OPTICAL CABLE CORPORATION

Condensed Notes to Condensed Consolidated Financial Statements

Three Months Ended January 31, 2020

(Unaudited)

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 high volatility, timing of large sales orders, and high sales concentration among a limited number of customers in certain markets, particularly the wireless carrier market; terrorist attacks or acts of war, and any current or potential future military conflicts; changes in the level of military spending or other spending by the United States government, including, but not limited to reductions in government spending due to automatic budget cuts or sequestration; ability to recruit and retain key personnel; poor labor relations; the impact of cybersecurity risks and incidents and the related actual or potential costs and consequences of such risks and incidents, including costs 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; the impact of the Patient Protection and Affordable Care Act of 2010, the Health Care and Education Reconciliation Act of 2010, and any revisions to those acts that apply to us and the related legislation and regulation associated with those acts, which directly or indirectly result in increases to our 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 financial debt covenants with our lender; 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; impact of weather, natural disasters or epidemic or pandemic diseases (such as disease cause by Covid-19) in the areas of the world in which we operate, market our products and/or acquire raw materials; 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 providers’ offerings. 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 and broadcast applications, and for 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 First Quarter of Fiscal Year 2020

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 negatively 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 January 31, 2020 and 2019

Net Sales

Consolidated net sales for the first quarter of fiscal year 2020 were $12.9 million, a decrease of 23.1%, compared to net sales of $16.8 million for the same period last year. We experienced a decrease in net sales in our enterprise and wireless carrier markets in the first quarter of fiscal year 2020 compared to the same period last year, partially offset by increases in other specialty markets. The decrease in net sales when comparing the two periods is primarily due to the recognition of net sales totaling, in the aggregate, approximately $2.8 million as the result of a number of large orders from one domestic customer in the first quarter of fiscal year 2019 that did not recur at the same levels in the first quarter of fiscal year 2020. Net sales to this one customer totaled, in the aggregate, $498,000 in the first quarter of fiscal year 2020, a decrease of $2.3 million compared to the first quarter of fiscal year 2019. Historically, net sales to this customer have been volatile from quarter to quarter and from year to year.

Net sales to customers in the United States decreased $3.1 million, or 22.7%, in the first quarter of fiscal year 2020, compared to the same period last year, primarily due to the $2.3 million decrease in net sales to the one domestic customer in the first quarter of fiscal year 2020 compared to the same period last year.  Net sales to customers outside of the United States decreased 24.5% compared to the same period last year. 

Gross Profit

Our gross profit was $2.4 million in the first quarter of fiscal year 2020, a decrease of 32.5% compared to gross profit of $3.6 million in the first quarter of fiscal year 2019. Gross profit margin, or gross profit as a percentage of net sales, was 18.7% in the first quarter of fiscal year 2020 compared to 21.3% in the first quarter of fiscal year 2019.

Our gross profit margins tend to be higher when we achieve higher net sales levels, as certain fixed manufacturing costs are spread over higher sales. This operating leverage, which is beneficial at higher sales levels, was the primary factor putting downward pressure on our gross profit margin during the first quarter of fiscal year 2020, as fixed costs were spread over lower sales.

During fiscal year 2019, we took actions to reduce employee related costs in cost of goods sold anticipated to create savings during fiscal year 2020. We believe many benefits of these actions were attained during the first quarter of fiscal year 2020, and expect the benefits will be more fully realized as sales increase during the remainder of the fiscal year. 

Selling, General, and Administrative Expenses

SG&A expenses decreased 28.8% to $4.8 million during the first quarter of fiscal year 2020, compared to $6.8 million for the same period last year. SG&A expenses as a percentage of net sales were 37.4% in the first quarter of fiscal year 2020, compared to 40.4% in the first quarter of fiscal year 2019.

The decrease in SG&A expenses during the first quarter of fiscal year 2020 compared to the same period last year was primarily the result of decreases in employee related costs totaling $1.4 million and $507,000 in net reductions in other SG&A expenses.  The decrease in employee related costs was due primarily to decreases in share-based compensation expense, including the related payroll tax expense, as a result of previously granted long-term, performance-based equity grants that vested on January 31, 2019.  Vesting of performance-based equity grants did not recur in the first quarter of fiscal year 2020 due to the fiscal year 2019 financial results. Also contributing to the deceases in employee related costs were decreases in commissions due to decreases in commissionable sales when comparing the first quarter of fiscal year 2020 to the same period last year.

Royalty Income (Expense), Net

We recognized royalty expense, net of royalty income, totaling $18,000 during the first quarter of fiscal year 2020 compared to less than $1,000 during the first quarter of fiscal year 2019.

