Good afternoon. Welcome to Clearfield’s Fiscal Third Quarter 2020 Earnings Conference Call. My name is Daryl, and I will be your operator this afternoon. Joining us for today’s presentation are the company’s President and CEO, Cheri Beranek; and CFO, Dan Herzog. Following their commentary, we will open the call for questions.

I would now like to remind everyone that this call will be recorded and made available for replay via a link in the Investor Relations section of the company’s website.

This call is also being webcasted and accompanied by a PowerPoint presentation called the FieldReport, which is also available in the Investor Relations section of the company’s website.

Please note that during the course of this call, management will be making forward-looking statements regarding future events and the future financial performance of the company. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements.

It is important to note also that the company undertakes no obligation to update such statements, except as required by law. The company cautions you to consider risk factors that could cause actual results to differ materially from those in the forward-looking statements contained in today’s press release, FieldReport and in this conference call.

The Risk Factors section in Clearfield’s most recent Form 10-K filing with the Securities and Exchange Commission provides description of those risks. As a reminder, the slides in this presentation are not controlled by the speaker, but rather by you, the listener. Please advance through the presentation as the speakers present their remarks.

With that, I would like to turn the call over to Clearfield’s CEO, Cheri Beranek. Please proceed..

Good afternoon, and thank you, everyone, for joining us today. I hope everyone is safe and healthy during these truly unprecedented times. The third quarter of fiscal 2020 was a strong quarterly performance for Clearfield, as we achieved the highest level of revenue for any quarter in our company’s history.

The $26 million we reported for Q3 was up 27% sequentially and 19% year-over-year. This robust growth was driven most significantly by contributions from our MSO and Community Broadband markets, which were up 48% and 22% year-over-year, respectfully.

The record top line performance in the quarter helped produce record gross profit, which totaled $10.8 million as a percentage of revenue to 41.5% marked the highest gross profit margin we’ve achieved as a company in more than two years.

Both of these achievements were due to a favorable product mix in the quarter, as well as the continued realization of the operational efficiency initiatives we’ve implemented since the start of fiscal 2020.

This includes the expanded use of our Mexico manufacturing plant, a reduction in tariff costs, and the cost reduction efforts across our product lines. All of these measures have helped increase our efficiency and enabled us to keep our operating expenses relatively stable, while driving our top line.

In fact, the $3 million of net income we generated in the quarter was the highest quarterly level in several years. We ended the quarter with a robust order backlog of $8.5 million, which was down slightly from the prior quarter-end, but up 68% from the same period last year.

I’m also encouraged to report that we continue to look at industry-leading lead times for our standard products. Before I turn the call over to our CFO, Dan Herzog, I’d like to walk through our financial performance in more detail, spending a moment reviewing some of our recent operational updates and progress in our core end markets.

I’m encouraged to report that Clearfield did not experience any particular customer ordering delays or negative changes in ordering patterns during fiscal Q3 due to COVID-19. Within that context, let’s look at our market segments by revenue, starting first with our core Community Broadband market.

In the third quarter, we generated revenue of $16.7 million, which was up 22% from the same period last year on a trailing 12-month basis ending June 30, 2020. Community Broadband market revenue totaled $55.2 million, which was up 3% from the comparable period last year.

Our National Carrier business was our second largest market, comprising 15% of our total revenue in fiscal Q3 and 17% for the trailing 12-month period.

From a growth standpoint, we built on the momentum we established over the last several quarters, realizing a 19% year-over-year increase in revenue to $3.9 million in the third quarter and a 37% year-over-year increase to $14.9 million for the trailing 12-month period.

As I’ve addressed within prior field reports, the growth we’re seeing in the National Carrier market is related to the continued demand from fiber-to-the-home and fiber-to-the-business applications. We believe the momentum in our National Carrier market to date validates the strategic investments we’ve made to capitalize on the Tier 1 market.

In addition to positive results we experienced in our National Carrier market, we realized another quarter of double-digit growth in our MSO or cable TV market. In fiscal Q3, we generated $3.7 million in revenue, which was up 48% year-over-year.

For the trailing 12-month period, we generated $11.1 million from this market, which was up 38% year-over-year. Revenue in our international market was down 47% year-over-year and down 35% on a trailing 12-month basis. The decline in this quarter was primarily related to currency conversion rates, which have yet to return to their pre-COVID level.

