Business Context and Reporting Period
Company: Optical Cable Corporation (OCC)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Six months ended April 30, 2010 (Second Quarter of Fiscal Year 2010)
Business Overview: OCC manufactures fiber optic and copper data communication cabling and connectivity solutions for enterprise, military, and harsh environment markets. The company operates facilities in Roanoke, VA; Asheville, NC; and Dallas, TX. Recent strategic acquisitions include Superior Modular Products (SMP) and Applied Optical Systems (AOS).
Key Financial Metrics
| Metric | Three Months Ended Apr 30, 2010 |
Six Months Ended Apr 30, 2010 |
Six Months Ended Apr 30, 2009 |
|---|---|---|---|
| Net Sales | $15,255,913 | $30,263,148 | $30,301,401 |
| Gross Profit | $4,285,531 | $9,786,632 | $10,511,105 |
| Gross Margin | 28.1% | 32.3% | 34.7% |
| Net Loss (Attributable to OCC) | $(7,466,129) | $(7,781,983) | $(726,485) |
| EPS (Basic & Diluted) | $(1.27) | $(1.32) | $(0.12) |
| Cash and Equivalents | $1,105,316 | $1,105,316 | $2,889,380 |
| Total Debt (Current + Long-term) | $8,525,161 | $8,525,161 | $8,536,035 |
| Working Capital | $20,242,484 | $20,242,484 | $20,070,227 |
Note: Total Debt includes current installments of long-term debt ($172,036), long-term debt excluding current installments ($8,281,125), and note payable to bank ($1,112,019).
Material Changes vs. Prior Period
- Revenue Stability: Net sales remained flat year-over-year for both the quarter (-0.6%) and the six-month period (-0.1%). Domestic sales increased 9.7% (quarter) and 2.7% (six months), offset by a 23.4% (quarter) and 7.0% (six months) decline in international sales.
- Margin Compression: Gross profit decreased 25.1% for the quarter and 6.9% for the six months. Gross margins declined due to a shift in product mix toward lower-margin enterprise connectivity products and higher variable production costs for fiber optic cables.
- Goodwill Impairment: The company recorded a non-recurring, non-cash impairment charge of $6,246,304 to write off the entire carrying value of goodwill associated with the AOS acquisition. This charge was the primary driver of the net loss.
- Operating Expenses: Selling, General, and Administrative (SG&A) expenses increased 6.5% for the quarter and 5.3% for the six months, largely due to integration costs and legal fees ($275,000 for the quarter; $589,000 for six months) related to the AOS patent litigation.
- Cash Flow: Net cash used in operating activities was $1.6 million for the six months ended April 30, 2010, compared to $423,000 provided in the prior year period. This shift was driven by the net loss, increased inventory levels ($1.0 million increase), and decreased accounts payable.
Guidance, Outlook, Risks, and Unusual Items
- Unusual Items: The $6.2 million goodwill impairment is a non-cash charge. Excluding this charge, the company would have reported a loss before income taxes of $1.7 million for the quarter and $2.3 million for the six months.
- Legal Proceedings: AOS is involved in a patent infringement lawsuit with Amphenol Fiber Systems International (AFSI). A jury found no infringement on one design, and a court found no infringement on two others as a matter of law. However, a preliminary injunction remains in place (excluding U.S. Government sales) while a motion to dissolve is pending. AOS has a pending counterclaim for inequitable conduct. Management does not believe this will have a material adverse effect.
- Liquidity and Credit Facilities: On April 30, 2010, OCC replaced its Valley Bank revolving loan with a new $6.0 million revolving credit facility with SunTrust Bank. As of the reporting date, $1.1 million was outstanding, leaving $4.9 million in available credit. The company also holds two real estate term loans totaling approximately $8.5 million.
- Outlook: Management believes cash flow from operations and existing credit facilities are adequate for the next 12 months. The company notes that sales of enterprise connectivity products have improved, potentially signaling the beginning of market recovery, though fiber optic cable sales remain a lagging indicator.
- Stock Repurchase: A plan to repurchase up to 325,848 shares was approved in October 2009; however, no shares were repurchased as of April 30, 2010.
Investor Verification Checklist
- Goodwill Impairment Rationale: Verify the methodology used to determine the fair value of the AOS reporting unit and the justification for the full write-off of $6.2 million in goodwill.
- Patent Litigation Status: Monitor the status of the motion to dissolve the preliminary injunction and the outcome of the inequitable conduct counterclaim against AFSI.
- Product Mix Trends: Assess whether the shift toward lower-margin enterprise connectivity products is a temporary fluctuation or a structural change in the company's revenue base.
- Debt Covenants: Review the terms of the new SunTrust Bank facility and existing real estate loans to ensure compliance with financial covenants given the recent losses.
- Inventory Levels: Investigate the $1.0 million increase in inventory to determine if it represents strategic stockpiling or potential obsolescence risks.