ITEM 1A. RISK FACTORS
Risks Relating to Our Operations
The COVID-19 pandemic has significantly
impacted worldwide economic conditions and could have a material adverse effect on our business, financial condition and operating
results.
As a result of the COVID-19 pandemic, governmental
authorities have implemented and are continuing to implement numerous and constantly evolving measures to try to contain the virus,
such as travel bans and restrictions, limits on gatherings, quarantines, shelter-in-place orders, and business shutdowns. We have
manufacturing operations in the U.S. and Mexico that have been affected by the outbreak and we have taken measures to try to contain
it. Measures providing for business shutdowns generally exclude certain essential services, and those essential services commonly
include critical infrastructure and the businesses that support that critical infrastructure. While both of our facilities currently
remain operational, these measures have impacted and may further impact our workforce and operations, as well as those of our customers
and suppliers. The constraints and limits imposed on our operations may slow or diminish our product development activities and
qualification activities with our customers. Although many governmental measures have had specific expiration dates, some of those
measures have already been extended more than once; as a result, there is considerable uncertainty regarding the duration of such
measures and potential future measures. Restrictions on our manufacturing, support operations or workforce, or similar limitations
for our suppliers, could limit our ability to meet customer demand and could have a material adverse effect on our financial condition
and results of operations. Furthermore, restrictions or disruptions of transportation, such as reduced availability of air transport,
port closures and increased border controls or closures, have started to result in higher costs and delays, which could harm our
profitability, make our products less competitive, or cause our customers to seek alternative suppliers.
In response to these developments, we have
modified our business practices, including restricting employee travel, modifying employee work locations, implementing social
distancing and enhanced sanitary measures in our facilities, and cancelling attendance at industry events and conferences. Many
of our customers, suppliers, and service providers have made similar modifications. The resources available to employees working
remotely may not enable them to maintain the same level of productivity and efficiency, particularly our sales employees whose
in-person access to our customers and customer prospects has been significantly limited. While we have experienced only limited
absenteeism from those employees who are required to be on-site to perform their jobs, absenteeism may increase in the future and
may harm our productivity. Further, our increased reliance on remote access to our information systems increases our exposure to
potential cybersecurity breaches. We may take further actions as government authorities require or recommend or as we determine
to be in the best interests of our employees, customers, partners and suppliers. There is no certainty that such measures will
be sufficient to mitigate the risks posed by COVID-19, in which case our ability to continue operations may be significantly negatively
impacted, and we may be required to temporarily suspend our operations in the U.S. or in Mexico or in both locations. The resumption
of normal business operations after such interruptions may be delayed or constrained by lingering effects of COVID-19 on our suppliers,
third-party service providers, and/or customers.
In addition, government funding programs
such as the CARES Act, which was enacted in March 2020 in response to the COVID-19 pandemic, provides grant money for customers
that deploy products by certain calendar dates. The Company has increased its inventory to respond to increased demand related
to this program. If the program ends or is not extended, we could see a decrease in orders which may result in decreasing customer
purchasing patterns. If the programs are extended by governments, we may not be able to predict increases and decreased in customer
purchasing patterns.
The degree to which COVID-19 impacts our
results will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to,
the duration and spread of the outbreak, its severity, the actions to contain the virus and address its impact, and how quickly
and to what extent normal economic and operating conditions can resume.
We rely on single-source suppliers, which could cause delays, increases in costs or prevent us from completing customer orders, all of which could materially harm our business.
We assemble our products using materials and components supplied by various subcontractors and suppliers. We purchase critical components for our products, including injected molded parts, various cabling, optical components, and connectors from third parties, some of whom are single- or limited-source suppliers. If any of our suppliers are unable to ship critical components, we may be unable to manufacture and ship products to our distributors or customers. If the price of these components increases for any reason, or if these suppliers are unable or unwilling to deliver, we may have to find another source, which could result in interruptions, increased costs, delays, lost sales and quality control problems.
Further, the costs to obtain certain raw materials and supplies, such as fiber and copper cabling, are subject to price fluctuations, which may be substantial, because of global market demands. Many companies utilize the same raw materials and supplies in the production of their products as we use in our products. Companies with more resources than us may have a competitive advantage in obtaining raw materials and supplies due to greater purchasing power. Some raw materials or supplies may be subject to regulatory actions, which may affect available supplies. Further, tariffs may be imposed by the U.S. on imports from other countries that are the single- or limited-source of our materials and components. Tariffs increase the cost of the materials and components that go into making our products, but we are generally unable to pass long these increased costs to our customers. Accordingly, these increased costs adversely impact the gross margin that we earn on our products. Furthermore, due to general economic conditions in the United States and globally, our suppliers may experience financial difficulties, which could result in increased delays, additional costs, or loss of a supplier.
The termination or interruption of any of these relationships, or the failure of these manufacturers or suppliers to supply components or raw materials to us on a timely basis or in sufficient quantities, likely would cause us to be unable to meet orders for our products and harm our reputation and our business. Identifying and qualifying alternative suppliers would take time, involve significant additional costs and may delay the production of our products. If we fail to forecast our manufacturing requirements accurately or fail to properly manage our inventory with our contract manufacturers, we could incur additional costs, experience manufacturing delays and lose sales. Further, if we obtain a new supplier or assemble our product using an alternative source of supply, we may need to conduct additional testing of our products to ensure they meet our quality and performance standards. Any delays in delivery of our product to distributors or customers could be extended, and our costs associated with the change in product manufacturing could increase.
The failure of our third-party manufacturers to manufacture the products for us or the failure of our suppliers of components and raw materials to supply us these items consistent with our requirements as to quality, quantity and timeliness could materially harm our business by causing delays, lost sales, increases in costs and lower gross profit margins.
An increasing amount of products
manufactured by the Company are produced outside the United States, including in our Mexico facilities. The Company’s manufacturing
facilities in Mexico are authorized to operate as Maquiladoras by the Ministry of Economy of Mexico. Maquiladora status allows
the Company to import certain items from the United States into Mexico duty-free, provided that such items, after processing, are
exported from Mexico within a stipulated time frame. Maquiladora status, which is renewed periodically, is subject to various restrictions
and requirements, including compliance with the terms of the Maquiladora program and other local regulations. Failure to comply
with these regulations or other disruptions within the program could adversely affect the Company’s financial position, results
of operations, and cash flows.
Due to COVID-19, the Company
has increased its safety stock of inventory at multiple facilities in order to be able to manufacture it products to increased
levels in the case there is a shut down or short term disruptions at any of its production facilities. As a result, the Company
has increased inventory of high run rate components to meet increased orders for fiber optic products. Should ordering patterns
decline in the short term for any reason, the Company may have excess inventory.
A significant percentage
of our sales in the last three fiscal years have been made to a small number of customers, and the loss of these major customers
could adversely affect us.
Our customer base includes direct customers, original equipment manufacturers (OEMs) and distributors. For fiscal years 2020 and 2019, the Company had two customers that comprised 30% and 29% of net sales, respectively. Both of these customers are distributors.
These customers, like our other customers, purchase our products from time to time through purchase orders. We do not have any agreements that obligate our customers to purchase products in the future from us. Our agreements with our distributor customers do not prohibit them from purchasing or offering products or services that compete with ours.
We believe that the loss of our major distributor customers would
likely result in purchases being re-directed through other sales channels, for example our other distributors, independent sales
representatives, or through direct sales by the Company to customers. However, there can be no assurance that the loss of a distributor
customer would not have an adverse effect on our sales or gross margins in this event.
The loss of any one or more of our key customers, the substantial reduction, delay or cancellation in orders from any such customer or our inability to collect the accounts receivable from these customers, could have a material adverse effect on our business, financial position and results of operations.
Further consolidation among our customers may result in the loss of some customers and may reduce sales during the pendency of business combinations and related integration activities.
We believe consolidation among our customers in the future will continue in order for them to increase market share and achieve greater economies of scale. In connection with this merger and acquisition activity, our customers may postpone or cancel orders for our product based on revised plans for technology or network expansion pending consolidation activity. Customers integrating large-scale acquisitions may also reduce their purchases of equipment during the integration period, or postpone or cancel orders.
