Quarterly report pursuant to Section 13 or 15(d)

Accounting Policies (Policies)

Accounting Policies (Policies)

6 Months Ended

Mar. 28, 2021

Principles of Consolidation: The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Optex Systems, Inc. All significant inter-company balances and transactions have been eliminated in consolidation.

The condensed consolidated financial statements of Optex Systems Holdings included herein have been prepared by Optex Systems Holdings, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in conjunction with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading.

These condensed consolidated financial statements should be read in conjunction with the annual audited consolidated financial statements and the notes thereto included in the Optex Systems Holdings’ Form 10-K for the year ended September 27, 2020 and other reports filed with the SEC.

The accompanying unaudited interim condensed consolidated financial statements reflect all adjustments of a normal and recurring nature which are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows of Optex Systems Holdings for the interim periods presented. The results of operations for these periods are not necessarily comparable to, or indicative of, results of any other interim period or for the fiscal year taken as a whole. Certain information that is not required for interim financial reporting purposes has been omitted.

Leases

Leases: On January 11, 2021 the Company executed amendments for each of the leased facilities extending the terms for eighty-six (86) months, commencing at the end of the current lease agreements. The Richardson lease amendment commences on April 1, 2021 for an eighty-six (86) month term ending on May 31, 2028. The Dallas lease amendment commences on November 1, 2021 for an eighty-six (86) month term ending on December 31, 2028. Each of the leases include two full months of rent abatement at the beginning of the commencement term. Execution of the new lease amendments 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 three months ended March 28, 2021. See also Note 4.

Inventory

Inventory: As of March 28, 2021, and September 27, 2020, inventory included:

	(Thousands)
	March 28, 2021			September 27, 2020
Raw Material	$	4,855		$	5,506
Work in Process		3,974			3,214
Finished Goods		731			638
Gross Inventory	$	9,560		$	9,358
Less: Inventory Reserves		(567	)		(567	)
Net Inventory	$	8,993		$	8,791

Concentration of Credit Risk

Concentration of Credit Risk: Optex Systems Holdings’ accounts receivables for the period ended March 28, 2021 are derived from revenues of U.S. government agencies: 16%, three major U.S. defense contractors: 46%, 11% and 9%, one commercial customer: 5%, and all other customers: 13%. The Company does not believe that this concentration results in undue credit risk because of the financial strength of and its long history with these customers.

Accrued Warranties

Accrued Warranties: Optex Systems Holdings accrues product warranty liabilities based on the historical return rate against period shipments as they occur and reviews and adjusts these accruals quarterly for any significant changes in estimated costs or return rates. The accrued warranty liability includes estimated costs to repair or replace returned warranty backlog units currently in-house plus estimated costs for future warranty returns that may be incurred against warranty covered products previously shipped as of the period end date. As of March 28, 2021, and September 27, 2020, the Company had warranty reserve balances of $63 thousand and $83 thousand, respectively.

	Three months ended						Six months ended
	March 28, 2021			March 29, 2020			March 28, 2021			March 29, 2020
Beginning balance	$	49		$	75		$	83		$	46

Incurred costs for warranties satisfied during the period		(25	)					(68	)		-

Warranty Expenses:
Warranties reserved for new product shipped during the period⁽¹⁾		5			36			9			56
Change in estimate for pre-existing warranty liabilities ⁽²⁾		34			(6	)		39			3
Warranty Expense		39			30			48			59

Ending balance	$	63		$	105		$	63		$	105

(1) Warranty expenses accrued to cost of sales (based on current period shipments and historical warranty return rate.

(2) Changes in estimated warranty liabilities for associated with the period end customer returned warranty backlog or repaired/replaced warranty units which were shipped to the customer during the period.

Use of Estimates

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.

Fair Value of Financial Instruments

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 and accounts payable, 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. 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.

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 6 “Warrant Liabilities”. The warrant liability measurement 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.

Revenue Recognition

Revenue Recognition: 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 began in October 2017 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 over a three-year period. 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. During the three and six months ended March 28, 2021 and March 29, 2020, there was $120 thousand and $240 thousand in 2021 and $113 thousand and $226 thousand in 2020 in service contract revenue recognized over time.

During the three and six-month periods ended March 28, 2021 and March 29, 2020, there was $0 and $1 thousand in 2021 and $3 and $3 thousand in 2020 of revenue recognized from customer deposit liabilities (deferred contract revenue). As of March 28, 2021, there are no customer deposit liabilities. As of the six months ended March 28, 2021, there are no sales commissions or other significant deferred contract costs.

Income Tax/Deferred Tax

Income Tax/Deferred Tax: As of March 28, 2021 and September 27, 2020, Optex Systems, Inc. has a deferred tax asset valuation allowance of $1.0 million against deferred tax assets of $1.2 million. The valuation allowance has been established due to historical losses resulting in a Net Operating Loss Carryforward for each of the fiscal years 2011 through 2016 which may not be fully recognized due to an IRS Section 382 limitation related to a change in control.

Earnings Per Share

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.

A significant number of our outstanding warrants are participating securities which share dividend distributions and the allocation of any undistributed earnings (deemed dividends) with our common shareholders. During the three and six months ended March 28, 2021, there were no declared dividends and $0 and $163 thousand in allocated undistributed earnings attributable to the participating warrants, respectively. During the three and six months ended March 29, 2020, there were no declared dividends, and $633 thousand and $413 thousand in undistributed earnings attributable to participating warrants, respectively.

The Company has potentially dilutive securities outstanding which include unvested restricted stock units, stock options and warrants. In computing the dilutive effect of warrants, the numerator is adjusted to add back any deemed dividends on participating securities (warrants) and the denominator is increased to assume the conversion of the number of additional incremental common shares. The Company uses the Treasury Stock Method to compute the dilutive effect of any dilutive shares. Unvested restricted stock units, stock options and warrants that are anti-dilutive are excluded from the calculation of diluted earnings per common share.

For the three months ended March 28, 2021, 99,000 unvested restricted stock units (which convert to 15,018 incremental shares) and 240,000 shares of unvested restricted stock (which convert to 36,407 incremental shares) were excluded in the diluted earnings per share calculation due to the net loss during the period. For the six months ended March 28, 2021, 99,000 unvested restricted stock units (which convert to 31,129 incremental shares) and 240,000 restricted shares (which convert to 81,755 incremental shares) were included in the diluted earnings per share calculation.

For the three and six-months ended March 29, 2020, 182,000 unvested restricted stock units (which convert to 55,009 and 84,807 incremental shares for the three and six-months, respectively) were included in the diluted earnings per share calculation.

For the three and six-months ended March 28, 2021 and the three and six-months ending March 29, 2020, 4,125,200 warrants were excluded from the diluted earnings per share calculation due to the antidilutive effect of the undistributed earnings.