Ladies and gentlemen, greetings, and welcome to the Clearfield Fiscal Second Quarter 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Greg McNiff, Investor Relations for Clearfield. Please go ahead, sir.

Thank you. Joining me on the call today are Cheri Beranek, Clearfield's President and CEO; and Dan Herzog, Clearfield's CFO. As a reminder, the slides in this presentation are controlled by you, the listener. Please advance forward through the presentation as the speaker presents their remarks. Please note that during this call, management will be making remarks regarding future events and the future financial performance of the company. These remarks constitute forward-looking statements for purposes of the safe harbor provisions of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. It is important to also note that the company undertakes no obligation to update such statements except as required by law. The company cautions you to consider risk factors that could cause actual results to differ materially from those in the forward-looking statements contained in today's press release, earnings presentation, and on this conference call. The Risk Factors section in Clearfield's most recent Form 10-K filing with the Securities and Exchange Commission, and its subsequent filings on Form 10-Q provide a description of these risks. They are also summarized on Slide 2 of the earnings presentation. With that, I would like to turn the call over to Clearfield's President and CEO, Cheri Beranek. Cheri?

Good afternoon, everyone. Thank you for joining us today to discuss Clearfield's results for the fiscal second quarter 2024. We also intend to provide an update on our business and current market trends. Please turn to Slide 4. While we view 2024 as a transition year, we believe that the quarter ending in March represents the beginning of a gradual recovery as broadband service providers continue to deploy equipment and long-term demand remains robust. In the following slides, I will discuss the latest market data, which supports this view. Total net sales for the second quarter of fiscal 2024 were $36.9 million, above the high end of our guidance range, driven by higher-than-expected sales from our Community Broadband customers as this customer segment was the least impacted by the inventory overhang. Dan will discuss our financial results for the quarter in more detail shortly. I would note that while we continue to expect ordering patterns for the remainder of the year to be impacted by the inventory overhang predominantly in our Large Regional and MSO accounts, we have seen a pickup in quoting activity in our second quarter across all markets that is more consistent with the traditional build season. While we believe the recovery will be a gradual process. We remain focused on positioning Clearfield to take share when ordering patterns return to a more normalized cadence. We also continue to expand and enhance our product portfolio. As we announced in February, our newest active cabinet delivers a rightsized raw footprint option for raw expansion. The small form factor of the FiberFlex 600 is designed to configure the numerous applications, including remote passive optical network distribution, wireless base stations with fiber backhaul aggregation and active network equipment with backup power needs, utilizing a flexible layout. This is Clearfield's latest…

Thank you, Cheri, and good afternoon, everyone. Please turn to Slide 7 to look at our fiscal second quarter 2024 results in more detail. Consolidated net sales in the second quarter of fiscal 2024 were $36.9 million, a 49% decrease from $71.8 million in the same year ago period, but above our guidance range of $29 million to $33 million. The year-over-year decrease in total net sales was due to lingering inventory headwinds we have talked about in the past. As we transition into the build season, we anticipate a gradual uptick in orders, more closely aligning with traditional ordering patterns. Throughout this transition phase, we remain focused on reducing costs and enhancing margins across the company. In Europe, this effort involves strategically investing in more efficient manufacturing equipment and introducing higher-margin plug-and-play connectivity products. Additionally, we continue to be focused on labor utilization for enhanced productivity in order to improve gross margins at all our manufacturing locations, alongside efforts to reduce our inventory levels to enhance cash flow from operations. Order backlog increased 9% to $47.2 million on March 31, 2024, from $43.5 million on December 31, 2023. This quarter stands out as the first time in several quarters where our backlog has shown a sequential increase. We interpret this as an encouraging indicator of normalizing ordering patterns during a build season, while customers continue to work through their inventory. We are continuing to collaborate with our customers to align their open orders with their current deployment schedules. As a reminder, we expect backlog to become less of an indicator for future sales as most orders will be fulfilled within the quarter they are received. Our lead times averaged 4 weeks across most product lines. Turning to Slide 8, I will now review net sales by our key markets.…

