ITEM 2. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The statements contained in this Quarterly
Report on Form 10-Q that are not purely historical are “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements relate to future events and typically address the Company’s
expected future business and financial performance. Words such as “plan,” “expect,” “aim,”
“believe,” “project,” “target,” “anticipate,” “intend,” “estimate,”
“will,” “should,” “could” and other words and terms of similar meaning, typically identify
these forward-looking statements. Forward-looking statements are based on certain assumptions and expectations of future events
and trends that are subject to risks and uncertainties. Actual results could differ from those projected in any forward-looking
statements because of the factors identified in and incorporated by reference from Part I, Item 1A, “Risk Factors,”
of our Annual Report on Form 10-K for the year ended September 30, 2016, as well as in other filings we make with the Securities
and Exchange Commission, which should be considered an integral part of Part I, Item 2, “Management’s Discussion
and Analysis of Financial Condition and Results of Operations.” All forward-looking statements included herein are made as
the date of this Quarterly Report on Form 10-Q and we assume no obligation to update the forward-looking statements or to update
the reasons why actual results could differ from those projected in the forward-looking statements.
The following discussion and analysis of our
financial condition and results of operations as of and for the three months ended December 31, 2016 and 2015 should be read in
conjunction with the financial statements and related notes in Item 1 of this report and our Annual Report on Form 10-K for
the year ended September 30, 2016.
OVERVIEW
General
Clearfield, Inc. designs, manufactures and distributes
fiber optic management, protection and delivery products for communications networks. Our “fiber to the anywhere” platform
serves the unique requirements of leading incumbent local exchange carriers (Traditional Carriers), including large national and
global telecom providers (Tier 1), wireless operators, MSO/cable TV companies, utility/municipality, enterprise, data center and
military markets, while also serving the broadband needs of the competitive local exchange carriers (Alternative Carriers).
The Company has historically focused on the
un-served or under-served rural communities who receive their voice, video and data services from independent telephone companies.
By aligning its in-house engineering and technical knowledge alongside its customers, the Company has been able to develop, customize
and enhance products from design through production. Final build and assembly of the Company’s products is completed at Clearfield’s
plants in Brooklyn Park, Minnesota, and Mexico, with manufacturing support from a network of domestic and global manufacturing
partners. Clearfield specializes in producing these products on both a quick-turn and scheduled delivery basis. The Company deploys
a hybrid sales model with some sales made directly to the customer, some made through two-tier distribution (channel) partners,
and some sales through original equipment suppliers who private label their products.
RESULTS OF OPERATIONS
Three months ended December 31, 2016 vS. three
months ended December 31, 2015
Net sales for the first quarter of fiscal 2017
ended December 31, 2016 were $18,266,000, an increase of approximately 16% or $2,576,000, from net sales of $15,690,000 for the
first quarter of fiscal 2016. Net sales to broadband service providers and commercial data networks customers were $17,020,000
in the first quarter of fiscal 2017 versus $14,644,000 in the same period of fiscal 2016. Among this group, the Company recorded
$1,586,000 in international sales for the first quarter of fiscal 2017 versus $746,000 in the same period of fiscal 2016. Net sales
to build-to-print and OEM customers were $1,246,000 in the first quarter of fiscal 2017 versus $1,046,000 in the same period of
fiscal 2016. The Company allocates sales from external customers to geographic areas based on the location to which the product
is transported. Accordingly, international sales represented 9% and 5% of total net sales for the first quarters of fiscal 2017
and 2016, respectively.
The increase in net sales for the quarter ended
December 31, 2016 of $2,576,000 compared to the quarter ended December 31, 2015 is primarily attributable to an increase of $2,462,000
in net sales to our customer base of commercial data network providers, build-to-print and OEM manufacturers, and broadband service
providers, outside of the Alternative Carrier group and international sales noted below, when compared to the same period of fiscal
2016. The improvement was due to increased deployments by the Company’s Traditional Carrier customers, wireless customers,
as well as expanded sales channels. Also, international sales increased $840,000 during the same period due to an increase in demand
and more favorable foreign currency exchange rates. Net sales were negatively affected by a decrease in the ongoing builds of an
Alternative Carrier customer of $726,000 in the quarter ended December 31, 2016. Revenue from all customers is obtained from purchase
orders submitted from time to time. Accordingly, the Company’s ability to predict orders in future periods or trends affecting
orders in future periods is limited.
