ADDVANTAGE TECHNOLOGIES GROUP INC - Quarter Report: 2018 March (Form 10-Q)

 

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See notes to unaudited consolidated condensed financial statements.

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ADDVANTAGE TECHNOLOGIES GROUP, INC.

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

Note 1 - Basis of Presentation and Accounting Policies

Basis of presentation

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

The accompanying unaudited consolidated condensed 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, consisting only of normal recurring items which are, in the opinion of management, necessary in order to make the consolidated condensed financial statements not misleading.  It is suggested that these consolidated condensed financial statements 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, 2017.

Reclassification

Certain prior year amounts have been reclassified to conform to the current year presentation.  These reclassifications had no effect on previously reported results of operations or retained earnings.

Recently Issued Accounting Standards

In May 2014, the FASB issued ASU No. 2014-09: “Revenue from Contracts with Customers (Topic 606)”. This guidance was issued to clarify the principles for recognizing revenue and develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards (“IFRS”).  In addition, in August 2015, the FASB issued ASU No. 2015-14: “Revenue from Contracts with Customers (Topic 606).  This update was issued to defer the effective date of ASU No. 2014-09 by one year.  Therefore, the effective date of ASU No. 2014-09 is for annual reporting periods beginning after December 15, 2017.  Based on management’s assessment of ASU No. 2014-09, management does not expect that ASU No. 2014-09 will have a material impact on the Company’s consolidated financial statements as the Company’s contracts generally consist of a single performance obligation to deliver tangible goods.  As part of the Company’s review of its contracts, the Company changed its processes for contract review of performance obligation contracts to help ensure the Company will be in compliance with this standard.

In February 2016, the FASB issued ASU No. 2016-02: “Leases (Topic 842)” which is intended to improve financial reporting about leasing transactions.  This ASU will require organizations (“lessees”) that lease assets with lease terms of more than twelve months to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases.  Organizations that own the assets leased by lessees (“lessors”) will remain largely unchanged from current GAAP.  In addition, this ASU will require disclosures to help investors and other financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases.  The guidance is effective for annual periods beginning after December 15, 2018 and early adoption is permitted.  Based on management’s initial assessment, ASU No. 2016-02 will have a material impact on the Company’s consolidated financial statements.  Management reviewed its lease obligations and determined that the Company generally does not enter into long-term lease obligations with the exception of its real estate leases for its facilities.  The Company is a lessee on certain real estate leases that will need to be reported as right of use assets and liabilities at an estimated amount of $3 million on the Company’s consolidated financial statements on the date of adoption.

In March 2016, the FASB issued ASU No. 2016-09: “Compensation – Stock Compensation (Topic 718)” which is intended to improve employee share-based payment accounting.  This ASU identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with
 

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actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows.  The guidance is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods.  Early adoption is permitted.  Management has determined that ASU No. 2016-09 will not have a material impact on the Company’s consolidated financial statements.  The Company does not currently have excess tax benefits or deficiencies from stock compensation expense.  The Company adopted ASU No. 2016-09 on October 1, 2017.

In June 2016, the FASB issued 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.  Entities will now 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.  ASU 2016-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal periods.  Entities may adopt earlier as of the fiscal year beginning after December 15, 2018, including interim periods within those fiscal years.  We are currently in the process of evaluating this new standard update.

In August 2016, the FASB issued ASU 2016-15: “Statement of Cash Flows (Topic 230) – Classification of Certain Cash Receipts and Cash Payments.”  This ASU addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice.  The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years.  Early adoption is permitted.  Based on management’s initial assessment of ASU No. 2016-15, the cash flows associated with guaranteed payments for acquisition of businesses will be reported as a financing activity in the Statement of Cash Flows, as opposed to an investing activity where it is currently reported.

In January 2017, the FASB issued ASU 2017-04: “Intangibles – Goodwill and Other (Topic 350) – Simplifying the Test for Goodwill Impairment.”  This ASU eliminates the second step in the goodwill impairment test which requires an entity to determine the implied fair value of the reporting unit’s goodwill.  Instead, an entity should recognize an impairment loss if the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, with the impairment loss not to exceed the amount of goodwill allocated to the reporting unit. This ASU is effective for annual and interim goodwill impairment tests conducted in fiscal years beginning after December 15, 2019, with early adoption permitted.  The Company is currently evaluating methodology changes that may be required in performing its annual goodwill impairment assessment in connection with this ASU and any impact that these changes may have on the Company’s financial statements.

