Earnings Call Transcript - CLFD Q2 2023

Operator, Operator

Good day, and welcome to the Clearfield Fiscal Second Quarter 2023 Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Greg McNiff, Investor Relations for Clearfield. Please go ahead.

Greg McNiff, Investor Relations

Thank you. Joining me on the call today are Cheri Beranek, Clearfield's President and CEO; Dan Herzog, Clearfield's CFO; and Kevin Morgan, Clearfield’s CMO. 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 in the forward-looking statements. It is important to note also 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. With that, I would like to turn the call over to Clearfield's President and CEO, Cheri Beranek. Cheri?

Cheri Beranek, President and CEO

Good afternoon, everyone, and thank you for joining us today to discuss Clearfield's results for the second quarter of fiscal 2023. We will also provide an update on our business and current market trends. Before I review our performance and current market dynamics, I want to emphasize that we remain more confident than ever that the long-term demand for fiber broadband remains exceptionally strong as the superiority of fiber as both a technology and an investment is well established. Accordingly, we are focused on positioning the company to capture market share once industry ordering patterns return to more normalized levels. I'll discuss these initiatives in more detail shortly. Clearfield has always differentiated itself on its crisp execution. As demand increased throughout the pandemic, Clearfield was able to respond quickly, driving revenue beyond 40% growth for the previous 9 quarters. Moreover, our execution allowed us to move into larger accounts and take share as demand for hardware intensified. We intend to remain focused on execution as the industry works through the near-term dynamics and prepares for the return to growth, led by significant government funding initiatives. Our second quarter fiscal 2023 revenue and net income per share came in relatively in line with our forecast for the quarter. Total net sales for the second quarter were $72 million, which includes the $11 million contribution from Nestor Cables. However, following our first quarter report, what we originally thought was a transition to a more normalized seasonally driven ordering and deployment patterns by some of our customers has developed into a much more significant lull in demand as inventory is digested. Specifically, we have experienced order pushouts by several large regional service providers and some multiple system operators, MSOs or cable TV providers who had accumulated an excess inventory position during the pandemic period. In light of this inventory digestion, we expect revenue to be lower than we previously anticipated. Accordingly, we are updating our revenue guidance for fiscal year 2023. We now expect revenue for the full year to be in the range of $260 million to $275 million. Additionally, we are updating our 2023 net income per share guidance. We now expect net income per diluted share to be in the range of $1.80 to $2.10. The majority of this downward revision to guidance is due to a pause in orders at the large regional service providers and to a lesser extent, the MSOs. Of the approximately $120 million in revenue reduction at the midpoint of guidance, a significant portion was due to pushouts in orders while the remainder was due to an inventory overhang related to purchases during the pandemic. As we discussed in our previous earnings call, throughout the pandemic, our customers ordered products early in their deployment schedule to stay ahead of any supply chain challenges. This just-in-case approach, particularly at our large regional service providers, led to growth in our backlog, which reached record levels by the end of fiscal year 2022. As our customers digest this inventory buildup, we are rightsizing capacity levels with this level of demand. In light of this inventory digestion, we expect revenues to be lower than we previously anticipated. In order to provide more visibility into this dynamic, starting this quarter, we will break out revenue contributions from our large regional service provider customers, such as Lumen, Frontier and Windstream. The historical financials for the new market segmentation can be found in the appendix on Slide 22. I want to stress that we have not lost any customers in this segment, and we believe we will continue to take share in this segment when growth returns. We remain confident that long-term demand for high-speed broadband remains strong and that we are well positioned to benefit from the significant rural broadband build that is still in front of us. While we are rightsizing capacity levels to meet current demand, we are maintaining the infrastructure and processes for long-term growth and continue to design products to address our customers' biggest pain points and reduce the amount of skilled labor required to install. As many of you are aware, our primary end market is community broadband, which is predominantly comprised of Tier 2 and Tier 3 incumbent local exchange carriers as well as a number of municipalities, utilities, co-ops and wireless carriers. While there are pockets of excess inventory within this market segment, we believe it has less exposure to these headwinds. I now want to highlight how Clearfield is preparing to take share once we get through this period of inventory digestion. First, we continue to design our product line to be craft friendly in the field, reducing both the amount of necessary skilled labor needed for the installation and the level of skill required to install our hardware. As illustrated on Slide 5, the most recent example of this strategy is our SeeChange product. SeeChange is designed to enable customers to complete their deployments faster and more efficiently, accelerating their time to revenue. As a reminder, labor accounts for approximately 70% of total deployment costs, so these savings can be significant. SeeChange has already received significant positive feedback from multiple carriers. Second, the scalable nature of our equipment allows customers to pursue a pay-as-you-grow strategy. Our Clearfield Cassette has changed the rules of fiber management. This integrated fiber management system is based on multiples of 12 fibers and can be utilized whenever and wherever it is required in the network. Other vendors' equipment is customized to specific parts of the network, an approach which requires more labor to install and resources to manage. This modular and scalable strategy has allowed us to extend our market leadership in underserved rural broadband to become the leading provider. Additionally, we have been able to move upmarket to larger customers looking to accelerate their deployment cycles and reduce labor costs. We intend to keep delivering additional craft-friendly products that shorten the deployment time; combined with superior execution, this proven strategy will allow us to continue taking share. Please turn to Slide 6. To further enhance our positioning, we have worked to improve our product delivery lead time. During the pandemic, lead times reached a height of 20 weeks due to supply constraints. Lead times are now more in the range of 6 to 8 weeks, and we are targeting long-term lead times of 4 to 6 weeks across all product lines with the exception of Active Cabinets we still face supply constraints. This work to improve our lead time covers our customer ordering cycles as they begin to return to pre-COVID patterns, but at post-COVID volumes.

