OCC Optical Cable Corporation

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Information

This Form 10-Q may contain certain forward-looking information within the meaning of the federal securities laws. The forward-looking information may include, among other information, (i) statements concerning our outlook for the future, (ii) statements of belief, anticipation or expectation, (iii) future plans, strategies or anticipated events, and (iv) similar information and statements concerning matters that are not historical facts. Such forward-looking information is subject to known and unknown variables, uncertainties, contingencies and risks that may cause actual events or results to differ materially from our expectations. Such known and unknown variables, uncertainties, contingencies and risks (collectively, “factors”) may also adversely affect Optical Cable Corporation and its subsidiaries (collectively, the “Company” or “OCC®”), the Company’s future results of operations and future financial condition, and/or the future equity value of the Company. Factors that could cause or contribute to such differences from our expectations or that could adversely affect the Company include, but are not limited to: the level of sales to key customers, including distributors; timing of certain projects and purchases by key customers; the economic conditions affecting network service providers; corporate and/or government spending on information technology; actions by competitors; fluctuations in the price of raw materials (including optical fiber, copper, gold and other precious metals, plastics and other materials); fluctuations in transportation costs; our dependence on customized equipment for the manufacture of certain of our products in certain production facilities; our ability to protect our proprietary manufacturing technology; market conditions influencing prices or pricing in one or more of the markets in which we participate, including the impact of increased competition; our dependence on a limited number of suppliers for certain product components; the loss of or conflict with one or more key suppliers or customers; an adverse outcome in any litigation, claims and other actions, and potential litigation, claims and other actions against us; an adverse outcome in any regulatory reviews and audits and potential regulatory reviews and audits; adverse changes in state tax laws and/or positions taken by state taxing authorities affecting us; technological changes and introductions of new competing products; changes in end-user preferences for competing technologies relative to our product offering; economic conditions that affect the telecommunications sector, the data communications sector, certain technology sectors and/or certain industry market sectors (for example, mining, oil & gas, military, and wireless carrier industry market sectors); economic conditions that affect U.S.-based manufacturers; economic conditions or changes in relative currency strengths (for example, the strengthening of the U.S. dollar relative to certain foreign currencies) and import and/or export tariffs imposed by the U.S. and other countries that affect certain geographic markets, industry market sector, and/or the economy as a whole; changes in demand for our products from certain competitors for which we provide private label connectivity products; changes in the mix of products sold during any given period (due to, among other things, seasonality or varying strength or weaknesses in particular markets in which we participate) which may impact gross profits and gross profit margins or net sales; variations in orders and production volumes of hybrid cables (fiber and copper) with high copper content, which tend to have lower gross profit margins; significant variations in sales resulting from: (i) high volatility within various geographic markets, within targeted markets and industries, for certain types of products, and/or with certain customers (whether related to the market generally or to specific customers’ business in particular), (ii) timing of large sales orders, and (iii) high sales concentration among a limited number of customers in certain markets, particularly the wireless carrier market; terrorist attacks or acts of war, any current or potential future military conflicts, and acts of civil unrest; cold wars and economic sanctions as a result of these activities; changes in the level of spending by the United States government, including, but not limited to military spending; ability to recruit and retain key personnel (including production personnel); poor labor relations; increasing labor costs; delays, extended lead times and/or changes in availability of needed raw materials, equipment and/or supplies; shipping and other logistics challenges; impact of inflation on costs, including raw materials and labor, and ability to pass along any increased costs to customers; impact of rising interest rates increasing the cost of capital; impact of cybersecurity risks and incidents and the related actual or potential costs and consequences of such risks and incidents, including costs and regulations to limit such risks; the impact of data privacy laws and the General Data Protection Regulation and the related actual or potential costs and consequences; the impact of changes in accounting policies and related costs of compliance, including changes by the Securities and Exchange Commission (“SEC”), the Public Company Accounting Oversight Board (“PCAOB”), the Financial Accounting Standards Board (“FASB”), and/or the International Accounting Standards Board (“IASB”); our ability to continue to successfully comply with, and the cost of compliance with, the provisions of Section 404 of the Sarbanes-Oxley Act of 2002 or any revisions to that act which apply to us; the impact of changes and potential changes in federal laws and regulations adversely affecting our business and/or which result in increases in our direct and indirect costs, including our direct and indirect costs of compliance with such laws and regulations; rising healthcare costs; impact of new or changed government laws and regulations on healthcare costs; the impact of changes in state or federal tax laws and regulations increasing our costs and/or impacting the net return to investors owning our shares; any changes in the status of our compliance with covenants with our lenders; our continued ability to maintain and/or secure future debt financing and/or equity financing to adequately finance our ongoing operations; the impact of future consolidation among competitors and/or among customers adversely affecting our position with our customers and/or our market position; actions by customers adversely affecting us in reaction to the expansion of our product offering in any manner, including, but not limited to, by offering products that compete with our customers, and/or by entering into alliances with, making investments in or with, and/or acquiring parties that compete with and/or have conflicts with our customers; voluntary or involuntary delisting of the Company’s common stock from any exchange on which it is traded; the deregistration by the Company from SEC reporting requirements as a result of the small number of holders of the Company’s common stock; adverse reactions by customers, vendors or other service providers to unsolicited proposals regarding the ownership or management of the Company; the additional costs of considering, responding to and possibly defending our position on unsolicited proposals regarding the ownership or management of the Company; direct and indirect impacts of weather, natural disasters and/or epidemic, pandemic or endemic diseases in the areas of the world in which we operate, market our products and/or acquire raw materials including impacts on supply chains, labor constraints impacting our production volumes and costs; any present or future government mandates, travel restrictions, shutdowns or other regulations regarding any epidemic, pandemic or endemic diseases; an increase in the number of shares of the Company’s common stock issued and outstanding; economic downturns generally and/or in one or more of the markets in which we operate; changes in market demand, exchange rates, productivity, market dynamics, market confidence, macroeconomic and/or other economic conditions in the areas of the world in which we operate and market our products; and our success in managing the risks involved in the foregoing.

