Clearfield, Inc. (CLFD) FY 2024 MD&A

ITEM 7.         MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Statement Regarding Forward-Looking Information

Statements made in this Annual Report on Form 10-K, in the Company’s other SEC filings, in press releases and in oral statements, that are not statements of historical fact are “forward-looking statements.” Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results or performance of the Company to be materially different from the results or performance expressed or implied by such forward-looking statements. The words “believes,” “expects,” “anticipates,” “seeks,” “may,” “will,” and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. The risks and uncertainties that could cause actual results to differ materially and adversely from those expressed or implied by the forward-looking statements include those risks described in Part I, Item 1A “Risk Factors.”

Overview of Business: The Clearfield operating segment designs, manufactures, and distributes fiber optic management, protection, and delivery products for communications networks. Its “fiber to the anywhere” platform serves the unique requirements of leading broadband service providers in the United States, which include Community Broadband, Large Regional Service Providers, National Carriers, and Multiple System Operators (“MSOs” or “cable TV”), while also serving the broadband needs of the International markets, primarily in Europe, the Caribbean, Canada, and Mexico. These customers are collectively included in the category of Broadband Service Providers. The Clearfield operating segment also provides contract manufacturing services to its Legacy customers for build-to-print services which include OEM requiring copper and fiber cable assemblies built to their specifications. The Company’s sales channels include direct to customer, through distribution partners, and to original equipment suppliers who private label its products. The Company’s products are sold by its sales employees and independent sales representatives.

The Nestor Cables operating segment manufactures fiber optic and copper telecommunication cables and equipment which it distributes to telecommunication operators, network owners, electric companies, building contractors, and industrial companies. Nestor Cables has been a supplier to Clearfield for over a decade. Nestor has two types of production processes, the process of manufacturing cable in its Finland facility and the finished assembly portion of its business performed in Estonia. Nestor Cables sells its products predominantly to customers in Europe.

Results of Operations

Year ended September 30, 2024, compared to year ended September 30, 2023

The Company’s net sales for fiscal year 2024 decreased 38%, or $102,015,000, to $166,705,000 from net sales of $268,720,000 in fiscal year 2023. The Company allocates sales from external customers to geographic areas based on the location to which the product is transported. Accordingly, international sales represented 27% and 19% of net sales for the years ended September 30, 2024, and 2023, respectively.

The decrease in net sales for fiscal year 2024 of $102,015,000 compared to fiscal year 2023 is attributable to decreased demand across the Clearfield segment’s core markets. Sales to the Community Broadband market decreased 41%, or $45,703,000, from $111,708,000 in fiscal year 2023 to $66,005,000 in fiscal year 2024. Sales to Clearfield’s MSO/Cable TV market decreased 49%, or $22,182,000, from $45,669,000 in fiscal year 2023 to $23,487,000 in fiscal year 2024. Sales to National Carriers decreased 2%, or $187,000, from $8,954,000 in fiscal year 2023 to $8,767,000 in fiscal year 2024. The decrease in sales to these customers was due to a lull in demand for fiber connectivity products as customers digest their larger than normal inventory levels built up during the pandemic which were purchased over the previous years.

Revenue from customers is obtained from purchase orders submitted from time to time, 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 can be further limited by global supply chain issues and customer deployment schedules and factors affecting customer ordering patterns, which may result in changes in customer ordering trends in a relatively short period of time. The Company’s ability to recognize revenue in the future for customer orders will depend on the Company’s ability to manufacture and deliver products to the customers and fulfill its other contractual obligations.

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Cost of sales for fiscal year 2024 was $137,816,000, a decrease of $45,625,000, or 25%, from $183,441,000 in fiscal year 2023. Gross profit decreased 66%, or $56,389,000, from $85,278,000 for fiscal year 2023 to $28,889,000 for fiscal year 2024. The decrease in gross profit was primarily due to lower net sales and lower gross profit margin in fiscal year 2024 in the Clearfield segment.

Gross profit percent was 17.3% in fiscal year 2024 compared to 31.7% for fiscal year 2023. Gross profit margin was negatively affected by unabsorbed overhead in our manufacturing facilities due to lower levels of demand. The Company’s gross profit was also negatively impacted by an increase in inventory reserves of $9,841,000 during the fiscal year ended September 30, 2024. Inventory reserves are primarily due to excess inventory due to the lull in demand in the Clearfield Segment while customers draw down their existing products previously purchased during the period of long lead time supply chain created by the pandemic. The Company expects to operate at gross profit percentage levels at or below these levels for several quarters until revenue levels increase, which is expected to bring improved margins.

