UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

FOR THE QUARTERLY PERIOD ENDED June 30,December 31, 2015

ADDvantage Technologies Group, Inc.

ADDVANTAGE TECHNOLOGIES GROUP, INC.

Form 10-Q

For the Period Ended June 30,December 31, 2015

Item 1.  Financial Statements.

 

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”).  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, 2014.2015.

New inventory includes products purchased from the 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 TelevisionTV 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 TelevisionTV segment to allow for obsolete inventory, which increased the cost of sales during the ninethree months ended June 30,December 31, 2015, and 2014, by approximately $0.5$0.2 million.  For the Telco segment, any obsolete and excess telecommunications inventory is processed through its recycling program when it is identified.

Note 34 – Intangible Assets

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.  The intangible assets with their associated accumulated amortization amounts at June 30,December 31, 2015 and September 30, 20142015 are as follows:

The Company has an Amended and Restated Revolving Credit and Term Loan Agreement (“Credit and Term Loan Agreement”). with its primary financial lender.  At June 30,December 31, 2015, the Company has two term loans outstanding under the Credit and Term Loan Agreement.  The first outstanding term loan has an outstanding balance of $1.2$1.1 million at June 30,December 31, 2015 and is due on November 20,30, 2021, with monthly principal payments of $15,334 plus accrued interest.  The interest rate is the prevailing 30-day LIBOR rate plus 1.4% (1.58%(1.64% at June 30,December 31, 2015) and is reset monthly.  This term loan is collateralized by inventory, accounts receivable, equipment and fixtures and general intangibles.

The second outstanding term loan has an outstanding balance of $4.2$3.9 million at June 30,December 31, 2015 and is due March 4, 2019, with monthly principal and interest payments of $68,505, with the balance due at maturity.  It is a five year term loan with a seven year amortization payment schedule with a fixed interest rate of 4.07%.  This term loan is collateralized by inventory, accounts receivable, equipment and fixtures and general intangibles.

Capital Lease Obligations

The Company has two capital lease obligations related to machinery and equipment totaling $48$37 thousand at June 30,December 31, 2015 with monthly principal and interest payments of $2,069.  The capital lease obligations are due on June 20, 2017 and September 20, 2017.

The Company has a $7.0 million Revolving Line of Credit (“Line of Credit”) under the Credit and Term Loan Agreement.  At June 30,December 31, 2015, the Company had no balance outstanding under the Line of Credit.  The Line of Credit requires quarterly interest payments based on the prevailing 30-day LIBOR rate plus 2.75% (2.91% at June 30,December 31, 2015), and the interest rate is reset monthly.  Any future borrowings under the Line of Credit are due on November 27, 2015.March 31, 2017.  Future borrowings under the Line of Credit are limited to the lesser of $7.0 million or the net balance of 80% of qualified accounts receivable plus 50% of qualified inventory.  Under these limitations, the Company’s total available Line of Credit borrowing base was $7.0 million at June 30,December 31, 2015.  Among other financial covenants, the Line of Credit agreement provides that the Company maintain a fixed charge ratio of coverage (EBITDA to total fixed charges) of not less than 1.25 to 1.0, determined quarterly.  The Line of Credit is collateralized by inventory, accounts receivable, equipment and fixtures and general intangibles.

The Company has determined the fair value of its fixed-rate term loan utilizing the Level 2 hierarchy as the fair value can be estimated from broker quotes corroborated by other market data. These broker quotes are based on observable market interest rates at which loans with similar terms and maturities could currently be executed.  The Company then estimated the fair value of the fixed-rate term loan using cash flows discounted at the current market interest rate obtained.  The fair value of the Company’s fixed rate loan was $4.1$3.9 million as of June 30,December 31, 2015.

Note 56 – Earnings Per Share

Basic earnings per share are based on the sum of the average number of common shares outstanding and issuable restricted and deferred shares.  Diluted earnings per share include any dilutive effect of stock options and restricted stock.  In computing the diluted weighted average shares, the average stockshare price for the period is used in determining the number of shares assumed to be reacquired under the treasury stock method from the exercise of options.

Basic and diluted earnings per share for the three and nine months ended June 30,December 31, 2015 and 2014 are:

At the annual meeting of shareholders in March 2015, the shareholders approved theThe 2015 Incentive Stock Plan (the “Plan”).  The Plan provides for awards of stock options and restricted stock to officers, directors, key employees and consultants.  The Plan provides an additional 500,000 shares of common stock available for issuance in addition to those stock awards that were outstanding under the previous incentive stock plan.  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 June 30,December 31, 2015, 1,100,5911,100,415 shares of common stock were reserved for stock award grants under the Plan.  Of these reserved shares, 500,000532,085 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.

The Company records compensation expense over the vesting term of the related options.  At June 30,December 31, 2015, compensation costs related to these unvested stock options not yet recognized in the consolidated condensed statements of operationsincome was $119,288.$67,636.

