill Bates(3) - - - - - 33,000 $ 62,370 - $ -
(1) Restricted Stock Unit Agreement dated January 2, 2019 and pursuant to amended and restated employment agreement executed on November 1, 2021, 49,500 restricted stock units will vest upon a “Change in Control Date”.
(2) Pursuant to Restricted Stock Unit Agreement dated January 2, 2019, 16,500 shares (33% of 50,000 RSU grant) will vest on January 1, 2022.
(3) Pursuant to Restricted Stock Unit Agreement dated February 17, 2020, 16,500 shares (33% of 50,000 RSU grant each year) will vest on January 1, 2022 and on January 1, 2023.
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.
As of October 3, 2021, there are 99,000 outstanding unvested restricted stock units remaining to vest, of which 33,000 will vest as of January 1, 2022, 49,500 will vest upon a Change of Control Date pursuant to terms of Danny Schoening’s employment agreement effective as of December 1, 2021, and the remaining 16,500 will vest on January 1, 2023.
On December 1, 2021 the Company executed an amended and restated employment agreement for Danny Schoening, effective as of December 1, 2021 and expiring on November 30, 2022. The amended agreement modifies the Restricted Stock Unit Agreement vesting requirements for his remaining 49,500 unvested units from January 1, 2022 to vesting upon a “Change of Control Date” as defined in the employment agreement. In the event of Mr. Schoening’s termination without cause, or resignation with good reason prior to expiration of the employment agreement, any unvested RSUs will continue to be outstanding until the earlier of (i) the Change of Control Date, on which date, if still outstanding, they vest, or (ii) March 13, 2023, on which date, if still outstanding, they will be forfeited and expire for no consideration. In the event of termination prior to a Change of Control Date, for any reason other than termination without cause, or resignation with good reason, any unvested RSUs would be forfeited. For additional information on the amended and restated employment agreement and amended vesting terms, please see “Item 11. Executive Compensation - Employment Agreements - Danny Schoening,” which disclosure is incorporated by reference herein.
Restricted Shares Issued to Independent Board Members
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 $1.75 as of April 30, 2020. The Company will amortize the fair market value to stock compensation expense on a straight-line basis across the five-year vesting period beginning on April 30, 2020. As of period ended October 3, 2021, 60,000 of the restricted shares had vested.
Post-Termination Compensation
We have not entered into change in control agreements with any of our named executive officers or other members of the executive management team other than the provision with respect to Mr. Schoening and Ms. Hawkins described above. Other than the final tranche of Mr. Schoening’s 2019 RSU award, no awards of equity incentives under our equity incentive plans provide for immediate vesting upon a change in control. However, our Board of Directors has the full and exclusive power to interpret the plans, including the power to accelerate the vesting of outstanding, unvested awards. A “change in control” is generally defined as (1) the acquisition by any person of 66% or more of the combined voting power of our outstanding securities or (2) the occurrence of a transaction requiring stockholder approval and involving the sale of all or substantially all of our assets or the merger of us with or into another corporation, but has a different definition for purposes of such 2019 RSU award.
Director Compensation
The following table provides information regarding compensation paid to directors for services rendered during the year ended October 3, 2021.
Name Fees Earned or Paid in Cash ($)(1) Vested Restricted Stock Awards(2) Total
Compensation
Rimmy Malhotra $ 36,000 $ 35,000 $ 71,000
Larry Hagenbuch 36,000 35,000 71,000
Dale Lehmann 36,000 35,000 71,000
Danny Schoening - - -
(1) Director fees paid quarterly.
(2) Represents restricted shares issued to each independent director vesting at a rate of 20% per year. The amounts in the “Stock awards” column reflect the dollar amounts recognized as the director portion of compensation expense for financial statement reporting purposes for each named director, as required by FASB ASC 718, disregarding any estimates for forfeitures relating to service-based vesting conditions.
The members of our board of directors are actively involved in various aspects of our business ranging from relatively narrow board oversight functions to providing hands-on guidance to our executives and scientific staff with respect to matters within their personal experience and expertise. We believe that the active involvement of all directors in our principal business and policy decisions increases our board of directors’ understanding of our needs and improves the overall quality of our management decisions.
With the exception of Danny Schoening, our directors are compensated separately for service as independent members of our board of directors.
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. As of period ended October 3, 2021, 60,000 (20%) of the restricted shares had vested.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
On December 13, 2021, we had 8,462,310 shares of common stock outstanding, zero options, zero warrants, and 99,000 granted and unvested restricted stock units. The following table sets forth certain information with respect to the beneficial ownership of our securities as of December 13, 2021, for (i) each of our directors and executive officers; (ii) all of our directors and executive officers as a group; and (iii) each person who we know beneficially owns more than 5% of our common stock.
Beneficial ownership data in the table has been calculated based on Commission rules that require us to identify all securities that are exercisable or convertible into shares of our common stock within 60 days of December 13, 2021 and treat the underlying stock as outstanding for the purpose of computing the percentage of ownership of the holder.
Except as indicated by the footnotes following the table, and subject to applicable community property laws, each person identified in the table possesses sole voting and investment power with respect to all capital stock held by that person. The address of each named executive officer and director, unless indicated otherwise by footnote, is c/o our corporate headquarters.
