NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
Note 1 – Unaudited interim condensed consolidated
financial statements
Our accompanying unaudited condensed consolidated
financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America
for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information
and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.
In the opinion of management, all adjustments, which are normal and recurring, have been included in order to make the information
not misleading. Information included in the consolidated balance sheet as of October 31, 2019 has been derived from, and certain
terms used herein are defined in, the audited consolidated financial statements of RF Industries, Ltd. as of October 31, 2019 included
in our Annual Report on Form 10-K (“Form 10-K”) for the year ended October 31, 2019 that was previously filed with
the Securities and Exchange Commission (“SEC”). Operating results for the three months ended January 31, 2020 are not
necessarily indicative of the results that may be expected for the year ending October 31, 2020. The unaudited condensed consolidated
financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in
our Annual Report on Form 10-K for the year ended October 31, 2019.
Principles of consolidation
The accompanying unaudited condensed
consolidated financial statements include the accounts of RF Industries, Ltd. and our four wholly-owned subsidiaries, Cables
Unlimited, Inc. (“Cables Unlimited”), Rel-Tech Electronics, Inc. (“Rel-Tech”), C Enterprises, Inc.
(“C Enterprises”), and Schroff Technologies International, Inc. (“Schrofftech”). C Enterprises is a
wholly-owned subsidiary that RF Industries, Ltd. acquired effective March 15, 2019. For periods on or before January 31,
2019, references herein to the “Company” shall refer to RF Industries, Ltd., Cables Unlimited, and Rel-Tech, and
periods between January 31, 2019 and October 31, 2019, references to the “Company” shall refer to RF Industries,
Ltd., Cables Unlimited, Rel-Tech, and C Enterprises. Schrofftech is a wholly-owned subsidiary that RF Industries, Ltd.
acquired effective November 1, 2019. For periods after October 31, 2019, references to the “Company” shall refer
to RF Industries, Ltd., Cables Unlimited, Rel-Tech, C Enterprises, and Schrofftech. All intercompany balances and
transactions have been eliminated in consolidation.
Fair value measurement
We measure at fair
value certain financial assets and liabilities. Fair value is defined as the price that would be received to sell an asset or transfer
a liability in an orderly transaction between market participants at the measurement date. U.S. GAAP specifies a hierarchy of valuation
techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect
market data obtained from independent sources, while unobservable inputs reflect our market assumptions. These two types of inputs
have created the following fair-value hierarchy:
Level 1 –
Quoted prices for identical instruments in active markets;
Level 2 –
Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are
not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active
markets; and
Level 3 –
Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
As of January 31, 2020 and October 31, 2019,
the carrying amounts reflected in the accompanying condensed consolidated balance sheets for cash and cash equivalents, accounts
receivable, and accounts payable approximated their carrying value due to their short-term nature. See Note 5 for discussion on
the fair value of other long-term liabilities.
Revenue recognition
In accordance with Accounting Standards
Update ASU No. 2014-09, Revenue from Contacts with Customers (Topic 606) (“ASC 606”), we recognize revenue in an amount
that reflects the consideration to which we expect to be entitled in exchange for goods or services promised to customers. We follow
a five-step model to: (1) identify the contract with our customer; (2) identify our performance obligations in our contract; (3)
determine the transaction price for our contract; (4) allocate the transaction price to our performance obligations; and (5) recognize
revenue when (or as) each performance obligation is satisfied. In accordance with this accounting principle, we recognize revenue
using the output method at a point in time when finished goods have been transferred to the customer and there are no other obligations
to customers after the title of the goods have transferred. Title of goods are transferred based on shipping terms for each customer
– for shipments with terms of FOB Shipping Point, title is transferred upon shipment; for shipments with terms of FOB Destination,
title is transferred upon delivery.
Leases
In accordance with ASU No. 2016-02,
Leases, we determine if an arrangement is a lease at inception. Operating leases are included in our consolidated balance
sheet as operating lease right of use (“ROU”) assets, other current liabilities, and operating lease
liabilities. Finance leases are included in finance ROU assets, other current liabilities, and finance lease liabilities on
our consolidated balance sheet. ROU assets represent our right to use an underlying asset for the duration of the lease term,
and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and
liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of
our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at
commencement date in determining the present value of lease payments. The operating lease ROU asset also includes any lease
payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is
reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis
over the lease term and is recognized on the consolidated statements of operations.
Recent accounting standards
Recently issued
accounting pronouncements not yet adopted:
In January 2017, the FASB issued ASU No.
2017-04, Intangibles-Goodwill and Other, which simplifies the accounting for goodwill impairments by eliminating step 2 from the
goodwill impairment test. Instead, if “the carrying amount of a reporting unit exceeds its fair value, an impairment loss
shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.”
The guidance is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted. We are currently evaluating
the impact the adoption of this new standard will have on our consolidated financial statements.
