Note 9. Income Taxes

For the three months ended December 31, 2021, the Company recorded income tax expense of $2,780,000, reflecting an effective tax rate of 21.1%. The difference between the effective tax rate and the statutory tax rate for the three months ended December 31, 2021 was primarily related to excess tax benefits from restricted stock vesting during the period, Section 162(m) compensation deduction limitations, foreign derived intangibles income deduction (FDII), and research and development credits. For the three months ended December 31, 2020, the Company recorded income tax expense of $684,000 reflecting an effective tax rate of 17.8%.  The differences between the effective tax rate and the statutory tax rate were primarily related to excess tax benefits from non-qualified stock options exercised during the quarter as well as research and development credits. For the three months ended December 31, 2019, the Company recorded a provision for income taxes of $123,000, reflecting an effective tax rate of 19.7%. The differences between the effective tax rate and the statutory tax rate were related to nondeductible meals and entertainment, nondeductible stock compensation, foreign derived intangibles income deduction (FDII) and research and development credits.

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 December 31, 2020 2021 and September 30, 2020 2021 a valuation allowance against ourthe 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 December 31, 2020, 2021, 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.

2020.

ITEM 2. MANAGEMENT’SMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are “forward-looking statements”“forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements relate to future events and typically address the Company’sCompany’s expected future business and financial performance. Words such as “plan, “plan,” “expect,“expect,” “aim,“aim,” “believe,“believe,” “project,“project,” “target,“target,” “anticipate,“anticipate,” “intend,“intend,” “estimate,“estimate,” “will,“will,” “should,“should,” “could”“could” and other words and terms of similar meaning, typically identify these forward-looking statements. Forward-looking statements are based on certain assumptions and expectations of future events and trends that are subject to risks and uncertainties. Actual results could differ from those projected in any forward-looking statements because of the factors identified in and incorporated by reference from PartI, Item 1A, “Risk“Risk Factors,” of our Annual Report on Form 10-K for the year ended September 30, 2020,2021 and Part II, Item 1A. “Risk Factors” of this Quarterly Report on Form 10-Q, as well as in other filings we make with the Securities and Exchange Commission, which should be considered an integral part of PartI, Item 2, “Management’s“Management’s Discussion and Analysis of Financial Condition and Results of Operations.” All forward-looking statements included herein are made as the date of this Quarterly Report on Form 10-Q and we assume no obligation to update the forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements.

The following discussion and analysis of the Company’s financial condition and results of operations as of and for the three months ended December 31, 20202021 and 20192020 should be read in conjunction with the financial statements and related notes in Item 1 of this report and our Annual Report on Form 10-K for the year ended September 30, 2020.2021.

OVERVIEW

General

Clearfield, Inc. (“Clearfield” or the “Company”) 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 (“U.S.”), which include Community Broadband, MSO’s, and 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 for its Legacy customers which include original equipment manufacturers (OEM) requiring copper and fiber cable assemblies built to their specifications.  

The Company has historically focused on the unserved or underserved rural communities that receive voice, video and data services from independent telephone companies. By aligning its in-house engineering and technical knowledge alongside its customers, the Company has been able to develop, customize and enhance products from design through production. Final build and assembly of the Company’s products is completed at Clearfield’s manufacturing facilities in Brooklyn Park, Minnesota, and Tijuana, Mexico, with manufacturing support from a network of domestic and global manufacturing partners. Clearfield specializes in producing these products on both a quick-turn and scheduled delivery basis. The Company deploys a hybrid sales model with some sales made directly to customers, some made through two-tier distribution (channel) partners, sales agents and manufacturing representatives, and sales through original equipment suppliers who private label their products.