We caution readers that the foregoing list of important factors is not exclusive. Furthermore, we incorporate by reference those factors included in current reports on Form 8‑K and/or in our other filings.

Dollar amounts presented in the following discussion have been rounded to the nearest hundred thousand, except in the case of amounts less than one million and except in the case of the table set forth in the “Results of Operations” section, the amounts in which both cases have been rounded to the nearest thousand.

Overview of Optical Cable Corporation

Optical Cable Corporation (or OCC®) is a leading manufacturer of a broad range of fiber optic and copper data communication cabling and connectivity solutions primarily for the enterprise market and various harsh environment and specialty markets (collectively, the non-carrier markets), and also the wireless carrier market, offering integrated suites of high quality products which operate as a system solution or seamlessly integrate with other components. Our product offerings include designs for uses ranging from enterprise network, data center, residential, campus and Passive Optical LAN (“POL”) installations to customized products for specialty applications and harsh environments, including military, industrial, mining, petrochemical, renewable energy and broadcast applications, as well as the wireless carrier market. Our products include fiber optic and copper cabling, hybrid cabling (which includes fiber optic and copper elements in a single cable), fiber optic and copper connectors, specialty fiber optic, copper and hybrid connectors, fiber optic and copper patch cords, pre-terminated fiber optic and copper cable assemblies, racks, cabinets, datacom enclosures, patch panels, face plates, multimedia boxes, fiber optic reels and accessories and other cable and connectivity management accessories, and are designed to meet the most demanding needs of end-users, delivering a high degree of reliability and outstanding performance characteristics.

OCC® is internationally recognized for pioneering the design and production of fiber optic cables for the most demanding military field applications, as well as of fiber optic cables suitable for both indoor and outdoor use, and creating a broad product offering built on the evolution of these fundamental technologies. OCC is also internationally recognized for pioneering the development of innovative copper connectivity technology and designs used to meet industry copper connectivity data communications standards.

Founded in 1983, Optical Cable Corporation is headquartered in Roanoke, Virginia with offices, manufacturing and warehouse facilities located in Roanoke, Virginia, near Asheville, North Carolina, and near Dallas, Texas. We primarily manufacture our fiber optic cables at our Roanoke facility which is ISO 9001:2015 registered and MIL-STD-790G certified, primarily manufacture our enterprise connectivity products at our Asheville facility which is ISO 9001:2015 registered, and primarily manufacture our harsh environment and specialty connectivity products at our Dallas facility which is ISO 9001:2015 registered and MIL-STD-790G certified.

OCC designs, develops and manufactures fiber optic and hybrid cables for a broad range of enterprise, harsh environment, wireless carrier and other specialty markets and applications. We refer to these products as our fiber optic cable offering. OCC designs, develops and manufactures fiber and copper connectivity products for the enterprise market, including a broad range of enterprise and residential applications. We refer to these products as our enterprise connectivity product offering. OCC designs, develops and manufactures a broad range of specialty fiber optic connectors and connectivity solutions principally for use in military, harsh environment and other specialty applications. We refer to these products as our harsh environment and specialty connectivity product offering.

We market and sell the products manufactured at our Dallas facility through our wholly owned subsidiary Applied Optical Systems, Inc. (“AOS”) under the names Optical Cable Corporation and OCC® by the efforts of our integrated OCC sales team.

The OCC team seeks to provide top-tier communication solutions by bundling all of our fiber optic and copper data communication product offerings into systems that are best suited for individual data communication needs and application requirements of our customers and the end-users of our systems.

OCC’s wholly owned subsidiary Centric Solutions LLC (“Centric Solutions”) provides cabling and connectivity solutions for the data center market. Centric Solutions’ business is located at OCC’s facility near Dallas, Texas.