Note 2 – Inventories

Inventories at March 31, 2018 and September 30, 2017 are as follows:

 

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New inventory includes products purchased from manufacturers plus “surplus-new”, which are unused products purchased from other distributors or multiple system operators.  Refurbished inventory includes factory refurbished, Company refurbished and used products.  Generally, the Company does not refurbish its used inventory until there is a sale of that product or to keep a certain quantity on hand.

The Company regularly reviews the Cable TV segment inventory quantities on hand, and an adjustment to cost is recognized when the loss of usefulness of an item or other factors, such as obsolete and excess inventories, indicate that cost will not be recovered when an item is sold.  The Company recorded charges in the Cable TV segment to allow for obsolete inventory, which increased the cost of sales by zero and $0.3 million during the six months ended March 31, 2018 and 2017, respectively, to an allowance of $2.3 million at March 31, 2018.

For the Telco segment, any obsolete or excess telecommunications inventory is generally processed through its recycling program when it is identified.  However, the Telco segment has identified certain inventory that more than likely will not be sold or that the cost will not be recovered when it is sold, and had not yet been processed through its recycling program.  Therefore, the Company has a $0.7 million allowance at March 31, 2018.  In the six months ended March 31, 2018, the Company increased the allowance, by $0.1 million.  The Company also reviewed the cost of inventories against estimated net realizable value and recorded a lower of cost or net realizable value charge for the six months ended March 31, 2018 and March 31, 2017 of $27 thousand and $52 thousand, respectively, for inventories that have a cost in excess of estimated net realizable value.

 

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remeasurement of the Company’s deferred tax balances was $0.4 million.  The accounting for the effects of the rate change on the deferred tax balances is complete and no provisional amounts were recorded for the new legislation.

Note 5 – Notes Payable and Line of Credit

Notes Payable

The Company has an Amended and Restated Revolving Credit and Term Loan Agreement (“Credit and Term Loan Agreement”) with its primary financial lender.  Revolving credit and term loans created under the Credit and Term Loan Agreement are collateralized by inventory, accounts receivable, equipment and fixtures, general intangibles and a mortgage on certain property.  Among other financial covenants, the Credit and Term Loan Agreement provides that the Company maintain a fixed charge coverage ratio (net cash flow to total fixed charges) of not less than 1.25 to 1.0 and a leverage ratio (total funded debt to EBITDA) of not more than 2.50 to 1.0.  Both financial covenants are determined quarterly.  The Company was not in compliance with the fixed charge ratio at March 31, 2018.  The Company has notified its primary financial lender of the covenant violation and requested that the primary financial lender waive the covenant violation.  As of the date of this filing, the primary financial lender has neither granted nor denied our waiver request.  In addition, the Company believes it may be out of compliance with its debt covenants again within the next twelve months.  Therefore, the Company has classified the $2.9 million outstanding balance of its term loans under the Credit and Term Loan Agreement, as current liabilities.

The noncompliance with these covenants results in an event of default, which if not cured or waived, could result in the lender accelerating the maturity of the Company’s indebtedness or preventing access to additional funds under the Credit and Term Loan Agreement, or requiring prepayment of outstanding indebtedness under the Credit and Term Loan Agreement.  If the maturity of the indebtedness is accelerated, sufficient cash resources to satisfy the debt obligations may not be available, and the Company may not be able to continue operations as planned.  The indebtedness under the Credit and Term Loan Agreement is secured by a security interest in substantially all of the tangible and intangible assets of the Company.  If the Company is unable to repay such indebtedness or refinance with a different lender, the primary financial lender could foreclose on these assets or require amendments to the Company’s debt agreements that could reduce its liquidity.   However, if these events occur, the Company believes that it will be able to secure funding from a different lender based on its continued ability to service the existing debt, its available assets, and the sales strategy and operational improvements it is implementing within its segments.

