- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2003
-------------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
--------------------- ------------------------
Commission File Number: 0-10355
-------
COMMUNICATIONS SYSTEMS, INC.
.................................................................................
(Exact name of registrant as specified in its charter)
MINNESOTA 41-0957999
.................................................................................
(State or other jurisdiction of (Federal Employer
incorporation or organization) Identification No.)
213 South Main Street, Hector, MN 55342
.................................................................................
(Address of principal executive offices) (Zip Code)
(320) 848-6231
.................................................................................
Registrant's telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES [ ] NO [X]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS Outstanding at July 31, 2003
- ----------------------- ----------------------------
Common Stock, par value 8,161,216
$.05 per share
Total Pages (21)
- --------------------------------------------------------------------------------
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
INDEX
Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income (Loss) and 4
Comprehensive Income (Loss)
Consolidated Statements of Changes in
Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
Part II. Other Information 17
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
June 30 December 31
Assets: 2003 2002
------------ ------------
Current assets:
Cash $ 5,974,525 $ 19,816,328
Trade receivables, net 22,038,189 19,128,399
Related party receivables 224,941 412,930
Inventories 34,226,365 28,958,291
Deferred income taxes 3,354,568 3,354,568
Other current assets 636,178 1,339,024
------------ ------------
Total current assets 66,454,766 73,009,540
Property, plant and equipment 32,419,868 33,974,215
less accumulated depreciation (25,751,441) (26,549,665)
------------ ------------
Net property, plant and equipment 6,668,427 7,424,550
Other assets:
Excess of cost over net assets acquired 5,253,793 5,253,793
Deferred income taxes 2,796,978 2,796,978
Other assets 328,478 273,631
------------ ------------
Total other assets 8,379,249 8,324,402
------------ ------------
Total Assets $ 81,502,442 $ 88,758,492
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable $ 1,000,000 $ 7,000,000
Accounts payable 3,736,106 5,291,706
Accrued compensation and benefits 2,816,796 2,655,056
Other accrued liabilities 2,426,780 1,797,656
Dividends payable 326,449 325,714
Income taxes payable 1,378,751 2,817,082
------------ ------------
Total current liabilities 11,684,882 19,887,214
Stockholders' Equity 69,817,560 68,871,278
------------ ------------
Total Liabilities and Stockholders' Equity $ 81,502,442 $ 88,758,492
============ ============
See notes to consolidated financial statements.
3
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
(unaudited)
Three Months Ended June 30 Six Months Ended June 30
---------------------------- -----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Sales $ 24,868,683 $ 27,174,589 $ 51,443,833 $ 51,094,929
Costs and expenses:
Cost of sales 17,454,032 22,539,883 36,623,393 40,083,612
Selling, general and
administrative expenses 6,668,606 6,163,756 12,890,497 11,889,018
------------ ------------ ------------ ------------
Total costs and expenses 24,122,638 28,703,639 49,513,890 51,972,630
------------ ------------ ------------ ------------
Operating income (loss) 746,045 (1,529,050) 1,929,943 (877,701)
Other income and (expenses):
Investment and other income 270,436 54,530 293,010 130,434
Interest expense (18,279) (57,696) (51,680) (150,093)
------------ ------------ ------------ ------------
Other income, (expense) net 252,157 (3,166) 241,330 (19,659)
Income (loss) before income taxes 998,202 (1,532,216) 2,171,273 (897,360)
Income taxes (benefit) 370,000 (490,000) 820,000 (325,000)
------------ ------------ ------------ ------------
Net income (loss) 628,202 (1,042,216) 1,351,273 (572,360)
------------ ------------ ------------ ------------
Other comprehensive income (loss):
Foreign currency
translation adjustment 148,070 263,982 88,556 196,332
============ ============ ============ ============
Comprehensive income (loss) $ 776,272 $ (778,234) $ 1,439,829 $ (376,028)
============ ============ ============ ============
Basic net income (loss) per share $ .08 $ (.13) $ .17 $ (.07)
Diluted net income (loss) per share $ .08 $ (.13) $ .17 $ (.07)
Average Basic Shares Outstanding 8,161,216 8,287,147 8,160,931 8,284,677
Average Dilutive Shares Outstanding 8,176,809 8,290,306 8,174,406 8,290,859
See notes to consolidated financial statements.
