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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 SEPTEMBER 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 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 October 31, 1997
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Common Stock, par value 9,322,835
$.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
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
September 30 December 31
Assets: 1997 1996
------------ ------------
Current assets:
Cash $ 23,644,909 $ 17,799,398
Marketable securities 796,100 889,782
Receivables, net 12,213,181 10,375,080
Inventories - Note 3 18,105,242 13,861,914
Prepaid expenses 424,905 460,692
Deferred income taxes 1,062,283 792,000
------------ ------------
Total current assets 56,246,620 44,178,866
Property, plant and equipment 26,072,307 24,299,704
less accumulated depreciation (16,845,146) (15,335,114)
------------ ------------
Net property, plant and equipment 9,227,161 8,964,590
Net assets of discontinued operations 536,679
Other assets:
Investments in mortgage backed and other
securities 3,669,383 4,487,934
Excess of cost over net assets acquired 2,972,751 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 1,059,483 559,979
------------ ------------
Total other assets 13,202,054 13,915,979
------------ ------------
Total Assets $ 78,675,835 $ 67,596,114
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Accounts payable $ 4,429,178 $ 3,164,406
Accrued expenses 3,464,539 2,622,853
Dividends payable 837,498 728,585
Income taxes payable 3,051,549 2,064,792
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Total current liabilities 11,782,764 8,580,636
Stockholders' Equity 66,893,071 59,015,478
------------ ------------
Total Liabilities and Stockholders' Equity $ 78,675,835 $ 67,596,114
============ ============
See notes to consolidated financial statements.
3
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Three Months Ended September 30 Nine Months Ended September 30
------------------------------ ------------------------------
1997 1996 1997 1996
------------ ------------ ------------ ------------
Revenues from continuing operations:
Sales $ 19,790,212 $ 18,390,779 $ 56,787,475 $ 50,618,464
Costs and expenses:
Cost of sales 13,015,205 12,529,048 38,674,614 35,504,434
Selling, general and
administrative expenses 2,742,209 2,869,937 8,353,346 7,884,875
------------ ------------ ------------ ------------
Total costs and expenses 15,757,414 15,398,985 47,027,960 43,389,309
------------ ------------ ------------ ------------
Operating income from
continuing operations 4,032,798 2,991,794 9,759,515 7,229,155
Other income and (expenses):
Investment income 456,567 175,506 1,231,813 490,719
Interest expense (4,492) (16,499)
------------ ------------ ------------ ------------
Other income, net 456,567 171,014 1,231,813 474,220
Income from continuing operations
before income taxes 4,489,365 3,162,808 10,991,328 7,703,375
Income taxes (Note 4) 1,335,000 730,000 2,785,000 1,600,000
------------ ------------ ------------ ------------
Income from continuing operations 3,154,365 2,432,808 8,206,328 6,103,375
Loss from discontinued operations,
net of income taxes (27,846) (355,124)
Loss on disposal of discontinued operations,
including provision of $30,000 for operating
losses during disposal period (net of income
tax benefit of $133,000) (393,000) (393,000)
------------ ------------ ------------ ------------
Net income $ 3,154,365 $ 2,011,962 $ 8,206,328 $ 5,355,251
============ ============ ============ ============
Net income per share:
Continuing operations $ .33 $ .26 $ .88 $ .65
Discontinued operations (.05) (.08)
------------ ------------ ------------ ------------
$ .33 $ .21 $ .88 $ .57
============ ============ ============ ============
Average common and common
equivalent shares outstanding 9,444,000 9,371,000 9,299,000 9,393,000
============ ============ ============ ============
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 8,206,328 8,206,328
Shareholder dividends (2,400,904) (2,400,904)
Issuance of common stock under
Employee Stock Purchase Plan 16,622 831 182,842 183,673
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 162,334 8,117 1,817,892 1,826,009
Cumulative translation adjustment (237,513) (237,513)
--------- -------------- ------------- -------------- ------------- --------------
BALANCE at September 30, 1997 9,307,135 $ 465,357 $ 23,754,043 $ 42,661,709 $ 11,962 $ 66,893,071
========= ============== ============= ============== ============= ==============
See notes to consolidated financial
statements.
