Clearfield - Q2 2024

Transcript

Operator (participant)

Ladies and gentlemen, greetings and welcome to the Clearfield Fiscal Second Quarter 2024 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star and zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Greg McNiff, Investor Relations for Clearfield. Please go ahead, sir.

Greg McNiff (Head of Investor Relations)

Thank you. Joining me on the call today are Cheri Beranek, Clearfield's President and CEO, and Dan Herzog, Clearfield's CFO. As a reminder, the slides in this presentation are controlled by you, the listener. Please advance forward through the presentation as the speaker presents their remarks. Please note that during this call, management will be making remarks regarding future events and the future financial performance of the company. These remarks constitute forward-looking statements for purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. It is important to also note that the company undertakes no obligation to update such statements except as required by law.

The company cautions you to consider risk factors that could cause actual results to differ materially from those in the forward-looking statements contained in today's press release, earnings presentation, and on this conference call. The risk factors section in Clearfield's most recent Form 10-K filing with the Securities and Exchange Commission and its subsequent filings on Form 10-Q provide a description of these risks. They are also summarized on slide 2 of the earnings presentation. With that, I'd like to turn the call over to Clearfield's President and CEO, Cheri Beranek. Cheri?

Cheri Beranek (CEO)

Good afternoon, everyone. Thank you for joining us today to discuss Clearfield's results for the fiscal second quarter 2024. We also intend to provide an update on our business and current market trends. Please turn to slide 4. While we view 2024 as a transition year, we believe that the quarter ending in March represents the beginning of a gradual recovery as broadband service providers continue to deploy equipment and long-term demand remains robust. In the following slides, I will discuss the latest market data which supports this view. Total net sales for the second quarter of fiscal 2024 were $36.9 million, above the high end of our guidance range, driven by higher-than-expected sales from our community broadband customers, as this customer segment was the least impacted by the inventory overhang. Dan will discuss our financial results for the quarter in more detail shortly.

I would note that while we continue to expect ordering patterns for the remainder of the year to be impacted by the inventory overhang, predominantly in our large regional and MSO accounts, we have seen a pickup in quoting activity in our second quarter across all markets that is more consistent with the traditional build season. While we believe the recovery will be a gradual process, we remain focused on positioning Clearfield to take share when ordering patterns return to a more normalized cadence. We also continue to expand and enhance our product portfolio. As we announced in February, our newest active cabinet delivers a right-sized, small-footprint option for role expansion.

The small form factor of the FiberFlex 600 is designed to configure the numerous applications, including remote passive optical network distribution, wireless base stations with fiber backhaul aggregation, and active network equipment with backup power needs utilizing a flexible layout. This is Clearfield's latest and smallest-sized option in the FiberFlex series. With its small form factor, the FiberFlex 600 will give our customers more flexibility in how it is deployed in the outside plant, helping to overcome permitting and right-of-way challenges as they look to deploy fiber broadband in less populated areas. As with our CraftSmart and FieldSmart products, we are working to ensure these products and all other Clearfield offerings will be compliant with the Build America, Buy America Act, known as BABA, as required by the Broadband Equity, Access, and Deployment Program legislation, known as BEAD. I want to provide a brief update on the BEAD process.

As many of you know, the states have started announcing RFPs. While this is a great progress, we do not expect to recognize any significant revenue from customer participation in the BEAD program until calendar year 2025. Turning to the overall industry outlook, as illustrated on slide five, industry forecasts from RVA indicate that the next five-year period will see up to 59 million additional homes passed with fiber, which equates to a 12.5% compound annual growth rate. Of these 59 million homes, roughly a third are forecasted to have access to more than one fiber provider. We believe the introduction of a two-fiber competition among providers is a very healthy development and expands our total addressable market. Coming back to Clearfield's performance, I'd now like to pass the call over to our CFO, Dan Herzog, who will walk us through our financial results for the fiscal second quarter 2024.

Daniel Herzog (CFO)

Thank you, Cheri, and good afternoon, everyone. Please turn to slide 7 to look at our fiscal second quarter 2024 results in more detail. Consolidated net sales in the second quarter of fiscal 2024 were $36.9 million, a 49% decrease from $71.8 million in the same year-ago period but above our guidance range of $29 million-$33 million. The year-over-year decrease in total net sales was due to lingering inventory headwinds we have talked about in the past. As we transition into the build season, we anticipate a gradual uptick in orders more closely aligning with traditional ordering patterns. Throughout this transition phase, we remain focused on reducing costs and enhancing margins across the company. In Europe, this effort involves strategically investing in more efficient manufacturing equipment and introducing higher-margin plug-and-play connectivity products.