The impact of significant mergers among our customers on our business is likely to be unclear until sometime after such transactions are completed, which may take a year or more. After a consolidation occurs, a customer may choose to reduce the number of vendors from which it purchases equipment and may choose one of our competitors as its preferred vendor. There can be no assurance that we will continue to supply equipment to the surviving communications service provider after a business combination is completed.
We may be subject to risks associated with acquisitions, and the risks could adversely affect future operating results.
We monitor our product portfolio and business and customer trends. In response, we have made and may continue to make acquisitions. The success of our acquisitions will depend on our ability to integrate the new products or operations with our existing products or operations. We cannot ensure that the expected benefits of any acquisition will be realized or will be realized within the time frames we expect. Costs could be incurred on pursuits or proposed acquisitions that have not yet or may not close which could impact our operating results, financial condition, or cash flows. Additionally, after the acquisition, unforeseen issues could arise which adversely affect the anticipated returns or which are otherwise not recoverable as an adjustment to the purchase price. The price we pay for a business or product line may exceed the value we realize, and we cannot provide assurance that we will obtain the expected revenues, anticipated synergies and strategic benefits of any acquisition within the time we expect or at all. Acquisitions may result in the recording of goodwill and other intangible assets which are subject to potential impairments in the future that could negatively impact our financial results.
Product defects or the failure of our products to meet specifications could cause us to lose customers and sales or to incur unexpected expenses.
If our products do not meet our customers’ performance requirements, our customer relationships may suffer. Also, our products may contain defects or fail to meet product specifications. Any failure or poor performance of our products could result in:
● lack of or delayed market acceptance of our products;
● delayed product shipments;
● damage to our reputation and our customer relationships;
● delayed recognition of sales or reduced sales;
● increased product warranty claims; and
Our products are often critical to the performance of telecommunications systems. We offer customers limited warranty provisions. If the limitations on the product warranties are unenforceable in a particular jurisdiction or if we are exposed to product liability claims that are not covered by insurance, a claim could harm our business.
We are dependent on key personnel.
Our failure to attract and retain skilled personnel could hinder the management of our business, our research and development, our sales and marketing efforts and our manufacturing capabilities. Our future success depends to a significant degree upon the continued services of key senior management personnel, including Cheryl Beranek, our Chief Executive Officer and John Hill, our Chief Operating Officer. We have employment agreements with Ms. Beranek and Mr. Hill that provide that if we terminate the employment of either executive without cause or if the executive terminates her or his employment for good reason, we would be required to make specified payments to them as described in their employment agreements. We have key person life insurance on Ms. Beranek and Mr. Hill. We also have employment agreements with other key management. Further, our future success also depends on our continuing ability to attract, retain and motivate highly qualified managerial, technical and sales personnel. Our inability to retain or attract qualified personnel could have a significant negative effect and thereby materially harm our business and financial condition.
Our business is dependent on interdependent management information
systems.
We rely on effective management information systems, including our enterprise resource planning (“ERP”) software, for critical business operations and to support strategic business decisions. We rely on our ERP system to support such important business operations as processing sales orders and invoicing, manufacturing, shipping, inventory control, purchasing and supply chain management, human resources, and financial reporting. Some of these systems are made up of multiple software and system providers. The interdependence of these solutions and systems is a risk, and the failure of any one system could have a material adverse effect on our overall information technology infrastructure. We also rely on management information systems to produce information for business decision-making and planning and to support e-commerce activities. Failure to maintain an adequate digital platform to support e-commerce activities could have a material adverse impact on our business through lost sales opportunities. If we are unable to maintain our management information systems, including our IT infrastructure, to support critical business operations and to produce information for business decision-making activities, we could experience a material adverse impact on our business or an inability to timely and accurately report our financial results.
Our IT systems may also be vulnerable to disruptions from human error, outdated applications, computer viruses, natural disasters, unauthorized access, cyber-attack and other similar disruptions. Any system failure, accident or security breach could result in disruptions to our operations. To the extent that any disruptions, cyber-attack or other security breach results in a loss or damage to our data, or inappropriate disclosure of confidential information, it could harm our business. In addition, we may be required to incur significant costs to protect against damage caused by these disruptions or security breaches in the future.
Risks Relating to Our Markets and Industry
To compete effectively, we must continually
improve existing products and introduce new products that achieve market acceptance.
The telecommunications equipment industry
is characterized by rapid technological changes, evolving industry standards, changing market conditions and frequent new product
and service introductions and enhancements. The introduction of products using new technologies or the adoption of new industry
standards can make our existing products, or products under development, obsolete or unmarketable. In order to remain competitive
and increase sales, we will need to anticipate and adapt to these rapidly changing technologies, enhance our existing products
and introduce new products to address the changing demands of our customers.
Many of our competitors have greater engineering
and product development resources than we have. Although we expect to continue to invest resources in product development activities,
our efforts to achieve and maintain profitability will require us to be selective and focused with our research and development
expenditures. In addition, sales to certain broadband service providers may require third-party independent laboratory testing
in order to obtain industry certifications to be able to sell to those customers. Further, our existing and development-stage products
may become obsolete if our competitors introduce newer or more appealing technologies. If these technologies are patented or proprietary
to our competitors, we may not be able to access these technologies.
If we fail to anticipate or respond in
a cost-effective and timely manner to technological developments, changes in industry standards or customer requirements, or if
we experience any significant delays in product development or introduction, our business, operating results and financial condition
could be affected adversely.
Changes in government funding programs may cause our customers and prospective
customers to delay, reduce, or accelerate purchases, leading to unpredictable and irregular purchase cycles.
The telecommunications and cable television industries are subject to significant and changing U.S. federal and state regulation, some of which subsidizes or encourages spending on initiatives that utilize our products.
For example, programs like the Connect America Fund (CAF), which provides
a capital expenditure subsidy for the build-out of the country’s broadband network, and the Rural Digital Opportunity Fund
(RDOF), which will provide a capital expenditure subsidy for the support high-speed broadband networks in rural America, may subsidize
or encourage spending by our customers or prospective customers on capital spending projects that utilize our products. Customers
may seek to time or otherwise adjust their technology or network expansion projects to the availability of subsidies under these
or other programs, which will affect the timing and size of orders for our products. In addition, other universal service and inter-carrier
compensation reforms scheduled to begin in the coming years will eliminate subsidies that carriers have traditionally relied upon
to support service in high-cost, rural areas. Further, changes in government programs in our industry or uncertainty regarding
future changes could adversely impact our customers’ or prospective customers’ decisions regarding timing and amounts
of capital spending, which could decrease demand for our products, delay orders or result in pricing pressure from these customers.
In addition, government funding programs such as the CARES Act, which was enacted in March 2020 in response to the COVID-19 pandemic,
provides grants to our customers and prospective customers for deploying improved broadband connections to unserved and underserved
areas of the United States provided they are deployed by specific calendar deadlines, which may cause customers and prospective
customers to accelerate their purchases for their long term network deployment plans into a shorter timeframe.
Intense competition in our industry
may result in price reductions, lower gross profits and loss of market share.
Competition in the telecommunications equipment
and services industry is intense. Our competitors may have or could develop or acquire marketing, financial, development and personnel
resources that exceed ours. Our ability to compete successfully will depend on whether we can continue to advance the technology
of our products and develop new products, the acceptance of our products among our customers and prospective customers, and our
ability to anticipate customer needs in product development, as well as the price, quality and reliability of our products, our
delivery and service capabilities and our control of operating expenses.
We cannot assure you that we will be able
to compete successfully against our current or future competitors. Competition from manufacturers of telecommunications equipment
such as ours may result in price reductions, lower gross profit margins, increased discounts to customers, and loss of market share
could require increased spending by us on research and development, sales and marketing, and customer support.
Our success depends upon adequate protection
of our patent and intellectual property rights.
