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, 2019, 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, 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, 2019.
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 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 Build-to-Print customers which include 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 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 the customer, some made
through two-tier distribution (channel) partners, sales agents and manufacturing representatives, and sales through original equipment
suppliers who private label their products.
Due to the role Clearfield’s
solutions play in supporting communications infrastructure, the Company’s operations in Minnesota have been classified as
critical sector work under the State of Minnesota “stay at home” executive order adopted in response to the novel coronavirus
(“COVID-19”) pandemic. We have transitioned our corporate employees at our Brooklyn Park headquarters to remote work
arrangements. In accordance with the CDC and WHO guidelines, we also have implemented health and safety measures for the production
staff that remain onsite at our Brooklyn Park facility. We have continued to maintain our manufacturing capacity in Brooklyn Park
with these personnel. Similarly, we have implemented the recommended health and safety measures for the production staff that remains
onsite at our Tijuana, Mexico manufacturing facilities.
The Company is closely
monitoring the operations and staffing levels at its manufacturing facilities in Tijuana, Mexico and the status of restrictions
at the U.S.-Mexico border. The State of Baja California, where our facilities are located, has adopted an order that has temporarily
suspended the operations of other manufacturers in the region. While our operations in Tijuana have not been affected, we may become
subject to local enforcement of the order at any time.
Even if our manufacturing
capacity in Mexico continues, we may experience challenges to timely supply of materials to our Mexico facilities and timely product
deliveries from the facilities due to border restrictions or border delays. Depending on the severity of these border issues, 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.
We dual source all
our components and most of our supply chain partners remain operational and continue to provide the necessary components for our
products to be manufactured in Minnesota and Mexico. We continue to monitor our supply chain, however uncertainties caused by the
impact of COVID-19 present significant risk of disruption in our supply chain.
Should the Company
experience a disruption in our ability to continue to produce in one or both of our facilities, disruption in our supply chain,
or a decline in operational abilities, our contingency plans would result in a potentially significant increase in manufacturing
costs and could impair our ability to fulfill customer orders.
RESULTS OF OPERATIONS
Three months ended
MArch 31, 2020 vS. three months ended mARCH 31, 2019
Net sales for the second
quarter of fiscal 2020 ended March 31, 2020 were $20,409,000, an increase of approximately 7% or $1,324,000, from net sales of
$19,084,000 for the second quarter of fiscal 2019. Net sales to Broadband Service Providers were $19,642,000 in the second quarter
of fiscal 2020 versus $17,948,000 in the same period of fiscal 2019. Among this group, the Company recorded $919,000
in international sales for the second quarter of fiscal 2020 versus $1,949,000 in the same period of fiscal 2019. Net sales
to build-to-print customers were $766,000 in the second quarter of fiscal 2020 versus $1,136,000 in the same period of fiscal 2019.
The Company allocates sales from external customers to geographic areas based on the location to which the product is transported.
Accordingly, international sales represented 5% and 10% of total net sales for the second quarter of fiscal 2020 and 2019, respectively.
The increase in net
sales for the quarter ended March 31, 2020 of $1,324,000 compared to the quarter ended March 31, 2019 was driven by increased sales
to Tier 1 and MSO customers of $1,549,000 and $1,130,000, respectively. Offsetting this were decreased sales to International customers
of $1,005,000, and Build-to-Print customers of $475,000, due to lower demand for each in the period. Additionally, sales to Community
Broadband customers increased $125,000, relatively unchanged from the prior period.
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 product delivery or changes in customer ordering patterns due to COVID-19. The Company’s
ability to recognize revenue in the third quarter of 2020 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. During March 2020,
the Company experienced increased orders as the Company’s customers remained committed to their 5G builds and other projects
to expand communications networks, which are part of the world’s critical infrastructure. The
Company believes that Tier 1 customers may expand their 5G-related capital expenditure budgets, which may lead to accelerated opportunities
for sales due to COVID-19. However, at this time, the Company does not have visibility into how long these customer ordering trends
will continue. We expect that restrictions on our employees’ ability to access our customers may negatively impact sales
in future quarters.
Cost
of sales for the second quarter of fiscal 2020 was $12,257,000, an increase of $198,000, or 1.6%, from $12,059,000 in the comparable
period of fiscal 2019. Gross profit percent was 39.9% of net sales in the fiscal 2020 second quarter, an increase from 36.8% of
net sales for the fiscal 2019 second quarter. Gross profit increased $1,126,000, or 16%, to $8,151,000 for the three months ended
March 31, 2020 from $7,025,000 in the comparable period in fiscal 2019. The increase in gross profit in the second quarter
of fiscal 2020 was due to increased volume while the increase in gross profit percent was primarily due to improved manufacturing
costs, supply chain management initiatives and lower tariff costs. Gross profit was negatively impacted by tariff costs of approximately
$61,000 for the three months ended March 31, 2020 and $268,000 in the comparable period in fiscal 2019. In the second quarter of
fiscal 2020 ended March 31, 2020, the Company did not experience any significant impacts on cost of sales due to COVID-19.
