Annual Report

2015

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(1) Fiscal year 2015 includes a $2.4 million non-cash charge related to the establishment of an allowance against OCC's net deferred tax assets. The deferred tax asset valuation allowance in fiscal year 2015 increased income tax expense, increased net loss, increased net loss attributable to OCC, reduced total assets attributable to OCC and reduced total shareholders' equity attributable to OCC, in each case by $2.4 million. The deferred tax asset valuation allowance also increased the net loss per share attributable to OCC by $0.39 per share in fiscal year 2015. See "Income Tax Expense" in the Management Discussion and Analysis section of this annual report and Note 12 to the Consolidated Financial Statements.

Letter from the CEO

Dear Shareholders of Optical Cable Corporation:

Navigating Through a Difficult Environment.

Optical Cable Corporation (OCC^®) demonstrated strong operational and financial performance in the enterprise market in fiscal year 2015: our consolidated net sales in this market increased by more than 9% to $38.0 million¹, as we continued to execute on key initiatives that we believe will support future growth. Our development of new and updated product families for the enterprise market over the last two years—particularly our enterprise connectivity products—contributed to our increase in sales in this market.

Despite our strength in the enterprise market, our financial results were impacted by weakness in certain harsh environment and specialty markets, including the mining, oil & gas, and military markets, as well as by volatility in the wireless carrier market. The strong U.S. dollar also impacted our sales outside of the U.S.

Unusually slow sales activity in the United States toward the end of calendar year 2015 was suprising, and impacted OCC’s fourth quarter. While weakness in the U.S. will impact OCC’s sales in our first quarter of fiscal 2016, we are optimistic about the remainder of the year.

Importantly, the OCC team is nimble and able to adjust to market challenges, and we will continue to take the actions necessary to ensure OCC’s success. We are confident that we have built a solid foundation that will support continued growth and shareholder value creation in 2016 and beyond.

Financial Overview and Key Financial Performance Metrics.

OCC’s key financial performance metrics for fiscal year 2015 included:

Ability to Adjust. Actions Taken.

The OCC team has a demonstrated ability to adjust course in challenging operating environments in order to position the Company for future success. The OCC team has taken and is taking the following steps:

These proactive steps were taken after careful and thorough consideration, and will position OCC for future opportunities.

We are committed to enhancing shareholder value, and the OCC team continues to look for additional opportunities to increase sales, realize manufacturing efficiencies, and reduce costs.

Looking Forward to Fiscal Year 2016.

The global macroeconomic environment remains challenging as we enter 2016. The slowing Chinese economy, crude oil prices at 12-year lows, weakness in the stock markets, and downsizing at a number of leading manufacturing companies are headline news.

OCC continues to have a strong market position despite the macroeconomic and market headwinds, and we are confident that OCC is well-positioned for continued growth and success.

We have created a broad and growing suite of top-tier integrated connectivity and cabling solutions through product line expansions and innovative product designs. We are confident that these products and solutions, coupled with our investments in manufacturing, will continue to result in new opportunities for value creation at OCC.

We are also fortunate to have a strong team and a committed base of employees. On behalf of the Board and leadership team, we thank them for their hard work, dedication, and service, which enables OCC to maintain safe and productive operations.

Importantly, OCC’s leadership team remains committed to executing our strategy to create substantial long-term value for shareholders. Current employees and members of the Board of Directors own more than 36% of the outstanding shares of OCC as of October 31, 2015—squarely aligning the team’s interests with those of our shareholders.

All of us at OCC are working hard to ensure OCC’s success, and we are confident that we have the right team and the right plan in place to meet the needs of our customers and create value for all OCC shareholders.

