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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, 1997
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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 former 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, 1997
Common Stock, par value 9,205,713
$.05 per share
Total Pages (12) Exhibit Index at (NO EXHIBITS)
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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 9
Part II. Other Information 12
2
PART I. FINANCIAL INFORMATION
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
June 30 December 31
Assets: 1997 1996
____________ ____________
Current assets:
Cash $ 20,715,678 $ 17,799,398
Marketable securities 786,325 889,782
Receivables, net 11,665,420 10,375,080
Inventories - Note 3 16,055,091 13,861,914
Prepaid expenses 274,756 460,692
Deferred income taxes 1,062,283 792,000
____________ ____________
Total current assets 50,559,553 44,178,866
Property, plant and equipment 25,793,418 24,299,704
less accumulated depreciation (16,355,320) (15,335,114)
____________ ____________
Net property, plant and equipment 9,438,098 8,964,590
Net assets of discontinued operations 536,679
Other assets:
Investments in mortgage backed
and other securities 3,905,368 4,487,934
Excess of cost over net assets
acquired 3,063,957 3,166,422
Deferred income taxes 835,047 835,047
Notes receivable from sale of
assets of discontinued operations 4,665,390 4,866,597
Other assets 918,587 559,979
____________ ____________
Total other assets 13,388,349 13,915,979
____________ ____________
Total Assets $ 73,386,000 $ 67,596,114
____________ ____________
____________ ____________
Liabilities and Stockholders' Equity:
Current liabilities:
Accounts payable $ 3,546,794 $ 3,164,406
Accrued expenses 3,204,624 2,622,853
Dividends payable 828,109 728,585
Income taxes payable 2,493,047 2,064,792
____________ ____________
Total current liabilities 10,072,574 8,580,636
Stockholders' Equity 63,313,426 59,015,478
____________ ____________
Total Liabilities and
Stockholders'Equity $ 73,386,000 $ 67,596,114
____________ ____________
____________ ____________
See notes to consolidated financial statements.
3
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Three Months Ended June 30 Six Months Ended June 30
_____________________________ ____________________________
1997 1996 1997 1996
____________ ____________ ____________ ____________
Revenues from continuing operations:
Sales $ 20,181,244 $ 16,433,864 $ 36,997,263 $ 32,227,685
Costs and expenses:
Cost of sales 13,834,378 11,812,722 25,659,409 22,975,386
Selling, general and
administrative expenses 2,987,631 2,696,442 5,611,137 5,014,938
____________ ____________ ____________ ____________
Total costs and expenses 16,822,009 14,509,164 31,270,546 27,990,324
____________ ____________ ____________ ____________
Operating income from
continuing operations 3,359,235 1,924,700 5,726,717 4,237,361
Other income and (expenses):
Investment income 399,159 173,159 775,246 315,213
Interest expense (5,609) (12,007)
____________ ____________ ____________ ____________
Other income, net 399,159 167,550 775,246 303,206
Income from continuing operations
before income taxes 3,758,394 2,092,250 6,501,963 4,540,567
Income taxes (Note 4) 875,000 425,000 1,450,000 870,000
____________ ____________ ____________ ____________
Income from continuing operations 2,883,394 1,667,250 5,051,963 3,670,567
Income from discontinued operations,
net of income taxes (368,636) (327,278)
____________ ____________ ____________ ____________
Net income $ 2,883,394 $ 1,298,614 $ 5,051,963 $ 3,343,289
____________ ____________ ____________ ____________
____________ ____________ ____________ ____________
Net income per share:
Continuing operations $ .31 $ .18 $ .55 $ .39
Discontinued operations (.04) (.03)
____________ ____________ ____________ ____________
$ .31 $ .14 $ .55 $ .36
____________ ____________ ____________ ____________
____________ ____________ ____________ ____________
Average common and common
equivalent shares outstanding 9,259,000 9,425,000 9,234,000 9,412,000
____________ ____________ ____________ ____________
____________ ____________ ____________ ____________
See notes to consolidated financial statements.
