Optex Systems Holdings Inc 10-K

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, September 29, 2024, 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 September 29, 2024, 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 2023 or 2024 with respect to our financial position and results of operations are to our fiscal years ended October 1, 2023 or September 29, 2024, respectively. Background Optex Systems, Inc. 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 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 the NATO Support and Procurement Agency and South American countries, and as a subcontractor for several large U.S. defense companies serving foreign governments. 27 By way of background, the Federal Acquisition Regulation (“FAR”) 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 FAR 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 FAR 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 material pending terminations for convenience or for default on our existing contracts. In the event a termination for convenience were to occur, FAR 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 FAR clause 52.249-8. In addition, some of our contracts allow for government contract financing in the form of contract progress payments pursuant to FAR 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. Material Trends and Recent Developments We have experienced substantial increases in the costs of aluminum, steel and acrylic commodities, which has affected our net income in the year ended September 29, 2024 and is expected to continue to have a negative effect on the margins generated under several of our long-term fixed contracts over the next two years. See also “ Item 1A. Risk Factors – Risks Related to Our Business - Certain of our products are dependent on specialized sources of supply potentially subject to disruption which could have a material, adverse impact on our business.” We have experienced significant material shortages during the fiscal year ended October 1, 2023 and the first half of fiscal year ended September 29, 2024 from several significant suppliers of our periscope covers and housings. These shortages affect several of our periscope products at the Optex Richardson segment. The delays in key components, combined with labor shortages during the first half of the fiscal year ended September 29, 2024, have negatively impacted our production levels and have pushed back expected delivery dates. We have obtained an alternative source for one of our key components and are expediting our other suppliers to support the increased production levels. We have seen improvements in the local labor market since 2023 and increased our direct labor force and employee overtime in concert with improvements in our supplier delivery performance. Further, we have invested in additional machinery and equipment and other process improvements to increase production capacity and alleviate process bottlenecks. While we are encouraged by improvements in supplier performance and available manpower for the Optex Richardson segment periscope line which yielded increased revenue performance during fiscal year 2024, we have yet to ramp up deliveries sufficiently to keep pace with our current customer demands. As such, we cannot give any assurances that expected customer delivery dates for our periscope products will not experience further delays. We refer also to “ Item 1. Business – Market Opportunity: U.S. Military ” for a description of current trends in U.S. government military spending and its potential impact on Optex, which may be material, including particularly the tables included in that section and disclosure on the significant reduction in spending for U.S ground system military programs, which has a direct impact on the Optex Systems Richardson segment revenue, all of which is incorporated herein by reference. We refer to “ Item 1. Business – Recent Events ” of this report for recent developments affecting the Company. 28 Results of Operations by Segment 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 September 29, 2024 and October 1, 2023 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 September 29, 2024 October 1, 2023 Optex Systems Richardson Applied Optics Center Dallas Other (non- allocated costs and eliminations) Consolidated Optex Systems Richardson Applied Optics Center Dallas Other (non- allocated costs and eliminations) Consolidated Revenue from External Customers $ 18,171 $ 15,824 $ - $ 33,995 $ 12,120 $ 13,539 $ - $ 25,659 Intersegment Revenues - 1,042 (1,042 ) - - 893 (893 ) - Total Segment Revenue 18,171 16,866 (1,042 ) 33,995 12,120 14,432 (893 ) 25,659 Total Cost of Sales 14,401 11,107 (1,042 ) 24,466 9,729 10,204 (893 ) 19,040 Gross Profit 3,770 5,759 - 9,529 2,391 4,228 - 6,619 Gross Margin % 20.7 % 34.1 % - 28.0 % 19.7 % 29.3 % - 25.8 % General and Administrative Expense 3,630 653 425 4,708 3,121 464 247 3,832 Segment Allocated G&A Expense (1,486 ) 1,486 - - (1,338 ) 1,338 - - Net General & Administrative Expense 2,144 2,139 425 4,708 1,783 1,802 247 3,832 Operating Income (Loss) 1,626 3,620 (425 ) 4,821 608 2,426 (247 ) 2,787 Operating Income (Loss) % 8.9 % 21.5 % - 14.2 % 5.0 % 16.8 % - 10.9 % Interest Expense - - (47 ) (47 ) - - (55 ) (55 ) Income (Loss) before taxes $ 1,626 3,620 (472 ) 4,774 $ 608 2,426 (302 ) 2,732 Income (loss) before taxes % 8.9 % 21.5 % - 14.0 % 5.0 % 16.8 % - 10.6 % Our total external sales revenues increased by $8.3 million in the fiscal year 2024, or 32.5% compared to the 2023 fiscal year. The Optex Systems segment realized a $6.1 million, or 49.9% increase, and the Applied Optics Center segment realized an increase of $2.3 million, or 16.9%, in external revenue compared to the prior year period. Intersegment revenues were $1.0 million for 2024 and $0.9 million in 2023. Intersegment revenues relate primarily to coated filters provided by the Applied Optics Center to Optex Systems in support of the Optex Systems periscope line. 29 Gross profit increased $2.9 million and the gross margin percentage increased by 2.2 points from 25.8% in the 2023 fiscal year to 28.0% in the 2024 fiscal year. Optex Systems gross profit increased by $1.4 million and the gross margin percentage increased to 20.7% as compared to 19.7% in the prior year period. Applied Optics Center gross profit increased by $1.5 million and the gross margin percentage increased to 34.1% as compared to 29.3% in the prior year period. The increase in each segment and consolidated gross profit is primarily attributable to higher revenue and increased absorption of fixed cost. Consolidated general and administrative costs increased from $3.8 million for the twelve months ended October 1, 2023 to $4.7 million for the twelve months ended September 29, 2024. General and administrative costs increased $0.9 million due to increased royalties and selling expenses of $0.4 million, increased stock compensation expenses of $0.2 million, increased labor and fringe costs of $0.2 million and increased information technology costs of $0.1 million. During the fiscal years 2024 and 2023, Applied Optics Center absorbed $1.5 million and $1.3 million, respectively, of fixed general and administrative costs incurred by Optex Systems for support services. The increase in allocated general and administrative expenses during the 2024 year is directly attributable to increased general and administrative costs during the current year period as compared to the prior year. 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. Consolidated operating income increased by $2.0 million in the year ended September 29, 2024 to $4.8 million as compared to the prior year operating income of $2.8 million. The increase in operating income is primarily attributable to higher revenue and gross profit, partially offset by increases in general and administrative costs. The operating income increased across both segments as compared to the prior year on higher revenue and gross profit. Income before taxes increased $2.0 million, to $4.8 million in the 2024 fiscal year from a prior year income before taxes of $2.7 million. The increase in income before taxes year over year is primarily due to higher revenue and gross profit, partially offset by increased general and administrative costs. New Orders and Backlog Product backlog represents the value of unfulfilled customer manufacturing orders yet to be recognized as revenue. While backlog is not a non-GAAP financial measure, it is also not defined by GAAP. Therefore, our methodology for calculating backlog may not be consistent with methodologies used by other companies. The booked backlog by period may also not be fully indicative of the predicted revenues for those periods as many of our orders provide for accelerated delivery without penalty and may additionally provide customers the option to adjust schedules to meet their most recent projected demand quantities. However, we provide customer order and backlog information as we believe it provides significant insight into forward demand, with some predictive power to short term future revenues. During the twelve months ended September 29, 2024, the Company booked $36.4 million in new orders, representing a 5.2% increase from the prior year period orders of $34.6 million. The orders for the most recently completed twelve months consist of $23.5 million for our Optex Richardson segment and $12.9 million attributable to the Applied Optics Center segment. The following table depicts the new customer orders for the twelve months ending September 29, 2024 as compared to the prior year period in millions of dollars: (Millions) Product Line Twelve months ended September 29, 2024 Twelve months ended October 1, 2023 Variance % Chg Periscopes $ 19.9 $ 15.9 $ 4.0 25.2 Sighting Systems 0.4 4.0 (3.6 ) (90.0 ) Howitzer - - - - Other 3.2 3.4 (0.2 ) (5.9 ) Optex Systems – Richardson 23.5 23.3 0.2 0.9 Optical Assemblies 1.8 1.9 (0.1 ) (5.3 ) Laser Filters 9.2 7.6 1.6 21.1 Day Windows 0.1 0.3 (0.2 ) (66.7 ) Other 1.8 1.5 0.3 20.0 Applied Optics Center – Dallas 12.9 11.3 1.6 14.2 Total Customer Orders $ 36.4 $ 34.6 $ 1.8 5.2 30 During the year ended September 29, 2024, orders in the Company’s Optex Richardson segment