Business Context and Reporting Period
Optical Cable Corporation (OCC) designs and manufactures fiber-optic and copper cabling and connectivity products, including enterprise, military and harsh-environment solutions. This unaudited Form 10-Q covers the quarter and nine months ended July 31, 2011; comparisons are to the corresponding 2010 periods. OCC reports one principal segment, with Centric Solutions LLC separately described.
Financial Results and Position
| Metric | Quarter ended July 31, 2011 | Nine months ended July 31, 2011 |
|---|---|---|
| Net sales | $18.8 million | $53.7 million |
| Gross profit / margin | $6.5 million / 34.7% | $18.9 million / 35.2% |
| Operating income | $421,000 | $911,000 |
| Net income attributable to OCC | $118,000; $0.02 per share | $430,000; $0.07 per share |
| Operating cash flow | Not separately stated | $966,000 |
- Quarterly SG&A was $6.2 million, or 33.2% of sales; nine-month SG&A was $18.3 million, or 34.1% of sales.
- At July 31, cash was $1.2 million; current assets were $30.2 million and current liabilities $6.9 million, yielding working capital of $23.3 million and a 4.4:1 current ratio.
- Total debt was approximately $9.2 million: $8.2 million of real-estate term loans and $1.0 million drawn on the revolving facility. OCC reported $5.0 million of revolving availability, subject to borrowing-base limits.
- Nine-month investing cash use was $1.2 million, primarily capital expenditures; financing cash use was $1.1 million. Cash declined $1.3 million from October 31, 2010.
- Inventories were $15.7 million, up $1.3 million from fiscal year-end; total assets were $44.3 million and total liabilities $17.0 million at July 31.
Material Changes Versus Prior Period
- Quarterly sales were essentially flat year over year, while nine-month sales rose 9.4%. Growth was led by specialty markets, applied interconnect systems and, for the nine-month period, fiber-optic cable; commercial-market sales were weaker.
- Quarterly gross profit fell 4.4% and margin declined from 36.2% to 34.7%. Management cited product mix and lower gross margins typical of enterprise connectivity and applied interconnect products relative to fiber-optic cable.
- Nine-month gross profit rose 13.8%, with margin improving from 33.8% to 35.2%. OCC’s attributable net result improved from a $7.2 million loss in 2010 to $430,000 income in 2011, largely because 2010 included a $6.2 million goodwill impairment charge; no such charge was recorded in 2011.
- Quarterly attributable income decreased from $575,000 to $118,000, mainly due to lower gross profit and higher SG&A. SG&A increased 3.8% for the quarter, including higher shipping costs.
- Net royalty income declined to $645,000 for nine months from $925,000. Certain patents generating royalty income begin expiring in fiscal 2012; management expects royalty income to decline, alongside declining intangible-asset amortization expense.
- OCC repurchased the remaining shares under its previously announced plan, completing repurchases of 325,848 shares for total cost of approximately $1.27 million. It declared a quarterly dividend of $0.01 per share.
Outlook, Risks, Contingencies and Unusual Items
- Management said cash on hand, operating cash flow and existing credit facilities should fund operations for at least the next 12 months. No specific revenue or earnings guidance was provided.
- OCC describes historical seasonality, with sales generally stronger in the second half, but cautions that projects, customer budgets and economic conditions can alter the pattern. Management also warns that continued economic weakness may pressure sales.
- Key stated risks include customer and project timing, government and IT spending, product mix and pricing, raw-material and shipping costs, supplier and customer concentration, competition and technology changes, manufacturing-facility dependence, and declining patent-related royalties.
- In April 2011, Valley Bank term-loan rates were reduced from 6.0% to 5.85% and maturities extended from June 2013 to April 2018. SunTrust renewed the revolving facility through May 31, 2013; its rate is the greater of LIBOR plus 2.0% or 3.0%.
- A patent case involving wholly owned Applied Optical Systems ended in a final district-court judgment for AOS on the infringement claims, while AFSI prevailed on AOS’s counterclaims. AFSI’s post-judgment motions remained pending and an appeal was anticipated if denied. OCC said it did not expect a material adverse effect; a new trial or injunction remained a possible risk.
- Centric Solutions generated $607,000 of nine-month revenue and incurred a $643,000 operating loss, compared with $303,000 revenue and a $982,000 loss in the prior-year period.
- The nine-month 2011 effective tax rate was 38.7%; the quarter’s was 70.7%, reflecting the disproportionate effect of permanent book-tax differences at relatively low pretax income. The 2010 nine-month rate was affected by the non-deductible goodwill impairment.
Important Facts for Investors to Verify
- Whether specialty-market growth can offset weakness in commercial and international sales, and whether quarterly gross margins recover from product-mix pressure.
- Whether operating cash generation is sufficient to fund capital spending, working capital and shareholder returns as cash balances decline and inventory rises.
- Borrowing-base availability and compliance under the revolving facility, plus the refinancing and repayment terms of the term loans.
- The pace of royalty declines as patents expire beginning in fiscal 2012, and the degree to which lower amortization offsets that loss.
- Developments in the AFSI litigation, including post-judgment rulings, any appeal or retrial, and potential product restrictions or damages.
- Centric Solutions’ continuing operating losses and OCC’s ability to sustain profitability excluding the prior-year goodwill impairment comparison.