Optical Cable Corporation™, OCC®, Procyon®, Superior Modular Products™, SMP Data Communications™, Applied Optical Systems™, Centric Solutions™ and associated logos are trademarks of Optical Cable Corporation.

Summary of Company Performance for Second Quarter of Fiscal Year 2023

Results of Operations

We sell our products internationally and domestically to our customers which include major distributors, various regional and smaller distributors, original equipment manufacturers and value-added resellers. All of our sales to customers outside of the United States are denominated in U.S. dollars. We can experience fluctuations in the percentage of net sales to customers outside of the United States and in the United States from period to period based on the timing of large orders, coupled with the impact of increases and decreases in sales to customers in various regions of the world. Sales outside of the U.S. can also be impacted by fluctuations in the exchange rate of the U.S. dollar compared to other currencies.

Net sales consist of gross sales of products by the Company and its subsidiaries on a consolidated basis less discounts, refunds and returns. Revenue is recognized at the time product is transferred to the customer (including distributors) at an amount that reflects the consideration expected to be received in exchange for the product. Our customers generally do not have the right of return unless a product is defective or damaged and is within the parameters of the product warranty in effect for the sale.

Cost of goods sold consists of the cost of materials, product warranty costs and compensation costs, and overhead and other costs related to our manufacturing operations. The largest percentage of costs included in cost of goods sold is attributable to costs of materials.

Our gross profit margin percentages are heavily dependent upon product mix on a quarterly basis and may vary based on changes in product mix. To the extent not impacted by product mix, gross profit margins tend to be higher when we achieve higher net sales levels, as certain fixed manufacturing costs are spread over higher sales. Hybrid cables (containing fiber and copper) with higher copper content tend to have lower gross profit margins.

Selling, general and administrative expenses (“SG&A expenses”) consist of the compensation costs for sales and marketing personnel, shipping costs, trade show expenses, customer support expenses, travel expenses, advertising, bad debt expense, the compensation costs for administration and management personnel, legal, accounting, advisory and professional fees, costs incurred to settle litigation or claims and other actions against us, and other costs associated with our operations.

Royalty income (expense), net consists of royalty income earned on licenses associated with our patented products, net of royalty and related expenses.

Amortization of intangible assets consists of the amortization of the costs, including legal fees, associated with internally developed patents that have been granted. Amortization of intangible assets is calculated using the straight-line method over the estimated useful lives of the intangible assets.

Other income (expense), net consists of interest expense and other miscellaneous income and expense items not directly attributable to our operations.

The following table sets forth and highlights fluctuations in selected line items from our condensed consolidated statements of operations for the periods indicated:

Three Months Ended April 30, 2023 and 2022

Net Sales

Consolidated net sales for the second quarter of fiscal year 2023 increased 14.1% to $19.6 million, compared to net sales of $17.2 million for the same period last year. We experienced an increase in net sales in our specialty markets in the second quarter of fiscal year 2023, compared to the same period last year, but the increase was partially offset by decreases in net sales in our enterprise market.

Net sales to customers in the United States increased 7.0%, or $1.0 million, and net sales to customers outside of the United States increased 57.4%, or $1.4 million, in the second quarter of fiscal year 2023, compared to the same period last year. We can experience fluctuations in sales from quarter to quarter in the various markets (both industries and geographies) in which we operate for various reasons.

Our sales order backlog/forward load continues to remain at higher than typical levels, while decreasing to approximately $8.0 million at the end of the second quarter of fiscal year 2023, compared to more than $12.0 million at the end of the fourth quarter of fiscal year 2022.  Net sales for the remainder of fiscal year 2023 could be negatively impacted by various continuing macroeconomic pressures, risks and uncertainties.  Certain of our markets are showing signs of softening.  At the same time, we see what we believe to be positive indicators in certain of our other markets. 

We believe our net sales benefited from increased production throughput during the second quarter of fiscal year 2023, compared to the same period last year, as well as our higher than typical levels of sales order backlog/forward load. Additionally, improved product pricing, increased to cover certain inflationary costs, began to take effect for new orders received during the latter half of fiscal year 2022.

Gross Profit

Our gross profit was $6.8 million in the second quarter of fiscal year 2023, an increase of 34.8% compared to gross profit of $5.0 million in the second quarter of fiscal year 2022. Gross profit margin, or gross profit as a percentage of net sales, increased to 34.6% in the second quarter of fiscal year 2023 compared to 29.3% in the second quarter of fiscal year 2022.

Our gross profit margins tend to be higher when we achieve higher net sales levels due to our operating leverage as certain fixed manufacturing costs are spread over higher sales. This operating leverage, which is beneficial at higher sales levels, positively impacted our gross profit margin during the second quarter of fiscal year 2023 when compared to the same period last year. Our gross profit margin percentages are also heavily dependent upon product mix on a quarterly basis and may vary based on changes in product mix.

