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 and six months ended March 31, 2017 and
2016 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,
within the Tier 2 and Tier 3 broadband markets), 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 also provides contract manufacturing services for
original equipment manufacturers (OEM) requiring copper and fiber cable assemblies built to their specifications.
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
March 31, 2017 vS. three months ended March 31, 2016
Net sales for the second
quarter of fiscal 2017 ended March 31, 2017 were $17,652,000, an increase of approximately 4%, or $705,000, from net sales of $16,947,000
for the second quarter of fiscal 2016. Net sales to broadband service providers and commercial data networks customers were $16,623,000
in the second quarter of fiscal 2017, versus $15,678,000 in the same period of fiscal 2016. Among this group, the Company recorded
$1,787,000 in international sales for the second quarter of fiscal 2017, versus $713,000 in the same period of fiscal 2016. Net
sales to build-to-print and OEM customers were $1,029,000 in the second quarter of fiscal 2017 versus $1,269,000 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 10% and 4% of total net sales for the second quarters of fiscal 2017
and 2016, respectively.
The increase in net
sales for the quarter ended March 31, 2017 of $705,000 compared to the quarter ended March 31, 2016 is partially attributable to
an increase of $115,000 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 and
Tier 1 customers. Also, international sales increased $1,074,000 during the same period due to an increase in demand. Net sales
were negatively affected by a decrease in the ongoing builds of an Alternative Carrier customer of $484,000 in the quarter ended
March 31, 2017. 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 second quarter of fiscal 2017 was $10,209,000, an increase of $542,000, or 6%, from $9,667,000 in the comparable
period of fiscal 2016. Gross profit was 42.2% of net sales in the fiscal 2017 second quarter, a decrease from 43.0% of net sales
for the fiscal 2016 second quarter. Gross profit increased $163,000, or 2%, to $7,443,000 for the three months ended March 31,
2017 from $7,280,000 in the comparable period in fiscal 2016.
The increase in gross profit in the second quarter of fiscal
2017 was due to increased volume while the decrease in gross profit percent for the quarter was due to a higher percentage of sales
to the Tier 1 customer group, which typically have lower margins, 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 $1,025,000, or 20%, to $6,162,000 in the fiscal 2017 second quarter from $5,137,000 for the fiscal
2016 second quarter. The increase in the second quarter of fiscal 2017 consists primarily of increased compensation costs of $562,000
due primarily to additional sales and marketing personnel, increased stock compensation expense of $311,000, increased product
development costs of $209,000, and increased legal expenses of $165,000, somewhat offset by lower performance compensation accruals
of $397,000 when compared to the fiscal 2016 second quarter.
Income from operations
for the quarter ended March 31, 2017 was $1,281,000 compared to income from operations of $2,143,000 for the comparable quarter
of fiscal 2016, a decrease of approximately 40%. This decrease is primarily attributable to increased selling, general and administrative
expenses.
Interest
income for the quarter ended March 31, 2017 was $60,000 compared to $39,000 for the comparable quarter for fiscal 2016. The increase
is due mainly to higher interest rates earned on its investments in fiscal 2017 as well as higher cash invested balances. 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 $433,000 and $690,000 for the three months ended March 31, 2017 and 2016, 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 $257,000
from the second quarter of fiscal 2016 is primarily due to lower profitability in the second quarter of fiscal 2017. The increase
in the income tax expense rate to 32.3% for the second quarter of fiscal 2017 from 31.6% for the second quarter of fiscal 2016
is primarily the result of the Company having additional positive discrete items during the second quarter of fiscal 2016 primarily
related to excess tax benefits for stock-based compensation awards.
The Company’s
net income
for the three months ended March 31, 2017 was $908,000, or $0.07 per basic and diluted share.
The Company’s net income
for the three months ended March 31, 2016 was $1,493,000, or $0.11
per basic and diluted share.
Six months ended
March 31, 2017 vS. six months ended March 31, 2016
Net sales for the six
months ended March 31, 2017 were $35,918,000, an increase of 10%, or approximately $3,281,000, from net sales of $32,637,000 for
the first six months of fiscal 2016. Net sales to broadband service providers and commercial data networks customers were $33,651,000
for the first six months of fiscal 2017, versus $30,321,000 in the same period of fiscal 2016. Among this group, the Company recorded
$3,373,000 in international sales versus $1,459,000 in the same period of fiscal 2016. Net sales to build-to-print and OEM customers
were $2,267,000 in the first six months of fiscal 2017 versus $2,316,000 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 4% of total net sales for the first six months of fiscal 2017 and 2016, respectively.