Additionally, we continue to be focused on labor utilization for enhanced productivity in order to improve gross margins at all our manufacturing locations, alongside efforts to reduce our inventory levels to enhance cash flow from operations. Order backlog increased 9% to $47.2 million on March 31, 2024, from $43.5 million on December 31, 2023. This quarter stands out as the first time in several quarters where our backlog has shown a sequential increase. We interpret this as an encouraging indicator of normalizing ordering patterns during a build season while customers continue to work through their inventory. We are continuing to collaborate with our customers to align their open orders with their current deployment schedules.

As a reminder, we expect backlog to become less of an indicator for future sales as most orders will be fulfilled within the quarter they are received. Our lead times average four weeks across most product lines. Turning to slide 8, I will now review net sales by our key markets. Sales to our primary market, community broadband, comprised 43% of our net sales in the second quarter of fiscal 2024. In Q2, we generated net sales of approximately $16.1 million in community broadband, down 52% from the same period last year. As Cheri mentioned, our community broadband market experienced a sequential uptick of 32% driven by a gradual increase in orders, including some new customers in the space as providers are preparing for the upcoming build season.

Net sales in our MSO business were $5 million, which comprised 13% of our net sales in the second quarter and decreased by approximately 50% in the second quarter of this fiscal year versus the prior year's second quarter. Net sales for the second quarter in our large regional service provider market were $3.2 million, comprising 9% of our total net sales and declined by approximately 75% in the second quarter of this fiscal year versus the prior year's second quarter. These customers continue to have a concentration of inventory from which they are deploying. Future quarters could be lumpy in this segment due to product mix concentrations and potential changes in their deployment strategies.

Net sales in our national carrier market for the second quarter were $2.1 million, accounting for 6% of total net sales and were relatively unchanged in the second quarter of this fiscal year versus the prior year's second quarter. Finally, net sales in our international market were $9.9 million and comprised 27% of total net sales in the second quarter. Net sales in this market decreased by approximately 24% in the second quarter of fiscal 2024 versus the prior year's second quarter. Revenues in Northern Europe were affected by a late spring and some economic issues in Finland. We anticipate a sequential increase in this market due to seasonality. As illustrated on slide 9, gross profit margin in the second quarter declined to 7.7% of net sales from 32.8% of net sales in the same year-ago quarter.

Our gross margin continues to be impacted by unabsorbed overhead in our manufacturing facilities and an increase in reserves for excess inventory due to the current low levels of demand. As mentioned on the prior quarter earnings call, non-cash excess inventory charges in the second quarter did increase sequentially by $1.5 million to about $5.2 million in the quarter. While we continue to expect revenue and gross margins in the second half of fiscal 2024 to be impacted by elevated inventory levels at our customers, we believe the second fiscal quarter represents the bottom of our customers' inventory digestion phase. As we transition into the build season, we expect order volumes and patterns to gradually improve. This anticipated increase in capacity utilization should subsequently result in improvements in gross margin levels. Now, please turn to slide 10.

Operating expenses for the second quarter were $12.6 million, up from $11.5 million in the same year-ago quarter. The company continues to strategically invest in the organization, yet with a prudent and disciplined approach to its cost controls. As a percentage of net sales, operating expenses for the second quarter were 34.1%, up from 16% in the same year-ago period due to lower sales volumes. Turning to slide 11, net loss in the second quarter was $5.9 million, compared to net income of $10.4 million in the same year-ago period and net loss of $5.3 million in the first quarter of fiscal 2024. Our net loss was heavily affected by our reduced volume levels, which in turn resulted in lower gross profit percentage and was also affected by the non-cash inventory reserves I mentioned earlier.

As illustrated on slide 12, our balance sheet remains healthy with $149 million of cash, short-term and long-term investments, and just $2 million of debt. We had $2 million in capital expenditures in the quarter, mainly to support our manufacturing operations, and $4.4 million year-to-date. Our inventory balance decreased from $95 million at the end of the first quarter of fiscal 2024 to $84 million in the second quarter of fiscal 2024. Our cash, short-term and long-term investments reflect a reduction of $20 million from December 31, of which $15.5 million was associated with the repurchase of shares in the second quarter. While we recorded a use of $3.2 million in our cash flow from operations in the second quarter, year-to-date we have generated $4.6 million from operations.