Our future success depends in part upon
our proprietary technology. We attempt to protect our proprietary technology through patents, trademarks, copyrights and trade
secrets. However, these legal means afford us only limited protection and may not adequately protect our rights or remedies to
gain or keep any advantages we may have over our competitors. Accordingly, we cannot predict whether these protections will be
adequate, or whether our competitors will develop similar technology independently, without violating our proprietary rights.
Our competitors, many of which have significant
resources, may make substantial investments in competing products and technologies, or may apply for and obtain patents that will
prevent, limit, or interfere with our ability to manufacture or market our products. We may litigate to enforce patents issued
to us and to defend against claimed infringement of the rights of others or to determine the ownership, scope, or validity of our
proprietary rights and the rights of others.
Litigation has been in the past and may
be necessary in the future to defend or enforce our intellectual property rights, to protect our patents and trade secrets, and
to determine the validity and scope of our proprietary rights. Any litigation also may involve
substantial costs and diversion of the attention of company management away from operational activities. Any claim of infringement
against us could involve significant liabilities to third parties, could require us to seek licenses from third parties, and could
prevent us from manufacturing, selling or using our products. The occurrence of this litigation or the effect of an adverse determination
in the current litigation or similar future litigation could have a material adverse effect on our business, financial condition
and results of operations.
If the telecommunications
market does not expand as we expect, our business may not grow as fast as we expect, which could adversely impact our business,
financial condition and operating results.
Our future success as
a provider of fiber management, fiber protection and fiber delivery products depends on the continued growth of demand for fiber
broadband and, in particular, the continued expansion in the United States and in our other markets of information networks, particularly
those directly or indirectly dependent upon a fiber optic infrastructure. As part of that growth, we anticipate that demand for
voice, video, and other data services delivered over high-speed connections (both wired and wireless) will continue to increase.
If this demand does not increase, the need for enhanced high-speed bandwidth using fiber connections may not increase. Currently,
demand for high-speed broadband capabilities and access is increasing but future growth may be limited by several factors, including,
among others: (1) relative strength or weakness of the global economy or certain countries or regions, including the impact of
the current global recession due to COVID-19, (2) an uncertain regulatory environment, and (3) uncertainty regarding long-term
sustainable business models as multiple industries, such as the cable, traditional telecommunications, wireless and satellite industries,
offer competing content delivery solutions. The telecommunications market also has experienced periods of overcapacity, some of
which have occurred even during periods of relatively high network usage and bandwidth demands. If the factors described above
were to occur and cause the demand for fiber broadband capabilities or access to slow, stop or reverse, our business, financial
condition and operating results would be negatively affected.
We face risks associated with expanding
our sales outside of the United States.
We believe that our future growth depends
in part upon our ability to increase sales in international markets. These sales are subject to a variety of risks, including fluctuations
in currency exchange rates, tariffs, import restrictions and other trade barriers, unexpected changes in regulatory requirements,
longer accounts receivable payment cycles, potentially adverse tax consequences, and export license requirements. In addition,
we are subject to the risks inherent in conducting business internationally, including political and economic instability and unexpected
changes in diplomatic and trade relationships. Currency fluctuations may also increase the relative price of our product in international
markets and thereby could also cause our products to become less affordable or less price competitive than those of international
manufacturers. These risks associated with international operations may have a material adverse effect on our revenue from or costs
associated with international sales.
Risks Relating to
Our Common Stock
Our operating results may fluctuate
significantly from quarter to quarter, which may make budgeting for expenses difficult and may negatively affect the market price
of our common stock.
Because many purchases by customers of
our products relate to a specific customer project and are procured by the customer from time to time through purchase orders,
the short-term demand for our products can fluctuate significantly. This fluctuation can be further affected by the long sales
cycles necessary to obtain contracts to supply equipment for these projects, the availability of capital to fund our customers’
projects, changes, or delays in customer deployment schedules and the impact of the government regulation
to encourage service to unserved or underserved communities, rural areas or other high cost areas on customer buying patterns.
These long sales cycles may result in significant effort expended with no resulting sales or sales that are not made in
the anticipated quarter or fiscal year. Certain customers and prospective customers, typically larger broadband service providers,
are conducive to these long sales cycles which may be multi-year efforts. Demand for our products will also depend upon the extent
to which our customers and prospective customers initiate these projects and the extent to which we are selected to provide our
equipment in these projects, neither of which can be assured. In addition, a sharp increase in demand could result in actual lead
times longer than quoted, and a sharp decrease in demand could result in excess stock. These factors generally result in fluctuations,
sometimes significant, in our operating results. Other factors that may affect our quarterly operating results include:
· mergers and acquisitions activity among our customers;
· the timing of new product and service announcements;
· the availability of products and services;
· variations in the mix of products and services we sell;
· accounting treatment related to stock-based compensation.
Further, we budget our expenses based in
part on expectations of future sales. If sales levels in a particular quarter are lower than expected, our operating results will
be affected adversely.
Because of these factors, our quarterly
operating results are difficult to predict and are likely to vary in the future. If our operating results are below financial analysts’
or investors’ expectations, the market price of our common stock may fall abruptly and significantly.
Our stock price has been volatile
historically and may continue to be volatile. The price of our common stock may fluctuate significantly.
The trading price of our common stock has
been and may continue to be subject to wide fluctuations. Our stock price may fluctuate in response to a number of events and factors,
such as quarterly variations in operating results, announcements of technological innovations or new products by us or our competitors,
changes in financial estimates and recommendations by securities analysts, the operating and stock price performance of other companies
that investors may deem comparable to us, and new reports relating to trends in our markets or general economic conditions.
In addition, the stock market is subject
to price and volume fluctuations that affect the market prices for companies in general, and small-capitalization, high-technology
companies like us in particular. These broad market and industry fluctuations may adversely affect the price of our common stock,
regardless of our operating performance. Further, any failure by us to meet or exceed the expectations of financial analysts or
investors is likely to cause a decline in our common stock price. Further, recent economic conditions have resulted in significant
fluctuations in stock prices for many companies, including Clearfield. We cannot predict when the stock markets and the market
for our common stock may stabilize. In addition, although our common stock is listed on the NASDAQ Stock Market, our common stock
has at times experienced low trading volume in the past. Limited trading volume subjects our common stock to greater
price volatility and may make it difficult for our shareholders to sell shares at an attractive price.
Anti-takeover provisions in our organizational documents, Minnesota law and other agreements could prevent or delay a change in control of our company.
Certain provisions of our articles of incorporation and bylaws, Minnesota law, and other agreements may make it more difficult for a third-party to acquire, or discourage a third-party from attempting to acquire, control of our company, including:
These measures could discourage or prevent a takeover of us or changes in our management, even if an acquisition or such changes would be beneficial to our shareholders. This may have a negative effect on the price of our common stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
Clearfield leases a 71,000 square foot facility at 7050 Winnetka Avenue North, Brooklyn Park, Minnesota consisting of our corporate offices, manufacturing and warehouse space. The lease term is ten years and two months and commenced on January 1, 2015. On June 30, 2019, the Company amended its lease to add 14,000 square feet to this facility, with the lease term for the additional space coterminous with the original lease. Upon proper notice and payment of a termination fee of approximately $249,000, the Company has a one-time option to terminate the lease effective as of the last day of the eighth year of the term after the Company commenced paying base rent.
We currently lease a 46,000 square foot manufacturing facility
in Tijuana, Mexico. From the expiration of our indirect lease on July 31, 2020 until the signing of our new indirect lease for
this facility, the lease was month-to-month. Refer to Note 7- Subsequent Events for further detail on the new indirect lease entered
into subsequent to the fiscal year end.
On February 12, 2020, we entered into an indirect lease arrangement
for an additional 52,000 square foot manufacturing facility in Tijuana, Mexico. The lease term is approximately 42 months and commenced
on February 12, 2020. The lease contains written options to renew for two additional consecutive periods of three years each.