In June 2016, the FASB issued ASU
2016-13, Financial Instruments—Credit Losses, which requires a financial asset (or a group of financial assets)
measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses
is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying
value at the amount expected to be collected on the financial asset. The guidance is effective for fiscal years beginning
after December 15, 2019. Early adoption is permitted. We are currently evaluating the impact the adoption of this new
standard will have on our consolidated financial statements.
Recently issued accounting pronouncements
adopted:
In February 2016, the FASB issued ASU No.
2016-02, Leases. This ASU requires lessees to recognize lease assets and lease liabilities for those leases classified as operating
leases under the current GAAP. Under ASU 2016-02, lessees and lessors are required to recognize and measure leases at the beginning
of the earliest period presented using a modified retrospective approach, which includes a number of optional practical expedients.
We adopted the standard as of November 1, 2019, the beginning of our fiscal 2020, applying the modified retrospective method.
We elected the package of practical expedients permitted under the transition guidance with the new standard, which among other
things, allows us to carryforward the historical lease classification. We elected the policy which allows us to combine the nonlease
components with its related lease components rather than separating, and the policy election to keep leases with an initial term
of 12 months or less off of the balance sheet. We have recognized those lease payments in the consolidated statements of operations
on a straight-line basis over the lease term. The adoption of the standard resulted in a material recognition of additional right
of use assets and lease liabilities of approximately $2.3 million and $2.4 million, respectively, as of November 1, 2019, but
did not materially affect our consolidated net income.
In May 2014, the FASB issued ASC 606, which
superseded Topic 605, Revenue Recognition, in addition to other industry-specific guidance. The new standard requires a company
to recognize revenue in a manner that depicts the transfer of promised goods or services to customers in an amount that reflects
the consideration to which the company expects to be entitled in exchange for those goods and services. In August 2015,
the FASB issued ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, as a revision to ASU 2014-09,
which revised the effective date to fiscal years, and interim periods within those years, beginning after December 15, 2017. Early
adoption is permitted but not prior to periods beginning after December 15, 2016 (i.e., the original adoption date per ASU 2014-09).
In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations, which
clarifies certain aspects of the principal-versus-agent guidance, including how an entity should identify the unit of accounting
for the principal versus agent evaluation and how it should apply the control principle to certain types of arrangements, such
as service transactions. The amendments also reframe the indicators to focus on evidence that an entity is acting as a principal
rather than as an agent. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance
Obligations and Licensing, which clarifies how an entity should evaluate the nature of its promise in granting a license of intellectual
property, which will determine whether it recognizes revenue over time or at a point in time. The amendments also clarify when
a promised good or service is separately identifiable (i.e., distinct within the context of the contract) and allow entities to
disregard items that are immaterial in the context of a contract. On November 1, 2018, we adopted ASC 606 applying the modified
retrospective method. We performed a review of ASC 606 as compared to our previous accounting policies for product revenue and
did not identify any material impact to revenue. Therefore, there was no adjustment to retained earnings for a cumulative effect.
Note 2 – Business Acquisition
C Enterprises, Inc.
On March 15, 2019, through C Enterprises,
Inc. (“C Enterprises”), its newly formed subsidiary, we purchased the business and assets of C Enterprises L.P., a
California based designer and manufacturer of quality connectivity solutions to telecommunications and data communications distributors.
In consideration for the C Enterprises business and assets, we paid $600,000 in cash and assumed certain liabilities. The acquisition
was determined not to be material and was accounted for in accordance with the acquisition method of accounting. The acquired assets
and assumed liabilities were recorded at their estimated fair values in accordance with ASC 805, Business Combinations. There were
no intangible assets identified as part of the acquisition.
The results of C Enterprises’ operations
subsequent to March 15, 2019 have been included in the results of the Custom Cabling Manufacturing and Assembly segment (“Custom
Cabling segment”) as well as in the consolidated statements of operations. Costs related to the acquisition of C Enterprises
were approximately $100,000 and have been expensed as incurred and categorized in selling and general expenses.
The following table summarizes the components
of the purchase price at fair value at March 15, 2019:
Cash consideration paid
|
|
$
|
600,000
|
|
Total purchase price
|
|
$
|
600,000
|
|
The following table summarizes the allocation
of the estimated purchase price at fair value at March 15, 2019:
Current assets
|
|
$
|
2,008,000
|
|
Fixed assets
|
|
|
30,000
|
|
Other assets
|
|
|
18,000
|
|
Non-interest bearing liabilities
|
|
|
(1,456,000
|
)
|
Net assets
|
|
$
|
600,000
|
|
Schroff Technologies International, Inc.
On November 4, 2019, we purchased the business
of Schroff Technologies International, Inc. (“Schrofftech”), a Rhode Island-based manufacturer and marketer of
intelligent thermal control systems used by telecommunications companies across the U.S. and Canada, and shrouds for small cell
integration and installation. At the closing, in consideration for the Schrofftech business, we paid the sellers $4 million in
cash, and, if certain financial targets are met by Schrofftech over a two-year period, agreed to pay additional cash earn-out payments
of up to $2.4 million.