Kevin Morgan, CMO

Thank you, Cheri. It's great to be joining all of you this afternoon. The latest market research forecast from RVA, a leading market research authority in the field of fiber optic telecommunications market research reflects the industry commitment to fiber expansion. As you can see from the chart, the Tier 1 independent local exchange carriers, or ILEC, led the initial build-out phase of the fiber-to-the-home market during the first 20 years of deployment. However, in 2023, the shift is occurring in the market. According to the data, the other service providers in the market collectively will surpass the cumulative fiber to the homes marketed total of the Tier 1 ILEC. Other service providers include the community broadband and MSO customer segments. The appetite for high-speed broadband communications has never been greater and shows no sign of letting up. This continues to drive fiber deployments deeper into every corner of society and across all market segments. As Cheri mentioned, we believe our work to maintain our world-class lead times and further progress our Elite strategic plan enhances our position for the long-term demand environment. In 2022, a fiber provider survey published in December by the Fiber Broadband Association estimated a 10-year annual average run rate of 11.3 million fiber deployments. In 2022 alone, fiber providers passed 7.9 million additional homes, representing a new record for annual deployment. This momentum gives us a powerful foundation for 2023 and the years ahead. We're positioned within an investment cycle that has yet to reach its peak. We continue to view the gradual disbursement of ARPA and RDOF funds and the upcoming distribution of B funding as meaningful but gradual industry tailwinds that further expand our market opportunity.