4
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(unaudited)
Additional Cumulative
Common Stock Paid in Retained Translation
Shares Amount Capital Earnings Adjustment Total
__________ _____________ ___________ ____________ ___________ ____________
BALANCE at December 31, 1995 9,183,401 $459,170 $19,706,125 $34,140,435 ($230,154) $54,075,576
Net Income 8,232,531 8,232,531
Shareholder dividends (2,868,154) (2,868,154)
Issuance of common stock under
Employee Stock Purchase Plan 14,346 717 157,806 158,523
Issuance of common stock under
Employee Stock Option Plan 52,381 2,619 466,427 469,046
Tax benefit from nonqualified
employee stock options 12,701 12,701
Purchase of Communications Systems
Inc. common stock (255,495) (12,775) (601,381) (2,648,527) (3,262,683)
Issuance of common stock to acquire
Automatic Tool and Connector Co. 112,676 5,634 1,712,675 1,718,309
Cumulative translation adjustment 479,629 479,629
__________ _____________ ___________ ____________ ___________ ____________
BALANCE at December 31, 1996 9,107,309 455,365 21,454,353 36,856,285 249,475 59,015,478
Net Income 5,051,963 5,051,963
Shareholder dividends (1,563,406) (1,563,406)
Issuance of common stock to
Employee Stock Ownership Plan 20,870 1,044 298,956 300,000
Issuance of common stock under
Employee Stock Option Plan 73,034 3,652 665,657 669,309
Cumulative translation adjustment (159,918) (159,918)
__________ _____________ ___________ ____________ ___________ ____________
BALANCE at June 30, 1997 9,201,213 $460,061 $22,418,966 $40,344,842 $89,557 $63,313,426
__________ _____________ ___________ ____________ ___________ ____________
__________ _____________ ___________ ____________ ___________ ____________
See notes to consolidated financial statements.
5
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended June 30
____________________________
1997 1996
____________ ____________
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 5,051,963 $ 3,343,289
Add: Loss from discontinued operations 327,278
____________ ____________
Income from continuing operations 5,051,963 3,670,567
Adjustments to reconcile income from continuing operations
to net cash provided by operating activities:
Depreciation and amortization 1,246,477 1,219,550
Adjustment to marketable securities reserve (24,684) 31,134
Changes in assets and liabilities:
Decrease in marketable securities 128,141
Increase in accounts receivable (1,250,215) (977,050)
Decrease (increase) in inventory (2,236,126) 576,564
Decrease (increase) in prepaid expenses 184,692 (191,416)
Increase in deferred income taxes (269,643) (221,000)
Increase (decrease) in accounts payable 431,064 (1,170,408)
Increase in accrued expenses 594,946 394,610
Increase (decrease) in income taxes payable 426,952 (93,733)
____________ ____________
Net cash provided by operating activities 4,283,567 3,238,818
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,601,178) (1,310,857)
Decrease in mortgage backed and other investment securities 582,566 498,259
Decrease (increase) in other assets (458,039) 162,185
Changes in assets and liabilities of discontinued operations 536,679 23,128
Decrease in notes receivable from discontinued operations 201,207
Payment for purchase of Austin Taylor Communications, Ltd. (79,947) (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 (818,712) (1,940,424)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable (47,387)
Dividends paid (1,463,882) (1,294,413)
Proceeds from issuance of common stock 969,309 452,171
____________ ____________
Net cash used in financing activities (494,573) (889,629)
____________ ____________
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (54,002) 2,756
____________ ____________
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,916,280 411,521
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 17,799,398 11,703,536
____________ ____________
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 20,715,678 $ 12,115,057
____________ ____________
____________ ____________
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 1,010,076 $ 793,841
Interest paid -- 12,007
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, 1997, the
statements of income for the three and six month periods ended June 30, 1997 and
1996, and the statements of cash flows for the six month periods ended June 30,
1997 and 1996 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, 1997 and 1996 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, 1996 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 - DISCONTINUED OPERATIONS
On November 4, 1996, the Company completed the sale of its contract
manufacturing subsidiary, Zercom Corporation, to Nortech Systems, Inc. (Nasdaq
National Market: NSYS). Nortech Systems acquired all the assets of Zercom,
except cash and accounts receivable, in exchange for $1.5 million cash and a
$4.9 million term note secured by Zercom's assets.
The Company's financial statements have been restated to separate the net assets
and operating results of Zercom Corporation from the Company's continuing
operations. Zercom's operating results were as follows:
Three Months Ended Six Months Ended
June 30, 1996 June 30, 1996
--------------------- -------------------
Sales $ 4,147,833 $ 8,813,125
Costs and expenses 4,724,513 9,323,714
Interest income, net 8,044 13,311
--------------------- -------------------
Loss before income taxes (568,636) (497,278)
Income tax benefit (200,000) (170,000)
---------------------- --------------------
Net loss $ (368,636) $ (327,278)
====================== ====================
Net assets of discontinued Zercom operations at December 31, 1996 consisted of:
Accounts receivable $ 567,679
Deferred income taxes 269,000
Accrued expenses (300,000)
----------------------
Net assets of discontinued operations $ 536,679
======================
7
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
NOTE 3 - INVENTORIES
Inventories summarized below are priced at the lower of first-in, first-out cost
or market:
June 30 December 31
1997 1996
Finished Goods $ 4,850,001 $ 3,957,655
Raw Materials 11,205,090 9,904,259
------------------- --------------------
Total $ 16,055,091 $ 13,861,914
=================== ====================
NOTE 4 - 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, 1997
and 1996 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 5 - 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.