Thank you for your investment in OCC and the privilege of allowing us to lead your company.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Information

This report 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, and 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; our dependence on a limited number of suppliers; the loss of or conflict with one or more key suppliers or customers; an adverse outcome in litigation, claims and other actions, and potential litigation, claims and other actions against us; an adverse outcome in 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) that affect certain geographic markets, the relative costs of U.S. products exported, 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 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; variations resulting from high volatility, large sales orders and high sales concentration among a limited number of customers in 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 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; 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 results 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 lenders; 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; a reduction or elimination of dividends declared to shareholders due to inadequate or alternative uses of cash on hand; 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 or natural disasters 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 (the non-carrier markets), 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, datacenter, residential and campus 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, fiber optic and copper connectors, specialty fiber optic and copper connectors, fiber optic and copper patch cords, pre-terminated fiber optic and copper cable assemblies, racks, cabinets, datacom enclosures, patch panels, face plates, multi-media 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 its role in establishing copper connectivity data communications standards through its innovative and patented technologies.

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 9001:2008 registered and MIL-STD-790F certified, our enterprise connectivity products at our Asheville facility which is ISO 9001:2008 registered, and our harsh environment and specialty connectivity products at our Dallas facility which is ISO 9001:2008 registered and MIL-STD-790F certified.

OCC designs, develops and manufactures fiber optic cables for a broad range of enterprise, harsh environment and 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 and other harsh environment 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.

Optical Cable Corporation owns 70% of the authorized membership interests of Centric Solutions LLC (“Centric Solutions”). Centric Solutions is a business founded in 2008 that provides turnkey cabling and connectivity solutions for the datacenter market. Centric Solutions operates and goes to market independently from Optical Cable Corporation; however, in some cases, Centric Solutions may offer products from OCC’s product offering. Centric Solutions’ facility lease expired November 30, 2015, subsequent to the end of OCC’s fiscal year 2015, and was not renewed. OCC has transitioned Centric Solutions’ business to OCC’s facility near Dallas, Texas.

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

Summary of Company Performance for Fiscal Year 2015

Results of Operations

We sell our products internationally and domestically through our sales force 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 less discounts, refunds and returns. Revenue is recognized at the time of product shipment or delivery to the customer (including distributors) provided that the customer takes ownership and assumes risk of loss (based on shipping terms), collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. 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 (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 expense, net consists of royalty and related expenses, net of royalty income earned, if any, on licenses associated with our patented products.

Amortization of intangible assets consists of the amortization of capitalized costs associated with internally developed patents that have been granted. Amortization of intangible assets in fiscal years 2014 and 2013 also included the amortization of intellectual property and customer list acquired in the acquisition of AOS. Both the intellectual property and customer list were fully amortized during fiscal year 2014. Amortization of intangible assets is calculated using the straight line method over the estimated useful lives of the intangible assets.

Other 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 consolidated statements of operations for the periods indicated:

Net Sales

Consolidated net sales for fiscal year 2015 were $73.6 million, a decrease of $9.4 million (or 11.3%) when compared to net sales of $83.0 million in fiscal year 2014, due to weakness in various specialty markets and volatility in the wireless carrier market. A consolidated net sales increase of more than 9% to approximately $39.0 million (excluding Centric Solutions) in OCC’s enterprise market was insufficient to overcome decreases in these other markets.

The decrease in net sales when comparing fiscal years 2015 and 2014 is due to the decrease in net sales of our fiber optic cable products in various specialty markets and our harsh environment and specialty connectivity products. The majority of the net sales decrease in fiscal year 2015 was attributable to large orders from one customer decreasing $6.0 million (or 42.9%) to $8.0 million, when compared to $14.0 million in orders from this customer in fiscal year 2014.

Additionally, OCC’s net sales were negatively impacted by a decrease in demand in the military, oil & gas, and mining specialty markets, during fiscal year 2015—markets experiencing macroeconomic weakness. Many of our products for these specialty markets require specific product and solution expertise and tend to generate higher gross profit margins. We are also seeing downward pressure on pricing in certain markets, particularly the wireless carrier market.

Net sales outside the U.S. were also negatively impacted by a strong U.S. dollar relative to other currencies, particularly in certain geographic regions. We also experienced unusual weakness in many of our markets at the end of fiscal year 2015 (and during the end of calendar 2015), impacting net sales during the fourth quarter of fiscal year 2015. Net sales during the fourth quarter typically are stronger due to historic seasonality.

The OCC team continues to look for opportunities to increase sales, to increase manufacturing efficiencies and to reduce costs during this period of weakness in certain of our markets. 

