CLFD 10-Q Quarter ended June 30, 2022

Note 1. Basis of Presentation

The accompanying (a) condensed balance sheet as of September 30, 2021, which has been derived from audited financial statements, and (b) unaudited interim condensed financial statements as of and for the three and nine months ended June 30, 2022 have been prepared by Clearfield, Inc. (the “Company”) in accordance with accounting principles generally accepted in the United States of America for interim financial information, pursuant to the rules and regulations of the Securities and Exchange Commission. Pursuant to these rules and regulations, certain financial information and footnote disclosures normally included in the financial statements have been condensed or omitted. However, in the opinion of management, the financial statements include all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the financial position, results of operations and cash flows of the interim periods presented. Operating results for the interim periods presented are not necessarily indicative of results to be expected for the full year or for any other interim period, due to variability in customer purchasing patterns and seasonal, operating and other factors. These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10 -K for the year ended September 30, 2021.

In preparation of the Company’s financial statements, management is required to make estimates and assumptions that affect reported amounts of assets and liabilities and related revenues and expenses during the reporting periods. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates.

New Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“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 its financial statements.

Note 2. Net Income Per Share

Basic net income per common share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding for the reporting period. Diluted EPS equals net income divided by the sum of the weighted average number of shares of common stock outstanding plus all additional common stock equivalents, such as stock options, when dilutive.

The following is a reconciliation of the numerator and denominator of the net income per common share computations for the three and nine months ended June 30, 2022 and 2021:

Note 3. Investments

The Company invests in certificates of deposit (“CDs”) that are fully insured by the Federal Deposit Insurance Corporation (“FDIC”) as well as U.S. Treasury and money market securities. Historically, the Company’s investment portfolio had been classified as held-to-maturity and recorded at amortized cost. During the second quarter of fiscal 2022, the Company sold investments and has reclassified its investment portfolio to available-for-sale, which is reported at fair value. The unrealized gain or loss on investment securities is recorded in other comprehensive income, net of tax.

At June 30, 2022, available-for-sale investments consist of the following:

At June 30, 2022, investments in debt securities in an unrealized loss position were as follows:

As of June 30, 2022, there were 60 securities in an unrealized loss position which is due to the securities paying lower interest rates than the market. As of June 30, 2022, there are no securities which are other than temporarily impaired as the Company intends to hold these securities until their value recovers and there is negligible credit risk due to the nature of the securities which are backed by the FDIC and US federal government.

Note 4. Fair Value Measurements

The Company determines the fair value of its assets and liabilities based on the market price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company determines the fair value of U.S. treasury securities, and certificates of deposit based on valuations provided by an external pricing service, who obtains them from a variety of industry standard data providers.

The Company’s investments are categorized according to the three -level fair value hierarchy which distinguishes between observable and unobservable inputs, in one of the following levels:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 - Unobservable inputs to the valuation methodology that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Level 3 assets and liabilities include those with fair value measurements that are determined using pricing models, discounted cash flow valuation or similar techniques, as well as significant management judgment or estimation.

The following provides information regarding fair value measurements for our investment securities as of June 30, 2022 according to the three -level fair value hierarchy:

During the nine months ended June 30, 2022 and the year ended September 30, 2021, we owned no Level 3 securities and there were no transfers within the fair value level hierarchy.

Non-financial assets such as equipment and leasehold improvements, goodwill and intangible assets and right-of-use assets for operating leases are subject to non-recurring fair value measurements if they are deemed impaired. We had no re-measurements of non-financial assets to fair value in the three or nine months ended June 30, 2022.

Note 5. Other Comprehensive Loss

Changes in components of other comprehensive loss and taxes related to items of other comprehensive income (loss) are as follows:

At June 30, 2022 components of accumulated other comprehensive loss is as follows:

Note 6. Stock-Based Compensation

The Company recorded $ 638,000 and $ 1,647,000 of compensation expense related to current and past restricted stock grants, non-qualified stock options and the Company’s Employee Stock Purchase Plan (“ESPP”) for the three and nine months ended June 30, 2022, respectively. For the three months ended June 30, 2022, $ 606,000 of this expense is included in selling, general and administrative expense, and $ 32,000 is included in cost of sales. For the nine months ended June 30, 2022, $ 1,552,000 of this expense is included in selling, general and administrative expense, and $ 95,000 is included in cost of sales. The Company recorded $ 343,055 and $ 966,290 of compensation expense related to current and past restricted stock grants, non-qualified stock options and the Company’s ESPP for the three and nine months ended June 30, 2021, respectively. For the three months ended June 30, 2021, $ 328,710 of this expense is included in selling, general and administrative expense, and $ 14,345 is included in cost of sales. For the nine months ended June 30, 2021, $ 923,256 of this expense is included in selling, general and administrative expense, and $ 43,034 is included in cost of sales. As of June 30, 2022, $ 4,020,000 of total unrecognized compensation expense related to non-vested restricted stock awards and stock options is expected to be recognized over a period of approximately 2.4 years.