Restricted Stock

The Company granted restricted stock in December 2015 and October 2015 to two new Directors totaling 3,333 and 4,465 shares, respectively which were valued at market value on the date of the grants.  The holding restriction on these shares will expire the first week of March 2016.  The fair value of the shares issued December 2015 and October 2015 totaled $7,500 and $10,000, respectively and is being amortized over the holding period as compensation expense.  The Company granted restricted stock in March 2015 to its Board of Directors totaling 31,91525,532 shares, net of forfeited shares of 6,383 shares, which were valued at market value on the date of grant.  The shares are being held by the Company for 12 months and will be delivered to the directors at the end of the 12 month holding period.  The fair value of these shares upon issuance totaled $75,000$60,000 and is being amortized over the 12 month holding period as compensation expense.  The Company granted restricted stock in April of 2014 to certain employees totaling 23,676 shares, which were valued at market value on the date of grant.  The shares have a holding restriction, which will expire in equal annual installments of 7,892 shares over three years starting in April 2015.  The fair value of these shares upon issuance totaled $76,000 and is being amortized over the respective one, two and three year holding periods as compensation expense.  The unamortized portion of the restricted stock is included in prepaid expenses on the Company’s consolidated condensed balance sheets.

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

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 also repairs cable television equipment for various cable companies.

The Company’s Telco segment primarily sells certified used telecommunications networking equipment from a broad range of manufacturers to customers primarily in North America as well as other international regions.America.  In addition, this segment alsois a reseller of new telecommunications equipment from certain manufacturers.  Also, this segment offers its customers decommissioning services for surplus and obsolete equipment, which it in turn processes through its recycling program.services.

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 plant and equipment, goodwill and intangible assets.

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 economic environment generally, 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 achievement 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, 2014,2015, 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.

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.

The Company’s Telco segment sells certified used telecommunications networking equipment from a broad range of manufacturers primarily in North America.  In addition, this segment is a reseller of new telecommunications equipment from certain manufacturers.  Also, this segment offers its customers decommissioning services for surplus and obsolete equipment, which it then processes through its recycling program.

Results of Operations

Consolidated sales increaseddecreased $2.6 million, or 28%24%, to $11.9$8.2 million for the three months ended June 30,December 31, 2015 from $9.3$10.8 million for the three months ended June 30,December 31, 2014.  The increasedecrease in sales resulted from a $2.4was in both the Cable TV and Telco segment of $1.8 million and $0.2$0.8 million, increase in sales in the Telco segment and Cable TV segment, respectively, compared to the same period last year.respectively.  Consolidated gross profit increased $0.9decreased $1.0 million, or 29%28%, to $4.1$2.8 million for the three months ended June 30,December 31, 2015 from $3.2$3.8 million for the same period last year.  The increase in gross profit was due primarily to a $0.5 million increase of gross profit from the Cable TV segment as a result of increased refurbished equipment sales that have higher gross profit margins, while gross profit from the Telco segment increased $0.4 million as a result of increased equipment sales compared to the same period last year.

million compared to the same period last year. Consolidated gross profit increased $4.9 million, or 67%, to $12.2 million for the nine months ended June 30, 2015 from $7.3 million for the same period last year.  The increasedecrease in gross profit was due to an increase in both the Telco segment of $4.3 million as a result of the Nave Communications acquisition and an increase in the Cable TV segment of $0.6 million.million and 0.4 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 increased $2.9decreased $0.4 million, or 40%13%, to $10.1$2.7 million for the ninethree months ended June 30,December 31, 2015 from $7.2$3.1 million for the same period last year.  This increasedecrease in expenses was primarily due to increased expenses of the Telco segment of $3.3$0.5 million, as a result of the Nave Communications acquisition, partially offset by decreasedan increase in expenses of $0.1 million in the Cable TV segment of $0.4 million.segment.

Interest expense remained relatively flat at $0.1 million for the three months ended December 31, 2015.

Operating, selling, general and administrative expenses increased $0.1 million to $0.2$1.5 million for the ninethree months ended June 30,December 31, 2015 from $0.1$1.4 million for the same period last year.  The increase was due primarily to interest expense incurred on the second outstanding term loan entered into in connection with the Nave Communications acquisition.

Sales for the Telco segment increased $11.2decreased $0.7 million to $15.1$3.3 million for the ninethree months ended June 30,December 31, 2015 from $3.9$4.0 million for the same period last year primarily as a result of the acquisition of Nave Communications.year.  The increasedecrease in sales resulted from an increasefor Telco segment was due to a decrease in used equipment sales of $10.9 million and recycling revenue of $0.9 million and $0.1 million, respectively, partially offset by an increase of new equipment revenue of $0.3 million.  The increaseWe believe the decline in used equipment sales was benefited by a $1.5 million equipment saledue largely to an end-user customerdelays in capital expenditures from our major customers due to weak economic conditions and budgetary constraints.  We expect that our sales will begin to increase over the second quarter of 2015.next several months.  Gross margin was 40%36% for the ninethree months ended June 30,December 31, 2015 and 44%45% for the same period last year.three months ended December 31, 2014.  The decrease in gross margin was due primarily to decreased margins from recycling revenue resulting from lower commodity prices.