OCC’s net sales for fiscal year 2014 were $83.0 million—the second highest annual net sales in our history. Net sales increased 10.2% in fiscal year 2014 compared to $75.3 million in fiscal year 2013. The increase in net sales when comparing fiscal years 2014 and 2013 is due primarily to the increase in net sales of our fiber optic cable products. We recognized net sales totaling approximately $14.0 million in fiscal year 2014 as the result of a number of large orders for one customer, compared to net sales of approximately $4.5 million in fiscal year 2013 for that customer.

Net sales to customers outside of the United States were 22%, 21% and 30% of total net sales for fiscal years 2015, 2014 and 2013, respectively. Net sales to customers in the United States decreased 12.3% during fiscal year 2015 compared to fiscal year 2014, and net sales to customers outside of the United States decreased 7.7%. Net sales outside the U.S. continue to be negatively impacted by the strong U.S. dollar relative to other currencies.

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 cycles of our customers. However, this pattern may be substantially altered during any quarter or year, as was the case in the fiscal year 2015, by 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, 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.

Gross Profit

Gross profit decreased 23.4% to $21.8 million in fiscal year 2015 from $28.5 million in fiscal year 2014. Gross profit margin, or gross profit as a percentage of net sales, was 29.6% for fiscal year 2015, compared to 34.3% for fiscal year 2014. Gross profit was impacted by lower net sales in certain specialty industry markets which tend to have higher gross profit margins. Also impacting gross profit was the wireless carrier market, with pricing pressures and with volumes of hybrid cables (fiber and copper) with high copper content, which tend to have lower gross profit margins.

The OCC team implemented cost reductions near the end of fiscal year 2015 and during the first quarter of 2016, which we expect will positively impact cost of goods sold, gross profit and SG&A expenses later in fiscal year 2016. The cost reductions implemented include personnel cost reductions at the end of fiscal year 2015 expected to save approximately $1.0 million per year beginning in fiscal year 2016. Personnel cost reductions to date primarily are expected to positively impact cost of goods sold and gross profit.

Gross profit was $28.5 million in fiscal year 2014, a 9.9% increase from $25.9 million in fiscal year 2013. Gross profit margin was 34.3% for fiscal year 2014, compared to 34.4% for fiscal year 2013.

Net sales decreases in certain specialty markets and pricing pressures in certain markets, particularly the wireless carrier market, negatively impacted gross profits during fiscal year 2015, compared to fiscal year 2014. Additionally, our gross profit margin percentages are heavily dependent upon product mix on a quarterly basis and may vary based on changes in product mix. The lower gross profit margin in fiscal year 2015 when compared to fiscal year 2014 was primarily due to the sale of certain lower margin products that negatively impacted our gross profit margin.

The slightly lower gross profit margin in fiscal year 2014, when compared to fiscal year 2013, was primarily due to an increase in sales of certain products that negatively impacted our gross profit margin.

Selling, General and Administrative Expenses

SG&A expenses decreased $2.9 million (or 10.9%) to $24.0 million in fiscal year 2015 from $27.0 million in fiscal year 2014, consistent with our efforts to control and reduce costs. SG&A expenses as a percentage of net sales were 32.7% in fiscal year 2015, compared to 32.5% in fiscal year 2014.

The decrease in SG&A expenses during fiscal year 2015 compared to fiscal year 2014 was primarily due to decreased employee related costs, decreased legal and professional fees and decreased shipping costs. Compensation costs have decreased when comparing fiscal year 2015 to fiscal year 2014 due to the reorganization initiatives implemented during the latter part of fiscal year 2014 and decreases in commissions and employee incentives resulting from decreased net sales and the financial results during fiscal year 2015. Legal and professional fees decreased when comparing fiscal year 2015 to fiscal year 2014 due to atypically high legal and professional fees that occurred in fiscal year 2014 that were not expected to recur and that did not recur in fiscal year 2015. Shipping costs decreased due to the decrease in net sales.