Stock Options

The Company uses the Black-Scholes option pricing model to determine the fair value of options granted. During the nine months ended June 30, 2022, the Company granted employees non-qualified stock options to purchase an aggregate of 62,730 shares of common stock with a weighted average contractual term of five years, a weighted average three -year vesting term, and a weighted average exercise price of $ 66.48 . During the nine months ended June 30, 2021, the Company granted employees non-qualified stock options to purchase an aggregate of 105,089 shares of common stock with a weighted average contractual term of five years, a weighted average three -year vesting term, and a weighted average exercise price of $ 23.74

The fair value of stock option awards during the nine months ended June 30, 2022 was estimated as of the respective grant dates using the assumptions listed below:

The expected stock price volatility is based on the historical volatility of the Company’s stock for a period approximating the expected life. The expected life represents the period of time that options are expected to be outstanding after their grant date. The risk-free interest rate reflects the interest rate as of the grant date on zero -coupon U.S. governmental bonds with a remaining life similar to the expected option term.

Options are granted at fair market values determined on the date of grant and vesting normally occurs over a three to five -year period. Shares issued upon exercise of a stock option are issued from the Company’s authorized but unissued shares.

The following is a summary of stock option activity during the nine months ended June 30, 2022:

The intrinsic value of an option is the amount by which the fair value of the underlying stock exceeds its exercise price.  As of June 30, 2022, the weighted average remaining contractual term for all outstanding and exercisable stock options was 1.91 years and their aggregate intrinsic value was $ 6,824,000 .

Restricted Stock

The Company’s 2007 Stock Compensation Plan permits its Compensation Committee to grant stock-based awards, including stock options and restricted stock, to key employees and non-employee directors. The Company has made restricted stock grants that vest over one to ten years.

During the nine months ended June 30, 2022, the Company granted newly elected non-employee directors restricted stock awards totaling 318 and 2,758 shares of common stock, with a vesting term of approximately one year and a fair value of $ 62.77 and $ 63.35 per share, respectively. During the nine months ended June 30, 2022, the Company granted non-employees restricted stock awards totaling 3,118 shares of common stock, with a vesting term of approximately one year and a fair value of $ 64.11 per share. During the nine months ended June 30, 2022, the Company also granted employees restricted stock awards totaling 23,318 shares of common stock, with a vesting term of approximately three years and a fair value of $ 66.48 per share.

During the nine months ended June 30, 2021, the Company granted non-employee directors elected at the Company’s 2021 Annual Meeting of Shareholders restricted stock awards totaling 2,120 shares of common stock, with a vesting term of approximately one year and a fair value of $ 32.41 per share. During the nine months ended June 30, 2021, the Company also granted employees restricted stock awards totaling 37,687 shares of common stock, with a vesting term of approximately three years and a fair value of $ 23.74 per share.

Restricted stock transactions during the nine months ended June 30, 2022 are summarized as follows:

Employee Stock Purchase Plan

The Company’s ESPP allows participating employees to purchase shares of the Company’s common stock at a discount through payroll deductions. The ESPP is available to all employees subject to certain eligibility requirements. Terms of the ESPP provide those participating employees the ability to purchase the Company’s common stock on a voluntary after-tax basis. Employees may purchase the Company’s common stock at a price that is no less than the lower of 85 % of the fair market value of one share of common stock at the beginning or end of each stock purchase period or phase. The ESPP is carried out in six -month phases, with phases beginning on January 1 and July 1 of each calendar year. For the phase that ended on June 30, 2022 and December 31, 2021, employees purchased 5,605 and 7,678 shares at a price of $ 52.66 and $ 32.43 per share, respectively. After the employee purchase on June 30, 2022, 181,590 shares of common stock were available for future purchase under the ESPP.

Note 7. Revenue

Revenue Recognition

Net sales include products and shipping and handling charges. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products. All revenue is recognized when the Company satisfies its performance obligations under the contract. The Company recognizes 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. The Company recognizes revenue for shipping and handling charges at the time the products are delivered to or picked up by the customer. The majority of the Company’s contracts have a single performance obligation and are short term in nature. Sales taxes and value added taxes in foreign jurisdictions that are collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from net sales.

