Good day, and welcome to the Clearfield Fiscal Third Quarter 2023 Conference Call. All participants will be in a listen-only mode for the duration of the call. [Operator Instructions.] Please note that this event is being recorded today. And as a reminder, the slides in this presentation are controlled by you, the listener.

Please advance forward through the presentation as the speakers present their remarks. I would now like to turn the conference over to Greg McNiff, Investor Relations for Clearfield. Please go ahead, sir..

Thank you. Joining me on the call today are Cheri Beranek, Clearfield's President and CEO, Dan Herzog, Clarus Hill's CFO and Kevin Morgan, Clearfield's CMO. Please note that during this call, management will be making remarks regarding future events and the future financial performance of the company.

These remarks constitute forward-looking statements for purposes of the safe harbor provisions of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements.

It is important to note also that the company undertakes no obligation to update such statements.

Except as required by law, the company cautions you to consider risk factors that could cause actual results to differ materially from those in the forward-looking statement contained in today's press release, earnings presentation and on this conference call.

The Risk Factor section in Clearfield's most recent Form 10-K filing with the Securities and Exchange Commission and its subsequent filings on Form 10-Q provide a description of these risks. With that, I would like to turn the call over to Clearfield's President and CEO, Cheri Beranek.

Cheri?.

Good afternoon, everyone, and thank you for joining us today to discuss Berfield results for the third quarter of fiscal 2023. We also intend to provide an update on our business and current market trends. Our third quarter of fiscal 2023 reflects the commentary we provided on our prior two earnings calls.

Total net sales for the third quarter were $61 million, which includes a record $13 million contributed from Nestor Cables. While visibility remains limited, we are reiterating our revenue guidance and increasing our net income per share guidance for the year ending September 30, 2023, based upon our backlog and current ordering trends.

I want to reiterate that we remain as confident as ever in the long-term demand for fiber broadband. Likewise, we believe our market share remains stable. Accordingly, we continue to focus on positioning the company to capture market share once industry ordering patterns return to a more normalized level.

I'll discuss these initiatives in more detail shortly. End-user demand remains strong and is best reflected in ongoing take rates that our broadband service provider customers are achieving. A take rate is defined as the percentage of subscribers over total homes passed.

Take rates in the 40% range are typical over several years that can vary depending upon competition and environment. Current industry take rates allow broadband service providers to recognize a strong return on investment, reducing their cost of operations and increasing their revenue per subscriber.

To that end, take rates for fiber-based services remain extremely strong and continue to improve relative to alternative solutions.

As we enter the initial stages of the disbursement of government funding programs, namely the Broadband Equity, Access and Deployment program, or BEAD, we are more certain that the industry will return to a more normalized cadence of deployment.

However, it's important to understand the relationship between government funding and orders placed with these funds. While our Chief Marketing Officer, Kevin Morgan, will address this topic in more detail in his prepared remarks, I want to highlight a near-term impact related to this dynamic.

In order to compete for BEAD funding, service providers are required to contribute matching funds to each deployment.

To ensure that they have the necessary financing and capital available, we expect our community broadband customers to continue to be cautious with respect to near-term deployments, particularly given rising interest rates and labor costs.

We believe that this is a prudent step by our customers to best take advantage of the significant opportunity ahead and not a slowdown in end user demand. Additionally, based on conversations with our service provider customers, we expect the inventory buildup impacting the industry to continue into the first half of fiscal 2024.

Also, as many of you are aware, the industry typically undergoes a slowdown during the winter. And for these reasons, we expect revenues to seasonally soften during this period. Accordingly, we expect the next several quarters results and the year-over-year comparison to be impacted by these dynamics.

While we continue to right size capacity levels to meet current demand, we are maintaining the infrastructure and processes for long-term growth and continue to design products to address our customers' most significant pain points and reduce the amount of skilled labor required to install our hardware.

To that end, our recently announced SeeChange terminal is receiving very positive reception from field studies conducted by our customers.

These recent deployment studies, which were commissioned by two of our MSO customers included that by eliminating the need for splicing, SeeChange in our other plug-and-play terminals could increase the number of homes connected from an average of 2.5 to nearly four homes per day per laborer.

For those of you who have followed Clearfield over the last several years, this level of improvement is consistent with our FieldSmart fiber distribution hubs. We continue to focus on developing products that reduce the deployment time and the labor required by our customers.