Our healthy balance sheet continues to ensure our readiness to competitively pursue larger customer prospects and strategic opportunities to enhance our market product portfolio. Likewise, our strong cash balance positions us to manage the business for the long term and, through our share repurchase program, reinvest for the long term. Please turn to slide 13. We anticipate third quarter fiscal 2024 net sales to be in the range of $40 million-$44 million. We expect to generate a net loss per share in the range of $0.31-$0.38. This loss per share range is based on the number of shares outstanding at the end of the second quarter and does not reflect share repurchases in the third quarter.

While our visibility remains limited beyond this quarter, we are encouraged by signs indicating ordering patterns are beginning to normalize with the onset of the build season and could follow the historical trend that our revenue in fiscal third and fourth quarters have been consistent with each other. As I indicated earlier, we repurchased an additional $15.5 million in stock in the second quarter as part of our share buyback program, which represented 543,439 shares at an average price of $28.48. Our belief in the value of our company and the market opportunity remains unchanged, as demonstrated by the size and scale of our buyback program. As such, our board of directors has increased our share buyback authorization from $40 million-$65 million, giving us $30.4 million authorized for additional repurchases when added to the $5.4 million repurchase amount available as of March 31, 2024.

This increase in our buyback authorization is a clear and proactive commitment on our part, driven by our strong conviction that our current share price is not reflective of our long-term opportunity. That concludes my preparatory remarks for our fiscal second quarter 2024. We appreciate the support of our investors as we continue to work to drive shareholder value. I will now turn the call back over to Cheri.

Cheri Beranek (CEO)

Thanks for the financial update, Dan. Turning to slide 15, I would now like to provide a brief update on our multiyear strategic plan, which we have labeled LEAP. As a reminder, LEAP is our roadmap for how we intend to capitalize on the significant opportunities ahead when industry demand returns to a more normalized cadence. Clearfield continues to build our product offerings to be craft-friendly, with the inherent goal of reducing the cost of deployments by improving installation time. To aid in this process, we have long provided in-field as well as classroom and online training through Clearfield College. In March, Clearfield announced the availability of an app-based 3D interactive training tool that provides an easy way to streamline the installation process. This solution is delivered on the BILT platform and is available at no extra charge.

The animated guides were developed in response to the Clearfield customer base and will help reduce installation errors, time, and field issues by ensuring field technicians have access to the information they need right at their fingertips. This training tool is exactly what fiber technicians are in need of, offering interactive guidance for step-by-step instruction without relying on manuals. We believe this is how today's workforce, and particularly new hires, can learn how to install Clearfield products correctly so that our customers can move quickly from deployment to service availability. Today's workforce is more tech-savvy and digitally oriented, making it ideal to develop an installation tool that aligns with their preferred methods of learning and consuming information. The availability of Clearfield instructions in the BILT app is part of the company's commitment to improve workforce development practices and tools.

As the industry works to increase the fiber technician workforce, this 3D interactive-based tool makes it easier to onboard and attract the newer generation of technician. Both voice and text guidance for Clearfield products are immediately available in English, Spanish, and German. Anyone can download the free BILT app worldwide from the App Store or Google Play. As we expressed last quarter, we remain confident that the long-term demand for fiber is as strong as ever, and Clearfield is well positioned to help service providers meet that demand. With that, we will open the call to your questions.

Operator (participant)

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. If you would like to ask a question, please press star and one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question is from the line of Ryan Koontz with Needham & Company. Please go ahead.

Ryan Koontz (Managing Director and Senior Analyst)

Hi, Cheri and Dan. Nice to hear commentary on filling the bottom here. Dan, first one for you on this reserves write-down. At a high level, is this related to obsolescence or costs that were out of line with what you can buy from today? And secondly, what was the impact of that write-down? What would margin have been without the write-down in the quarter?

Daniel Herzog (CFO)

Right. Sure. No, this is related to an excess only because of the value of the amount of inventory we have compared to our sales. It's not about obsolescence, and it's not about a lower of cost or market. So I think we would have had I think our overall gross margin here would have been closer to a 20% sorry, 19% number if you would have taken that to more of a normalized number.

