ADDvantage Technologies (AEYGQ) 10-Q2022 Q2 Quarterly report

The consolidated financial statements include the accounts of ADDvantage Technologies Group, Inc. and its subsidiaries, all of which are wholly owned (collectively, the “Company”). Intercompany balances and transactions have been eliminated in consolidation. The Company’s reportable segments are Wireless Infrastructure Services (“Wireless”) and Telecommunications (“Telco”).

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial statements and do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. However, the information furnished reflects all adjustments, which are, in the opinion of management, necessary in order to make the unaudited consolidated financial statements not misleading. 

The Company’s business is subject to seasonal variations due to weather in the geographic areas where services are performed, as well as calendar events and national holidays. Therefore, the results of operations for the six months ended March 31, 2022 and 2021, are not necessarily indicative of the results to be expected for the full fiscal year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2021.

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13: “Financial Instruments – Credit Losses (Topic 326) – Measurement of Credit Losses on Financial Instruments.”  This ASU requires entities to measure all expected credit losses for most financial assets held at the reporting date based on an expected loss model which includes historical experience, current conditions, and reasonable and supportable forecasts. Upon adoption, entities will use forward-looking information to better form their credit loss estimates. This ASU also requires enhanced disclosures to help financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. On November 15, 2019, the FASB delayed the effective date of the standard for companies that qualify under smaller reporting company reporting rules. As amended, the effective date of ASC Topic 326 was delayed until fiscal years beginning after December 15, 2022 for SEC filers that are eligible to be smaller reporting companies under the Securities and Exchange Commission definition. We are currently in the process of evaluating this new standard update, however we do not anticipate the adoption will have a material impact on our results.

Contract assets and contract liabilities are included in unbilled revenue and deferred revenue, respectively, in the consolidated balance sheets. At March 31, 2022 and September 30, 2021, contract assets were $3.2 million and $2.5 million, respectively, and contract liabilities were $0.2 million and $0.2 million, respectively. The Company recognized $0.2 million of contract revenue during the six months ended March 31, 2021 related to contract liabilities recorded in deferred revenue at September 30, 2021.

On March 17, 2022, the Company replaced its $3.0 million credit facility for its Nave and Triton subsidiaries with its primary financial lender with new accounts receivable purchase facilities with capacities of $9.0 million for Nave and $1.5 million for Triton. Under both facilities, the lender advances the Company 90% of sold receivables and establishes a reserve of 10% of the sold receivables until the Company collects the sold receivables. The lender charges a fee of 1.3% of sold receivables, and both facilities mature on March 17, 2023.

For the six months ended March 31, 2022 and 2021, the Company received proceeds from the sold receivables from all of the facilities of $19.9 million and $9.5 million, respectively, and included the proceeds in net cash used in operating activities in the consolidated statements of cash flows. The Company recorded costs of $0.3 million and $0.1 million for the six months ended March 31, 2022 and 2021, respectively, in other expense in the consolidated statements of operations.

New equipment includes products purchased from manufacturers plus “surplus-new,” which are unused products purchased from other distributors or multiple system operators. Refurbished and used equipment include factory refurbished, Company refurbished and used products.

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the asset’s carrying amount may not be recoverable. The Company groups assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities and evaluate the asset group against the sum of the undiscounted future cash flows. If the undiscounted future cash flows do not indicate the carrying amount of the asset is recoverable, an impairment charge is measured as the amount by which the carrying amount of the asset group exceeds its fair value based on discounted cash flow analysis or appraisals.

On March 17, 2022, the Company closed its $3.0 million credit facility for its Nave and Triton subsidiaries with its primary financial lender. See Note 3 - Accounts Receivable Agreements for more information about the Company's receivables purchase facilities.

On April 24, 2020, the Company entered into an Equity Distribution Agreement with Northland Securities, Inc., as agent (“Northland”), pursuant to which the Company may offer and sell, from time to time, through Northland, shares of the Company’s common stock, par value 0.01 per share, having an aggregate offering price of up to $13.9 million ("Shares").

The offer and sale of the Shares will be made pursuant to a shelf registration statement on Form S-3 and the related prospectus filed by the Company with the Securities and Exchange Commission (the “SEC”) on March 3, 2020, as amended on March 23, 2020, and declared effective by the SEC on April 1, 2020.