The Financial Accounting Standards Board (FASB) has issued SFAS 128, "Earnings
per Share" which requires public companies to present basic earnings per share
and, if applicable, diluted earnings per share instead of primary and fully
diluted earnings per share. SFAS 128 is effective for interim and annual periods
ending after December 15, 1997. The new standard would have no effect on the
Company's net income per share for the periods ended June 30, 1997 and 1996.
NOTE 6 - ACQUISITION OF AUTOMATIC TOOL AND CONNECTOR CO., INC.
Effective January 4, 1996, the Company purchased all the capital stock of
Automatic Tool and Connector Co., Inc. for $3,191,000, consisting of $1,473,000
of cash and 112,676 shares of the Company's common stock. The fair value of
assets acquired in the transaction was $4,063,000 (which includes excess of cost
over net assets acquired of $2,864,000, which is being amortized over ten years
on a straight line basis) and liabilities of $872,000 were assumed. Results of
Automatic Tool, which are not material to the Company's financial results, are
included in Company operations beginning January 4, 1996.
8
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Six Months Ended June 30, 1997 Compared to
Six Months Ended June 30, 1996
Revenues from continuing operations increased $4,770,000 or 15% from the 1996
period. Sales to domestic (U.S. and Puerto Rico) customers increased $3,280,000
or 13%. Sales to the Big 8 telephone companies (the seven Regional Bell
Operating Companies and GTE) increased $2,476,000 or 15%. The sales increase was
due to a 78% increase in sales of the Company's CorroShield line of corrosion
resistant products from the 1996 period. CorroShield products accounted for 36%
of all shipments from U.S. plants in the 1997 period. Sales to retailers
increased $317,000 or 14% due to increased sales to Radio Shack stores. Sales to
electrical distributors and original equipment manufacturers increased $604,000
or 10%, due to increased sales of data products and increased sales of voice
products to distributors.
Sales to international customers increased $1,489,000 or 22%. Sales by Austin
Taylor, the Company's United Kingdom based subsidiary, increased $1,344,000 or
25% due to increased sales of metal street cabinets and cable television
("CATV") customer premise equipment to U.K. based customers. U.S. export sales,
including sales to Canada, increased $145,000 or 10%.
Gross margin as a percentage of sales was 31% compared to 29% in the 1996
period. Margin percentages in U.S. plants were 33% compared to 31% in 1996.
Improvements were due to volume drive reductions in manufacturing overhead
percentages, which offset higher raw material costs. Margins earned on Austin
Taylor products improved to 19% from 17% in the 1996 period for the same
reasons.
Selling, general and administrative expenses increased $596,000 or 12% from the
1996 period. The increase was due to increased sales expenses associated with
efforts to increase sales of the Company's data products and develop export
markets for telephone station apparatus products.
Operating income from continuing operations increased $1,489,000 or 35%.
Investment income, net of interest expense, increased $472,000 from the 1996
period due to higher interest rates earned on investments and increases in
investable cash balances. The Company's effective income tax rate was 22%
compared to 19% in the 1996 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 effective tax rate increased because
income from Puerto Rico in the 1997 period exceeded the tax credits available to
the Company to completely shelter it from U.S tax. Income from continuing
operations increased $1,381,000, or 38%. Loss from discontinued operations was
$327,000 in the 1996 period. Net income increased $1,709,000, or 51%.
9
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Three Months Ended June 30, 1997 Compared to
Three Months Ended June 30, 1996
Revenues from continuing operations increased $3,747,000 or 23% from the 1996
period. Sales to domestic (U.S. and Puerto Rico) customers increased $2,222,000
or 17%. Sales to the Big 8 telephone companies (the seven Regional Bell
Operating Companies and GTE) increased $1,367,000 or 15%. The sales increase was
due to an 85% increase in sales of the Company's CorroShield line of corrosion
resistant products from the 1996 period. A portion of the increased CorroShield
volume was due to shipments scheduled for March which were delayed due to
inventory supply problems. CorroShield products accounted for 40% of all
shipments from U.S. plants in the 1997 period. Sales to electrical distributors
and original equipment manufacturers increased $1,108,000 or 46%, due to
increased sales of data products and increased sales of CorroShield products to
distributors. Sales to retailers decreased $44,000 or 3%.
