Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated historical financial statements and the notes to those statements that appear elsewhere in this report. Certain statements in the discussion contain forward-looking statements based upon current expectations that involve risks and uncertainties, such as plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors.
General
The Company reports its financial performance based on two external reporting segments: Wireless and Telecommunications. These reportable segments are described below.
Wireless Infrastructure Services (“Wireless”)
The Company's Wireless Segment, which consists entirely of the assets of Fulton, 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.
Telecommunications (“Telco”)
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, which it in turn processes through a recycling partner.
Recent Business Developments
Change in year end
In September 2022, the Company's Board of Directors approved a change in the Company's fiscal year end from September 30 to December 31, effective for the fiscal year beginning January 1, 2022. As a result of the change in year end, the Company filed a Transition Report on Form 10-Q for the period from October 1, 2021 through December 31, 2021.
Wireless Segment Operating Results
During 2022, Fulton achieved revenues of $30.8 million. Fulton has maintained a strong employee base, and we continue to successfully recruit strong industry talent throughout the business to help us implement operational improvements with a focus on improving our quality and project margins. We also have a large part of our workforce made up of reliable, high quality subcontractors that give us the ability to flex up and down with the changes in workload and to ramp up quickly for new programs. We are expecting increased activity in the industry as wireless carriers roll out 5G and the required densification of their networks. Our goal is to solidify our processes and project oversight to successfully and profitably take advantage of new growth opportunities as the 5G expansion becomes essential.
Telco Segment
The Telco segment achieved revenues of $66.2 million during 2022. We continue to focus our core team on sales and procurement. Both Nave and Triton grew over 40% year-over-year in 2022.
At Triton, our facility is designed to streamline our processes, including inventory management, shipping and receiving and the refurbishment operations. We have developed the internal systems necessary to expand our refurbishment capabilities and new equipment sales by adding additional product lines and manufacturers. We have also increased our focus on the brokerage business and internet sales by expanding our sales channels. We believe that Triton is poised to expand, capturing additional market share and developing new customers.
Our Nave business experienced significant upside during the year related to the global chip shortage along with expansion of our offerings to both wireless and optical network carriers to support both wireless and broadband connectivity for optical and IP transport.
Results of Operations
Comparison of Operating Results for the Years Ended December 31, 2022 and September 30, 2021
Consolidated
Consolidated sales increased $34.8 million, or 56%, to $97.0 million for 2022 from $62.2 million for 2021. The increase in sales was related to an increase of $24.7 million in the Telco segment mainly attributable to increased demand for refurbished network equipment resulting from the global chip shortage. Sales for the Wireless segment increased $10.1 million as a result of the 5G network rollout.
Consolidated gross profit increased $11.6 million, or 72%, to $27.8 million for 2022 from $16.1 million for 2021. Telco gross profit increased $9.3 million and our Wireless segment gross profit increased $2.3 million. The improvement in gross profit was due to strong demand in our Telco segment fueled by global supply issues, along
with expansion of our offerings to both wireless and optical network carriers to support both wireless and broadband connectivity for optical and IP transport.
Consolidated operating expenses include indirect costs associated with operating our business. Indirect costs include indirect personnel costs, facility costs, vehicles, fuel, insurance, communication, and business taxes, among other cost categories. Operating expenses increased $0.5 million to $9.8 million for the twelve months ended December 31, 2022 compared with $9.3 million for the prior year. The increase in operating expenses was due primarily to our investment in our regional growth strategy to meet the demand of our customers in the Wireless segment, partially offset by cost control measures instituted by the Company during the latter part of the first quarter and continuing throughout 2022.
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 $0.7 million or 5% to $15.6 million in 2022 compared to $14.9 million in 2021. The increase in SG&A relates primarily to increased selling and commissions expenses to support higher revenues.
The income tax provision (benefit) was $8 thousand for 2022 and $(0.1) million for 2021, or an effective tax rate of 1.7% and (0.8)%, respectively. The income tax provision in fiscal 2022 was the result of State income taxes which were not offset by losses from other subsidiaries. The income tax benefit in fiscal 2021 was the result of an increase in the valuation allowance against our deferred tax assets, offset by certain refundable credits generated in the current fiscal year. The Company continues to provide a valuation allowance of $9.1 million for net deferred assets where the Company believes it is more likely than not that those deferred taxes will not be realized.
Segment results
Wireless
Revenues for the Wireless segment were $30.8 million and $20.7 million for the years ended December 31, 2022 and September 30, 2021, respectively, an increase of 49%. The growth in revenues over the prior year relates to the pace of the 5G services activity undertaken on behalf of our expanded customer base.