4
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(unaudited)
Cumulative
Additional Other
Common Stock Paid-in Retained Comprehensive
Shares Amount Capital Earnings Income (Loss) Total
--------- --------- ------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 2001 8,262,314 $ 413,116 $ 27,855,529 $ 39,463,137 $ (423,781) $ 67,308,001
Net income 2,336,672 2,336,672
Issuance of common stock under
Employee Stock Purchase Plan 36,276 1,814 188,744 190,558
Issuance of common stock to
Employee Stock Ownership Plan 25,000 1,250 187,250 188,500
Issuance of common stock under
Employee Stock Option Plan 1,700 85 11,645 11,730
Purchase of stock (182,574) (9,130) (630,005) (553,737) (1,192,872)
Shareholder dividends (325,714) (325,714)
Other comprehensive gain 354,403 354,403
--------- --------- ------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 2002 8,142,716 407,135 27,613,163 40,920,358 (69,378) 68,871,278
Net income 1,351,273 1,351,273
Issuance of common stock to
Employee Stock Ownership Plan 32,000 1,600 253,440 255,040
Purchase of stock (13,500) (675) (45,781) (48,735) (95,191)
Shareholder dividends (653,396) (653,396)
Other comprehensive gain 88,556 88,556
--------- --------- ------------ ------------ ------------ ------------
BALANCE AT JUNE 30, 2003 8,161,216 $ 408,060 $ 27,820,822 $ 41,569,500 $ 19,178 $ 69,817,560
========= ========= ============ ============ ============ ============
See notes to consolidated financial statements.
5
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended June 30
-------------------------
2003 2002
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 1,351,273 $ (572,360)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 1,246,018 1,570,744
Changes in assets and liabilities net of
effects of the purchase of MiLAN Technology
Corporation in 2002:
Trade receivables (2,626,442) 1,524,624
Inventories (5,136,616) 2,920,977
Other current assets 749,928 266,929
Accounts payable (1,585,473) 791,746
Accrued expenses 785,668 2,909,116
Income taxes payable (1,438,373) (1,411,407)
----------- -----------
Net cash (used in) provided by
operating activities (6,654,017) 8,000,369
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (390,981) (935,740)
Other assets (134,775) (68,766)
Collection of notes receivable 2,765,390
Payment for purchase of MiLAN Technology
Corporation (8,058,932)
----------- -----------
Net cash used in investing activities (525,756) (6,298,048)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable (6,000,000) (2,000,000)
Dividends paid (652,661)
Proceeds from issuance of stock 11,730
Purchase of stock (675) (25,269)
----------- -----------
Net cash used in financing activities (6,653,336) (2,013,539)
----------- -----------
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (8,294) 38,329
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (13,841,403) (272,889)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 19,816,328 22,239,883
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,974,925 $21,966,994
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 2,251,045 $ 455,641
Interest paid 71,467 211,617
See notes to consolidated financial statements.
6
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - CONSOLIDATED FINANCIAL STATEMENTS
The balance sheet and statement of changes in stockholders' equity as of June
30, 2003, the statements of income (loss) and comprehensive income (loss) for
the three and six month periods ended June 30, 2003 and 2002 and the statements
of cash flows for the six-month periods ended June 30, 2003 and 2002 and for the
periods then ended have been prepared by the Communications Systems, Inc. and
Subsidiaries (the Company or we) without audit. In the opinion of management,
all adjustments (which include only normal recurring adjustments) necessary to
present fairly the financial position, results of operations, and cash flows at
June 30, 2003 and 2002 and for the six months then ended have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested these condensed financial
statements be read in conjunction with the financial statements and notes
thereto included in the Company's December 31, 2002 Annual Report to
Shareholders. The results of operations for the periods ended June 30 are not
necessarily indicative of the operating results for the entire year.
In February 2003, the Company issued 32,000 shares of the Company's common stock
to the Employee Stock Ownership Plan in payment of its 2002 obligation. In a
noncash transaction, the Company recorded additional stockholders' equity of
$255,040 (reflecting the market value of the stock at the time of the
contribution) and reduced accrued expenses by the same amount.
The Company has downsized operations by closing two of three manufacturing
facilities in Puerto Rico in 2002 and its final building in May 2003 to align
production capacities and overhead with current business volumes. Severance and
other related closing costs incurred in the second quarter were approximately
$150,000. The Company also realized a net gain on disposal of assets in Puerto
Rico in the second quarter of approximately $280,000 which was recorded as other
income.