This has made our products temporarily cost prohibitive, causing customers to delay purchasing decisions. Revenue in our legacy build-to-print business was down slightly in the third quarter and down 5% over the trailing 12-month period.

On that trailing 12-month basis, total revenue was $4.2 million, which is consistent with our expectations for this business to operate at approximately $4 million annual run rate for the foreseeable future. With that, I’ll now turn the presentation over to Dan, who will walk us through our financial performance for the third quarter of fiscal 2020..

Thank you, Cheri, and good afternoon, everyone. Now looking at our third quarter financial results in more detail. Our revenue in the third quarter of fiscal 2020 increased 19% to $26 million from $21.9 million in the same year ago period.

The increase in revenue was primarily due to higher sales in our Community Broadband, MSO and National Carrier markets, partially offset by lower international sales, as Cheri just mentioned. Gross profit for the third quarter of fiscal 2020 totaled $10.8 million, or 41.5% of total revenue.

This was an improvement from $8.4 million, or 38.4% of total revenue in the third quarter last year. The increase in gross profit dollars was due to increased sales volume.

The increase in gross margin was due to a more favorable product mix, as well as cost reduction efforts across our product lines, including expanded use of our Mexico manufacturing plant and efficiencies realized from our supply chain programs.

Our operating expenses for the third quarter of fiscal 2020 were $7.2 million, which were up from $6.9 million in the same year ago quarter. As a percentage of total revenue, operating expenses in Q3 were 27.8%, compared to 31.4% in the same year ago period.

The increase in operating expenses was primarily due to the higher compensation costs and costs associated with product testing required for Tier 1 certification, offset by lower travel, entertainment and marketing costs due to COVID-19 restrictions.

In terms of our profitability measures, income from operations was $3.6 million in the third quarter of fiscal 2020, which compares to $1.5 million in the same year ago quarter. Income tax expense increased to $763,000 in the third quarter of fiscal 2020, up from $454,000 in the third quarter of 2019.

In the third quarter of fiscal 2020, net income totaled $3 million, or $0.22 per diluted share, an improvement from $1.3 million, or $0.10 per diluted share in the same year ago quarter. During the third quarter, our cash, cash equivalents and investments remained consistent at $48.4 million compared to the prior quarter-end.

We believe the $48.4 million of cash on hand and short-term investments, along with cash flow from operations, is sufficient to meet our working capital and investment requirements for beyond the next 12 months.

As I mentioned on our last FieldReport, our Board of Directors suspended the company’s share repurchase plan in April to further ensure our financial stability through the current COVID-19 operating environment. Our Board and leadership team will continue to evaluate our capital allocation strategy for our shareholders.

That concludes my prepared remarks. I will now turn the call back over to Cheri.

Cheri?.

Thanks, Dan. Before I provide an update on our Coming of Age plan, I’d like to spend a few moments providing an update on how we continue to navigate the COVID-19 pandemic and the operational measures we’ve taken over the last several months.

In March, Clearfield’s operations were classified as critical sector work due to the vital role our solutions play in supporting the communications infrastructure. Since that time, we have continued to be fully operational despite the unprecedented global business closures and the slowdown caused by the health crisis.

We continue with production operations in both our U.S. and Mexican manufacturing facilities and have established multiple contingency plans in the event of our ability to operate is diminished or eliminated at either location.

I’m encouraged to report that our production operations are working at normal capacity, while adhering to state and federal government social distancing guidelines. Our non-production employees are all working remotely, and we are actively promoting and demonstrating our product solutions effectively through video conferencing and other methods.

I’m so very proud of how our team has seamlessly adapted to today’s dynamic working environment. We dual source the majority of our components. And as of today, the majority of our supply chain partners remain operational and have continued to provide the necessary components for our products.

I’m encouraged to report that we experienced limited impact in our supply chain in fiscal Q3 related to COVID-19. Thanks to our forward planning, such as strategically increasing our safety stock inventory levels at both our Minneapolis and Mexico facilities.

It’s worth pointing out that rather than optimizing the plant for a particular product line, we made the decision to maximize the availability of all product lines by ensuring that each location can manufacture across our broad product portfolio.

