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, 2020, 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 the Company’s financial condition and results of operations as of and for the three months ended December
31, 2020 and 2019 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, 2020.
OVERVIEW
General
Clearfield, Inc. (“Clearfield”
or the “Company”) 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 Broadband Service
Providers in the United States, which include Community Broadband, National Carriers, and MSO’s, while also serving the broadband
needs of the International markets, primarily countries in the Caribbean, Canada, and Central and South America. These customers
are collectively included in Broadband Service Providers. The Company also provides contract manufacturing services for its Legacy
customers which include original equipment manufacturers (OEM) requiring copper and fiber cable assemblies built to their specifications.
The Company has historically
focused on the unserved or underserved rural communities that receive 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 manufacturing facilities in Brooklyn Park, Minnesota, and Tijuana, 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 customers, some made through
two-tier distribution (channel) partners, sales agents and manufacturing representatives, and sales through original equipment
suppliers who private label their products.
Under U.S. federal
and state guidance in response to the COVID-19 pandemic, Clearfield’s operations are classified as part of the Cybersecurity
and Infrastructure Security Agency (“CISA”) critical infrastructure sector and similar categorization in Minnesota.
In March 2020, we transitioned our corporate employees at our Brooklyn Park headquarters to remote work arrangements and they currently
continue remote work. In accordance with the Centers for Disease Control and Prevention (“CDC”) and World Health Organization
(“WHO”) guidelines, we implemented and have continued health and safety measures for the production staff that remain
onsite at our Brooklyn Park facility. We have maintained our manufacturing capacity in Brooklyn Park with these personnel at near
historic levels. Similarly, we have implemented the recommended health and safety measures for the production staff that remains
onsite at our Tijuana, Mexico manufacturing facilities. Throughout the COVID-19 pandemic, the Company has closely monitored the
operations and staffing levels at its Brooklyn Park facility and its two manufacturing facilities in Tijuana, Mexico.
Due to the risks to
timely supply of materials to our facilities, we have taken multiple actions to ensure sufficient safety stock inventory levels
at both our Minnesota and Mexico facilities. Additionally, we made the decision to maximize the availability of all product lines
at all three of our plants by assuring that each location can manufacture across our broad product portfolio. These actions, combined
with our historic practice of dual sourcing most of our components, has positioned us to meet our obligations to customers and
to fulfill our order backlog going forward. However, in the event of serious border restrictions or border delays or serious disruption
in our supply chain, we may experience diminished or temporarily suspended operations, longer lead times than typical for product
deliveries, or temporarily suspended product deliveries, which would result in delayed or reduced revenue from the affected orders
in production and higher operating costs.
RESULTS OF OPERATIONS
Three months ended
December 31, 2020 vS. three months ended December 30, 2019
Net sales for the first
quarter of fiscal 2021 ended December 31, 2020 were $27,092,000, an increase of approximately 40% or $7,714,000, from net sales
of $19,378,000 for the first quarter of fiscal 2020. Net sales to Broadband Service Providers were $26,570,000 in the first quarter
of fiscal 2021 versus $18,155,000 in the same period of fiscal 2020. Among this group, the Company recorded $1,060,000 in international
sales for the first quarter of fiscal 2021 versus $1,137,000 in the same period of fiscal 2020. Net sales to Legacy customers decreased
$711,000 to $515,000 in the first quarter of fiscal 2021 from $1,223,000 in the same period of fiscal 2020. The Company allocates
sales from external customers to geographic areas based on the location to which the product is transported. Accordingly, international
sales represented 4% and 6% of total net sales for the first quarter of fiscal 2021 and 2020, respectively.
The increase in net
sales for the quarter ended December 31, 2020 of $7,714,000 compared to the quarter ended December 31, 2019 was driven primarily
by increased sales to Community Broadband Service Providers and MSO customers of $8,198,000, and $701,000, respectively. Offsetting
this was decreased sales to Legacy and Tier 1 customers of $711,000 and $379,000, respectively. The increase to Community Broadband
and MSO customers was due to increased demand in response to COVID-19 driven by customers accelerating their purchasing decisions
and deployment schedules of our fiber optic solutions and the need for high-speed broadband required in the work from anywhere
environment.