STOCK BASED COMPENSATION PLANS
The Company has adopted the disclosure provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation," but applies APB Opinion No. 25, "Accounting for
Stock Issued to Employees" for measurement and recognition of stock-based
transactions with its employees and accordingly no stock-based employee
compensation cost is reflected in net income. If the Company had elected to
recognize compensation cost for its stock based transactions using the method
prescribed by SFAS No. 123, pro forma net income (loss) and net income per share
would have been as follows:
Three Months Ended June 30
---------------------------
2003 2002
------------ -------------
Net Income (Loss)
As reported $ 628,000 $ (1,042,000)
Compensation expense, net of tax $ 126,000 $ 185,000
Pro forma $ 502,000 $ (1,227,000)
Earnings (Loss) Per Share-Basic
As reported $ . 08 $ (.13)
Pro forma $ . 06 $ (.15)
Earnings (Loss) Per Share-Diluted
As reported $ . 08 $ (.13)
Pro forma $ . 06 $ (.15)
7
Six Months Ended June 30
---------------------------
2003 2002
------------ -------------
Net Income (Loss)
As reported $ 1,351,000 $ (572,000)
Compensation expense, net of tax $ 176,000 $ 305,000
Pro forma $ 1,175,000 $ (877,000)
Earnings (Loss) Per Share-Basic
As reported $ . 17 $ (.07)
Pro forma $ . 14 $ (.11)
Earnings (Loss) Per Share-Diluted
As reported $ . 17 $ (.07)
Pro forma $ . 14 $ (.11)
NOTE 2 - NET INCOME PER SHARE
Basic net (loss) income per common share is based on the weighted average number
of common shares outstanding during each year. Diluted net (loss) income per
common share takes into effect the dilutive effect of potential common shares
outstanding. The Company's only potential common shares outstanding are stock
options. The Company calculates the dilutive effect of outstanding options using
the treasury stock method.
NOTE 3 - ACQUISITIONS
Effective March 25, 2002 the Company acquired substantially all of the assets
and assumed certain liabilities of Digi International Inc.'s MiLAN legacy
business. The business has been reincorporated as MiLAN Technology Corporation.
Located in Sunnyvale, California, MiLAN is a growing provider of leading edge
wireless telecommunications products for businesses and residences, managed and
unmanaged LAN switches, media conversion products and print servers. The Company
expects the MiLAN acquisition will be both complementary and supplementary to
its Transition Networks business by increasing the product offerings and
expanding the customer bases of both business units.
The operations of MiLAN, which were not material to the Company's financial
statements, are included in the Company's financial results from the purchase
date. In the acquisition, the following assets were acquired and liabilities
assumed:
Accounts receivable $ 2,426,713
Inventory 5,121,936
Plant and equipment 5,120
Identifiable intangible asset (royalty agreement) 201,341
Excess of cost over net assets acquired 635,046
Accrued expenses (262,405)
-------------
Total purchase price $ 8,127,751
=============
8
NOTE 4 - INVENTORIES
Inventories summarized below are priced at the lower of first-in, first-out cost
or market:
June 30 December 31
2003 2002
------------ -------------
Finished Goods $ 16,989,343 $ 14,188,306
Raw Materials 17,237,022 14,769,985
------------ -------------
Total $ 34,226,365 $ 28,958,291
============ =============
NOTE 5 - EXCESS OF COST OVER NET ASSETS ACQUIRED (GOODWILL) AND
OTHER INTANGIBLE ASSETS
Goodwill represents the amount by which the purchase price and transaction costs
of business the Company has acquired exceed the estimated fair value of the net
tangible assets and separately identifiable assets of these businesses. The
Company adopted Statement of Financial Accounting Standards (SFAS) No. 142
"Goodwill and Other Intangible Assets" on January 1, 2002. Under SFAS No. 142,
goodwill and intangible assets with indefinite useful lives are not amortized,
but are tested at least annually for impairment. We reassess the value of our
business units and related goodwill balances at the beginning of the first
quarter of each fiscal year and at other times if events have occurred or
circumstances exist that indicate the carrying amount of goodwill may not be
recoverable. Accordingly, we have determined that there was no impairment as of
January 1, 2003 and no events occurred during the six months ended June 30, 2003
that indicated our remaining goodwill was not recoverable. As of June 30, 2003
the Company had net goodwill of $5,254,000. Intangible assets with definite
useful lives (consisting of a royalty agreement) will continue to be amortized
over its remaining life of five years. Amortization included in costs and
expenses was $34,000 for the six months ended June 30, 2003.
NOTE 6 - WARRANTY
We provide reserves for the estimated cost of product warranties at the time
revenue is recognized. We estimate the costs of our warranty obligations based
on our warranty policy or applicable contractual warranty, historical experience
of known product failure rates, and use of materials and service delivery costs
incurred in correcting product failures. Management reviews the estimated
warranty liability on a quarterly basis to determine its adequacy.
The following table presents the changes in the Company's warranty liability for
the six months ended June 30, 2003, the majority of which relates to a five-year
obligation to provide for potential future liabilities for network equipment
sales.
Beginning Balance $ 662,672
Actual warranty costs paid (80,124)
Amounts charged to expense 90,144
-------------
Ending balance $ 672,692
=============
9
NOTE 7 - SEGMENT INFORMATION
The Company classifies its businesses into four segments: Suttle, which
manufactures U.S. standard modular connecting and wiring devices for voice and
data communications; Austin Taylor, which manufactures British standard line
jacks, patch panels, wiring harness assemblies, metal boxes, distribution
cabinets and central office frames; Transition Networks and MiLAN Technology
(substantially all assets of MiLAN purchased March 25, 2002), which designs and
markets data transmission, computer network and media conversion products and
print servers; and JDL Technologies (JDL) which provides telecommunications
network design, specification and training services to educational institutions.