Disaggregation of Revenue

The Company allocates sales from external customers to geographic areas based on the location to which the product is transported. Sales outside the United States are principally to countries in the Caribbean, Canada, Central and South America.

Revenues related to the following geographic areas were as follows for the three and nine months ended:

The Company manufactures and sells a proprietary product line designed for the Broadband Service Provider marketplace. In addition, the Company’s Legacy business provides build-to-print services for original equipment manufacturers requiring copper and fiber cable assemblies built to their specification.

The percentages of our sales by markets were as follows for the three and nine months ended:

Broadband Service Providers are made up of Community Broadband, which includes local and regional telecom companies, utilities, municipalities and alternative carriers, multiple system operators (“MSO’s, or Cable TV”), which are also referred to as Tier 2 and Tier 3 customers; National Carriers, which includes large national and global wireline and wireless providers also referred to as Tier 1’s; and International customers.

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 writes off accounts receivable when they become uncollectible; payments subsequently received on such receivables are credited to the allowance for doubtful accounts. As of both June 30, 2022 and September 30, 2021, the balance in the allowance for doubtful accounts was $ 79,000 .

See Note 9, “Major Customer Concentration” for further information regarding accounts receivable and net sales.

Note 8. Inventories

Inventories consist of the following as of:

Note 9. Major Customer Concentration

For the three months ended June 30, 2022, Customers A, and B comprised 18 % and 11 % of the Company’s net sales, respectively.  Customers A and B are distributors. For the nine months ended June 30, 2022, Customer A comprised 15 % of the Company’s net sales.  Customer A is a distributor. For the three months ended June 30, 2021, Customers A and C comprised 18% and 12 % of the Company’s net sales, respectively.  For the nine months ended June 30, 2021, Customers A and C comprised 20 % and 11 % of the Company’s net sales, respectively.  Both of these customers were distributors. These major customers, like our other customers, purchase our products from time to time through purchase orders, and the Company does not have any agreements that obligate these major customers to purchase products from us in the future.

As of June 30, 2022, Customers A and D comprised 13 % and 11 % of the Company’s accounts receivable. Customer D is a National Carrier. As of September 30, 2021, Customer E was 16 % of accounts receivable. Customer E is a regional broadband service provider.

Note 10. Goodwill and Intangibles

The Company analyzes its goodwill for impairment annually or at an interim period when events occur or changes in circumstances indicate potential impairment. The result of the analysis performed as of September 30, 2021 did not indicate an impairment of goodwill. During the nine months ended June 30, 2022, there were no triggering events that indicate potential impairment exists.

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 June 30, 2022, the Company has 31 patents granted and multiple pending applications both inside and outside the United States.

In addition, the Company has various finite lived intangible assets, most of which were acquired as a result of the acquisition of the active cabinet product line from Calix, Inc. during fiscal year 2018. The Company analyzes its intangible assets for impairment annually or at interim periods when events occur or changes in circumstances indicate potential impairment. The result of the analysis performed as of September 30, 2021 did not indicate an impairment of our intangible assets. During the nine months ended June 30, 2022, there were no triggering events that indicate potential impairment exists.

Note 11. Income Taxes

For the three and nine months ended June 30, 2022, the Company recorded income tax expense of $ 3,884,000 and $ 9,480,000 , reflecting an effective tax rate of 23.4 % and 22.7 %, respectively. The difference between the effective tax rate and the statutory tax rate for the three and nine months ended June 30, 2022 was primarily related to Section 162 (m) compensation deduction limitations, nondeductible acquisition costs, foreign derived intangibles income deduction (FDII), and research and development credits.

For the three and nine months ended June 30, 2021, the Company recorded income tax expense of $ 1,725,000 and $ 3,344,000 , reflecting an effective tax rate of 22.1 % and 20.6 %, respectively. The differences between the effective tax rate and the statutory tax rate for the three and nine months ended June 30, 2021 were primarily related

to excess tax benefits from non-qualified stock options exercised during the period, research and development credits, and foreign derived intangibles income deduction (FDII).