Selling, general and administrative expense for fiscal year 2024 was $52,111,000, an increase of $4,119,000, or 9%, compared to $47,992,000 for fiscal year 2023. The increase was primarily due to increased performance-based compensation of $1,307,000, increased stock-based compensation of $1,034,000, and increased professional fees of $1,970,000.

Loss from operations for fiscal year 2024 was $23,222,000 compared to income from operations of $37,286,000 for fiscal year 2023. The decrease is attributable to lower sales and gross profit due to excess supply of fiber products in the Clearfield segment as described above and also higher unabsorbed overhead related to expanded manufacturing capacities in the Clearfield segment.

Net investment income in fiscal year 2024 was $7,472,000 compared to $5,206,000 for fiscal year 2023. The increase in interest income is due to a higher average investments balance and higher interest rates earned for the year ended September 30, 2024. The higher overall investments balance is a result of the Company’s capital raise of approximately $130,000,000 completed late in the first fiscal quarter of 2023 and cash generated from operations in fiscal 2024. The Company invests its excess cash primarily in Federal Deposit Insurance Company (“FDIC”) backed bank certificates of deposit, United States (“U.S.”) treasury securities, and money market funds and accounts. We expect interest income to remain at these levels through fiscal year 2025, subject to changes in market interest rates and changes in the average investments balance.

Interest expense in fiscal year 2024 was $506,000 compared to $881,000 for fiscal year 2023. The decrease is primarily due to the decrease in the average factoring liability held by Nestor Cables during fiscal year 2024.

Income tax benefit for fiscal year 2024 was $3,803,000 compared to income tax expense of $9,079,000 for fiscal year 2023. The decrease in tax expense of $12,882,000 from the year ended September 30, 2023, is primarily due to the decrease in pretax book income for fiscal year 2024. The increase in the income tax expense rate to 23.4% for fiscal year 2024 from 21.8% for fiscal year 2023 is primarily due to changes in state tax, foreign tax and decreased excess tax benefits from stock option exercises and restricted stock vesting, resulting in a shortfall in the current period. decreased excess tax benefits related to stock option exercises and restricted stock vesting, resulting in a shortfall in the current period. Our provision for income taxes includes current U.S. federal, state and foreign current and deferred tax expense.

Net loss for fiscal year 2024 was $12,453,000 or $(0.85) per basic and diluted share compared to net income of $32,533,000 or $2.17 per basic and diluted share for fiscal year 2023.

Year ended September 30, 2023, compared to year ended September 30, 2022

The Company’s net sales for fiscal year 2023 decreased 1%, or $2,163,000, to $268,720,000 from net sales of $270,883,000 in fiscal year 2022. The Company allocates sales from external customers to geographic areas based on the location to which the product is transported. Accordingly, international sales represented 19% and 6% of net sales for the years ended September 30, 2023, and 2022, respectively.

The decrease in net sales for fiscal year 2023 of $2,163,000 compared to fiscal year 2022 is attributable to decreased demand across the Clearfield’s segment core markets. Sales to the Community Broadband market decreased 12%, or $15,312,000, from $127,478,000 in fiscal year 2022 to $112,166,000 in fiscal year 2023. Sales to Clearfield’s MSO/Cable TV market decreased 5%, or $2,252,000, from $47,921,000 in fiscal year 2022 to $45,669,000 in fiscal year 2023. Sales to National Carriers decreased 17%, or $1,817,000, from $10,772,000 in fiscal year 2022 to $8,954,000 in fiscal year 2023. The decrease in sales to these customers was due to a lull in demand for fiber connectivity products as customers digest their larger than normal inventory levels built up during the pandemic which were purchased over the previous years. Net sales to International customers increased 226% or $34,570,000 from $15,316,000 in fiscal year 2022 to $49,885,000 in fiscal year 2023, primarily driven by the Company’s acquisition of Nestor Cables in July 2022.

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Revenue from customers is obtained from purchase orders submitted from time to time, 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 is further limited by global supply chain issues, customer deployment schedules and factors affecting customer ordering patterns, which may result in changes in customer ordering trends in a relatively short period of time. The Company’s ability to recognize revenue in the future for customer orders will depend on the Company’s ability to manufacture and deliver products to the customers and fulfill its other contractual obligations.

