Note 1 - Business activities and summary of significant accounting policies

Business activities

The Company’s business is comprised of the design, manufacture and/or sale of communications equipment primarily to the radio and other professional communications related industries. The Company currently conducts its operations through seven related business divisions: (i) RF Connector and Cable Division is engaged in the design, manufacture and distribution of coaxial connectors and cable assemblies used primarily in radio and other professional communications applications; (ii) Aviel Division is engaged in the design, manufacture and sales of radio frequency, microwave and specialized connectors and connector assemblies for aerospace, original electronics manufacturers and military electronics applications; (iii) Oddcables.com Division is engaged in sales of microwave and radio frequency connectors and cable assemblies to end users in multi-media, radio and other communications applications; (iv) Bioconnect Division is engaged in the design, manufacture and sales of cable interconnects for medical monitoring applications; (v) Neulink Division is engaged in the design, manufacture and sales of radio links for receiving and transmitting control signals for remote operation and monitoring of equipment, personnel and monitoring services; (vi) RadioMobile Division is engaged as an OEM provider of end-to-end mobile management solutions implemented over wireless networks. RadioMobile Division operates as a separate division and supplements the operations of the Company’s Neulink division; and (vii) the Cables Unlimited Division manufactures custom and standard cable assemblies, adapters, and electromechanical wiring harnesses for communication, computer, LAN, automotive and medical equipment and is a Corning Cables Systems CAH Connections SM Gold Program member, authorized to manufacture fiber optic cable assemblies that are backed by Corning Cables Systems’ extended warranty (see Note 11).

Use of estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Actual results may differ from those estimates.

Principles of consolidation

The accompanying consolidated financial statements include the accounts of RF Industries, Ltd. and Cables Unlimited, Inc. (“Cables Unlimited”) and its variable interest entity (“VIE”) K&K Unlimited LLC (“K&K”). All intercompany balances and transactions have been eliminated in consolidation. See Note 11 for a discussion of the Cables Unlimited acquisition, which occurred June 15, 2011.

Cash equivalents

The Company considers all highly-liquid investments with a maturity of three months or less when purchased to be cash equivalents.

Revenue recognition

Four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; and (4) collectability is reasonably assured. The Company recognizes revenue from product sales after purchase orders are received which contain a fixed price and the products are shipped. Most of the Company’s products are sold to continuing customers with established credit histories.

Inventories

Inventories, consisting of materials, labor and manufacturing overhead, are stated at the lower of cost or market. Cost has been determined using the weighted average cost method.

Property and equipment

Equipment, tooling and furniture are recorded at cost and depreciated over their estimated useful lives (generally 3 to 7 years) using the straight-line method. The VIE’s building is recorded at cost and depreciated over its estimated useful life (39 years) using the straight-line method. Expenditures for repairs and maintenance are charged to operations in the period incurred.

Deferred financing costs

Included in other assets are deferred financing costs of $70,668 incurred by K&K and related to the financing of its building acquisition. Such costs are amortized over the term of the related debt or 20 years. Amortization expense totaled $1,307 during the year ended October 31, 2011.

Goodwill

The Company reviews its goodwill for impairment annually at the reporting unit level. The Company also analyzes whether any indicators of impairment exist each quarter. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include a sustained, significant decline in the Company’s share price and market capitalization, a decline in the Company’s expected future cash flows, a significant adverse change in legal factors or in the business climate, unanticipated competition, the testing for recoverability of the Company’s long-lived assets, and/or slower growth rates, among others.

The Company estimates the fair value of its reporting units using discounted expected future cash flows. If the fair value of the reporting unit exceeds its net book value, goodwill is not impaired, and no further testing is necessary. If the net book value of the Company’s reporting units exceeds their fair value, a second test is performed to measure the amount of impairment loss, if any.

On June 15, 2011 the Company completed its acquisition of Cables Unlimited. Goodwill related to this acquisition is included within the Cables Unlimited reporting unit. As of October 31, 2011, the goodwill balance related solely to the Cables Unlimited division. As of October 31, 2011, management noted no negative trends since the acquisition date that would necessitate a further review and test of impairment of goodwill.