Both of these Mexico facilities
operate under a Maquiladora arrangement. Maquiladora status allows us to import certain items from the United States into Mexico
duty-free, provided that such items, after processing, are exported from Mexico within a stipulated time frame. Maquiladora status,
which is renewed with the Ministry of the Economy of Mexico periodically, is subject to various restrictions and requirements,
including compliance with the terms of the Maquiladora program and other local regulations, which have become stricter in recent
years.
We believe our existing facilities are sufficient to meet our current and future space requirements.
ITEM 3. LEGAL PROCEEDINGS
There are no pending legal proceedings against or involving the Company for which the outcome is likely to have a material adverse effect upon its financial position or results of operations.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II.
Our common stock is traded on The NASDAQ Global Market system of The NASDAQ Stock Market LLC under the symbol “CLFD.”
Number of Holders of Common Stock
There were 282 holders of
record of our common stock as of September 30, 2020.
Dividends
We have never paid cash dividends on our common stock. We currently intend to retain any earnings for use in our operations and do not intend in the foreseeable future to pay cash dividends on our common stock.
Equity Compensation Plan Information
The following table describes shares of our common stock that are available on September 30, 2020 for purchase under outstanding stock-based awards, or reserved for issuance under stock-based awards or other rights that may be granted in the future, under our equity compensation plans:
Equity compensation plans approved by security holders
There are no equity compensation plans not approved by the Company’s shareholders and all outstanding equity awards have been granted pursuant to shareholder-approved plans. In addition to options, the 2007 Stock Compensation Plan permits restricted stock awards and other stock-based awards.
Issuer Repurchases
The Company repurchased a total of 9,585 shares of our common stock during the fourth quarter of fiscal year 2020 in connection with payment of taxes upon the vesting of restricted stock previously issued to employees.
Additionally, in November 2014, the Company’s Board of Directors authorized an $8,000,000 common stock repurchase program, which was increased by $4,000,000 on April 25, 2017 to a total authorization of $12,000,000. As of September 30, 2020, we have repurchased an aggregate of 565,590 shares for approximately $7,019,000, leaving approximately $4,981,000 available within our $12,000,000 stock repurchase program. The repurchase program does not obligate Clearfield to repurchase any particular amount of common stock during any period. The repurchase will be funded by cash on hand. In April 2020, the Board of Directors suspended the share repurchase plan due to uncertainties caused by COVID-19 and the Company’s desire to ensure financial stability.
The following table presents the total number of shares repurchased during the fourth quarter of fiscal 2020 by month and the average price paid per share:
ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 6. SELECTED FINANCIAL INFORMATION
Not required for Smaller Reporting Companies
Cautionary Statement Regarding Forward-Looking Information
Statements made in this Annual Report on Form 10-K, in the Company’s other SEC filings, in press releases and in oral statements, that are not statements of historical fact are “forward-looking statements.” Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results or performance of the Company to be materially different from the results or performance expressed or implied by such forward-looking statements. The words “believes,” “expects,” “anticipates,” “seeks,” “may,” “will,” and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. The risks and uncertainties that could cause actual results to differ materially and adversely from those expressed or implied by the forward-looking statements include those risks described in Part I, Item 1A “Risk Factors.”
Overview of Business:
Clearfield, Inc. designs, manufactures and distributes fiber optic management, protection and delivery products for communications
networks. Our “fiber to the anywhere” platform serves the unique requirements of leading Broadband Service Providers
in the United States, which include Community Broadband, National Carriers, and MSO’s, while also serving the broadband
needs of the International markets, primarily countries in the Caribbean, Canada, and Central and South America. These customers
are collectively included in Broadband Service Providers. The Company also provides contract manufacturing services to its Legacy
customers for Build-to-Print services which include original equipment manufacturers (OEM) requiring copper and fiber cable assemblies
built to their specifications. The Company’s sales channels include direct to customer, through distribution partners, and
to original equipment suppliers who private label its products. The Company’s products are sold by its sales employees and
independent sales representatives.
Critical Accounting Policies:In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our sales, income or loss from operations and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet. We believe that there are several accounting policies that are critical to an understanding of our historical and future performance, as these policies affect the reported amounts of sales, expenses and significant estimates and judgments applied by management. While there are a number of accounting policies, methods and estimates affecting our financial statements, areas that are particularly significant include:
● Revenue recognition
● Accounting for stock-based compensation
● Income taxes
● Valuation of inventory, long-lived assets, finite lived intangible assets and goodwill
Revenue Recognition Our revenue is comprised of the sale of our products to customers and is recognized when the Company satisfies its performance obligations under the contract. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. The majority of our contracts have a single performance obligation and are short term in nature. We recognize revenue by transferring the promised products to the customer, with substantially all revenue recognized at the point in time the customer obtains control of the products. Shipping and handling costs charged to our customers are included in net sales, while the corresponding shipping expenses are included in cost of sales. Sales, value add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenue) basis.
Stock-Based Compensation We measure and recognize
compensation expense for all stock-based awards at fair value over the requisite service period. We use the Black-Scholes option
pricing model to determine the weighted average fair value of options. For restricted stock grants, fair value is determined as
the average price of the Company’s stock on the date of grant. Equity-based compensation expense is broken out between cost
of sales and selling, general and administrative expenses based on the classification of the employee. The determination of fair
value of stock-based awards on the date of grant using an option-pricing model is affected by our stock price as well as by assumptions
regarding a number of subjective variables. These variables include, but are not limited to, the expected stock price volatility
over the term of the awards, and actual and projected employee stock option exercise behaviors.
The expected terms of the options are based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at grant date. Volatility is based on historical and expected future volatility of the Company’s stock. The Company has not historically issued any dividends and does not expect to in the future. Forfeitures for both option and restricted stock grants are estimated at the time of the grant and revised in subsequent periods if actual forfeitures differ from estimates.
If factors change and we employ different assumptions in the determination of the fair value of grants in future periods, the related compensation expense that we record may differ significantly from what we have recorded in the current periods.
Income TaxesWe account for income taxes in accordance with Accounting Standards Codification (“ASC”) 740, Income Taxes, under which deferred income taxes are recognized based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income, and available tax planning strategies. If tax regulations, operating results, or the ability to implement tax-planning strategies vary, adjustments to the carrying value of deferred tax assets and liabilities may be required. A valuation allowance is recorded when it is more likely than not that a deferred tax asset will not be realized. The recorded valuation allowance is based on significant estimates and judgments and if the facts and circumstances change, the valuation allowance could materially change.
In accounting for uncertainty in income taxes, we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. The Company recognizes interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.
As of September 30, 2020 and 2019, the Company had no U.S. federal net operating loss (“NOL”) carry-forwards and approximately $769,000 and $1,905,000 of state NOLs, respectively. The state NOL carry forward amounts expire in fiscal years 2020 through 2022 if not utilized. In fiscal year 2009, the Company completed an Internal Revenue Code Section 382 analysis of the loss carry-forwards and determined that all of the Company’s loss carry-forwards were utilizable and not restricted under Section 382. The Company has not updated its Section 382 analysis subsequent to 2009 and does not believe there have been any events subsequent to 2009 that would impact the analysis.
As part of the process of preparing our financial statements, we are required to estimate our income tax liability in each of the jurisdictions in which we do business. This process involves estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that these deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not more likely than not or unknown, we must establish a valuation allowance. If the valuation allowance is reduced, the Company would record an income tax benefit in the period in which that determination is made. If the valuation allowance is increased, the Company would record additional income tax expense.
As of September 30, 2020 and 2019, the Company had a remaining valuation allowance of approximately $0 and $47,000, respectively, related to state net operating loss carry forwards. During the fourth quarter of 2020, the Company reversed the remaining $47,000 valuation allowance. This consisted of decreasing the valuation allowance based on the Company’s projections that it will be able to fully utilize its remaining state net operating losses. The Company will continue to assess the assumptions used to determine the amount of our valuation allowance and may adjust the valuation allowance in future periods based on changes in assumptions of estimated future income and other factors.