Dan Herzog, CFO

Thank you, Kevin, and good afternoon, everyone. Please turn to Slide 9 to look at our fiscal second quarter 2023 results in more detail. Consolidated net sales in the second quarter of fiscal 2023 were $72 million, a 34% increase from $53 million in the same year-ago period. This figure includes $61 million of organic net sales from Clearfield and an $11 million contribution from Nestor Cables, reflecting a 50% increase from Nestor Cables over the previous quarter. As many of you are aware, we acquired that business in July of last year. We are investing in capital equipment and faster processing capability to reduce costs and improve margins at Nestor. Furthermore, the discovery process and how to best provide higher-margin connectivity solutions into the European market continues. The year-over-year increase in net sales was due to higher sales across our core end markets, particularly in our community broadband and MSO markets, along with the contribution from Nestor Cables in our international markets. Order backlog declined 21% to $108 million on March 31, 2023, down from $136 million on March 31, 2022, and $136 million on December 31, 2022. We expect backlog will reduce further and that it will be roughly equivalent to quarterly revenue. While we continue to disclose backlog based on the feedback we received from our investors, we believe our lead time progress remains a more meaningful measure of our operational performance going forward. As Cheri noted, our lead times are currently 6 to 8 weeks with a goal of getting down to 4 to 6 weeks, excluding Active Cabinets. Turning to Slide 10. I will now review net sales by our key markets. Sales to our primary market, Community Broadband, comprised 47% of our net sales in the second quarter of fiscal 2023. In Q2, we generated net sales of approximately $34 million in community broadband, up 26% from the same period last year. In addition, for the trailing 12 months ended on March 31, 2023, our community broadband market net sales totaled approximately $152 million, which was up 72% from the comparable period last year. As Cheri indicated, we are breaking out revenue contributions from our large regional service provider customers, which were previously included in the Community Broadband and national carrier segments. We believe this new customer segmentation will allow investors to better understand the near-term industry dynamics Cheri highlighted earlier. To provide clarity to this customer group, we have broken our community broadband customer market to disclose revenue from the traditional smaller providers and from ILECs with footprints of 500,000 subscribers and above, which we refer to as large regional service providers. While net sales in our large regional service providers market were up 19% over the trailing 12-month period, net sales for the second quarter declined by approximately 17% year-over-year for this market. We anticipate the revenue decrease among this customer group will continue for a period of time. Please refer to the slide at the end of this presentation to view the historical revenue contribution for this new customer market. Our MSO business comprised 14% of our net sales in the second quarter. Net sales grew 39% year-over-year and are up 127% for the trailing 12-month period. Net sales in our national carrier market for the second quarter decreased by approximately 16% year-over-year. On a trailing 12-month basis, net sales in our national carrier market were up 25% from the year-ago period. Finally, net sales in the international market increased 800% year-over-year in the second quarter compared to the same period last year, and we are up 255% in net sales year-over-year on a trailing 12-month basis due to the acquisition of Nestor Cables, who contributed $11 million towards this market. As detailed on Slide 12, gross profit margin in the second quarter declined to 32.8% of net sales from 43.3% of net sales in the same year-ago quarter. Our gross margin was impacted by unused capacity in our Mexico facility due to the lower levels of demand as well as Nestor's lower gross margins as its revenue contribution represented a higher percentage of overall revenue. Given the dynamics impacting the industry, including rising supply costs as well as our exposure to large regional service providers, we now expect gross margins to finish the fiscal year near 30% and expect to achieve mid-30s to 40% when volumes ramp up to our initial fiscal year 2023 revenue guidance levels. While Clearfield does not compete on price, we have been prudent in how we pass along rising costs to our customers in the interest of maintaining our long-term relationships. We will continue to be thoughtful in addressing these costs with our customers going forward. Now please turn to Slide 13. Operating expenses for the second quarter were $11.5 million, which were up slightly from $11.2 million in the same year-ago quarter. This increase is the result of the addition of operating expenses from the Nestor Cables business acquired in July 2022, offset by the reversal of performance-based compensation accruals during the fiscal second quarter. As a percentage of net sales, operating expenses for the second quarter were 16%, down from 21% in the same year-ago period, which reflects improved operating leverage. Turning to Slide 14. Net income in the second quarter increased 12% to $10.4 million from $9.2 million in the same year-ago period and was down from $14.3 million in the first quarter of fiscal 2023. As a percentage of net sales, net income for the second quarter was 14%, down from 17% in the same year-ago period and down from 17% in the first quarter of fiscal 2023. As illustrated on Slide 15, our balance sheet remains strong with $166 million of cash, short-term and long-term investments, and $2 million of debt. We had $2.5 million in capital expenditures in the quarter, mainly to support our manufacturing operations. Our inventory balance increased from $90 million to $101 million in the second quarter, driven by the industry dynamics we have discussed. While we expect inventory levels to increase slightly throughout the year, we do not expect them to do so at the same levels as we experienced in fiscal year 2022, resulting in improved free cash flow in the fiscal year ahead. As Cheri noted, we now expect revenue for the full year to be in the range of $260 million to $275 million. Additionally, we now expect net income per diluted share to be in the range of $1.80 to $2.10 per share. With the capital raise we undertook last year, we plan to continue investing in our infrastructure and other necessary strategic areas. Additionally, our strong balance sheet ensures that we are well positioned to effectively compete for larger customer opportunities and the ability to pursue strategic opportunities to enhance our product portfolio. That concludes my prepared remarks for our second quarter of fiscal 2023. 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, President and CEO