The OCC team implemented cost reductions near the end of fiscal year 2015 and during the first quarter of 2016, which we expect will positively impact cost of goods sold, gross profit and SG&A expenses later in fiscal year 2016. The cost reductions implemented include personnel cost reductions at the end of fiscal year 2015 expected to save approximately $1.0 million per year beginning in fiscal year 2016. Personnel cost reductions to date primarily are expected to positively impact cost of goods sold and gross profit.

SG&A expenses increased to $27.0 million in fiscal year 2014 from $25.0 million in fiscal year 2013. SG&A expenses as a percentage of net sales decreased to 32.5% in fiscal year 2014, compared to 33.2% in fiscal year 2013.

The increase in SG&A expenses during fiscal year 2014 compared to fiscal year 2013 was primarily due to increased legal and professional fees, reorganization initiatives and employee related costs. Compensation costs increased in fiscal year 2014 when compared to fiscal year 2013 largely as a result of increases in commissions and employee incentives due to increased net sales during fiscal year 2014.

Royalty Expense, Net

We recognized royalty expense, net of royalty income, totaling $124,000 during fiscal year 2015, compared to $110,000 during fiscal year 2014. We expect the trend of royalty expense largely or completely offsetting royalty income to continue in fiscal year 2016 as a result of the decline in royalty income due to the expiration of patents for licensed products.

We recognized royalty expense, net of royalty income, totaling $110,000 during fiscal year 2014, compared to $79,000 during fiscal year 2013.

Amortization of Intangible Assets

We recognized $11,000 of amortization expense, associated with intangible assets, during fiscal year 2015, compared to amortization expense of $41,000 during fiscal year 2014. The decrease in amortization expense when comparing the two fiscal years is primarily due to the fact that intangible assets, acquired in connection with the acquisition of AOS in 2009, were fully amortized during fiscal year 2014.

We recognized $41,000 of amortization expense, associated with intangible assets, during fiscal year 2014, compared to amortization expense of $70,000 during fiscal year 2013.

Other Expense, Net

We recognized other expense, net of $433,000 in fiscal year 2015 compared to $442,000 in fiscal year 2014. Other expense, net for fiscal year 2015 is comprised of: interest expense totaling $440,000 related primarily to monies borrowed in connection with the acquisition of SMP Data Communications in fiscal year 2008, borrowings under our revolving credit facility, and other interest incurred in the normal course of business; and other miscellaneous items which may fluctuate from period to period.

We recognized other expense, net of $442,000 in fiscal year 2014 compared to $492,000 in fiscal year 2013. Other expense, net for fiscal year 2014 is comprised of: interest expense totaling $414,000 related primarily to monies borrowed in connection with the acquisition of SMP Data Communications in fiscal year 2008, borrowings under our revolving credit facility, and other interest incurred in the normal course of business; and other miscellaneous items which may fluctuate from period to period.

Income (Loss) Before Income Taxes

We reported a loss before income taxes of $2.8 million for fiscal year 2015 compared to income before income taxes of $891,000 for fiscal year 2014. This change was primarily due to the decrease in gross profit of $6.7 million in fiscal year 2015 compared to fiscal year 2014, partially offset by the decrease in SG&A expenses of $2.9 million, compared to fiscal year 2014.

We reported income before income taxes of $891,000 for fiscal year 2014 compared to $275,000 for fiscal year 2013. This increase was primarily due to the increase in gross profit of $2.6 million in fiscal year 2014 compared to fiscal year 2013, partially offset by the increase in SG&A expenses of $2.0 million, compared to fiscal year 2013.

Income Tax Expense

Income tax expense totaled $1.5 million for fiscal year 2015, compared to $268,000 for fiscal year 2014. Our effective tax rate was negative 52.7% in fiscal year 2015, compared to 30.0% in fiscal year 2014.

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. 

Our effective tax rate for fiscal year 2015 was significantly impacted by the establishment of a $2.4 million valuation allowance against all of our net deferred tax assets, which is a non-cash charge that increased our net loss attributable to OCC for fiscal year 2015 by $2.4 million, or $0.39 per share. See Note 12 to the Consolidated Financial Statements.