The acquisition was accounted for as an
acquisition of assets in accordance with the acquisition method of accounting. The acquired assets and assumed liabilities have
been recorded at their estimated preliminary fair values. We determined the estimated preliminary fair values with the assistance
of appraisals or valuations performed by an independent third-party specialist. We expect to complete the valuation of the net
assets in the second quarter of fiscal 2020. Schrofftech serves the high growth wireless, telecom and cable markets. All manufacturing
operations are performed at Schrofftech’s facilities in Rhode Island. The Schrofftech business allows us to diversify the
types of services provided for our customers in the cable industry.
Although the closing occurred on November
4, 2019, the acquisition of Schrofftech is deemed to have become effective for financial accounting purposes as of November 1,
2019. Accordingly, Schrofftech’s financial results have been included in the results of the Custom Cabling segment for the
three months ended January 31, 2020 as well as in the consolidated statements of operations. Total costs related to the acquisition
of Schrofftech were approximately $136,000, of which $108,000 was incurred in fiscal 2019 and $28,000 was incurred in the three
months ended January 31, 2020. All acquisition-related costs have been expensed as incurred and categorized in selling and general
expenses. For the three months ended January 31, 2020, Schrofftech contributed revenue and pretax income of $1.1 million and $83,000,
respectively.
The following table summarizes the components
of the purchase price at preliminary fair values at November 1, 2019:
Cash consideration paid
|
|
$
|
4,000,000
|
|
Earn-out
|
|
|
1,249,000
|
|
Total purchase price
|
|
$
|
5,249,000
|
|
The following table summarizes the allocation
of the estimated preliminary purchase price at fair value at November 1, 2019:
Current assets
|
|
$
|
1,168,000
|
|
Fixed assets
|
|
|
58,000
|
|
Intangible assets
|
|
|
3,299,000
|
|
Goodwill
|
|
|
1,413,000
|
|
Non-interest bearing liabilities
|
|
|
(689,000
|
)
|
Net assets
|
|
$
|
5,249,000
|
|
The following unaudited pro forma financial
information presents the combined operating results of the Company, C Enterprises, and Schrofftech as if both acquisitions had
occurred as of the beginning of the earliest period presented. Pro forma data is subject to various assumptions and estimates and
is presented for informational purposes only. This pro forma data does not purport to represent or be indicative of the consolidated
operating results that would have been reported had the transaction been completed as described herein, and the data should not
be taken as indicative of future consolidated operating results.
Unaudited pro forma financial information
assuming the acquisition of C Enterprises and Schrofftech as of November 1, 2018 is presented in the following table:
|
|
Three
Months Ended January 31,
|
|
|
|
2020
|
|
|
2019
|
|
Revenue
|
|
$
|
12,414
|
|
|
$
|
16,199
|
|
Net income
|
|
|
26
|
|
|
|
1,388
|
|
|
|
|
|
|
|
|
|
|
Earnings per share
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.00
|
|
|
$
|
0.15
|
|
Diluted
|
|
$
|
0.00
|
|
|
$
|
0.14
|
|
Note 3 – Inventories and major vendors
Inventories, consisting of materials, labor
and manufacturing overhead, are stated at the lower of cost or net realizable value. Cost has been determined using the weighted
average cost method. Inventories consist of the following (in thousands):
|
|
January 31, 2020
|
|
|
October 31, 2019
|
|
Raw materials and supplies
|
|
$
|
3,949
|
|
|
$
|
3,576
|
|
Work in process
|
|
|
489
|
|
|
|
791
|
|
Finished goods
|
|
|
3,952
|
|
|
|
3,878
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
8,390
|
|
|
$
|
8,245
|
|
No vendors accounted for more than 10% of
inventory purchases for the three months ended January 31, 2020. For the three months ended January 31, 2019, two vendors each
accounted for 17% of inventory purchases. We have arrangements with these vendors to purchase products based on purchase orders
that we periodically issue.
Note 4 – Other current assets
Other current assets consist of the following
(in thousands):
|
|
January 31, 2020
|
|
|
October 31, 2019
|
|
Prepaid taxes
|
|
$
|
65
|
|
|
$
|
-
|
|
Prepaid expense
|
|
|
523
|
|
|
|
346
|
|
Other
|
|
|
133
|
|
|
|
339
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
721
|
|
|
$
|
685
|
|
Note 5 – Accrued expenses and other long-term liabilities
Accrued expenses consist
of the following (in thousands):
|
|
January 31, 2020
|
|
|
October 31, 2019
|
|
Wages payable
|
|
$
|
1,176
|
|
|
$
|
1,591
|
|
Accrued receipts
|
|
|
1,068
|
|
|
|
1,683
|
|
Warranty liability
|
|
|
200
|
|
|
|
-
|
|
Deferred revenue
|
|
|
404
|
|
|
|
-
|
|
Other accrued expenses
|
|
|
463
|
|
|
|
379
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
3,311
|
|
|
$
|
3,653
|
|
Accrued receipts represent purchased
inventory for which invoices have not been received.