increased by $0.2 million, or 0.9%, as compared to the prior year. The primary reason for the increase relates to a prior year award for $3.4 million in sighting systems to repair and refurbish night vision equipment for the Government of Israel. We began shipments against the contract in December 2023. The decrease in orders for sighting systems and other products was offset by a significant increase in periscope orders in the year ended September 29, 2024. The Applied Optics Center orders increased $1.6 million, or 14.2%, as we continue to see increases in orders for laser filter units for several prime government contractors, in addition to an increase in customer orders for other products driven by our new program of Infrared (IR) Signature Reduction Coatings used on aircraft. The Optex Richardson segment currently has five open US Government IDIQ type military contracts for periscopes, collimators, and big eye assemblies with unspent funding which covers base year and option year requirement ordering periods into January 2029. During the year, approximately 20% of Optex Richardson’s segment orders, or $4.8 million, were awards against active IDIQ contracts. The Applied Optics Center has two open US Government IDIQ orders. During the year, approximately 22% of Applied Optics Center segment orders, or $2.8 million, were awards against active IDIQ contracts. We anticipate additional orders throughout the next five years for these ongoing contracts. In addition, the Company has several open bid requests for new multi-year IDIQ contracts pending with the U.S. Government and other prime contractors for additional periscopes, and unity mirrors that are expected to be awarded in the next three to six months. Backlog as of September 29, 2024 was $44.2 million as compared to a backlog of $41.8 million as of October 1, 2023, representing an increase of 5.7%. The following table depicts the current expected delivery by quarter of all contracts awarded as of September 29, 2024, as well as the September 29, 2024 backlog as compared to the backlog on October 1, 2023. (Millions) Product Line Q1 2025 Q2 2025 Q3 2025 Q4 2025 2025 Delivery 2026+ Delivery Total Backlog 9/29/2024 Total Backlog 10/1/2023 Variance % Chg Periscopes $ 3.6 $ 5.7 $ 5.6 $ 4.7 $ 19.6 $ 3.1 $ 22.7 $ 14.9 $ 7.8 52.3 Sighting Systems 0.4 0.4 0.3 0.4 1.5 2.3 3.8 4.7 (0.9 ) (19.1 ) Howitzer - - - - - 2.3 2.3 2.3 - - Other 0.4 0.5 0.9 - 1.8 1.2 3.0 4.6 (1.6 ) (34.8 ) Optex Systems – Richardson 4.4 6.6 6.8 5.1 22.9 8.9 31.8 26.5 5.3 20.0 Optical Assemblies 0.5 0.2 - - 0.7 - 0.7 2.8 (2.1 ) (75.0 ) Laser Filters 3.3 2.7 1.8 0.9 8.7 0.8 9.5 9.9 (0.4 ) (4.0 ) Day Windows 0.2 0.2 0.2 0.2 0.8 0.3 1.1 1.7 (0.6 ) (35.3 ) Other 0.4 0.2 0.2 0.3 1.1 - 1.1 0.9 0.2 22.2 Applied Optics Center – Dallas 4.4 3.3 2.2 1.4 11.3 1.1 12.4 15.3 (2.9 ) (19.0 ) Total Backlog $ 8.8 $ 9.9 $ 9.0 $ 6.5 $ 34.2 $ 10.0 $ 44.2 $ 41.8 $ 2.4 5.7 Optex Systems - Richardson During the twelve months ended September 29, 2024, backlog for our Optex Richardson segment increased by 20.0%, or $5.3 million to $31.8 million, as compared to the prior year ending backlog of $26.5 million. Backlog for our periscope product line has increased 52.3% or $7.8 million to $22.7 million, from our 2023 fiscal year end level of $14.9 million, primarily on increased orders above our delivery capacity during the 2024 year. With the majority of material shortages behind us, we have substantially increased the headcount and overtime hours in addition to the purchase of machinery and equipment to eliminate process bottlenecks and increase periscope throughput up to 60-75% over the next year in line with our customer demands. We are anticipating an increase of approximately 60% in periscope revenue in fiscal year 2025 as compared to 2024. Sighting Systems product line backlog decreased 19.1%, or $0.9 million, to $3.8 million, from our 2023 fiscal year end level of $4.7 million. The decreased backlog is primarily driven by deliveries of $0.7 million against our 2023 order for sighting systems to repair and refurbish night vision equipment for the Government of Israel combined with revenues of $0.2 million recognized against our long term OWSS maintenance contract. The Howitzer contract awarded in July 2020 continues to experience customer driven delays related to customer furnished materials. This program is currently on hold pending statement of work changes and materials furnished by the customer. We anticipate deliveries against the Howitzer contract to begin in fiscal year 2026. 