Amortization of Intangible Assets

We recognized $10,000 of amortization expense, associated with intangible assets, during the first quarter of fiscal year 2020, compared to $9,000 during the first quarter of fiscal year 2019.

Other Expense, Net

We recognized other expense, net in the first quarter of fiscal year 2020 of $139,000 compared to $117,000 in the first quarter of fiscal year 2019. Other expense, net is comprised primarily of interest expense together with other miscellaneous items.

Loss Before Income Taxes

We reported a loss before income taxes of $2.6 million for the first quarter of fiscal year 2020, compared to $3.3 million for the first quarter of fiscal year 2019. The decrease was primarily due to the decrease in SG&A expenses of $1.9 million, partially offset by the decrease in gross profit of $1.2 million, compared to the same period in 2019.

Income Tax Expense (Benefit)

Income tax expense totaled $5,000 in the first quarter of fiscal year 2020, compared to income tax benefit of $27,000 for the same period in fiscal year 2019. Our effective tax rate was less than negative one percent for the first quarter of fiscal years 2020 and less than one percent for the first quarter of fiscal year 2019.

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.

During fiscal year 2015, we 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.

Net Loss

Net loss for the first quarter of fiscal year 2020 was $2.6 million compared to $3.3 million for the first quarter of fiscal year 2019. This decrease was due primarily to the decrease in loss before income taxes of $751,000.

Financial Condition

Total assets decreased $3.4 million, or 8.6%, to $36.7 million at January 31, 2020, from $40.1 million at October 31, 2019. This decrease was primarily due to a $3.5 million decrease in trade accounts receivable, net, and a $915,000 decrease in inventories, partially offset by an increase in other assets resulting from the addition of right-to-use assets of $1.1 million related to the adoption of ASC 842. The decrease in trade accounts receivable, net largely resulted from the decrease in net sales in the first quarter of fiscal year 2020 when compared to the fourth quarter of fiscal year 2019. Inventories decreased largely as the result of the timing of certain raw material purchases as well as lower replenishment rates due to lower sales and the timing of sales of stock inventory.

Total liabilities decreased $884,000, or 4.7%, to $18.0 million at January 31, 2020, from $18.9 million at October 31, 2019. The decrease in total liabilities was primarily due to a decrease in accounts payable and accrued expenses, including accrued compensation and payroll taxes, totaling $1.5 million, primarily resulting from the timing of raw material purchases and certain vendor payments, partially offset by an increase in other liabilities resulting from the addition of an operating lease liability of $1.1 million related to the adoption of ASC 842.

Total shareholders’ equity at January 31, 2020 decreased $2.6 million in the first quarter of fiscal year 2020. The decrease resulted from a net loss of $2.6 million.

Liquidity and Capital Resources

Our primary capital needs have been to fund working capital requirements and to make principal payments on long-term debt and our note payable to bank. Our primary source of capital for these purposes has been existing cash and cash provided by operations.

Our cash totaled $694,000 as of January 31, 2020, an increase of $157,000, compared to $537,000 as of October 31, 2019. The increase in cash for the three months ended January 31, 2020 primarily resulted from net cash provided by operating activities of $544,000, partially offset by capital expenditures totaling $47,000 and cash used in financing activities of $319,000.

On January 31, 2020, we had working capital of $13.2 million compared to $15.8 million on October 31, 2019. The ratio of current assets to current liabilities as of January 31, 2020 was 2.1 to 1.0 compared to 2.2 to 1.0 as of October 31, 2019. The decrease in working capital and in the current ratio was primarily due to the $3.5 million decrease in trade accounts receivable, net and the $915,000 decrease in inventories, partially offset by the $1.5 million decrease in accounts payable and accrued expenses, including accrued compensation and payroll taxes.

As of January 31, 2020 and October 31, 2019, we had outstanding loan balances under our revolving credit facility totaling $5.7 million. As of January 31, 2020 and October 31, 2019, we had outstanding loan balances, excluding our revolving credit facility, totaling $5.6 million and $5.9 million, respectively.

Net Cash

Net cash provided by operating activities was $544,000 in the first quarter of fiscal year 2020, compared to net cash used in operating activities of $1.2 million in the first quarter of fiscal year 2019. Net cash provided by operating activities during the first quarter of fiscal year 2020 primarily resulted from certain adjustments to reconcile a net loss of $2.6 million to net cash provided by operating activities including depreciation and amortization of $393,000. Additionally, the cash flow impact of decreases in trade accounts receivable, net totaling $3.6 million and the decrease in inventories totaling $915,000 further contributed to net cash provided by operating activities. All of the aforementioned factors positively affecting cash provided by operating activities were partially offset by the cash flow impact of decreases in accounts payable and accrued expenses, including accrued compensation and payroll taxes totaling $1.7 million.