Information concerning the Company's operations in the various segments for the
six-month periods ended June 30, 2003 and 2002 is as follows:
Austin Transition
Suttle Taylor Networks/MiLAN JDL Technologies Corporate Consolidated
------------ ----------- -------------- ---------------- ------------ -------------
Six Months Ended June 30, 2003:
Sales $ 15,442,285 $ 3,286,946 $ 24,717,251 $ 7,997,351 $ 51,443,833
Cost of sales 12,537,965 3,279,684 15,727,223 5,078,521 36,623,393
------------ ----------- -------------- ----------------- -------------
Gross profit 2,904,320 7,262 8,990,028 2,918,830 14,820,440
Selling, general and
administrative expenses 2,418,779 687,598 6,992,874 1,854,535 $ 936,711 12,890,497
------------ ----------- -------------------------------- ------------ -------------
Operating income (loss) $ 485,541 $ (680,336) $ 1,997,154 $ 1,064,295 $ (936,711) $ 1,929,943
============ =========== ============== ================ ============ =============
Depreciation and amortization $ 762,859 $ 154,392 $ 190,407 $ 90,360 $ 48,000 $ 1,246,018
============ =========== ============== ================ ============ =============
Capital expenditures $ 162,377 $ - $ 59,882 $ 145,994 $ 22,728 $ 390,981
============ =========== ============== ================ ============ =============
Assets $ 36,157,535 $ 4,886,904 $ 27,690,812 $ 6,659,483 $ 6,107,708 $ 81,502,442
============ =========== ============== ================ ============ =============
Six Months Ended June 30, 2002:
Sales $ 16,815,072 $ 3,701,551 $ 20,291,979 $ 10,286,327 $ 51,094,929
Cost of sales 15,481,098 3,285,097 13,899,790 7,417,627 40,083,612
------------ ----------- -------------- ---------------- -------------
Gross profit 1,333,974 416,454 6,392,189 2,868,700 11,011,317
Selling, general and
administrative expenses 3,316,437 465,001 5,486,803 1,777,396 $ 843,381 11,889,018
------------ ----------- -------------- ---------------- ------------ -------------
Operating income (loss) $(1,982,463) $ (48,547) $ 905,386 $ 1,091,304 $ (843,381) $ (877,701)
============ =========== ============== ================ ============ =============
Depreciation and amortization $ 1,081,505 $ 232,361 $ 148,878 $ 60,000 $ 48,000 $ 1,570,744
============ =========== ============== ================ ============ =============
Capital expenditures $ 422,768 $ 15,186 $ 475,313 $ (1,462) $ 23,935 $ 935,740
============ =========== ============== ================ ============ =============
Assets $ 48,599,053 $ 5,681,714 $ 20,731,950 $ 6,955,750 $ 7,018,491 $ 88,986,958
============ =========== ============== ================ ============ =============
10
Information concerning the Company's operations in the various segments for the
three-month periods ended June 30, 2003 and 2002 is as follows:
Austin Transition
Suttle Taylor Networks/MiLAN JDL Technologies Corporate Consolidated
------------ ------------ -------------- ---------------- ------------ -------------
Three Months Ended June 30, 2003:
Sales $ 7,299,435 $ 1,712,835 $ 12,335,908 $ 3,520,505 $ 24,868,683
Cost of sales 5,859,002 1,619,099 7,923,887 2,052,044 17,454,032
------------ ----------- -------------- ---------------- -------------
Gross profit 1,440,433 93,736 4,412,021 1,468,461 7,414,651
Selling, general and
administrative expenses 1,218,077 363,231 3,573,289 963,533 $ 550,476 6,668,606
------------ ----------- -------------- ---------------- ------------ -------------
Operating income (loss) $ 222,356 $ (269,495) $ 838,732 $ 504,928 $ (550,476) $ 746,045
============ =========== ============== ================ ============ =============
Depreciation and amortization $ 345,289 $ 74,220 $ 111,116 $ 45,180 $ 6,662 $ 582,467
============ =========== ============== ================ ============ =============
Capital expenditures $ (100,830) $ (61,302) $ 40,564 $ 67,121 $ 21,347 $ (33,100)
============ =========== ============== ================ ============ =============
Three Months Ended June 30, 2002:
Sales $ 8,532,050 $ 1,805,156 $ 10,738,896 $ 6,098,487 $ 27,174,589
Cost of sales 8,433,701 1,632,030 7,810,947 4,663,205 22,539,883
------------ ----------- -------------- -----------=---- -------------
Gross profit 98,349 173,126 2,927,949 1,435,282 4,634,706
Selling, general and
administrative expenses 1,768,710 247,354 2,862,185 846,891 $ 438,616 6,163,756
------------ ----------- -------------- ---------------- ------------ -------------
Operating income (loss) $ (1,670,361) $ (74,228) $ 65,764 $ 588,391 $ (438,616) $ (1,529,050)
============ =========== ============== ================ ============ =============
Depreciation and amortization $ 613,100 $ 155,450 $ 82,520 $ 30,000 $ 24,000 $ 881,070
============ =========== ============== ================ ============ =============
Capital expenditures $ 246,503 $ 7,201 $ 394,664 $ (1,462) $ 19,170 $ 646,906
============ =========== ============== ================ ============ =============
NOTE 8 - INCOME TAXES
In the preparation of the Company's consolidated financial statements,
management calculates income taxes based upon the estimated effective rate
applicable to operating results for the full fiscal year. This includes
estimating current tax liability as well as assessing temporary differences
resulting from different treatment of items for tax and book accounting
purposes. These differences result in deferred tax assets and liabilities, which
are recorded on the balance sheet. These assets and liabilities are analyzed
regularly and management assesses the likelihood that deferred tax assets will
be recovered from future taxable income.