We recognize an accrued warranty liability
for the estimated claims to remedy potential deficiencies of quality or performance of our products in the Schrofftech division
within the Custom Cabling segment. The product warranties extend over various periods, depending upon the product subject to the
warranty. We record a provision for estimated future warranty claims based upon the historical relationship of warranty claims
to sales, any specifically identified warranty issues and current trends and knowledge. We base our estimates in part on historical
experience and on assumptions that are believed to be reasonable under the circumstances and revise our estimates, as appropriate,
when events or changes in circumstances indicate that revisions may be necessary. Although these estimates are based on management’s
knowledge of and experience with past and current events and on management’s assumptions about future events, it is reasonably
possible that they may ultimately differ materially from actual results, including in the case of a significant product failure.
Warranty related expenses have not been material and were not material for the period ended January 31, 2020. Warranty liabilities
were $200,000 as of January 31, 2020.
The purchase agreement for the Schrofftech
acquisition provides for earn-out payments of up to $2,400,000, which is earned through October 31, 2022 and payable on October
31, 2022. The initial earn-out liability was valued at its fair value using an option pricing based approach with a risk-neutral
framework using Black Scholes due to the option-like nature of the earn-out payout structure. The earn-out was and will continue
to be revalued quarterly using a present value approach and any resulting increase or decrease will be recorded into selling and
general expenses. Any changes in the amount of the actual results and forecasted scenarios could impact the fair value. Significant
judgment is employed in determining the appropriateness of the assumptions used in calculating the fair value of the earn-out as
of the acquisition date. Accordingly, significant variances between actual and forecasted results or changes in the assumptions
can materially impact the amount of contingent consideration expense we record in future periods.
The contingent consideration liability
represents future earn-out liability that we may be required to pay in conjunction with the acquisition of Schrofftech. We
estimate the fair value of the earn-out liability using an option pricing based approach with a risk-neutral framework
using Black Scholes related to Schrofftech calculated at net present value (level 3 of the fair value hierarchy).
The following table summarizes our financial
assets and liabilities measured at fair value on a recurring basis as of January 31, 2020 (in thousands):
Description
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Earn-out liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,215
|
|
There were no financial assets or liabilities measured at fair value as of October 31, 2019.
The following table summarizes the Level 3 transactions
for the three months ended January 31, 2020:
|
|
Level 3
|
|
|
|
January 31, 2020
|
|
|
October 31, 2019
|
|
Beginning balance
|
|
$
|
1,249
|
|
|
$
|
-
|
|
Payments
|
|
|
-
|
|
|
|
-
|
|
Change in value
|
|
|
(34
|
)
|
|
|
-
|
|
Ending Balance
|
|
$
|
1,215
|
|
|
$
|
-
|
|
As of January 31, 2020, the full amount
of the $1.2 million earn-out was classified as other long-term liabilities.
Note 6 – Earnings per share
Basic earnings per share is computed by
dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is
computed by dividing net income by the weighted average number of common shares outstanding increased by the effects of assuming
that other potentially dilutive securities (such as stock options) outstanding during the period had been exercised and the treasury
stock method had been applied. Potentially issuable securities totaling 392,838 and 93,000 shares for the three months ended January
31, 2020 and 2019, respectively, were excluded from the calculation of diluted per share amounts because of their anti-dilutive
effect.
The following table summarizes the computation
of basic and diluted weighted average shares outstanding:
|
|
Three Months Ended January 31,
|
|
|
|
2020
|
|
|
2019
|
|
Weighted average shares outstanding for basic earnings per share
|
|
|
9,564,533
|
|
|
|
9,309,454
|
|
|
|
|
|
|
|
|
|
|
Add effects of potentially dilutive securities-assumed exercise of stock options
|
|
|
308,803
|
|
|
|
528,700
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding for diluted earnings per share
|
|
|
9,873,336
|
|
|
|
9,838,154
|
|
|
|
|
|
|
|
|
|
|
Note 7 – Stock-based compensation and equity transactions
On December 3, 2018, two employees were
each granted 25,000 incentive stock options. These options vested 5,000 each on the date of grant, and the balance vests as to
5,000 shares each per year thereafter on each of the next four anniversaries of December 3, 2018, and expire ten years from the
date of grant. Also on December 3, 2018, one employee was granted 10,000 incentive stock options. These options vested 2,000 shares
on the date of grant, and the balance vests as to 2,000 shares per year thereafter on each of the next four anniversaries of December
3, 2018, and expire ten years from the date of grant.
On March 8, 2019, one employee was granted
25,000 incentive stock options. These options vested 5,000 on the date of grant, and the balance vests as to 5,000 shares per year
thereafter on each of the next four anniversaries of March 8, 2019, and expire ten years from the date of grant.
On December 6, 2019, one employee was granted
50,000 incentive stock options. These options vested 10,000 on the date of grant, and the balance vests as to 10,000 shares per
year thereafter on each of the next four anniversaries of December 6, 2019, and expire ten years from the date of grant.
On January 9, 2020, we granted the following
equity awards to our managers and officers:
|
·
|
Stock grants for a total of 12,075 common shares to three employees.
