R F Industries Ltd: Form 10-Q for the period ended Apr 30, 2024

This report contains forward-looking statements. These statements relate to future events or our 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 we believe that the expectations reflected in the forward-looking statements are reasonable, we 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. We are 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 our 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 our 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 our Annual Report filed on Form 10-K for the year ended October 31, 2023 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 unaudited condensed 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 Credit Losses

Our accounts receivable arise primarily from sales on credit to customers. We establish an allowance for credit losses to present the net amount of accounts receivable expected to be collected. The allowance is determined by using the loss-rate method, which requires an estimation of loss rates based upon historical loss experience adjusted for factors that are relevant to determining the expected collectability of accounts receivable. Some of these factors include macroeconomic conditions that correlate with historical loss experience, delinquency trends, aging behavior of receivables and credit and liquidity quality indicators for industry groups, customer classes or individual customers. During the three months ended April 30, 2024, we considered the current and expected future economic and market conditions and concluded that no material adjustment to Credit Losses was required as of April 30, 2024.

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.

Income Taxes

We record a tax provision (benefit) 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 high-performance components such as RF connectors and adapters, dividers, directional couplers and filters, coaxial cables, data cables, wire harnesses, fiber optic cables, custom cabling, energy-efficient cooling systems and integrated small cell enclosures. 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. We also design, engineer, 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 RF connector, adapter, coupler, divider, and cable products, including coaxial passives and cable assemblies that are 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 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 4G and 5G small cell integrated enclosures.

For the six months ended April 30, 2024, revenues from the Custom Cabling segment were generated from the sale of fiber optics cable, copper cabling, custom patch cord assemblies, and wiring harnesses, which collectively accounted for 37% 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 63% of total sales for the six months ended April 30, 2024. 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 can therefore be more volatile than the revenues of the RF Connector segment.

Our corporate headquarters are located at 16868 Via Del Campo Court, Suite 200, San Diego, CA 92127. Our phone number is (858) 549-6340.

Liquidity and Capital Resources

Historically, we have been able to fund our liquidity and other capital requirements from funds we generated from operations. However, we have incurred an operating loss during the six months ended April 30, 2024. During the period, we have implemented certain cost-cutting measures to reduce our operating expenses and to help drive positive operating cash flow and increase liquidity. Our plan includes consolidating facilities and recognizing the related operating efficiencies and synergies in our production operations. We intend to continue to pursue additional continuous improvement and cost reduction measures, as well as organic growth in revenue and profitability.

As of April 30, 2024, we had a total of $1.4 million of cash and cash equivalents compared to a total of $4.9 million of cash and cash equivalents as of October 31, 2023. As of April 30, 2024, we had working capital of $10.9 million and a current ratio of approximately 1.6:1 with current assets of $30.2 million and current liabilities of $19.3 million. We believe that the amount of cash remaining, plus the amount available to us under the EBC Revolving Loan Facility, will be sufficient to fund our anticipated liquidity needs.

As of April 30, 2024, we had $18.0 million of backlog, compared to $16.1 million as of October 31, 2023. 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 six months ended April 30, 2024, we generated $1.0 million of cash in our operating activities. This net inflow of cash is primarily related to $2.7 million from deferred income taxes, $2.4 million from inventories, $1.3 million from depreciation and amortization, $0.5 million from stock-based compensation expense, $0.3 million from right-of-use assets, $0.2 million from other current assets, $25,000 from debt issuance amortization and $14,000 from extinguishment of debt issuance costs. The cash usage was primarily due to the net loss of $5.7 million, accrued expenses of $0.4 million, change in accounts receivable of $0.3 million, payments of accounts payable of $45,000 and bad debt expense of $8,000.

During the six months ended April 30, 2024, we also spent $0.3 million on capital expenditures, $13.2 million in BofA Term Loan payments, $0.5 million of debt issuance cost and drew $10.0 million on the EBC Revolving Loan Facility (used to pay down the BofATerm Loan).