- --------------------------------------------------------------------------------
Statements regarding the Company's anticipated performance in future periods are
forward looking and involve risks and uncertainties, including but not limited
to: buying patterns of its Regional Bell Operating Customers, competitor's
products, the success of its recent acquisitions and changes in tax laws.
- --------------------------------------------------------------------------------
11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
- --------------------------------------------------------------------------------
Six Months Ended June 30, 2003 Compared to
Six Months Ended June 30, 2002
Consolidated sales in 2003 increased less than 1% to $51,443,000 compared to
$51,095,000 in 2002. The 2003 six-month revenues include $6,800,000 in sales
contributed from the MiLAN business unit, which was acquired March 25, 2002
compared to MiLAN sales of $2,900,000 in the first six months of 2002.
Consolidated operating income in 2003 increased to $1,930,000 compared to an
operating loss of $878,000 in the first six months of 2002. The Company recorded
a writedown for excess and obsolete inventory of $1,500,000 in the second
quarter of 2002. The Company continues to be adversely affected by the general
economic downturn in the communications equipment industry as reflected in sales
declines by the Company's voice and data connectivity products manufacturing
units, Suttle and U.K. subsidiary Austin Taylor Communications Ltd. The
Company's business units providing broadband products and services; Transition
Networks, MiLAN and JDL Technologies are driving the revenue and earnings in the
first six months of 2003.
Suttle sales decreased 8% in the first six months of 2003 to $15,442,000
compared to $16,815,000 in the same period of 2002. Sales to the major telephone
companies (the Regional Bell Operating Companies ("RBOCs" which are Verizon
Logistics, Bell South, SBC Communications and Qwest) increased 9% to $8,224,000
in 2003. Sales to these customers accounted for 53% and 45% of Suttle's U.S.
customer sales in 2003 and 2002 respectively. Sales to distributors, original
equipment manufacturers (OEMs), and electrical contractors decreased 30% to
$3,744,000 in 2003. Contract manufacturing sales totaled $1,780,000 in the first
six months of 2003.
Suttle's gross margins increased to $2,904,000 in the first six months of 2003
compared to $1,334,000 in the same period in 2002. Suttle recorded a write down
of excess and slow-moving inventory in the second quarter in the amount of
$1,500,000. Gross margin percentage was 19% in 2003 compared to 8% in 2002. The
gross margin percentage increase was due to cost reduction measures implemented
in 2002 and 2003. Selling, general and administrative expenses decreased
$898,000 or 27% in the first six months of 2003 compared to the same period in
2002. The Company has downsized operations by closing two of three manufacturing
facilities in Puerto Rico in 2002 and it's final building in May 2003 to align
production capacities and overhead with current business volumes. Severance and
other related closing costs incurred in the second quarter were approximately
$150,000. In addition, the Company has continued to outsource more manufacturing
in Asia and shifted manufacturing to the lower cost plant in Costa Rica. These
actions contributed to a positive impact on gross margin and operating results.
Suttle's operating income was $486,000 in the first six months of 2003 compared
to an operating loss of $1,982,000 in the same period of 2002.
Austin Taylor's sales decreased to $3,287,000 in the first six months of 2003
compared to $3,702,000 in the same period of 2002. Austin Taylor's gross margin
declined to $7,200 in the first six months of 2003 compared to $417,000 in 2002.
The decline in gross margin was principally due to increased pricing competition
and lower business volumes and excess manufacturing and overhead capacity.
Selling, general and administrative expenses increased by $223,000 in the first
six months compared to the same period in 2002 due to severance costs incurred.