Selling, General, and Administrative Expenses

SG&A expenses increased to $5.7 million during the second quarter of fiscal year 2023, compared to $5.0 million for the same period last year. SG&A expenses as a percentage of net sales were 28.9% in the second quarter of fiscal year 2023, compared to 29.3% in the second quarter of fiscal year 2022.

The increase in SG&A expenses during the first quarter of fiscal year 2023 compared to the same period last year was primarily the result of increases in employee and contracted sales personnel related costs totaling $518,000. Included in employee and contracted sales personnel related costs are employee incentives and commissions which increased due to increased net sales and the improved financial results during the second quarter of fiscal year 2023.

Also contributing to the increase in SG&A expenses during the second quarter of fiscal year 2023 were increases in travel and marketing expenses due to the return to a more typical level of business travel and an increase in the number of, and the attendance at, tradeshows during the second quarter of fiscal year 2023, when compared to the same period last year.

Royalty Income (Expense), Net

We recognized royalty expense, net of royalty income, totaling $7,000 during the second quarter of fiscal years 2023 and 2022. Royalty expense and/or income may fluctuate based on sales of related licensed products and estimates of amounts for non-licensed product sales, if any.

Amortization of Intangible Assets

We recognized $14,000 of amortization expense, associated with intangible assets, during the second quarter of fiscal year 2023, compared to $12,000 during the second quarter of fiscal year 2022.

Income (loss) from operations

We reported income from operations of $1.1 million for the second quarter of fiscal year 2023, compared to a loss from operations of $21,000 for the second quarter of fiscal year 2022.

Other Income (Expense), Net

We recognized other income, net in the second quarter of fiscal year 2023 of $1.4 million, compared to other expense, net of $212,000 in the second quarter of fiscal year 2022.

Other income, net for the fiscal quarter ended April 30, 2023 is comprised primarily of the gain on insurance proceeds received for damage to property and equipment totaling $1.7 million, partially offset by interest expense and other miscellaneous items. The change in other income, net during the second quarter of fiscal year 2023 compared to the same period last year was primarily due to the gain on insurance proceeds received.

During the second quarter of fiscal year 2023, we received insurance proceeds in connection with our office building and its contents at our Asheville facilities sustaining water damage from a burst pipe at the end of December 2022. In connection with this event, we recognized a gain on insurance proceeds received for damage to property and equipment during the second quarter of fiscal year 2023 totaling $1.7 million. To the extent we incur expenses in future periods to restore, repair or replace damaged assets, we may recognize offsetting losses in those future periods. At this time, we do not expect future restoration and repair costs to exceed any insurance proceeds.

The office building sustaining water damage at our Asheville facilities is separate from our manufacturing building, which houses our manufacturing operations and certain offices at the same location. There was no significant impact to our operations as a result of this event.

Income (Loss) Before Income Taxes

We reported income before income taxes of $2.5 million for the second quarter of fiscal year 2023, compared to a loss before income taxes of $233,000 for the second quarter of fiscal year 2022. The improvement was primarily due to the increase in gross profit of $1.7 million, and the gain on insurance proceeds received for damage to property and equipment of $1.7 million, partially offset by the increase in SG&A expenses of $626,000.

Income Tax Expense (Benefit)

Income tax expense totaled $75,000 in the second quarter of fiscal year 2023, compared to income tax benefit of $5,000 in the second quarter of fiscal year 2022. Our effective tax rate was 3.0% for the second quarter of fiscal year 2023 and 2.2% for the second quarter of fiscal year 2022.

Fluctuations in our effective tax rates are primarily due to permanent differences in U.S. GAAP and tax accounting for various tax deductions and benefits, but can also be significantly different from the statutory tax rate when income or loss before taxes is at a level such that permanent differences in U.S. GAAP and tax accounting treatment have a disproportional impact on the projected effective tax rate.

We previously established a valuation allowance against all of our net deferred tax assets. As a result of establishing a full valuation allowance against our net deferred tax assets, if we generate sufficient taxable income in subsequent periods to realize a portion or all of our net deferred tax assets, our effective income tax rate could be unusually low due to the tax benefit attributable to the necessary decrease in our valuation allowance. Further, if we generate losses before taxes in subsequent periods, our effective income tax rate could also be unusually low as any increase in our net deferred tax asset from such a net operating loss for tax purposes would be offset by a corresponding increase to our valuation allowance against our net deferred tax assets.