31 Our backlog in other product groups decreased by $1.6 million or 34.8% from $4.6 million in 2023 to $3.0 million in 2024 on shipments against a long-term collimator IDIQ of $1.3 million and commercial wedge assemblies of $0.3 million. Applied Optics Center – Dallas The Applied Optics Center backlog decreased by $2.9 million, or 19.0%, for the year ended September 29, 2024, from $15.3 million in 2023 to $12.4 million in 2024. Backlog for our optical assemblies decreased by $2.1 million, or 75.0%, as compared to the prior year on lower customer demand. We anticipate new orders during the next three to six months for deliveries in 2025. Laser filter backlog decreased by $0.4 million, or 4.0%, during the year due to increased shipments against our laser interface filter and laser filter units during the year. We are anticipating additional orders for shipment during the 2025 year. Day window backlog decreased by $0.6 million, or 35.3%, during the period as compared to the prior year primarily due to shipments against a long-term IDIQ contract with deliveries scheduled into 2026. We anticipate additional orders in the next three months. Other Applied Optics backlog increased by $0.2 million, or 22.2% for the year ended September 29, 2024, on an increase in customer orders for Infrared (IR) Signature Reduction Coatings used on aircraft. Please refer to “ Material Trends and Recent Events ” above or “ Liquidity and Capital Resources ” below for more information on recent developments and trends with respect to our orders and backlog, which information is incorporated herein by reference. The Company continues to pursue domestic, international and commercial opportunities in addition to maintaining its current footprint with U.S. vehicle manufactures, with existing as well as new product lines. We are also reviewing potential products outside our traditional product lines. Further, we continue to look for strategic businesses to acquire that will strengthen our existing product line, expand our operations, offer operational scale and enter new markets. Twelve months ended September 29, 2024 compared to the twelve months ended October 1, 2023 Revenues The table below details the revenue changes by segment and product line for the year ended September 29, 2024 as compared to the year ended October 1, 2023. Twelve months ended (Millions) Product Line September 29, 2024 October 1, 2023 Variance % Chg Periscopes $ 12.1 $ 8.6 $ 3.5 40.7 Sighting Systems 1.4 1.0 0.4 40.0 Howitzers - - - - Other 4.7 2.5 2.2 88.0 Optex Systems – Richardson 18.2 12.1 6.1 50.4 Optical Assemblies 3.9 5.6 (1.7 ) (30.4 ) Laser Filters 9.6 6.4 3.2 50.0 Day Windows 0.7 0.6 0.1 16.7 Other 1.6 1.0 0.6 60.0 Applied Optics Center – Dallas 15.8 13.6 2.2 16.2 Total Revenue $ 34.0 $ 25.7 $ 8.3 32.3 Our total revenues increased by $8.3 million, or 32.3% in fiscal year 2024 compared to fiscal year 2023. The Optex Systems Richardson segment realized a $6.1 million, or 50.4%, increase in revenue and the Applied Optics Center segment realized an increase of $2.2 million, or 16.2%, in revenue compared to the prior year. 32 Optex Systems - Richardson Revenues on our periscope line increased $3.5 million, or 40.7%, during the twelve months ended September 29, 2024 and October 1, 2023 on increased customer demand and higher production throughput during the year. Revenues on sighting systems increased by $0.4 million, or 40.0% from the prior year period due to deliveries against the 2023 order for repair and refurbishment of night vision equipment to the Government of Israel. Optex Systems-Richardson revenue on other product lines increased by $2.2 million, or 88.0%, compared to revenues in the prior year due to increased orders for collimators, windows, beamsplitters, cell assemblies and other spares. Applied Optics Center - Dallas Revenue on optical assemblies decreased by $1.7 million, or 30.4%, during the twelve months ended September 29, 2024 as compared to the prior twelve-month period on lower customer demand. We are anticipating revenue over the next twelve months to approximate the 2024 revenue level pending new customer orders in the next three to six months. Laser filter revenue increased by $3.2 million, or 50.0%, during the twelve months ended September 29, 2024 as compared to the prior twelve-month period on increased customer demand. We anticipate revenue to continue at the higher levels throughout 2025. Revenues on our day windows increased by $0.1 million, or 16.7%, during the twelve months ended September 29, 2024 as compared to October 1, 2023 as we continue to ship against the long-term IDIQ contract for these units. We anticipate revenues to continue at this, or a slightly increased, level through 2025. Applied Optics Center revenue for other product lines increased by $0.6 million, or 60.0%, during the twelve months ended September 29, 2024 as compared to the prior twelve-month period on increased deliveries in products for Infrared (IR) Signature Reduction Coatings used on aircraft. We anticipate these delivery levels to continue into 2025 combined with additional increases for shipments against our current binocular contract. Gross Margin . The gross margin for the year ended September 29, 2024 was 28.0% of revenue as compared to a gross margin of 25.8% of revenue for the year ended October 1, 2023. Cost of sales increased by $5.4 million to $24.5 million for 2024 compared to $19.0 million for 2023. The gross profit increased by $2.9 million to $9.5 million in 2024 as compared to $6.6 million in 2023. The increase is primarily due to increased revenue, and higher absorption of fixed cost and changes in product mix between the segments. G&A Expenses . For the