Except as otherwise set forth below, the address of each of the persons listed below is our address.
Title of Class Name of Beneficial Owner Number of Shares Percentage of
Outstanding Shares
5% Holders Ephraim Fields (1) 1,154,399 13.6 %
Dayton Judd, Sudbury Holdings LLC(2) 845,000 9.9 %
Directors and Officers: Danny Schoening (3) 834,030 9.8 %
Karen Hawkins (4) 250,144 2.9 %
Bill Bates (5) 62,631 0.7 %
Rimmy Malhotra (6)(7) 195,210 2.3 %
Larry Hagenbuch(7) 110,000 1.3 %
Dale Lehmann (7) 166,558 2.0 %
Directors and officers as a group (6 Individuals) (8)
1,618,573 19.0 %
Represents 1,154,399 common shares reported as held by Ephraim Fields located at 265 East 66th Street #42E, New York, NY 10065 as per SEC Form 4/A (filed on September 1, 2021).
Represents 820,000 common shares reported as held by Sudbury Holdings, LLC and controlled by Dayton Judd who also holds an additional 25,000 shares for a total combined holding of 845,000 shares. Both are located at 136 Oak Trail, Coppell, TX 75019 as per SEC Schedule 13D (filed on September 7, 2021).
Includes common shares held of 834,030.
Includes common shares held of 233,644 and restricted stock units of 16,500 expected to vest on January 1, 2022.
Includes common shares held of 46,131 and restricted stock units of 16,500 expected to vest on January 1, 2022.
Includes 76,900 shares held by Nicoya Capital and controlled by Rimmy Malhotra.
Includes 80,000 unvested restricted shares for each independent director.
Represents common shares held by Danny Schoening, Karen Hawkins, Bill Bates, Rimmy Malhotra, Larry Hagenbuch and Dale Lehmann.
Information with respect to our equity compensation plans
Stock Option Plan
Optex Systems Holdings adopted its 2009 Stock Option Plan on March 26, 2009. On December 9, 2011, the Board of Directors of Optex Systems Holdings, Inc. authorized an amendment to its Stock Option Plan to increase the number of issuable shares from 6,000 to 50,000 and authorized the grant of 10,000 options to two board members and a total of 36,070 to Optex Systems Holdings employees including 20,000 options to executive officers. On December 19, 2013, the Board of Directors of Optex Systems Holdings, Inc. authorized an amendment to its Stock Option Plan to increase the number of issuable shares from 50,000 to 75,000. As of October 3, 2021, there were no outstanding options.
Restricted Stock Unit Plan
On June 14, 2016, our Compensation Committee approved our 2016 Restricted Stock Unit Plan. This plan provides for issuance of restricted stock units (“RSUs”) for up to 1,000,000 shares of our common stock. Each RSU constitutes a right to receive one share of our common stock, subject to vesting, which unless otherwise stated in an RSU agreement, shall vest in equal amounts on the first, second and third anniversary of the grant date. Shares of our common stock underlying the number of vested RSUs will be delivered as soon as practicable after vesting. During the period between grant and vesting, the RSUs may not be transferred, and the grantee has no rights as a shareholder until vesting has occurred. If the grantee’s employment is terminated for any reason (other than following a change in control of us or a termination of an officer other than for cause), then any unvested RSUs under the award will automatically terminate and be forfeited. If an officer grantee’s employment is terminated by us without cause or by the grantee for good reason, then, provided that the RSUs have not been previously forfeited, the remaining unvested portion of the RSUs will immediately vest as of the officer grantee’s termination date. In the event of a change in control, our obligations regarding outstanding RSUs shall, on such terms as may be approved by the Committee prior to such event, immediately vest, be assumed by the surviving or continuing company or cancelled in exchange for property (including cash).
On December 1, 2021 the Company executed an amended and restated employment agreement for Danny Schoening, effective as of December 1, 2021 and expiring on November 30, 2022. The amended agreement modifies the Restricted Stock Unit Agreement vesting requirements for his remaining 49,500 unvested units from January 1, 2022 to vesting upon a “Change of Control Date” as defined in the employment agreement. In the event of Mr. Schoening’s termination without cause, or resignation with good reason prior to expiration of the employment agreement, any unvested RSUs will continue to be outstanding until the earlier of (i) the Change of Control Date, on which date, if still outstanding, they vest, or (ii) March 13, 2023, on which date, if still outstanding, they will be forfeited and expire for no consideration. In the event of termination prior to a Change of Control Date, for any reason other than termination without cause, or resignation with good reason, any unvested RSUs would be forfeited. For additional information on the amended and restated employment agreement and amended vesting terms, please see “Item 11. Executive Compensation - Employment Agreements - Danny Schoening,” which disclosure is incorporated by reference herein.
As of October 3, 2021, there are 99,000 outstanding unvested restricted stock units remaining to vest of which 33,000 will vest on January 1, 2021, and 500,000 authorized restricted stock units from the 2016 Restricted Stock Unit Plan remaining to be granted at a future date.
