Clearfield, Inc. (CLFD) Q2 2024 Earnings Call Transcript

Ladies and gentlemen, greetings, and welcome to the Clearfield Fiscal Second Quarter 2024 Earnings Conference Call. 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.

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 would like to turn the call over to Clearfield's President and CEO, Cheri Beranek. Cheri?

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 rightsized raw footprint option for raw 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 American Act, known as BABA, as required by the broadband equity and access 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 5, industry forecasts from RVA indicate that the next 5-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 1/3 are forecasted to have access to more than one fiber provider. We believe the introduction of a 2-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.

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 to $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 averaged 4 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 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 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 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 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, noncash 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 margin 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 a 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 noncash 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 to $44 million. We expect to generate a net loss per share in the range of $0.31 to $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 to $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 prepared 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.

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 build 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, 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 build 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 technicians. Both voice and text guidance for Clearfield products are immediately available in English, Spanish, and German. Anyone can download the free build 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. And with that, we will open the call to your questions.

Our first question is from Ryan Koontz with Needham and Company.

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

This is related to excess inventory due to the value we have compared to our sales. It is not about obsolescence or lower market costs. I believe our overall gross margin would have been closer to 19% if we had adjusted to a more normalized number.

And Cheri, on the Community Broadband trend, nice to see that rebounding there. Can you maybe give us a little color on some of the trends you're seeing in that Tier 3 market in terms of new builds versus edge-outs versus fill-in, connected home? Any color you can share there in that Tier 3 space, please?

Yes, 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 3 providers who were not necessarily telco providers, but community-based deployments and other providers who are new to us who are coming onboard through distribution.

And then on the kind of government funding side, I don't think many would be surprised by your commentary on BEAD in '25. Any commentary you would share on the non-BEAD programs as it relates to ARPA or capital projects fund? It feels like every month, we're seeing hundreds of millions of new awards in that space. 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?

We observed that some projects were initiated before BEAD was introduced, contributing to the recovery in 2022 and 2023. These are early-stage programs that faced fewer administrative hurdles compared to the BEAD program or were existing programs that were extended, allowing for greater awareness. Some of these projects have reached the Tier 3 market, while others are more closely linked to larger providers in the MSO space, particularly the mid-market MSOs that are starting to leverage these opportunities. I anticipate we will witness progress during the 2024 build season, which will serve as a bridge to the broader BEAD program set to launch in 2025 and onwards.

Our next question comes from the line of Scott Searle with ROTH Capital Partners.

Also nice to see you guys putting in the trough and a sequential outlook improving into the June quarter. 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?

I will begin by discussing the later part of the year. We expect to see the start of a normalized build season. While we cannot predict the product mix beyond this quarter, we are noticing certain ordering and quoting patterns that suggest we are entering a normalized program. As a result, the fourth quarter appears to be relatively consistent. Regarding the large cable providers and Large Regional providers, their return to full operation remains uncertain. These providers hold significant inventory and have questions about how quickly they will deploy their capital equipment in relation to their subscriber acquisition rates. Therefore, the Large Regional MSO providers are the variables that could impact our forecasts, which is why we need to proceed with caution.

And Cheri, to follow up on that, what are you considering from those two categories over the next few quarters? With the T-Mobile joint venture now involving Lumen, which has historically been a customer, how do you see that developing for you?

T-Mobile and Lumen make a compelling partnership. It highlights the progression towards a unified fiber network where wireless and wireline services merge. As 5G rollout accelerates, T-Mobile can deploy 5G using a different spectrum that enables faster implementation, but this method lacks scalability. To accommodate more bandwidth and users, especially for their fixed wireless services, they need to expand their fiber infrastructure. A collaboration or joint venture with Lumen is a promising solution for them to achieve this control. We have previously engaged with Lumen and contributed to their development. While we tend to avoid naming customers due to competitive sensitivities, it's exciting to see progress being made. People are no longer in a holding pattern; they are actively planning to move forward.

And one last one, if I could, Dan, just to clarify on 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?

Yes. Sure. Yes, it still stays there. I see it being a little bit lower, like more like $3 million or so, at least plus or minus, but that's what we're looking at for Q3 right now. As revenue goes up, these things are going to go down and sequentially will go down as revenues increase. 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 become bigger, we'll start to get into our numbers.

Our next question comes from Jaeson Schmidt with Lake Street Capital.

Most have been covered, but just curious if you could update us on how the cross-selling opportunities with the Nestor product portfolio has progressed since you brought that online.

It's ongoing, but I would say it's still in the discovery phase. We have had the advantage of engaging with some current customers who are purchasing cable, as well as potential customers primarily related to connectivity at several European trade shows over the past few weeks. We will continue this momentum with ANGA COM in Germany in a couple of weeks. What's crucial here is that it's not about generating revenue at this moment; it's more about establishing partnerships. We believe we have a strong product sense, but we need to align ourselves better to expand our channel offerings. In the U.S., we have a robust direct sales program and a very well-developed distribution network. Therefore, we are evaluating that distribution network in targeted countries to see how we can enhance the product offerings we currently have.

Yes. 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.

As there are no further questions, I now hand the conference over to Cheri Beranek for closing comments.

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 5 years. The next 5 years is really what Clearfield is looking for. And we hope you're part of our journey.

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