Net cash used in operating activities during the first quarter of fiscal year 2019 primarily resulted from an increase in inventories totaling $2.0 million and the decrease in accrued compensation and payroll taxes totaling $1.9 million, partially offset by a decrease in the cash flow impact of decreases in trade accounts receivable, net totaling $3.0 million and certain adjustments to reconcile a net loss of $3.3 million to net cash used in operating activities including depreciation and amortization of $443,000 and share-based compensation expense of $862,000. Additionally, the cash flow impact of increases in accounts payable and accrued expense totaling $1.7 million further contributed to offset net cash used in operating activities.

Net cash used in investing activities totaled $68,000 in the first quarter of fiscal year 2020, compared to $344,000 in the first quarter of fiscal year 2019. Net cash used in investing activities during the first quarter of fiscal years 2020 and 2019 resulted primarily from purchases of property and equipment and deposits for the purchase of property and equipment.

Net cash used in financing activities totaled $319,000 in the first quarter of fiscal year 2020, compared to net cash provided by financing activities of $1.7 million in the first quarter of fiscal year 2019. Net cash used in financing activities in the first quarter of fiscal year 2020 resulted from principal payments on long-term debt. Net cash provided by financing activities in the first quarter of fiscal year 2019 resulted primarily from proceeds from a note payable to our bank under our line of credit, net of repayments, totaling $1.8 million, partially offset by principal payments on long-term debt totaling $63,000.

We have a plan (the “Repurchase Plan”), approved by our Board of Directors on July 14, 2015, to purchase and retire up to 400,000 shares of our common stock, or approximately 6.0% of the shares then outstanding. When the Repurchase Plan was approved, we had anticipated that the purchases would be made over a 24- to 36-month period, but there was no definite time period for repurchase or plan expiration. As of January 31, 2020 we had 398,400 shares remaining to purchase under this Repurchase Plan, and we have made no specific determination whether and over what period these shares may or may not be purchased. At this time, we have no plans to repurchase and retire any additional shares under the Repurchase Plan; however, this is subject to change at any time.

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 Note and related agreements (collectively, the “Revolver”).

Both the Virginia Real Estate Loan and the North Carolina Real Estate Loan are with Pinnacle Bank (“Pinnacle”), have a fixed interest rate of 3.95% and are secured by a first priority lien on all of our personal property and assets, all money, goods, machinery, equipment, fixtures, inventory, accounts, chattel paper, letter of credit rights, deposit accounts, commercial tort claims, documents, instruments, investment property and general intangibles now owned or hereafter acquired by us and wherever located, as well as a first lien deed of trust on our real property.

Our Revolver with Pinnacle provides the Company with a $6.5 million revolving line of credit for our working capital needs. Under the Revolver, Pinnacle provides us with one or more revolving loans in a collective maximum principal amount of $6.5 million. We may borrow, repay, and reborrow at any time or from time to time while the Revolver is in effect. Through January 22, 2020, the Revolver had an interest rate on advances of prime lending rate plus 0.25%.

On January 22, 2020, OCC entered into an Eighth Loan Modification Agreement with Pinnacle to modify the Credit Agreement dated April 26, 2016 entered into between the Company and Pinnacle and the term loans dated April 26, 2016. The purpose of the Eighth Loan Modification Agreement was to (i) reduce the aggregate outstanding balance under the Credit Agreement by $200,000 on or before April 15, 2020 by reducing the outstanding principal balances on the term loans; (ii) provide that all outstanding and future advances under the Revolver accrue interest at an interest rate of prime lending rate plus 0.50%, effective January 22, 2020, (iii) remove the current ratio financial covenant for the fiscal quarter ended October 31, 2019, (iv) remove the fixed charge coverage ratio for the fiscal year ended October 31, 2019, and (v) provide that OCC engage in good faith to negotiate a letter of intent or similar expression of interest to refinance the Revolver by March 31, 2020 and enter into a financing commitment letter, similar equity commitment or combination thereof relating to the financing by May 1, 2020 with closing planned on or before June 30, 2020.

As of January 31, 2020, the Revolver accrued interest of prime lending rate plus 0.50% (resulting in a 5.25% rate at January 31, 2020). The Revolver is payable in monthly payments of interest only with principal and any outstanding interest due and payable at maturity.