The Company files income tax returns in the U.S. Federal jurisdiction and various state jurisdictions. Based on its evaluation, the Company has concluded that it has no significant unrecognized tax benefits. With limited exceptions, the Company is no longer subject to U.S. federal and state income tax examinations for fiscal years ending prior to 2004. We are generally subject to U.S. federal and state tax examinations for all tax years since 2004 due to our net operating loss carryforwards and the utilization of the carryforwards in years still open under statute.
Impairment of Long-Lived Assets, Intangible Assets and GoodwillThe Company’s long-lived assets as of September 30, 2020 consisted primarily of property, plant and equipment, right of use lease assets, patents, intangibles, and goodwill. The Company reviews the carrying amount of its property, plant and equipment, right of use lease assets, and intangible assets if events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. When this review indicates the carrying amount of an asset or asset group exceeds the sum of the future undiscounted cash flows expected to be generated by the assets, the Company recognizes an asset impairment charge against operations for the amount by which the carrying amount of the impaired asset exceeds its fair value.
Determining fair values of property, plant and equipment, right of use lease assets, and intangible assets using a discounted cash flow method involves significant judgment and requires the Company to make significant estimates and assumptions, including long-term projections of cash flows, market conditions and appropriate discount rates. Judgments are based on historical experience, current market trends, consultations with external valuation specialists and other information. If facts and circumstances change, the use of different estimates and assumptions could result in a materially different outcome. The Company generally develops these forecasts based on recent sales data for existing products, planned timing of new product launches or acquisitions, and estimated future growth of the FTTP market.
The Company operates as one reporting unit and reviews the carrying amount of goodwill annually in the fourth quarter of each fiscal year and more frequently if events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company determines its fair value for goodwill impairment testing purposes by calculating its market capitalization and comparing that to the Company’s carrying value. The Company’s goodwill impairment test for the years ended September 30, 2020 and 2019 resulted in excess fair value over carrying value and therefore, no adjustments were made to goodwill. During the year ended September 30, 2020, there were no triggering events that indicated goodwill could be impaired.
A significant reduction in our market capitalization or in the carrying amount of net assets of a reporting unit could result in an impairment charge. If the carrying amount of a reporting unit exceeds its fair value, the Company would measure the possible goodwill impairment loss based on an allocation of the estimate of fair value of the reporting unit to all of the underlying assets and liabilities of the reporting unit, including any previously unrecognized intangible assets. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized to the extent that a reporting unit's recorded goodwill exceeds the implied fair value of goodwill. An impairment loss would be based on significant estimates and judgments, and if the facts and circumstances change, a potential impairment could have a material impact on the Company’s financial statements.
No impairment of long-lived assets, intangible assets or goodwill has occurred during the years ended September 30, 2020 and 2019, respectively.
Valuation of InventoryThe Company maintains a material amount of inventory to support its manufacturing operations and customer demand. This inventory is stated at the lower of cost or net realizable value. On a regular basis, the Company reviews its inventory and identifies that which is excess, slow moving and obsolete by considering factors such as inventory levels, expected product life and forecasted sales demand. Any identified excess, slow moving and obsolete inventory is written down to its market value through a charge to cost of sales. It is possible that additional inventory write-down charges may be required in the future if there is a significant decline in demand for the Company’s products and the Company does not adjust its manufacturing production accordingly.
Results of Operations
Year ended September 30, 2020compared to year ended September 30, 2019
Net sales for fiscal year 2020 increased 9.5%, or $8,040,000, to $93,075,000 from net sales of $85,034,000 in 2019. The Company allocates sales from external customers to geographic areas based on the location to which the product is transported. Accordingly, international sales represented 4% and 8% of net sales for the years ended September 30, 2020 and 2019, respectively.
Sales in fiscal year 2020 to commercial data networks and broadband service providers were 96% of net sales, or $89,571,000, compared to $80,366,000, or 95%, of net sales in fiscal 2019. Among this group, the Company recorded $4,054,000 in international sales in fiscal year 2020 versus $6,481,000 in fiscal year 2019. Sales associated to Legacy customers for build-to-print manufacturing for original equipment manufacturers in 2020 were 4% of net sales, or $3,503,000, compared to $4,668,000, or 5%, of net sales in fiscal year 2019.
The increase in net sales for fiscal year 2020 of $8,040,000 as
compared to fiscal year 2019 is primarily attributable to an increase in sales to Tier 1, MSO, and Community Broadband customers
of $2,189,000, $3,998,000 and $5,418,000 respectively. The increase to Community Broadband and MSO’s was due to increased
demand in response to COVID-19 driven by customers accelerating their purchasing decisions and deployment schedules of our fiber
optic solutions and the need for high speed broadband required in the work from anywhere environment. Net sales to national carriers
also increased from $11,900,000 in fiscal year 2019 to $14,100,000 in fiscal year 2020, due to increased demand due to COVID-19
customer purchasing decisions and growth in sales of the Company’s product portfolio to its existing customers. This overall
increase was offset by decreased sales to international customers of $2,427,000 and $1,137,000 to Legacy customers due to lower
demand for fiscal year 2020 as compared to fiscal 2019.
Revenue from all customers is obtained from purchase orders submitted
from time to time. Accordingly, the Company’s ability to predict orders in future periods or trends affecting orders in future
periods is limited. The Company’s ability to predict revenue has become further limited by potential disruption to its supply
chains or changes in customer ordering patterns due to COVID-19. The Company’s ability to recognize revenue in the future
for its backlog of customer orders will depend on the Company’s ability to manufacture and deliver products to the customers
and fulfill its other contractual obligations.
Cost of sales for fiscal year 2020 was $55,160,000, an increase of $2,815,000, or 5.4%, from the $52,345,000 in fiscal year 2019. Gross profit increased 2.3%, or $5,225,000, from $32,689,000 for fiscal year 2019 to $37,914,000 for fiscal year 2020. Gross profit percent was 40.7% in fiscal year 2020, as compared to 38.4% for fiscal year 2019. The year-over-year increase in gross profit was primarily due to increased sales volume. The increase in gross profit percent was due to increased volume and a higher gross profit percent. The increase in gross profit percent was primarily due to improved manufacturing efficiencies and costs in its manufacturing facilities, and lower tariff costs. Tariff costs were $327,000 in fiscal year 2020, compared to $1,089,000 in fiscal year 2019. The reduction in tariff costs is due to utilizing the Company’s manufacturing facilities and supply chain sourcing to more cost-effectively manage outsourced materials, as well as lower tariff costs assessed in 2020. In fiscal year 2020, the Company did not experience any material cost impacts in its cost of sales due to COVID-19.
Selling, general and administrative expense for fiscal year 2020 was
$29,530,000, an increase of $2,029,000, or 7.4%, compared to $27,501,000 for fiscal year 2019. This increase is primarily composed
of an increase of $3,972,000 in compensation costs due to additional personnel and higher performance-based compensation accruals
as well as sales commissions and agent fees to external sales representatives due to higher sales volumes. In addition, expenses
related to product certification testing expenses increased by $343,000. These were partially offset by lower travel, entertainment
and marketing costs in fiscal year 2020 of $1,401,000 due to COVID-19 restrictions, and a decrease of $887,000 in stock-based compensation
expense resulting from prior issuances of equity awards becoming fully vested in fiscal year 2019.
Income from operations for
fiscal year 2020 was $8,384,000 compared to $5,188,000 for fiscal year 2019. This increase is attributable to increased sales
and gross profit, partially offset by increased selling, general and administrative expenses as described above.
Interest income in fiscal year 2020 was $771,000 compared to $738,000
for fiscal year 2019. This is due to interest earned on increased investment balances in fiscal 2020. The Company invests its excess
cash primarily in FDIC-backed bank certificates of deposit, treasury securities, and money market accounts. The Company expects
to earn less in interest income in fiscal year 2021 due to declining interest rates.