The Company performed a valuation analysis in the third quarter of fiscal 2010, utilizing an income approach in the Company’s goodwill assessment process. The following describes the valuation methodologies used to derive the fair value of the Company’s reporting units:

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Income Approach: To determine each reporting unit’s estimated fair value, the Company discounts the expected cash flows of its reporting units. The Company estimate its future cash flows after considering current economic conditions and trends; estimated future operating results, growth rates, anticipated future economic and regulatory conditions; and the availability of necessary technology. The discount rate used represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk involved in the Company’s operations and the rate of return an outside investor would expect to earn. To estimate cash flows beyond the final year of the Company’s model, the Company uses a terminal value approach. Under this approach, the Company uses estimated operating income before depreciation and amortization in the final year of the Company’s model, adjusted to estimate a normalized cash flow, and then apply a perpetuity growth assumption and discount by a perpetuity discount factor to determine a terminal value. The Company incorporates the present value of the resulting terminal value into its estimate of fair value.

Due to the ongoing negative effects of the global recession and related triggers (due to Aviel division not meeting its revenue forecasts), during the third quarter of 2010, the Company performed an impairment analysis of the Aviel goodwill balance. The sales generated by this division were significantly lower than expected and the forecasted improvements from prior periods did not occur. As such, triggers were evident at this division in the third quarter of 2010. Prior to management’s analysis, the Company had a total of $137,328 of goodwill residual from the acquisition of the Aviel division. As a result of its analysis, management recorded a goodwill impairment charge of $137,328 for the third quarter of fiscal 2010. No goodwill impairment occurred in 2011; all remaining goodwill at October 31, 2011 relates to the acquisition of Cables Unlimited in June 2011.

Variable interest entity

Management analyzes if the Company has any variable interests in variable interest entities (“VIE”). This analysis includes a qualitative review based on an evaluation of the design of the entity, its organizational structure, including decision making ability and financial agreements, as well as a quantitative review. Accounting principles generally accepted in the United States of America require a reporting entity to consolidate a VIE when the reporting entity has a variable interest that provides it with a controlling financial interest in the VIE. The entity that consolidates a VIE is referred to as the primary beneficiary of the VIE. See Note 12 for further discussion.

The changes in the carrying amounts of segment goodwill for fiscal 2011 and 2010 are as follows:

	RF Connectors
	And Cable Assembly			Cables Unlimited		Total
Balance at November 1, 2009	$	137,328		$	-	$	137,328

Impairment Charge		(137,328	)		-		(137,328	)

Balance at October 31, 2010		-			-		-

Acquisition of Cables Unlimited		-			3,076,023		3,076,023

Balance at October 31, 2011	$	-		$	3,076,023	$	3,076,023

Long-lived assets

The Company assesses potential impairments to its long-lived assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. An impairment loss is recognized when the undiscounted cash flows expected to be generated by an asset (or group of assets) is less than its carrying amount. Any required impairment loss is measured as the amount by which the assets carrying value exceeds its fair value, and is recorded as a reduction in the carrying value of the related asset and a charge to operations.

Intangible assets

	October 31, 2011
Intangible assets
Non-compete agreements (estimated life 5 years)	$	200,000
Accumulated amortization		(15,000	)
		185,000

Customer relationships (estimated life 9.6 years)		1 ,730,000
Accumulated amortization		(67,579	)
		1,662,421

Backlog (estimated life 6 months)		75,000
Accumulated amortization		(56,250	)
		18,750
Total	$	1,866,171
Non-amortizable intangible assets
Trademarks	$	410,000

Estimated amortization expense related to finite lived intangible assets are as follows:

Year ending October 31,	Amount

2012	$	238,958
2013		220,208
2014		220,208
2015		220,208
2016		205,208
Thereafter		761,381
Total	$	1,866,171

Amortization of amortizable intangible assets is provided over their estimated useful lives on a straight-line basis. In fiscal 2011, the Company retired $81,000 of fully amortized intangible assets, impacting both the gross carrying amount and accumulated amortization for this amount.

