Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
This report contains forward-looking statements. These statements relate to future events or the Company’s future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “except,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.
Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither the Company, nor any other person, assumes responsibility for the accuracy and completeness of the forward-looking statements. The Company is under no obligation to update any of the forward-looking statements after the filing of this Quarterly Report on Form 10-Q to conform such statements to actual results or to changes in its expectations.
The following discussion should be read in conjunction with the Company’s unaudited condensed consolidated financial statements and the related notes and other financial information appearing elsewhere in this Form 10-Q. Readers are also urged to carefully review and consider the various disclosures made by the Company which attempt to advise interested parties of the factors which affect the Company’s business, including without limitation the disclosures made under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the caption “Risk Factors,” and the audited consolidated financial statements and related notes included in the Company’s Annual Report filed on Form 10-K for the year ended October 31, 2020 and other reports and filings made with the Securities and Exchange Commission.
Critical Accounting Policies
Our unaudited condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these consolidated financial statements requires us to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. We evaluate our estimates, including those related to bad debts, inventory reserves, earn-out liabilities, and contingencies on an ongoing basis. We base our estimates on historical experience and on various other assumptions that are believed to be appropriate under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Inventories
Inventories are stated at the lower of cost or net realizable value, with cost determined using the weighted average cost method of accounting. Certain items in inventory may be considered obsolete or excess and, as such, we periodically review our inventories for excess and slow moving items and make provisions as necessary to properly reflect inventory value. Because inventories have, during the past few years, represented up to one-fourth of our total assets, any reduction in the value of our inventories would require us to take write-offs that would affect our net worth and future earnings.
Allowance for Doubtful Accounts
We record an allowance for doubtful accounts based upon our assessment of various factors. We consider historical experience, the age of the accounts receivable balance, credit quality of our customers, current economic conditions and other factors that may affect a customer’s ability to pay.
Long-Lived Assets Including Goodwill
We assess property, plant and equipment and intangible assets, which are considered definite-lived assets, for impairment. Definite-lived assets are reviewed when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We measure recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If property and equipment and intangible assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the asset exceeds its fair market value.
We amortize our intangible assets with definite useful lives over their estimated useful lives and review these assets for impairment.
We test our goodwill and trademarks and indefinite-lived assets for impairment at least annually or more frequently if events or changes in circumstances indicate these assets may be impaired. These events or circumstances require significant judgment and could include a significant change in the business climate, legal factors, operating performance indicators, competition and sale or disposition of all or a portion of a division. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital.
Earn-out Liability
The purchase agreement for the acquisition of Schrofftech provides for an earn-out payment of up to $2.4 million, which amount is earned through October 31, 2021. 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.
Income Taxes
We record a tax provision for the anticipated tax consequences of the reported results of operations. Income taxes are accounted for under the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates as of the date of the financial statements that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. We record a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized.
The calculation of the tax provision involves significant judgment in estimating the impact of uncertainties in the application of GAAP and complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on our financial condition and operating results.
Stock-based Compensation
We use the Black-Scholes model to value the stock option grants. This valuation is affected by our stock price as well as assumptions regarding a number of inputs which involve significant judgments and estimates. These inputs include the expected term of employee stock options, the expected volatility of the stock price, the risk-free interest rate and expected dividends.
Overview
RF Industries, Ltd. (together with subsidiaries, the “Company,” we,” “us,” or “our”) is a national manufacturer and marketer of interconnect products and systems, including coaxial and specialty cables and connectors, fiber optic cables and connectors, and electrical and electronic specialty cables and components. Through our manufacturing and production facilities, we provide a wide selection of interconnect products and solutions primarily to telecommunications carriers and equipment manufacturers, wireless and network infrastructure carriers and manufacturers and to various original equipment manufacturers (OEMs) in several market segments. Since the acquisition of Schrofftech in November 2019, we also manufacture and sell energy-efficient cooling systems and integrated small cell solutions and related components.
We operate through two reporting segments: (i) the RF Connector and Cable Assembly (“RF Connector”) segment, and (ii) the Custom Cabling Manufacturing and Assembly (“Custom Cabling”) segment. The RF Connector segment primarily designs, manufactures, markets and distributes a broad range of connector and cable products, including coaxial connectors and cable assemblies that are integrated with coaxial connectors, used in telecommunications and information technology OEM markets and other end markets. The Custom Cabling segment designs, manufactures, markets and distributes custom copper and fiber cable assemblies, complex hybrid fiber optic and power solution cables, electromechanical wiring harnesses, wiring harnesses for a broad range of applications in a diverse set of end markets, energy-efficient cooling systems for wireless base stations and remote equipment shelters and custom designed, pole-ready 5G small cell integrated enclosures.
