=============================================================================== 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, 1996 ------------------------------------------ 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 ............................................................................... (Former name, address, and fiscal year, if changed since last report) 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 ___ APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. YES ___ NO ___ APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date. CLASS Outstanding at July 31, 1996 Common Stock, par value 9,346,458 $.05 per share Total Pages (11) Exhibit Index at (NO EXHIBITS) =============================================================================== COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES INDEX Page No. Part I. Financial Information Item 1. Financial Statements Consolidated Balance Sheets 3 Consolidated Statements of Income 4 Consolidated Statements of 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 8 Part II. Other Information 11 2
PART I. FINANCIAL INFORMATION COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (unaudited) June 30 December 31 Assets: 1996 1995 ____________ ____________ Current assets: Cash $13,036,777 $12,198,455 Marketable securities 868,335 899,469 Receivables, net 12,323,056 10,931,382 Inventories - Note 2 18,612,946 19,522,963 Prepaid expenses 551,893 400,778 Deferred income taxes 1,409,000 1,188,000 ____________ ____________ Total current assets 46,802,007 45,141,047 Property, plant and equipment 27,377,665 25,762,350 less accumulated depreciation (16,061,239) (14,847,042) ____________ ____________ Net property, plant and equipment 11,316,426 10,915,308 Other assets: Investments in mortgage backed and other securities 4,899,126 5,398,316 Excess of cost over net assets acquired 3,415,606 839,229 Deferred income taxes 461,047 461,047 Other assets 370,217 532,285 ____________ ____________ Total other assets 9,145,996 7,230,877 ____________ ____________ Total Assets $67,264,429 $63,287,232 ____________ ____________ ____________ ____________ Liabilities and Stockholders' Equity: Current liabilities: Notes payable $92,675 $146,923 Accounts payable 3,504,429 4,104,349 Accrued expenses 2,808,800 2,296,996 Dividends payable 747,717 642,838 Income taxes payable 1,926,709 2,020,550 ____________ ____________ Total current liabilities 9,080,330 9,211,656 Stockholders' Equity 58,184,099 54,075,576 ____________ ____________ Total Liabilities and Stockholders' Equity $67,264,429 $63,287,232 ____________ ____________ ____________ ____________ See notes to consolidated financial statements.
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COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (unaudited) Three Months Ended March 31 Six Months Ended June 30 ___________________________________ ____________________________________ 1996 1995 1996 1995 ____________ ____________ ____________ ____________ Revenues: Sales $20,581,697 $21,866,017 $41,040,810 $46,671,964 Costs and expenses: Cost of sales 15,959,764 17,003,442 31,176,575 35,760,644 Selling, general and administrative expenses 3,273,913 2,149,999 6,137,463 5,166,773 ____________ ____________ ____________ ____________ Total costs and expenses 19,233,677 19,153,441 37,314,038 40,927,417 Operating income 1,348,020 2,712,576 3,726,772 5,744,547 Other income and (expenses): Investment income 181,221 216,353 328,597 521,063 Interest expense (5,627) (14,242) (12,080) (27,921) ____________ ____________ ____________ ____________ Other income, net 175,594 202,111 316,517 493,142 Income before income taxes 1,523,614 2,914,687 4,043,289 6,237,689 Income taxes (Note 3) 225,000 620,000 700,000 1,420,000 ____________ ____________ ____________ ____________ Net income $1,298,614 $2,294,687 $3,343,289 $4,817,689 ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ Net income per share $ .14 $ .25 $ .36 $ .53 ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ Average common and common equivalent shares outstanding 9,425,000 9,232,000 9,412,000 9,171,000 ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ See notes to consolidated financial statements.
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COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (unaudited) Additional Cumulative Common Stock Paid in Retained Advances Translation Shares Amount Capital Earnings to ESOP Adjustment Tota __________________________________________________________________________________________________ BALANCE at December 31, 1994 8,986,523 $449,326 $18,001,322 $27,519,954 ($72,000) ($332,161) $45,566,441 Net Income 9,084,153 9,084,153 Shareholder dividends (2,463,672) (2,463,672) Issuance of common stock under Employee Stock Option Plan 173,311 8,666 1,267,846 1,276,512 Tax benefit from nonqualified employee stock options 243,000 243,000 Issuance of common stock under Employee Stock Purchase Plan 23,567 1,178 193,957 195,135 Issuance of common stock to Welsh Development Agency 20,142 1,007 219,325 220,332 Purchase of Communications Systems Inc. common stock (20,142) (1,007) (219,325) (220,332) Cumulative translation adjustment 102,007 102,007 Repayment of advances to ESOP 72,000 72,000 __________ ________ ___________ _____________ __________ ___________ _____________ BALANCE at December 31, 1995 9,183,401 459,170 19,706,125 34,140,435 0 (230,154) 54,075,576 Net Income 3,343,289 3,343,289 Shareholder dividends (1,399,292) (1,399,292) Issuance of common stock under Employee Stock Option Plan 50,381 2,519 449,652 452,171 Issuance of common stock to acquire Automatic Tool and Connector Co. 112,676 5,634 1,712,675 1,718,309 Cumulative translation adjustment (5,954) (5,954) __________ ________ ___________ _____________ __________ ___________ _____________ BALANCE at June 30, 1996 9,346,458 $467,323 $21,868,452 $36,084,432 0 ($236,108) $58,184,099 __________ ________ ___________ _____________ __________ ___________ _____________ __________ ________ ___________ _____________ __________ ___________ _____________ See notes to consolidated financial statements.