Income tax expense for fiscal year 2020 was $1,862,000 compared to $1,360,000 for fiscal year 2019. The increase in tax expense of $502,000 from the year ended September 30, 2019 is primarily due to the increase in taxable income for fiscal year 2020. The decrease in the income tax expense rate to 20.3% for fiscal year 2020 from 22.9% for fiscal year 2019 is primarily due to increased research and development credits and the reversal of the valuation allowance against state NOLs in fiscal year 2020. Our provision for income taxes include current federal tax expense, state income tax expense, and deferred tax expense.
Net income for fiscal year 2020 was $7,293,000 or $0.53 per basic and diluted share, compared to $4,566,000 or $0.34 per basic and diluted share for the fiscal year 2019.
Liquidity and Capital Resources
As of September 30, 2020, the Company had combined balances of cash,
cash equivalents, short term and long-term investments of $52,175,000 as compared to $47,508,000 as of September 30, 2019. As of
September 30, 2020, our principal source of liquidity was our cash and cash equivalents and short-term investments. Those sources
total $27,032,000 as of September 30, 2020, compared to $23,606,000, as of September 30, 2019. Investments considered long-term
were $25,143,000 as of September 30, 2020, compared to $23,902,000 as of September 30, 2019. Our excess cash is invested mainly
in certificates of deposit, and money market accounts. Substantially all of our funds are insured by the FDIC. We believe the combined
balances of short-term cash and investments along with long-term investments provide a more accurate indication of our available
liquidity. We had no long-term debt obligations as of September 30, 2020 or 2019, respectively.
We believe our existing cash equivalents and short-term investments,
along with cash flow from operations, will be sufficient to meet our working capital and investment requirements beyond the next
12 months. The Company intends on utilizing its available cash and assets primarily for its
continued organic growth and potential future strategic transactions, as well as execution of the share repurchase program adopted
by our Board of Directors. The share repurchase program was originally adopted on November 13, 2014 with $8,000,000 authorized
for common stock repurchases. On April 25, 2017, our Board of Directors increased the authorization to $12,000,000 of common
stock. In April 2020, to further ensure our financial stability in response to COVID-19, the Company suspended its share repurchase
program.
Operating Activities
Net cash generated from operations for the fiscal year ended September
30, 2020 totaled $6,656,000. Cash provided by operations included net income of $7,293,000 for the fiscal year ended September
30, 2020, non-cash expenses for depreciation and amortization of $2,422,000, stock-based compensation of $774,000, slightly offset
by a non-cash amortization of discounts on investments of $64,000, in addition to changes in operating assets and liabilities using
cash. Changes in operating assets and liabilities using cash include an increase in net inventories of $5,396,000 and accounts
receivables of $1,378,000. The increase in inventory is a result of additional stocking levels to support the Company’s increased
backlog and higher demand, and additional safety stock across the Company’s multiple locations due to the uncertainty of
COVID-19 on the Company’s supply chain and manufacturing locations. The increase in accounts receivable was due to higher
net sales offset by improved days sales outstanding in the current year. Days sales outstanding, which measures how quickly receivables
are collected, decreased 9 days from 47 to 38 from September 30, 2019 to September 30, 2020. Also, changes in operating assets
and liabilities providing cash include an increase in accounts payable and accrued expenses of $3,152,000.
Net cash generated from operations for the fiscal year ended September
30, 2019 totaled $14,733,000. Cash provided by operations included net income of $4,566,000 for the fiscal year ended September
30, 2019, non-cash expenses for depreciation and amortization of $2,178,000, stock-based compensation of $1,729,000, and a change
in allowance for doubtful accounts of $210,000, slightly offset by a non-cash amortization of discounts on investments of $72,000,
in addition to changes in operating assets and liabilities using cash. Changes in operating assets and liabilities providing cash
include a decrease to inventories of $1,037,000 and accounts receivables of $3,493,000. The decrease in accounts receivable was
due to timing of customer payments. Also, changes in operating assets and liabilities providing cash include an increase in accounts
payable and accrued expenses of $1,605,000.
Investing Activities
For the fiscal year ended September 30, 2020, we used $1,806,000
in cash for the purchase of capital equipment and patents. These purchases were mainly related to manufacturing equipment, including
the expansion to a second manufacturing facility in Mexico, as well as information technology equipment. During fiscal year 2020,
we purchased $34,057,000 of FDIC-backed certificates of deposit and had $35,822,000 of FDIC-backed certificates of deposit and
U.S. Treasuries mature or be called. The result is cash used in investing activities of $41,000 in fiscal year 2020 as compared
to $12,962,000 in fiscal year 2019. The decrease in cash used in investing activities was driven by reduced purchases of long term
investments due to the current low interest rate environment. In fiscal year 2021, the Company intends to continue investing in
the necessary computer hardware and software required to optimize its business, facility needs, and appropriate manufacturing equipment
to continue to maintain a competitive position in manufacturing capability.
For the fiscal year ended September 30, 2019,
we used $2,512,000 in cash for the purchase of capital equipment and patents. These purchases were mainly related to manufacturing
equipment, including the expansion of capacity in our Mexico facility, as well as information technology equipment. During fiscal
year 2019, we purchased $20,311,000 of FDIC-backed certificates of deposit and U.S. Treasuries and sold $9,861,000 of FDIC-backed
certificates of deposit. The result is cash used in investing activities of $12,962,000 in fiscal year 2019.
Financing Activities
For the fiscal year ended September 30, 2020, the Company used $429,000 of cash to repurchase its own common stock. For the fiscal year ended September 30, 2020, the Company received $349,000 from employees’ purchase of stock through our Employee Stock Purchase Plan (“ESPP”). The Company used $176,000 to pay for taxes related to employees’ exercises of stock options and vesting of restricted shares using share withholding. As a result, the net cash used in financing activities during fiscal year 2020 was $247,000.
For the fiscal year ended September 30, 2019, the Company did not
use any cash to repurchase its common stock. For the fiscal year ended September 30, 2019, the Company received $314,000 from employees’
purchase of stock through our ESPP. The Company used $553,000 to pay for taxes as a result of employees’ exercises of stock
options and vesting of restricted shares using share withholding. As a result, the net cash used in financing activities during
fiscal year 2019 was $236,670.
Recent Accounting Pronouncements:
Effective October 1, 2019, we adopted the Financial Accounting Standards
Board (“FASB”) Accounting Standards Update (“ASU”) 2016-02, Leases, using the effective date method
under the modified retrospective approach. The amended guidance requires lessees, at the commencement date, to recognize a lease
liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis, and to
record a right-of-use (“ROU”) asset, which is an asset that represents the lessee’s right to use, or control
the use of, a specified asset for the lease term. In July 2018, the FASB issued ASU 2018-11, Leases, Targeted Improvements,
which gave companies the option of applying the new standard at the adoption date, rather than retrospectively to the earliest
period presented in the financial statements. The Company elected the package of practical expedients permitted under the new standard,
which among other things, allowed the Company to carry forward the historical lease classification. The Company also elected the
practical expedient to not recognize a lease liability and ROU asset for short-term leases less than 12 months. We chose the option
to apply the new standard at the adoption date, and therefore we are not required to restate the financial statements for prior
periods, nor are we required to provide the disclosures required by the new standard for prior periods. Upon adoption, we
recognized an approximate $2.4 million ROU asset, and an approximate $2.6 million lease liability. Our adoption of the new
standard did not impact our cash flows or have a material impact on our results of operations. We have expanded our financial statement
disclosures to comply with the requirements of the new standard.
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill, which offers amended guidance to simplify the accounting for goodwill impairment by removing Step 2 of the goodwill impairment test. A goodwill impairment will now be measured as the amount by which a reporting unit’s carrying value exceeds its fair value, limited to the amount of goodwill allocated to that reporting unit. This guidance is to be applied on a prospective basis effective for the Company’s interim and annual periods beginning after December 15, 2019, with early adoption permitted for any impairment tests performed after January 1, 2017. The new guidance is effective for the Company beginning in the first quarter of fiscal 2021, with early adoption permitted. The Company is evaluating the impact of the adoption of ASU 2017-04 on our financial statements and does not believe the adoption of this ASU will have a material impact on our financial statements.
