Quarterly report pursuant to Section 13 or 15(d)

Accounting Policies (Policies)

Accounting Policies (Policies)

9 Months Ended

Jun. 30, 2024

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 October 1, 2023 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.

Inventory

Inventory: As of June 30, 2024 and October 1, 2023, inventory included:

Schedule of Inventory

	June 30, 2024			October 1, 2023
	(Thousands)
	June 30, 2024			October 1, 2023
Raw Material	$	9,302		$	8,211
Work in Process		6,164			4,460
Finished Goods		659			489
Gross Inventory	$	16,125		$	13,160
Less: Inventory Reserves		(1,007	)		(1,007	)
Net Inventory	$	15,118		$	12,153

Concentration of Credit Risk

Concentration of Credit Risk: The Company’s accounts receivables as of June 30, 2024 consisted of U.S. government agencies (14%), five major U.S. defense contractors (22%, 11%, 11%, 10%, and 6%, respectively), one commercial customer (12%) and all other customers (14%). The Company does not believe that this concentration results in undue credit risk because of the financial strength of the customers and the Company’s long history with these customers.

Accrued Warranties

Accrued Warranties: The Company 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 June 30, 2024 and October 1, 2023, the Company had warranty reserve balances of $36 thousand and $75 thousand, respectively.

Schedule of Warranty Reserves

	June 30, 2024			July 2, 2023			June 30, 2024			July 2, 2023
	Three months ended						Nine months ended
	June 30, 2024			July 2, 2023			June 30, 2024			July 2, 2023
Beginning balance	$	69		$	266		$	75		$	169

Incurred costs for warranties satisfied during the period		(15	)		(82	)		(52	)		(99	)

Warranty Expenses:
Warranties reserved for new product shipped during the period⁽¹⁾		26			57			90			177
Change in estimate for pre-existing warranty liabilities⁽²⁾		(44	)		-			(77	)		(6	)
(Reversal of) Warranty Expense		(18	)		57			13			171

Ending balance	$	36		$	241		$	36		$	241

(1)	Warranty expenses accrued to cost of sales (based on current period 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 current 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, accounts payable and 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.

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.

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 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. During the three and nine months ended June 30, 2024, there was $126 thousand and $357 thousand in service contract revenue. During the three and nine months ended July 2, 2023, there was $115 thousand and $340 thousand in service contract revenue.

During the three- and nine-month periods ended June 30, 2024, there was $161 thousand of revenue recognized from customer deposit liabilities (deferred contract revenue). During the three- and nine-month periods ended July 2, 2023, there was zero and $223 thousand of revenue recognized from customer deposit liabilities (deferred contract revenue). As of June 30, 2024 and October 1, 2023, customer deposit liabilities were $320 thousand and $481 thousand, respectively.

As of June 30, 2024 and October 1, 2023, there was $250 and $336 thousand in accrued selling expenses and $237 and $336 thousand in contract assets related to a new $3.4 million contract booked in November 2022. The costs will be amortized against the revenue for the contract deliveries which began in the fourth quarter of fiscal year 2023 and extend into fiscal year 2025.

Contract Loss Reserves

Contract Loss Reserves: The Company records loss provisions in the event that the current estimated total revenue against a contract and the total estimated cost remaining to fulfill the contract indicate a loss upon completion. When the estimated costs indicate a loss, we record the entire value of the loss against the contract loss reserve in the period the determination is made. The Company has several long-term fixed price contracts that are currently indicative of a loss condition due to recent inflationary pressures on material and labor, combined with increased manufacturing overhead costs. One of these long-term contracts has an option year ordering period ending in February 2025 with deliveries that may extend into February 2026. As of June 30, 2024 and October 1, 2023, the accrued contract loss reserves were $101 thousand and $243 thousand, respectively. During the three and nine months ended June 30, 2024, the Company recognized a gain on changes in estimates for the contract loss reserves of $16 thousand and $45 thousand and applied reserves of $34 thousand and $97 thousand to cost of sales against revenues booked during the periods, respectively.

Income Tax/Deferred Tax

Income Tax/Deferred Tax: As of June 30, 2024 and October 1, 2023, the Company had a deferred tax asset valuation allowance of ($0.8) million against deferred tax assets of $1.6 million and $1.7 million, respectively, for a net deferred tax asset of $0.8 million and $0.9 million, respectively. 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. During the nine months ended June 30, 2024, our deferred tax assets decreased by $0.1 million related to temporary tax adjustments.

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.

The Company has potentially dilutive securities outstanding, which include unvested restricted stock units and unvested shares of restricted stock. The Company uses the Treasury Stock Method to compute the dilutive effect of any dilutive shares. Unvested restricted stock units and shares of restricted stock that are anti-dilutive are excluded from the calculation of diluted earnings per common share.

For the three and nine months ended June 30, 2024, 60,000 shares of unvested restricted stock and 66,500 unvested restricted stock units (which convert to an aggregate of 88,401 and 67,434 incremental shares), respectively, were included in the diluted earnings per share calculation. For the three and nine months ended July 2, 2023, 120,000 shares of unvested restricted stock (which convert to an aggregate of 43,141 and 35,011 incremental shares), respectively, were included in the diluted earnings per share calculation.