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COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Six Months Ended June 30 _________________________________ 1996 1995 ____________ ____________ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $3,343,289 $4,817,689 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,502,722 1,275,066 Adjustment to marketable securities reserve 31,134 (120,922) Changes in assets and liabilities: Decrease in marketable securities 40,000 Increase in accounts receivable (896,895) (801,088) Decrease (increase) in inventory 1,359,141 (131,123) Decrease (increase) in prepaid expenses (138,557) 76,067 Increase in deferred taxes (221,000) Decrease in accounts payable (1,345,504) (1,333,139) Increase (decrease) in accrued expenses 517,031 (23,825) Increase (decrease) in income taxes payable (93,733) (773,446) ____________ ____________ Net cash provided by (used in) operating activities 4,057,628 3,025,279 CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (1,673,488) (2,431,295) Decrease in mortgage backed and other investment securities 498,259 11,240 Decrease in other assets 162,185 133,393 Payment for purchase of Austin Taylor Communications, Ltd. (135,131) Payment for purchase of Automatic Tool and Connector Company, Inc., net of cash acquired (1,178,008) ____________ ____________ Net cash used in investing activities (2,326,183) (2,286,662) CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of notes payable (53,637) (95,833) Dividends paid (1,294,413) (1,080,641) Proceeds from issuance of common stock 452,171 1,085,462 Purchases of Communications Systems, Inc. common stock (220,332) ____________ ____________ Net cash used in financing activities (895,879) (311,344) ____________ ____________ EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH 2,756 37,609 ____________ ____________ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 838,322 464,882 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 12,198,455 8,829,776 ____________ ____________ CASH AND CASH EQUIVALENTS AT END OF PERIOD $13,036,777 $9,294,658 ____________ ____________ ____________ ____________ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Income taxes paid $793,841 $2,193,520 Interest paid 12,080 27,921 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 stockholders' equity as of June 30, 1996, the statements of income for the three and six month periods ended June 30, 1996, and 1995 and the statements of cash flows for the six month periods ended June 30, 1996 and 1995 have been prepared by the Company 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, 1996 and 1995 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, 1995 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. NOTE 2 - INVENTORIES Inventories summarized below are priced at the lower of first-in, first-out cost or market:
June 30 December 31 1996 1995 Finished Goods $5,130,893 $5,475,458 Raw Materials 13,482,053 14,047,505 ------------ -------------- Total $18,612,946 $19,522,963 ============ ==============
NOTE 3 - INCOME TAXES Income taxes are computed based upon the estimated effective rate applicable to operating results for the full fiscal year. For the periods ended June 30, 1996 and 1995 income taxes do not bear a normal relationship to income before income taxes, primarily because income from Puerto Rico operations are taxed at rates lower than the U.S. rate. NOTE 4 - NET INCOME PER COMMON SHARE Net income per share is based on the weighted average number of common and common equivalent shares outstanding during the periods. Common equivalent shares reflect the dilutive effect of outstanding stock options. Primary and fully diluted earnings per share are substantially the same. NOTE 5 - ACQUISITION OF AUTOMATIC TOOL AND CONNECTOR CO., INC. Effective January 4, 1996, the Company acquired Automatic Tool and Connector Co., Inc., a Union, New Jersey based manufacturer of fiber optic connectors, in exchange for $1,373,000 in cash and 112,676 shares of Communications Systems, Inc. common stock. The acquisition was accounted for as a purchase and the purchase price was allocated to the assets acquired. Excess of cost over net assets acquired was $2,760,000, which is being amortized over ten years on a straight line basis. Results of Automatic Tool, which were not material to the Company's financial results, were included in Company operations beginning January 4, 1996. 7 COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Six Months Ended June 30, 1996 Compared to Six Months Ended June 30, 1995 Consolidated revenues decreased $5,631,000 or 12% from the 1995 period. Telephone station apparatus revenue decreased $2,389,000 or 7%. Apparatus sales to domestic (U.S. and Puerto Rico) customers decreased $35,000. The domestic sales decrease was due to lower sales to the Big 8 telephone companies (the seven Regional Bell Operating Companies and GTE) which fell $1,707,000 or 11%. Reduced shipments to this market segment were attributed to customer inventory overstocks and reduced construction activity in the first quarter of 1996. Sales to electrical distributors and original equipment manufacturers decreased $794,000 or 24%. Sales to retailers decreased $650,000 or 22%. Lower sales to these segments were offset by increased sales to other customers (up 1,232,000 or 33%) and by sales of fiber optic connectors by Automatic Tool and Connector Co.