For the three months ended January 31, 2021, most of our revenues were generated from the Custom Cabling segment from the sale of fiber optics cable, copper cabling, custom patch cord assemblies, and wiring harnesses, which collectively accounted for 64% of the Company’s total sales. Revenues from the RF Connector segment were generated from the sales of RF connector products and cable assemblies and accounted for 36% of total sales for the three months ended January 31, 2021. The RF Connector segment mostly sells standardized products regularly used by customers and, therefore, has a more stable revenue stream. On the other hand, the Custom Cabling segment mostly designs, manufactures, and sells customized cabling and wireless-related equipment under larger purchase orders. Accordingly, the Custom Cabling segment is more dependent upon larger orders, and its revenues are therefore, more volatile than the revenues of the RF Connector segment.
In March 2020, the World Health Organization (the “WHO”) declared coronavirus (“COVID-19”) a pandemic emergency. The COVID-19 pandemic has negatively impacted regional and global economies, disrupted global supply chains, and created significant volatility and disruption of financial markets. The global impact of the outbreak has been rapidly evolving and certain jurisdictions, including those where we have operations, have also reacted by instituting quarantines, restrictions on travel, “shelter in place” rules, social distancing protocols and restrictions on types of business that may continue to operate. While we have been deemed an “essential” business, and therefore have been permitted to continue our operations, the impact of the COVID-19 pandemic has affected both our operations and those of our customers. Our operations have been negatively affected by partial shutdowns of our facilities (particularly in the Northeast), by changes that we had to make on our operating methods and procedures, and by our reduced workforce as many of our employees stayed at home. Many of our customers and vendors have likewise had temporary closures of their facilities and have otherwise been impacted by changes in their industries. As a result, overall demand for our products has been reduced, and certain costs have increased. We have taken measures to protect the health and safety of our employees, and we continue to work with our customers and vendors to minimize potential disruptions in addressing the challenges posed by this global pandemic.
The extent of the impact of the COVID-19 pandemic on our operational and financial performance will depend on future developments, including the duration and spread of the pandemic and related actions taken by domestic and international jurisdictions to prevent disease spread, all of which are uncertain and cannot be predicted. The outbreak impacted our performance for the three months ended January 31, 2021. We currently expect the decline caused by the economic slowdown to persist through at least the second quarter of 2021. The operations of our Cables Unlimited, Inc. subsidiary in Long Island, New York, was particularly affected as many employees stayed at home and as local customers shut down or otherwise delayed, deferred or cancelled orders for our products. Because of the impact that COVID-19 had on our Northeastern operations, in May 2020 we applied for and received loans under the Paycheck Protection Program (“PPP”) of the CARES Act totaling approximately $2.8 million (“PPP Loans”). The funds from the PPP Loans were used to retain employees, maintain payroll and benefits, and make lease and utility payments. Without the PPP Loans, we would have made material reductions in our workforce (particularly at Cables Unlimited). In February 2021, the full $2.8 million of PPP Loans was forgiven and considered paid in full (including applicable interest) by the Small Business Administration (“SBA”).
Liquidity and Capital Resources
Historically, we have been able to fund our liquidity and other capital requirements from funds we generated from operations. While we still believe that our existing current assets, the amount of cash we anticipate will be generated from on-going operations, and funds we received from the PPP Loans collectively will be sufficient to fund our anticipated liquidity and capital resource needs for at least twelve months from the date of this filing, there are some uncertainties because of the unknown future impact of the COVID-19 pandemic on our business. Nevertheless, we believe that our existing assets and the cash we expect to generate from operations, including from our current backlog of unfulfilled orders, will be sufficient to fund our liquidity needs during the next twelve months from the date of this filing based on the following:
As of January 31, 2021, we had a total of $15.5 million of cash and cash equivalents compared to a total of $15.8 million of cash and cash equivalents as of October 31, 2020. As of January 31, 2021, we had working capital of $24.5 million and a current ratio of approximately 4.4:1 with current assets of $31.8 million and current liabilities of $7.3 million.
As of January 31, 2021, we had $7.1 million of backlog, compared to $6.3 million as of October 31, 2020. Since purchase orders are submitted from customers based on the timing of their requirements, our ability to predict orders in future periods or trends in future periods is limited. Furthermore, purchase orders may be subject to cancellation from customers, although we have not historically experienced material cancellations of purchase orders.