At March 31, 2018, the Company has two term loans outstanding under the Credit and Term Loan Agreement.  The first outstanding term loan has an outstanding balance of $0.7 million at March 31, 2018 and is due on November 30, 2021, with monthly principal payments of $15,334 plus accrued interest.  The interest rate is the prevailing 30-day LIBOR rate plus 1.4% (3.09% at March 31, 2018) and is reset monthly.

 

The second outstanding term loan has an outstanding balance of $2.2 million at March 31, 2018 and is due October 14, 2019, with monthly principal and interest payments of $118,809.  The interest rate on the term loan is a fixed interest rate of 4.40%.

 

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·	Level 1 – Quoted prices for identical assets in active markets or liabilities that we have the ability to access. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

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Level 2 – Inputs are other than quoted prices in active markets included in Level 1 that are either directly or indirectly observable. These inputs are either directly observable in the marketplace or indirectly observable through corroboration with market data for substantially the full contractual term of the asset or liability being measured.

·	Level 3 – Inputs that are not observable for which there is little, if any, market activity for the asset or liability being measured. These inputs reflect management’s best estimate of the assumptions market participants would use in determining fair value.

 

Note 7 – Stock-Based Compensation

 

Plan Information

The 2015 Incentive Stock Plan (the “Plan”) provides for awards of stock options and restricted stock to officers, directors, key employees and consultants.  Under the Plan, option prices will be set by the Compensation Committee and may not be less than the fair market value of the stock on the grant date.

At March 31, 2018, 1,100,415 shares of common stock were reserved for stock award grants under the Plan.  Of these reserved shares, 187,301 shares were available for future grants.

Stock Options

All share-based payments to employees, including grants of employee stock options, are recognized in the financial statements based on their grant date fair value over the requisite service period.  Compensation expense for share-based awards is included in the operating, selling, general and administrative expense section of the Company’s consolidated condensed statements of operations.

Stock options are valued at the date of the award, which does not precede the approval date, and compensation cost is recognized on a straight-line basis over the vesting period.  Stock options granted to employees generally become exercisable over a three, four or five-year period from the date of grant and generally expire ten years after the date of grant.  Stock options granted to the Board of Directors generally become exercisable on the date of grant and generally expire ten years after the grant.

A summary of the status of the Company's stock options at March 31, 2018 and changes during the six months then ended is presented below:

 

Note 8 – Segment Reporting

The Company is reporting its financial performance based on its external reporting segments: Cable Television and Telecommunications. These reportable segments are described below.

Cable Television (“Cable TV”)

The Company’s Cable TV segment sells new, surplus and re-manufactured cable television equipment throughout North America, Central America, South America and, to a substantially lesser extent, other international regions that utilize the same technology.  In addition, this segment repairs cable television equipment for various cable companies.

Telecommunications (“Telco”)

The Company’s Telco segment sells new and used 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.  In addition, this segment offers its customers decommissioning services for surplus and obsolete equipment, which it in turn processes through its recycling program.

The Company evaluates performance and allocates its resources based on operating income.  The accounting policies of its reportable segments are the same as those described in the summary of significant accounting policies.

Segment assets consist primarily of cash and cash equivalents, accounts receivable, inventory, property and equipment, goodwill and intangible assets.

 

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Special Note on Forward-Looking Statements

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,” “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 cable television industry, changes in the trends of the telecommunications industry, changes in our supplier agreements, technological developments, changes in the general economic environment, 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.

Overview

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, 2017, which includes our audited consolidated financial statements and the accompanying notes to the consolidated financial statements.

The Company is reporting its financial performance based on its external reporting segments: Cable Television and Telecommunications. These reportable segments are described below.

Cable Television (“Cable TV”)

The Company’s Cable TV segment sells new, surplus and re-manufactured cable television equipment throughout North America, Central America and South America.  In addition, this segment also repairs cable television equipment for various cable companies.

Telecommunications (“Telco”)

The Company’s Telco segment sells new and used 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.  In addition, this segment offers its customers decommissioning services for surplus and obsolete equipment, which it in turn processes through its recycling program.