Equity Compensation Plan Table
The following table provides information about our common stock that may be issued upon the exercise, vesting and/ or settlement of securities outstanding under all our existing equity compensation plans as of October 3, 2021:
Plan category (a) Number of securities to be issued upon exercise of outstanding options, warrants and rights (b) Weighted-average exercise price of outstanding options, warrants and rights (c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security holders - NA NA
Equity compensation plans not approved by security holders 99,000 - 500,000
Total 99,000 - 500,000

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13. Certain Relationships and Related Transactions, and Director Independence
None.
Transactions with Executive Management
See the “Executive Compensation” section for a discussion of the material elements of compensation awarded to, earned by or paid to our named executive officers. Other than as stated in the “Executive Compensation” section, we have not entered into any transactions with executive management.
Director Independence
As of the date of filing of this Annual Report, the Company has three independent directors, as such term is defined under NASDAQ standards and one non independent director.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14. Principal Accountant Fees and Services
The following table sets forth the fees paid to date for audit services rendered during fiscal years ended October 3, 2021 and September 27, 2020, respectively.
Fee Category
Audit Fees (1) $ 101,786 $ 89,802
Tax Fees 8,500 7,613
(1) Audit Fees are fees for professional services performed for the audit of our annual consolidated financial statements and review of consolidated financial statements included in our 10-Q filings for the fiscal years ended October 3, 2021 and September 27, 2020, respectively.

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15. Exhibits
(a)(1)
Financial Statements. The following financial statements of Optex Systems Holdings, Inc. are included in Part II, Item 8:
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Income for the years ended October 3, 2021 and September 27, 2020
Consolidated Balance Sheets as of October 3, 2021 and September 27, 2020
Consolidated Statement of Stockholders’ Equity for the years ended October 3, 2021 and September 27, 2020
Consolidated Statements of Cash Flows for the years ended October 3, 2021 and September 27, 2020
Notes to the Consolidated Financial Statements
(a)(2) Financial Statement Schedules.
All schedules are omitted because they are not applicable, or not required, or because the required information is included in the consolidated financial statements or notes thereto.
(a)(3) Exhibits.
See Exhibit Index
Exhibits
Exhibit No. Description
2.1 Agreement and Plan of Reorganization, dated as of the March 30, 2009, by and between registrant, a Delaware corporation and Optex Systems, Inc., a Delaware corporation(1).
3.1 Certificate of Incorporation, as amended to date
3.2 Bylaws of Optex Systems Holdings(1).
3.3 Charters of the Audit Committee, Compensation Committee and Nominating Committee(6).
4.1 Description of Capital Stock
4.2 Specimen Stock Certificate(2)
10.1 Lease for 1420 Presidential Blvd., Richardson, TX(1).
10.2 Third Amendment to Lease, between Aquiport DFWIP and Optex Systems, Inc., dated January 7, 2010(3)
10.3 Restricted Stock Unit Plan(7)
10.4 Form of RSU Agreement(7)
10.5 Employment Agreement with Karen Hawkins, dated as of August 1, 2016(5)
10.6 Form of Lease(8)
10.7 Form of Letter of Credit(8)
10.8
Form of Award/Contract between the Company and US DLA, dated July 3, 2017(9)
10.9
Employment Agreement with Danny Schoening, dated December 1, 2021 (10)
10.10
Sixth Amendment to Lease Agreement
10.11
First Amendment to Lease
10.13
BBVA Business Loan Agreement(11)
10.14
BBVA Letter of Credit
10.15
2009 Stock option Plan (4)
14.1
Code of Ethics(2)
21.1
List of Subsidiaries - Optex Systems, Inc.(1)
31.1
Certifications pursuant to Section 302 of Sarbanes Oxley Act of 2002
31.2
Certifications pursuant to Section 302 of Sarbanes Oxley Act of 2002
32.1
Certifications pursuant to Section 906 of Sarbanes Oxley Act of 2002
32.2
Certifications pursuant to Section 906 of Sarbanes Oxley Act of 2002
101.INS
Inline XBRL Instance Document
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
Cover Page Interactive Data File (embedded within the Inline XBRL document)
(1) Incorporated by reference from our Current Report on Form 8-K dated April 3, 2009.
(2) Incorporated by reference from our Registration Statement on Form S-1 filed on May 19, 2009
(3) Incorporated by reference from our Amendment No. 4 to Registration Statement on Form S-1 filed on June 14, 2010
(4) Incorporated by reference from our Current Report on Form 8-K dated April 3, 2009.
(5) Incorporated by reference from our Current Report on Form 8-K, filed on August 10, 2016
(6) Incorporated by reference from our Amendment No. 1 to Registration Statement on Form S-1 filed on July 23, 2015
(7) Incorporated by reference from our Current Report on Form 8-K, filed on June 17, 2016
(8) Incorporated by reference from our Current Report on Form 8-K, filed on November 23, 2016
(9) Incorporated by reference from our Current Report on Form 8-K, filed on July 10, 2017
(10) Incorporated by reference from our Current Report on Form 8-K, dated December 7, 2021
(11) Incorporated by reference from our Current Report on Form 8-K, dated April 20, 2020