This allowed us to meet customer orders in Q3 and enable us to continue to fulfill orders going forward as well. Turning to a Coming of Age plan, which is our three-year strategic plan, designed to strengthen our core business and position our company for disruptive growth opportunities.

As our financial and operational performance in fiscal Q3 and the first nine months of fiscal 2020 have demonstrated, we’re beginning to realize results from this plan. I’ll now spend a moment providing a brief update on how our three major initiatives within that plan are working.

In terms of our first initiative, expanding our core Community Broadband business. During the third quarter, we saw customers push forward with their purchase decisions and deployments in response to COVID-19. As I’ve talked about before, the global pandemic has absolutely highlighted the need for high-speed broadband front and center.

This has created a swelling of demand, so to speak, that we believe will continue in our fiscal Q4 and into fiscal 2021. Another driver for our Community Broadband market is the anticipated government funding on the horizon. In particular, the U.S.

Rural Digital Opportunity Fund, or RDOF, is designed to bridge the digital divide to efficiently fund the deployment of broadband networks in rural America.

Through the two-phase process, the FCC will direct up to $20.4 billion over 10 years to finance up to gigabit speed broadband networks in unserved rural areas, connecting millions of American homes and businesses to digital opportunity.

The RDOF phase one auction is currently scheduled to begin on October 22, 2020, and will target over 6 million homes and businesses in census blocks that are entirely unserved by voice and broadband. Phase two will cover locations in census blocks that are partially served, as well as locations not funded in phase one.

Earlier this month, there were two proposed bills in the U.S.

Congress, which would direct the FCC to more quickly hand out these monies from the RDOF program by condensing the application process, setting earlier build-out requirements and automatically awarding funds to applicants that are in the sole bidder in an area that commits to offering symmetrical gigabit service.

These measures would likely result in a notable proportion of funds going to rural cooperatives, local governments and other community-based broadband providers to quickly build high-quality fiber networks.

We are continuing to watch these bills, so we are poised for success in working with service providers, who will benefit from the expanded funding programs. A longstanding competitive differentiator for Clearfield has been our innovative products.

Our ability to listen to customer once and market demands informs our product roadmap, so that we’re introducing products that fill a need in the market. Along that line, during fiscal Q3, we introduced two new products, the Aerial Fiber Distribution Hub and the FiberFlex 2000.

The Aerial FDH, which is part of our StreetSmart portfolio, was specifically designed for environments where permitting and right of way have been a problem.

Clearfield’s Aerial FDH can be placed directly on the strand in the same space as other aerial enclosures, eliminating the bulk of the engineering, permitting, construction, and material time and class associated with ground or pole mounted FDH options.

The Aerial FDH has seen strong interest from new alternative carriers looking to overcome right of way challenges. The other new product, FiberFlex, is the industry’s first active cabinet designs for fiber. The product is currently shipping and has been extremely well received by the market.

FiberFlex is part of the future of both edge computing as well as the need to move electronics deeper into the access network. Our success on our operational effectiveness initiatives over the last several quarters is perhaps most evident in our expanding gross profit.

One of the chief underlying drivers for this is related to the investments we’ve made to our operations in Mexico, which are starting to yield dividends both in improved efficiencies and cost effectiveness.

As many of you know, we signed a lease for a second manufacturing facility in Mexico in fiscal Q2, which doubled our square footage there and allowed us to establish lean manufacturing initiatives.

While COVID-19 caused temporary delays in our ability to begin shipping product from the new facility in fiscal Q2, the second facility is now fully operational and we commence shipping during the third quarter.

The third initiative of our plan involves capitalizing on disruptive growth opportunities within the wireline markets of National Carriers and all wireless markets. As reported earlier in this FieldReport, National Carrier business was up 19% for the quarter.

However, while National Carriers have declared a commitment to capital equipment expenditures despite the COVID pandemic. COVID has impacted the deployment plans for 5G, both in the near and midterm. As it relates to the near-term, certain carriers identified that in locations where 4G was available, they deemed 5G as not an essential service.

Accordingly, we saw a bit of a pause in new deployments by the carriers because of these restrictions. Within the general wireless carrier space, we saw growth in the deployment of optical component revenue, specifically as it related to optimizing existing fiber assets to meet exploding bandwidth requirements.