years ended September 29, 2024 and October 1, 2023, we recorded operating expenses of $4.7 million and $3.8 million, respectively. General and administrative cost increased $0.9 million, or 22.9%, for fiscal year 2024 as compared to the prior year due to increased royalties and selling expenses of $0.4 million, increased stock compensation expenses of $0.2 million, increased labor and fringe costs of $0.2 million and increased information technology costs of $0.1 million. The selling expenses are directly related to new products including the Speedtracker acquisition and the Government of Israel repair and refurbishment on night vision products and the royalties are related to the new Infrared (IR) Signature Reduction Coatings product. Operating Income . For the year ended September 29, 2024, we recorded operating income of $4.8 million as compared to operating income of $2.8 million during the year ended October 1, 2023. The $2.0 million increase in operating income is primarily due to increased revenue and gross profit, offset by higher general and administrative costs. Net income applicable to common shareholders . During the year ended September 29, 2024, we recorded net income applicable to common shareholders of $3.8 million as compared to net income applicable to common shareholders of $2.3 million during the year ended October 1, 2023. The increase of net income of $1.5 million is primarily attributable to increased revenue and gross profit, offset by higher general and administrative costs and increased federal income taxes of $0.5 million. 33 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 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 September 29, 2024 and October 1, 2023, in terms of both the GAAP net income measure and the non-GAAP Adjusted EBITDA measure. (Thousands) Twelve months ended September 29, 2024 October 1, 2023 Net Income — GAAP $ 3,768 $ 2,263 Add: Federal Income Tax Expense 1,006 469 Depreciation & Amortization 487 345 Stock Compensation 425 247 Interest Expense 47 55 Adjusted EBITDA - Non GAAP $ 5,733 $ 3,379 Our Adjusted EBITDA increased by $2.4 million to $5.7 million during the twelve months ended September 29, 2024 as compared to $3.4 million during the twelve months ended October 1, 2023. The increase in EBITDA is primarily driven by increased net income, offset by increased taxes, depreciation and amortization, and stock compensation. Operating segment performance is discussed in greater detail throughout the previous sections. Liquidity and Capital Resources As of September 29, 2024, Optex Systems Holdings had working capital of $15.1 million, as compared to $13.5 million as of October 1, 2023. During the twelve months ended September 29, 2024, we generated operating cash of $1.8 million, primarily driven by increased revenue and net income. As of September 29, 2024, there was no net change against the outstanding credit facility balance of $1.0 million. The Company has capital commitments of $0.3 million for the purchase of property and equipment consisting of a significant coating chamber upgrade, a black bond dispensing machine, an air compressor, and an Opotek tunable laser system. Backlog as of September 29, 2024 was $44.2 million as compared to a backlog of $41.8 million as of October 1, 2023, representing an increase of 5.7%. For further details, see “ Results of Operations – New Orders and Backlog ” above. The Company has historically funded its operations through cash from operations, convertible notes, common and preferred stock offerings and bank debt. The Company’s ability to generate positive cash flows depends on a variety of factors, including the continued development and successful marketing of the Company’s products. At September 29, 2024, the Company had approximately $1.0 million in cash and an outstanding payable balance of $1.0 against its $3.0 million line of credit. As of September 29, 2024, our outstanding accounts receivable balance was $3.8 million, which has been collected during the first quarter of fiscal 2025. During the first quarter of 2025, we paid down our credit facility to zero. We refer to the disclosure above under “ Material Trends and Recent Developments” with respect to recent supply chain disruptions and material shortages, which disclosure is incorporated herein by reference. 34 In the short term, the Company plans to utilize its current cash, available line of credit and operating cash flow to fund inventory purchases in support of the backlog growth and higher anticipated revenue during the next twelve months. Short term cash in excess of our working capital needs may be also be used to fund the purchase of product lines and other assets. We may also repurchase common stock against our current stock repurchase plan. Longer term, excess cash beyond our operating needs may be used to fund new product development, company, product line or other asset acquisitions, or additional stock purchases as attractive opportunities present themselves. On January 18, 2024, the Company acquired certain intellectual property and technical and marketing information relating