If we generate sufficient income before taxes in subsequent periods such that U.S. GAAP would permit us to conclude that the removal of any valuation allowance against our net deferred tax asset is appropriate, then during the period in which such determination is made, we will recognize the non-cash benefit of such removal of the valuation allowance in income tax expense on our consolidated statement of operations, which will increase net income and will also increase the net deferred tax asset on our consolidated balance sheet. If we do not generate sufficient income before taxes in subsequent periods such that U.S. GAAP would permit us to conclude that the reduction or removal of any valuation allowance against our net deferred tax asset is appropriate, then no such non-cash benefit would be realized. There can be no assurance regarding any future realization of the benefit by us of all or part of our net deferred tax assets. As of October 31, 2022, the valuation allowance against our total gross deferred tax assets totaled $4.4 million.

Net Income (Loss)

Net income for the second quarter of fiscal year 2023 was $2.4 million, or $0.31 per share, compared to a net loss of $228,000, or $0.03 per share, for the second quarter of fiscal year 2022. This improvement was primarily due to the increase in income before income taxes of $2.7 million, which includes the $1.7 million gain on insurance proceeds received for damage to property and equipment included in other income, net.

Six Months Ended April 30, 2023 and 2022

Net Sales

Consolidated net sales for the first half of fiscal year 2023 were $37.9 million, an increase of 19.8% compared to net sales of $31.6 million for the same period last year. We experienced increases in net sales in our specialty markets in the first half of fiscal year 2023, compared to the same period last year, but the increases were partially offset by decreases in net sales in our enterprise market. Net sales to customers in the United States increased 12.9%, or $3.5 million, and net sales to customers outside of the United States increased 59.3%, or $2.8 million, in the first half of fiscal year 2023, compared to the same period last year. We can experience fluctuations in sales from quarter to quarter in the various markets in which we operate for various reasons. 

Our sales order backlog/forward load continues to remain at higher than typical levels, while decreasing to approximately $8.0 million at the end of the first half of fiscal year 2023, compared to more than $12.0 million at the end of fiscal year 2022.  Net sales for the remainder of fiscal year 2023 could be negatively impacted by various continuing macroeconomic pressures, risks and uncertainties.  Certain of our markets are showing signs of softening.  At the same time, we see what we believe to be positive indicators in certain of our other markets. 

We believe our net sales benefited from increased production throughput during the first half of fiscal year 2023, compared to the same period last year, as well as our higher than typical levels of sales order backlog/forward load. Additionally, improved product pricing, increased to cover certain inflationary costs, began to take effect for new orders received during the latter half of fiscal year 2022.

Gross Profit

Our gross profit was $13.3 million in the first half of fiscal year 2023, an increase of 46.5% compared to gross profit of $9.1 million in the first half of fiscal year 2022. Gross profit margin increased to 35.1% in the first half of fiscal year 2023 compared to 28.7% in the first half of fiscal year 2022.

Our gross profit margins tend to be higher when we achieve higher net sales levels due to our operating leverage as certain fixed manufacturing costs are spread over higher sales. This operating leverage, which is beneficial at higher sales levels, positively impacted our gross profit margin during the first half of fiscal year 2023 when compared to the same period last year. Our gross profit margin percentages are also heavily dependent upon product mix on a quarterly basis and may vary based on changes in product mix.

Selling, General, and Administrative Expenses

SG&A expenses increased 13.3% to $11.1 million during the first half of fiscal year 2023, compared to $9.8 million for the same period last year. SG&A expenses as a percentage of net sales were 29.3% in the first half of fiscal year 2023, compared to 31.0% in the first half of fiscal year 2022.

The increase in SG&A expenses during the first half of fiscal year 2023 compared to the same period last year was primarily the result of increases in employee and contracted sales personnel related costs totaling $979,000. Included in employee and contracted sales personnel related costs are employee incentives and commissions which increased due to increased net sales and the improved financial results during the second quarter of fiscal year 2023.

Also contributing to the increase in SG&A expenses during the second quarter of fiscal year 2023 were increases in shipping expenses and increases in travel and marketing expenses. Shipping expenses increased due to the increase in net sales and the increase in the costs charged by shippers, when compared to the same period last year. Travel and marketing expenses increased due to the return to a more typical level of business travel and an increase in the number of, and the attendance at, tradeshows during the first half of fiscal year 2023, when compared to the same period last year.

Royalty Income (Expense), Net

We recognized royalty expense, net of royalty income, totaling $13,000 during the first half of fiscal year 2023 compared to $14,000 during the first half of fiscal year 2022. Royalty income and/or expense may fluctuate based on sales of related licensed products and estimates of amounts for non-licensed product sales, if any.

Amortization of Intangible Assets

We recognized $27,000 of amortization expense, associated with intangible assets, during the first half of fiscal year 2023, compared to $24,000 during the first half of fiscal year 2022.

Income (loss) from operations

We reported income from operations of $2.1 million for the first half of fiscal year 2023, compared to a loss from operations of $774,000 for the first half of fiscal year 2022.

Other Income (Expense), Net

We recognized other income, net in the first half of fiscal year 2023 of $1.2 million, compared to other expense, net of $382,000 in the first half of fiscal year 2022.