Results of Operations

Consolidated

Consolidated sales increased $0.3 million before the impact of intercompany sales, or 3%, to $11.6 million for the three months ended March 31, 2018 from $11.3 million for the three months ended March 31, 2017.  The increase in sales was in the Telco segment of $0.7 million, partially offset by a decrease in sales in the Cable TV segment of $0.4 million.  Consolidated gross profit decreased $0.5 million, or 11%, to $3.3 million for the three months ended March

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31, 2018 from $3.8 million for the same period last year.  The decrease in gross profit was in the Cable TV segment and Telco segment of $0.3 million and $0.2 million, respectively.

Consolidated operating, selling, general and administrative expenses include all personnel costs, which include fringe benefits, insurance and business taxes, as well as occupancy, communication and professional services, among other less significant cost categories.  Operating, selling, general and administrative expenses decreased $0.3 million, or 7%, to $3.4 million for the three months ended March 31, 2018 from $3.7 million for the same period last year.  This decrease in expenses was due to the Cable segment of $0.3 million, while the Telco segment was relatively flat.

Other income and expense primarily consists of activity related to our investment in YKTG Solutions, including equity earnings (losses).  Equity losses for the three months ended March 31, 2018 were $0.3 million and zero for the three months ended March 31, 2017.  The equity losses for the three months ended March 31, 2018 consisted primarily of a legal settlement with a subcontractor on the YKTG Solutions wireless cell tower decommissioning project and the associated legal expenses.

Interest expense decreased $50 thousand to $50 thousand for the three months ended March 31, 2018 from $100 thousand for the period ended March 31, 2017.  The decrease in interest expense was due primarily to the impact of paying off one of our term loans in December 2017.

The benefit for income taxes was $0.1 million for the three months ended March 31, 2018 compared to a benefit for income taxes of $21 thousand for the three months ended March 31, 2017.  The effective income tax rate for the three months ended March 31, 2018 was 33%, which was favorably impacted from net operating losses in states with higher tax rates due primarily to the loss from YKTG Solutions.  The Company estimates that the effective income tax rate for the remaining quarters of fiscal year 2018 will be approximately 30% as a result of the Tax Cuts and Jobs Act enacted on December 22, 2017.

Segment Results

Cable TV

Sales for the Cable TV segment decreased $0.4 million to $4.6 million for the three months ended March 31, 2018 from $5.0 million for the same period last year.  The decrease in sales was due to a decrease in refurbished equipment sales and repair service revenue of $0.2 million and $0.8 million, partially offset by an increase in new equipment revenue of $0.6 million.  The decrease in the refurbished equipment sales was due primarily to an overall decrease in demand for the three months ended March 31, 2018 as compared to last year.  The decrease in repair service revenue was due primarily to the loss of a large repair business customer in the first quarter of fiscal year 2018.  As a result of this loss, the Company has closed two of its repair facilities and reduced personnel at its remaining repair facilities.

Gross margin was 33% for the three months ended March 31, 2018 compared to 35% for the same period last year due primarily to decreased margins on its equipment sales, partially offset by lower expenses related to the allowance for obsolete and excess inventory.

Operating, selling, general and administrative expenses decreased $0.3 million to $1.2 million for the three months ended March 31, 2018 from $1.5 million for the three months ended March 31, 2017.  This decrease was due primarily to decreased employee expenses as the Company closed two of its repair facilities and reduced personnel at its remaining repair facilities in 2017.

Telco

Sales for the Telco segment increased $0.7 million to $7.0 million for the three months ended March 31, 2018 from $6.3 million for the same period last year.  The increase in sales for the Telco segment was due to an increase in equipment sales of $1.2 million, partially offset by a decrease in recycling revenue of $0.5 million.  The increase in Telco equipment sales was due primarily to increased sales at Nave Communications of $1.4 million, partially offset by lower equipment sales at Triton Datacom of $0.2 million.  The decrease in recycling revenue was due primarily to timing of recycling shipments.  The increase in equipment sales at Nave Communications can be attributed in part to

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the Company addressing the lower equipment sales it had been experiencing over the past several quarters at Nave Communications by restructuring its sales force and implementing a new sales strategy.

Gross margin was 26% for the three months ended March 31, 2018 and 32% for the three months ended March 31, 2017.  The decrease in gross margin was due primarily to lower gross margins from Nave Communications equipment sales due primarily to the increased percentage of sales to resellers as compared to end user customers.  In addition, the decreased recycling revenue for the three months ended March 31, 2018 resulted in lower gross margins due primarily to the fixed costs incurred within this product line.