Under U.S. federal and state guidance in response to the COVID-19 pandemic, Clearfield’s operations are classified as part of the Cybersecurity and Infrastructure Security Agency (“CISA”) critical infrastructure sector and similar categorization in Minnesota. In March 2020, we transitioned our corporate employees at our Brooklyn Park headquarters to remote work arrangements and they currently continue remote work.primarily working remote. In accordance with the Centers for Disease Control and Prevention (“CDC”) and World Health Organization (“WHO”) guidelines, we implemented and have continued health and safety measures for the production staff that remain onsite at our Brooklyn Park facility. We have maintained our manufacturing capacity in Brooklyn Park with these personnel at near historic levels. Similarly, we have implemented the recommended health and safety measures for the production staff that remains onsite at our Tijuana, Mexico manufacturing facilities. Throughout the COVID-19 pandemic, the Company has closely monitored the operations and staffing levels at its Brooklyn Park facility and its two manufacturing facilities in Tijuana, Mexico.

Due to the risks to timely supply of materials to our facilities, we have taken multiple actions to ensure sufficient safety stock inventory levels at both our Minnesota and Mexico facilities. Additionally, we made the decision to maximize the availability of all product lines at all three of our plants by assuring that each location can manufacture across our broad product portfolio. These actions, combined with our historic practice of dual sourcing most of our components, has positioned us to meet our obligations to customers and to fulfill our order backlog going forward.sales backlog. However, in the event of serious border restrictions or border delays, continuing or worsening component material shortages, supply chain transportation delays, or other serious disruption in our supply chain, we may experience diminished or temporarily suspended operations, longer lead times than typical for product deliveries, or temporarily suspended product deliveries, which would result in delayed or reduced revenue from the affected orders in production and higher operating costs. In addition, due to the unprecedented lead-times and challenges in the global supply chain, we are working with our customers to place longer lead-time purchase orders to ensure availability of components and materials from our supply chain. Based on current supply chain dynamics, lead times have stretched to 8 to 12 weeks or longer for certain product categories. Progressing into 2022, the Company is working to manage lead times to more historic levels from receipt of purchase order.

RESULTS OF OPERATIONS

Three months ended DecemberTHREE MONTHS ENDED DECEMBER 31, 2021 VS. THREE MONTHS ENDED DECEMBER 31, 2020 vS. three months ended December 30, 2019

Net sales for the first quarter of fiscal 20212022 ended December 31, 20202021 were $27,092,000,$51,109,000, an increase of approximately 40%89% or $7,714,000,$24,017,000, from net sales of $19,378,000$27,092,000 for the first quarter of fiscal 2020.2021.  Net sales to Broadband Service Providers were $26,570,000$50,406,000 in the first quarter of fiscal 20212022 versus $18,155,000$26,570,000 in the same period of fiscal 2020.2021.  Among this group, the Company recorded $1,060,000$1,991,000 in international sales for the first quarter of fiscal 20212022 versus $1,137,000$1,060,000 in the same period of fiscal 2020.2021.  Net sales to Legacy customers decreased $711,000 to $515,000were $702,000 in the first quarter of fiscal 2021 from $1,223,0002022 versus $515,000 in the same period of fiscal 2020.2021.  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 6% of total net sales for the first quarter of both fiscal 20212022 and 2020, respectively.2021.

The increase in net sales for the quarter ended December 31, 20202021 of $7,714,000$24,017,000 compared to the quarter ended December 31, 20192020 was driven primarily by increased sales to Community Broadband Service Providers, and MSO customers of $8,198,000,$15,964,000, and $701,000, respectively. Offsetting this was decreased sales to Legacy and Tier 1 customers of $711,000 and $379,000,$6,081,000, respectively. The increase to Community Broadband and MSO customers was due to continuing increased demand for fiber connectivity products 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.