Thanks for the financial update, Dan. Turning to Slide 15, I would now like to provide a brief update on our multiyear strategic plan, which we had labeled LEAP. As a reminder, LEAP is our roadmap for how we intend to capitalize on the significant opportunities ahead when industry demand returns to a more normalized cadence. Clearfield continues to build our product offerings to be craft friendly with the inherent goal of reducing the cost of deployments by improving installation time. To aid in this process, we have long provided in-field as well as classroom and online training through Clearfield College. In March, Clearfield announced the availability of an app-based 3D interactive training tool that provides an easy way to streamline the installation process. This solution is delivered on the build platform and is available at no extra charge. The animated guides were developed to response to the Clearfield customer base and will help reduce installation errors, time and field issues by ensuring field technicians have access to the information they need right at their fingertips. This training tool is exactly what fiber technicians are in need of offering interactive guidance for a step-by-step instruction without relying on manuals. We believe this is how today's workforce and particularly new hires can learn how to install Clearfield products correctly so that our customers can move quickly from deployment to service availability. Today's workforce is more tech-savvy and digitally oriented, making it ideal to develop an installation tool that aligns with their preferred methods of learning and consuming information. The availability of Clearfield instructions in the built app is part of the company's commitment to improve workforce development practices and tools. As the industry works to increase the fiber technician workforce, this 3D interactive based tool makes it easier to onboard and attract the newer generation of technician. Both voice and text guidance for Clearfield products are immediately available in English, Spanish and German. Anyone can download the free build app worldwide from the App Store or Google Play. As we expressed last quarter, we remain confident that the long-term demand for fiber is as strong as ever. And Clearfield is well positioned to help service providers meet that demand. And with that, we will open the call to your questions.

[Operator Instructions] Our first question is from the line of Ryan Koontz with Needham and Company.

Cheri and Dan, nice to hear commentary on filling the bottom here. Dan, first one for you on this reserve write-down. At a high level, is this related to obsolescence or costs that are -- were out of line with what you can buy from today? And secondly, what would gross -- what was the impact of that write-down or what margin they have been without the write-down in the quarter?

Right. Sure. No, this is related to like in excess only because of the value of -- the amount of inventory we have compared to our sales. It's not about obsolescence and it's not about a lower of cost or market. So I think we would have had -- I think our overall gross margin here would have been closer to a 20% -- sorry, 19% number, if you would have taken that to more of a normalized number.

And Cheri, on the Community Broadband trend, nice to see that rebounding there. Can you maybe give us a little color there on some of the trends you're seeing in that Tier 3 market in terms of new builds versus edge-outs versus fill-in, connected home? Any color you can share there in that Tier 3 space, please?

Yes, we're excited a couple of things. One is we're definitely seeing there's somewhat of a decrease in excitement of our homes passed, not because people aren't ready to do it, but because they want to be able to focus on homes connected. And that's really the growth initiative is making sure that they turn that home passing into a subscriber that generates revenue, which gives us some new revenue opportunities since the inventory that is out there is predominantly cabinets associated with passing homes. The other thing we're seeing is new customers, new Tier 3 providers who were not necessarily telco providers, but community-based deployments and other providers who are new to us who are coming onboard through distribution.

And then on the kind of government funding side, I don't think many surprised by your commentary on BEAD in '25. Any commentary you'd share on the non-BEAD programs as it relates to ARPA or capital projects fund? It feels like every month, we're seeing hundreds of millions of new awards in that space. And are you heard about those projects coming to bat now? Is that already starting to impact some of your bookings for the year? And how would you characterize your thinking about those shorter term projects over the next couple of years?

We saw some of those projects as part -- before BEAD come into play, that's been part of the recovery in '22 and '23. So it's early-stage programs that didn't have all of the administrative challenges, that the BEAD program does or were Legacy programs that were extended so that people knew more about them. I would say some of them have hit the Tier 3 market. Others probably more associated in the MSO space, where we're seeing some of the -- somewhat the larger provider, but certainly the middle market MSO get involved in being able to take advantage of it. I think we'll see some of that in this build season in '24. And it will be a good bridge until we get to the larger BEAD program in '25 and beyond.

Our next question comes from the line of Scott Searle with ROTH Capital Partners.

Also nice to see you guys putting in the trough and a sequential outlook improving into the June quarter. Maybe just to follow up on some of the other customer segments, Cheri, Large Regionals, MSOs, it sounds like that's still a little bit lumpy. But are you expecting to see sequential improvement as we look out into the June-September quarter? And maybe folding into that question, I thought Dan had a comment about seasonality returning in the fiscal fourth quarter. Are you kind of implying that we look flattish into September?

So I'll start at the back end. So yes, what we are anticipating is that we're starting the beginning of a normalized build season. While we can't see a lot of the product mix beyond this quarter, we are seeing some ordering patterns and some quoting patterns that would indicate that we are in kind of this normalized program were through in the fourth quarter are pretty consistent with each other. From an orientation of what do we see in regard to the large cable providers or the Large Regional providers kind of coming back up to speed, I would say that's the biggest question mark that we have. Those are the providers that unfortunately have either the largest inventory position or have the biggest question mark in regard to how their -- how fast they're going to be deploying in order to align their capital equipment expenditures alongside their subscriber take rates. So those -- I would say the Large Regional-MSO providers are the swing that could take us below or above our numbers, and that's why we have to be a little careful.