Thanks for the finance update, Dan. Turning to Slide 17, I would now like to provide an update on our multi-year strategic plan, LEAP, which is our roadmap for how we intend to capitalize on the significant opportunities ahead. Starting with L, which stands for leverage, we remain focused on leveraging our significant relationships in community broadband by listening to our customers and responding with solutions that address their pain points. As I mentioned earlier, we recently announced the launch of SeeChange, which reduces deployment time and labor costs. We expect to make similar announcements throughout the year. E stands for execution. To that end, we are currently rightsizing our capacity in our Mexico facility in order to navigate current market dynamics while ensuring we are ready to meet the market opportunity ahead. Likewise, we remain focused on reducing our lead times by strengthening our supply chain partnerships. Finally, we are pursuing cross-selling opportunities with Nestor's fiber cable, both domestically and at some point in the near future in Europe. The A in our LEAP plan is to accelerate infrastructure investment. We expect investments in our systems to continue to drive incremental growth and margin expansion going forward. We will also continue to expand Clearfield College to provide online and in-field training support as our industry navigates the ongoing shortage of skilled labor in the market. Finally, the P in LEAP stands for position innovation at the forefront of our value proposition. To that end, we intend to increase the cadence of our product releases while ensuring we provide the best value for our customers through our innovative product design. Several third-party analysts have estimated the total government funding for underserved and unserved markets to be approximately $100 billion over the next several years. Moreover, this funding is aimed at those markets in which we are a clear leader. As Kevin highlighted, this funding will drive a sizable shift in the coverage of fiber deployment such that the share of households passed will shift to the smaller and alternative carriers. Clearfield is favorably positioned to benefit from this shift and expects to recognize revenue from these funding initiatives beginning next year. In addition to the significant demand generated by the government funding outlay, we are preparing for several large opportunities over the coming years, including expansion into Europe, for which Nestor Cables provides a strong base. The integration of wireline and wireless architectures as 5G ramps up and the evolution of the fiber network to the edge to manage low latency, data-intensive applications. In summary, while our second quarter financial results and guidance reflect the current state of the market, we are focused on building a strong foundation from which to address the long-term demand for high-speed broadband across our markets. While we are rightsizing capacity levels to meet current demand, we are maintaining the infrastructure and processes for long-term growth and continue to design products to address our customers' biggest pain points and to reduce the amount of skilled labor required to install. And with that, we will open the call to your questions.

Operator, Operator

Our first question comes from Ryan Koontz with Needham.

Ryan Koontz, Analyst

Thanks for the added metrics on the regionals. It's clearly an area of concern here. I wonder if you can kind of walk through, I mean, we've seen the regionals, a lot of them downsized their plans and revised CapEx lower this year. That's obviously a contributor and kind of doubling the problem of overbuying last year. I wonder if you could reflect on that and maybe some of the other segments, specifically community broadband and how you think about that market evolving over the next couple of quarters where I don't think we're aware of such an inventory issue, but are labor costs as big of an issue in the community broadband side as well as the regionals.

Cheri Beranek, President and CEO

Yes, as you've noted, this is very much an industry issue affecting the regional service providers. The global economic and macroeconomic challenges, along with inflation, are prompting some of these providers to reassess their capital expenditures, which they have announced in recent weeks. It appears that after placing significant inventory last year as a precaution, they are gaining better insights as we enter the build season. In discussions with them during February, March, and April, there was definitely a noticeable change in their approach. Long-term, there is a strong commitment to broadband, and as many others in the industry have mentioned recently, we anticipate a robust return to broadband deployment in the latter half of the year. Unfortunately for Clearfield, our latter half of the year is approaching quickly, as our fiscal year ends in September. Compared to regional service providers, community broadband tends to be less inventory intensive. While there are some exceptions, we observe that many smaller community broadband providers are starting to initiate their deployments, which highlights the strength of our business in this segment. Overall, we are encountering labor challenges, but we are hearing that the situation is gradually improving, though not rapidly. Additionally, while community broadband faces fewer issues, regional providers are experiencing challenges with permitting. These permitting issues arise not only from having a single provider but also from multiple providers entering a market, resulting in cities and communities becoming overwhelmed in their response. This is a dynamic situation that will need to be navigated. However, we are excited about our ability to thrive in this environment, even though it is quite challenging at the moment.