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. The Company’s ability to predict revenue has become further
limited by potential disruption to its supply chains or changes in customer ordering patterns due to COVID-19. The Company’s
ability to recognize revenue in the future for its backlog of customer orders will depend on the Company’s ability to manufacture
and deliver products to the customers and fulfill its other contractual obligations.
Cost of sales for the
first quarter of fiscal 2021 was $15,723,000, an increase of $4,072,000, or 35%, from $11,650,000 in the comparable period of fiscal
2020. Gross profit percent was 42.0% of net sales in the first quarter of fiscal 2021, an increase from 39.9% of net sales for
the first quarter of fiscal 2020. Gross profit increased $3,642,000, or 47%, to $11,369,000 for the three months ended December
31, 2020 from $7,728,000 in the comparable period in fiscal 2020. The increase in gross profit in the first quarter of fiscal 2021
was due to increased volume of net sales while the increase in gross profit percent was primarily due to a favorable product mix
and cost reduction efforts across the Company’s product lines, including greater use of its Mexico manufacturing plants and
efficiencies realized from supply chain programs. Gross profit was negatively impacted by tariff costs of approximately $113,000
for the three months ended December 31, 2020 and $100,000 in the comparable period in fiscal 2020. In the first quarter of fiscal
2021, the Company did not experience any significant impacts on cost of sales due to COVID-19.
Selling,
general and administrative expenses increased $329,000, or 4%, to $7,656,000 in the first quarter fiscal 2021 from $7,327,000 for
the fiscal 2020 first quarter. The increase in expense in the first quarter of fiscal 2021 consists primarily of increases of $809,000
in compensation expense due to increased wages and performance compensation driven by higher net sales, partially offset by lower
travel and entertainment expenses of $373,000 due to COVID-19 restrictions. In the first quarter of fiscal 2021, other than the
travel and entertainment costs mentioned above, the Company did not experience any significant impacts on selling, general and
administrative expense due to COVID-19.
Income from operations
for the quarter ended December 31, 2020 was $3,714,000 compared to $401,000 for the comparable quarter of fiscal 2020, an increase
of approximately 826%. This increase is attributable to increased gross profit from higher sales, offset by higher selling, general
and administrative expenses.
Interest
income for the quarter ended December 31, 2020 was $134,000 compared to $223,000 for the comparable quarter for fiscal 2020. The
decrease is due to lower interest rates earned on investments in the first quarter of fiscal 2020. We expect interest income to
decline due to the prevailing lower interest rates and the potential for further decreases in rates in the current economic environment.
The Company invests its excess cash in FDIC-backed bank certificates of deposit, and money market accounts.
We
recorded a provision for income taxes of $684,000 and $123,000 for the three months ended December 31, 2020 and 2019, respectively.
We record our quarterly provision for income taxes based on our estimated annual effective tax rate for the year. The increase
in tax expense of $561,000 from the first quarter for fiscal 2020 is primarily due to increased income from operations.
The decrease in the income tax expense rate to 17.8% for the first quarter of fiscal 2021 from 19.7%
for the first quarter of fiscal 2020 is primarily due to excess tax benefits from non-qualified stock options exercised
during the quarter.
The Company’s
net income for the three months ended December 31, 2020 was $3,163,000, or $0.23 per basic and diluted
share. The Company’s net income for the three months ended December 31, 2019 was $501,000,
or $0.04 per basic and diluted share.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31,
2020, our principal source of liquidity was our cash, cash equivalents and short-term investments. Those sources total $28,277,000
as of December 31, 2020 compared to $27,032,000 as of September 30, 2020. Our excess cash is invested mainly in certificates of
deposit backed by the FDIC, U.S. treasury securities and money market accounts. Substantially all of our funds are insured by the
FDIC. Investments considered long-term were $26,142,000 as of December 31, 2020, compared to $25,143,000 as of September 30, 2020.