Generally, net deferred tax assets arise from temporary differences between amounts recognized for purposes of U.S. generally accepted accounting principles (“U.S. GAAP”) and amounts recognized for tax purposes that result in deductible amounts in future years based on provisions of the tax law. For example, net deferred tax assets can arise from allowances for doubtful accounts (not currently deducted for income tax purposes), allowances against inventory for damaged or slow moving items (not currently deducted for income tax purposes), net operating loss carryforwards (not useable in the current period to reduce income taxes), and similar items from which we might expect to realize a future tax benefit.

U.S. GAAP requires us to evaluate whether it is “more likely than not” that we will be unable to realize the future benefits of our net deferred tax assets. The amount of our loss before income taxes in fiscal year 2015 exceeds our income before taxes during the last two fiscal years. Under U.S. GAAP, this is significant negative evidence—quite difficult to overcome—that leads us to conclude that it is “more likely than not” that we will be unable to realize the future benefits of our net deferred tax assets in the coming years. We have not been able to overcome this conclusion under U.S. GAAP with the required objectively verifiable positive evidence.

While we believe that ultimately we will utilize the benefit of our net deferred tax assets in the future (prior to any expiration of the usability of such deferred tax assets for income tax purposes), we have concluded as a result of our cumulative loss position and insufficient objectively verifiable positive evidence, it is appropriate under U.S. GAAP for us to establish a full valuation allowance against net deferred tax assets as of October 31, 2015.

As a result of establishing a full valuation allowance against our net deferred tax assets, if we generate sufficient taxable income in future 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. Furthermore, if we generate losses before taxes in future 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 future 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 our net income attributable to OCC and will also increase the net deferred tax asset on our consolidated balance sheet. If we do not generate sufficient income before taxes in future 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 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.

See also “Critical Accounting Policies” below and Note 12 to the Consolidated Financial Statements.

Income tax expense totaled $268,000 for fiscal year 2014, compared to $348,000 for fiscal year 2013. Our effective tax rate was 30.0% in fiscal year 2014, compared to 126.3% in fiscal year 2013. During fiscal year 2013, our effective tax rate was negatively impacted by both the disproportionate share of our combined permanent differences relative to pretax income and the impact of the loss of a portion of the permanent domestic manufacturing deductions taken by us in fiscal years 2011 and 2012, resulting from the anticipated carryback of our fiscal year 2013 net operating loss.

Net Income (Loss)

Net loss attributable to OCC for fiscal year 2015 was $4.3 million compared to net income attributable to OCC of $684,000 for fiscal year 2014. This change was primarily due to the decrease in income before income taxes of $3.7 million and the increase in income tax expense of $1.2 million in fiscal year 2015 compared to fiscal year 2014.

Net loss attributable to OCC for fiscal year 2015 was increased by $2.4 million, or $0.39 per share, due to a non-cash charge of $2.4 million to income tax expense to reflect the establishment of a $2.4 million valuation allowance against net deferred tax assets. See disclosures under “Income Tax Expense” above.

Net income attributable to OCC for fiscal year 2014 was $684,000 compared to a net loss attributable to OCC of $43,000 for fiscal year 2013. This change was primarily due to the increase in income before income taxes of $615,000 for fiscal year 2014 compared to fiscal year 2013.

Financial Condition

Total assets decreased $5.0 million, or 10.0%, to $45.0 million at October 31, 2015, from $50.0 million at October 31, 2014. This decrease is primarily due to a $4.9 million decrease in trade accounts receivable, net and a $2.3 million decrease in deferred tax assets. Trade accounts receivable, net decreased largely as a result of the decrease in net sales in the fourth quarter of fiscal year 2015 when compared to the fourth quarter of fiscal year 2014. Deferred tax assets decreased due to the establishment of a $2.4 million valuation allowance against net deferred tax assets, resulting in a non-cash $2.4 million increase in net loss attributable to OCC. See disclosures under “Income Tax Expense” above.

Total liabilities decreased $592,000, or 3.0%, to $19.1 million at October 31, 2015, from $19.7 million at October 31, 2014. The decrease in total liabilities was primarily due to a $3.0 million decrease in accounts payable and accrued expenses, including accrued compensation and payroll taxes and a $676,000 decrease in income taxes payable, partially offset by a $3.5 million increase in note payable to bank under our revolving credit facility. Accounts payable and accrued expenses, including accrued compensation and payroll taxes, decreased primarily due to the timing of payments related to certain raw material purchases when comparing the two periods and the timing of certain vendor and payroll related payments. The balance on our revolving credit facility has increased primarily as the result of investments in new manufacturing equipment at our fiber optic cable production facility.