Cost of sales for fiscal year 2023 was $183,441,000, an increase of $25,505,000, or 16%, from the $157,936,000 in fiscal year 2022. Gross profit decreased 25%, or $27,669,000, from $112,947,000 for fiscal year 2022 to $85,278,000 for fiscal year 2023. The decrease in gross profit was primarily due to lower net sales and lower gross profit margin in fiscal year 2023 in the Clearfield segment.

Gross profit percent was 31.7% in fiscal year 2023 compared to 41.7% in fiscal year 2022. Gross profit margin was negatively affected by excess overhead and production capacity in the Company’s Clearfield segment that was underutilized. The Company continues to realign capacity to current market conditions. Gross profit was also affected by lower gross profit realized in our Nestor Cables cable manufacturing business which was acquired in July 2022 and was not included in the comparable period of fiscal 2022.

Selling, general and administrative expense for fiscal year 2023 was $47,992,000, a decrease of $1,155,000, or 2%, compared to $49,130,000 for fiscal year 2022. While relatively consistent year over year, expense for the year ended September 30, 2023, decreased due to lower performance-based compensation and transaction costs, offset by additional professional and legal expenses related to the Nestor Cables business acquired in July 2022, as well as increased Clearfield employee compensation costs, stock-based compensation and travel and entertainment expenses.

Income from operations for fiscal year 2023 was $37,286,000 compared to $63,817,000 for fiscal year 2022. The decrease is attributable to lower sales and gross profit due to excess supply of fiber products in the Clearfield segment as described above, higher unabsorbed overhead related to expanded manufacturing capacities in the Clearfield segment, as well as a full year of Nestor Cables, which has a lower gross profit profile related to its bulk cable and duct product offerings.

Net investment income in fiscal year 2023 was $5,206,000 compared to $328,000 for fiscal year 2022. The increase in interest income was due to a higher average investments balance and higher interest rates earned for the year ended September 30, 2023. The higher investments balance was a result of the Company’s capital raise of approximately $130,000,000 completed in the first fiscal quarter of 2023. The Company invested its excess cash primarily in FDIC backed bank certificates of deposit, U.S. treasury securities, and money market funds and accounts.

Interest expense in fiscal year 2023 was $881,000 compared to $311,000 for fiscal year 2022. The increase was primarily due to incurring a full year of interest expense on the factoring liability held by Nestor Cables which was acquired in July 2022.

Income tax expense for fiscal year 2023 was $9,079,000 compared to $14,472,000 for fiscal year 2022. The decrease in tax expense of $5,393,000 from the year ended September 30, 2022, was primarily due to the decrease in taxable income for fiscal year 2023. The decrease in the income tax expense rate to 21.8% for fiscal year 2023 from 22.7% for fiscal year 2022 was due to decreased permanent addback items including nondeductible compensation and transaction costs. Our provision for income taxes included current U.S. federal tax expense and state tax expense, Finland taxes and deferred tax expense.

Net income for fiscal year 2023 was $32,533,000, or $2.17 per basic and diluted share, compared to $49,362,000, or $3.58 per basic and $3.55 per diluted share, for fiscal year 2022.

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Reportable Segments

The Company’s reportable segments are based on the Company’s method of internal reporting. These results are not necessarily indicative of the results of operations that would have occurred had each segment been an independent, stand-alone entity during the periods presented. The internal reporting of these operating segments is defined based, in part, on the reporting and review process used by the Company’s Chief Executive Officer.

On July 26, 2022, Clearfield, through its newly created Finnish subsidiary, Clearfield Finland Oy, acquired all of the equity of Nestor Cables Oy, which has a wholly owned Estonian subsidiary Nestor Cables Baltics OÜ. Following the closing of the acquisition of Nestor Cables on July 26, 2022, the Company reassessed its operating segments as defined under ASC 280, Segment Reporting. Under ASC 280, operating segments are defined as components of an enterprise where discrete financial information is available that is evaluated regularly by the chief operating decision-maker (“CODM”), in deciding how to allocate resources and in assessing performance. Prior to July 26, 2022, we were considered to be a single operating segment structure. Based upon the Company’s assessment following the acquisition of Nestor Cables, the Company determined that the business of Nestor Cables was considered a second reportable segment as of July 26, 2022. Accordingly, beginning with the year ended September 30, 2022, the Company has two reportable segments: (1) Clearfield; and (2) Nestor Cables. The entities that comprise the Nestor Cables segment are Clearfield Finland Oy, Nestor Cables Oy and Nestor Cables Baltics OÜ.