Pursuant to the Sales Agreement, Northland may sell the Shares by any method permitted by law deemed to be an “at the market offering” as defined in Rule 415 of the Securities Act of 1933 (the “Securities Act”), including sales made by means of ordinary brokers’ transactions, including on The Nasdaq Capital Market, at market prices or as otherwise agreed with Northland. Northland will use commercially reasonable efforts consistent with its normal trading and sales practices to sell the Shares from time to time, based upon instructions from the Company, including any price or size limits or other customary parameters or conditions the Company may impose. The Sales

Agreement may be terminated without prior notice at any time prior to the fulfillment if additional sales are deemed not warranted.

The Company will pay Northland a commission rate equal to an aggregate of 3.0% of the aggregate gross proceeds from each sale of Shares and have agreed to provide Northland with customary indemnification and contribution rights. The Company will also reimburse Northland for certain specified expenses in connection with entering into the Sales Agreement. The Sales Agreement contains customary representations and warranties and conditions to the placements of the Shares pursuant thereto.

During the six months ended March 31, 2022, 464,772 shares were sold by Northland on behalf of the Company with gross proceeds of $0.8 million, and net proceeds after commissions and fees of $0.8 million.

Basic and diluted earnings per share for the three and six months ended March 31, 2022 and 2021 are (in thousands, except per share amounts):

The table below includes information related to stock options that were outstanding at the end of each respective three and six-month period ended March 31, but have been excluded from the computation of weighted-average stock options for dilutive securities because their effect would be anti-dilutive.

As of September 30, 2021, there were 50,000 stock options with a weighted average exercise price of $1.28 per share and an aggregate intrinsic value of $54,000 outstanding under the Plan. There were no stock options granted, exercised, expired or forfeited during the six months ended March 31, 2022. As of March 31, 2022, 50,000 stock options remained outstanding and exercisable, with an average exercise price of $1.28 per share and an aggregate intrinsic value of $7,500.

During the three month period ended March 31, 2022 and 2021, compensation expenses related to share-based arrangements including restricted stock and stock option awards, were $0.2 million and $0.2 million, respectively.

During the six month period ended March 31, 2022 and 2021, compensation expenses related to share-based arrangements including restricted stock and stock option awards, were $0.5 million and $0.6 million respectively.

The Company did not recognize a tax benefit for compensation expense recognized during the three and six month period ended March 31, 2022 and 2021.

At March 31, 2022, unrecognized compensation expense related to non-vested share-based compensation awards not yet recognized in the consolidated statements of operations was $0.6 million. That cost is expected to be recognized over a period of 2.9 years.

Our Telco segment has an operating lease for a building in Jessup, Maryland for Nave Communications.  As a result of moving Nave’s operations to Palco Telecom, a third-party logistics provider in Huntsville, Alabama, in fiscal year 2020, Nave completely vacated the building in May 2020 and has subleased part of the building through the end of the lease period. 

Certain statements in Management's Discussion and Analysis (“MD&A”), other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements generally are identified by the words “estimates,” “projects,” "anticipates," “believes,” “plans,” “intends,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. These statements are subject to a number of risks, uncertainties and developments beyond our control or foresight, including changes in the trends of the wireless infrastructure services industry, changes in the trends of the telecommunications industry, changes in our supplier agreements, technological developments, changes in the general economic environment, the potential impact of the novel strain of coronavirus (“COVID-19”) pandemic, the growth or formation of competitors, changes in governmental regulation or taxation, changes in our personnel and other such factors. Our actual results, performance or achievements may differ significantly from the results, performance or achievements expressed or implied in the forward-looking statements. We do not undertake any obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

The following MD&A is intended to help the reader understand the results of operations, financial condition, and cash flows of the Company. MD&A is provided as a supplement to, and should be read in conjunction with the information presented elsewhere in this quarterly report on Form 10-Q and with the information presented in our annual report on Form 10-K for the year ended September 30, 2021, which includes our audited consolidated financial statements and the accompanying notes to the consolidated financial statements.

The Company reports its financial performance based on two external reporting segments: Wireless and Telecommunications.  These reportable segments are described below.

The Company’s Wireless segment provides turn-key wireless infrastructure services for the four major U.S. wireless carriers, communication tower companies, national integrators, and original equipment manufacturers that support these wireless carriers. These services primarily consist of the installation and upgrade of technology on cell sites and the construction of new small cells for 5G.

The Company’s Telco segment sells new and refurbished telecommunications networking equipment, including both central office and customer premise equipment, to its customer base of telecommunications providers, enterprise customers and resellers located primarily in North America. This segment also offers its customers repair and testing services for telecommunications networking equipment. In addition, this segment offers its customers decommissioning services for surplus and obsolete equipment.

