Optical Cable Corporation (OCC) Q2 2020 Earnings Report, Transcript and Summary

Good morning. My name is Christie and I will be the conference operator today. At this time, I would like to welcome everyone to the Optical Cable Corporation Second Quarter 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period [Operator Instructions]. Thank you. I will now turn the conference over to Mr. Palash. Please go ahead.

Thank you, Christie and good morning, and thank you all for participating on Optical Cable Corporation's second quarter of fiscal year 2020 conference call. By this time, everyone should have a copy of the earnings press release issued earlier today. You can also visit www.occfiber.com for a copy. On the call with us today are Neil Wilkin, President and Chief Executive Officer of OCC and Tracy Smith, Senior Vice President and Chief Financial Officer. Before we begin, I'd like to remind everyone that this call may contain forward-looking statements that involve risks and uncertainties. The actual future results of Optical Cable Corporation may differ materially due to a number of factors and risks, including but not limited to, those factors referenced in the forward-looking statements section of this morning's press release. These cautionary statements apply to the content of the Internet webcast on www.occfiber.com, as well as today's call. With that, I'll turn the call over to Neil Wilkin. Neil, please begin.

Thank you, Aaron and good morning, everyone. I will begin the call today with a few opening remarks. Tracy will then review the second quarter results for the three month and six month period ended April 30, 2020 in some additional detail. After Tracy's remarks, we will answer as many of your questions as we can. As is our normal practice, we will only take questions from analysts and institutional investors during the Q&A session. However, we also offer other shareholders the opportunity to submit questions in advance of our earnings call. Instructions regarding such submissions are included in our press release announcing the date and time of our call today. Let me start my remarks by acknowledging that this is a challenging time. I want to thank the OCC team for rising to the occasion in the face of the COVID-19 pandemic and the many challenges that has created. We have taken a number of steps to ensure the health and safety of our employees and their families, and we have been able to mitigate the impact of COVID-19 on our employees and on day to day operations, which has continued uninterrupted at lower production volumes. OCC is obligated and continues to operate during the COVID-19 pandemic, because our workforce is classified as a defense industrial base essential critical infrastructure workforce, under the guidelines from the U.S. Department of Defense and an essential critical infrastructure workforce under the guidelines of the U.S. Department of Homeland Security, Cybersecurity and Infrastructure Security Agency. While we continue to operate, OCC has been negatively impacted by the COVID-19 pandemic. Revenues in many of our markets were negatively impacted, production volumes and operations were negatively impacted and financial flexibility was negatively impacted. We also experienced increased bad debt expense, some minor disruptions in our supply chains, as well as other pressures on our business. As a result, our net sales in the second quarter of fiscal year 2020 decreased 21.6% compared to the same period last year. Excluding the revenue impact of one domestic customer, however, our net sales would have decreased only 7.7% during the second quarter. Sequentially, net sales increased 15.3% in the second quarter compared to the first quarter of fiscal year 2020. As you all know, OCC is a patriotic organization. Our team is incredibly proud to provide mission critical products to support our country's military, first responders and other essential workers, including healthcare facilities, hospitals, test centers and laboratories. We have and will continue to do our part to meet the needs of our customers and end users, both here in the United States and around the world. We have worked hard to build a diversified customer base and are pleased that strong demand from certain markets tends to somewhat mitigate reduced sales in other markets. We have a strong foundation and a resilient business model. We have taken and are continuing to take actions to enhance OCC's financial flexibility, execute on our sales and business growth initiatives, design to best position OCC even during these challenging times, build on our operating leverage and focus on driving efficiency and effectiveness improvements across our manufacturing operations, and of course control SG&A expenses. OCC is uniquely positioned in our industry. We are confident that our distinct competitive advantages and capabilities will facilitate profitable growth and enable OCC to successfully compete against our larger competitors now and into the future. And with that, I'll turn the call over to Tracy Smith who will review in additional detail our second quarter of fiscal year 2020 financial results.