Our goal to expand and grow our business both organically and through acquisitions may require material additional capital equipment. In the past, we have purchased all additional equipment, or financed some of our equipment and furnishings requirements through capital leases. At this time, we have not identified any additional capital equipment purchases that would require significant additional leasing or capital expenditures during the next 12 months. We also believe that based on our current financial condition, our current backlog of unfulfilled orders, and our anticipated future operations, we would be able to finance our expansion, if necessary.

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. Since our goal is to continue to expand our operations and accelerate our growth through future acquisitions, we may use some of our current capital resources to fund acquisitions we may undertake in the future.

Results of Operations

Three Months Ended April 30, 2024 vs. Three Months Ended April 30, 2023

Net sales for the three months ended April 30, 2024 (the “fiscal 2024 quarter”) decreased by 27.8%, or $6.2 million, to $16.1 million as compared to the three months ended April 30, 2023 (the “fiscal 2023 quarter”). Net sales for the fiscal 2024 quarter at the Custom Cabling segment decreased by $3.5 million, or 36.1%, to $6.2 million, compared to $9.7 million in the fiscal 2023 quarter. The decrease was primarily the result of a decrease in sales of hybrid fiber cables to wireless customers. Net sales for the fiscal 2024 quarter at the RF Connector segment decreased by $2.7 million, or 21.4%, to $9.9 million as compared to $12.6 million in the fiscal 2023 quarter, primarily due to a decrease in sales related to lower levels of inventory being kept on hand at our distributor customers based on seasonality and the lower carrier capital expenditure environment, and fewer carrier projects involving approved RF components.

Gross profit for the fiscal 2024 quarter decreased by $1.3 million to $4.8 million, and gross margins increased to 29.9% of sales compared to 27.4% of sales in the fiscal 2023 quarter. The decrease in gross profit and increase in gross margin was primarily result of increased efficiencies from facility consolidation, cost reduction initiatives and product mix.

Engineering expenses decreased by $0.2 million to $0.6 million in the fiscal 2024 quarter compared to $0.9 million in the fiscal 2023 quarter. The decrease was the result of headcount reduction and other cost savings initiatives. Engineering expenses represent costs incurred relating to the ongoing research and development of current and new products.

Selling and general expenses decreased by $0.1 million to $4.6 million (28.7% of sales) compared to $4.7 million (21.3% of sales) in the second quarter last year primarily due to a decrease in variable compensation related to commissions and bonuses as a result of the lower sales along with cost savings relating to reduced office and information technology spend. We also incurred a one-time charge of $0.1 million relating to consulting spend and severance in the fiscal 2024 quarter.

For the fiscal 2024 quarter, the Custom Cabling segment had pretax income of $0.4 million and the RF Connector segment had a pretax loss of $0.7 million, as compared to $0.3 million income and $0.2 million income, respectively, for the comparable quarter last year. The increase in pretax income at the Custom Cabling segment was due to a more favorable product mix. The decrease in the pretax net income at the RF Connector segment was primarily due to the decrease in sales related to lower levels of inventory being kept on hand at our distributor customers and the lower carrier capital expenditure environment, and fewer carrier projects involving approved RF components.

For fiscal 2024 and 2023 quarters, we recorded income tax provision (benefit) of $3,649,000 and ($164,000), respectively. The effective tax rate was (564.7%) for the fiscal 2024 quarter, compared to (39.3%) for the fiscal 2023 quarter. The change in the effective tax rate from the fiscal 2024 quarter to fiscal 2023 quarter was primarily driven by the recording of a valuation allowance on our deferred tax asset.

For the fiscal 2024 quarter, net loss was $4.3 million and fully diluted loss per share was $0.41, compared to a net income of $0.6 million and fully diluted earnings per share of $0.06 for the fiscal 2023 quarter. For the fiscal 2024 quarter, the diluted weighted average shares outstanding were 10,495,548 as compared to 10,327,271 for the fiscal 2023 quarter.