Advertising

The Company expenses the cost of advertising and promotions as incurred. Advertising costs charged to operations were approximately $244,000 and $215,000 in 2011 and 2010, respectively.

Research and development

The Company expenses research and development costs as incurred. Research and development costs charged to operations and included in engineering were approximately $622,000 and $422,000 in 2011 and 2010, respectively.

Income taxes

The Company accounts for income taxes under the asset and liability method, based on the income tax laws and rates in the jurisdictions in which operations are conducted and income is earned. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Developing the provision for income taxes requires significant judgment and expertise in Federal, international and state income tax laws, regulations and strategies, including the determination of deferred tax assets and liabilities and, if necessary, any valuation allowances that may be required for deferred tax assets. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Management’s judgments and tax strategies are subject to audit by various taxing authorities.

The Company’s VIE, K&K, is a single member LLC and this is treated as a disregarded entity for Federal and state income tax purposes. The stockholders report their respective shares of the net taxable income or loss on their personal tax returns.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense.

Stock options

For stock option grants to employees, the Company recognizes compensation expense based on the estimated fair values of the options at date of grant. Stock based employee compensation expense is recognized on the straight-line basis over the requisite service period. The Company issues previously unissued common shares upon exercise of stock options.

For the fiscal years ended October 31, 2011and 2010, charges related to stock based compensation amounted to approximately $312,000 and $231,000, respectively. For the fiscal years ended October 31, 2011 and 2010, stock based compensation classified in cost of sales amounted to $61,000 and $33,000 and stock based compensation classified in selling, general and engineering expense amounted to $251,000 and $198,000 respectively.

Earnings per share

Basic earnings per share is calculated by dividing net income applicable to common stockholders by the weighted average number of common shares outstanding during the period. The calculation of diluted earnings per share is similar to that of basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares, principally those issuable upon the exercise of stock options, were issued and the treasury stock method had been applied during the period. The greatest number of shares potentially issuable by the Company upon the exercise of stock options in any period for the years ended October 31, 2011 and 2010, that were not included in the computation because they were anti-dilutive, totaled 590,968 and 443,748, respectively.

The following table summarizes the calculation of basic and diluted earnings per share:

	2011		2010
Numerators:
Consolidated net income (A)	$	773,011	$	1,220,247

Denominators:
Weighted average shares outstanding for basic earnings per share (B)		6,382,845		5,719,606
Add effects of potentially dilutive securities - assumed exercise of stock options		909,003		766,004

Weighted average shares for diluted earnings per share (C)		7,291,848		6,485,610

Basic net earnings per share (A)÷(B)	$	0.12	$	0.21

Diluted net earnings per share (A)÷(C)	$	0.11	$	0.19

Recent accounting standards

In December 2010, the FASB issued ASU 2010-28, “Intangible –Goodwill and Other (Topic 350): When to perform Step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts.” This update requires an entity to perform all steps in the test for a reporting unit whose carrying value is zero or negative if it is more likely than not (more than 50%) that a goodwill impairment exists based on qualitative factors, resulting in the elimination of an entity’s ability to assert that such a reporting unit’s goodwill is not impaired and additional testing is not necessary despite the existence of qualitative factors that indicate otherwise. The new disclosures required by ASU 2010–28 is effective for the Company for periods beginning November 1, 2011. The adoption of ASU 2010 - 28 is not expected to have a material effect on our consolidated financial statements.

In December 2010, the FASB issued Accounting Standards Update 2010 - 29, “Disclosure of Supplementary Pro Forma Information for Business Combinations” (“ASU 2010-29”), which specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments in this update also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The new disclosures required by ASU 2010–29 are effective for the Company for periods beginning November 1, 2011. The adoption of ASU 2010–29 is not expected to have a material effect on our consolidated financial statements.