Total shareholders’ equity attributable to OCC at October 31, 2015 decreased $4.4 million, or 14.1%, during fiscal year 2015. The decrease resulted primarily from a net loss attributable to OCC of $4.3 million (which includes a non-cash charge of $2.4 million related to the establishment of a valuation allowance against the full value of our net deferred tax assets), dividends declared of $560,000 and the repurchase and retirement of 80,636 shares of our common stock for $380,000, partially offset by share-based compensation, net of $819,000.

Liquidity and Capital Resources

Our primary capital needs during fiscal year 2015 have been to fund working capital requirements and capital expenditures. Our primary source of capital for these purposes has been existing cash, borrowings under our revolving credit facility and cash provided by operations. As of October 31, 2015 and 2014, we had an outstanding loan balance under our revolving credit facility totaling $6.0 million and $2.5 million, respectively. As of October 31, 2015 and 2014, we had outstanding loan balances, excluding our revolving credit facility, totaling $7.2 million and $7.5 million, respectively. We have not borrowed any funds under our revolving credit facility since August 2015.

Our cash totaled $1.1 million as of October 31, 2015 and 2014. Net cash provided by operating activities of $1.2 million and net cash provided by financing activities of $2.0 million were offset by capital expenditures totaling $3.1 million.

On October 31, 2015, we had working capital of $23.5 million, compared to $26.1 million as of October 31, 2014. The ratio of current assets to current liabilities as of October 31, 2015, was 5.2 to 1 compared to 3.8 to 1 as of October 31, 2014. The decrease in working capital as of October 31, 2015 compared to October 31, 2014 was primarily due to the $4.9 million decrease in trade accounts receivable, net and the $1.9 million decrease in deferred tax assets - current, partially offset by the $3.0 million decrease in accounts payable and accrued expenses, including accrued compensation and payroll taxes. The improved ratio of current assets to current liabilities as of October 31, 2015 compared to October 31, 2014 was due to the fact that current assets decreased 17.6% while current liabilities decreased 39.3%.

Net Cash

Net cash provided by operating activities was $1.2 million in fiscal year 2015 compared to $4.4 million in fiscal year 2014, and $3.5 million in fiscal year 2013.

Net cash provided by operating activities during fiscal year 2015 primarily resulted from certain adjustments to reconcile a net loss of $4.3 million to net cash provided by operating activities including depreciation, amortization and accretion of $2.1 million and share-based compensation expense of $1.1 million. Additionally, the cash flow impact of decreases in trade accounts receivable, net of $4.9 million 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, of $3.4 million.

Net cash provided by operating activities during fiscal year 2014 primarily resulted from net income of $623,000 and certain adjustments to reconcile net income to net cash provided by operating activities, including depreciation, amortization and accretion of $2.0 million, and share-based compensation expense of $957,000. Additionally, the cash flow impact of increases in accounts payable and accrued expenses, including accrued compensation and payroll taxes, of $3.8 million, and the decrease in inventories of $716,000 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 increases in trade accounts receivable, net of $4.1 million.

Net cash provided by operating activities during fiscal year 2013 primarily resulted from certain adjustments to reconcile a net loss of $72,000 to net cash provided by operating activities, including depreciation, amortization and accretion of $2.1 million, and share-based compensation expense of $971,000. Additionally, the cash flow impact of decreases in trade accounts receivable, net of $2.6 million 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, of $3.0 million.

Net cash used in investing activities totaled $3.2 million in fiscal year 2015 compared to $3.0 million in fiscal year 2014 and $3.1 million in fiscal year 2013. Net cash used in investing activities during fiscal years 2015, 2014 and 2013 resulted primarily from the purchase of property and equipment and deposits for the purchase of property and equipment.