Ryan Koontz, Analyst

Understood. Just a quick follow-up if I could around the ARPA contribution. Are you still seeing momentum there? Is there also a similar pause going on in the area of these ARPA awards that seem to be a nice steady stream of awards over the last few months?

Cheri Beranek, President and CEO

We're expecting to see revenue growth in Community Broadband this summer. While some of our smaller providers won't reach the 10,000 homes mark this year, they're securing contracts for communities that are reaching 3,000 or 2,000 homes, and all of these efforts contribute to our overall growth. We’re enthusiastic about collaborating with several of these accounts, both directly and through our distribution channels.

Operator, Operator

Our next question comes from Jaeson Schmidt with Lake Street.

Maxwell Michaelis, Analyst

This is Max on for Jaeson. Just in terms of the guide, I want to get your cadence for the next couple of quarters. In other words, when should investors see a trough in revenue?

Cheri Beranek, President and CEO

We anticipate the next couple of quarters will be pretty consistent with each other. So, it will drop from current conditions for third quarter and then third and fourth quarter, we think we'll be pretty consistent with each other. This is, at this point, the build season, the higher build season. And as a result, we tend to see some nice momentum already, which we haven't, unfortunately, picked up in March and April. We're looking for that in May and June. And because the lead times are shrinking drastically, that should work out just fine. I hope that answers your question.

Maxwell Michaelis, Analyst

No, it does. And then I just want to clear something up. So, you mentioned that you expect gross margin to be 30%. Is that for the next 2 quarters? Or do you expect the entire fiscal year 2023 gross margin to end up at 30%?

Cheri Beranek, President and CEO

Yes. No, that's a cumulative. So obviously, the third and fourth quarters will be less than that.

Operator, Operator

Our next question comes from Tim Savageaux with Northland Capital Markets.

Timothy Savageaux, Analyst

A couple of questions. As you look at your kind of reclassification, I assume you took Lumen out of national carrier into regional. But if we look at that particular segment of revenue, should we consider that effectively going to diminutive levels, immaterial levels, in the next couple of quarters as a primary driver of the revenue decline?

Cheri Beranek, President and CEO

Yes, the third and fourth quarters will be quite small. This is due to some inventory delays and order pushouts, as well as our expectations for follow-on orders that have not yet come through. However, looking ahead, there is a strong market opportunity for us, and our products are well-regarded in that sector, much like they are in community broadband. None of those carriers accounted for more than 10% of our business in a single quarter. However, when several of them have high single-digit contributions and face similar inventory challenges and project delays tied to postponed capital expenditures, it begins to have a significant impact.

Timothy Savageaux, Analyst

I asked about community broadband because it had a strong second half last year, but it seems to have a lesser impact on smaller carriers, which might have declined slightly from current levels. Am I understanding that correctly? I know there was a significant drop, so let's just address that one before moving on to the next question.

Cheri Beranek, President and CEO

Yes. Community broadband has shown a notable increase in the second quarter, rising by over 20% compared to the previous year's 70% growth. This indicates some inventory challenges with certain larger community broadband providers. Looking ahead to the third quarter, we anticipate new community broadband providers coming online. The main concern will be how quickly they can navigate their permitting processes and other challenges. In the long term, we expect a return to balance, but there might be some decline in the next two quarters, primarily due to larger providers utilizing their existing inventory for summer deployment.

Timothy Savageaux, Analyst

Got it. I have a similar question regarding the cable segment. There was a notable decline in the second quarter. Looking ahead, can you clarify whether your comments on cable pertain to the past quarter or are more forward-looking? Do you anticipate further significant declines in that segment for the remainder of the year?