to the Speedtracker Mach product line and entered into an asset purchase agreement and a contract manufacturing agreement with RUB Aluminium s.r.o. (“RUB”). The Company acquired the assets using $1 million cash on hand, with potential additional future cash payments based on successful completion of defined milestones. The initial term of the contract manufacturing agreement is one year, subject to additional one-year renewal terms. After the acquisition, the Company determined it would be more economical to move the manufacturing operations in house and is no longer ordering assembled units under the original contract manufacturing agreement. RUB will continue to provide the Company with purchased kit parts for the manufacture of the Speedtracker Mach products. The acquisition included transaction costs of $30 thousand for legal fees. Pursuant to the asset purchase agreement, the total earnout payment will be $238 thousand only if the earnout revenue milestone is achieved during the earnout period, otherwise the earnout will be zero. As of September 29, 2024, it was determined that the earnout revenue milestone was unlikely to be achieved during the earnout period and the fair value of the contingent liability was zero. The asset will be amortized on a straight-line basis over a seven-year period. In some instances, new contract awards may allow for government contract financing in the form of contract progress payments pursuant to FAR 52.232-16, “Progress Payments.” Subject to certain limitations, this clause provides for government payment of up to 90% of incurred program costs prior to product delivery for small businesses like us. To the extent any contracts allow for progress payments and the respective contracts would result in significant preproduction cash requirements for design, process development, tooling, material or other resources which could exceed our current working capital or line of credit availability, we intend to utilize this benefit to minimize any potential negative impact on working capital prior to receipt of payment for the associated contract deliveries. Currently none of our existing contracts allow for progress payments. We refer to “ Note 8 – Commitments and Contingencies – Rental Payments under Non-cancellable Operating Leases ” for a tabular depiction of our remaining minimum lease and estimated C ommon Area Maintenance (“C AM ”) payments under such leases as of September 29, 2024, which disclosure is incorporated herein by reference. 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 line of credit facility 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 March 22, 2023, the Company and its subsidiary, Optex Systems, Inc. (“Optex”, and with the Company, the “Borrowers”), entered into a Business Loan Agreement (the “Loan Agreement”) with Texas Capital Bank (the “Lender”), pursuant to which the Lender will make available to the Borrowers a revolving line of credit in the principal amount of $3 million (the “Credit Facility”). The commitment period for advances under the Credit Facility is twenty-six months expiring on May 22, 2025. We refer to the expiration of that time period as the “Maturity Date.” Outstanding advances under the Credit Facility will accrue interest at a rate equal to the secured overnight financing rate (SOFR) plus a specified margin, subject to a specified floor interest rate. The interest rate is currently at 7.509% per annum. As of September 29, 2024, the interest rate was 7.67% per annum. The Loan Agreement contains customary events of default (including a 25% change in ownership) and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes (including changes in management), investments, and restricted payments (including cash dividends). The Loan Agreement also requires the Borrowers to maintain a fixed charge coverage ratio of at least 1.25:1 and a total leverage ratio of 3.00:1. The Credit Facility is secured by substantially all of the operating assets of the Borrowers as collateral. The Borrowers’ obligations under the Credit Facility are subject to acceleration upon the occurrence of an event of default as defined in the Loan Agreement. The Loan Agreement further provides for a $125,000 Letter of Credit sublimit. As of September 29, 2024, there was $1.0 million borrowed under the Credit Facility. As of September 29, 2024, the Company was in compliance with all covenants under the Credit Facility. The Credit Facility replaced the prior $2 million line of credit with PNC Bank, National Association. 