We accounted for these shares as stock-based compensation totaling $77,000;
|
|
·
|
A total of 3,241 incentive stock options to two employees, all of
which vested immediately on the date of grant; and
|
|
·
|
A total of 38,500 shares of restricted stock and 77,000 incentive
stock options to five employees. The shares of restricted stock and incentive stock options vest over four years as follows: (i)
one-quarter of the restricted shares and options shall vest on January 9, 2021; and (ii) the remaining restricted shares and options
shall vest in twelve equal quarterly installments over the next three years, commencing with the first quarter following January
9, 2021. All incentive stock options expire ten years from the date of grant.
|
No other shares or options were granted
to company employees during the three months ended January 31, 2020 and 2019.
The weighted average fair value of employee
stock options that were granted during the three months ended January 31, 2020 and 2019 was estimated to be $3.13 and $4.14, respectively,
per share, using the Black-Scholes option pricing model with the following assumptions:
|
|
Three Months Ended January 31,
|
|
|
|
2020
|
|
|
2019
|
|
Risk-free interest rate
|
|
|
1.57
|
%
|
|
|
2.98
|
%
|
Dividend yield
|
|
|
1.23
|
%
|
|
|
0.94
|
%
|
Expected life of the option
|
|
|
6.47 years
|
|
|
|
5.76 years
|
|
Volatility factor
|
|
|
49.14
|
%
|
|
|
55.64
|
%
|
Expected volatilities are based on historical
volatility of our stock price and other factors. We used the historical method to calculate the expected life of the 2020 and 2019
option grants. The expected life represents the period of time that options granted are expected to be outstanding. The risk-free
rate is based on the U.S. Treasury rate with a maturity date corresponding to the options’ expected life. The dividend yield
is based upon the historical dividend yield.
Company stock option plans
Descriptions of our stock option plans are
included in Note 10 of our Annual Report on Form 10-K for the year ended October 31, 2019. A summary of the status of the options
granted under our stock option plans as of January 31, 2020 and the changes in options outstanding during the three months then
ended is presented in the table that follows:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
Shares
|
|
|
Exercise Price
|
|
Outstanding at November 1, 2019
|
|
|
890,147
|
|
|
$
|
3.62
|
|
Options granted
|
|
|
130,241
|
|
|
$
|
6.53
|
|
Options exercised
|
|
|
(215,943
|
)
|
|
$
|
1.81
|
|
Options outstanding at January 31, 2020
|
|
|
804,445
|
|
|
$
|
4.58
|
|
Options exercisable at January 31, 2020
|
|
|
417,279
|
|
|
$
|
4.24
|
|
Options vested and expected to vest at January 31, 2020
|
|
|
803,409
|
|
|
$
|
4.59
|
|
Weighted average remaining contractual life
of options outstanding as of January 31, 2020: 5.73 years
Weighted average remaining contractual life
of options exercisable as of January 31, 2020: 3.72 years
Weighted average remaining contractual life
of options vested and expected to vest as of January 31, 2020: 5.72 years
Aggregate intrinsic value of options outstanding
at January 31, 2020: $1,474,000
Aggregate intrinsic value of options exercisable
at January 31, 2020: $886,000
Aggregate intrinsic value of options vested
and expected to vest at January 31, 2020: $1,464,000
As of January 31, 2020, $765,000 and $313,000
of expenses with respect to nonvested stock options and restricted shares, respectively, has yet to be recognized but is expected
to be recognized over a weighted average period of 4.64 and 1.50 years, respectively.
Non-employee directors receive a compensation
package of $50,000 annually, which is paid one-half in cash and one-half through the grant of non-qualified awards. For fiscal
2020, compensation payable to non-employee directors will be prorated from November 1, 2019 through August 31, 2020. On November
4, 2019, we granted each of our five non-employee directors 3,270 shares of restricted stock. The number of restricted shares granted
to each director was determined by prorating $25,000 for the 10 months ending August 31, 2020 and dividing by the 20-day average
RFIL stock price ($6.36). These restricted shares vest ratably through August 31, 2020.
Stock option expense
During the three months ended January 31,
2020 and 2019, stock-based compensation expense totaled $187,000 and $114,000, respectively, and was classified in selling and
general expense.
Note 8 – Concentrations of credit risk
Financial instruments that potentially subject
us to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. We maintain our cash
and cash equivalents with high-credit quality financial institutions. At January 31, 2020, we had cash and cash equivalent balances
in excess of federally insured limits in the amount of approximately $13.1 million.
For the three months ending January 31,
2020, two customers, both distributors, each accounted for approximately 11% of net sales, while one other customer, a wireless
carrier, accounted for approximately 17% of net sales. The two distributors had accounts receivable balances that each accounted
for 12% of the total net accounts receivable balance at January 31, 2020. For the three months ending January 31, 2019, two customers,
a distributor and a wireless carrier, accounted for approximately 38% and 14%, respectively, of net sales. At January 31,
2019, these two customers’ accounts receivable balances accounted for approximately 30% and 22%, respectively, of the total
net accounts receivable balance. Although these customers have been on-going major customers of the Company, the written agreements
with these customers do not have any minimum purchase obligations and they could stop buying our products at any time and for any
reason. A reduction, delay or cancellation of orders from these customers or the loss of these customers could significantly reduce
our future revenues and profits.