As a reminder, labor makes up approximately 70% of the total build cost and is the gating factor in deployment. We also continue to improve our product delivery times. During the pandemic, lead times reached a height of 20 weeks due to supply constraints. Lead times now are in our target range of four to six weeks across most product lines.

Any remaining supply constraints are predominantly limited to subcomponents of our active cabinets. For some additional insights and what we're seeing in the market and the significant long-term opportunity, I would like to welcome our Chief Marketing Officer, Kevin Morgan, to the call.

Kevin?.

Thank you, Cheri. I want to go into a little more detail on the government funding initiatives and how they will translate into orders over the coming years. As many of you know, the initial disbursements to the states related to the BEAD program are underway.

This program allocates $42.45 billion towards high-speed internet access in unserved and underserved areas as part of the Infrastructure Investment and Jobs Act.

The states received their formal notice of allocations on June 30 and have until December 27, to submit proposals to the NTIA for how they will allocate these funds to run their grant programs. As illustrated on Slide 4, these government funding initiatives will peak next year and will continue at significant levels for the next several years.

However, due to the processes and requirements in place to distribute these funds to specific service providers, we estimate there will be a lag of 6 to 12 months from when a state receives its funds to when a service provider places orders for specific builds.

Adjusting for this timing lag, third-party industry analysts expect the industry to grow at 13% to 15% for the next several years, driven substantially by these funding initiatives. The message is very clear. We anticipate significant demand in our core demographic starting late next year and continuing for the next several years.

In terms of total addressable market, we estimate our opportunity to be slightly less than $10 billion over the same time period. Coming back to Clearfield's fiscal third quarter performance.

I'd now like to pass the call over to our Chief Financial Officer, Dan Herzog, who will walk us through our financial results for the fiscal third quarter of 2023..

Thank you, Kevin, and good afternoon, everyone. Please turn to Slide 6 to look at our fiscal third quarter 2023 results in more detail. Consolidated net sales in the third quarter of fiscal 2023 were $61 million, a 14% decrease from $71 million in the same year ago period.

This figure includes $48 million of organic net sales from Clearfield and a $13 million contribution from Nestor Cables, reflecting an 18% increase from Nestor cables over the previous quarter. We continue to invest in capital equipment with faster processing capability to reduce costs and improve margins at Nestor.

Furthermore, we are continuing the discovery process regarding how to best introduce higher-margin connectivity solutions into the European market. The year-over-year decrease in net sales was due to lower sales across our core end markets, particularly in our community broadband and MSO markets.

As Cheri noted, we are seeing service providers in these markets prepare for the upcoming BEAD programs by setting aside financial support that will be necessary to match the BEAD appropriations.

In comparison to last year, where service providers were utilizing a just-in-case approach to inventory accumulation, this year's wait-and-see approach will have a negative near-term impact on year-over-year comparisons.

Order backlog declined 52% to $75 million on June 30, 2023, down from $157 million on June 30, 2022, and $108 million on March 31, 2023. We are collaborating with our service provider customers to align their open orders with their deployment schedules, which resulted in some order cancellations this period.

As Cheri noted, our lead times are now in our target range of four to six weeks across most product lines. Turning to Slide 7. I will now review net sales by our key markets. Sales to our primary market, community broadband comprised 32% of our net sales in the third quarter of fiscal 2023.

In Q3, we generated net sales of approximately $19 million in community broadband, down 49% from the same period last year. For the trailing 12 months ended on June 30, 2023, our community broadband market net sales totaled approximately $133 million, which was up 26% from the comparable periods last year.

As we did last quarter, we are breaking out revenue contribution from our large regional service provider customers, which was previously included in the Community Broadband and national carrier markets. We believe this customer breakout allows investors to better understand the near-term industry dynamics we referenced on the last earnings call.

Specifically, we have broken apart our community broadband customer market to disclose revenue from the traditional smaller providers and from ILEC with footprints of 500,000 subscribers and above, which we refer to as large regional service providers.

Net sales for the third quarter in our large regional service providers market declined by approximately 4% year-over-year. Net sales were up 2% over the trailing 12-month period. Please refer to the slide at the end of this presentation to view the historical revenue contribution from this customer group.