Operating income decreased $632,000 to a loss of $688,000 in the first six
months in 2003 compared to an operating loss of $48,500 in the same period of
2002.
12
Transition Networks / MiLAN Technology segment sales increased by 22% to
$24,717,000 in the first six months of 2003 compared to $20,292,000 in the same
period in 2002. Sales for this segment include a $6,800,000 contribution from
MiLAN Technology in the first six months of 2003 and $2,900,000 in 2002 which
CSI purchased substantially all the assets from Digi International on March 25,
2002. The demand for media conversion and related products has remained strong
in the first half of 2003 and is expected to remain a growth market for some
time. Gross margin increased to $8,990,000 in the first six months of 2003 from
$6,392,000 in 2002. Gross margin as a percentage of sales was 36% in 2003
compared to 27% in 2002. Gross margins in 2002 were adversely affected by the
sale of the MiLAN acquired inventory, which had lower margins. Selling, general
and administrative expenses increased to $6,993,000 in the first six months of
2003 compared to $5,486,000 in 2002. Operating income for this segment increased
$1,092,000 to $1,997,000 in the first six months of 2003 compared to the same
period in 2002.
Sales by JDL Technologies, Inc. were $7,997,000 in the first six months of 2003
compared to $10,287,000 in the same period in 2002. The decrease was due to
reduced sales of hardware purchases and services to plan, design, implement and
manage network data systems for several large school districts. Gross margin in
the first six months of 2003 increased to $2,918,000 compared to $2,869,000 in
the same period of 2002. Gross margin as a percentage of sales increased to 36%
from 28% in the 2002 period due to higher margin sales of design and maintenance
services to client school districts. Selling, general and administrative
expenses increased $77,000 in the first six months of 2003 compared to the same
period of 2002. JDL's operating income was $1,064,000 in the first six months of
2003 compared to operating income of $1,091,000 in the same period in 2002.
Consolidated investment and other income increased $163,000 in the first six
months 2003 compared to 2002. The Company realized a net gain on disposal of
assets relative to the closing of the final building in Puerto Rico in the
second quarter of approximately $280,000 which was recorded as other income.
Interest expense decreased by $98,000 in the first six months of 2003 compared
to the same period in 2002 due to a decrease in borrowings on the line of credit
and a lower interest rate. Income before income taxes increased by $3,068,000 to
$2,171,000. The Company's effective income tax rate was 38% in 2003. Net income
through the first six months of 2003 increased $1,924,000 compared to the same
period in 2002 to $1,351,000.
Three Months Ended June 30, 2002 Compared to
Three Months Ended June 30, 2001
Consolidated sales decreased 8% to $24,869,000 in the three-month period ended
June 30, 2003 compared to the same period in 2002. Consolidated operating income
increased $2,275,000 in the three months ended June 30, 2003 compared to the
same period in 2002. The Company recorded a writedown for excess and obsolete
inventory of $1,500,000 in the second quarter of 2002.
Suttle sales decreased 14% to $7,299,000 in 2003 compared to $8,532,000 in 2002.
Suttle's gross margins increased to $1,342,000 in 2003 compared to $98,000 in
2002. Suttle recorded a write down of excess and slowmoving inventory in the
second quarter in the amount of $1,500,000, which resulted in an 18% reduction
in gross margin. Suttle had operating income of $222,000 in the three-month
period in 2003 compared to an operating loss of $1,670,000 in the same period in
2002.
Austin Taylor's sales decreased 5% to $1,713,000 in the 2002 three-month period
compared to $1,805,000 in 2002. Austin Taylor's gross margin declined to $94,000
in 2003 compared to $173,000 in 2002. Selling, general and administrative
expenses increased $116,000 due to severance costs incurred in the second
quarter of 2003. Operating income decreased $195,000 to an operating loss of
$269,000 in the second quarter of 2003.
13
Transition Networks / MiLAN Technology segment sales increased by 15% to
$12,336,000 in the second quarter of 2003 compared to $10,739,000 in the same
period in 2002. Sales for this segment include sales from MiLAN Technology,
which CSI purchased substantially all the assets from Digi International on
March 25, 2002. Gross margin increased to $4,412,000 in 2003 from $2,928,000 in
2002. Gross margin as a percentage of sales was 36% in 2003 compared to 27% in
2002. In 2002 gross margins were adversely affected by the sale of the MiLAN
acquired inventory, which had lower margins. Selling, general and administrative
expenses increased to $3,573,000 in 2003 compared to $2,862,000 in 2002.
Operating income increased to $839,000 in the second quarter of 2003 compared to
$66,000 in the same period of 2002.