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. At the end of the first quarter of fiscal 2021, our cash, cash equivalents and short-term and long-term
investments increased to $54.4 million compared to $52.2 million as of the prior quarter end. We had no long-term debt obligations
as of December 31, 2020 or September 30, 2020.
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 to mitigate the potential impacts of COVID-19 on the Company’s business.
Due to the economic
crisis resulting from the COVID-19 pandemic, our future cash flow from operating and investing activities may be negatively impacted.
Our uses of cash may also be materially impacted by increased operating expense associated with mitigating supply chain, logistics,
and customer fulfillment risks caused by COVID-19.
Operating Activities
Net cash provided by
operating activities totaled $2,717,000 for the three months ended December 31, 2020. This was primarily due to net income of $3,163,000,
non-cash expenses for depreciation and amortization of $568,000, and stock-based compensation of $289,000 in addition to changes
in operating assets and liabilities providing cash. Changes in operating assets and liabilities using cash include a decrease in
accounts payable and accrued expenses of $2,860,000, offset by decreases in inventory of $721,000 and accounts receivable of $699,000.
The decrease in accounts payable and accrued expenses is due to the timing of payments to vendors in the quarter and $2,373,000
of fiscal 2020 accrued bonus compensation accruals paid in the first quarter of fiscal 2021. The
decrease in inventory is a result of higher utilization of inventory components due to increased net sales. 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 two days to 33 days from September 30, 2020 to December 31, 2020.
Net cash used in operating
activities totaled $100,000 for the three months ended December 31, 2019. This was primarily due to net income of $501,000, non-cash
expenses for depreciation and amortization of $607,000, and stock-based compensation of $241,000 in addition to changes in operating
assets and liabilities providing cash. Changes in operating assets and liabilities using cash include increases in inventory of
$1,617,000, decreases in accounts payable of $1,816,000, offset by decreases in accounts receivable of $2,093,000. 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, decreased two days to 33 days from September 30, 2019 to December 31, 2019. The increase
in inventory represents an adjustment for seasonal demand along with changes in stocking levels. Changes in working capital reflects
items using cash, including a decrease in accounts payable and accrued expenses of $1,848,000 which primarily reflects fiscal 2019
accrued bonus compensation accruals and accounts payable paid in the first quarter of fiscal 2020.
Investing Activities
We invest our excess
cash in money market accounts, U.S. Treasury securities 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, 2020, we used cash to purchase $3,968,000 of FDIC-backed securities and received $4,426,000
on CDs that matured. Purchases of property, plant and equipment, mainly related to manufacturing equipment, consumed $379,000 of
cash during the three months ended December 31, 2020.
During the three months
ended December 31, 2019, we used cash to purchase $3,211,000 of FDIC-backed securities and received $4,438,000 on CDs that matured.
Purchases of property, plant and equipment, mainly related to manufacturing equipment, consumed $788,000 of cash during the three
months ended December 31, 2019.
Financing Activities
For the three months
ended December 31, 2020, we received $179,000 from employees’ participation and purchase of stock through our ESPP, we used
$262,000 related to share withholding for taxes associated with the issuance of common stock upon cashless exercise of stock options
and used $11,000 to pay for taxes as a result of employees’ vesting of restricted shares using share withholding.
For the three months
ended December 31, 2019, we received $170,000 from employees’ participation and purchase of stock through our ESPP and used
$6,000 to pay for taxes as a result of employees’ vesting of restricted shares using share withholding.
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,
and valuation of inventory, long-lived assets, finite lived intangible assets and goodwill.
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, 2020. Management made no changes to the Company’s
critical accounting policies during the quarter ended December 31, 2020.
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, 2020.