Reportable segments are as follows:

Clearfield Segment

The following table provides net sales and net (loss) income for the Clearfield segment for the fiscal years ended:

Net sales in the Clearfield segment decreased 44%, or $100,154,000, for the fiscal year ended September 30, 2024, resulting from decreased sales to its Community Broadband, MSO/Cable TV, and Large Regional customers as these customers work to digest inventory that was purchased previously during the period of long lead time supply chain created by the pandemic.

Net loss in the Clearfield segment for the fiscal year ended September 30, 2024 increased 128%, or $41,348,000, from net income of $32,834,000 for the fiscal year ended September 30, 2023, driven by the changes in sales outlined above, as well as lower gross profit margin which was negatively affected by the buildup in capacity that was not utilized, as well as reserves for inventory.

Nestor Cables Segment

The following table provides net sales and net loss for the Nestor Cables segment for the fiscal year ended:

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Net sales in the Nestor Cables segment decreased 4%, or $1,861,000, for the fiscal year ended September 30, 2024, as compared to the fiscal year ended September 30, 2023, excluding sales to the Clearfield segment.

Net loss in the Nestor Cables segment for the fiscal year ended September 30, 2024, increased 112%, or $3,638,000, from the fiscal year ended September 30, 2023, driven by lower gross profit margin as well as increased operating expenses.

Sales Backlog

Sales backlog reflects purchase order commitments for our products received from customers that have yet to be fulfilled. The Company had a backlog of $25,133,000 and $57,285,000 as of September 30, 2024, and 2023, respectively. The decrease in backlog was primarily due to a lull in demand for fiber connectivity products at our Clearfield segment as customers digest their larger than normal inventory levels built up during the pandemic which were purchased over the previous years. We believe that the Nestor Cables segment generally experiences the same seasonality as the Clearfield segment.

Liquidity and Capital Resources

As of September 30, 2024, the Company had combined consolidated balances of cash, cash equivalents, short-term and long-term investments of $155,497,000 compared to $174,456,000 as of September 30, 2023. Additionally, we have a line of credit for $40 million that has no outstanding borrowing as of September 30, 2024. Our excess cash is invested mainly in certificates of deposit backed by the FDIC, U.S. Treasury securities, and money market funds.

On April 27, 2022, Clearfield entered into a loan agreement and a security agreement to provide 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. As of September 30, 2024, the interest rate was 7.05%. The loan agreement and the security agreement contained 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.

On August 5, 2024, the Company entered into an amendment to the loan agreement that, among other things, (i) eliminated the 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 that the Company 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 12 month period; (ii) added a requirement that the Company maintain accounts with the lender with a minimum aggregate liquidity of unrestricted and unencumbered cash and cash equivalents at all times of not less than the outstanding principal balance of the Company’s revolving credit promissory note payable to the lender; and (iii) waived the Company’s compliance with the debt to cash flow ratio for the fiscal quarter ended June 30, 2024. As of the date of the amendment, there was not an outstanding principal balance on the Company’s revolving credit promissory note with the lender.

As of September 30, 2024, the Company had no borrowings against this line of credit and was in compliance with all applicable covenants. As of September 30, 2024, and 2023, the Company had a loan for €2,000,000, which equates to $2,228,000 and $2,112,000, as of September 30, 2024 and 2023, respectively. We believe the combined balances of short-term cash and investments, along with long-term investments and available bank lines of credit, provide a more accurate indication of our available liquidity.

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We believe our existing cash equivalents and short-term investments, along with cash flow from operations and line of credit, will be sufficient to meet our working capital and investment requirements beyond the next 12 months. The Company intends on utilizing its available cash and assets primarily for its continued organic growth and potential future strategic transactions, as well as execution of the share repurchase program adopted by our board of directors. Effective January 27, 2022, the Company reinstated its stock repurchase program that had been suspended due to COVID uncertainty in April 2020. The Company’s board of directors increased the share repurchase program $18,000,000 effective November 7, 2023, and an additional $25,000,000 effective April 30, 2024, to an aggregate of $65,000,000. During the year ended September 30, 2024, the Company repurchased 1,164,190 shares for approximately $33,058,000. As of September 30, 2024, we have repurchased an aggregate of 1,729,780 shares for $40,077,000 leaving approximately $24,923,000 available within our $65,000,000 stock repurchase program. The repurchase program does not obligate Clearfield to repurchase any particular amount of common stock during any period. The repurchases will be funded by cash on hand. During the year ended September 30, 2023, the Company did not repurchase any shares under the stock repurchase program.