5
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended September 30
----------------------------
1997 1996
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 8,206,328 $ 5,355,251
Add: Loss from discontinued operations 748,124
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Income from continuing operations 8,206,328 6,103,375
Adjustments to reconcile income from continuing
operations to net cash provided by operating
activities:
Depreciation and amortization 1,872,513 1,832,389
Adjustment to marketable securities reserve (34,459) 39,579
Loss on foreign exchange 73,696
Changes in assets and liabilities:
Decrease in marketable securities 128,141
Increase in accounts receivable (1,859,360) (2,101,972)
Decrease (increase) in inventory (4,337,843) 2,078,504
Decrease (increase) in prepaid expenses 32,717 (260,366)
Increase in deferred income taxes (269,310)
Increase (decrease) in accounts payable 1,364,665 (786,495)
Increase in accrued expenses 1,177,422 304,049
Increase (decrease) in income taxes payable 992,716 591,591
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Net cash provided by operating activities 7,347,226 7,800,654
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,981,448) (1,576,342)
Decrease in mortgage backed and other
investment securities 818,551 755,171
Decrease (increase) in other assets (600,910) 190,377
Changes in assets and liabilities of discontinued
operations 536,679 142,513
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)
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Net cash used in investing activities (1,105,868) (1,801,420)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable (58,969)
Dividends paid (2,291,991) (2,042,130)
Proceeds from issuance of common stock 2,009,682 610,694
Purchases of Communications Systems, Inc. common stock (1,326,412)
------------ ------------
Net cash used in financing activities (282,309) (2,816,817)
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EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (113,538) 6,229
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 5,845,511 3,188,646
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 17,799,398 11,703,536
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 23,644,909 $ 14,892,182
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 1,786,294 $ 1,004,628
Interest paid 16,499
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 September 30,
1997, the statements of income for the three and nine month periods ended
September 30, 1997 and 1996, and the statements of cash flows for the nine month
periods ended September 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 September 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 September 30 are
not necessarily indicative of the operating results for the entire year.
In February, 1997 the Company issued 20,870 shares of the Company's common stock
to the Employee Stock Ownership Plan in payment of its 1996 obligation. In a
noncash transaction, the Company recorded additional stockholders' equity of
$300,000 (reflecting the market value of the stock at the time of the
contribution) and reduced accrued expenses by the same amount.
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 Nine Months Ended
September 30, 1996 September 30, 1996
Sales $ 3,033,690 $ 11,846,815
Costs and expenses 3,077,965 12,401,679
Interest income, net 11,429 24,740
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Loss before income taxes (32,846) (530,124)
Income tax benefit (5,000) (175,000)
---------------- ----------------
Loss from operations 27,846) (355,124)
Loss on disposal of discontinued operations,
including provision of $30,000 for operating
losses during disposal period, net of tax
benefits of $133,000 (393,000) (393,000)
---------------- ----------------
$ (420,846) $ (748,124)
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7
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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)
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Net assets of discontinued operations $ 536,679
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NOTE 3 - INVENTORIES
Inventories summarized below are priced at the lower of first-in, first-out cost
or market:
September 30 December 31
1997 1996
Finished Goods $ 4,928,649 $ 3,957,655
Raw Materials 13,176,593 9,904,259
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Total $ 18,105,242 $ 13,861,914
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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 September 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.
The Puerto Rico Bureau of Income Tax has examined the Company's tax returns for
1993, 1994 and 1995 and has proposed certain adjustments to taxable income which
the Company is contesting. If the Bureau of Income Tax positions were to
prevail, it could affect the Company's U.S. federal and state tax liabilities in
those years, and have ramifications for future years income taxes. The Company
believes this matter will be resolved with no material adverse effect on
financial position or results of operations.
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 material effect
on the Company's net income per share for the periods ended September 30, 1997
and 1996.
8
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Nine Months Ended September 30, 1997 Compared to
Nine Months Ended September 30, 1996
Revenues from continuing operations increased $6,169,000 or 12% from the 1996
period. Sales to domestic (U.S. and Puerto Rico) customers increased $4,428,000
or 11%. The sales increase was due to a 66% increase in sales of the Company's
CorroShield line of corrosion resistant products from the 1996 period.