Operating, selling, general and administrative expenses remained flat at $2.2 million for both the three months ended March 31, 2018 and for the same period last year.

Consolidated

Consolidated sales increased $0.5 million before the impact of intercompany sales, or 2%, to $23.9 million for the six months ended March 31, 2018 from $23.4 million for the six months ended March 31, 2017.  The increase in sales was in the Telco segment of $1.6 million, partially offset by a decrease in the Cable TV segment of $1.1 million.  Consolidated gross profit decreased $1.1 million, or 14%, to $6.7 million for the six months ended March 31, 2018 from $7.8 million for the same period last year.  The decrease in gross profit was in the Cable TV segment of $1.4 million, partially offset by an increase in the Telco segment of $0.3 million.

Consolidated operating, selling, general and administrative expenses include all personnel costs, which include fringe benefits, insurance and business taxes, as well as occupancy, communication and professional services, among other less significant cost categories.  Operating, selling, general and administrative expenses decreased $0.2 million, or 3%, to $7.1 million for the six months ended March 31, 2018 from $7.3 million for the same period last year.  This decrease in expenses was due to the Cable segment of $0.4 million, partially offset by an increase in the Telco segment of $0.2 million.

Other income and expense primarily consists of activity related to our investment in YKTG Solutions, including equity earnings (losses).  Equity losses for the six months ended March 31, 2018 were $0.3 million and zero for the six months ended March 31, 2017.  The equity losses for the six months ended March 31, 2018 consisted primarily of a legal settlement with a subcontractor on the YKTG Solutions wireless cell tower decommissioning project and the associated legal expenses.

Interest expense decreased $0.1 million to $0.1 million for the six months ended March 31, 2018 from $0.2 million for the same period last year.  The decrease in interest expense was due primarily to the impact of paying off one of our term loans in December 2017.

The provision for income taxes was $0.2 million for the six months ended March 31, 2018, from a provision for income taxes of $0.1 million for the six months ended March 31, 2017.  The increase in the tax provision was due primarily to the Tax Cuts and Jobs Act enacted on December 22, 2017.  One of the provisions of this legislation was to reduce the corporate income tax rates effective beginning January 1, 2018.  As a result of the reduced corporate income tax rate, the Company remeasured its deferred tax balances at the reduced corporate income tax rate, which resulted in income tax expense of $0.4 million.  The effective tax rate for the six months ended March 31, 2018 was also favorably impacted by net operating losses in states with higher tax rates due primarily to the loss from YKTG Solutions.  The Company estimates that its effective income tax rate for the remaining quarters of fiscal year 2018 will be approximately 30% as a result of the legislation.

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Segment Results

Cable TV

Sales for the Cable TV segment decreased $1.1 million to $10.5 million for the six months ended March 31, 2018 from $11.6 million for the same period last year.  The decrease in sales was due to a decrease in refurbished equipment sales and repair service revenue of $0.7 million and $1.3 million, respectively, partially offset by an increase in new equipment revenue of $0.9 million.  The decrease in the refurbished equipment sales was due primarily to an overall decrease in demand for the six months ended March 31, 2018 as compared to last year.  The decrease in repair service revenue was due primarily to the loss of a large repair business customer in the first quarter of fiscal year 2018.  As a result of this loss, the Company has closed two of its repair facilities and reduced personnel at its remaining repair facilities.

Gross margin was 26% for the six months ended March 31, 2018 compared to 36% for the same period last year.  The decrease in gross margin was due primarily to a significant increase in volume for a new equipment sales customer with low margins and an overall decrease in margins on equipment sales, partially offset by lower expenses related to the allowance for obsolete and excess inventory.

Operating, selling, general and administrative expenses decreased $0.4 million to $2.6 million for the six months ended March 31, 2018 from $3.0 million for the same period last year.  This decrease was due primarily to decreased employee expenses as the Company closed two of its repair facilities and reduced personnel at its remaining repair facilities in 2017.