Operating Activities

Net cash provided by operations for the fiscal year ended September 30, 2024, totaled $22,223,000. Cash provided by operations included net loss of $12,453,000 for the fiscal year ended September 30, 2024, non-cash income and expenses for depreciation and amortization of $7,411,000, stock-based compensation of $4,641,000, amortization of discount on investments of $4,406,000, in addition to changes in operating assets and liabilities using cash. Changes in operating assets and liabilities using cash include a decrease in net inventories of $31,990,000 and a decrease in accounts receivable of $7,799,000. The decrease in inventory is due to lower inventory purchases during fiscal year 2024 as the Company utilized inventory on hand to fulfill customer orders to support sales demand, as well as higher excess inventory charges taken in fiscal year 2024. The decrease in accounts receivable is due to lower net sales in the fiscal 2024 compared to the prior year. Days sales outstanding (“DSO”), which measures how quickly receivables are collected, decreased 11 days from 53 to 42 from September 30, 2023, to September 30, 2024. Changes in operating assets and liabilities using cash include an increase in other assets of $9,225,000 and receiving cash due to an increase in accounts payable and accrued expenses of $544,000. The increase in other assets is related to prepaid expenses including value added taxes related to cross border inventory transfers.

Net cash provided by operations for the fiscal year ended September 30, 2023, totaled $18,423,000. Cash provided by operations included net income of $32,533,000 for the fiscal year ended September 30, 2023, non-cash expenses for depreciation and amortization of $6,054,000, stock-based compensation of $3,578,000, amortization of discount on investments of $3,512,000, in addition to changes in operating assets and liabilities using cash. Changes in operating assets and liabilities using cash include an increase in net inventories of $15,083,000 and a decrease in accounts payable and accrued expenses of $27,843,000. The increase in inventory is a result of additional stocking levels to support the Company’s anticipated customer demand, as well as stocking of long lead time components to limit manufacturing delays due to raw material component shortages and supply chain delays experienced during the pandemic. The decrease in accounts payable is due to lower purchasing activity of inventory near the end of the period in response to lower demand from customers, as well as lower performance-based compensation accruals as of September 30, 2023. Also, changes in operating assets and liabilities providing cash include a decrease in accounts receivable of $26,277,000, due to lower net sales in the Company’s fourth quarter of fiscal 2023 compared to the prior year. DSO remained consistent as it increased 1 day from 52 to 53 from September 30, 2022, to September 30, 2023.

Net cash provided by operations for the fiscal year ended September 30, 2022, totaled $2,258,000. Cash provided by operations included net income of $49,362,000 for the fiscal year ended September 30, 2022, non-cash expenses for depreciation and amortization of $3,426,000, stock-based compensation of $2,339,000, in addition to changes in operating assets and liabilities using cash. Changes in operating assets and liabilities using cash include an increase in net inventories of $43,744,000 and accounts receivables of $24,234,000. The increase in inventory is a result of additional stocking levels to support the Company’s increased sales backlog and higher demand, and stocking of high turn and long lead time components to limit manufacturing delays due to raw material component shortages and supply chain delays. The increase in accounts receivable was due to higher net sales as well as increased DSO due to higher sales to certain customers with longer payment terms. DSO increased 13 days from 39 to 52 from September 30, 2021, to September 30, 2022. Also, changes in operating assets and liabilities providing cash include an increase in accounts payable and accrued expenses of $15,760,000, due to timing of accounts payable and $8,738,000 in fiscal year 2022 incentive compensation accruals to be paid after year end.

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Investing Activities

We invest our excess cash in money market accounts, U.S. Treasury securities, money market funds, and bank certificates of deposit in denominations across numerous banks. We believe we obtain a competitive rate of return given the economic climate and relative risk profile of these investments. For the fiscal year ended September 30, 2024, the Company received proceeds from maturities of investments of $162,064,000 and used cash to purchase $159,393,000 of investments in certificates of deposit below FDIC insured levels and U.S. Treasuries. The Company used $9,567,000 in cash to purchase fixed and intangible assets. The result is cash used in investing activities of $6,896,000 in fiscal year 2024. In fiscal year 2025, the Company intends to continue investing in the necessary information technology, manufacturing equipment, and facility needs.