CorroShield products accounted for 37% of all shipments from U.S. plants in the
1997 period. Sales to the Big 8 telephone companies (the seven Regional Bell
Operating Companies and GTE) increased $2,268,000 or 9%. Sales to retailers
increased $763,000 or 20% due to increased sales to Radio Shack stores. Sales to
electrical distributors and original equipment manufacturers increased
$1,458,000 or 16%.
Sales to international customers increased $1,741,000 or 17%. Sales by Austin
Taylor, the Company's United Kingdom based subsidiary, increased $1,619,000 or
20% 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 $122,000 or 6%.
Gross margin as a percentage of sales was 32% compared to 30% in the 1996
period. Margin percentages in U.S. plants were 35% compared to 32% in 1996.
Improvements were due to volume drive reductions in manufacturing overhead
percentages and reductions of unfavorable production overhead variances, which
offset higher raw material costs. Margins earned on Austin Taylor products
improved to 19% from 18% in the 1996 period for the same reasons.
Selling, general and administrative expenses increased $468,000 or 6% 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. These increases offset selling
and administrative expense reductions at Austin Taylor.
Operating income from continuing operations increased $2,530,000 or 35%.
Investment income, net of interest expense, increased $758,000 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 25%
compared to 21% 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 $2,103,000, or 38%. Loss from discontinued operations was
$748,000 in the 1996 period. Net income increased $2,851,000, or 53%.
9
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Three Months Ended September 30, 1997 Compared to
Three Months Ended September 30, 1996
Revenues from continuing operations increased $1,399,000 or 8% from the 1996
period. Sales to domestic (U.S. and Puerto Rico) customers increased $1,147,000
or 8%. The sales increase was due to an 47% increase in sales of the Company's
CorroShield line of corrosion resistant products from the 1996 period.
CorroShield products accounted for 38% of all shipments from U.S. plants in the
1997 period. Sales to electrical distributors and original equipment
manufacturers increased $854,000 or 46%, due to increased sales of CorroShield
products to distributors. Sales to retailers increased $446,000 or 32% due to
strong sales to Radio Shack stores. Sales to the Big 8 telephone companies (the
seven Regional Bell Operating Companies and GTE) decreased $208,000 or 2%.
Sales to international customers increased $252,000 or 7%. Sales by Austin
Taylor, the Company's United Kingdom based subsidiary, increased $275,000 or 9%
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,
decreased $23,000 or 3%.
Gross margin as a percentage of sales was 34% compared to 32% in the 1996
period. Margin percentages in U.S. plants were 37% compared to 34% in 1996. .
Improvements were due to volume drive reductions in manufacturing overhead
percentages and reductions of unfavorable production overhead variances, which
offset higher raw material costs. Margins earned on Austin Taylor products
declined to 19% from 20% in the 1996 period due to higher raw material costs.
Selling, general and administrative expenses decreased $128,000 or 4% from the
1996 period. The decrease was due to lower selling and administrative expenses
at Austin Taylor and lower corporate administrative expenses, which offset
increased U.S. apparatus sales expenses for data products and export products.
Operating income from continuing operations increased $1,041,000 or 37%.
Investment income, net of interest expense, increased $286,000 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 30%
compared to 23% 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 $722,000, or 30%. Loss from discontinued operations was
$421,000 in the 1996 period. Net income increased $1,142,000, or 57%.
10
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Liquidity and Capital Commitments
At September 30, 1997, the Company held approximately $23,645,000 of cash
compared to $17,799,000 at December 31, 1996. Working capital was $44,464,000
compared to $35,598,000 at December 31, 1996. The Company's current ratio was
4.8 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 $8,335,000.
Net cash provided by operating activities was $7,347,000 compared to $7,801,000
in the first nine 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. The Company received $2,010,000 of cash in the 1997 period
from issuance of its common stock, mostly due to exercises of employee stock
options.
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 approximately $1,800,000.
The Company's balance sheet remains strong, with stockholders' equity of
$66,893,000 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.
- --------------------------------------------------------------------------------
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 the Regional Bell Operating Companies and other
customers, competitive products, and other factors.
- --------------------------------------------------------------------------------
11
PART II. OTHER INFORMATION
Items 1 - 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: November 13, 1997
12