Sales by JDL Technologies, Inc. decreased $2,578,000 to $3,521,000 in the second
quarter of 2003 compared to the same period in 2002. JDL's gross margin
increased $33,000 to $1,468,000 due to increased sales of design and maintenance
services. Gross margin as a percentage of sales increased to 42% from 24% in the
2002 period due to increased sales of higher margin design and maintenance
services. Selling, general and administrative expenses increased $117,000 in the
second quarter of 2003 compared to the same period of 2002. JDL's operating
income was $505,000 in the second quarter of 2003 compared to $589,000 in the
2002 second quarter.
Investment and other income in the second quarter of 2003 increased by $216,000
in 2003 compared to 2002. The Company realized a net gain on disposal of assets
relative to the closing of the final building in Puerto Rico in the second
quarter of approximately $280,000 which was recorded as other income. Interest
expense decreased by $39,000 in the second quarter of 2003 compared to the same
period in 2002 due to a decrease in borrowings on the line of credit and a lower
interest rate. Income before income taxes increased by $2,530,000 to $998,000 in
the second quarter of 2003. The Company's effective income tax rate was 37% in
2003. Net income for the second quarter of 2003 was $628,000 compared to a net
loss of $1,042,000 in the second quarter of 2002.
Liquidity and Capital Resources
At June 30, 2003, the Company had $5,975,000 of cash and cash equivalents
compared to $19,816,000 of cash and cash equivalents at December 31, 2002. The
Company had working capital of approximately $54,770,000 and a current ratio of
5.7 to 1 compared to working capital of $53,122,000 and a current ratio of 3.7
to 1 at the end of 2002.
Net cash used in operating activities was $6,654,000 in the first six months of
2003 compared to net cash provided by operating activities of $8,000,000 in the
same period in 2002. The decrease was due primarily to supporting higher levels
of accounts receivable and inventory and paying down accounts payable and income
taxes.
14
Net cash used in investing activities was $526,000 in the first six months in
2003 compared to $6,298,000 in the same period in 2002. In March 2002, the
Company acquired substantially all of the assets of MiLAN Technology for
approximately $8,058,000 in cash. Also in the first quarter of 2002, the Company
received the balance of $2,765,000 of the note receivable related to the sale of
assets of a previously discontinued business unit. In the first six months in
2003 cash investments in new plant and equipment totaled $391,000 compared to
$936,000 in 2002. Plant and equipment purchases in both years were financed by
internal cash flows. The Company expects to spend $1,000,000 in total on capital
additions in 2003.
Net cash used in financing activities was $6,653,000 in the first six months of
2003 compared to net cash used in financing activities in 2002 of $2,014,000. In
2003, the Company paid down the line of credit to $1,000,000 from $7,000,000 at
December 31, 2002. The Company purchased and retired 13,500 shares of its stock
in open market transactions during the 2003 period. At June 30, 2003 Board
authorizations are outstanding to purchase an additional 283,565 shares. Cash
dividends paid in the first six months of 2003 was $653,000.
In the opinion of management, based on the Company's current financial and
operating position and projected future expenditures, sufficient funds are
available to meet the Company's anticipated operating and capital expenditure
needs.
Critical Accounting Policies
Our critical accounting policies, including the assumptions and judgements
underlying them, are discussed in our 2002 Form 10-K in Note 1 Summary of
Significant Accounting Policies included in our Consolidated Financial
Statements. There were no significant changes to our critical accounting
policies during the six months ended June 30, 2003. These policies have been
consistently applied in all material respects and disclose such matters as
allowance for doubtful accounts, sales returns, inventory valuation, warranty
expense, income taxes, revenue recognition, asset impairment recognition and
foreign currency translation. On an ongoing basis, we evaluate our estimates
based on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the result of which form the
basis for making judgements about the carrying value of assets and liabilities
that are not readily apparent from other sources. Results may differ from these
estimates due to actual outcomes being different from those on which we based
our assumptions. Management on an ongoing basis reviews these estimates and
judgements.
Recently Issued Accounting Pronouncements
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" (FIN 45). FIN 45 establishes accounting and disclosure
requirements for a company's obligations under certain guarantees that it has
issued. A guarantor is required to recognize a liability for the obligation it
has undertaken in issuing a guarantee, including the ongoing obligation to stand
ready to perform over the term of the guarantee in the event that the specified
triggering events or conditions occur. The objective of the initial measurement
of that liability is the fair value of the guarantee at its inception. The
initial recognition and measurement provisions of this Interpretation are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. FIN 45 also requires expanded disclosure of information
related to product warranty amounts recorded in the financial statements. The
disclosure provisions are effective for interim and annual periods ending after
December 15, 2002. The adoption of FIN 45 is further discussed with appropriate
disclosures in Note 6 to the consolidated financials statements.
15
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure", an amendment to SFAS No. 123. This
standard provides alternative methods of transition for any voluntary changes to
the fair value based method of accounting for stock-based employee compensation.