Our MSO business comprised 15% of our net sales in the third quarter. Net sales declined 9% year-over-year and are up 83% for the trailing 12-month period. Net sales in our national carrier market for the third quarter decreased by approximately 43% year-over-year.

On a trailing 12-month basis, net sales in our national carrier market were down 7% from the year ago period.

Finally, net sales in the international market increased 464% year-over-year in the third quarter compared to the same period last year and are up 393% year-over-year on a trailing 12-month basis due to the acquisition of Nestor Cables, which contributed $13 million towards this segment in the third fiscal quarter.

As detailed on Slide 8, gross profit margin in the third quarter declined to 31.1% of net sales from 41.1% of net sales in the same year ago quarter. Our gross margin was impacted by unused capacity in our Mexico facility due to the lower levels of demand as well as Nestors inclusion in this quarter's revenue.

As a reminder, Nestor was acquired in July of last year. The company continues to strategically realign capacity to current market conditions. While Clearfield does not compete on price, we have been prudent in how we pass along rising costs to our customers in the interest of maintaining our long-term relationships.

We will continue to be thoughtful in addressing these costs with our customers going forward. Now please turn to Slide 9. Operating expenses for the third quarter were $13.4 million, which were up slightly from $12.7 million in the same year ago quarter.

This increase is primarily the result of the addition of operating expenses of the Nestor Cables business. As a percentage of net sales, operating expenses for the third quarter were 22%, up from 18% in the same year ago period. Turning to Slide 10.

Net income in the third quarter decreased 59% to $5.2 million from $12.7 million in the same year-ago period and was down from $10.4 million in the second quarter of fiscal 2023. As a percentage of net sales, net income for the third quarter was 9%, down from 18% in the same year ago period and down from 14% in the second quarter of fiscal 2023.

As illustrated on Slide 11, our balance sheet remains strong with $169 million of cash, short-term and long-term investments and $2 million of debt. We had $1.6 million in capital expenditures in the quarter, mainly to support our manufacturing operations.

Our inventory balance increased from $101 million in March to $105 million in the third quarter, driven by the industry dynamics we have discussed.

While we expect inventory levels to increase slightly next quarter, we do not expect them to do so at the same levels as we experienced in fiscal year 2022, resulting in improved free cash flow in the fiscal year ahead. We are reiterating our fiscal 2023 revenue guidance.

We expect full year fiscal 2023 net sales to be within a range of $260 million to $275 million and are increasing our net income per share guidance to be in the range of $2.05 to $2.15 per share, up from $1.80 to $2.10 per share previously.

The increase in our net income per share guidance is due to better-than-expected product margin as well as cost-saving initiatives. With the capital raise we undertook last year, we plan to continue investing in our infrastructure and other necessary strategic areas.

Additionally, our strong balance sheet ensures that we are well positioned to effectively compete for larger customer opportunities and to pursue strategic opportunities to enhance our product portfolio. That concludes my prepared remarks for our third quarter fiscal 2023.

We appreciate the support of our investors as we continue to work to drive shareholder value. I will now turn the call back over to Cheri..

Thanks for the financial update, Dan. Turning to Slide 14. I would now like to provide an update on our multiyear strategic plan LEAP, which is our road map for how we intend to capitalize on the significant opportunities ahead. To leap is to jump higher, longer and with great force.

For those organizations such as Clearfield, that were able to meet the overwhelming demand for broadband access in 2022, the service provider inventory digestion challenge is a new hurdle to overcome.

LEAP contains strategic directions for how we navigate this near-term pause in demand with the need to invest in our infrastructure in order to meet the significant long-term demand Kevin highlighted. We have always prided ourselves on listening to our customers in order to provide them with the best products and service.

We demonstrated this capacity throughout the last several years with record growth while continuing to make significant investments in capacity. Today, these same customers are telling us that they need some time to do a little rightsizing after several years of record industry growth.

Rather than cutting costs or lowering prices to offset the slowdown, we are taking a thoughtful and strategic approach by using this time to position the company to meet the significant demand ahead. I'd like to discuss some of the investments we're making to scale the organization when the marketplace returns to a more normalized level of orders.

First, we continue to invest in Clearfield College to address the skilled labor shortage. Clearfield College is both an internal and an external training curriculum. Our people, both on the manufacturing floor and within our SG&A functions, will be able to leap higher and stronger because of the know-how we are building.