Selling,
general and administrative expenses increased $704,000, or 10%, to $7,431,000 in the fiscal 2020 second quarter from $6,728,000
for the fiscal 2019 second quarter. The increase in expense in the second quarter of fiscal 2020 consists primarily of increases
of $1,176,000 in compensation expense due to additional personnel, $187,000 in product certification testing expenses and $174,000
in outside sales representative commissions, offset by decreases of $449,000 in stock based compensation expense and $210,000 in
bad debt expense related to a customer bankruptcy occurring in the prior year period. In the second quarter of fiscal 2020 ended
March 31, 2020, 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 March 31, 2020 was $720,000 compared to $297,000 for the comparable quarter of fiscal 2019, an increase of
approximately 142%. This increase is attributable to increased gross profit, offset by higher selling, general and administrative
expenses.
Interest
income for the quarter ended March 31, 2020 was $218,000 compared to $169,000 for the comparable quarter for fiscal 2019. The increase
is due to increased balances and higher interest rates earned on investments in the second 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, U.S. treasury securities, and
money market accounts.
We
recorded a provision for income taxes of $190,000 and a provision for income taxes of $99,000 for the three months ended March
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 $91,000 from the second quarter for fiscal 2019 is primarily due to increased
income from operations. The decrease in the income tax expense rate to 20.3% for the second quarter
of fiscal 2020 from 21.2% for the second quarter of fiscal 2019 is primarily due to increased research and development tax credits.
The Company’s
net income for the three months ended March 31, 2020 was $748,000, or $0.05 per basic and diluted share.
The Company’s net income for the three months ended March 31, 2019 was $368,000, or $0.02
per basic and diluted share.
Six months ended
March 31, 2020 vS. six months ended March 31, 2019
Net sales for the six
months ended March 31, 2020 were $39,787,000, an increase of 2%, or approximately $613,000, from net sales of $39,174,000 for the
first six months of fiscal 2019. Net sales to Broadband Service providers were $37,798,000 for the first six months of fiscal 2020,
versus $36,761,000 in the same period of fiscal 2019. Among this group, the Company recorded $2,055,000 in international sales
versus $3,533,000 in the same period of fiscal 2019. Net sales to build-to-print customers were $1,990,000 in the first six months
of fiscal 2020 versus $2,413,000 in the same period of fiscal 2019. The Company allocates sales from external customers to geographic
areas based on the location to which the product is transported. Accordingly, international sales represented 5% and 9% of total
net sales for the first six months of fiscal 2020 and 2019, respectively.
The increase in net
sales for the six months ended March 31, 2020 of $613,000 compared to the six months ended March 31, 2019 is primarily attributable
to an increase in sales to Tier 1 and MSO customers of $2,324,000 and $1,555,000, respectively. This was offset by decreased sales
to International customers of $1,445,000, Community Broadband customers of $1,304,000 and Build-to-Print of $518,000.
Cost
of sales for the six months ended March 31, 2020 was $23,908,000, a decrease of $294,000, or 1%, from $24,202,000 in the comparable
period of fiscal 2019. Gross profit percent was 39.9% of net sales in the fiscal 2020 first six months, up from 38.2% for the comparable
six months in fiscal 2019. Gross profit increased $907,000, or 6%, to $15,879,000 for the six months ended March 31, 2020 from
$14,972,000 in the comparable period in fiscal 2019. The increase in gross profit in the six months ended March 31, 2020
was due to increased volume and a higher gross profit percent. The increase in gross profit percent was primarily due to improved
manufacturing efficiencies and costs in its manufacturing facilities, and lower tariff costs. Tariff costs were $161,000 in the
six months ended March 31, 2020, compared to $559,000 in the comparable six month period. In the six months ended March 31, 2020,
the Company did not experience any significant impacts on cost of sales due to COVID-19.
Selling,
general and administrative expenses increased 9%, or $1,254,000, from $13,504,000 for the first six months of fiscal 2019 to $14,758,000
for the first six months of fiscal 2020. The decrease in the first six months of fiscal 2020 consists primarily of increases of
$1,932,000 in compensation expense due to additional personnel, $257,000 in product certification testing expenses and $333,000
in outside sales representative commissions, offset by decreases of $721,000 in stock based compensation expense and $210,000 in
bad debt expense related to a customer bankruptcy in the prior year period. In the six months ended March 31, 2020, the Company
did not experience any significant impacts on selling, general and administrative expense due to COVID-19.
Income from operations
for the six months ended March 31, 2020 was $1,121,000 compared to income from operations of $1,468,000 for the first six months
of fiscal 2019, a decrease of $347,000, or 24%. This decrease is primarily attributable to increased gross profit, offset by increased
selling, general and administrative expenses.
Interest income for
the six months ended March 31, 2020 was $441,000 compared to $305,000 for the comparable period for fiscal 2019. The increase is
due to increased balances and higher interest rates earned on investments in fiscal 2020.
We recorded a provision
for income taxes of $313,000 and a provision for income taxes of $395,000 for the six months ended March 31, 2020 and 2019, respectively.