($2,081,000 in the first six months of 1996), which the Company acquired in January, 1996. Sales of telephone station apparatus to international customers decreased $2,353,000 or 27%. Sales by Austin Taylor, the Company's United Kingdom based subsidiary, decreased $1,957,000 or 27% due to the phase-out of certain products previously sold to British Telecom. Shipments of new products intended to replace this business have been delayed into the third and fourth quarters of 1996. U.S. export sales decreased $462,000 or 42%. Sales in Canada increased $65,000 or 13%. Contract manufacturing sales decreased $3,243,000 or 27%. Sales to Thermo-King, which was the segment's principal customer, declined $3,236,000 or 62%, due to Thermo-King's decision to move more of its manufacturing process to a plant it owns in Puerto Rico. Sales to Thermo-King accounted for 22% of contract manufacturing sales in the 1996 period compared to 43% of sales in the 1995 period. Sales of multi-function display units used by a major watercraft manufacturer increased $207,000 or 9%. Sales of electronic fishing products decreased $428,000 or 47%. Gross margin as a percentage of apparatus sales was 29% compared to 27% in the first half of 1995. Margin percentages improved in U.S. plants due to reduction in manufacturing overheads, freight charges and payroll overtime premiums. Margins earned on Austin Taylor products declined to 17% from 19% in the 1995 period due to increased raw material costs and unfavorable overhead absorption caused by reduced production volume. Gross margin on contract manufacturing sales, before inventory reserve adjustments, was 14% unchanged from the 1995 period. During the 1996 period, the Company established a $650,000 reserve against slow-moving electronic fishing products inventory held by its contract manufacturing business. Selling, general and administrative expenses increased $971,000 or 19% from the 1995 period. The increase was due to selling and administrative expenses associated with the newly acquired Automatic Tool and Connector Co. operations and increased international sales expenses in the Company's telephone station apparatus business. Consolidated operating income decreased $2,018,000 or 35%. Net other income decreased $177,000 from the 1995 period due to fluctuations in the value of the Company's marketable securities portfolio. The Company's effective income tax rate was 17% compared to 23% in the 1995 period. The Company's tax rate is lower than the full U.S. rate due to tax exemptions and benefits received by the Company's Puerto Rico operations. The Company's tax rate was higher in 1995 due to limitations on the possessions tax credit the Company receives against U.S. income taxes on the earnings of its Puerto Rico subsidiary. Net income decreased $1,474,000, or 31%. 8 COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES Three Months Ended June 30, 1996 Compared to Three Months Ended June 30, 1995 Consolidated revenues decreased $1,284,000 or 6% from the 1995 period. Telephone station apparatus revenue decreased $160,000 or 1%. Apparatus sales to domestic (U.S. and Puerto Rico) customers increased $1,448,000 or 12%. The domestic sales increase was due to the acquisition of Automatic Tool and Connector Co., (which added $1,001,000 to sales during the 1996 period) and sales to other customers (principally distributors serving non-RBOC customers) which increased $1,077,000 or 57%.. Sales to the Big 8 telephone companies (the seven Regional Bell Operating Companies and GTE) increased $97,000 or 1%. Sales to electrical distributors and original equipment manufacturers decreased $452,000 or 29%. Sales to retailers decreased $273,000 or 18%. Sales of telephone station apparatus to international customers decreased $1,608,000 or 35%. Sales by Austin Taylor, the Company's United Kingdom based subsidiary, decreased $1,109,000 or 32% due to the phase-out of certain products previously sold to British Telecom. U.S. export sales decreased $570,000 or 69%. Sales in Canada increased $71,000 or 29%. Contract manufacturing sales decreased $1,124,000 or 21%. Sales to Thermo-King, which was the segment's principal customer, declined $994,000 or 56%, due to Thermo-King's decision to move more of its manufacturing process to a plant it owns in Puerto Rico. Sales to Thermo-King accounted for 19% of contract manufacturing sales in the 1996 period compared to 34% of sales in the 1995 period. Sales of multi-function display units used by a major watercraft manufacturer increased $12,000 or 1%. Sales of electronic fishing products decreased $266,000 or 59%. Gross margin as a percentage of apparatus sales was 28% compared to 24% in the second quarter of 1995. Margin percentages improved in U.S. plants due to reduction in manufacturing overheads, freight charges and payroll overtime premiums. Margins earned on Austin Taylor products declined to 12% in the 1996 period due to increased raw material costs and unfavorable overhead absorption caused by reduced production volume. Gross margin on contract