Note 9 – Segment information
We
aggregate operating divisions into two reporting segments that have similar economic characteristics primarily in the following
areas: (1) the nature of the product and services; (2) the nature of the production process; (3) the type or class of customer
for their products and services; (4) the methods used to distribute their products or services; (5) if applicable, the nature of
the regulatory environment. Based upon this evaluation, as of January 31, 2020, we had two segments – RF
Connector and Cable Assembly (“RF Connector segment”) and Custom Cabling Manufacturing and Assembly (“Custom
Cabling segment”).
The
RF Connector segment consisted of one division and the Custom Cabling segment was composed of four divisions. The five divisions
that met the quantitative thresholds for segment reporting are the RF Connector and Cable Assembly division (“RF Connector
division”), Cables Unlimited, Rel-Tech, C Enterprises, and Schrofftech. While each segment has similar products and services,
there was little overlapping of these services to their customer base. The biggest difference in segments is in the channels of
sales: sales or product and services for the RF Connector segment were primarily through the distribution channel, while the
Custom Cabling segment sales were through a combination of distribution and direct to the end customer.
Management identifies segments based on
strategic business units that are, in turn, based along market lines. These strategic business units offer products and services
to different markets in accordance with their customer base and product usage. For segment reporting purposes, the RF Connector
division constitutes the RF Connector segment, and the Cables Unlimited, Rel-Tech, C Enterprises, and Schrofftech divisions constitute
the Custom Cabling segment.
As reviewed by our chief operating decision
maker, we evaluate the performance of each segment based on income or loss before income taxes. We charge depreciation and amortization
directly to each division within the segment. Accounts receivable, inventory, property and equipment, right of use assets, goodwill
and intangible assets are the only assets identified by segment. Except as discussed above, the accounting policies for segment
reporting are the same for the Company as a whole.
Substantially all of our operations are
conducted in the United States; however, we derive a portion of our revenue from export sales. We attribute sales to geographic
areas based on the location of the customers. The following table presents the sales by geographic area for the three months ended
January 31, 2020 and 2019 (in thousands):
|
|
Three Months Ended January 31,
|
|
|
|
2020
|
|
|
2019
|
|
United States
|
|
$
|
12,173
|
|
|
$
|
10,470
|
|
Foreign Countries:
|
|
|
|
|
|
|
|
|
Canada
|
|
|
116
|
|
|
|
165
|
|
Mexico
|
|
|
5
|
|
|
|
-
|
|
All Other
|
|
|
120
|
|
|
|
12
|
|
|
|
|
241
|
|
|
|
177
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
12,414
|
|
|
$
|
10,647
|
|
Net sales, income before
provision for income taxes and other related segment information for the three months ended January 31, 2020 and 2019 are as follows
(in thousands):
|
|
RF Connector
|
|
|
Custom Cabling
|
|
|
|
|
|
|
|
|
|
and
|
|
|
Manufacturing and
|
|
|
|
|
|
|
|
|
|
Cable Assembly
|
|
|
Assembly
|
|
|
Corporate
|
|
|
Total
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
3,189
|
|
|
$
|
9,225
|
|
|
$
|
-
|
|
|
$
|
12,414
|
|
Income (loss) before provision for income taxes
|
|
|
282
|
|
|
|
(281
|
)
|
|
|
11
|
|
|
|
12
|
|
Depreciation and amortization
|
|
|
42
|
|
|
|
213
|
|
|
|
-
|
|
|
|
255
|
|
Total assets
|
|
|
7,496
|
|
|
|
17,158
|
|
|
|
15,178
|
|
|
|
39,832
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
3,258
|
|
|
$
|
7,389
|
|
|
$
|
-
|
|
|
$
|
10,647
|
|
Income before provision for income taxes
|
|
|
280
|
|
|
|
506
|
|
|
|
22
|
|
|
|
808
|
|
Depreciation and amortization
|
|
|
45
|
|
|
|
92
|
|
|
|
-
|
|
|
|
137
|
|
Total assets
|
|
|
6,635
|
|
|
|
11,026
|
|
|
|
14,846
|
|
|
|
32,507
|
|
Note 10 – Income taxes
We use an estimated annual effective tax
rate, which is based on expected annual income, statutory tax rates and tax planning opportunities available in the various jurisdictions
in which we operate, to determine its quarterly provision (benefit) for income taxes. Certain significant or unusual items are
separately recognized in the quarter in which they occur and can be a source of variability in the effective tax rates from quarter
to quarter.
The provision (benefit) for income taxes
was (120%) and 21% of income before income taxes for the three months ended January 31, 2020 and 2019, respectively. The change
in the effective tax rate from the fiscal 2019 quarter to fiscal 2020 quarter was primarily driven by the tax-effect of our year-to-date
income adjusted for book-tax differences which has a rate impact compared to forecasted book income for the year.