Revenue from all customers is obtained from purchase orders submitted from time to time. Accordingly, thetime, with a limited number of customers recently issuing purchase orders for longer time frames. 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 becomeis further limited by potential disruption to itsglobal supply chains or changes in customer ordering patterns due to COVID-19.chain issues. 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 the first quarter of fiscal 20212022 was $15,723,000,$28,137,000, an increase of $4,072,000,$12,414,000, or 35%79%, from $11,650,000$15,723,000 in the comparable period of fiscal 2020.2021. Gross profit percent was 42.0%44.9% of net sales in the first quarter of fiscal 2021,2022, an increase from 39.9%42.0% of net sales for the first quarter of fiscal 2020.2021. Gross profit increased $3,642,000,$11,603,000 or 47%102%, to $11,369,000$22,972,000 for the three months ended December 31, 20202021 from $7,728,000$11,369,000 in the comparable period in fiscal 2020.2021. The increase in gross profit in the first quarter of fiscal 20212022 was due to increased volume of net sales described above while the increase in gross profit percent was primarily due to a favorable product mix and cost reduction efforts acrossassociated with higher net sales in the Company’s product lines, including greater use of its MexicoCommunity Broadband market, as well as improved manufacturing plants and efficiencies realized from supply chain programs. Gross profit was negatively impactedwith higher sales volumes, offset by tariff costs of approximately $113,000 for the three months ended December 31, 2020higher freight and $100,000 in the comparable period in fiscal 2020. In the first quarter of fiscal 2021, the Company did not experience any significant impacts on cost of sales due to COVID-19.transportation costs.

Selling, general and administrative expenses increased $329,000,$2,267,000 or 4%30%, to $7,656,000$9,923,000 in the first quarter fiscal 20212022 from $7,327,000$7,656,000 for the fiscal 20202021 first quarter.  The increase in expense in the first quarter of fiscal 20212022 consists primarily of increases of $809,000$1,842,000 in compensation expense due to additional headcount and increased wages and performance compensation accruals driven by higher net sales, partially offset by lowerincreased travel and entertainment expenses of $373,000$172,000 due to reduced COVID-19 restrictions. In the first quartertravel restrictions, and increased stock compensation expense of fiscal 2021, other than the travel and entertainment costs mentioned above, the Company did not experience any significant impacts on selling, general and administrative expense due to COVID-19.$128,000.

Income from operations for the quarter ended December 31, 20202021 was $3,714,000$13,049,000 compared to $401,000$3,714,000 for the comparable quarter of fiscal 2020,2021, an increase of approximately 826%251%. This increase is attributable to increased gross profit fromdriven by higher sales in the Company’s Community Broadband and MSO markets, offset by higher selling, general and administrative expenses.

Interest income for the quarter ended December 31, 20202021 was $134,000$120,000 compared to $223,000$134,000 for the comparable quarter for fiscal 2020.2021. The decrease is due to lower interest rates earned on investments in the first quarter of fiscal 2020.2022. We expect interest income tomay decline due to the prevailing lower interest rates and the potential for further decreases in rates in the current economic environment. The Company invests its excess cash in FDIC-backed bank certificates of deposit, and money market accounts.

We recorded a provision for income taxes of $684,000$2,780,000 and $123,000$684,000 for the three months ended December 31, 20202021 and 2019,2020, respectively. We record our quarterly provision for income taxes based on our estimated annual effective tax rate for the year. The increase in tax expense of $561,000$2,096,000 from the first quarter for fiscal 20202021 is primarily due to increased income from operations. The decrease in the income tax expense rate to 17.8% for the first quarter of fiscal 20212022 increased to 21.1%, from 19.7% for17.8% recorded in the first quarter of fiscal 2020 is primarily2021, due to excess tax benefits from non-qualified stock options exercised during the quarter.increased taxable income.

The Company’s net income for the three months ended December 31, 2021 was $10,389,000, or $0.76 per basic share or $0.75 per diluted share. The Company’s net income for the three months ended December 31, 2020 was $3,163,000, or $0.23 per basic and diluted share. The Company’s net income increase in basic and diluted earnings per share for the three months ended December 31, 20192021 as compared to December 31, 2020 was $501,000, or $0.04 per basic and diluted share.

due to higher net income.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2020,2021, our principal source of liquidity was our cash, cash equivalents and short-term investments. Those sources total $28,277,000$23,055,000 as of December 31, 20202021 compared to $27,032,000$23,590,000 as of September 30, 2020.2021. Our excess cash is invested mainly in certificates of deposit backed by the FDIC, U.S. treasuryTreasury securities and money market accounts. Substantially all of our funds are insured by the FDIC. Investments considered long-term were $26,142,000$35,192,000 as of December 31, 2020,2021, compared to $25,143,000$36,913,000 as of September 30, 2020.2021. 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. At the end of the first quarter of fiscal 2021,2022, our cash, cash equivalents and short-term and long-term investments increaseddecreased to $54.4$58.2 million compared to $52.2$60.5 million as of the prior quarter end. We had no long-term debt obligations as of December 31, 20202021 or September 30, 2020.2021.