Cost of sales for
the first quarter of fiscal 2017 was $11,057,000, an increase of $2,044,000, or 23%, from $9,013,000 in the comparable period of
fiscal 2016. Gross margin was 39.5% in the fiscal 2017 first quarter, down from 42.6% for the fiscal 2016 first quarter. Gross
profit increased $532,000, or 8%, to $7,209,000 for the quarter ended December 31, 2016 from $6,677,000 in the comparable period
in fiscal 2016.
The increase in gross profit in the first quarter of fiscal 2017 was due to increased volume while the decrease
in gross margin for the quarter was due to a higher percentage of sales to the Tier 1 customer group, along with a lower percentage
of sales associated with the integration of optical components within our product line, which typically have higher margins.
Selling, general and administrative expenses
increased $1,321,000, or 28%, to $6,018,000 in the fiscal 2017 first quarter from $4,697,000 for the fiscal 2016 first quarter.
The increase in the first quarter of fiscal 2017 consists primarily of higher compensation expenses in the amount of $811,000 mainly
due to additional personnel, wage increases, and higher performance compensation accruals. Also contributing to the increase were
increased selling, general and administrative stock compensation expense of $334,000, and increased development costs of $217,000
when compared to the fiscal 2016 first quarter.
Income from operations for the quarter ended
December 31, 2016 was $1,191,000 compared to income from operations of $1,980,000 for the comparable quarter of fiscal 2016, a
decrease of approximately 40%. This decrease is attributable to increased selling, general and administrative expenses.
Interest income for
the quarter ended December 31, 2016 was $53,000 compared to $34,000 for the comparable quarter for fiscal 2016. The increase is
due mainly to higher interest rates earned on its investments in fiscal 2017. The Company invests its excess cash primarily in
FDIC-backed bank certificates of deposit and money market accounts
.
We recorded a provision for income taxes of
$367,000 and $526,000 for the quarters ended December 31, 2016 and 2015, respectively. We record our quarterly provision for income
taxes based on our estimated annual effective tax rate for the year. The decrease in tax expense of $159,000 from the first quarter
for fiscal 2016 is primarily due to lower profitability in the first quarter of fiscal 2017. The increase in the income tax expense
rate to 29.5% for the first quarter of fiscal 2017 from 26.1% for the first quarter of fiscal 2016 is primarily the result of the
Company having additional positive discrete items during the first quarter of fiscal 2016 primarily related to excess tax benefits
for stock-based compensation awards.
The Company’s net income
for
the quarter ended December 31, 2016 was $877,000, or $0.06 per basic and diluted share.
The Company’s net income
for
the quarter ended December 31, 2015 was $1,487,000, or $0.11 per basic and diluted share.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2016, our principal source
of liquidity was our cash, cash equivalents and short-term investments. Those sources total $29,988,000 at December 31, 2016 compared
to $33,541,000 at September 30, 2016. Our excess cash is invested mainly in certificates of deposit backed by the FDIC and money
market accounts. Substantially all of our funds are insured by the FDIC. Investments considered long-term were $13,281,000 as of
December 31, 2016, compared to $10,703,000 as of September 30, 2016. We believe the combined balances of short-term cash and investments
along with long-term investments provide a more accurate indication of our available liquidity. We had no long-term debt obligations
at December 31, 2016 or September 30, 2016.
We believe our existing cash equivalents and
short-term investments, along with cash flow from operations, will be sufficient to meet our working capital and investment requirements
for beyond the next 12 months.
The Company intends on utilizing its available
cash and assets primarily for its continued organic growth and potential future strategic transactions, as well as execution of
the $8,000,000 share repurchase program adopted by the Board of Directors on November 13, 2014.