In environments where our technologies are used to lower the cost of access network deployment, revenues were slower than anticipated, as COVID restrictions reduced the number of installation crews deployed in the hard hit Northeast early in the quarter.

As the COVID hotspots moved to other locations, COVID temporarily delayed two planned field trials with another Tier 1 customer. We are currently planning for one of the trials to commence in fiscal Q4 and the other in fiscal 2021. The third quarter was a strong period for Clearfield.

Our financial performance and operational effectiveness demonstrated the resilience of our business, customer base and industry as a whole. Our success in Q3 has given us significant momentum in Q4 and a positive outlook for fiscal 2021.

At no time in our history, has the need for high-speed broadband connectivity been more apparent than during this COVID crisis. Working remotely, often from home, has blurred or even destroyed the business versus consumer distinction within all networks now carrying business critical and entertainment data all at the same time.

Service providers who do not know where demand will come from next, were faced with needing to put capacity everywhere. The business case for optical fiber markets for 5G and access network deployment couldn’t be more evidence or brighter. And with that, we’re ready to open the call for your questions.

Operator?.

Thank you. We will now be taking questions from the company’s publishing sell-side analysts. [Operator Instructions] Our first question will come from the line of Jaeson Schmidt of Lake Street Capital. Please proceed with your questions..

Hey, guys, thanks for taking my questions. I just want to start if you think, just given the momentum you saw in the June quarter.

Do you think any orders got pulled in from the second-half of this calendar year?.

No, I don’t think so. I mean, I think we saw – and Community Broadband has typically been strong in the third and fourth quarter. And so, we went into the quarter a little bit early.

I mean, I think, we may have had a little bit of the backlog in March 31, might have been pulled in a little bit the last couple of weeks of the quarter as people kind of get ready and wanted to make sure they were in the front, but not significant, and that was in March. Our – the quarter here, it’s strong kind of across the markets.

There’s no significant one large customer in Community Broadband or in cable TV, it’s really kind of a broad spacing. So really pleased with where it’s at..

Okay, that’s helpful. And just curious if you could comment on the linearity of orders in the June quarter.

Did it – was it fairly linear throughout the quarter?.

Very consistent. So I mean, we’re – I actually – I have a graph that I call everybody thinks I’m funny, but it’s a graph that is our average daily bookings per month since the day we started Clearfield. So we track that very carefully and consistently, and we did have a very regular booking period throughout the quarter..

Okay. And the last one for me, and I’ll jump back into queue. Obviously, a very strong gross margin in the June quarter, you laid out a number of drivers behind that.

How should we think about gross margin going forward? Is this going to be sort of the new normal level?.

I wouldn’t get too comfortable. We like it a lot. We work very hard to get here. And we think there’s a – there’s room for improvement in that it’s – we believe in the world-class operations and I’ve got an amazing team to pull that together. But everything did click really nicely together here.

So this might be a little high to model indefinitely moving forward. The – but I think we are kind of showing a little bit higher than what we originally forecasted for the year, because things did work nicely.

But we made some strong investments by which to do that, putting inventory in both locations, ensuring that we didn’t have issues associated with expedites and all. We made a lot of the right decisions.

And if you think back the last 100 days, the amount of guesswork that we were doing, we were right more times than not, and I think we’ve got some really good data that we used to do that. But as we move forward, there’s still an awful lot of change out there that we don’t quite know how to anticipate.

So we’re being cautiously optimistic and working hard to stay here and improve, but I wouldn’t model at these levels quite yet..

Okay. Thanks a lot..

Thank you. Our next question comes from the line of Tim Savageaux of Northland Capital Markets. Please proceed with your questions.

Tim, would you be able to check if your phone is on mute, please?.

Yes. Sorry about that..

No problem..

…and congratulations, folks, on the spectacular quarter..

Thank you..

Yes. Thanks..

And I wanted to talk a little bit more about that. Now, we’ve seen some of your peers as well, Calix earlier in the week, and some pretty strong growth in kind of Tier 3 Community Broadband markets around or over 20%.

And that’s – I think you mentioned that you’re seeing that enhanced by increased capacity needs from – I think what’s more of a baseline of double digits or so.

And I guess, my question is twofold, which is in saying, you expect this momentum to continue into Q4, which is usually a pretty strong seasonal period for you as well, notwithstanding any kind of network access impacts.