And Cheri, maybe just to follow up on that. So what are you factoring in from those 2 categories over the next couple of quarters? And maybe through the T-Mobile joint venture into there now with lumen had been -- historically been a customer. How do you see that playing out for you guys?

T-Mobile and Lumos is a really interesting combination. And I think it really shows the development of a one fiber network where the wireless and wireline provider becomes one. As 5G deployment start to move forward, T-Mobile has had the opportunity to deploy 5G with a different level of spectrum, which has allowed it to be faster for deployment, but not isn't as scalable. And so they need -- in order for it to continue to be able to add more bandwidth and more users especially for their fixed wireless providers, they need to get more fiber in the ground. And so a joint venture, our partnership with Lumos or our acquisition in this case, is an exciting way by which for them to control it. We have been excited to be part of the Lumos field in the past. We have been part of the lumen build in the past as well. We don't typically throw around customer names, because it's -- there's so much competitive foundation there that one has to be very diligent and prudent about continuing to earn the business. But I would say what's most exciting is the fact that it's happening. And people are back to a standpoint of they're not waiting to see, they're actually making plans to make it happen.

And one last one, if I could, Dan, just to clarify on the gross margins. You've got the excess inventory reserves. Looking at your guidance, it seems like that continues into the June quarter. Just want to clarify, how long does that continue? It seems like this is an accounting adjustment again, not for obsolete inventory. So at some point, you should see the benefit of that. But when do we see that kind of work its way through the system, if you will, from an accounting perspective?

Yes. Sure. Yes. So yes, it still stays there. I see it being a little bit lower, like more like $3 million or so, at least plus or minus, but that's what we're looking at Q3 right now. And as revenue goes up, those things are going to go down and sequentially will go down as the revenues go up. So we're going to -- it's still going to be around, obviously, if our revenues in Q4 are similar to our projections in Q3, but probably more at that level that I just spoke to. And then as the U keeps growing sequentially, those become smaller and recoveries become big, will start to get into our numbers.

[Operator Instructions] Our next question is from the line of Jaeson Schmidt with Lake Street Capital.

Most have been covered, but just curious if you could update us on how the cross-selling opportunities with the Nestor product portfolio has progressed since you brought that online.

It's continuing, but I'd say it's still in the discovery phase. We have had the benefit of being able to be in front of some customers in -- or current customers buying cable and then prospective customers that would be associated more predominantly with connectivity in several European trade shows over the last few weeks. And we'll be continuing that moving forward with ANGA COM in Germany in just a couple of weeks. I think what's important here is it's not about revenue right now. It's really more about being able to establish those partnerships. And what we're really looking for is we know the product sense that we feel is best. But what we really need to align ourselves with is to expand our channel offerings. We have had, in the U.S., a very strong direct sales program, but more importantly an extremely strong and well-developed distribution network. And so we're looking at that distribution network in target countries and seeing what we can do to facilitate the product offerings that we have in play.

Okay. That's helpful. And then just as a follow-up, Dan, you noted kind of managing OpEx here. It was down sequentially in March. How should we think about it ramping through the second half of this year?

Yes. We'll have some additional variable costs that will go along with a little bit of increase in revenues here. So expect it to remain not too different percentage-wise from where we would be in Q2 right now, plus or minus a little bit. But you could probably aim at the same relative percentage.

[Operator Instructions] As there are no further questions, I now hand the conference over to Cheri Beranek for closing comments. Cheri?

Thank you. Once again, it's been a pleasure to talk and speak with you. I think really, in summary, we want to make sure that everyone understands that we're excited about where we're at right now. But we want to reassure everyone that we're at the beginning of a gradual U-shaped recovery like we've been talking about for the last couple of quarters. We see deployments continuing somewhat moving forward. The deployments are happening, although they're somewhat thwarted by economic conditions. But we also see the gap between revenue and customer deployments. While it's still present, we believe the build season will work to minimize it. Furthermore, and I think most importantly, I would close with that we believe Clearfield is uniquely positioned to serve the 59 million homes that are anticipated to be passed with fiber over the course of the next 5 years. The next 5 years is really what Clearfield is looking for. And we hope you're part of our journey.

Thank you. The conference of Clearfield has now concluded. Thank you for your participation. You may now disconnect your lines.