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. In November 2018, the FASB issued update ASU 2018-19 that clarifies the scope of the standard in the amendments in ASU 2016-13. This guidance introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. Financial instruments impacted include accounts receivable, trade receivables, other financial assets measured at amortized cost and other off-balance sheet credit exposures. The new guidance is effective for the Company beginning in the first quarter of fiscal 2023, with early adoption permitted. The Company is evaluating the impact of the adoption of ASU 2016-13 on our financial statements and disclosures.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The disclosure is not required
for a smaller reporting company.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Clearfield, Inc.
INDEX TO FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm 25
Financial Statements
Balance Sheets 26
Statements of Earnings 27
Statements of Shareholders’ Equity 28
Statements of Cash Flows 29
Notes to Financial Statements 30
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the board of directors of Clearfield, Inc.:
Opinion on the Financial Statements
We have audited the accompanying balance sheets of Clearfield, Inc.
(the "Company") as of September 30, 2020 and 2019, the related statements of earnings, shareholders’ equity and
cash flows for the years ended September 30, 2020 and 2019, and the related notes (collectively referred to as the "financial
statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of
the Company as of September 30, 2020 and 2019, and the results of its operations and its cash flows for the years ended September
30, 2020 and 2019, in conformity with accounting principles generally accepted in the United States of America.
Adoption of New Accounting Standard
As discussed in Note 6 to the financial statements, the Company has changed its method of accounting for operating leases as of October 1, 2019 due to the adoption of ASU 2016-02, Leases (Topic 842).
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Baker Tilly US, LLP
We have served as the Company's auditor since 2014.
Minneapolis, Minnesota
November 12, 2020
CLEARFIELD, INC.
CONDENSED BALANCE SHEETS
Assets
Current Assets
Other Assets
Right of use lease assets 2,539,100 -
Liabilities and Shareholders’ Equity
Current Liabilities
Current portion of lease liability $ 665,584 $ -
Other Liabilities
Long-term portion of lease liability 2,129,343 -
Deferred tax liability - 101,690
Shareholders’ Equity
SEE ACCOMPANYING NOTES TO CONDENSED FINANCIAL STATEMENTS
CLEARFIELD, INC.
STATEMENTS OF EARNINGS
Year Ended Year Ended
September 30, September 30,
Operating expenses
Net income per share Basic $ 0.53 $ 0.34
Net income per share Diluted $ 0.53 $ 0.34
Weighted average shares outstanding:
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
CLEARFIELD, INC.
STATEMENTS OF SHAREHOLDERS’ EQUITY
Common Stock Additional Retained Total share-
Shares Amount paid-in capital earnings holders’ equity
Restricted stock issuance, net (7,490 ) (75 ) 75 - -
Restricted stock issuance, net 8,580 86 (86 ) - -
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
CLEARFIELD, INC.
STATEMENTS OF CASH FLOWS
September 30, September 30,
Cash flows from operating activities
Change in allowance for doubtful accounts - 210,000
Amortization of discount on investments (64,327 ) (71,652 )
Loss on disposal of assets 5,785 -
Changes in operating assets and liabilities:
Accounts payable, accrued expenses and deferred rent 3,151,566 1,604,655
Cash flows from investing activities
Cash flows from financing activities
Repurchases of common stock (428,654 ) -
Supplemental disclosures for cash flow information
Non-cash financing activities
Cashless exercise of stock options $ 97,811 $ 17,390
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
NOTES TO FINANCIAL STATEMENTS
NOTE 1– SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business: Clearfield, Inc. (the “Company”)
is a manufacturer of a broad range of standard and custom passive connectivity products to customers throughout the United States
and internationally. These products include fiber distribution systems, optical components, Outside Plant (“OSP”) cabinets,
and fiber and copper cable assemblies that serve the communication service provider, including Fiber-to-the-Premises (“FTTP”),
large enterprise, and original equipment manufacturer (“OEM”) markets.
Revenue Recognition: Our revenue is comprised of the sale of our products to customers and is recognized when the Company satisfies its performance obligations under the contract. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. The majority of our contracts have a single performance obligation and are short term in nature. We recognize revenue by transferring the promised products to the customer, with substantially all revenue recognized at the point in time when the customer obtains control of the products. Shipping and handling costs charged to our customers are included in net sales, while the corresponding shipping expenses are included in cost of sales. Sales, value add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenue) basis.
Cash and Cash Equivalents: The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Cash equivalents as of September 30, 2020 and 2019 consist entirely of short-term money market accounts.
The Company maintains cash balances at multiple financial institutions, and at times, such balances exceed insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.
Investments:The Company currently invests its excess cash in bank certificates of deposit (“CDs”) that are fully insured by the Federal Deposit Insurance Corporation (“FDIC”) and Unites States Treasury securities with terms of not more than five years, as well as money market accounts. CDs and Treasuries with original maturities of more than three months are reported as held-to-maturity investments and are recorded at amortized cost, which approximates fair value due to the negligible risk of changes in value due to interest rates. The maturity dates of the Company’s investments are as follows:
Fair Value of Financial Instruments: The financial statements include the following financial instruments: cash and cash equivalents, short-term investments, long-term investments, accounts receivable, accounts payable and accrued expenses. Other than long-term investments, all financial instruments’ carrying values approximate fair values because of the short-term nature of the instruments. Long-term investments’ carrying value approximates fair value due to the negligible risk of changes in value due to interest rates.
Accounts Receivable: Credit is extended based on the evaluation of a customer’s financial condition and collateral is generally not required. Accounts that are outstanding longer than the contractual payment terms are considered past due. The Company does not charge interest on past due receivables. The Company determines its allowance by considering a number of factors, including the length of time trade receivables are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, and the condition of the general economy and the industry as whole. The Company writes off accounts receivable when they become uncollectible; payments subsequently received on such receivables are credited to the allowance for doubtful accounts.
The allowance for doubtful accounts activity for the years ended September 30, 2020 and 2019 is as follows:
Inventories: Inventories consist of finished goods, raw materials and work-in-process and are stated at the lower of average cost (which approximates first-in, first-out) or net realizable value. Inventory is valued using material costs, labor charges, and allocated factory overhead charges and consists of the following:
The
increase in inventory from fiscal year 2019 to fiscal year 2020 is a result of additional stocking levels to support the Company’s
increased sales order backlog and related demand, and additional safety stock across the Company’s multiple locations due
to the uncertainty of COVID-19 on the Company’s supply chain and manufacturing locations.
On a regular basis, the Company reviews its inventory and identifies
that which is excess, slow moving, and obsolete by considering factors such as inventory levels, expected product life, and forecasted
sales demand. A reserve is established for any identified excess, slow moving, and obsolete inventory down to its net realizable
value through a charge to cost of sales. Inventory write-down charges may be required in the future if there is a significant decline
in demand for the Company’s products and the Company does not adjust its manufacturing production accordingly or if new products
are not accepted by the market.
Property, Plant and Equipment: Property, plant and equipment are recorded at cost. Significant additions or improvements extending asset lives are capitalized, while repairs and maintenance are charged to expense when incurred. Depreciation is provided in amounts sufficient to relate the cost of assets to operations over their estimated useful lives. Leasehold improvements are amortized over the shorter of the remaining term of the lease or estimated life of the asset.
Estimated useful lives of the assets are as follows:
Years
Equipment 3 – 7
Leasehold improvements 7-10 or life of lease
Vehicles 3
Property, plant and equipment consist of the following:
Depreciation expense for the years ended September 30, 2020 and 2019 were $1,944,186 and $1,705,583, respectively.
Goodwill and Intangible Assets: The Company operates as one reporting unit and reviews the carrying amount of goodwill annually in the fourth quarter of each fiscal year and more frequently if events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company determines its fair value for goodwill impairment testing purposes by calculating its market capitalization and comparing that to the Company’s carrying value. The Company’s goodwill impairment test for the years ended September 30, 2020 and 2019 resulted in excess fair value over carrying value and therefore, no adjustments were made to goodwill. During the years ended September 30, 2020 and 2019, there were no triggering events that indicated goodwill could be impaired.