Sales to international customers increased $1,525,000 or 50%. Sales by Austin
Taylor, the Company's United Kingdom based subsidiary, increased $1,127,000 or
48% due to increased sales of metal street cabinets and CATV customer premise
equipment to U.K. based customers. U.S. export sales, including sales to Canada,
increased $398,000 or 57% due to increased export sales of CorroShield products.
Gross margin as a percentage of sales was 31% compared to 28% in the 1996
period. Margin percentages in U.S. plants were 34% compared to 31% in 1996.
Improvements were due to volume drive reductions in manufacturing overhead
percentages, which offset higher raw material costs. Margins earned on Austin
Taylor products improved to 19% from 12% in the 1996 period for the same
reasons.
Selling, general and administrative expenses increased $291,000 or 11% from the
1996 period. The increase was due to increased sales expenses associated with
efforts to increase sales of the Company's data products and develop export
markets for telephone station apparatus products.
Operating income from continuing operations increased $1,435,000 or 75%.
Investment income, net of interest expense, increased $232,000 from the 1996
period due to higher interest rates earned on investments and increases in
investable cash balances. The Company's effective income tax rate was 23%
compared to 20% in the 1996 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 effective tax rate increased because
income from Puerto Rico in the 1997 period exceeded the tax credits available to
the Company to completely shelter it from U.S tax. Income from continuing
operations increased $1,216,000, or 73%. Loss from discontinued operations was
$369,000 in the 1996 period. Net income increased $1,585,000, or 122%.
10
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Liquidity and Capital Commitments
At June 30, 1997, the Company held approximately $20,716,000 of cash compared to
$17,799,000 at December 31, 1996. Working capital was $40,487,000 compared to
$35,598,000 at December 31, 1996. The Company's current ratio was 5.0 to 1
compared to 5.1 to 1 at December 31, 1996. In addition to its cash and working
capital balances, the Company also holds investments in long-term securities and
notes receivable totaling $8,571,000.
Net cash provided by operating activities was $4,286,000 compared to $3,239,000
in the first six months of 1996. Cash was utilized during the period to finance
increases in accounts receivable and inventory, purchase new plant and equipment
and pay dividends.
Under provisions of the Small Business Job Protection Act of 1996, the
possessions tax credit, which shelters the Company's Puerto Rico income from
U.S. income tax, was repealed for years after 1995. However, companies like CSI
which currently qualify for the credit, may continue to claim the credit until
2005, subject to certain limitations. As of July 1, 1996, the credit no longer
applied to investment income earned in Puerto Rico. The credit will continue to
apply to business income earned in Puerto Rico through 2001. For the years 2002
to 2005, the amount of Puerto Rico business income eligible for the credit will
be limited to an inflation adjusted amount based on Puerto Rico business income
earned from 1990 to 1994. The possessions tax credit has a materially favorable
effect on the Company's income tax expense. Had the Company incurred income tax
expense on Puerto Rico operations in 1997 at the full U.S. rate, income tax
expense would have increased by $1,200,000.
The Company's balance sheet remains strong, with stockholders' equity of
$63,313,000 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.
The acquisition of Automatic Tool and Connector Co. and the disposition of
Zercom Corporation as well as other acquisitions and dispositions the Company
has made over the past several years have served to expand and focus the
Company's telecommunications 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 with
products that will enable the Company to better serve its target markets.
11
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
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 22,
1997 in Minneapolis, MN. The total number of shares outstanding and entitled to
vote at the meeting was 9,191,213 of which 8,584,389 were present either in
person or by proxy. Shareholders reelected Board Members Paul J. Anderson, Wayne
E. Sampson and Frederick M. Green to three year terms expiring at the 2000
Annual Meeting of Shareholders. Shareholders also elected Luella Gross Goldberg
and Gerald D. Pint to newly created Board positions. Ms. Goldberg's term expires
at the 1999 Annual Meeting of Shareholders and Mr. Pint's term expires at the
1998 Annual Meeting of Shareholders. The vote in favor of electing these Board
Members is summarized below.
In Favor Abstaining
Paul J. Anderson 8,565,189 19,200
Wayne E. Sampson 8,519,201 65,188
Frederick M. Green 8,565,889 18,500
Luella Gross Goldberg 8,563,989 20,400
Gerald D. Pint 8,565,489 18,900
Other Board Members continuing in office are Curtis A. Sampson and Joseph W.
Parris (whose terms expire at the 1998 Annual Meeting of Shareholders) and Edwin
C. Freeman, Edward E. Strickland and John C. Ortman (whose terms expire at the
1999 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 13, 1997
12