This progress is difficult to measure. But while our competitors are announcing significant layoffs and cost reductions, we continue to invest in the people that will make the difference. Second, we are modernizing our ERP and other internal software systems.

These system updates will enable us to better manage and fulfill orders, thereby improving customer satisfaction while reducing lead times. Further, we are actively recruiting to add expertise in new markets, especially in Europe where we intend to build on our Nestor platform.

Specifically, we're expanding our Estonia facility for microduct and connectivity manufacturing and intend to create a Clearfield operational umbrella that initially integrates our procurement programs and will follow with product management and sales initiatives.

In summary, while our third quarter financial results and guidance reflect the near-term uncertainty and lack of visibility we've discussed previously, we remain focused on building a strong foundation from which to address the long-term demand for high-speed broadband across our markets.

To that end, we are rightsizing capacity levels to meet current demand. We are maintaining the infrastructure and processes for long-term growth and continue to design products to address our customers' most significant pain points. We believe this is the right approach to drive significant shareholder value over the long term.

And with that, we will open the call to your questions..

We will now begin the question-and-answer session. [Operator Instructions.] At this time, we will take our first question, which will come from Ryan Koontz with Needham..

Cheri, I wanted to ask about seasonality. Nothing has, of course, been normal about seasonality for the last several years.

But as we look at this year and your strength here in the June quarter and your guide to be down sequentially, can you talk about some of the demand dynamics? And it seems like maybe there was some strength in a couple of segments, maybe you weren't anticipating, but maybe just kind of fill us in on what some of the puts and takes were on the strength you have in June and maybe what might step down in September..

Absolutely. We had some really nice opportunities to work inside with the large regional providers and really helping them be able to establish providing products because they had access to labor. And it's always difficult to know where the labor is going to come from and if they're going to be able to make it happen.

But we did have some sell-through in that large regional service provider area that was originally unanticipated. The community broadband, as I talked about, is a really strong market, and we are having a great time understanding where our customers are and where they're going.

But our seasonality, which is traditional, is still going to be there and now it's finally going to show up in that there just is going to be less labor done because of the weather. But it's going to be compounded by this financial structure that is coming up and facing the community or all providers, but especially the smaller providers.

And we alluded to that within the materials in that as the BEAD program was fully defined and now released, the financial obligations of a service provider that's going to apply for those funds are quite significant.

As an example, they need to be able to provide a letter of credit equal to 25% of their grant submission, which really puts a lot of capital sitting frozen waiting for allocation. So, we think it's really prudent that these customers are looking at their balance sheets that they are aggressively identifying opportunities.

And we're really -- that makes us very optimistic of our position for ongoing business next year as those materials get released. But I think it could force our winter months into a little more seasonality than we may have expected..

Right. That makes sense.

So, are these mostly incumbent providers you're referring to then that they are saving CapEx, so to speak, in the near term for anticipation of getting award for matching funds?.

Exactly. So, the incumbent providers, the ones who've had traditional balance sheets in place, but who are stretched, and those have been our traditional customers and will continue to be so.

As we look forward, we think there's some additional opportunity with the alternative providers, the [rural] utilities, some of the municipalities that haven't built previously. That's not showing up in our current seasonality, but it also is new revenue that will show up next year. So, you're right on target.

And it's one of the reasons that we did separate some of the large regional providers to isolate our market categories more tightly so that people understood the puts and takes of when things work well and when things create a level of [flaws] and some of the challenges that we're working to manage..

Got it. And just one follow-up, if I could, on the guidance for earnings looks like you're anticipating a step down in gross margins and from a pretty strong number relative to expectations this quarter in June.

Is that purely a factor of fixed costs and lower volume? Or are there other mix issues at play in the gross -- the implied gross margin guide down?.

Yes. No, it's absolutely volume-based there. We've done -- I've been extremely pleased with the work that we've been able to do the control class. We've chosen not to cut to the bone so that we could do a lot of training, a lot of investment in quality systems and different protocol.

I'm not looking to cut any further in that space so that we can come out strong over the winter. We have been able to pull their product margins right now quite well. But it really is a space allocation that there's just only so much you can do with overhead..

And our next question will come from Scott Searle with ROTH MKM..

Really nice job on the gross margins this quarter. I know it's a difficult operating environment. Maybe to quickly follow up on Ryan's question. Looking to the September quarter implies a range of $41 million to $56 million. I'm wondering if you could give us directionally in terms of some of the bigger categories, particularly community broadband.