A significant reduction in our market capitalization or in the carrying amount of net assets of a reporting unit could result in an impairment charge. If the carrying amount of a reporting unit exceeds its fair value, the Company would measure the possible goodwill impairment loss based on an allocation of the estimate of fair value of the reporting unit to all of the underlying assets and liabilities of the reporting unit, including any previously unrecognized intangible assets. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized to the extent that a reporting unit's recorded goodwill exceeds the implied fair value of goodwill. An impairment loss would be based on significant estimates and judgments, and if the facts and circumstances change, a potential impairment could have a material impact on the Company’s financial statements.
No impairment of goodwill has occurred during the years ended September 30, 2020 or 2019, respectively.
The Company capitalizes legal costs incurred to obtain patents. Once accepted by either the U.S. Patent Office or the equivalent office of a foreign country, these legal costs are amortized using the straight-line method over the remaining estimated lives, not exceeding 20 years. As of September 30, 2020, the Company has 22 patents granted and multiple pending applications both inside and outside the United States.
In addition, the Company has various finite
life intangible assets, most of which were acquired as a result of the acquisition of a portfolio of Telcordia certified outdoor
active cabinet products from Calix, Inc. (“Calix”) during fiscal year 2018. Finite life intangible assets as of September
30, 2020 and 2019 are as follows:
Years Gross Carrying Amount Accumulated Amortization Net Book Value Amount
Years Gross Carrying Amount Accumulated Amortization Net Book Value Amount
Amortization expense related to these assets for the years ended September 30, 2020 and 2019 were $477,568 and $472,827, respectively.
Impairment of Long-Lived Assets: The Company assesses potential impairments to its long-lived assets or asset groups when there is evidence that events occur or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recovered. An impairment loss is recognized when
the carrying amount of the long-lived asset or asset group is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset or asset group is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group.
Any required impairment loss is measured as the amount by which
the carrying amount of a long-lived asset or asset group exceeds its fair value and is recorded as a reduction in the carrying
value of the related asset or asset group and a charge to operating results. No impairment of long-lived assets occurred during
the years ended September 30, 2020 or 2019, respectively.
Income Taxes: The Company records income taxes in accordance with the liability method of accounting. Deferred taxes are recognized for the estimated taxes ultimately payable or recoverable based on enacted tax law. The Company establishes a valuation allowance to reduce the deferred tax assets when it is more likely than not that a deferred tax asset will not be realizable. Changes in tax rates are reflected in the tax provision as they occur.
In accounting for uncertainty in income taxes, we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. As of both September 30, 2020 and September 30, 2019, the Company did not have any unrecognized tax benefits. The Company recognizes interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. We do not expect any material changes in our unrecognized tax benefits over the next 12 months.
Stock-Based Compensation: We measure and recognize compensation expense for all stock-based awards at fair value over the requisite service period. We use the Black-Scholes option pricing model to determine the weighted average fair value of options. For restricted stock grants, fair value is determined as the average price of the Company’s stock on the date of grant. Equity-based compensation expense is broken out between cost of sales and selling, general and administrative expenses based on the classification of the employee. The determination of fair value of stock-based awards on the date of grant using an option-pricing model is affected by our stock price as well as by assumptions regarding a number of subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.
The expected terms of the options are based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at grant date. Volatility is based on historical and expected future volatility of the Company’s stock. The Company has not historically issued any dividends and does not expect to in the future. Forfeitures for both option and restricted stock grants are estimated at the time of the grant and revised in subsequent periods if actual forfeitures differ from estimates.
If factors change and we employ different assumptions in the determination of the fair value of grants in future periods, the related compensation expense that we record may differ significantly from what we have recorded in the current periods.
Research and Development Costs: Research and development
costs amounted to $1,269,542 and $1,089,637 for the years ended September 30, 2020 and 2019, respectively, and are charged to expense
when incurred.
Advertising Costs: Advertising costs amounted to $296,571
and $278,057 for the years ended September 30, 2020 and 2019, respectively, and are charged to expense when incurred.
Net Income Per Share: Basic and diluted net income per share is computed by dividing net income by the weighted average number of common shares outstanding and the weighted average number of dilutive shares outstanding, respectively.
Weighted average common shares outstanding for the years ended September 30, 2020 and 2019 were as follows:
Dilutive potential common shares - 8,343
Earnings per share:
There were 337,100 and 108,000 shares for the years ended September 30, 2020 and 2019, respectively, that were excluded from the above calculation as they were considered antidilutive in nature.
Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, related revenues and expenses and disclosure about contingent assets and liabilities at the date of the financial statements. Significant estimates include the rebates related to revenue recognition, stock-based compensation and the valuation of inventory, long-lived assets, finite lived intangible assets and goodwill. Actual results may differ materially from these estimates.
Recently Issued Accounting Pronouncements:
Effective October 1, 2019, we adopted the Financial Accounting Standards
Board (“FASB”) Accounting Standards Update (“ASU”) 2016-02, Leases, using the effective date method
under the modified retrospective approach. The amended guidance requires lessees, at the commencement date, to recognize a lease
liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis, and to
record a right-of-use (“ROU”) asset, which is an asset that represents the lessee’s right to use, or control
the use of, a specified asset for the lease term. In July 2018, the FASB issued ASU 2018-11, Leases, Targeted Improvements,
which gave companies the option of applying the new standard at the adoption date, rather than retrospectively to the earliest
period presented in the financial statements. The Company elected the package of practical expedients permitted under the new standard,
which among other things, allowed the Company to carry forward the historical lease classification. The Company also elected the
practical expedient to not recognize a lease liability and ROU asset for short-term leases less than 12 months. We chose the option
to apply the new standard at the adoption date, and therefore we are not required to restate the financial statements for prior
periods, nor are we required to provide the disclosures required by the new standard for prior periods. Upon adoption, we
recognized an approximate $2.4 million ROU asset, and an approximate $2.6 million lease liability. Our adoption of the new
standard did not impact our cash flows or have a material impact on our results of operations. We have expanded our financial statement
disclosures to comply with the requirements of the new standard.
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill, which offers amended guidance to simplify the accounting for goodwill impairment by removing Step 2 of the goodwill impairment test. A goodwill impairment will now be measured as the amount by which a reporting unit’s carrying value exceeds its fair value, limited to the amount of goodwill allocated to that reporting unit. This guidance is to be applied on a prospective basis effective for the Company’s interim and annual periods beginning after December 15, 2019, with early adoption permitted for any impairment tests performed after January 1, 2017. The new guidance is effective for the Company beginning in the first quarter of fiscal 2021, with early adoption permitted. The Company is evaluating the impact of the adoption of ASU 2017-04 on our financial statements and does not believe the adoption of this ASU will have a material impact on our financial statements.
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. In November 2018, the FASB issued update ASU 2018-19 that clarifies the scope of the standard in the amendments in ASU 2016-13. This guidance introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. Financial instruments impacted include accounts receivable, trade receivables, other financial assets measured at amortized cost and other off-balance sheet credit exposures. The new guidance is effective for the Company beginning in the first quarter of fiscal 2023, with early adoption permitted. The Company is evaluating the impact of the adoption of ASU 2016-13 on our financial statements.
NOTE 2– SHAREHOLDERS’ EQUITY
Share Repurchase Program: On November 13, 2014, the Company announced that its Board of
Directors had approved a stock repurchase program under which it will purchase up to $8,000,000 of its outstanding shares of common
stock. On April 25, 2017, the Board of Directors increased the repurchase authorization by $4,000,000 to $12,000,000 of common
stock. The program does not obligate Clearfield to repurchase any particular amount of common stock during any period. The repurchase
will be funded by cash on hand. The repurchase program is expected to continue indefinitely until the maximum dollar amount of
shares has been repurchased or until the repurchase program is earlier modified, suspended or terminated by the board of directors.
In April 2020, the Board of Directors suspended the share repurchase plan due to uncertainties caused by COVID-19 and the Company’s