The decrease in tax expense of $82,000 from the six months ended March 31, 2019 is primarily due a lower effective tax rate for
the six months ended March 31, 2020. The decrease in the income tax expense rate to 20.0% for the six months ended March 31, 2020
from 22.3% for the six months ended March 31, 2019 is primarily due to increased research and development credits.
The Company’s
net income for the first six months of fiscal 2020 ended March 31, 2020 was $1,249,000, or $0.09 per
basic and diluted share. The Company’s net income for the first six months of fiscal 2019
ended March 31, 2019 was $1,378,000, or $0.10 per basic and diluted share.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2020,
our principal source of liquidity was our cash, cash equivalents and short-term investments. Those sources total $23,284,000 as
of March 31, 2020 compared to $23,606,000 as of September 30, 2019. 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
or backed by the U. S. Government. Investments considered long-term were $25,130,000 as of March 31, 2020, compared to $23,902,000
as of September 30, 2019. 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 as of March 31, 2020 or September
30, 2019.
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 uncertainties caused by COVID-19
and the Company’s desire to maintain capital flexibility, the Board of Directors has suspended the share repurchase program
originally adopted on November 13, 2014. As originally adopted, the Board of Directors authorized $8,000,000 for common stock repurchases
and on April 25, 2017, our Board of Directors increased the authorization to $12,000,000 of common stock. As of March 31,
2020, there was approximately $4,981,000 remaining for repurchases under the authorization.
Due to the economic
crisis resulting from the COVID-19 pandemic, we expect that our future cash flow may be negatively impacted due to COVID -19 impacts
within our operating and investing activities. We also expect that our uses of cash may be materially impacted by increased operating
expense associated with mitigating supply chain, logistics, customer fulfillment risks caused by COVID-19.
Operating Activities
Net cash used in operating
activities totaled $2,296,000 for the six months ended March 31, 2020. This was primarily due to net income of $1,249,000, non-cash
expenses for depreciation and amortization of $1,211,000, and stock based compensation of $329,000 in addition to changes in operating
assets and liabilities providing cash. Changes in operating assets and liabilities using cash include increases in inventory of
$2,675,000 and accounts payable, accrued expenses and deferred rent of $1,091,000, offset by a decrease in accounts receivable
of $1,049,000. The increase in inventory is a result of additional stocking
levels to support the Company’s increased backlog, and additional safety stock due to the uncertainty of the COVID-19 virus
on the Company’s supply chain. Accounts receivable balances can be influenced by the timing of shipments for customer
projects and payment terms. Day’s sales outstanding, which measures how quickly receivables are collected, increased one
day to 36 days from September 30, 2019 to March 31, 2020.
Net cash provided by
operating activities totaled $8,473,000 for the six months ended March 31, 2019. This was primarily due to net income of $1,378,000,
non-cash expenses for depreciation and amortization of $1,064,000, and stock based compensation of $1,102,000 in addition to changes
in operating assets and liabilities providing cash. Changes in operating assets and liabilities providing cash include decreases
in accounts receivable and inventories of $3,623,000 and $1,777,000, respectively. Accounts receivable balances can be influenced
by the timing of shipments for customer projects and payment terms. Day’s sales outstanding, which measures how quickly receivables
are collected, decreased from 52 days at September 30, 2018 to 43 days at March 31, 2019. The decrease in inventory is a result
of stocking levels being maintained by suppliers, which reduced the Company’s inventory.
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 and U.S. Government on these
investments. During the six months ended March 31, 2020, we used cash to purchase $19,077,000 of both FDIC-backed and treasury
securities and received $16,720,000 on CDs and treasuries that matured. Purchases of property, plant and equipment, mainly related
to manufacturing equipment, consumed $1,183,000 of cash during the six months ended March 31, 2020.
During the six months
ended March 31, 2019, we used cash to purchase $12,274,000 of both FDIC-backed and treasury securities and received $3,572,000
on CDs that matured. Purchases of patents and capital equipment, mainly related to information technology and manufacturing equipment,
consumed $552,000 of cash in the six months ended March 31, 2019.
Financing Activities
For
the six months ended March 31, 2020, 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. We
used $429,000 to repurchase 41,796 shares of our common stock under the share repurchase program in the six months ended March
31, 2020. As of March 31, 2020, we had the authority to purchase approximately $4,981,000 in additional shares under the repurchase
program announced on November 13, 2014 that was subsequently increased on April 25, 2017.
For
the six months ended March 31, 2019, we received $146,000 from employees’ participation and purchase of stock through our
ESPP and used $7,000 to pay for taxes as a result of employees’ vesting of restricted shares using share withholding. We
did not repurchase our common stock under the repurchase program in the six months ended March
31, 2019. As of March 31, 2019, we had authority to purchase approximately $5,400,000 in additional shares under the repurchase
program announced on November 13, 2014 that was subsequently increased on April 25, 2017.
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, 2019. Management made no changes to the Company’s
critical accounting policies during the quarter ended March 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 March 31, 2020.