35 On September 22, 2021 the Company announced authorization for an additional $1 million stock repurchase program. As of September 29, 2024, there was an authorized balance of $560 thousand remaining to be spent against the repurchase program. During the years ended September 29,2024 and October 1, 2023, there were no stock repurchases against the plan. During the twelve months ended September 29, 2024 the Company declared and paid no dividends. As of September 29, 2024, there are no outstanding declared and unpaid dividends. Critical Accounting Estimates A critical accounting estimate is an estimate that: ● is made in accordance with generally accepted accounting principles, ● involves a significant level of estimation uncertainty, and ● has had or is reasonably likely to have a material impact on the company’s financial condition or results of operation. Our significant accounting policies are fundamental to understanding our results of operations and financial condition. Some accounting policies require that we use estimates and assumptions that may affect the value of our assets or liabilities and financial results. These policies are described in Note 2 “Summary of Significant Accounting Policies” of Item 8 “Financial Statements and Supplementary Data” of this report. Our critical accounting estimates include warranty costs, contract losses and the deferred tax asset valuation. Future warranty costs are based on the estimated cost of replacement for expected returns based upon our most recent experience rate of defects as a percentage of warranty covered sales. Our warranty covered sales primarily include the Applied Optics Center optical assemblies. While our warranty period is 12 months, our reserve balances assume a general 90-day return period for optical assemblies previously delivered plus any returned backlog in-house that has not yet been repaired or replaced to our customer. If our actual warranty returns should significantly exceed our historical rates on new customer products, significant production changes, or substantial customer changes to the 90-day turn-around times on returned goods, the impact could be material to our operating profit. We have not experienced any significant changes to our warranty trends in the preceding three years and do not anticipate any significant impacts in the near term. We monitor the actual warranty costs incurred to the expected values on a quarterly basis and adjust our estimates accordingly. As of September 29, 2024, the Company had accrued warranty costs of $52 thousand, as compared to $75 thousand as of October 1, 2023. The primary reason for the decrease in reserve balances relates to lower shipments of our optical assemblies during the twelve months ended September 29, 2024 as compared to the prior year. As of September 29, 2024 and October 1, 2023, we had $259 thousand, and $243 thousand, respectively, of contract loss reserves included in our balance sheet accrued expenses. These loss contracts are related to some of our older legacy periscope IDIQ contracts which were priced in 2018 through early 2020, prior to Covid-19 and the subsequent decline in revenue at the Optex Systems Richardson segment combined with significant inflationary pressures on materials and labor in the last two years. Due to inflationary price increases on component parts and higher internal manufacturing costs (as a result of escalating labor costs and higher burden rates), some of these contracts are in a loss condition, or at marginal profit rates. These contracts are typically three-year IDIQ contracts with two optional award years, and as such, we are obligated to accept new task awards against these contracts until the contract expiration. Should contract costs continue to increase above the negotiated selling price, or in the event the customer should release substantial quantities against these existing loss contracts, the losses could be material. For contracts currently in a loss status based on the estimated per unit contract costs, losses are booked immediately on new task order awards. During the twelve months ended September 29, 2024, the accrued contract losses increased by $16 thousand on new awards against one of our loss IDIQ contracts, partially offset by shipments during the twelve month period. There is no way to reasonably estimate future inflationary impacts, or customer awards on the existing loss contracts. We continue to monitor these contracts throughout the year for any significant changes in addition to seeking potential cost saving strategies to mitigate risk. As of September 29, 2024 and October 1, 2023, Optex Systems Inc. had a net carrying value of $0.9 million in deferred tax assets consisting of deferred tax assets of $1.7 million and valuation reserves of ($0.8) million. The valuation allowance covers certain deferred tax assets where we believe we will be unlikely to recover those tax assets through future operations. The valuation reserve includes assumptions related to future taxable income which would be available to cover net operating loss carryforward amounts. Because of the uncertainties of future income forecasts combined with the complexity of some of the deferred assets, these forecasts are subject to change over time. While we believe our current estimate to be reasonable, changing market conditions and profitability, changes in equity structure and changes in tax regulations may impact our estimated reserves in future periods. Recent Accounting Pronouncements Recent Accounting Pronouncements are detailed under Note 3 of Item 8 “Financial Statements and Supplementary Data” of this report. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Not applicable. 36