On March 10, 2020, OCC entered into a Ninth Loan Modification Agreement (the “Ninth Amendment”) with Pinnacle to modify the Credit Agreement dated April 26, 2016 entered into between the Company and Pinnacle and the term loans dated April 26, 2016. The purpose of the Ninth Amendment was to (i) remove the current ratio financial covenant for the fiscal quarters ended January 31, 2020 and ending April 30, 2020 and (ii) remove the total liabilities to tangible net worth ratio for the fiscal quarters ended January 31, 2020 and ending April 30, 2020. OCC also reaffirmed it would reduce the aggregate outstanding balance under the Credit Agreement by $200,000 on or before April 15, 2020 by reducing the outstanding principal balances on the term loans. OCC also affirmed that it would continue to engage in good faith to negotiate a letter of intent or similar expression of interest to refinance the Revolver by March 31, 2020 and enter into a financing commitment letter, similar equity commitment or combination thereof relating to the financing by May 1, 2020 with a closing planned on or before June 30, 2020.

All other terms and conditions of the Credit Agreement, as amended, remain unaltered and in effect.

The Revolver is secured by a perfected first lien security interest on all assets, including but not limited to, accounts, as-extracted collateral, chattel paper, commodity accounts, commodity contracts, deposit accounts, documents, equipment, fixtures, furniture, general intangibles, goods, instruments, inventory, investment property, letter of credit rights, payment intangibles, promissory notes, software and general tangible and intangible assets owned now or later acquired. The Revolver is also cross-collateralized with our real property.

The terms of our credit facilities with Pinnacle require us to comply, on a quarterly basis, with two financial covenants including a current ratio and a total liabilities to tangible net worth ratio. Except as modified relative to the quarter ended January 31, 2020, we are required to have a current ratio of not less than 3.0 to 1.0, measured at the end of each quarter. The ratio is calculated by dividing current assets by current liabilities. Our Revolver is scheduled to mature on June 30, 2020, and therefore the $5.7 million of outstanding borrowings on the Revolver has been classified as a current liability as of January 31, 2020. As of January 31, 2020, we had a current ratio of 2.1 to 1.0 and, therefore, we were not in compliance with the current ratio covenant. Had the maturity date of the Revolver been greater than one year from January 31, 2020, the $5.7 million of outstanding borrowings on the Revolver would have been classified as note payable to bank – noncurrent and we would have been in compliance with the current ratio covenant.

We are required to have a total liabilities to tangible net worth ratio of not more than 0.95 to 1.0, measured at the end of each quarter. The ratio is calculated by dividing total liabilities, as defined in the loan agreements, by tangible net worth, as defined in the loan agreements. As of January 31, 2020, we had a total liabilities to tangible net worth ratio of 1.0 to 1.0 and, therefore, we were not in compliance with the total liabilities to tangible net worth ratio covenant.

As of January 31, 2020, we had $5.7 million of outstanding borrowings on our Revolver and $850,000 in available credit.

The Revolver is set to expire on June 30, 2020. We are in the process of seeking alternative financing sources for our Revolver and, at this time, we believe we will be able to secure alternative financing for our Revolver on or before June 30, 2020.

Capital Expenditures

We did not have any material commitments for capital expenditures as of January 31, 2020. During our 2020 fiscal year budgeting process, we included an estimate for capital expenditures of $1.5 million for the year. We anticipate these expenditures, to the extent made, will be funded out of our working capital or borrowings, including under our credit facility. 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. Historically, we have spent less than our budgeted capital expenditures in most fiscal years.

Corporate acquisitions and other strategic investments, if any, are considered outside of our annual capital expenditure budgeting process.

Future Cash Flow Considerations

We believe that our future cash flow from operations, our cash on hand and our existing credit facilities or any additional credit facilities we may originate or additional equity financing we may raise will be adequate to fund our operations for at least the next twelve months.

Although the Company and Pinnacle Bank have previously amended our credit facilities to provide for alternative financial covenants for certain periods, absent such amendment, the terms of our credit facilities with Pinnacle require us to comply with financial covenants, including (i) a minimum current ratio of 3.0 to 1.0, measured quarterly, (ii) a total liabilities to tangible net worth ratio of no more than 0.95 to 1.0, measured quarterly, and (iii) a fixed charge coverage ratio of not less than 1.25 to 1.0, measured annually at the end of our fiscal year.

At this time, we believe that we have the ability to maintain and/or secure future debt and/or equity financing to adequately finance ongoing operations.

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. We believe this historical seasonality pattern is generally indicative of an overall trend and reflective of the buying patterns and budgetary considerations of our customers. However, this pattern may be substantially altered during any quarter or year, as was the case in fiscal years 2019 and 2018, by the quarterly and annual volatility of orders received for the wireless carrier market, the timing of larger projects, timing of order 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 substantially impact our net sales patterns during the year. Our trend for the last three fiscal years has been that an average of approximately 50%, 51% and 48% of our total net sales occurred during the first half of fiscal years 2019, 2018 and 2017, respectively, and an average of approximately 50%, 49% and 52% of our total net sales occurred during the second half of fiscal years 2019, 2018 and 2017, respectively.