On March 11, 2020, the World Health Organization declared the current outbreak of COVID-19 to be a global pandemic, and on March 13, 2020, the United States declared a national emergency. In response to these declarations and the rapid spread of COVID-19, federal, state and local governments have imposed varying degrees of restrictions on business and social activities to contain COVID-19, including quarantine and “stay-at-home” or “shelter-in-place” orders in markets where we operate. Despite these “stay-at-home” or “shelter-in-place” orders, we are classified as an essential business due to the services and products we provide to the

telecommunications industry. Therefore, we continue to operate in the markets we serve while these orders were in place. Most of our back-office and administrative personnel worked from home while these orders were in place, these personnel began working in the office as restrictions were relaxed or lifted. 

With the partial reopening of the economy the economic effects of the pandemic, including new Covid 19 variants, and resulting societal changes remain unpredictable. Although we experienced increased revenues in recent quarters compared to prior year quarters since the pandemic began in 2020, there are a number of uncertainties that could impact our future results of operations, including the efficacy and widespread distribution of a vaccine, the return of major outdoor events during the summer and fall months, and the impact of COVID-19 on the operating results and capital budgets of our customers.

Consolidated sales increased $11.1 million, or 88%, to $23.8 million for three months ended March 31, 2022 from $12.7 million for the three months ended March 31, 2021.  The increase in sales was due to increased sales in the Telco segment of $7.7 million and an increase in Wireless segment sales of $3.4 million.

Consolidated gross profit was $5.8 million, or 24% gross margin for the three months ended March 31, 2022, compared to gross profit of $3.2 million, or 25% gross margin for the three months ended march 31, 2021, an increase of $2.6 million. The increase in gross profit was due to an increase in the Telco segment of $2.6 million. The decrease in gross margin percent was due to lower margins in the Wireless segment offset by increases in the Telco segment as a result of continued global supply chain constraints.

Consolidated operating expenses include indirect costs associated with operating our business. Indirect costs include indirect personnel costs, facility costs, vehicles, insurance, communication, and business taxes, among other cost categories. Operating expenses were $2.8 million, compared to $2.2 million in the same period last year, an increase of $0.6 million due primarily to increases in headcount in our Wireless segment to support 5G services activity.

Consolidated selling, general and administrative ("SG&A") expenses include overhead costs, which consist of personnel costs, insurance, professional services, and communication, among other less significant cost categories. SG&A expense increased $0.1 million, or 2%, to $3.9 million for the three months ended March 31, 2022 from $3.8 million for the same period last year. The increase in SG&A relates primarily to increased selling and commissions expenses to support higher revenues.

Revenues for the Wireless segment increased $3.5 million to $7.8 million for the three months ended March 31, 2022 from $4.3 million for the same period of last year. The growth in revenues over the prior year period relates to the pace of the 5G services activity construction undertaken on behalf of our expanded customer base. Revenues from some customers have been impacted by global supply chain issues as components necessary for build outs have slowed in some cases.

Gross profit was $1.5 million, or 20% for the three months ended March 31, 2022 compared to $1.5 million, or 35%, for the three months ended March 31, 2021. The decrease in the gross profit percentage was the result of new business with a major customer at a lower margin level caused by deploying to new markets and related startup costs, and as a result of a couple of non-profitable markets, due to lower volume commitments from some customers, which we have exited.

Sales for the Telco segment increased $7.7 million to $16.0 million for the three months ended March 31, 2022 from $8.3 million for the same period last year. The increase in revenues was related to increased sales of used and refurbished equipment as a result of continued global supply chain constraints.

Gross profit was $4.2 million and $1.7 million for the three months ended March 31, 2022 and 2021, respectively. The increased gross profit was due primarily to increased revenues of $16.0 million. Additionally, global supply chain issues have generally led to higher pricing to customers.

Income from operations was $1.0 million for the three months ended March 31, 2022 compared to a loss of $1.5 million for the same period last year, primarily due to the reasons discussed above.

Income from operations was $1.5 million for the six months ended March 31, 2022 compared to a loss of $2.3 million for the same period last year.