Thank you, Neil. Consolidated net sales for the second quarter of fiscal 2020 were $14.9 million, a decrease of 21.6% compared to net sales of $19 million for the second quarter of fiscal 2019. Consolidated net sales for the first half of fiscal 2020 were $27.8 million, a decrease of 22.3% compared to net sales of $35.7 million in the same period last year. Net sales in certain of our markets were negatively impacted during the second quarter and first half of fiscal year 2020 due to the economic effects of the COVID-19 pandemic. The decrease in net sales in the second quarter and first half of fiscal 2020 was primarily the result of a number of large orders from one customer in the wireless carrier market in the second quarter and the first half of fiscal year 2019 that did not recur at the same levels in the second quarter and first half of fiscal year 2020. Net sales to this customer decreased $2.9 million and $5.2 million in the second quarter in the first half of fiscal 2020, respectively. Historically, net sales to this customer have been volatile from quarter-to-quarter and from year-to-year. Sequentially, net sales increased 15.3% in the second quarter of fiscal year 2020 compared to net sales of $12.9 million for the first quarter of fiscal year 2020. The increases in both the enterprise market and specialty markets, including the wireless carrier market. Turning now to gross profit. Gross profit was $4 million in the second quarter of fiscal 2020 compared to $5.3 million in the second quarter of fiscal 2019. Gross profit margin or gross profit as a percentage of net sales was 26.9% in the second quarter of fiscal 2020 compared to 28% in the second quarter of fiscal 2019. Gross profit was $6.4 million in the first half of fiscal 2020 compared to $8.9 million in the first half of fiscal 2019. Gross profit margin or gross profit as a percentage of net sales was 23.1% in the first half of fiscal 2020 compared to 24.8% in the first half of fiscal 2019. Gross profit margins tend to be higher when the company achieved higher net sales levels of certain fixed manufacturing costs spread over higher sales. This operating leverage, which is beneficial at higher sales levels, was the primary factor putting downward pressure on gross profit margin during the second quarter and first half of fiscal year 2020 as fixed costs were spread over lower sales, offsetting cost reductions and significant production throughput and efficiency improvements achieved principally in the company's Roanoke production facility. SG&A expenses decreased 3.9% to $5.5 million during the second quarter of fiscal 2020 compared to $5.8 million for the same period last year. SG&A expenses as a percentage of net sales were 37.3% in the second quarter of fiscal 2020 compared to 30.5% in the second quarter of fiscal 2019. SG&A expenses decreased 17.3% to $10.4 million during the first half of fiscal 2020 compared to $12.6 million for the same period last year. SG&A expenses as a percentage of net sales were 37.4% in the first half of fiscal 2020 compared to 35.1% in the first half of fiscal 2019. The decrease in SG&A expenses during the second quarter and first half of fiscal 2020 compared to the same period last year was primarily the result of decreases in employee related costs, including employee incentives and commissions and net reductions and other SG&A expenses. These decreases were partially offset by an increase in bad debt expense due to concerns about collectability of certain customer accounts during this unprecedented pandemic environment. OCC recorded a net loss of $1.7 million or $0.23 per basic and diluted share for the second quarter of fiscal 2020 compared to a net loss of $617,000 or $0.08 per basic and diluted share for the second quarter of fiscal 2019. OCC recorded a net loss of $4.3 million or $0.58 per basic and diluted share for the first half of fiscal 2020 compared to a net loss of $3.9 million or $0.53 per basic and diluted share for the first half of fiscal 2019. On April 15, 2020, we obtained an unsecured loan in the amount of $5 million as part of the Payckeck Protection Programs. The lender for this loan is Pinnacle Bank. On April 30, 2020, OCC’s credit agreement with Pinnacle Bank was amended to remove a requirement that the company’s secure financing commitment letter and more equity commitment or combination thereof to refinance the revolving credit notes under the credit agreement prior to May 1, 2020, as previously required. However, we are continuing to work to obtain another source of financing for our revolver. As of April 30, 2020, we had outstanding borrowings of $6 million on our revolving credit notes. We also had outstanding loan balances of $5.3 million under our real estate term loans and $5 million on our PPP loan. And with that, I will turn the call back over to Neil.

Thank you, Tracy. And now if you have any questions, we're happy to answer them. Christie, if you could please indicate the instructions for participants to call in any questions they may have I would appreciate it. And again, we're only taking live questions from analysts and institutional investors.

[Operator Instructions] And at this time, we have no questions. Neil, I hand the floor over to you.

Okay, thank you. Aaron, I know we have some questions submitted by individual investors. If you could go through those with us we'll answer those questions.

That sounds good. Here's the first one. Does OCC compete with foreign or domestic sources?

We have both domestic and international competitors. We're fortunate in the sense that in the U.S. in particular, a lot of folks, customers tend to buy from domestic sources, and we don't see a lot of, we don’t see significant amount of foreign competitors in most of our markets.

Next question, has China been a competitive force and specifically has China put pressure on pricing?

We don't experience a lot of pricing pressure from specific countries. We do have pricing pressure, both internationally and domestically in the markets that we participate in. And as I was mentioning before or leading to before, the international markets is where you would tend to see more price competition from international manufacturers. We're fortunate in the fact that [OCC] [ph] tends to position our product based on quality, customer service and performance, and rather than on price. And so that helps to mitigate some of the impact of pricing pressure in our markets.

Next question, is OCC involved with 5G and could OCC benefit from 5G as it advances and becomes more widely used in the years to come?

Yes. So everyone is talking about 5G and OCC has been over the years participated in various ways in the wireless carrier market and 5G is an extension of that. We believe we have products that are well suited for the expansion of 5G technologies. And we are working to best position ourselves so that we can obtain the benefits of those, of that expansion into 5G. Certainly, 5G is going to be a big contributor to growth in our industry overall. And again, we're doing our best to position ourselves so that we can participate in that.

Next question, has OCC seen any increased desire to do more USA sourcing?

Not specifically. In other words, we haven't had too many instances where someone says I’d normally would buy from a foreign source but I’ll buy from OCC, because you're a domestic source. But certainly, I think one of the advantages of sourcing things domestically and locally is that we're better able to provide a high level of customer service and we'll continue to do so.

Next question, does OCC market anything to the wireless carrier market?

I mean we obviously, as I mentioned before, we do sell into the wireless carrier market. We've talked about previously some of the markets that we operate in, the wireless carrier market tends to be a little bit more volatile or certainly more volatile than some of our other markets. But we do sell into that market and by extension believe and hope to participate and are positioning ourselves to participate in the 5G market as well.

Next question, can you break down the 15% increase in SG&A expenses sequentially?

Tracy is going to take that one.

Okay. Sure. That increase was primarily related to the increase in bad debt expense that we recorded this quarter that I referred to during my comments. Also, we generally have fluctuations in SG&A expense based on the timing of certain things that occurred during the year, including reporting requirements and other public company obligations, such as mailing proxy materials and things like that that occurred during our second quarter.

Next question, was there a reduction in headcount during the second quarter? If so, are any employees brought back? Have you reduced compensation costs by individuals in the second quarter and into the third quarter? And also has OCC experienced any COVID amongst its employees?

Let me take the last one first. We've been fortunate that we have not had any instances where our employees have contracted COVID-19. As we've talked about before, we're very careful about our social distancing for those folks that are at our facilities, limiting visitors, limiting travel and also working with employees to make sure that even outside of their work environment and they're working as you see that they're practicing social distancing and safe practices to keep all of our employees and their families safe. We have not specifically reduced headcount, that's always a possibility and would have been something I think we would have needed to look at sooner, but for the fact that the SBA, PPP loan was secure. And so from our standpoint, that loan served its purpose of allowing us to keep people employed and also was helpful for OCC, because when you let folks off and skilled workers off and lay off with a furlough or terminate, you do have the risk of impacting the critical mass of the company and the capabilities long-term of the company, particularly in what we hope is a more temporary impact on our business due to this COVID-19 pandemic this year. That doesn't mean that we don't continue to look at those issues. And we'll continue to look at those issues to make sure we're focused on positioning OCC best for the future, as well as making sure we're ensuring the financial flexibility and managing our earnings on the short-term basis, as well as on a long-term basis. So part of the question you asked Aaron was, have you brought people back? And obviously, since we haven't at this point specifically let people go that hasn't been, that last point hasn't been an issue.

Next question, can you talk about the second quarter bad debt expense?

COVID-19 has of course impacted many markets, including certain of those we serve. But during 2Q when completing our analysis of the allowance for doubtful accounts, it became apparent some customers would have more difficulty meeting their obligations. So to the best of our ability, we estimated the amounts that we believe necessary to reflect these doubtful accounts as bad debt in our earnings this quarter. We're obviously going to work to collect on this account to the extent possible and to the extent that we can do so, we’ll account for the recovery in future periods.

Next question, can you talk about inventory levels, were they down from October and down a bit from January? Over the longer term, should we expect inventories to increase?

We maintain appropriate inventory to meet our customer demand. Our inventory levels fluctuate based on sales each quarter, because of the nature of the business and the manner and timing of how our customers place orders, as well as the timing of raw material orders placed by us and the receipt of those orders. So our inventory does fluctuate from quarter to quarter and can fluctuate from quarter to quarter.

Next question, and you abbreviated in your balance sheet that accompanies the press release, where are you showing the PPP loan?

A portion of the loan is reflected in current liabilities that would be the amount expected to be repaid if not forgiven in the next 12 months, and the remainders in non-current liabilities. And you'll be able to see this in more, a little more clearly and in more detail in the 10-Q that we expected to file later today.

Can you give us an update of the throughput and efficiency improvements at the Roanoke production facility relative to your expectations?

As you all know, we spent fiscal year 2019 working very diligently to improve our systems, as well as make other changes that would improve our operations, particularly in our manufacturing facility to gain efficiency and to be more effective in our production processes. And we believe that the work that we've done there is continuing to pay benefits in this year, in fiscal year 2020. What's really happened in 2020 and maybe make some of those improvements less evident is we've always had a higher level of fixed costs, both in manufacturing and even in SG&A but with specifically the manufacturing, which means that if production volumes go down and then our gross profit margin is negatively impacted, because of that. And that's one of the reasons, as I mentioned in my remarks, we're focused on our sales and marketing, and business development initiatives, to make sure that we're bringing ourselves back up to more normalized volumes. So we have seen the benefit of those initiatives, with respect to improving lot of manufacturing. And we believe we're continuing to see the benefits and will see the benefits in the future, as we see sales volumes increase.

There was a recent suggesting that OCC may need to sell itself to a strategic buyer. What is your view?

I’ll first say that I haven't seen the article yet but I will look for it. I’m focused on the, I mean fairly standard answers to questions about M&A that companies give, public companies give and I'll give the same answer. But I'll start by saying that the question suggest that we may need to sell ourselves to the strategic buyer. And OCC is proud of the fact that we are flexible in our operations and are able to adjust to varying circumstances. So no, we don’t believe we’re in a situation where we need to sell to a strategic buyer. What I would say is that we are continually looking at the best way to maximize shareholder value, which can include those sorts of opportunities. But other than that, it'd be inappropriate for me to comment on M&A matters past what I've already said.

That was the final question. So Neil, I'll turn it back to you to wrap the call.

Okay. Well, thank you, Aaron. I appreciate everyone participating on the call today. I hope you all will, you and your families will stay safe. And I thank you for your interest in OCC.

Thank you. This does conclude today's conference call. You may now disconnect.