Optex Systems Holdings (OPXS) Risk Analysis

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.

We expect recent supply chain disruptions driven by Russia's invasion of Ukraine and the related sanctions, combined with raw material shortages, labor shortages, and transportation delays, to continue for the foreseeable future. These conditions have strained our suppliers and extended supplier delivery lead times, affecting their ability to sustain operations. Further, a dockworker strike on the east coast which has been suspended until January 15, 2025, pending negotiations, could have a negative impact on our ability to obtain key manufacturing materials such as adhesives and epoxies should the strike ensue and continue for a sustained period of time beyond our safety stock levels. We have experienced market wide material shortages for paint and resin products as well as critical epoxies and chemicals used in our manufacturing process. In addition, we have seen substantial increases in the costs of aluminum, steel and acrylic commodities and experienced supplier schedule delays for other key components which were driven by supplier labor and material shortages. In several cases, spotty supply and material shortages have resulted in stocking higher inventory "safety stock" levels to ensure adequate lead time to replenish critical supplies. 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 September 29, 2024, approximately 7% of our material requirements were single-sourced across 10 suppliers representing approximately 15% 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 September 29, 2024. Product Line   Supply Item   Risk   Purchase Orders               Sighting Systems DDAN   Digital camera system   Alternative source would take in excess of six months to qualify   Current firm fixed price & quantity purchase orders are in place with the supplier to meet all contractual requirements.               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   Military Spec welded housings for vision blocks   Would take approximately 8-10 months to re-qualify a new supplier source.   Currently working with current vendor to keep supply of these parts               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   Aluminum 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 qualify a new source               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.               Beamsplitter   Glass tight dimensions and Special Coating    Limited number of suppliers that can meet tight customer specifications without deviation   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.               Applied Optics Center LIF Assembly   Container Wrench and Retaining Ring   Mold tooling was manufactured by and used by one source. Tooling would not fit other potential supplier's equipment. Finding another source would be very expensive and take approximately 1 year to transition   Current firm fixed price and quantity purchase orders are in place with the supplier to meet all contractual requirements. Supplier is on schedule. Applied Optics Center LIF Assembly   Rubber Seal   Mold tooling was manufactured by and used by one source. Tooling would not fit other potential supplier's equipment. Finding another source would be very expensive and take approximately 1 year to transition   Current firm fixed price and quantity purchase orders are in place with the supplier to meet all contractual requirements. Supplier is on schedule.               Applied Optics Center Assorted LFU Assemblies   Anti-Reflective Device   Only one approved government source of supply at this time   Current firm fixed price and quantity purchase orders are in place with the supplier to meet all contractual requirements. Supplier is on schedule.

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 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 that attack did not 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.