It also amends the disclosure requirements to require prominent disclosure in
both the annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. The new disclosure requirements are effective for interim
periods beginning after December 15, 2002. (see Note 1 to the consolidated
financial statements). We will continue to apply the principles of APB Opinion
No. 25 and related interpretations in accounting for our stock based
compensation plans.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
- --------------------------------------------------------------------
The Company has no freestanding or embedded derivatives. All
contracts that contain provisions meeting the definition of a derivative also
meet the requirements of, and have been designated as normal purchases or sales.
The Company's policy is to not use freestanding derivatives and to not enter
into contracts with terms that cannot be designated as normal purchases or
sales.
The vast majority of our transactions are denominated in U.S. dollars; as such,
fluctuations in foreign currency exchange rates have historically not been
material to the Company. At June 30, 2003 our bank line of credit carried a
variable interest rate based on the London Interbank Offered Rate (Libor) plus
2%. The Company's investments are money market type of investments that earn
interest at prevailing market rates and as such do not have material risk
exposure.
Based on the Company's operations, in the opinion of management, no material
future losses or exposure exist relative to market risk.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The Company's Chief Executive Officer, Curtis A. Sampson, and Chief
Financial Officer, Paul N. Hanson, have evaluated the Company's disclosure
controls and procedures as of the end of the period covered by this report.
Based upon that review, they have concluded that these controls and procedures
are effective in ensuring that material information related to the Company is
made known to them by others within the Company.
(b) Changes in Internal Control over Financial Reporting
There have been no significant changes in internal control over
financial reporting that occurred during the fiscal quarter covered by this
report that have materially affected, or are reasonably likely to materially
affect, the registrant's internal control over financial reporting.
16
PART II. OTHER INFORMATION
Items 1 - 3. Not Applicable
Item 4. Submission of Matters to a Vote of Securities Holders
- --------------------------------------------------------------
The Annual Meeting of the Shareholders of the Registrant was held on May 21,
2003 in Eden Prairie, Minnesota. The total number of shares outstanding and
entitled to vote at the meeting was 8,161,666 of which 7,617,585 were present
either in person or by proxy. Shareholders re-elected board members Paul A.
Anderson, Frederick M. Green and Wayne E. Sampson to three-year terms expiring
at the 2006 Annual Meeting of Shareholders. The vote for these board members was
as follows:
In Favor Abstaining
----------- -----------
Paul A. Anderson 7,310,081 307,504
Frederick M. Green 7,310,681 306,904
Wayne E. Sampson 7,310,888 306,697
Board members continuing in office are Curtis A. Sampson and Gerald D. Pint
(whose terms expire at the 2004 Annual Meeting of Shareholders) and Edwin C.
Freeman, Luella Gross Goldberg and Randall D. Sampson (whose terms expire at the
2005 Annual Meeting of Shareholders).
Item 5. Not Applicable
Item 6. Exhibits and Reports on Form 8-K.
(a) The following exhibits are included herein:
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act).
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act).
32 Certifications pursuant Section 906 of the Sarbanes-Oxley Act of 2002
(18 U.S.C.ss.1350).
(b) Reports on Form 8-K.
On May 8, 2003, the Company filed a Current Report on Form 8-K with the
Securities and Exchange Commission, reporting under Item 9 its first quarter
2003 earnings release to shareholders.
17
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Communications Systems, Inc.
By /s/ Curtis A. Sampson
----------------------------
Curtis A. Sampson
Date: August 14, 2003 Chairman and
Chief Executive Officer
/s/ Paul N. Hanson
----------------------------
Date: August 14, 2003 Paul N. Hanson
Vice President and
Chief Financial Officer
18
Exhibit 31.1
CERTIFICATION
I, Curtis A. Sampson certify that:
1. I have reviewed this quarterly report on Form 10-Q of Communications Systems,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
By /s/ Curtis A. Sampson
----------------------------
Curtis A. Sampson
Date: August 14, 2003 Chairman and
Chief Executive Officer
19
Exhibit 31.2
CERTIFICATION
I, Paul N. Hanson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Communications Systems,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
By /s/ Paul N. Hanson
--------------------------
Paul N. Hanson
Date: August 14, 2003 Vice President and
Chief Financial Officer
20
Exhibit 32
CERTIFICATION
The undersigned certify pursuant to 18 U.S.C.ss.1350, that:
(1) The accompanying Quarterly Report on Form 10-Q for the period ended June 30,
2003, fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934; and
(2) The information contained in the accompanying Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
By /s/ Curtis A. Sampson
--------------------------
Curtis A. Sampson
Date: August 14, 2003 Chairman and
Chief Executive Officer
By /s/ Paul N. Hanson
--------------------------
Paul N. Hanson
Date: August 14, 2003 Vice President and
Chief Financial Officer
21