Gross profit was $8.6 million, or 28% for the year ended December 31, 2022 and $6.3 million, or 30%, for the year ended September 30, 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.
Loss from operations was $4.8 million and $6.9 million for the years ended December 31, 2022 and September 30, 2021, respectively. The decrease is mainly attributable to the increase in revenues and improvements in operating efficiencies.
Telco
Revenues for the Telco segment were $66.2 million and $41.5 million for the years ended December 31, 2022 and September 30, 2021, respectively, an increase of $24.7 million, or 59%. The increase was related to increased sales of used and refurbished equipment as a result of global supply chain constraints along with expansion of our offerings to both wireless and optical network carriers to support both wireless and broadband connectivity for optical and IP transport.
Gross profit increased $9.3 million, or 95%, to $19.2 million for the year ended December 31, 2022 compared to $9.9 million for the year ended September 30, 2021. Gross margin was 29% and 24% for the years ended December 31, 2022 and September 30, 2021, respectively. Gross margin increased primarily as a result of the segment's increase in revenues coupled with an increase in gross profit percent by 5% due to price elasticity associated with global supply chain issues.
Income from operations was $6.3 million for the year ended December 31, 2022 compared to a loss of $2.4 million for the year ended September 30, 2021. The increase was attributable to the increase in revenue and the aforementioned improvements.
Comparison of Operating Results for the Three Months Ended December 31, 2021 and December 31, 2020
Consolidated
Consolidated sales increased $6.0 million, or 47%, to $18.7 million for the three months ended December 31, 2021 from $12.7 million for the three months ended December 31, 2020. The increase was primarily due to a $1.9 million increase in Wireless revenue related to 5G tower work, and an increase of $4.1 million in Telco revenue due to increased demand for refurbished telecommunications equipment sold by the Telco segment.
Consolidated gross profit was $4.6 million, or 25% gross margin, compared to gross profit of $3.6 million, or 28% gross margin, for the same period last year. The net changes in gross profit were due to higher overall sales in both the Wireless and Telco segments, and the decrease in gross margin as a percent of sales was due to investments made with a new wireless customer and the impact of the Company onboarding new crews in anticipation of near-term wireless revenue increases.
Consolidated operating expenses increased $0.5 million to $2.5 million for the three months ended December 31, 2021 compared to $2.0 million the same period last year. The increase reflects the Company's investment in its regional growth strategy related to expected 5G infrastructure growth.
Consolidated SG&A expense increased $0.5 million, or 15%, to $3.7 million for the three months ended December 31, 2021 from $3.2 million for the same period last year. The increase in SG&A relates primarily to increased selling and commissions expenses to support higher revenues.
Segment Results
Wireless
Revenues for the Wireless segment increased $1.9 million to $7.1 million for the three months ended December 31, 2021 from $5.2 million for the same period of 2020. The growth in revenues over the prior year relates to the pace of the 5G services activity in 2021.
Gross profit was $1.5 million, or 21% for the three months ended December 31, 2021 and $1.6 million, or 31%, for the three months ended December 31, 2020. The decrease in the gross profit percentage was the result of new business with a major customer at a lower margin level, along with continuing investment in our regional growth strategy associated with anticipated 5G infrastructure build outs, which includes the expansion and training of new wireless service crews.
Loss from operations was $2.3 million and $1.1 million for three months ended December 31, 2021 and 2020, respectively. The increase is mainly attributable to investment in our regional growth strategy associated with anticipated 5G infrastructure build outs.
Telco
Revenues for the Telco segment increased $4.1 million to $11.6 million for the three months ended December 31, 2021 from $7.5 million for the same period of 2020. The increase in revenues was related to increased sales of used and refurbished equipment as a result of global supply chain constraints along with expansion of our offerings to both wireless and optical network carriers to support both wireless and broadband connectivity for optical and IP transport..
Gross profit was $3.1 million, or 27% for the three months ended December 31, 2021 and $2.0 million, or 27% for the three months ended December 31, 2020. The increased gross profit was due primarily to increased revenues of $4.1 million.
Income from operations was $0.4 million for the three months ended December 31, 2021 compared to a loss of $0.8 million for the same period last year, primarily due to the reasons discussed above.
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 also excludes stock compensation expense, gain on extinguishment of debt, impairment of intangibles and right of use assets, 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 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.