We had $123,000 and $80,000 of unrecognized
tax benefits, inclusive of interest and penalties, as of January 31, 2020 and October 31, 2019, respectively. The unrecognized
tax benefits, if recognized, would result in a net tax benefit of $28,000 as of January 31, 2020.
Note 11 – Intangible assets
Intangible assets consist of the following
(in thousands):
|
|
January 31, 2020
|
|
|
October 31, 2019
|
|
Amortizable intangible assets:
|
|
|
|
|
|
|
|
|
Non-compete agreement (estimated life 5 years)
|
|
$
|
423
|
|
|
$
|
200
|
|
Accumulated amortization
|
|
|
(211
|
)
|
|
|
(200
|
)
|
|
|
|
212
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Customer relationships (estimated lives 7 - 15 years)
|
|
$
|
5,058
|
|
|
$
|
2,879
|
|
Accumulated amortization
|
|
|
(2,005
|
)
|
|
|
(1,884
|
)
|
|
|
|
3,053
|
|
|
|
995
|
|
|
|
|
|
|
|
|
|
|
Backlog (estimated life 1 - 2 years)
|
|
|
287
|
|
|
|
134
|
|
Accumulated amortization
|
|
|
(167
|
)
|
|
|
(134
|
)
|
|
|
|
120
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Patents (estimated life 10 - 14 years)
|
|
|
368
|
|
|
|
142
|
|
Accumulated amortization
|
|
|
(53
|
)
|
|
|
(45
|
)
|
|
|
|
315
|
|
|
|
97
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
3,700
|
|
|
$
|
1,092
|
|
|
|
|
|
|
|
|
|
|
Non-amortizable intangible assets:
|
|
|
|
|
|
|
|
|
Trademarks
|
|
$
|
1,174
|
|
|
$
|
657
|
|
Amortization expense
for the three months ended January 31, 2020 and the year ended October 31, 2019 was $173,000 and $275,000, respectively. As of
January 31, 2020, the weighted-average amortization period for the amortizable intangible assets is 8.39 years.
Note 12 – Commitments
We currently lease our corporate headquarters
and RF connector and cable assembly manufacturing facilities in San Diego, California. At that location, we lease three buildings
with a total of approximately 21,908 square feet of office, warehouse and manufacturing space, that houses our corporate administration,
sales and marketing, and engineering departments. The buildings also are used for production and warehousing by the RF Connector
division. The term of the lease expires on July 31, 2022, and the rental payments under the lease currently are $26,176 per month.
The San Diego lease also requires the payment of our pro rata share of real estate taxes and insurance, maintenance and other operating
expenses related to the facilities.
|
(i)
|
The Cables Unlimited division leases its 12,000 square foot manufacturing facility in Yaphank, New York, from K&K Unlimited, a company controlled by Darren Clark, the former owner and current President of Cables Unlimited. Cables Unlimited’s monthly rent expense under the lease is $13,000 per month, plus payments of all utilities, janitorial expenses, routine maintenance costs and costs of insurance for Cables Unlimited’s business operations and equipment. The current lease expires on June 30, 2021.
|
|
|
|
(ii)
|
The Rel-Tech Electronic division leases an approximately
13,750 square feet located in Milford, Connecticut. The old lease expired in August 2019. On September 1, 2019, Rel-Tech extended
its lease term for an additional two years to August 31, 2021, with escalating rent payments over the two years. The net monthly
rent payments currently are $8,969 per month.
|
|
|
|
|
(iii)
|
On November 1, 2018, the Cables Unlimited division entered into
a lease agreement with 100 Bellport Avenue, LLC, as landlord, for approximately 7,500 square feet located in Yaphank, New York,
with a monthly rent expense of $5,625. On February 1, 2019, Cables Unlimited entered into an amendment to this lease to increase
the leased space by an additional 5,000 square feet and increase the monthly rent by $3,750, resulting in a total rent expense
of $9,375 per month. The lease expired on October 31, 2019 and was converted to a month-to-month lease at the same monthly rental
amount.
|
|
|
|
|
(iv)
|
The C Enterprises division leases approximately 24,014 square
feet of office, warehouse, and manufacturing space located in Vista, California. The term of the lease expires on June 30, 2023,
and the rental payments under the lease currently are $18,491 per month, plus payments of real estate taxes, management fee, property
insurance and other operating expenses related to the facilities.
|
|
|
|
|
(v)
|
The Schrofftech facilities, consisting of two buildings for
a total of 10,700 square feet, are leased by RF Industries, Ltd. under two leases that were renewed effective February 1, 2020
for two years expiring January 31, 2022. The aggregate monthly rental payment under the new leases currently is $6,525 per month.
|
|
|
|
|
(vi)
|
On February 15, 2020, the RF Connector and Cable Assembly division
entered into a lease for approximately 625 square feet located in Towson, Maryland and expires on February 28, 2022. The rental
payments under the lease currently are $1,016 per month, plus estimated monthly payments of $143 for common area maintenance fees.
|
Additionally, on January 1, 2020, the Cables
Unlimited division began making rental payments for various storage units located at the Yaphank facility. Monthly rental payments
are approximately $1,000 and made to K&K Unlimited, the company owned by Darren Clark, former owner and current President of
Cables Unlimited. Upon inception of this arrangement, it was determined that there was no physically distinct identified asset
and therefore, the arrangement does not constitute a lease. The rental payments, however, remain as rental expense.