Would you expect that type of growth rate to maintain into Q4? Would you expect to be able to grow sequentially in Q4? It looks like your backlog came down a bit, but stayed at pretty high levels.

And then as you look into 2021, for your comments on feeling positive about growth, would you expect market growth to return back to that double-digit level? Or could RDOF or any other stimulus that, that might materialize, keep it closer to where we are now?.

Our third and fourth quarters tend to mirror each other pretty well. And so it’s less about growth in kind of the run rate of the market. And so, last year, our fourth quarter was higher than our third. So growth rate over that might be a little tough to maintain at that – the 22% that we are showing here.

So I think fourth quarter was on par – the backlog went down a little bit. But I think fourth quarter, assuming COVID doesn’t hit one of our manufacturing plants. Demand should be consistent, and we expect to continue to be able to fulfill that. As we move into 2021, I don’t think people can wait.

In the past, we were in a situation in which the potential government funding programs actually, while they helped after they were implemented, they slowed things down while we were waiting for them. And I think right now, the market is such that consumers are demanding their bandwidth.

The difference between business service and consumer service has been blinded and kind of eroded, because we’re all working from home.

And in order to protect and prevent churn in their consumer bases, the service providers are doing whatever they can to either increase bandwidth today or to promise bandwidth tomorrow by the investments that they’re making in infrastructure.

So we’re very bullish about 2021, and think that there’s some really good opportunities that if we continue to execute that we should be able to bring in..

Great. And I’m just sorry, just a follow-up. And you mentioned – well, it sounds like you’re saying, whereas historically, you might have seen in discipline from the stimulus slow things down in this environment. It might be speeding it up to some degree, which is interesting.

And you mentioned those two factors, I guess, maybe increased traffic overall or work from home and perhaps anticipation of RDOF or something along those lines.

As you think about your Community Broadband market, I wonder if you might be able to wait those two factors in terms of what’s more – most important in terms of driving that growth or kind of order of magnitude, would it be two-thirds traffic and one-third stimulus, or I know, it’s kind of granular, but I’m just trying….

Oh, yes. Right. I mean….

…to get a sense as you look at the market.

What are the more important factors?.

Oh, demand and – supply and demand without question.

Dan, do you want to talk about to that?.

Yes, sure. No, I totally agree. It’s right there. It’s what’s happening right now versus the program that’s rolling out yet..

Right. And I know you commented on cable, I think, I might have missed it, though.

In terms of – is that – I guess, can you talk a little bit more about the drivers of your strength in the total segment in the quarter? And is that subscriber growth-driven? Or is that more on the business side?.

It’s definitely fiber investment. And it’s – I mean, we’re – we have emerging opportunities at the National Carriers, but just like we’re strong at the regional carriers within Community Broadband. We are strongest at the regional carriers within the cable TV market.

And so in a regional carrier level, the investment by the Tier 3 provider provides an incentive for the regional cable TV provider to continue to invest in fiber. And so our success in Tier 3 Community Broadband has been instrumental in some of the successes that we have to date in MSO markets.

And so, I mean, it’s off of a small base, but it’s grown now. I think this is the third quarter in a row, and I’m going to have to double check my numbers here. But I think it’s the third quarter in a row with more than double-digit growth. We also have some emerging opportunities at the National Carrier level.

We don’t talk a lot about, but it’s about national standards, things that the National Carriers are looking at in order to where they want to go, especially now in this COVID space as to the kind of investment that they need to do next year and beyond, partially about subscribers and also about leveraging some of their networks for backhaul for the wireless carriers.

So it’s truly that fiber to anywhere type protocol that we’ve been preaching for the last five years..

Great. Thanks very much and congrats again..

You’re very welcome..

At this time, this concludes the company’s question-and-answer session. If your question was not taken, you may contact Clearfield’s Investor Relations team at clfd@gatewayir.com. I’d now like to turn the call back over to Ms. Beranek for closing remarks..

Thank you, again, for joining us today. If any of you who are not part of the analyst community have an individual question, please feel free to send that to the IR address, and we will be sure to address those questions, get back to you on an individual basis. We look forward to updating you again on our progress soon. Stay safe and stay healthy..

Thank you for joining us today for Clearfield’s fiscal third quarter 2020 earnings call. You may now disconnect..