Other income, net for the first half of fiscal year 2023 is comprised primarily of the gain on insurance proceeds received for damage to property and equipment totaling $1.7 million, partially offset by interest expense and other miscellaneous items. The change in other income, net during the first half of fiscal year 2023 compared to the same period last year was primarily due to the insurance proceeds received.

During the second quarter of fiscal year 2023, we received insurance proceeds in connection with our office building and its contents at our Asheville facilities sustaining water damage from a burst pipe at the end of December 2022. In connection with this event, we recognized a gain on insurance proceeds received for damage to property and equipment during the second quarter of fiscal year 2023 totaling $1.7 million. To the extent we incur expenses in future periods to restore, repair or replace damaged assets, we may recognize offsetting losses in those future periods.

At this time, we do not expect any future restoration and repair costs to exceed any insurance proceeds. The office building sustaining water damage at our Asheville facilities is separate from our manufacturing building, which houses our manufacturing operations and certain offices at the same location. There was no significant impact to our operations as a result of this event.

Income (Loss) Before Income Taxes

We reported income before income taxes of $3.3 million for the first half of fiscal year 2023, compared to a loss before income taxes of $1.2 million for the first half of fiscal year 2022. The improvement was primarily due to the increase in gross profit of $4.2 million, and the gain on insurance proceeds received for damage to property and equipment of $1.7 million, partially offset by the increase in SG&A expenses of $1.3 million.

Income Tax Expense (Benefit)

Income tax expense totaled $107,000 in the first half of fiscal year 2023, compared to $8,000 in the first half of fiscal year 2022. Our effective tax rate was 3.2% for the first half of fiscal year 2023 and less than negative one percent for the first half of fiscal year 2022.

Fluctuations in our effective tax rates are primarily due to permanent differences in U.S. GAAP and tax accounting for various tax deductions and benefits, but can also be significantly different from the statutory tax rate when income or loss before taxes is at a level such that permanent differences in U.S. GAAP and tax accounting treatment have a disproportional impact on the projected effective tax rate.

We previously established a valuation allowance against all of our net deferred tax assets. As a result of establishing a full valuation allowance against our net deferred tax assets, if we generate sufficient taxable income in subsequent periods to realize a portion or all of our net deferred tax assets, our effective income tax rate could be unusually low due to the tax benefit attributable to the necessary decrease in our valuation allowance. Further, if we generate losses before taxes in subsequent periods, our effective income tax rate could also be unusually low as any increase in our net deferred tax asset from such a net operating loss for tax purposes would be offset by a corresponding increase to our valuation allowance against our net deferred tax assets.

If we generate sufficient income before taxes in subsequent periods such that U.S. GAAP would permit us to conclude that the removal of any valuation allowance against our net deferred tax asset is appropriate, then during the period in which such determination is made, we will recognize the non-cash benefit of such removal of the valuation allowance in income tax expense on our consolidated statement of operations, which will increase net income and will also increase the net deferred tax asset on our consolidated balance sheet. If we do not generate sufficient income before taxes in subsequent periods such that U.S. GAAP would permit us to conclude that the reduction or removal of any valuation allowance against our net deferred tax asset is appropriate, then no such non-cash benefit would be realized. There can be no assurance regarding any future realization of the benefit by us of all or part of our net deferred tax assets. As of October 31, 2022, the valuation allowance against our total gross deferred tax assets totaled $4.4 million.

Net Income (Loss)

Net income for the first half of fiscal year 2023 was $3.2 million, or $0.41 per share, compared to a net loss of $1.2 million, or $0.16 per share, for the first half of fiscal year 2022. This change was primarily due to the increase in income before income taxes of $4.5 million, which includes the $1.7 million gain on insurance proceeds received for damage to property and equipment.

Financial Condition

Total assets increased $5.4 million, or 13.4%, to $46.0 million at April 30, 2023, from $40.6 million at October 31, 2022. This increase was primarily due to a $3.7 million increase in inventories and a $1.5 million increase in restricted cash. Inventories increased largely as the result of the timing of certain raw material purchases, increases in work in process levels related to pending shipments, and the increase in finished goods inventory resulting from higher replenishment rates of stock inventory. Restricted cash increased resulting from the receipt of a portion of the proceeds from the insurance claim related to water damage from a burst pipe in the sprinkler system in our Asheville office building for which offsetting expenses have not yet been incurred. The insurance proceeds recorded in restricted cash relate to the collateral for the Company’s real estate term loans with Northeast Bank and, as a result, are held in escrow. Cash may be released from escrow as the Company submits details of expenses incurred for restoration and repair of the related property to Northeast Bank. Any cash remaining in escrow after any restoration and repairs are completed, will be available for the benefit of the Company or to pay down the real estate term loans once Northeast Bank is satisfied that the collateral has been returned to an acceptable state. Cash may also be released from escrow in the event the Company pays off the real estate term loans with Northeast Bank.