For the three months ended January 31, 2020,
the aggregate monthly rental payments for all of our facilities was approximately $83,000 per month, plus utilities, maintenance
and insurance.
Upon adoption of ASU 2016-02 on November
1, 2019, we adopted the practical expedient whereby the lease qualification and classification was carried over from the accounting
for leases under ASC 840. The lease contracts for the corporate headquarters, RF Connector division manufacturing facilities, Cables
Unlimited, Rel-Tech, and C Enterprises had commenced prior to the effective date of November 1, 2019. These contracts, therefore,
were determined to contain leases. All other new contracts have been assessed for the existence of a lease and for the proper classification
into operating leases. The rate implicit in the leases was undeterminable, and therefore, the discount rate used in all lease contracts
is our incremental borrowing rate.
We also have other operating leases for
certain equipment. The components of our operating lease expenses were as follows (in thousands):
|
|
Three Months Ended
|
|
|
|
January 31, 2020
|
|
Operating lease cost
|
|
$
|
254
|
|
Other information related to leases was
as follows (in thousands):
|
|
Three Months Ended
|
|
|
|
January 31, 2020
|
|
Supplemental Cash Flows Information
|
|
|
|
|
Right of use assets obtained in exchange for lease obligations:
|
|
|
|
|
Operating leases
|
|
$
|
2,024
|
|
|
|
|
|
|
Weighted Average Remaining Lease Term
|
|
|
|
|
Operating leases
|
|
|
30.49 months
|
|
|
|
|
|
|
Weighted Average Discount Rate
|
|
|
|
|
Operating leases
|
|
|
3.54
|
%
|
Future minimum lease payments under non-cancellable
leases as of January 31, 2020 were as follows:
Year ended October 31,
|
|
Operating Leases
|
|
2020 (excluding three months ended January 31, 2020)
|
|
$
|
719
|
|
2021
|
|
|
854
|
|
2022
|
|
|
507
|
|
2023
|
|
|
166
|
|
2024
|
|
|
-
|
|
Thereafter
|
|
|
-
|
|
Total future minimum lease payments
|
|
|
2,246
|
|
Less imputed interest
|
|
|
(122
|
)
|
Total
|
|
$
|
2,124
|
|
Reported as of January 31, 2020
|
|
Operating Leases
|
|
Other current liabilities
|
|
$
|
933
|
|
Operating lease liabilities
|
|
|
1,191
|
|
Finance lease liabilities
|
|
|
-
|
|
Total
|
|
$
|
2,124
|
|
As of January 31, 2020, operating
lease ROU asset was $2.0 million and operating lease liability totaled $2.1 million, of which $933,000 is classified as
current. There were no finance leases as of January 31, 2020. We have additional operating leases that have not yet
commenced as of January 31, 2020 of $178,000. These operating leases will commence in February 2020 with lease terms of 24
months.
Note 13 – Line of credit
In November 2019, we entered into an agreement
for a revolving line of credit (“LOC”) in the amount of $5.0 million. Amounts outstanding under the LOC shall bear
interest at a rate of 2.0% plus LIBOR Daily Floating Rate (“base interest rate”), with interest payable on the first
day of each month. Borrowings under the LOC are secured by a security interest in certain assets of the Company. The LOC contains
certain loan covenants. Failure to maintain the loan covenants may constitute an event of default, resulting in all outstanding
amounts of principal and interest becoming immediately due and payable. All outstanding principal and interest is due and payable
on December 1, 2021. As of January 31, 2020, we are in compliance with all loan covenants. Additionally, as of January 31, 2020,
no amounts were outstanding under the line of credit.
Note 14 – Cash dividend and declared dividends
We paid dividends of
$0.02 per share during the three months ended January 31, 2020 and 2019 for a total of $193,000 and $186,000, respectively.
Note 15 – Subsequent events
On February 1, 2020, the two leases for
the Schrofftech facilities were renewed effective February 1, 2020 for two years expiring January 31, 2022. The aggregate monthly
rental payments under the new leases are $6,525 per month.
On February 15, 2020, the RF Connector division
entered into a lease agreement for an approximately 625 square foot office facility located in Towson, Maryland that expires on
February 28, 2022. The rental payments under the lease currently are $1,016 per month, plus estimated monthly payments of $143
for common area maintenance fees.
On March 5, 2020, the Board of Directors
declared a quarterly cash dividend of $0.02 per share payable on April 15, 2020 to stockholders of record on March 31, 2020.