Six Months Ended April 30, 2024 vs. Six Months Ended April 30, 2023

Net sales for the six months ended April 30, 2024 (the “fiscal 2024 six-month period”) of $29.6 million decreased by 27.1%, or $11.0 million, compared to the six months ended April 30, 2023 (the “fiscal 2023 six-month period”). The decrease in net sales is attributable mainly to the RF Connector segment, which decreased by $5.6 million, or 23%, to $18.7 million compared to $24.3 million in the fiscal 2023 six-month period, primarily due to a decrease in sales related to lower levels of inventory being kept on hand at our distributor customers based on seasonality and the lower carrier capital expenditure environment, and fewer carrier projects involving approved RF components and the Net sales for the fiscal 2024 six-month period at the Custom Cabling segment decreased by $5.4 million, or 33.1%, to $10.9 million compared to $16.3 million in the fiscal 2023 six-month period, primarily due to a decrease in sales of hybrid fiber cables to wireless customers at Cables Unlimited.

Gross profit for the fiscal 2024 six-month period decreased by $3.1 million to $8.1 million while gross margins remained relatively consistent at 27.5% of sales compared to 27.6% of sales in the fiscal 2023 six-month period. The decrease in gross profit was primarily related to the overall decrease in sales while gross margins remained relatively consistent due to product mix.

Engineering expenses decreased $0.4 million to $1.4 million for the fiscal 2024 six-month period compared to $1.8 million in the fiscal 2023 six-month period. The decrease was primarily the result of headcount reduction and other cost savings initiatives. Engineering expenses represent costs incurred relating to the ongoing research and development of new products.

Selling and general expenses decreased by $0.8 million to $9.2 million (31.3% of sales) compared to $10.0 million (24.7% of sales) in the six-month period last year primarily due to a decrease in variable compensation related to commissions and bonuses as a result of the lower sales along with cost savings relating to reduced office and IT. We also incurred a one-time charges of $0.2 million relating to consulting spend, severance and inventory appraisal in fiscal 2024.

For the fiscal 2024 six-month period, pretax income for the Custom Cabling segment was $0.1 million and the pretax loss for the RF Connector segment was $2.4 million, as compared to $0.5 million loss and $0.4 million income, respectively, for the comparable six-month period last year.

For the fiscal 2024 and 2023 six-month periods, we recorded income tax provision (benefit) of $2,818,000 and ($324,000), respectively. The effective tax rate was (99.3%) for the fiscal 2024 six-month period, compared to 35.8% for the fiscal 2023 six-month period. The change in effective tax rate for the fiscal 2024 and 2023 six-month periods was primarily driven by the recording of a valuation allowance on our deferred tax asset.

For the fiscal 2024 six-month period, net loss was $5.7 million and fully diluted loss per share was ($0.54) per share as compared to a net loss of $0.6 million and fully diluted loss per share of $0.06 per share for the fiscal 2023 six-month period. For the fiscal 2024 six-month period, the diluted weighted average shares outstanding were 10,452,597 as compared to 10,256,158 for the fiscal 2023 six-month period.

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide the information required under this Item.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) that are designed to assure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide reasonable assurance only of achieving the desired control objectives, and we necessarily are required to apply our judgment in weighing the costs and benefits of possible new or different controls and procedures. Limitations are inherent in all control systems, so no evaluation of controls can provide absolute assurance that all control issues and any fraud have been detected. Because of the inherent limitations, we regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, and to maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient systems, consolidating activities, and migrating processes.

As required by Exchange Act Rule 13a-15(b), as of the end of the period covered by this report, we, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of April 30, 2024.

Changes in Internal Control Over Financial Reporting

During the second quarter of fiscal 2024, the Company implemented additional internal control over financial reporting as such term is defined in Rule 13a-15(f) of the Exchange Act, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

As described throughout this Quarterly Report, on March 15, 2024, the Company entered into the EBC Credit Agreement, under which proceeds from the initial drawings under the EBC Credit Facilities were used to repay in full the outstanding obligations under the BofA Loan Agreement. As a result of the EBC Credit Agreement and the loan structure, the Company implemented various processes and procedures which include continuous monitoring of the outstanding borrowings balance and the available borrowings, along with various updates to the payment process.