Total liabilities increased $2.0 million, or 10.9%, to $20.4 million at April 30, 2023, from $18.4 million at October 31, 2022. The increase in total liabilities was primarily due to net borrowings on our Revolver totaling $2.0 million.

Total shareholders’ equity at April 30, 2023 increased $3.4 million in the first half of fiscal year 2023. The increase resulted from net income of $3.2 million and share-based compensation, net of $174,000.

Liquidity and Capital Resources

Our primary capital needs have been to fund working capital requirements through payments on our Revolver. Our primary source of capital for these purposes has been existing cash, cash provided by operations and borrowings under our Revolver (see “Credit Facilities” below).

Our unrestricted cash of $325,000 and restricted cash of $1.5 million totaled $1.8 million as of April 30, 2023, an increase of $1.6 million compared to unrestricted cash of $216,000 as of October 31, 2022. The increase in cash and restricted cash for the six months ended April 30, 2023 primarily resulted from insurance proceeds received for damage to property and equipment totaling $1.7 million, net, and cash provided by financing activities of $1.7 million, partially offset by cash used in operating activities of $1.5 million.

On April 30, 2023, we had working capital of $27.6 million, excluding restricted cash of $1.5 million, compared to $23.7 million on October 31, 2022. The ratio of current assets, excluding restricted cash of $1.5 million, to current liabilities as of April 30, 2023 was 4.6 to 1.0 compared to 4.2 to 1.0 as of October 31, 2022. The increase in working capital, excluding restricted cash, and in the current ratio, excluding restricted cash, was primarily due to the increase in inventories of $3.7 million.

As of April 30, 2023 and October 31, 2022, we had outstanding loan balances under our Revolver totaling $8.0 million and $6.0 million, respectively. As of April 30, 2023 and October 31, 2022, we had other outstanding bank loan balances, excluding our Revolver, totaling $4.4 million and $4.5 million, respectively.

Net Cash

Net cash used in operating activities was $1.5 million in the first half of fiscal year 2023, compared to $3.0 million for the first half of fiscal year 2022. Net cash used in operating activities during the first half of fiscal year 2023 primarily resulted from an increase in inventories totaling $3.7 million, the cash flow impact of increases in trade accounts receivable, net totaling $358,000, and an adjustment to reconcile net income of $3.2 million to net cash used in operating activities for the gain on insurance proceeds received for damage to property and equipment totaling $1.7 million, partially offset by certain other adjustments to reconcile net income of $3.2 million to net cash used in operating activities including depreciation and amortization of $497,000 and share-based compensation expense of $290,000.

Net cash used in operating activities during the first half of fiscal year 2022 primarily resulted from an increase in inventories totaling $2.3 million and the cash flow impact of increases in trade accounts receivable, net totaling $2.2 million, partially offset by certain adjustments to reconcile a net loss of $1.2 million to net cash used in operating activities including depreciation and amortization of $569,000 and share-based compensation expense of $238,000. Additionally, the cash flow impact of increases in accounts payable and accrued expenses of $1.9 million further contributed to offset net cash used in operating activities.

Net cash provided by investing activities totaled $1.5 million in the first half of fiscal year 2023, compared to net cash used in investing activities of $112,000 in the first half of fiscal year 2022. Net cash provided by investing activities during the first half of fiscal year 2023 resulted primarily from the net insurance proceeds received for damage to property and equipment totaling $1.7 million, partially offset by purchases of property and equipment and deposits for the purchase of property and equipment. Net cash used in investing activities during the first half of fiscal year 2022 resulted primarily from purchases of property and equipment and deposits for the purchase of property and equipment.

Net cash provided by financing activities totaled $1.7 million for the first half of fiscal year 2023, compared to $3.2 million in the first half of fiscal year 2022. Net cash provided by financing activities in the first half of fiscal year 2023 resulted primarily from net proceeds on our revolving line of credit totaling $2.0 million, partially offset by principal payments on long-term debt totaling $168,000. Net cash provided by financing activities in the first half of fiscal year 2022 resulted primarily from net proceeds on our revolving line of credit totaling $3.6 million, partially offset by principal payments on long-term debt totaling $161,000.

Credit Facilities

We have credit facilities consisting of a real estate term loan, as amended and restated (the “Virginia Real Estate Loan”), a supplemental real estate term loan, as amended and restated (the “North Carolina Real Estate Loan”) and a Revolving Credit Master Promissory Note and related agreements (collectively, the “Revolver”).

Both the Virginia Real Estate Loan and the North Carolina Real Estate Loan are with Northeast Bank, have a fixed interest rate of 3.95% and are secured by a first lien deed of trust on the Company’s real property.

