Optical Cable Corporation (OCC) — Q2 FY2019 Form 10-Q
Reporting period: Three and six months ended April 30, 2019. OCC manufactures fiber-optic and copper cabling and connectivity products for enterprise, wireless-carrier, harsh-environment and specialty markets. Unaudited interim results are not necessarily indicative of the full fiscal year.
Financial performance
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Net sales | $19.0M | $26.9M | $35.7M | $44.4M |
| Gross profit | $5.3M | $9.0M | $8.9M | $14.2M |
| Gross margin | 28.0% | 33.3% | 24.8% | 31.9% |
| Operating income (loss) | ($0.5M) | $1.6M | ($3.7M) | $1.2M |
| Net income (loss) | ($0.6M) | $1.4M | ($3.9M) | $1.0M |
| Diluted EPS | ($0.08) | $0.18 | ($0.53) | $0.13 |
- Q2 sales fell 29.5% year over year; first-half sales fell 19.6%. Q2 sales rose 13.2% sequentially from Q1’s $16.8M, and gross profit rose 49.0% from $3.6M.
- Q2 SG&A was $5.8M, down 21.9% year over year; first-half SG&A was $12.6M, down 3.1%. SG&A nevertheless rose to 30.5% of Q2 sales from 27.5% a year earlier and to 35.1% of first-half sales from 29.2%.
- First-half operating cash flow was negative $0.45M, versus negative $3.05M in the prior-year period. Investing cash flow was negative $0.50M and financing cash flow positive $1.08M. Cash increased $0.13M to $0.31M.
- At April 30, current assets were $32.75M and current liabilities $10.19M; working capital was $22.6M and the current ratio was 3.2, down from 4.4 at October 31, 2018. Inventory rose $2.8M to $20.2M.
- Revolver borrowings were $5.15M, with $1.8M available under the $7.0M facility. Term debt was $6.29M; the revolver rate was 5.0% at quarter-end. The revolver maturity was extended to June 30, 2020.
Material changes and management commentary
- Management attributed much of the year-over-year sales decline to large orders from one customer in Q2 FY2018 that did not recur at comparable levels: the customer’s Q2 sales declined $9.1M year over year. For the first half, the decline in sales to that customer was $10.1M. Enterprise and wireless-carrier sales also decreased, partly offset by growth in other specialty markets.
- Q2 gross margin was pressured by product mix and approximately $319,000 of increased labor-related costs. For the first half, manufacturing throughput constraints and inefficiencies at the Roanoke facility, associated with workforce expansion, training, restructuring and process changes, added approximately $1.2M in labor costs. Management reported improvement in Q2 and expected further gross-margin improvement in Q3 FY2019; this is not quantified guidance.
- Accounts payable and accrued expenses rose about $5.0M from October 31, primarily due to raw-material purchases and vendor-payment timing. Accrued compensation and payroll taxes fell $1.8M. Management said inventory growth reflected stock replenishment and timing of raw-material purchases.
- The company reported sales concentration: two customers represented 15.0% and 19.4% of Q2 FY2019 sales, and 14.2% and 18.1% of first-half sales. The comparable 2018 periods included one customer at 47.7% and 37.3%, respectively.
Outlook, risks and unusual items
- OCC stated that cash on hand, operating cash flow and existing or additional credit facilities should fund operations for at least the next 12 months. Capital-expenditure budget for FY2019 was $2.5M; $0.45M was spent on property and equipment in the first half. No material capital-expenditure commitments were reported at April 30.
- OCC breached its quarterly total-liabilities-to-tangible-net-worth covenant: 0.96 to 1.0 versus a maximum of 0.95 to 1.0. Pinnacle Bank subsequently waived the breach for the quarter ended April 30. The facilities are secured by company assets and real property.
- Management cited volatility in large customer orders, market and product mix, competition, raw-material and transportation costs, supplier and customer concentration, economic conditions, and manufacturing execution among risks that could affect results. Management considered ordinary-course claims, legal matters and regulatory reviews not likely to have a material adverse effect.
- OCC adopted ASC 606 using the modified retrospective method; it reported no material effect on results, financial position or liquidity and recorded a $61,763 opening retained-earnings adjustment. A full valuation allowance remained against net deferred tax assets, making future tax benefits uncertain.
Important facts for investors to verify
- Whether Q3 margin improvement materialized and whether Roanoke throughput constraints and related labor costs were resolved.
- Whether sales recover without repeat large customer orders, and how customer concentration and demand in enterprise and wireless-carrier markets evolve.
- Compliance with the debt covenant after the waiver, available revolver capacity, and the company’s ability to refinance or repay debt before maturity.
- Inventory conversion, vendor-payment timing and operating cash generation, given first-half operating cash outflow and low cash on hand.
- Whether management’s at-least-12-month liquidity assessment remains supportable if operating performance or credit availability weakens.