Where do you expect to see most of that sequential progression from a revenue standpoint? Is it one or two areas? And at the lower end of the range, do you have pretty good visibility to that at the current time? Or do you need turns to get there? And then I had a couple of follow-ups..

Yes, the most fluctuation is in the large regional providers based upon sell-through and project fulfillment. We expect we'll be probably in the middle of that space. But we've got the low end of the space we pretty much have in backlog, and we're working through on that.

But now with the four to six-week lead time, our customers don't need to have their inventory stage. So, it's a little bit more hand to mouth, not in a bad way. It's the swings of the pendulum that have gone through in regard to inventory digestion.

So, it is an implication for the quarter that everything goes in the right direction, and we'll be at the high side. I don't -- I'm not expecting to be at the low side, but based upon the fact that I don't have those orders in hand and the marketplace is so unpredictable, we needed to be as transparent as we could to our shareholder base..

Got you. Very helpful.

And Cheri, if I could, to follow up, talking about continuing for another couple of quarters and injecting a little bit more seasonality into the mix, the results or the anticipated results in September, is that what we should expect into December and March? Or is there a little bit more variability in terms of what you're seeing? And lastly, I know you've been looking for other ways to differentiate your entry from a product standpoint into the European marketplace.

I'm wondering if you could give us some updated thoughts on that front?.

So, our -- looking in the first and second quarter throughout the winter. Mid of that range, maybe a little bit lower because of the standpoint associated with Europe in that today, our sales are very strongly Finland and breaking into some European Continental and Central European opportunities.

And so, the seasonality of Finland is much worse than the United States, unfortunately. So, they will be seasonally down next quarter and into the winter months.

They tend to see a stronger quarter ending in March because of the -- they such a short build season that they do tend to place orders early and to put things into place and have them ready to go. From a product orientation as to what we're doing in Europe is we're really pleased with the work that's been done on a microduct level.

That microduct work helps us to prepare for FieldShield and some of the works that we have done in pushable fiber and the means to be able to provide plug-and-play solutions into the European marketplace that has historically not seen plus-and-play.

We are evaluating how to use air blown fiber and how to use air blown fiber within the cassette and how we can utilize the traditional deployment methods that being air blown fiber with more the modularity that Clearfield has brought to market over the last 10 years.

So, we'll be displaying some of those technologies at a British trade show in late September and are anxious to be able to see the response that we receive so we can take those technologies into more specific product direction..

[Operator Instructions.] Our next question here will come from Greg Mesniaeff with WestPark Capital..

Can you talk a little bit about how the recent inventory buildup issues that customers has been impacting the pricing environment, if at all? It would be good to get some color..

I think the inventory build-up position is such that it's affecting their future purchases, but not necessarily affecting future pricing or price decisions. It's more of a frame of reference that customers are looking at already next year's build season and looking to try to be able to identify how costs have changed.

One of the challenges that any company needs to go through is being able to normalize the current valuation of their inventory against what they may have paid for it. And I think you'll see that service providers are not writing down their inventory as being worth any less than what it was when they purchased it.

In fact, if it's anything, it's going the other direction because of general material costs and the labor costs associated with building it..

Sure. And then just a quick follow-up.

Has there been any change in the competitive landscape that you're seeing recently? In other words, have any other larger competitors moved into the smaller carrier market?.

Yes. In the true small carrier world, the general community broadband, I mean, Corning [Indiscernible] have always been there, but they -- we've taken share from them over the period of the last 10 years due to our dedicated efforts, our nimble sales team and the product mix that's designed for those environments.

So, I wouldn't say that they are new to the market, but I would say that they have been focused on the larger providers, the larger regionals, probably and certainly the national carriers..

And with that, we will conclude the question-and-answer session. I'd like to turn the conference back over to Cheri Beranek for any closing remarks..

Thanks very much. These are very difficult times for us in this industry. I think across the board, you'll see my competitors struggling with being able to find the right product at the right time.

I'm very proud of my team on how we have been able to continue to serve shareholder value and be able to provide net income at 9% this quarter in times where others have struggled to make a profit. So, we are pleased to be able to be prudent. I hope you believe that we are well managed.

I certainly think my management team is top-notch, and we look forward to serving you next year and moving forward..

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