Telco

Sales for the Telco segment increased $1.6 million to $13.5 million for the six months ended March 31, 2018 from $11.9 million for the same period last year.  The increase in sales for the Telco segment was due to an increase in equipment sales of $1.8 million, partially offset by a decrease in recycling revenue of $0.2 million.  The increase in Telco equipment sales was due to increased sales at Nave Communications and Triton Datacom of $1.2 million and $0.6 million, respectively.  The increase in equipment sales at Nave Communications can be attributed in part to the Company addressing the lower equipment sales it had been experiencing over the past several quarters at Nave Communications by restructuring its sales force and implementing a new sales strategy.

Gross margin was 30% for the six months ended March 31, 2018 and 31% for the six months ended March 31, 2017.

Operating, selling, general and administrative expenses increased $0.2 million to $4.5 million for the six months ended March 31, 2018 from $4.3 million for the same period last year.  This increase was due primarily to increased personnel expenses.

Non-GAAP Financial Measure

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 excludes other income, 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.

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Critical Accounting Policies

Note 1 to the Consolidated Financial Statements in Form 10-K for fiscal 2017 includes a summary of the significant accounting policies or methods used in the preparation of our Consolidated Financial Statements.  Some of those significant accounting policies or methods require us to make estimates and assumptions that affect the amounts reported by us.  We believe the following items require the most significant judgments and often involve complex estimates.

General

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 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 could differ from these estimates under different assumptions or conditions.  The most significant estimates and assumptions are discussed below.

Inventory Valuation

Our position in the industry requires us to carry large inventory quantities relative to annual sales, but it also allows us to realize high overall gross profit margins on our sales.  We market our products primarily to MSOs, telecommunication providers and other users of cable television and 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.

We are required to make judgments as to future demand requirements from our customers.  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

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to market potential, or we may not be able to recover our acquisition costs for sales that we do make.  In order to address the risks associated with our investment in inventory, we review inventory quantities on hand and reduce the carrying value when the loss of usefulness of an item or other factors, such as obsolete and excess inventories, indicate that cost will not be recovered when an item is sold.

Our inventories consist of new and used electronic components for the cable television and telecommunications industries.  Inventories are 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, 2018, we had total inventory, before the allowance for excess and obsolete inventories, of $25.3 million, consisting of $14.8 million in new products and $10.5 million in used or refurbished products.

For the Cable TV segment, our allowance at March 31, 2018 for excess and obsolete inventory was $2.3 million, which reflects the same amount at September 30, 2017.  If actual market conditions are less favorable than those projected by management, and our estimates prove to be inaccurate, we could be required to increase our inventory allowance and our gross margins could be materially adversely affected.

For the Telco segment, any obsolete and excess telecommunications inventory is generally processed through its recycling program when it is identified.  However, the Telco segment identified certain inventory that more than likely will not be sold or that the cost will not be recovered when it is sold, and had not yet been processed through its recycling program.  Therefore, we have an allowance of $0.7 million at March 31, 2018.  In the six months ended March 31, 2018, we increased the allowance, by $0.1 million.  We also reviewed the cost of inventories against estimated market value and recorded a lower of cost or net realizable value write-off of $27 thousand for inventories that have a cost in excess of estimated net realizable value.  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, since the amounts involved are not considered material.

Accounts Receivable Valuation

Management judgments and estimates are made in connection with establishing the allowance for doubtful accounts. Specifically, we analyze the aging of accounts receivable balances, historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms.  Significant changes in customer concentration or payment terms, deterioration of customer credit-worthiness, or weakening in economic trends could have a significant impact on the collectability of receivables and our operating results.  If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, an additional provision to the allowance for doubtful accounts may be required.  The allowance for bad debts was $0.2 million at March 31, 2018 and September 30, 2017.  At March 31, 2018, accounts receivable, net of allowance for doubtful accounts, was $5.2 million.

Goodwill

Goodwill represents the excess of purchase price of acquisitions over the acquisition date fair value of the net assets of businesses acquired.  Goodwill is not amortized and is tested at least annually for impairment.  We perform our annual analysis during the fourth quarter of each fiscal year and in any other period in which indicators of impairment warrant additional analysis.  Goodwill is evaluated for impairment by first comparing our estimate of the fair value of each reporting unit, or operating segment, with the reporting unit’s carrying value, including goodwill.  Our reporting units for purposes of the goodwill impairment calculation are the Cable TV operating segment and the Telco operating segment.