The increase in net
sales for the six months ended March 31, 2017 of $3,281,000 compared to the six months ended March 31, 2016 is primarily attributable
to an increase of $2,591,000 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 and
Tier 1 customers. Also, international sales increased $1,914,000 during the same period due to an increase in demand. Net sales
were negatively affected by a decrease in the ongoing builds of an Alternative Carrier customer of $1,224,000 for the six months
ended March 31, 2017. 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 six months ended March 31, 2017 was $21,266,000, an increase of $2,586,000, or 14%, from $18,680,000 in the comparable
period of fiscal 2016. Gross profit was 40.8% of net sales in the fiscal 2017 first six months, down from 42.8% for the comparable
six months in fiscal 2016. Gross profit increased $695,000, or 5%, to $14,652,000 for the six months ended March 31, 2017 from
$13,957,000 in the comparable period in fiscal 2016. The increase in cost of sales in the first six months of fiscal 2017
was
due to increased volume while the decrease in gross profit percent was due to a higher percentage of sales to the Tier 1 customer
group, which typically have lower margins, 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 24%, or $2,346,000, from $9,834,000 for the first six months of fiscal 2016 to $12,180,000 for
the first six months of fiscal 2017. The increase in the first six months of fiscal 2017 consists primarily of higher compensation
expense in the amount of $1,222,000 mainly due to additional sales and marketing personnel and wage increases. Also contributing
to the increase were increased stock compensation expense of $645,000, increased product development costs of $426,000, and increased
legal expenses of $178,000 when compared to the same period of fiscal 2016. These were somewhat offset by lower performance compensation
accruals of $245,000.
Income from operations
for the six months ended March 31, 2017 was $2,472,000 compared to income from operations of $4,123,000 for the first six months
of fiscal 2016, a decrease of $1,651,000, or 40%. This decrease is primarily attributable to increased selling, general and administrative
expenses.
Interest
income for the six months ended March 31, 2017 was $113,000 compared to $73,000 for the comparable period for fiscal 2016. The
increase is due mainly to higher interest rates earned on its investments in fiscal 2017 as well as higher cash invested balances.
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 $800,000 and $1,216,000 for the six months ended March 31, 2017 and 2016, 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 $416,000
from the six months ended March 31, 2016 is primarily due to lower profitability in the first six months fiscal 2017. The increase
in the income tax expense rate to 31.0% for the first six months of fiscal 2017 from 29.0% for the first six months of fiscal 2016
is primarily the result of the Company having additional positive discrete items during the first six months of fiscal 2016 primarily
related to excess tax benefits for stock-based compensation awards.
The Company’s
net income
for the first six months of fiscal 2017 ended March 31, 2017 was $1,784,000, or $0.13 per
basic and diluted share.
The Company’s net income
for the first six months of fiscal 2016
ended March 31, 2016 was $2,980,000, or $0.22 per basic and diluted share.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2017,
our principal source of liquidity was our cash, cash equivalents and short-term investments. Those sources total $28,296,000 at
March 31, 2017 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 $15,015,000 as of March 31, 2017, 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 March 31, 2017 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 share repurchase program adopted by our Board of Directors. The share repurchase program was originally
adopted on November 13, 2014 with $8,000,000 authorized for common stock repurchases. On April 25, 2017, our Board of Directors
increased the authorization
to $12,000,000 of common stock.
Operating Activities
Net cash used in operating
activities totaled $12,000 for the six months ended March 31, 2017. This was primarily due to net income of $1,784,000, non-cash
expenses for depreciation and amortization of $800,000, and stock based compensation of $1,184,000 offset by changes in operating
assets and liabilities using cash. Changes in operating assets and liabilities providing cash include a decrease in other assets
of $234,000. 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 accounts receivable of $115,000, an increase in inventory of $1,598,000, and a
decrease in accounts payable and accrued expenses of $2,297,000. 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 six days to 41 days from September 30, 2016 to March 31, 2017. The increase in inventory represents an adjustment for
seasonal demand along with new product introductions 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 $3,030,000 for the six months ended March 31, 2016. This was primarily due to net income of $2,980,000,
non-cash expenses for depreciation and amortization of $706,000, deferred taxes of $1,126,000, and stock-based compensation of
$473,000 offset by changes in operating assets and liabilities using cash. Changes in operating assets and liabilities using cash
include increases for the six months ending March 31, 2016 in accounts receivable and inventory of $1,843,000 and $920,000, 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 seven days to 42 days from September 30, 2015 to March 31, 2016.
The increase in inventory represented an adjustment for seasonal demand along with changes in stocking levels. Changes in working
capital items providing cash include an increase in accounts payable and accrued expenses in the amount of $714,000, primarily
reflecting inventory purchases.
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 six months ended March
31, 2017, we used cash to purchase $10,166,000 of FDIC-backed securities and received $5,568,000 on CDs that matured. Purchases
of patents and capital equipment, mainly related to information technology and manufacturing equipment, consumed $1,065,000 of
cash in the six months ended March 31, 2017.
During the six months
ended March 31, 2016, we used cash to purchase $3,820,000 of FDIC-backed securities and received $3,858,000 on CDs that matured.
Purchases of patents and capital equipment, mainly related to information technology and manufacturing equipment, consumed $422,000
of cash in the six months ended March 31, 2016.
Financing Activities
For
the six months ended March 31, 2017, we received $170,000 from employees’ participation and purchase of stock through our
ESPP. We also received $28,000 from stock option exercises. Additionally, we used $49,000 to repurchase our common stock in the
six months ended March 31, 2017.
As of March 31, 2017, we had authority to purchase approximately $6,768,000 in additional
shares under the repurchase program announced on November 13, 2014.
For the six months
ended March 31, 2016, we received $118,000 from employees’ participation and purchase of stock through our ESPP. We also
received $85,000 from stock option exercises. Additionally, we used $334,000 to repurchase our common stock in the six months ended
March 31, 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 March 31, 2017.
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 March 31, 2017.