Our business, financial condition and operating results are affected by a number of factors, whether currently known or unknown, including risks specific to us or our industry, as well as risks that affect businesses in general. In addition to the information and risk factors set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended October 31, 2023, filed with the SEC on January 29, 2024. The risks disclosed in such Annual Report and in this Quarterly Report could materially adversely affect our business, financial condition, cash flows, or results of operations and thus our stock price. Other than the risk factor set forth below, we believe there have been no material changes in our risk factors from those disclosed in the Annual Report. However, additional risks and uncertainties not currently known or which we currently deem to be immaterial may also materially adversely affect our business, financial condition, or results of operations.

These risk factors may be important to understanding other statements in this Quarterly Report and should be read in conjunction with the unaudited condensed consolidated financial statements and related notes in Part I, Item 1, “Financial Statements” and Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report on Form 10-Q. Because of such risk factors, as well as other factors affecting the Company’s financial condition and operating results, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.

The following is an updated risk factor to the risk factors previously disclosed and included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2023:

We entered into a Loan Agreement to fund our acquisition of Microlab, which was subsequently replaced with a new credit facility, which may expose us to additional risks, including risks associated with the inability to repay the loan on a timely basis.

On March 15, 2024, we entered into a new loan and security agreement (the “EBC Credit Agreement”) with Eclipse Business Capital, as administrative agent (“EBC”) providing for (i) a senior secured revolving loan facility of up to $15.0 million (the “EBC Revolving Loan Facility”) and (ii) a senior secured revolving credit facility of up to $1.0 million (the “EBC Additional Line” and, together with the EBC Revolving Loan Facility, the “EBC Credit Facilities”) (with a $3.0 million swingline loan sublimit). We used proceeds from the initial drawings under the EBC Credit Facilities to repay in full outstanding obligations under the loan agreement (the “BofA Loan Agreement”) previously entered into by us and Bank of America, N.A. (the “BofA”) used to fund our acquisition of Microlab. Additional proceeds from the initial drawings under the EBC Credit Facilities were used to pay fees, premiums, costs and expenses, including fees payable in connection with the EBC Credit Agreement. The BofA Loan Agreement was terminated upon entry into the EBC Credit Agreement and is no longer in effect.

Availability of borrowings under the EBC Credit Facilities will be based upon a borrowing base formula and periodic borrowing base certifications valuing certain of our accounts receivable and inventories, as reduced by certain reserves, if any.

In the absence of an Event of Default (as defined in the EBC Credit Agreement) or certain other events (including the inability of EBC to determine the secured overnight financing rate “SOFR”), borrowings under (a) the EBC Revolving Loan Facility accrue interest at a rate of the one-month term SOFR reference rate plus an adjustment of 0.11448% (“Adjusted Term SOFR”) plus 5.00%, and (b) the EBC Additional Line accrue interest at a rate of Adjusted term SOFR plus 6.50%, in each case subject to a floor of 2.00% for Adjusted Term SOFR. We will be required to pay a commitment fee for the unused portion of the EBC Revolving Loan Facility of 0.50% per annum. In addition to the foregoing unused commitment fee, we are required to pay certain other administrative fees pursuant to the terms of the EBC Credit Agreement.

Our failure to comply with the terms of the EBC Credit Agreement could result in a default under the agreement. EBC may accelerate the payment terms of the EBC Credit Agreement upon the occurrence of certain events of default set forth therein. Any event that could require us to repay debt prior to its due date could have a material adverse impact on our financial condition and results of operations and may affect our ability to continue as a going concern. Further, any renegotiation, refinancing or additional indebtedness that we incur in the future may subject us to further covenants.

Our ability to comply with terms contained in the EBC Credit Agreement may be affected by events beyond our control, including prevailing economic, financial and industry conditions. Even if we are able to comply with all of the applicable covenants and terms, the restrictions on our ability to manage our business in our sole discretion could adversely affect our business by, among other things, limiting our ability to take advantage of financings, mergers, acquisitions and other corporate opportunities that we believe would be beneficial to us. In addition, our obligations under the EBC Credit Agreement are secured, on a first-priority basis, and such security interests could be enforced by EBC in the event of default by us.