Management utilizes a discounted cash flow analysis to determine the estimated fair value of each reporting unit.  Significant judgments and assumptions including the discount rate, anticipated revenue growth rate, gross margins and operating expenses are inherent in these fair value estimates.  As a result, actual results may differ from the

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estimates utilized in our discounted cash flow analysis.  The use of alternate judgments and/or assumptions could result in the recognition of different levels of impairment charges in the financial statements.  If the carrying value of one of the reporting units exceeds its fair value, a computation of the implied fair value of goodwill would then be compared to its related carrying value. If the carrying value of the reporting unit’s goodwill exceeds the implied fair value of goodwill, an impairment loss would be recognized in the amount of the excess.  If an impairment charge is incurred, it would negatively impact our results of operations and financial position.

We performed our annual impairment test for both reporting units in the fourth quarter of 2017 and determined that the fair value of our reporting units exceeded their carrying values.  Therefore, no impairment existed as of September 30, 2017.

We did not record a goodwill impairment for either of our two reporting units in the three year period ended September 30, 2017.  However, we are implementing strategic plans to help prevent impairment charges in the future, which include the restructuring and expansion of the sales organization in the Telco segment to increase the volume of sales activity, and reducing inventory levels in both the Cable TV and Telco segments.  Although we do not anticipate a future impairment charge, certain events could occur that might adversely affect the reported value of goodwill.  Such events could include, but are not limited to, economic or competitive conditions, a significant change in technology, the economic condition of the customers and industries we serve, a significant decline in the real estate markets we operate in, a material negative change in the relationships with one or more of our significant customers or equipment suppliers, failure to successfully implement our plan to restructure and expand the Telco sales organization, and failure to reduce inventory levels within the Cable TV or Telco segments.  If our judgments and assumptions change as a result of the occurrence of any of these events or other events that we do not currently anticipate, our expectations as to future results and our estimate of the implied fair value of each reporting unit also may change.

Intangibles

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.

Liquidity and Capital Resources

Cash Flows Provided by Operating Activities

We finance our operations primarily through cash flows provided by operations, and we have a bank line of credit of up to $5.0 million.  During the six months ended March 31, 2018, we generated $1.3 million of cash flows from operations.  The cash flows from operations was favorably impacted by $1.0 million from a net increase in accounts payable, which was due primarily to increased Cable TV inventory purchases at the end of March 2018.  The cash flows operations was negatively impacted by $0.4 million from a net decrease in accrued expenses, which primarily resulted from the first annual payment of the earn-out related to the acquisition of Triton Miami, Inc.

Cash Flows Used for Investing Activities

During the six months ended March 31, 2018, cash used in investing activities was $0.9 million, which primarily related to guaranteed payments related to the acquisition of Triton Miami, Inc. of $0.7 million.

Cash Flows Used for Financing Activities

During the six months ended March 31, 2018, we made principal payments of $3.4 million on our term loans under our Credit and Term Loan Agreement with our primary lender.  On December 6, 2017, as part of our overall plan to become compliant with our financial covenants with our primary financial lender, we extinguished one of our term loans by paying the outstanding balance of $2.7 million plus a prepayment penalty of $25,000.

Our first remaining term loan requires monthly payments of $15,334 plus accrued interest through November 2021.  Our second remaining term loan is a three year term loan with monthly principal and interest payments of $118,809 through October 2019.  The interest rate is a fixed rate of 4.40%.
 

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On March 30, 2018, the Company executed the Ninth Amendment under the Credit and Term Loan Agreement, which extended the Line of Credit maturity to March 29, 2019 and reduced the Line of Credit to $5.0 million from $7.0 million.  The other terms of the Line of Credit remained essentially the same.  At March 31, 2018, there was not a balance outstanding under our line of credit.   The lesser of $5.0 million or the total of 80% of the qualified accounts receivable plus 50% of qualified inventory is available to us under the revolving credit facility ($5.0 million at March 31, 2018).

We believe that our cash and cash equivalents of $0.9 million at March 31, 2018, cash flow from operations and our existing line of credit provide sufficient liquidity and capital resources to meet our working capital and debt payment needs.

Item 4.  Controls and Procedures.

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, 2018, 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.
 

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