Net cash provided by financing activities totaled $2.0 million in fiscal year 2015, compared to net cash used in financing activities totaling $1.1 million in fiscal year 2014 and $173,000 in fiscal year 2013. Net cash provided by financing activities in fiscal year 2015 resulted primarily from proceeds from a note payable to our bank under our line of credit, net of repayments, of $3.5 million, partially offset by the $556,000 payment of dividends previously declared and the repurchase and retirement of 80,636 shares of our common stock for $380,000. Net cash used in financing activities in fiscal year 2014 resulted primarily from the $540,000 payment of dividends previously declared, principal payments on our long-term debt of $259,000 and the repurchase and retirement of 44,464 shares of our common stock for $195,000. Net cash used in financing activities in fiscal year 2013 resulted primarily from the repurchase and retirement of 129,500 shares of our common stock for $543,000 and the $479,000 payment of dividends previously declared, partially offset by proceeds from a note payable to our bank under our line of credit, net of repayments, of $1.5 million.

We have a 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. We anticipate that the purchases will be made over a 24- to 36-month period, but there is no definite time period for repurchase. As of October 31, 2015, we had 398,400 shares remaining to purchase under this plan.

As of the date hereof, we have suspended purchases under our share repurchase plan given current business conditions. At this time, we believe this suspension will be temporary and we will evaluate resuming the share repurchase plan as appropriate.

Credit Facilities

We have credit facilities consisting of a real estate term loan, as amended (the “Virginia Real Estate Loan”), a supplemental real estate term loan, as amended (the “North Carolina Real Estate Loan”) and a revolving credit facility, as amended (the “Commercial Loan”).

Both the Virginia Real Estate Loan and the North Carolina Real Estate Loan are with BNC Bancorp, as successor to Valley Bank (“BNC”), have a fixed interest rate of 4.25% and are secured by a first priority lien on all of our personal property and assets, except for our inventory, accounts, general intangibles, deposit accounts, instruments, investment property, letter of credit rights, commercial tort claims, documents and chattel paper, as well as a first lien deed of trust on the Company’s real property.

The Commercial Loan with SunTrust Bank (“SunTrust”) provides us with a revolving line of credit for the working capital needs of the Company. Under the terms of the Commercial Loan, we may borrow an aggregate principal amount at any one time outstanding not to exceed the lesser of (i) $9.0 million, or (ii) the sum of 85% of certain receivables aged 90 days or less plus 35% of the lesser of $1.0 million or certain foreign receivables plus 25% of certain raw materials inventory.

On May 7, 2015, we entered into a commercial note of renewal (“Binding Letter of Renewal”) extending the maturity date of the Commercial Loan to August 31, 2017. The Binding Letter of Renewal extends the maturity date of the Commercial Loan. All other terms of the Commercial Loan remain unaltered and remain in full force and effect. Within the revolving loan limit of the Commercial Loan and Binding Letter of Renewal, we may borrow, repay, and reborrow, at any time until August 31, 2017. We also entered into an Amended and Restated Security Agreement dated May 7, 2015 which is substantially similar in all material aspects to, and replaces in its entirety, the original Security Agreement dated April 30, 2010.

Advances under the Commercial Loan accrue interest at LIBOR plus 2.2% (resulting in a 2.39% rate at October 31, 2015). Accrued interest on the outstanding principal balance is due on the first day of each month, with all then outstanding principal, interest, fees and costs due at the Commercial Loan maturity of August 31, 2017.

The Commercial Loan is secured by a first priority lien on all of our inventory, accounts, general intangibles, deposit accounts, instruments, investment property, letter of credit rights, commercial tort claims, documents and chattel paper.

The terms of our credit facilities with both SunTrust and BNC require us to comply, on a quarterly basis, with specific financial covenants including a debt service coverage ratio. We are required to maintain a debt service coverage ratio of not less than 1.5 to 1.0. The ratio is calculated by dividing adjusted EBITDA, as defined in the loan agreements, by current maturities of long-term debt plus consolidated interest expense. As of October 31, 2015, we had a debt service coverage ratio of 1.08, and therefore, we were not in compliance with the debt service coverage ratio covenant under our credit facilities.