For the fiscal year ended September 30, 2023, the Company received proceeds from maturities of investments of $107,060,000 and used cash to purchase $210,923,000 of investments in certificates of deposit below FDIC insured levels and U.S. Treasuries. The Company used $8,384,000 in cash to purchase fixed and intangible assets. The result is cash used in investing activities of $112,247,000 in fiscal year 2023.

For the fiscal year ended September 30, 2022, the Company had $17,386,000 of FDIC-backed certificates of deposit and U.S. Treasuries mature or be sold. The Company used $9,148,000 in cash to purchase fixed and intangible assets. Additionally, the Company used $16,187,000 in cash to acquire Nestor Cables in July 2022. The result was cash used in investing activities of $8,197,000 in fiscal year 2022.

Financing Activities

For the fiscal year ended September 30, 2024, the Company used cash to repurchase $33,058,000 of our common stock on the open market under our stock repurchase program. In connection with the stock repurchase, the Company accrued $316,000 of U.S. Federal excise taxes to be paid during fiscal year 2025. We received $586,000 from employees’ purchase of stock through our Employee Stock Purchase Plan (“ESPP”) The Company also used cash of $3,617,000 on repayments on factored accounts receivables, net of borrowings and $493,000 to pay for taxes as a result of employees’ vesting of restricted shares using share withholding. As a result, the net cash used for financing activities during fiscal year 2024 was $36,907,000.

For the fiscal year ended September 30, 2023, the Company received $130,262,000 of net proceeds through the issuance of common stock in the first quarter of fiscal 2023. The Company received cash of $1,587,000 on borrowings on factored accounts receivables, net of repayments The Company also received $611,000 from employees’ purchase of stock through our ESPP and $954,000 related to issuance of stock as payment for incentive compensation. The Company used $16,700,000 to pay down in full the then-outstanding principal on our line of credit, which was originally drawn in the fourth quarter of fiscal 2022 to fund the acquisition of Nestor Cables. The Company also used $491,000 related to share withholding for exercise and taxes associated with the issuance of common stock upon cashless exercise of stock options and used $1,220,000 to pay for taxes as a result of employees’ vesting of restricted shares using share withholding. As a result, the net cash provided by financing activities during fiscal year 2023 was $115,002,000.

For the fiscal year ended September 30, 2022, the Company borrowed $16,700,000 on its line of credit to fund the July acquisition of Nestor Cables. The Company received $544,000 from employees’ purchase of stock through our ESPP and $1,258,000 on repayments on factored accounts receivables, net of borrowings. The Company used $5,183,000 related to share withholding for exercise and taxes associated with the issuance of common stock upon cashless exercise of stock options and used $1,406,000 to pay for taxes as a result of employees’ vesting of restricted shares using share withholding. As a result, the net cash provided by financing activities during fiscal year 2022 was $9,397,000.

Operating Leases

We have entered into various non-cancelable operating lease agreements for office equipment at our office and manufacturing spaces in Minnesota, Mexico, Finland, and Estonia expiring at various dates through August 2034. Certain of these leases have escalating rent payment provisions. We recognize rent expense under such leases on a straight-line basis over the term of the lease.

Critical Accounting Estimates

In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our sales, income from operations and net income, as well as on the value of certain assets and liabilities on our consolidated balance sheets. We believe there are several accounting policies that are critical to an understanding of our historical and future performance, as these policies affect the reported amounts of sales, expenses and significant estimates and judgments applied by management. While there are a number of accounting policies, methods and estimates affecting our financial statements, areas that are particularly significant include:

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●    Accounting for stock-based compensation

●    Income taxes

●    Valuation of inventory, long-lived assets, finite lived intangible assets and goodwill

●    Valuation in business combinations

Stock-Based Compensation

We measure and recognize compensation expense for all stock-based awards at fair value over the requisite service period. We use the Black-Scholes option pricing model to determine the fair value of options. For restricted stock grants, fair value is determined as the closing price of the Company’s stock on the date of grant. Equity-based compensation expense is broken out between cost of sales and selling, general and administrative expenses based on the classification of the employee. The determination of fair value of stock-based awards on the date of grant using an option-pricing model is affected by our stock price as well as by assumptions regarding a number of subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.