Operating Activities
Net cash used in operating activities totaled
$605,000 for the three months ended December 31, 2016. This was primarily due to net income of $877,000, non-cash expenses for
depreciation and amortization of $389,000, and stock based compensation of $594,000 offset by changes in operating assets and liabilities
using cash. Changes in operating assets and liabilities providing cash include decreases in accounts receivable and other assets
of $548,000 and $228,000, respectively. Accounts receivable balances can be influenced by the timing of shipments for customer
projects and payment terms. Days sales outstanding, which measures how quickly receivables are collected, increased three days
to 38 days from September 30, 2016 to December 31, 2016. The decrease in other assets primarily represents a decrease in the current
income tax receivable. Changes in working capital items using cash include an increase in inventory of $341,000 and a decrease
in accounts payable and accrued expenses of $2,900,000. The increase in inventory represents an adjustment for seasonal demand
along with changes in stocking levels while the decrease in accounts payable and accrued expenses primarily reflects fiscal 2016
accrued bonus compensation accruals paid in the first quarter of fiscal 2017.
Net cash provided by operating activities totaled
$2,258,000 for the three months ended December 31, 2015. This was primarily due to net income of $1,487,000, non-cash expenses
for depreciation and amortization of $349,000, deferred taxes of $479,000, and stock based compensation of $227,000 offset by changes
in operating assets and liabilities using cash. Changes in operating assets and liabilities providing cash include decreases in
accounts receivable and inventory of $991,000 and $239,000, respectively. Accounts receivable balances can be influenced by the
timing of shipments for customer projects and payment terms. Days sales outstanding, which measures how quickly receivables are
collected, decreased six days to 29 days from September 30, 2015 to December 31, 2015. The decrease in inventory represents an
adjustment for seasonal demand along with changes in stocking levels. Changes in working capital items using cash include a decrease
in accounts payable and accrued expenses in the amount of $1,353,000, primarily reflecting fiscal 2015 accrued bonus compensation
accruals paid in the first quarter of fiscal 2016, and cash used for other assets of $163,000.
Investing Activities
We invest our excess cash in money market accounts
and bank CDs in denominations across numerous banks. We believe we obtain a competitive rate of return given the economic climate
along with the security provided by the FDIC on these investments. During the three months ended December 31, 2016, we used cash
to purchase $7,440,000 of FDIC-backed securities and received $2,459,000 on CDs that matured. Purchases of capital equipment and
patents, mainly related to information technology and manufacturing equipment, consumed $529,000 of cash.
During the three months ended December 31, 2015,
we used cash to purchase $1,184,000 of FDIC-backed securities and received $1,886,000 on CDs that matured. Purchases of capital
equipment and patents, mainly related to information technology and manufacturing equipment, consumed $227,000 of cash.
Financing Activities
For the three months
ended December 31, 2016, we received $170,000 from employees’ participation and purchase of stock through our ESPP and used
$10,000 to pay for taxes as a result of employees’ exercises of stock options and vesting of restricted shares using share
withholding.
As of December 31, 2016, we had authority to purchase approximately $6,817,000 in additional shares under the
repurchase program announced on November 13, 2014.
For the three months ended December 31, 2015, we received $118,000
from employees’ participation and purchase of stock through our ESPP. We also received $35,000 from the issuance of stock
as a result of employees exercising options. Additionally, we used $257,000 to repurchase our common stock during the first quarter
of fiscal 2016.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management utilizes its technical knowledge,
cumulative business experience, judgment and other factors in the selection and application of the Company’s accounting policies.
The accounting policies considered by management to be the most critical to the presentation of the financial statements because
they require the most difficult, subjective and complex judgments include revenue recognition, stock based compensation, deferred
tax asset valuation allowances, accruals for uncertain tax positions, and impairment of goodwill and long-lived assets.
These accounting policies are described in Item
7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s
Annual Report on Form 10-K for the year ended September 30, 2016. Management made no changes to the Company’s critical accounting
policies during the quarter ended December 31, 2016.
In applying its critical accounting policies,
management reassesses its estimates each reporting period based on available information. Changes in these estimates did not have
a significant impact on earnings for the quarter ended December 31, 2016.