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 2019 provides a summary of our significant accounting policies. Those significant accounting policies detailed in our fiscal year 2019 Form 10-K did not change during the period from November 1, 2019 through January 31, 2020 other than to reflect changes required by the adoption of ASC 842 related to leases and ASU 2018-07 related to stock compensation.

New Accounting Standards

In December 2019, the FASB issued Accounting Standards Update 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, with early adoption permitted. We are currently evaluating the impact of the adoption of ASU 2019-12 on our results of operations, financial position and liquidity and our related financial statement disclosures.

There are no other 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.

Item 4. Controls and Procedures

The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to be effective in providing reasonable assurance that information required to be disclosed in reports under the Exchange Act are recorded, processed and summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (the “SEC”), and that such information is accumulated and communicated to management to allow for timely decisions regarding required disclosure.

Our management evaluated, with the participation of our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), the effectiveness of the Company’s disclosure controls and procedures as of January 31, 2020. Based on this evaluation process, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of January 31, 2020, and that there were no changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter ended January 31, 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II.  OTHER INFORMATIOn

Item 5. Other Information

Eighth Loan Modification Agreement. On January 22, 2020, Optical Cable Corporation (the “Company” or “OCC”) and Pinnacle Bank, a Tennessee banking corporation, as successor in interest by name change and by merger with the Bank of North Carolina (the “Lender” or “Pinnacle Bank”) entered into an Eighth Loan Modification Agreement to modify the Credit Agreement dated April 26, 2016 (as amended and modified by Loan Modification Agreement dated December 21, 2016, and by Second Loan Modification Agreement dated February 28, 2017, and by Third Loan Modification Agreement dated April 27, 2017, and by Fourth Loan Modification Agreement dated April 10, 2018, and by Fifth Loan Modification Agreement dated October 15, 2018, and by Sixth Loan Modification Agreement dated April 30, 2019 and by Seventh Loan Modification Agreement dated September 11, 2019 (collectively, the “Credit Agreement”).

The purpose of the Eighth Loan Modification Agreement was to (i) reduce the aggregate outstanding balance under the Credit Agreement by $200,000 on or before April 15, 2020 by reducing the outstanding principal balances on the term loans; (ii) provide that all outstanding and future advances under the Revolver accrue interest at an interest rate of prime lending rate plus 0.50%, effective January 22, 2020, (iii) remove the current ratio financial covenant for the fiscal quarter ended October 31, 2019, (iv) remove the fixed charge coverage ratio for the fiscal year ended October 31, 2019, and (v) provide that the Company engage in good faith to negotiate a letter of intent or similar expression of interest to refinance the Revolver by March 31, 2020 and enter into a financing commitment letter, similar equity commitment or combination thereof relating to the financing by May 1, 2020 with closing planned on or before June 30, 2020.

Ninth Loan Modification Agreement. On March 10, 2020, subsequent to its fiscal quarter end, the Company and Pinnacle Bank entered into a Ninth Loan Modification Agreement (the “Ninth Amendment”) to modify the Credit Agreement. The purpose of the Ninth Amendment was to (i) remove the current ratio financial covenant for the fiscal quarters ended January 31, 2020 and ending April 30, 2020 and (ii) remove the total liabilities to tangible net worth ratio for the fiscal quarters ended January 31, 2020 and ending April 30, 2020. OCC also reaffirmed it would reduce the aggregate outstanding balance under the Credit Agreement by $200,000 on or before April 15, 2020 by reducing the outstanding principal balances on the term loans. OCC also affirmed that it would continue to engage in good faith to negotiate a letter of intent or similar expression of interest to refinance the Revolver by March 31, 2020 and enter into a financing commitment letter, similar equity commitment or combination thereof relating to the financing by May 1, 2020 with a closing planned on or before June 30, 2020.

The Loan remains generally secured by the land and buildings at the Company’s headquarters and manufacturing facilities located in Roanoke, Virginia and its manufacturing and office facilities located near Asheville, North Carolina and the Company’s personal property and assets.

All other terms and conditions of the Credit Agreement, as amended, remain unaltered and in effect.

PART II.  OTHER INFORMATION

Item 6. Exhibits

Exhibit Index

PART II.  OTHER INFORMATION

PART II.  OTHER INFORMATION

PART II.  OTHER INFORMATION

PART II.  OTHER INFORMATION

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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