Subsequent to our fiscal year end, we entered into (i) a Modification of Commercial Note and Agreement to Commercial Note and (ii) a Second Amended and Restated Security Agreement (collectively, the “Commercial Loan Modification”) with SunTrust, as of January 25, 2016, and we entered into a Seventh Loan Modification Agreement (the “Real Estate Loan Modification”) with BNC, dated as of January 25, 2016.

The Commercial Loan Modification and the Real Estate Loan Modification (together, the “Loan Modifications”) both provide a waiver of non-compliance of the debt service coverage ratio covenant for both the quarter ended October 31, 2015 and the quarter ending January 31, 2016. Further, the debt service coverage covenant has been temporarily modified to an interest coverage covenant, as defined in the Loan Modifications, with a ratio of 1.25 to 1.00 for the quarter ending April 30, 2016, increasing to 1.50 to 1.00 for the quarters ending July 31, 2016 and October 31, 2016.

Pursuant to the Commercial Loan Modification with SunTrust, we agreed to an increase in the interest rate on advances under the Commercial Loan from LIBOR plus 2.2% to LIBOR plus 2.75%, effective January 25, 2016, and a covenant waiver fee of $25,000. Additionally, the Commercial Loan Modification limits certain capital expenditures and additional indebtedness, if any, and has placed certain limits on dividend payments and stock repurchases, in each case as defined in the Commercial Loan Modification.

Pursuant to the Real Estate Loan Modification with BNC, we agreed to a covenant waiver fee of $10,000. Additionally, the Real Estate Loan Modification has similar limits on capital expenditures, as defined in the Real Estate Loan Modification, to those limits set forth in the Commercial Loan Modification with SunTrust.

As of October 31, 2015, we had $6.0 million of outstanding borrowings on our Commercial Loan and approximately $2.6 million in available credit.

Capital Expenditures

During the year ended October 31, 2015, we invested approximately $2.9 million to add new manufacturing equipment at our fiber optic cable production facility to further expand the breadth of our production capabilities and to support anticipated increased demand for our fiber optic cable products. As of October 31, 2015, we have committed approximately $500,000 to further support these efforts. We did not have any other material commitments for capital expenditures as of October 31, 2015. During our 2015 fiscal year budgeting process, we included an estimate for capital expenditures for the year of $5.5 million. We incurred capital expenditures totaling $3.1 million for items including new manufacturing equipment, improvements to existing manufacturing equipment, new information technology equipment and software, upgrades to existing information technology equipment and software, furniture and other capitalizable expenditures for property, plant and equipment for fiscal year 2015.

During our 2016 fiscal year budgeting process, we included an estimate for capital expenditures of $1.8 million for the year, including commitments as of October 31, 2015. Any capital expenditures will be funded out of our working capital, cash provided by operations or borrowings under our credit facilities, as appropriate. This amount includes estimates for capital expenditures for similar types of items as those purchased in fiscal year 2015. 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 are considered outside of our annual capital expenditure budgeting process.

Future Cash Flow Considerations

We believe that our 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

Historically, net sales are relatively lower in the first half of each fiscal year and relatively higher in the second half of each fiscal year, which we believe may be partially due to construction cycles and budgetary considerations of our customers. For example, our trend for the last three fiscal years has been that an average of approximately 49%, 44% and 48% of our net sales occurred during the first half of fiscal years 2015, 2014 and 2013, respectively, and an average of approximately 51%, 56% and 52% of our net sales occurred during the second half of fiscal years 2015, 2014 and 2013, respectively. We believe net sales may not follow this pattern in periods when overall economic conditions in the industry and/or in the world are atypical.

As a result, 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 cycles of our customers. However, this pattern may be substantially altered during any quarter or year, as was the case in the fourth quarter of fiscal year 2015, by the timing of larger projects, timing of orders from larger customers, other economic factors impacting our industry or impacting the industries of our customer and end-users and macroeconomic conditions. While we believe seasonality may be a factor that impacts our quarterly net sales results, 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.

Critical Accounting Policies and Estimates

Our discussion and analysis of financial condition and results of operations is based on the consolidated financial statements and accompanying notes which have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). The preparation of these 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.