A reconciliation by segment of loss from operations to Adjusted EBITDA follows, in thousands:
For the year ended December 31, 2022
For the year ended September 30, 2021
Wireless
Telco
Total
Wireless
Telco
Total
Income (loss) from operations
Depreciation and amortization expense
Stock compensation expense
Adjusted EBITDA (a) (b)
Three Months Ended December 31, 2021
Three Months Ended December 31, 2020
Wireless
Telco
Total
Wireless
Telco
Total
Income (loss) from operations
Depreciation and amortization expense
Stock compensation expense
Adjusted EBITDA
(a) The Telco segment includes an inventory obsolescence charge of $0.3 million and $0.4 million for the years ended December 31, 2022 and September 30, 2021, respectively. In addition, the Telco segment includes a lower of cost or net realizable value charge of $0.2 million and $0.1 million for the years ended December 31, 2022 and September 30, 2021, respectively.
(b) The Company allocates its corporate general and administrative expenses to the reportable segments. See Note 14 - Segment Reporting in the Consolidated Financial Statements for further discussion of segments.
Liquidity and Capital Resources
Liquidity and Capital Resources
At December 31, 2022 we had $3.7 million in cash and equivalents and restricted cash.
During fiscal 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 an overall capacity to factor its accounts receivable of $19.0 million for working capital needs. At December 31, 2022, the Company had $7.0 million utilized under the receivables purchase facilities, leaving $12.0 million available to the Company to purchase new receivables generated in 2023. The Company is evaluating various funding arrangements to supplement working capital, which could include the filing of a registration statement for the sale of equity, and the issuance of debt, either convertible or non-convertible, which might or might not include the issuance of warrants or shares associated with the transaction.
Cash Flows Provided by (Used in) Operating Activities
Cash provided by (used in) operating activities was $2.2 million, $(0.9) million and $(7.5) million for the year ended December 31, 2022, the transition period of three months ended December 31, 2021, and the year ended September 30, 2021, respectively. Cash flows from operations in 2022 were positively impacted by net income of $0.5 million, net cash provided by working capital of $30 thousand primarily related to the reduction of receivables associated with our new accounts receivable purchase facilities, an increase in inventory,, and non-cash adjustments of $1.7 million, primarily depreciation, amortization, provision for excess and obsolete inventories, charge for lower of cost or net realizable value inventories, and stock based compensation expenses.
Cash Flows Provided by (Used in) Investing Activities
Capital expenditures and proceeds from asset sales are the main components of our investing activities. Cash provided by (used in) investing activities was $0.3 million, $(0.1) million and $3.5 million for the year ended December 31, 2022, the transition period of three months ended December 31, 2021, and the year ended September 30, 2021, respectively. Cash flows from investing in 2022 consisted primarily of disposals of property and equipment, partially offset by purchases of property and equipment.
Cash Flows Provided by (Used in) Financing Activities
Cash (used in) financing activities consist primarily of repayments on our bank line of credit and payments on financing lease obligations, partially offset by net proceeds from the sale of our common stock using our shelf registration and proceeds from stock options exercised. Cash provided by (used in) financing activities was $(1.3) million, $0.5 million and $(1.4) million for the year ended December 31, 2022, the transition period of three months ended December 31, 2021, and the year ended September 30, 2021, respectively.
Critical Accounting Policies and Estimates
Note 1 to the Consolidated Financial Statements in this Form 10-K for fiscal year 2022 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
For our Telco segment, our position in the telecommunications industry requires us to carry relatively 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 telecommunication providers, telecommunication 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.
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 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 price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. At December 31, 2022, we had total inventory, before the reserve for excess and obsolete inventories, of $13.4 million, consisting of $2.3 million in new products and $11.1 million in used or refurbished products.
We identified certain inventory that more than likely will not be sold or that the cost will not be recovered when it is processed through recycling. Therefore, we have an obsolete and excess inventory reserve of $3.9 million at December 31, 2022. In 2022, we increased the reserve by $0.3 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 $0.2 million 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 a material component of cost of sales.
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 reserve for bad debts was $0.3 million as of December 31, 2022, 2021, and September 30, 2021. At December 31, 2022, 2021, and September 30, 2021, accounts receivable, net of allowance for doubtful accounts, were $1.7 million, $6.5 million and $7.0 million, respectively.
Intangibles
Intangible assets that have finite useful lives are amortized on a straight-line basis over their estimated useful lives ranging from 3 to 10 years. Intangible assets are also tested for impairment when events and circumstances indicate that the carrying value may not be recoverable.
Impairment of Long-Lived Assets
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 conducts its long-lived asset impairment analyses in accordance with Accounting Standards Codification (“ASC”) 360-10-15, “Impairment or Disposal of Long-Lived Assets.” ASC 360-10-15 requires the Company to group 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 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.
Recently Issued Accounting Standards
Our consideration of recent accounting pronouncements is included in Note 1 - Summary of Significant Accounting Policies to the Consolidated Financial Statements included in this annual report.
Off-Balance Sheet Arrangements
None.