The expected terms of the options are based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at grant date. Volatility is based on historical and expected future volatility of the Company’s stock. The Company has not historically issued any dividends and does not expect to in the future. Forfeitures for both option and restricted stock grants are estimated at the time of the grant and revised in subsequent periods if actual forfeitures differ from estimates.

If factors change and we employ different assumptions in the determination of the fair value of grants in future periods, the related compensation expense that we record may differ significantly from what we have recorded in the current periods.

Income Taxes

We account for income taxes in accordance with ASC 740, Income Taxes, under which deferred income taxes are recognized based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income, and available tax planning strategies. If tax regulations, operating results, or the ability to implement tax-planning strategies vary, adjustments to the carrying value of deferred tax assets and liabilities may be required. A valuation allowance is recorded when it is more likely than not that a deferred tax asset will not be realized. The recorded valuation allowance is based on significant estimates and judgments and if the facts and circumstances change, the valuation allowance could materially change.

In accounting for uncertainty in income taxes, we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. The Company recognizes interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.

As of September 30, 2024, and 2023, the Company had no U.S. federal or Estonia net operating loss (“NOL”) carry-forwards. As of September 30, 2024, there is a state NOL of $64,000. There was no state NOL as of September 30, 2023 As of September 30, 2024, and 2023, there is a Finnish NOL of $1,851,000 and $1,000, respectively.

As part of the process of preparing our financial statements, we are required to estimate our income tax liability in each of the jurisdictions in which we do business. This process involves estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that these deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not more likely than not or unknown, we must establish a valuation allowance. If the valuation allowance is reduced, the Company would record an income tax benefit in the period in which that determination is made. If the valuation allowance is increased, the Company would record additional income tax expense.

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The Company files income tax returns in the U.S. Federal jurisdiction and various state and foreign jurisdictions. Based on its evaluation, the Company has concluded that it has no significant unrecognized tax benefits. The Company is generally subject to U.S. federal examination for all tax years after 2019. The Company is subject to state examinations for all tax years after 2014 due to unexpired research and development credit carryforwards still open under statute. Nestor is generally subject to Finland examination for all tax years after 2020 and Estonia examination for all tax years after 2020.

Impairment of Long-Lived Assets, Intangible Assets and Goodwill

The Company’s long-lived assets as of September 30, 2024, consisted primarily of property, plant and equipment, right of use lease assets, patents, intangibles, and goodwill. The Company reviews the carrying amount of its property, plant and equipment, right of use lease assets, and intangible assets if events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. When this review indicates the carrying amount of an asset or asset group exceeds the sum of the future undiscounted cash flows expected to be generated by the assets, the Company recognizes an asset impairment charge against operations for the amount by which the carrying amount of the impaired asset exceeds its fair value.

Determining fair values of property, plant, and equipment, right of use lease assets, and intangible assets using a discounted cash flow method involves significant judgment and requires the Company to make significant estimates and assumptions, including long-term projections of cash flows, market conditions and appropriate discount rates. Judgments are based on historical experience, current market trends, consultations with external valuation specialists and other information. If facts and circumstances change, the use of different estimates and assumptions could result in a materially different outcome. The Company generally develops these forecasts based on recent sales data for existing products, planned timing of new product launches or acquisitions, and estimated future growth of the FTTP market.

Goodwill represents the excess purchase price over the fair value of tangible net assets acquired in acquisitions after amounts have been allocated to intangible assets. Goodwill is tested for impairment annually at fiscal year-end, or more frequently when events or changes in circumstances indicate that the asset might be impaired. Examples of such events or circumstances include, but are not limited to, a significant adverse change in legal or business climate, an adverse regulatory action or unanticipated competition. The Company assesses qualitative factors to determine whether the existence of events or circumstances would indicate that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. During the years ended September 30, 2024, 2023, and 2022, there were no triggering events that indicated goodwill or intangible assets may be impaired.

If after assessing the totality of events or circumstances, the Company were to determine that it is more likely than not that the fair value of the reporting unit is less than its carrying amount, then the Company would perform a quantitative test that compares the fair value to its carrying value to determine the amount of any impairment.