In the three months ended January 31, 2021, we used $0.6 million of cash in our operating activities. This net outflow of cash is due to our net loss ($0.4 million), inventory purchases resulting in an increase to our inventory balance ($0.4 million), and cash used for other current assets ($1.3 million), which expenditures included an increase of our income taxes receivable of $0.7 million due to the impact of the passage of the Consolidated Appropriations Act (“CAA”) that allows for PPP loan expenses to be deducted on our tax return. The foregoing cash usage was partially offset by an increase in cash from noncash credits of $0.7 million from the decrease of our deferred tax asset as a result of the passage of the CAA, $0.2 million from depreciation and amortization, $0.1 million from stock-based compensation expense, and $0.5 million from the collection in accounts receivable.
During the fiscal quarter ended January 31, 2021, we also spent $0.1 million on capital expenditures, and received $0.4 million of proceeds from the exercise of stock options. As a result of the net cash used in operating and investing activities, and the cash received from the exercise of stock options, our cash and cash equivalent balance decreased by $0.3 million during the January 31, 2021 quarter.
We do not anticipate needing material additional capital equipment in the next twelve months. In the past, we have financed some of our equipment and furnishings requirements through capital leases. No additional capital equipment purchases have been currently identified that would require significant additional leasing or capital expenditures during the next twelve months.
In November 2019, we entered into a $5.0 million revolving line of credit that bore interest at a rate of 2.0% plus LIBOR Daily Floating Rate. We never used the line of credit and on December 30, 2020, we closed the line of credit. Accordingly, we currently do not have a credit facility available to us should we need to borrow amounts to fund either our working capital needs or any future unplanned capital expenditures.
From time to time, we may undertake acquisitions of other companies or product lines in order to diversify our product and solutions offerings and customer base. Conversely, we may undertake the disposition of a division or product line due to changes in our business strategy or market conditions. Acquisitions may require the outlay of cash, which may reduce our liquidity and capital resources while dispositions may increase our cash position, liquidity and capital resources. On November 4, 2019, we purchased the business of Schroff Technologies International, Inc., 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 Schrofftech, 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 an additional cash earn-out payment of up to $2.4 million.
Results of Operations
Three Months Ended January 31, 2021 vs. Three Months Ended January 31, 2020
Net sales for the three months ended January 31, 2021 (the “fiscal 2021 quarter”) decreased by 19%, or $2.4 million, to $10.0 million as compared to the three months ended January 31, 2020 (the “fiscal 2020 quarter”). Net sales for the fiscal 2021 quarter at the Custom Cabling segment decreased by $2.8 million, or 30%, to $6.4 million, compared to $9.2 million in the fiscal 2020 quarter. The decrease was primarily the result of lower project-based wireless carrier macro and tower site business where we continued to see a general slowdown which impacted our sales. In addition we experienced project delays with small cell deployments due to COVID-19 as there were difficulties gaining site zoning approvals for small cell installations, challenges with building and site access, and limited availability of work crews. Net sales for the fiscal 2021 quarter at the RF Connector segment increased by $0.4 million, or 12%, to $3.6 million as compared to $3.2 million in the fiscal 2020 quarter.
Gross profit for the fiscal 2021 quarter decreased by $0.6 million to $2.6 million due to the decrease in net sales, although gross margins remained fairly consistent at 26.1% of sales compared to 26.2% of sales in the fiscal 2020 quarter.
Engineering expenses decreased by $0.2 million to $0.4 million in the fiscal 2021 quarter compared to $0.6 million in the fiscal 2020 quarter primarily due to the reduction in engineering marketing personnel, which costs are included in the engineering costs. Engineering expenses represent costs incurred relating to the ongoing research and development of new products.
Selling and general expenses increased by $0.1 million to $2.8 million (28% of sales) compared to $2.7 million (21% of sales) in the first quarter last year primarily due to hiring of additional sales people in the last half of the 2020 fiscal year and in the fiscal 2021 quarter.
For the fiscal 2021 quarter, the Custom Cabling segment had a pretax loss of $1.0 million while the RF Connector segment had pretax income of $0.5 million, as compared to $0.3 million loss and $0.3 million of income, respectively, for the comparable first quarter last year. The pretax loss at the Custom Cabling segment in the fiscal 2021 quarter was primarily due to the lower sales in the project-based business resulting from the slowdown in carrier spending.
The provision or benefit for income taxes was 32% and (120%) of (loss) income before income taxes for the fiscal 2021 quarter and the fiscal 2020 quarter, respectively. The change in the effective tax rate from the fiscal 2020 quarter to fiscal 2021 quarter was primarily driven by the disproportionate impact of various permanent book-tax differences with respect to our forecasted book income or loss in each period.
For the fiscal 2021 quarter, net loss was $0.4 million and fully diluted loss per share was $0.04 per share, compared to a net income of $26,000 and fully diluted earnings per share of $0.00 per share for the fiscal 2020 quarter. For the fiscal 2021 quarter, the diluted weighted average shares outstanding was 9,784,760 as compared to 9,873,336 for the fiscal 2020 quarter.