Deferred taxes recognize the impact of temporary differences between the amounts of the assets and liabilities recorded for financial statement purposes and these amounts measured in accordance with tax laws. The Company’s realization of deferred tax temporary differences is contingent upon future taxable earnings. The Company reviewed its deferred tax asset for expected utilization using a “more likely than not” criteria by assessing the available positive and negative factors surrounding its recoverability and determined that as of June 30, 2022 and September 30, 2021 a valuation allowance against the deferred tax assets is not required. The Company will continue to assess the need for a valuation allowance based on changes in assumptions of estimated future income and other factors in future periods.

As of June 30, 2022, the Company does not have any unrecognized tax benefits. It is the Company’s practice to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. The Company does not expect any material changes in its unrecognized tax positions over the next 12 months.

Note 12. Leases

The Company leases an 85,000 square foot facility at 7050 Winnetka Avenue North, Brooklyn Park, Minnesota consisting of corporate offices, manufacturing and warehouse space. The lease term is ten years and two months, ending on February 28, 2025 and is renewable. The renewal options have not been included within the lease term because it is not reasonably certain that the Company will exercise either option.

In July 2021, the Company entered into an indirect lease arrangement for an approximately 318,000 square foot manufacturing facility in Tijuana, Mexico. The lease term is for 7 years of which 5 years are mandatory, commencing March 2022. The lease contains written options to renew for two additional consecutive periods of 5 years each. The lease calls for monthly rental payments of $ 162,000 , increasing 2 % annually. The renewal options have not been included within the lease term because it is not reasonably certain that the Company will exercise either option.

On November 19, 2021, the Company signed a lease for a 105,000 square foot warehouse in Brooklyn Park, Minnesota. The lease term is five years commencing March 2022 and ending on February 28, 2027, with rent payments increasing annually. The lease includes an option to extend the lease for an additional five years. The renewal option has not been included within the lease term because it is not reasonably certain that the Company will exercise the option. The lease commenced in the second quarter of fiscal 2022.

Right-of-use lease assets and lease liabilities are recognized as of the commencement date based on the present value of the remaining lease payments over the lease term which includes renewal periods the Company is reasonably certain to exercise. The Company’s leases do not contain any material residual value guarantees or material restrictive covenants.

Operating lease expense included within cost of goods sold and selling, general and administrative expense was as follows for the three and nine months ended:

Future maturities of lease liabilities were as follows as of June 30, 2022 ( in thousands):

The weighted average term and weighted average discount rate for the Company’s leases as of June 30, 2022 were 4.47 years and 3.05 %, respectively, compared to 3.09 years and 3.41 %, respectively, as of June 30, 2021. For the three and nine months ended June 30, 2022, the operating cash outflows from the Company’s leases was $ 617,000 and $ 1,167,000 , compared to $ 243,000 and $ 723,000 for the three and nine months ended June 30, 2021.

Note 13. Line of Credit

On April 27, 2022, the Company entered into a loan agreement and a security agreement with Bremer Bank, National Association, that provides the Company with a $ 40 million revolving line of credit that is secured by certain of the Company’s U.S. assets. The line of credit matures on April 27, 2025 and borrowed amounts will bear interest at a variable rate of the CME Group one -month term Secured Overnight Financing Rate (“SOFR”) plus 1.85 %, but not less than 1.80 % per annum.  The loan agreement and the security agreement contains customary affirmative and negative covenants and requirements relating to the Company and its operations, including a requirement that the Company maintain a debt service coverage ratio of not less than 1.20 to 1 as of the end of each fiscal year for the fiscal year then ended and maintain a debt to cash flow ratio of not greater than 2 to 1 measured as of the end of each of the Company’s fiscal quarters for the trailing twelve ( 12 ) month period. Debt service coverage ratio is the ratio of Cash Available for Debt Service to Debt Service, each as defined in the loan agreement.  Debt and Cash Flow are also as defined in the loan agreement for the purposes of the debt to cash flow ratio covenant. As of June 30, 2022, the Company had no outstanding balance on the line of credit and was in compliance with all covenants.  See Note 14. Subsequent Events..

Note 14. Subsequent Events

On July 26, 2022, the Company completed the acquisition of Nestor Cables Oy (“Nestor”), a leading developer and manufacturer of fiber optic cable solutions located in Finland, upon the terms and conditions contained in a Share Sale and Purchase Agreement entered into on May 17, 2022. The total purchase price and the acquisition date fair value of the consideration transferred for the shares totaled €7.9 million in addition to €7.6 million related to the repayment of certain of Nestor’s debt. The purchase price was funded from a draw of $ 16.7 million under the Company’s revolving line of credit. The Company is in the process of finalizing the purchase accounting under ASC 805 - Business Combinations .