Ryan Koontz (Managing Director and Senior Analyst)

Great. Awesome. And super helpful. And Cheri, on the community broadband trend, nice to see that rebounding there. Can you maybe give us a little color there on some of the trends you're seeing in that tier three market in terms of new builds versus edge-outs versus fill-in, connected home? Any color you can share there in that tier three space, please.

Cheri Beranek (CEO)

Yeah, we're excited about a couple of things. One is we're definitely seeing there's somewhat of a decrease in excitement about homes passed, not because people aren't ready to do it, but because they want to be able to focus on homes connected. And that's really the growth initiative, is making sure that they turn that home passing into a subscriber that generates revenue, which gives us some new revenue opportunities since the inventory that is out there is predominantly cabinets associated with passing homes. The other thing we're seeing is new customers, new tier three providers who are not necessarily telco providers, but community-based deployments and other providers who are new to us who are coming on board through distribution.

Ryan Koontz (Managing Director and Senior Analyst)

That's great. Great to hear. And then on the kind of government funding side, I don't think anybody's surprised by your commentary on BEAD and 2025. Any commentary you'd share on the non-BEAD programs as it relates to ARPA or capital projects funds? It feels like every month we're seeing $hundreds of millions of new awards in that space. And are you hearing about those projects coming to bat now? Is that already starting to impact some of your bookings for the year? And how would you characterize your thinking about those shorter-term projects over the next couple of years?

Cheri Beranek (CEO)

Yeah, we saw some of those projects as part before BEAD could come into play. That's been part of the recovery in 2022 and 2023, is those early-stage programs that didn't have all of the administrative challenges that the BEAD program does or were legacy programs that were extended so that people knew more about them. I would say some of them have hit the tier three market, others probably more associated in the MSO space where we're seeing some of the somewhat the larger provider, but certainly the middle market MSO get involved and being able to take advantage of it. I think we'll see some of that in this build season in 2024, and it'll be a good bridge until we get to the larger BEAD program in 2025 and beyond.

Ryan Koontz (Managing Director and Senior Analyst)

That's great. I'll pass it on. Thanks for the comments.

Operator (participant)

Thank you. Our next question comes from the line of Scott Searle with Roth Capital Partners. Please go ahead.

Ryan Koontz (Managing Director and Senior Analyst)

Hey, good afternoon. Thanks for taking my questions. Also nice to see you guys putting in the trough and a sequential outlook improving into the June quarter. Hey, maybe just to follow up on some of the other customer segments. Cheri, large regionals, MSOs, it sounds like that's still a little bit lumpy, but are you expecting to see sequential improvement as we look out into the June, September quarter? And maybe folding into that question, I thought Dan had a comment about seasonality returning in the fiscal fourth quarter. Are you kind of implying that we look flattish into September?

Cheri Beranek (CEO)

So I'll start at the back end. So yes, what we're anticipating is that we're starting the beginning of a normalized build season. While we can't see a lot of the product mix beyond this quarter, we are seeing some ordering patterns and some quoting patterns that would indicate that we are in kind of this normalized program where third and fourth quarter are pretty consistent with each other. From an orientation of what do we see in regard to the large cable providers or the large regional providers kind of coming back up to speed, I would say that's the biggest question mark that we have.

Those are the providers that, unfortunately, have either the largest inventory position or have the biggest question mark in regard to how fast they're going to be, excuse me, deploying in order to align their capital equipment expenditures alongside their subscriber take rates. I would say the large regional MSO providers are the swing that could take us below or above our numbers, and that's why we have to be a little careful.

Ryan Koontz (Managing Director and Senior Analyst)

Gotcha. And Cheri, maybe just to follow up on that, so what are you factoring in from those two categories over the next couple of quarters? And maybe throw the T-Mobile joint venture into there now with Lumos. Had historically been a customer. How do you see that playing out for you guys?

Cheri Beranek (CEO)

T-Mobile and Lumos is a really interesting combination, and I think it really shows the development of a one-fiber network where the wireless and wireline provider becomes one. As 5G deployments start to move forward, T-Mobile has had the opportunity to deploy 5G with a different level of spectrum, which has allowed it to be faster for deployment but isn't as scalable. And so they need, in order for it to continue to be able to add more bandwidth and more users, especially for their fixed wireless providers, they need to get more fiber in the ground. And so a joint venture or partnership with Lumos or acquisition in this case is an exciting way by which for them to control it. We have been excited to be part of the Lumos build in the past. We have been part of the Lumen build in the past as well.