If the carrying amount of a reporting unit exceeds its fair value, the Company would measure the possible goodwill impairment loss based on an allocation of the estimate of fair value of the reporting unit to all of the underlying assets and liabilities of the reporting unit, including any previously unrecognized intangible assets. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized to the extent that a reporting unit's recorded goodwill exceeds the implied fair value of goodwill. An impairment loss would be based on significant estimates and judgments, and if the facts and circumstances change, a potential impairment could have a material impact on the Company’s financial statements.

No impairment of goodwill or intangible assets has occurred during the years ended September 30, 2024, 2023, and 2022, respectively.

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Valuation of Inventory

The Company maintains a material amount of inventory to support its manufacturing operations and customer demand. This inventory is stated at average cost, subject to the lower of cost or net realizable value. On a regular basis, the Company reviews its inventory and identifies inventory which is excess, slow moving, or obsolete by considering factors such as inventory levels, expected product life, and forecasted sales demand. Any identified excess, slow moving, and obsolete inventory is written down to its market value through a charge to cost of sales. It is possible that additional inventory write-down charges may be required in the future if there is a significant decline in demand for the Company’s products and the Company does not adjust its inventory procurement accordingly.

Valuation in Business Combinations

We record tangible and intangible assets acquired and liabilities assumed in business combinations under the purchase method of accounting under ASC 805, Business combinations. Amounts paid for each acquisition are allocated to the assets acquired and liabilities assumed based on their fair values at the dates of acquisition. The value recorded is based on estimates of future financial projections. These cash flow projections are discounted with a risk adjusted rate. The fair value of identifiable intangible assets is based on detailed valuations that use information and assumptions provided by management, which is considered management’s best estimate of inputs and assumptions that a market participant would use. We allocate any excess purchase price over the fair value of the net tangible and intangible assets acquired and liabilities assumed to goodwill.

Recently Adopted Accounting Pronouncements

On October 1, 2023, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standard Update (“ASU”) No. 2016-13, Measurement of Credit Losses on Financial Instruments, and subsequent amendments to the initial guidance: ASU No. 2018-19, ASU No. 2019-04, ASU No. 2019-05, and ASU No. 2020-02 (collectively, Topic 326). This guidance introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses (CECL). The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost. The Company adopted Topic 326 using the modified retrospective method for all financial assets measured at amortized cost, which are primarily trade accounts receivable for the Company. Results for reporting periods beginning after October 1, 2023, are presented under Topic 326 while prior period amounts continue to be reported in accordance with previously applicable U.S. GAAP. The impact of adopting Topic 326 as of October 1, 2023, was not material to the consolidated financial statements.

New Accounting Pronouncements Not Yet Adopted

In November 2023, the FASB issued ASU No. 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. ASU 2023-07 is intended to enhance financial reporting by requiring incremental disclosures for significant segment expenses on an annual and interim basis by public entities required to report segment information in accordance with Accounting Standards Codification Topic 280. The amendments in ASU 2023-07 are to be applied retrospectively to all periods presented in the financial statements and early adoption is permitted. This standard will be applicable to the Company for the 2025 annual period and quarterly periods thereafter. The Company is evaluating its disclosure approach for ASU 2023-07 and anticipates adopting the standard for the year ended September 30, 2025, and filings thereafter.

In December 2023, the FASB issued ASU No. 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures. The new guidance is expected to improve income tax disclosures primarily related to the rate reconciliation and income taxes paid information by requiring 1) consistent categories and greater disaggregation of information in the rate reconciliation and 2) income taxes paid disaggregated by jurisdiction. The guidance is effective on a prospective basis, although retrospective application and early adoption is permitted. The Company is evaluating its disclosure approach for ASU 2023-09 and anticipates adopting the standard for the annual period starting October 1, 2025.

In March 2024, the SEC adopted rules under SEC Release No. 33-11275, The Enhancement and Standardization of Climate-Related Disclosures for Investors, which requires the disclosure of material Scope 1 and Scope 2 greenhouse gas emissions and other climate-related topics in annual reports and registration statements. For large-accelerated filers and accelerated filers, disclosure requirements will begin phasing in for fiscal years beginning on or after January 1, 2025, and January 1, 2026, respectively, subject to legal challenges and the SEC’s voluntary stay of the disclosure requirements. The Company is currently evaluating the impact these rules will have on its consolidated financial statements and related disclosures.

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