Operating, selling, general and administrative expenses increased $3.3decreased $0.5 million to $5.7$1.2 million for the ninethree months ended June 30,December 31, 2015 from $2.4$1.7 million for the same period last year as a resultyear.  This decrease was due primarily to lower expenses of the acquisition of Nave Communications.  The increase in expenses included $0.8$0.4 million for the nine months ended June 30, 2015 and zero for the same period last year forrelated to the earn-out payments related topayment accrual for the Nave Communications acquisition.  In March 2015, we made our first of threeWe will make future earn-out payments for $0.7 million, which wasover the next two years equal to 70% of Nave Communications’ annual adjusted EBITDA in excess of $2.0 million for the twelve month period ending February 28, 2015.  We will make earn-out payments in March 2016 and 2017,per year (“Nave Earn-out”), which we estimate will be between $0.5 million and $1.0 million and $1.5 million each. In addition, for the nine months ended June 30, 2014, these expenses included $0.6 million of direct costs in connection with the acquisition of Nave Communications.annually.

EBITDA is a supplemental, non-GAAP financial measure.  EBITDA is defined as earnings before interest expense, income taxes, depreciation and amortization.  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 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.  EBITDA, as calculated below, may not be comparable to similarly titled measures employed by other companies.  In addition, EBITDA is not necessarily a measure of our ability to fund our cash needs.

A reconciliation by segment of operating income (loss) to EBITDA follows:

Critical Accounting Policies

Note 1 to the Consolidated Financial Statements in Form 10-K for fiscal 20142015 includes a summary of the significant accounting policies or methods used in the preparation of our Consolidated Condensed 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 periods.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 maycould differ from these estimates under different assumptions or

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 multiple system operators (“MSOs”),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 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.industry.  Inventory is stated at the lower of cost or market,and 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 June 30,December 31, 2015, we had total inventory, before the reserve for excess and obsolete inventory, of $27.1$25.9 million, consisting of $16.7$15.4 million in new products and $10.4$10.5 million in used or refurbished products.

For the Cable TV segment, our reserve at June 30,December 31, 2015 for excess and obsolete inventory was $2.6$2.9 million, which reflects an increase of approximately $0.5$0.2 million to reflect deterioration in the market demand of that inventory.  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 reserve and our gross margins could be materially adversely affected.

For the Telco segment, we do not maintain an inventory reserve as we recycle any surplus and obsolete equipment on hand through our recycling program when it is identified.

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.

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 reserve for bad debts was $0.2$0.3 million at June 30,December 31, 2015 and September 30, 2014.2015.   At June 30,December 31, 2015, accounts receivable, net of allowance for doubtful accounts, was $5.8$4.0 million.

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.  

We did not record a goodwill impairment for either of our two reporting units in the three year period ended September 30, 2015.  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, and a material negative change in the relationships with one or more of our significant customers or equipment suppliers.  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 value of each reporting unit also may change.

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.  We are currently evaluating a new operating system for our Telco segment, which when implemented, may impair a portion of our technology intangible asset.

Liquidity and Capital Resources

We finance our operations primarily through operations, and we also have available to us a bank line of credit of up to $7.0 million.  During the ninethree months ended June 30,December 31, 2015, we generated $1.1$1.0 million of cash flow forfrom operations.  The cash flow from operations was favorably impacted by $0.6$0.5 million from a net decrease in accounts receivable.inventory. The cash flow from operations was unfavorably impacted by $2.2$0.3 million from a net increasedecrease in inventoryaccrued expenses due primarily to purchases of used telecommunications equipment.a $0.2 million decrease in the earn-out accrual related to the Nave Communications acquisition.

During the ninethree months ended June 30,December 31, 2015, we increaseddecreased the earn-out liability related to the Nave Communications acquisition by $0.8$0.2 million, which is recorded in accrued expenses.  The earn-out is equal to 70% of Nave Communications adjusted EBITDA earnings in excess of $2.0 million for the twelve month period beginning March 1 each year.  In March 2015, we paid $0.7 million for the first of three annual Nave Earn-out payments.  We estimate the remaining two annual payments will be between $1.0$0.5 million and $1.5$1.0 million each.

In March 2015, we paid $1.0 million for the first of three annual installment payments to the Nave Communications owners for deferred consideration resulting from the Nave Communications acquisition.  The deferred consideration, which consists of $3.0 million to be paid in equal annual installments overDuring the three years, is recorded at its present value of $1.8 million at June 30, 2015.  During the nine months ended June 30,December 31, 2015, cash used in investing activities was $0.1$0.2 million primarily related to capital expenditures.the acquisition of the net operating assets of a business.  The acquisition is discussed in Note 2 of the Notes to the Consolidated Condensed Financial Statements included in Item 1 of this Quarterly Report on Form 10-Q.

At June 30,December 31, 2015, there was not a balance outstanding under our line of credit.  The lesser of $7.0 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 ($7.0 million at June 30,December 31, 2015).  Any future borrowings under the revolving credit facility are due at maturity.

We believe that our cash and cash equivalents of $4.6$6.7 million at June 30,December 31, 2015, 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.

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 June 30,December 31, 2015, 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.

PART II   OTHER INFORMATION

ADDVANTAGE TECHNOLOGIES GROUP, INC.

Exhibit Index