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 for beyond the next 12 months.  The Company intends on utilizing its available cash and assets primarily for its continued organic growth including expanding production capacity and facilities as well as inventory growth to meet customer demand, and potential future strategic transactions, the Company’s share repurchase program, as well as to mitigate the potential impacts of COVID-19 on the Company’s business.

Duebusiness due to the economic crisis resulting from the COVID-19 pandemic, our future cash flow from operating and investing activities may be negatively impacted. Our uses of cash may also be materially impacted by increased operating expense associated with mitigatingor supply chain, logistics, and customer fulfillment risks caused by COVID-19.risks.

Operating Activities

Net cash used by operating activities totaled $34,000 for the three months ended December 31, 2021. This was primarily due to net income of $10,389,000, non-cash expenses for depreciation and amortization of $639,000, and stock-based compensation of $440,000 in addition to changes in operating assets and liabilities providing and using cash. The primary change in operating assets and liabilities using cash was an increase in inventory of $16,049,000, partially offset by decreases in accounts receivable of $3,108,000 and increase in accounts payable and accrued expenses of $1,750,000. The Company increased stocking levels of inventory during the quarter ending December 31, 2021 to support the Company’s increased sales order backlog, as well as provide for safety stock for anticipated demand considering current long lead times for components and transportation within the global supply chain. We expect to maintain higher than historic stocking levels through fiscal year 2022. The decrease in accounts receivable is due to timing of payments from customers. Accounts receivable balances can be influenced by the timing of shipments for customer projects and payment terms. Days sales outstanding, which measures how quickly receivables are collected, decreased 11 days to 29 days from September 30, 2021 to December 31, 2021. The increase in accounts payable and accrued expenses is due to the timing of payments to vendors in the quarter. Beginning in second quarter of fiscal 2022, our cash payments on facilities leases will increase with our new Tijuana Mexico manufacturing facility and warehouse in Brooklyn Park, MN leases commencing.

Net cash provided by operating activities totaled $2,717,000$2,716,000 for the three months ended December 31, 2020. This was primarily due to net income of $3,163,000, non-cash expenses for depreciation and amortization of $568,000, and stock-based compensation of $289,000 in addition to changes in operating assets and liabilities providing cash. Changes in operating assets and liabilities using cash include a decrease in accounts payable and accrued expenses of $2,860,000, offset by decreases in inventory of $721,000 and accounts receivable of $699,000. The decrease in accounts payable and accrued expenses is due to the timing of payments to vendors in the quarter and $2,373,000 of fiscal 2020 accrued bonus compensation accruals paid in the first quarter of fiscal 2021. The decrease in inventory is a result of higher utilization of inventory components due to increased net sales. Accounts receivable balances can be influenced by the timing of shipments for customer projects and payment terms. Days sales outstanding, which measures how quickly receivables are collected, decreased two days to 33 days from September 30, 2020 to December 31, 2020.

Net cash used in operating activities totaled $100,000 for the three months ended December 31, 2019. This was primarily due to net income of $501,000, non-cash expenses for depreciation and amortization of $607,000, and stock-based compensation of $241,000 in addition to changes in operating assets and liabilities providing cash. Changes in operating assets and liabilities using cash include increases in inventory of $1,617,000, decreases in accounts payable of $1,816,000, offset by decreases in accounts receivable of $2,093,000. Accounts receivable balances can be influenced by the timing of shipments for customer projects and payment terms. Days sales outstanding, which measures how quickly receivables are collected, decreased two days to 33 days from September 30, 2019 to December 31, 2019. The increase in inventory represents an adjustment for seasonal demand along with changes in stocking levels. Changes in working capital reflects items using cash, including a decrease in accounts payable and accrued expenses of $1,848,000 which primarily reflects fiscal 2019 accrued bonus compensation accruals and accounts payable paid in the first quarter of fiscal 2020.