Adjusted EBITDA is a supplemental, non-GAAP financial measure.  EBITDA is defined as earnings before interest expense, income taxes, depreciation and amortization. Adjusted EBITDA as presented also excludes impairment charges for operating lease right-of-use assets and intangible assets including goodwill, stock compensation expense, other income, other expense, interest income and income from equity method investment. Adjusted EBITDA is presented below because this metric is used by the financial community as a method of measuring our financial performance and of evaluating the market value of companies considered to be in similar businesses.  Since Adjusted EBITDA is not a measure of performance calculated in accordance with GAAP, it should not be considered in isolation of, or as a substitute for, net earnings as an indicator of operating performance. Adjusted EBITDA, as calculated below, may not be comparable to similarly titled measures employed by other companies.  In addition, Adjusted EBITDA is not necessarily a measure of our ability to fund our cash needs.

Our unaudited consolidated financial statements are impacted by the accounting policies used and the estimates and assumptions made by management during their preparation. A complete summary of our significant accounting policies is included in Note 1- Basis of Presentation and Accounting Policies in our Form 10-K.

The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates and judgments on historical experience, current market conditions, and various other factors we believe to be reasonable, which form the basis for making judgments about the carrying values of certain assets. Actual results could differ from these estimates under different assumptions or conditions. The most significant estimates and assumptions are discussed below.

For our Telco segment, our position in the telecommunications industry requires us to carry large inventory quantities relative to annual sales, but it also allows us to realize higher gross profit margins on our sales.  We market our products primarily to telecommunication providers, resellers, and other users of telecommunication equipment who are seeking products for which manufacturers have discontinued production or cannot ship new equipment on a same-day basis, as well as providing used products as an alternative to new products from the manufacturer.  Carrying these large inventory quantities represents our largest risk for our Telco segment.

Our inventories are all carried in the Telco segment and consist of new and used electronic components for the telecommunications industry.  Inventory is stated at the lower of cost or net realizable value, with cost determined using the weighted-average method. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.  At March 31, 2022, we had total inventory, before the reserve for excess and obsolete inventories, of $9.5 million, consisting of $1.4 million in new products and $8.0 million in used or refurbished products.

We regularly review the value of our inventory in detail with consideration given to rapidly changing technology which can significantly affect future customer demand. For individual inventory items, we may carry inventory quantities that are excessive relative to market potential, or we may not be able to recover our acquisition costs. In order to address the risks associated with our investment in inventory, we review inventory quantities on hand and reduce the carrying value for obsolete and excess inventories, when our analysis indicates that cost will not be recovered when an item is sold.

We identified certain inventory that more than likely will not be sold or that the cost will not be recovered. Therefore, we have an obsolete and excess inventory reserve of $3.6 million at March 31, 2022. If actual market conditions differ from those projected by management, this could have a material impact on our gross margin and inventory balances based on additional write-downs to net realizable value or a benefit from inventories previously written down.

Inbound freight charges are included in cost of sales. Purchasing and receiving costs, inspection costs, warehousing costs, internal transfer costs and other inventory expenditures are included in operating expenses.

Intangible assets that have finite useful lives are amortized on a straight-line basis over their estimated useful lives ranging from 3 years to 10 years. Intangible assets are also tested for impairment when events and circumstances indicate that the carrying value may not be recoverable. As of March 31, 2022, there were no indicators of impairment present.

During the six months ended March 31, 2022, cash provided by operations was $4.7 million. Cash flows from operations were negatively impacted by a net loss of $3.4 million, offset by net cash provided by working capital of $6.8 million primarily related to the reduction of receivables associated with our new accounts receivable purchase facilities, and non-cash adjustments of $1.3 million, primarily depreciation and amortization.

During the six months ended March 31, 2022, cash used in investing activities was $0.2 million, consisting of purchases of property and equipment.

During the six months ended March 31, 2022, cash used in financing activities was $1.6 million, primarily consisting of $2.1 million related to repayment of our bank line of credit and payments on financing lease obligations of $0.3 million, partially offset by net proceeds from the sale of our common stock utilizing our shelf registration of $0.8 million. 

On March 17, 2022, the Company replaced its $3.0 million credit facility for its Nave and Triton subsidiaries with its primary financial lender with new accounts receivable purchase facilities. The Company also restructured its accounts receivable purchase facilities secured by the Company’s Fulton subsidiary’s receivables. With the new and restructured receivables purchase facilities, the Company has increased its overall capacity to factor its accounts receivable during the quarter ended March 31, 2022 from $16.0 million to $19.0 million for working capital needs.

We maintain disclosure controls and procedures that are designed to ensure the information we are required to disclose in the reports we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.  Based on their evaluation as of March 31, 2022, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to accomplish their objectives and to ensure the information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.