manufacturing sales, before inventory reserve adjustments, was 16% unchanged from the 1995 period. During the 1996 period, the Company established a $650,000 reserve against slow-moving electronic fishing products inventory held by its contract manufacturing business. Selling, general and administrative expenses increased $1,126,000 or 52% from the 1995 period. The increase was due to selling and administrative expenses associated with the newly acquired Automatic Tool and Connector Co. operations and increased international sales expenses in the Company's telephone station apparatus business. Consolidated operating income decreased $1,367,000 or 50%. Net other income decreased $27,000 from the 1995 period due to fluctuations in the value of the Company's marketable securities portfolio. The Company's effective income tax rate was 15% compared to 21% in the 1995 period. The Company's tax rate is lower than the full U.S. rate due to tax exemptions and benefits received by the Company's Puerto Rico operations. The Company's tax rate was higher in 1995 due to limitations on the possessions tax credit the Company receives against U.S. income taxes on the earnings of its Puerto Rico subsidiary. Net income decreased $998,000, or 43%. 9 COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES Liquidity and Capital Commitments At June 30, 1996 the Company had approximately $13,037,000 in cash compared to $12,198,000 at December 31, 1995. Working capital was $37,722,000 compared to $35,929,000 at December 31, 1995. The Company's current ratio was 5.2 to 1, compared to 4.9 to 1 at year end 1995. Net cash provided by operating activities was $4,058,000 compared to $3,025,000 in the first half of 1995. The Company expects its operating cash flows for the full year to approximate the results of 1995, which produced cash from operations of $6,983,000. Cash was utilized during the period to pay current liabilities, purchase new plant and equipment, pay dividends and acquire Automatic Tool and Connector Co., Inc. The Company's balance sheet remains strong, with stockholders' equity of $58,184,000 and no long-term debt. The Company has available a $2,000,000 bank line of credit. Management believes, based on the Company's current financial position and projected future expenditures, that sufficient funds are available to meet the Company's anticipated needs. On August 5, 1996, the Company's Board of Directors authorized the purchase and retirement, from time to time, of up to 500,000 shares of the Company's common stock on the open market, or in private transactions consistent with overall market and financial conditions. The Company's cash reserves will be utilized to make the purchases. If all 500,000 shares are purchased and retired, it would reduce the number of the Company's currently outstanding shares by 5%. On January 4, 1996, the Company acquired Automatic Tool and Connector Co., Inc. of Union, New Jersey, in exchange for $1,373,000 in cash and 112,676 shares of common stock. Automatic Tool and Connector Co. (ATC) is a manufacturer of high performance fiber optic connectors, interconnect devices and coaxial cable assemblies for the telecommunications, medical electronics, computer and other markets. The acquisition represents the Company's entrance into the market for fiber optic connectors, which is the fastest growing segment in the telecommunications connector market. ATC's sales for its 1995 fiscal year were approximately $3,200,000. This acquisition, as well as other acquisitions and dispositions the Company has made over the past several years (including the 1992 acquisition of Austin Taylor Communications, Ltd.), have served to expand the Company's product offerings and customer base in both U.S. and international markets. The Company is seeking to position itself in the marketplace as a growth oriented manufacturer of telecommunications connecting devices. The Company is continuing to search for acquisition candidates which fit the Company's target markets. 10 PART II. OTHER INFORMATION Items 1 - 3. Not Applicable Item 4. Submission of Matters to a Vote of Security Holders The Annual Meeting of the Shareholders of the Registrant was held on May 14, 1996 in Minneapolis, MN. The total number of shares outstanding and entitled to vote at the meeting was 9,311,210 of which 8,627,266 were present either in person or by proxy. By a vote of 8,612,288 in favor, 14,978 abstaining, shareholders reelected Board Members Edwin C. Freeman, Edward E. Strickland and John C. Ortman to three year terms expiring at the 1999 Annual Meeting of Shareholders. The Board of Directors appointed Fredrick Green to fill the unexpired term of Board Member C.A. Anderson, who passed away in February, 1996. Mr. Green's term will expire at the 1997 Annual Meeting of Shareholders. Other Board Members continuing in office are Paul J. Anderson and Wayne E. Sampson (whose terms expire at the 1997 Annual Meeting of Shareholders) and Curtis A. Sampson and Joseph W. Parris (whose terms expire at the 1998 Annual Meeting of Shareholders). Items 5 - 6. Not Applicable 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 Paul N. Hanson Paul N. Hanson Vice President and Chief Financial Officer Date: August 14, 1996