Investing Activities

We invest our excess cash in money market accounts, U.S. Treasury securities and bank CDs in denominations across numerous banks. We believe we obtain a competitive rate of return given the economic climate along with the security provided by the FDIC on these investments. During the three months ended December 31, 2021, we used cash to purchase $248,000 of U.S. Treasury and FDIC-backed securities and received $1,980,000 on CDs that matured. Purchases of property, plant and equipment, mainly related to manufacturing equipment and intangible assets, consumed $2,051,000 of cash during the three months ended December 31, 2021.

During the three months ended December 31, 2020, we used cash to purchase $3,968,000 of FDIC-backed securities and received $4,426,000 on CDs that matured. Purchases of property, plant and equipment, mainly related to manufacturing equipment, consumed $379,000 of cash during the three months ended December 31, 2020.

DuringFinancing Activities

For the three months ended December 31, 2019,2021, we received $249,000 from employees’ participation and purchase of stock through our ESPP, we used cash to purchase $3,211,000 of FDIC-backed securities and received $4,438,000 on CDs that matured. Purchases of property, plant and equipment, mainly$274,000 related to manufacturing equipment, consumed $788,000share withholding for exercise and taxes associated with the issuance of cash duringcommon stock upon cashless exercise of stock options and used $156,000 to pay for taxes as a result of employees’ vesting of restricted shares using share withholding. We did not repurchase common stock under our share repurchase program in the three months ended December 31, 2019.

Financing Activities2021.

For the three months ended December 31, 2020, we received $179,000 from employees’ participation and purchase of stock through our ESPP, we used $262,000 related to share withholding for taxes associated with the issuance of common stock upon cashless exercise of stock options and used $11,000 to pay for taxes as a result of employees’ vesting of restricted shares using share withholding.

For the three months endedAs of both December 31, 2019,2021 and December 31, 2020, we received $170,000had the authority to purchase approximately $4,981,000 in additional shares under the repurchase program announced on November 13, 2014 that was subsequently increased on April 25, 2017.  Effective January 27, 2022, the Company reinstated its stock repurchase program that had been suspended due to COVID uncertainty in April 2020. In addition, the Company’s board of directors increased the share repurchase program by an additional $10 million to an aggregate of $22 million, from employees’ participation and purchase of stock through our ESPP and used $6,000 to pay for taxes as a result of employees’ vesting of restricted shares using share withholding.

the previous $12 million.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management utilizes its technical knowledge, cumulative business experience, judgment and other factors in the selection and application of the Company’s accounting policies. The accounting policies considered by management to be the most critical to the presentation of the financial statements because they require the most difficult, subjective and complex judgments include revenue recognition, stock-based compensation, income taxes and valuation of inventory, long-lived assets, finite lived intangible assets and goodwill.

These accounting policies are described in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s Annual Report on Form 10-K for the year ended September 30, 2020.2021. Management made no changes to the Company’s critical accounting policies during the quarter ended December 31, 2020.2021.

In applying its critical accounting policies, management reassesses its estimates each reporting period based on available information. Changes in these estimates did not have a significant impact on earnings for the quarter ended December 31, 2020.2021.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management carried out an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and the Company’s Chief Financial Officer of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of December 31, 2020.2021. Based upon that evaluation, the Company’s Chief Executive Officer and the Company’s Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There were no changes to the Company’s internal control over financial reporting, as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934, that occurred during the quarter ended December 31, 2020 2021 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. 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 1A. RISK FACTORS

The most significant risk factors applicable to the Company are described in Part I,II, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended September 30, 2020.2021 There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

In the three months ending December 31, 2020, theThe Company repurchased shares of stock associated with exercise and satisfaction of employee tax withholding requirements on vesting or exercise of equity awards under the Company’s 2007 Stock Compensation Plan for the three months ended December 31, 2021 as follows: