Optical Cable Corp (OCC) 2003 Q3 法說會逐字稿

Ladies and gentlemen, good morning and thank you for standing by. Welcome to the Optical Cable third quarter earnings conference call. At this time, all participants are in a listen-only mode.

Following today's presentation, instructions will be given for the question and answer session. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder, this conference is being recorded on Friday, September 12th of 2003.

I would now like to turn the conference over to Ms. Marilynn Meek from FRB Weber Shandwick. Please go ahead, ma'am.

Thank you, Erika. Good morning and thank you for participating on Optical Cable Corporation's third quarter of fiscal 2003 conference call. By this time, everyone should have obtained a copy of the earnings release. However, if you haven't, please call my office at the financial relations board at 212-445-8453, and we'll fax our or email you a copy immediately. On the call with us today is Neil Wilkin, President and Chief Financial Officer of Optical Cable Corporation, as well as other members of senior management.

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 including but not limited to those factors set forth in detail in the forward-looking statements section of yesterday's press release. These cautionary statements apply to the contents of the Internet Web cast on www.CCBN.com as well as today's call.

I'd like to now turn the call over to Neil Wilkin. Neil, please begin.

Thank you, Marilyn, and good morning. Joining me here today in Optical Cable Corporation's offices are Tracy Smith, our Controller, Charlie Carson, Senior Vice President of Marketing and Strategy, and Luke Huybrechts, Senior Vice President of Sales.

Today I'll start with a few introductory remarks. We'll then briefly review some of the financial results for the third quarter. Finally, we'll answer as many of your questions as we can.

I'll preface my comments by reminding everyone that Optical Cable Corporation, like a number of other companies, does not provide specific earnings guidance. However, I will say that as we indicated last quarter, our sales appear to have stabilized during fiscal 2003.

Additionally, we are happy to report that in the third quarter, we have seen some improvement in our net sales. This was anticipated, and we continue to be cautiously optimistic that the industry will not worsen or will slowly improve as the market turns.

Additionally, we are quite pleased with the long-term outlook for the company. Some reasons for our optimism include recent initiatives by the regional (inaudible), recent customer activity that we're seeing in the market place, enough demand due to lower IT expenditures in the past and continuing demand for higher bandwidth by customers and businesses.

For the third quarter of fiscal 2003, the company incurred a net loss of $71,000 or one penny per share. During the third quarter, we recognized the remaining impact of the variable accounting treatment related to the warrants issued in connection with the shareholder litigation.

Except for this non-cash expense in the amount of $296,000 before taxes, we would have reported net income for the quarter of approximately $57,000 or one penny per share net of estimated taxes. You will recall that we agreed to issue 250,000 warrants with an exercise price of $4.88 per share in connection with the shareholder class action settlement in September of last year.

Generally accepted accounting principles required the fair value of these warrants to be adjusted at each reporting period until certain conditions were met, including the registration of the shares to be issued upon exercise of the warrants, a condition that was satisfied in May or the first month of our fiscal third quarter.

As a result of this quarterly adjustment, the company recognized charges included in income or loss from operations in each of the first three quarters of fiscal 2003 totaling over $862,000 due to the fair value adjustment. The fair value of the warrants for purposes of this adjustment was determined using a Black-Schole’s model.

The additional $296,000 non-cash charge recognized in the third quarter was a result of the increase in the price of the company's common stock from May 1st through May 19th. And the impact of this increase on the calculation of the fair value of the warrants under GAAP.

I am pleased to say that after the third quarter of 2003, the company will have no further charges arising from any change in the fair value of the warrants.

Additionally, during the third quarter of fiscal 2003, the fair value of the warrants previously expensed and accrued as an accrued shareholder litigation liability were reclassified to permanent equity in accordance with GAAP.

Sales for the third quarter of fiscal 2003 increased 5.4% to $10.3 million from $9.7 million for the same period last year. Quarter-over-quarter, net sales also increased slightly from $9.7 million in the first quarter and $9.8 million in the second quarter.

Gross profit as a percentage of net sales for our third fiscal quarter was 29.4%, a decrease when compared to our gross profit margin of 33% for the same period in 2002 and to our gross margins of 35.9% and 39.5% during the first and second quarters of fiscal 2003 respectively.

During the third quarter, our gross profit margin was negatively impacted by a charge of $166,000 resulting from a change in estimate with respect to the net realizable value of certain finished goods inventory and a charge of $133,000 resulting from a change in estimate regarding the collectability of a refund associated with raw material purchases.

Except for these unusual charges, our gross profit margin would have been 32.3% for the third quarter, which is in line when compared to the 33% gross profit margin for the same period last year.

You will recall that we indicated in our gross margins during the last quarter, our second quarter, were higher than normal, and that we did not expect our gross margins to continue at that level. Because of the two unusual charges mentioned, our gross margins during this quarter, third quarter, were lower than our expectations of future quarters.

SG&A expenses excluding shareholder litigation settlement expenses decreased 13.3% to $2.9 million from $3.4 million for the same period last year. This compares to SG&A costs which ranged from $3.3 million to $3.4 million during the two prior quarters.

Decrease in SG&A costs during the third quarter of fiscal year 2003 compared to the same period last year resulted from decreases in certain types of marketing expenditures, legal and professional fees excluding those associated with the shareholder litigation, and bad debt expense, partly offset by increases in compensation and related costs associated with additional hires earlier this year.

While we continue to carefully monitor all of our expenses including SG&A in order to keep costs down, quarterly SG&A expenses are unlikely to continue at such low levels in future quarters, and will instead trend towards what we've seen in the past.

During the third quarter of 2003, our effective tax rate was 67.3% compared to our effective tax rate of 35.2% during the same period in 2002. Fluctuations in the effective tax rates were primarily due to the amount and timing of the tax benefits associated with our estimated Extraterritorial Income Exclusion, also referred to as EIE. The EIE excludes from federal taxable income a portion of the net profit realized from sales outside of the United States for products manufactured inside the United States.

When our loss for federal income tax purposes is significantly increased by the amount of EIE relative to the amount of our net loss calculated with GAAP, the disproportional amount of federal tax benefit we receive from our EIE results in a higher effective tax rate and benefit relative to our GAAP net loss.

We are again pleased to report our bank debt continues to decrease. At the end of the third quarter, this debt totaled only $244,000, down from just over $1 million at the end of the second quarter, and a little over $2 million at the end of the first quarter.

Optical Cable Corporation's management remains committed to both growing the company for the future and increasing profits, and we are taking the necessary actions to ensure that we achieve these goals. Our efforts include both sales initiatives of various types as well as improvements to our infrastructure.

Now at this time, we'd be happy to answer questions. Marilyn, if you'd please indicate or have the operator indicate the instructions for people to call in their questions, I'd appreciate it.

Sure. Erika will give you instructions in one minute, but let me just first start off by saying that we are taking questions only from professional investors, analysts and fund managers, and in the interest of time, each person wishing to ask questions will be permitted to ask two questions initially. If there is time following everyone given this opportunity, we will allow for follow-up questions. And Erika, if you could give the instructions for dialing.

Thank you. Ladies and gentlemen, if you have a question, please press the star followed by the 1 on your pushbutton phone. If you would like to decline from the polling process, please press the star followed by the 2. You will hear a three-tone prompt acknowledging your selection. Your questions will be polled in the order they are received. If you are using speakerphone equipment, you will need to lift the handset before pressing the numbers.

One moment, please, for the first question. Our first question comes from Mr. Matthew Curtis (ph) with Kinney Securities. Please go ahead with your question.

Good morning, Neil and everyone. Let me get right to my questions here. The inventory estimate change that results in the charge to your gross margins, did that also impact the carrying value of remaining inventory that you still have left to sell, or was that related specifically to a purchase that was made during the quarter?

Well, it still relates to inventory that's available for sale, Matthew. And it if I understand your question correctly, it also obviously impacts our balance sheet by reducing our net realizable value of our inventory.

OK.

Does that answer your question?

It does. Thank you. Going on, following with this, these estimate changes, are these -- obviously as we just talked about from the last question, the inventory charge will obviously continue. However, the collectability of the refund -- I guess my question this time relates to specifically to how we might see these estimates impact your future gross margins. Are you currently expecting them to be a little lower than we've seen historically because of these estimate changes, or were these more related specifically to just this quarter?

We're hopeful that they're related more specifically to this quarter, but we offer a broad range of products, specifically addressing the inventory portion of your question, we offer a broad range of cable products for numerous applications and industries, and based on the performance of the market currently, we are constantly evaluating the net realizable value of those inventories and will continue to do so.

If I thought that we were going to have additional charges or that we weren't going to realize value on certain inventory in the future, then we would have taken that charge in this quarter. And so I can't assure you -- let me be clear. I cannot assure you that we won't have any sorts of charges like this in the future, but clearly our intention is to not have this part of our ongoing expenses in future quarters.

OK. Very good. I think that's my two questions so I'll let the others speak. Thank you very much.

Thanks, Matthew.

Thank you. Our next question comes from Mr. Kevin Wink with (inaudible) Capital Management. Please go ahead with your question.

Good morning, Neil.

Good morning, Kevin.

Nice revenue quarter and in what is still a tough environment out there. Couple of questions, though. One general comment you made is that you're cautiously optimistic, and if there's any additional color you can give to that as to what are the things that cause you to be optimistic and what are the things that cause you to still be cautious?

Sure. We've seen -- as I think I've already said, we've seen some initiatives at the regional bells, we're seeing some additional customer activity which is very encouraging with various different customers, distributors as well as OEM's, and there continues to be the sense through our contacts in the marketplace that there's pent-up IT demand, and so as that loosens, we expect to see sales increase. As you know, Kevin, the industry has been for some time increasing some sort of a turn in our market and it always seems to be six months out. Now that three to six months or quarter to two quarters seems a little more real than it did before, but no one has really seen significant evidence of it at this time.

OK. And any particular things that are behind the cautious part of the comment? Or is it still that it's still maybe one to two quarters out?

Part of it is exactly what you're saying, the timing that it's going to -- whether it's one to two quarters out, that makes me be a little cautious, as well as I think there's still some uncertainty in the economy, and so -- and, quite frankly, you know, Kevin, we've seen some indications at times where it seems like we start to see things turn around and then they retrench, and we've seen that sometimes on a monthly basis, and so I'm cautious, but we are optimistic, and certainly over the longer term, we're very optimistic about the opportunities for fiber.

Over the long term, people are going to have to move to fiber in order to get the bandwidth that they need and away from copper, and that's where we play.

OK. Question number two is a gross margin-related question. You have some variance sequentially versus the previous quarter, and then historically, gross margins at one point had ranged between 40 and 45%. In the most recent quarter, was it mainly a mix change from the mix that you'd had in Q2 and just in general, what are the structural cost differences currently between what's going on and when gross margins were the 40 to 45%?

Kevin, the biggest thing that affects us are product mix changes, and that can be multi-mode and single mode shifts. That can also be - because we play in so many different areas and different industries with different applications, it can be larger orders for different types of products, and that's what makes significant changes for us.

As I said in the second quarter, the margins we saw there are slightly over 39%, were not something that we'd anticipate to continue, and I can safely say that the 29% is not something -- the little over 29% we saw this quarter continue to trend towards what we've seen in other more recent quarters.

With respect to past performance, the industry has fundamentally changed from when the company was able to see margins greater than 40%. Customers that demanded lower prices and also those margins were obtained really at a time when it was almost impossible -- maybe I shouldn't say it that strongly, but in some instances, it was very difficult, I should say, to get fiber at all, and that provided cable manufacturers opportunities to extract higher values in order to allocate the limited supply to a demand that was -- to that larger demand.

OK. Thanks.

Thank you.

Thank you. Ladies and gentlemen, if there are any additional questions at this time, please press the star followed by the 1. And as a reminder, if you are using speaker speakerphone equipment, you will need to press the handset before pressing the numbers. We have a follow-up question from Mr. Kevin Wink. Please go ahead.

Sorry to keep bugging you, Neil. Shareholders equity increased about $1.1 million from the end of Q2 to the end of Q3 taking out the actual net income effects. Have most of the warrants now been exercised and actually paid for or did that come from something else?

I'll let Tracy answer the question.

Hi Kevin. The increase in the shareholders' equity section does relate to the warrants but it does not indicate that they have been exercised. The GAAP requires when the variable accounting treatment ended, the accounts that were met for the variable accounting treatments and the warrants that we reclassified the fair market value net of issuance cost to equity.

OK. Have you seen any exercise of the warrants so far or since the quarter ended?

We're not really tracking that, but as you know, I'd be surprised if we did. The real value of the warrant is the option effect, which is only really realized, you know, over time. I wouldn't imagine someone would want to exercise it right away unless they wanted to get out of the investment. We really haven't seen any significant activity in that area.

OK. One second question if I might. Inventories decreased about 500K after adjusting for the couple of charges you listed. Are you at a point where this is optimal now for you or do you think there's still some optimization that you can do in inventory that may take them down further?

I think there's always room for improvement, but what I'd also say is there's no magic number that we're looking to get to. We evaluate inventories on a regular basis. We are undergoing efforts to make sure that things that are not moving maybe as quickly are being moved, but there's no sort of magic optimal inventory level we're trying to trend towards.

OK. I guess one short final question. You're almost debt-free now. What's the possibility you may be debt-free by fiscal year-end?

I think it's actually likely if we continue on the same path that we have to this point. Now what might change that is in the event that we incur some additional -- or if we expend some additional funds on capital expenditures. And as you know, our capital expenditures year-to-date is slightly higher than they were last year for the entire fiscal year. And we will see some additional capital expenditures, but I think even with those, I would expect our debt to be zero.

Speaking of the CAPEX, how is the automation project going that you had initiated a little bit earlier in the year?

Actually we're very pleased with the progress up until this point, but it is a long-term project, and I don't expect to see the benefits, for example, or fully realize the benefits, for example, in the fourth quarter or the first quarter, but it's more of a long-term benefit that we're going to be seeing.

OK. Thanks.

Thanks, Kevin.

Thank you. We have another follow-up question from Mr. Matthew Curtis. Please go ahead with your question.

Thank you. Let's try and keep this short. First of all, would you mind disclosing at this point what your operating cash flow for the quarter was?

We're going to be filing our 10-Q by Monday, and so in the next couple of days, you'll have that number. Since it's outside the scope of our press release, I'd prefer not to.

OK. Fair enough. The EIE tax impact this particular quarter, were there a higher percentage of sales that occurred overseas for you all this quarter, or is this a cumulative impact that's been building up for the last couple of quarters?

You'll see in our quarterly report what our breakdown between international and domestic sales are in our 10-Q. When you do an EIE calculation, it's rather complex and, in fact, we use our accountants to assist us in making that calculation or the folks we have help us with our taxes.

Because of that, there's some estimates that are involved on a quarter-by-quarter basis, and so each quarter, we're always trying to use our best estimate of where we think we're going to be and what that effect is going to have, what the effect of the EIE is going to have on our tax rate, and so some of those changes in estimates or if we revise an estimate based on what we see in the third quarter can flow from the first and second quarter into the third quarter as well as any adjustment that's necessary in the third quarter.

OK. I'm wondering now that it looks like the operational side of the business tends to be generally moving in a positive direction, if you guys are looking at the possibility of adding a small R&D staff or an R&D budget to look at further improvements in processes and or products that you supply to the market?

What I can say, Matthew, is that we've continued to invest in improvements in our processes. We've actually made some additions to our engineering staff recently, and while we haven't broken it out as R&D, per se, because it involves a number of different things, you know, our automation project involves improvement to our processes, there's other evaluations that we're currently undergoing to further improve our manufacturing processes, we're looking at new products and are in the process of evaluating new cable constructions that can better serve our customer needs.

All those things are currently ongoing, and I think what's making us different from a lot of our competitors who have been forced to cut their way to break-even, we've been able at the same time that everyone else -- as everyone is going through this difficult industry environment, been able to add resources, both at the management level as well as engineering personnel and others, so I'm very pleased with the progress we're making on those fronts.

OK. Very good. Just two final quick questions. The SG&A decreases that we talked about, or you talked about in your release, you've already stated that you expect to see those trend a little higher than we saw this quarter.

Correct.

I guess that leads to my question about this quarter. Were there just some projects that were put on hold? Was there a switch of providers that occurred in this quarter or what led to the specific decline this quarter?

No, we're not -- there's no specific items that we're trying to defer on our expenses, but we did have a decrease in some of our legal expenses, we've had some decreases in marketing expenses as those have been better managed, and just the timing of the normal business operations create a situation where SG&A was unusually low this quarter.

It's also interesting, I mean, we're talking about just a couple of hundred thousand dollar swing or a little bit more than a couple hundred thousand dollar swing because we're so close to profitability and would be profitable but for these warrant charges. Any small change in SG&A or cost of good sold has an effect on the bottom line. But in the overall scheme of things, these aren't significant amounts.

Sure. OK. And then finally, from your customers and -- which include the OEM's and the distributors, would you be able to comment on how much of your cable is being used specifically for storage networking applications in these metropolitan networks as opposed to just standard networking interfaces?

We don't comment on -- for competitive reasons on specifically what we're using for applications. What I can tell you is we do have customers in that area, and we do have sales personnel that are engaged in selling into that market.

Thank you very much.

Thank you.

Thank you. We do have another question, a follow-up question from Kevin Wink. Please go ahead with your question.

Sorry for one more, but something that actually looked like great performance during the quarter. Receivables dropped about 800K. Is it just, you know, more efficient collections or a different mix of business, or what comments are appropriate to make about that?

Tracy will answer that for you, Kevin.

Sure. Actually, Kevin, we partially - the decrease in the accounts receivable is partially due to timing but largely it was due to more aggressive collection attempts during the quarter.

OK. Any breakdown there between, you know, what the mix is between domestic and international? Were you able to improve international more or were you able to improve domestic more?

It's really been across the board, Kevin. I mean, Tracy and her team has been working towards improving our days outstanding inventory, and it's been one of the things she's focused on, and also as the economy is seeing some indices of improvement, we're finding customers are more willing to pay us quicker too.

OK. It's a great way to generate more cash flow.

That's right.

All right. Thanks.

Thank you.

Thank you. Ladies and gentlemen, if there are any additional questions at this time, please press the star followed by the 1. As a reminder, if you are using speakerphone equipment, you will need to lift the handset before pressing the numbers.

There appear to be no further questions at this time. Mr. Wilkin, please continue with any concluding comments.

Just want to thank everyone for participating in our earnings call, and look forward to next quarter. Thank you.

Ladies and gentlemen, this concludes the Optical Cable third quarter earnings conference call. If you would like to listen to a replay of today's conference, please dial 1-800-405-2236, followed by access number 552458. Once again, if you would like to listen to a replay of today's conference, please dial 1-800-405-2236, followed by access number 552458. This once again does conclude today's conference. You may disconnect, and thank you for using ACT Teleconferencing.