Cheri Beranek, President and CEO

Yes, we mentioned that the declines were primarily among regional service providers and to a lesser extent with the MSOs. I don't see much difference in the rate between the segments. The key difference is that one carrier can account for millions of forecasts in MSOs and regional service providers, while community broadband represents a much smaller figure. In terms of cable TV, I don't see any significant change; they remain optimistic about maintaining a strong foothold in the residential broadband market. As the CapEx spending among telcos decreases, the competitive pressure they have faced also diminishes. This year, the situation has shifted from a frantic race for market share to a focus on successful deployment by concentrating on connecting already passed homes and additional future homes. Their ROI models need to adapt; the cost to connect a home has been underestimated, and labor costs are higher than anticipated. Additionally, this year's interest rates differ substantially from what their business plans were based on, which has extended the timeline for opportunities rather than providing immediate results. For fiber-to-the-home, they achieved a record of 7.9 million homes last year, which is impressive, but they project the average over the next decade will exceed 11 million. Overall, the timeline for advancements has been pushed further into the future rather than being realized in a shorter timeframe.

Timothy Savageaux, Analyst

Okay. And last question for me. I mean, historically, kind of pre the big pandemic-driven surge, you had talked about kind of sustainable growth rates for Clearfield in kind of the double-digit 10% to 15% range. As we look forward to realizing visibility is not great right now, care to frame growth expectations heading into 2024 relative to those historic benchmarks?

Cheri Beranek, President and CEO

While we're not giving 2024 guidance, we firmly believe that Clearfield is in a position as the shift moves from larger carriers to the smaller alternative carriers that we can grow faster than market rates. And so that will be our goal and our positioning by which to do that.

Operator, Operator

Our next question comes from Scott Searle with ROTH.

Scott Searle, Analyst

Cheri, looking at the business mix across different customers, last year was primarily about expanding our footprint, and there's also revenue generated from connections in CapEx. Could you provide insight into how that business mix appears across the broader base, where you are observing growth, and how the gross margins compare? I have a couple of follow-up questions as well.

Cheri Beranek, President and CEO

Our gross margins for homes passed and homes connected are quite similar, so this does not affect our gross profit outlook. As a company, we have a higher penetration in homes passed with our Cabinet line compared to the number of homes connected, and our share among homes connected is lower than our share of homes passed. This year, one of our major initiatives is to establish ourselves in community broadband, where we have a higher penetration of homes connected compared to large regional service providers. In those regional providers, we focus on passing homes and have not yet become a portfolio provider for our full range of solutions. This highlighted the need for even simpler products than we currently offer. Alongside the terminals and drop cables we provided before, we launched a product line called SeeChange this spring. SeeChange is an entirely package-in-place solution that requires no splicing; you simply plug it in and move on. Not only is it easier to install, but it simplifies the process for users. This new proprietary product at Clearfield has been in the market for about 60 days and will help us boost our penetration rate into homes connected as we look ahead to 2024 and beyond.

Scott Searle, Analyst

Right. Very helpful. And maybe to follow up, we talked a lot about excess inventory and kind of hitting the pause button at a number of the different categories in terms of regional providers and MSOs. But do you have an idea of what the existing inventory levels look like within those two groups? It seems like it's built into the expectations now of it's going to persist into June and the September time frame. But it also seems like you're seeing some indication that maybe in December, there starts to be a pickup. So, thoughts on inventory within those customers and these two quarters to kind of work through those inventory excess levels.

Cheri Beranek, President and CEO

We have visibility into some accounts regarding their inventory levels through their Excel charts, and we also track distributors, although not every community broadband provider. We communicate with most community broadband customers at least quarterly and engage with regional service providers weekly or even daily, depending on the situation. Therefore, I can't provide a definitive timeline of three or six months regarding the inventory position, as it depends on whether these customers will follow through with their initial plans. Last year, they did not execute their original plans, leading to excess inventory. My best response is that we remain optimistic about the environment. We adopted a conservative approach for our guidance due to uncertainties surrounding their plans and execution history. We aim to keep our investors informed, which is why we highlighted additional market segments for transparency. One of the strong aspects of Clearfield is our focus on profitability from the outset. Over the past nine quarters, we've consistently grown our top line by 40% while achieving high teens in net income, delivering a solid return for investors. While we currently have capacity exceeding current demand, we have successfully responded to demand in the past and believe that demand will return. Our product lines have been positively received, and we now have the infrastructure in place to meet the original forecasted levels, not just this year, but certainly in the future.

Scott Searle, Analyst

Great. Very helpful. And lastly, if I could, on the gross margin front, certainly, you're going through some absorption issues over the next couple of quarters, but you referenced rationalizing some of the Mexican capacity. I wonder if you could talk about that. And then as well, inventory levels are elevated by design. But now as the world has started to normalize from a supply chain perspective, how is that playing into the gross margin headwinds because you're not running the factories as hard as well? The absorption issues are exacerbating that. And how quickly do they come back then with the top line starting to recover at some point as we get into fiscal 2024?

Cheri Beranek, President and CEO

You're right, we have not fully absorbed our capacity and overhead allocations. We have reduced costs by employing fewer workers in some of our factories. From an inventory perspective, we've seen an increase tied to our inventory summits and organics, along with a significant rise at Nestor Cables. We are extremely proud of the nearly 50% increase in Nestor Cables in the first quarter. The demand opportunity in Europe is proving substantial, and we expect to see a strong contribution from Nestor Cables in the third quarter. On the downside, they operate at a lower gross profit percentage compared to organic Clearfield, meaning the mix between Clearfield and Nestor will likely lower our overall numbers. We are investing significantly in additional equipment and capacity in Europe to enhance the gross profit of Nestor, and as we introduce connectivity products into Europe, we anticipate seeing improvements in our global gross profit figures. Looking ahead to 2024, while we can't eliminate fixed costs from our Mexican and Minneapolis facilities, we are effectively managing variable costs. We expect to reach a gross margin level near our forecast of about 40% once we achieve the revenue targets in this year's guidance program.

Operator, Operator

Our next question comes from Greg Mesniaeff with WestPark Capital.

Greg Mesniaeff, Analyst

When you look at the order intake softness across your various customer categories, I'm assuming that the vast majority of it relates to products designed for the residential broadband market, not for the small- to medium-sized business. Is that correct?

Cheri Beranek, President and CEO

Our product line, the Clearview Cassette, can be used for residential as well as for business class deployment. It's one of the advantages of our architecture so that you use all of the same products regardless of where it's being deployed.

Greg Mesniaeff, Analyst

Right. But you don't know whether the lower orders are related to softer residential demand on the part of your customers or business, that's not…

Cheri Beranek, President and CEO

No, I couldn't tell you that.

Greg Mesniaeff, Analyst

Okay. And second part of the question is, as your customer base moves further upstream into the larger carriers, what kind of, if any, competitive landscape issues are you running into as far as competition?

Cheri Beranek, President and CEO

As we engage more with regional service providers, we are increasingly competing against larger rivals. In the past couple of years, especially during the COVID period when our competitors lacked the capacity to serve these providers, we seized the opportunity to win new business. It was crucial for us not to merely take orders during that time; I wanted to focus on establishing relationships for repeat business. We conducted several trials to demonstrate labor savings and how we could become long-term partners in that sector. Typically, larger service providers will yield lower gross profits than community broadband, but this will be obscured in our future reports due to overhead absorption masking the higher margins we would usually expect from a standard community broadband operation.

Greg Mesniaeff, Analyst

And then one final. Any commentary or color on the use of proceeds from your raise?

Cheri Beranek, President and CEO

We were very fortunate to be in a position to raise money last winter, and our balance sheet being very strong has given us the opportunity to really look at a variety of factors. Certainly, in a time of uncertainty like now, having a strong balance sheet gives us a lot of considerations. It allows us to compete for big business and bigger customers, and it also allows us the opportunity to strategically look at opportunities to expand our product lines or to expand the channels by which we offer them. So, no definitive plans at this point but we are looking and managing our balance sheet with a very disciplined orientation.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Cheri Beranek for any closing remarks.

Cheri Beranek, President and CEO

Thank you very much. It's certainly been a challenging time, and I take it personally to disappoint investors. Your support and confidence in us is something we take great pride in. I believe in this company, I believe in everything that we're doing, and I look forward to continuing to earn your respect and trust moving forward.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.