The Revolver with North Mill Capital LLC (doing business as SLR Business Credit, “SLR”) provides us with one or more advances in an amount up to: (a) 85% of the aggregate outstanding amount of eligible accounts (the “eligible accounts loan value”); plus (b) the lowest of (i) an amount up to 35% of the aggregate value of eligible inventory, (ii) $5.0 million, and (iii) an amount not to exceed 100% of the then outstanding eligible accounts loan value; minus (c) $1.15 million.

The maximum aggregate principal amount subject to the Revolver is $18.0 million. Interest accrues on the daily balance at the per annum rate of 1.5% above the Prime Rate in effect from time to time, but not less than 4.75% (the “Applicable Rate”). In the event of a default, interest may become 6.0% above the Applicable Rate. As of April 30, 2023, the Revolver accrued interest at the prime lending rate plus 1.5% (resulting in a 9.5% rate at April 30, 2023). The termination date of the Revolver is July 24, 2025 and the loan may be extended in one year periods subject to the agreement of SLR.

The Revolver is secured by all of the following assets: properties, rights and interests in property of the Company whether now owned or existing, or hereafter acquired or arising, and wherever located; all accounts, equipment, commercial tort claims, general intangibles, chattel paper, inventory, negotiable collateral, investment property, financial assets, letter-of-credit rights, supporting obligations, deposit accounts, money or assets of the Company, which hereafter come into the possession, custody, or control of SLR; all proceeds and products, whether tangible or intangible, of any of the foregoing, including proceeds of insurance covering any or all of the foregoing; any and all tangible or intangible property resulting from the sale, lease, license or other disposition of any of the foregoing, or any portion thereof or interest therein, and all proceeds thereof; and any other assets of the Company which may be subject to a lien in favor of SLR as security for the obligations under the Loan Agreement.

As of April 30, 2023, we had $8.0 million of outstanding borrowings on our Revolver and $5.0 million in available credit.

Capital Expenditures

We did not have any material commitments for capital expenditures as of April 30, 2023. During our 2023 fiscal year budgeting process, we included an estimate for capital expenditures of $1.0 million for the fiscal year. We anticipate these expenditures, to the extent made, will be funded out of our working capital, cash provided by operations or borrowings under our Revolver, as appropriate. Capital expenditures are reviewed and approved based on a variety of factors including, but not limited to, current cash flow considerations, the expected return on investment, project priorities, impact on current or future product offerings, availability of personnel necessary to implement and begin using acquired equipment, and economic conditions in general. Additionally, total capital expenditures exceeding $1.0 million per fiscal year would require approval from our lender.

Corporate acquisitions and other strategic investments, if any, are considered outside of our annual capital expenditure budgeting process. Our office building and its contents at our Asheville facilities sustained water damage from a burst pipe at the end of December 2022. The office building damaged is separate from our manufacturing building, which houses our manufacturing operations and certain offices at the same location. There was no significant impact to our operations as a result of this event. At this time, we do not expect any future costs to restore, repair or replace damaged assets to exceed any insurance proceeds. To the extent we have future expenditures as a result of this event, such expenditures may be expensed or capitalized in future periods, in accordance with U.S. GAAP.

Future Cash Flow Considerations

We believe that our future cash flow from operations, our cash on hand and our existing credit facilities will be adequate to fund our operations for at least the next twelve months.

From time to time, we are involved in various claims, legal actions and regulatory reviews arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our financial position, results of operations or liquidity.

Seasonality

We typically expect net sales to be relatively lower in the first half of each fiscal year and relatively higher in the second half of each fiscal year, and excluding other volatility, we would normally expect 48% of total net sales to occur during the first half of a fiscal year and 52% of total net sales to occur during the second half of a fiscal year. We believe this historical seasonality pattern is generally indicative of an overall trend and reflective of the buying patterns and budgetary cycles of our customers. However, this pattern may be altered during any quarter or year by the quarterly and annual volatility of orders received for the wireless carrier market, the timing of larger projects, timing of orders from larger customers, other economic factors impacting our industry or impacting the industries of our customers and end-users, and macroeconomic conditions. While we believe seasonality may be a factor that impacts our quarterly net sales results, particularly when excluding the volatility of sales in the wireless carrier market, we are not able to reliably predict net sales based on seasonality because these other factors can also, and often do, substantially impact our net sales patterns during the year.

Critical Accounting Policies and Estimates

Our discussion and analysis of financial condition and results of operations is based on the condensed consolidated financial statements and accompanying condensed notes that have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and the instructions to Form 10‑Q and Regulation S‑X. The preparation of these condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Note 1 to the consolidated financial statements filed with our Annual Report on Form 10-K for fiscal year 2022 provides a summary of our significant accounting policies. Those significant accounting policies detailed in our fiscal year 2022 Form 10-K did not change during the period from November 1, 2022 through April 30, 2023.

New Accounting Standards

There are no new accounting standards issued, but not yet adopted by us, which are expected to be applicable to our financial position, operating results or financial statement disclosures.