We don't typically throw around customer names because there's so much competitive foundation there that one has to be very diligent and prudent about continuing to earn the business. But I would say what's most exciting is the fact that it's happening, and people are back to a standpoint of they're not waiting to see. They're actually making plans to make it happen.

Ryan Koontz (Managing Director and Senior Analyst)

Great. And one last one, if I could, Dan, just to clarify in the gross margins, you've got the excess inventory reserves. Looking at your guidance, it seems like that continues into the June quarter. Just want to clarify, how long does that continue? It seems like this is an accounting adjustment, again, not for obsolete inventory. So at some point, you should see the benefit of that. But when do we see that kind of work its way through the system, if you will, from an accounting perspective? Thanks.

Daniel Herzog (CFO)

Yeah. Sure. Yeah. So yeah, it still stays there. I'd see it being a little bit lower, more like $3 million or so, at least plus or minus, but that's what we're looking at at Q3 right now. And as revenues goes up, those things are going to go down, and sequentially, will go down as the revenues go up. So it's still going to be around, obviously, if our revenues in Q4 are similar to our projections in Q3, but probably more at that level that I just spoke to. And then as the U keeps growing sequentially, those become smaller, and recoveries will start to get into our numbers.

Ryan Koontz (Managing Director and Senior Analyst)

Great. Thanks so much. I'll get back in the queue.

Cheri Beranek (CEO)

All right. Thanks, Scott.

Operator (participant)

Thank you. Ladies and gentlemen, a reminder, if you wish to ask a question, please press star and one. Our next question is from the line of Jason Kreyer with Lake Street Capital. Please go ahead.

Jason Kreyer (Analyst)

Hey, guys. Thanks for taking my questions. Most have been covered, but just curious if you could update us on how the cross-selling opportunities with the Nestor product portfolio have progressed since you brought that online?

Cheri Beranek (CEO)

It's continuing, but I'd say it's still in the discovery phase. We have had the benefit of being able to be in front of some customers in our current customers buying cable and then prospective customers that would be associated more predominantly with connectivity in several European trade shows over the last few weeks and will be continuing that moving forward with ANGA COM in Germany in just a couple of weeks. I think what's important here is it's not about revenue right now. It's really more about being able to establish those partnerships. And what we're really looking for is we know the product sense that we feel is best, but what we really need to align ourselves with is to expand our channel offerings. We have had in the U.S. a very strong direct sales program, but more importantly, an extremely strong and well-developed distribution network.

We're looking at that distribution network in target countries and seeing what we can do to facilitate the product offerings that we have in play.

Jason Kreyer (Analyst)

Okay. That's helpful. And then just as a follow-up, Dan, you noted kind of managing OpEx here. It was down sequentially in March. How should we think about it ramping through the second half of this year?

Daniel Herzog (CFO)

Yeah. We'll have some additional variable costs that will go along with a little bit of increase in revenues here. So expect it to remain not too different percentage-wise from where we would be in Q2 right now, plus or minus a little bit, but you could probably aim at the same relative percentage.

Jason Kreyer (Analyst)

Got it. That's really helpful. Thanks a lot, guys.

Cheri Beranek (CEO)

You're welcome.

Operator (participant)

Thank you. Ladies and gentlemen, another reminder, if you wish to ask a question, please press star and one. As there are no further questions, I now hand the conference over to Cheri Beranek for closing comments. Cheri?

Cheri Beranek (CEO)

Thank you. Once again, it's been a pleasure to talk and speak with you. I think really, in summary, we want to make sure that everyone understands that we're excited about where we're at right now, but we want to reassure everyone that we're at the beginning of a gradual U-shaped recovery like we've been talking about for the last couple of quarters. We see deployments continuing somewhat moving forward. The deployments are happening, although they're somewhat thwarted by economic conditions. But we also see the gap between revenue and customer deployments. While it's still present, we believe the build season will work to minimize it. Furthermore, and I think most importantly, I would close with that we believe Clearfield is uniquely positioned to serve the 59 million homes that are anticipated to be passed with fiber over the course of the next five years.

The next five years is really what Clearfield is looking for, and we hope you're part of our journey.

Operator (participant)

Thank you. The conference of Clearfield has now concluded. Thank you for your participation. You may now disconnect your lines.