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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission File Number: 0-10355
COMMUNICATIONS SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Minnesota 41-0957999
- ---------------------------------- --------------------
(State or other jurisdiction (Federal Employer
of incorporation or organization) Identification No.)
213 South Main Street
Hector, MN 55342
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (320) 848-6231
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
Common Stock, $.05 par value
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 a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $127,328,000 based upon the closing sale price of
the Company's common stock on the NASDAQ National Market System on March 10,
1998.
As of March 11, 1998 there were outstanding 9,349,552 shares of the Registrant's
common stock.
Documents Incorporated by Reference: The Company's Proxy Statement for its
Annual Meeting of Shareholders to be held on May 19, 1998 is incorporated by
reference into Part III of this Form 10-K.
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PART I
ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
Communications Systems, Inc. is a Minnesota corporation organized in 1969
which, operating directly and through its subsidiaries located in New Jersey,
Puerto Rico, Costa Rica and Bethesda, Wales (herein collectively called "CSI" or
the "Company") is principally engaged in the manufacture and sale of modular
connecting and wiring devices for voice and data communications. The Company's
product line, which is commonly referred to as "telephone station apparatus",
consists primarily of equipment which connects telephones, data terminals and
related customer premise equipment to the telephone network.
Effective January 4, 1996, the Company acquired Automatic Tool and
Connector Company, Inc. ("ATC"). ATC is a manufacturer of connecting devices for
fiber optic equipment located in Union, New Jersey. The acquisition was
accounted for as a purchase and operations of ATC have been included in
consolidated operations from January 4, 1996. Additional information on this
acquisition can be found in subparagraph (c)(1)(iii) under Item 1 herein, in
"Acquisitions and Dispositions" under Item 7, Management's Discussion and
Analysis and in Note 1 of Notes to Consolidated Financial Statements under Item
8, herein.
Until November, 1996, the Company conducted a value-added design and
contract manufacturing operation through a subsidiary located in Merrifield,
Minnesota. During 1996, the Company's Board of Directors concluded this business
was no longer a strategic fit with the Company's telephone station apparatus
business. Effective November 4, 1996, these operations were sold to Nortech
Systems, Inc. For additional information on this divestiture, see subparagraph
(c)(2) under Item 1 herein and "Acquisitions and Dispositions" under Item 7,
Management's Discussion and Analysis and Note 2 of Notes to Consolidated
Financial Statements under Item 8, herein.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company's continuing operations are in one business segment - the
manufacture and sale of connecting and wiring devices for voice and data
communications. The Company conducts manufacturing in the United States
(including Puerto Rico), the United Kingdom and Costa Rica. Information
regarding operations in the various geographic areas is set forth in Note 10 in
the Financial Statements under Item 8 herein.
(c) NARRATIVE DESCRIPTION OF BUSINESS
(1) Telephone Station Apparatus Segment
Telephone station apparatus is manufactured and marketed under the "Suttle
Apparatus" brand name in the United States (U.S.) and internationally and
through Austin Taylor Communications in the United Kingdom (U.K.), Europe and
other foreign countries. Fiber optic connector products are manufactured and
marketed by Automatic Tool and Connector Co. in the U.S. and internationally.
Suttle Apparatus sales were $58,325,000 in 1997, or 77% of consolidated
revenues. Sales by Austin Taylor Communications accounted for $13,316,000 or 18%
of consolidated revenues. Sales by Automatic Tool and Connector Co. were
$4,091,000 or 5% of consolidated revenues.
2
(i) Suttle Apparatus Operations
The Company manufactures telephone station apparatus at its plants in
Hector, Minnesota (Suttle Apparatus Minnesota Division), Humacao, Puerto Rico
(Suttle Caribe, Inc.) and San Jose, Costa Rica (Suttle Costa Rica, S.A.).
Products are marketed under the "Suttle Apparatus" brand name in the U.S. and
internationally and under the "Tel Products" brand name in the U.S. retail
market.
(A) Products
Suttle Apparatus' telephone station apparatus products are used in
on-premise connection of telephones, data terminals and related equipment. The
product line consists primarily of modular connecting devices and includes
numerous types of jacks, connecting blocks and assemblies, adapters, cords and
related equipment, which are offered in a variety of colors, styles and wiring
configurations. Most of the Company's products are used in voice applications,
but the Company continues to develop an expanding line of products for network
systems applications. A significant portion of the Company's revenues are
derived from sales of a line of corrosion resistant connectors which utilize a
water resistant gel to offer superior performance in harsh environments. The
Company's station apparatus products generally range in price from $.70 to
$25.00 per unit. A majority of the sales volume, both in units and revenues, is
derived from products selling for under $5.00.
(B) Markets and Marketing
The Company competes in all major segments of the telephone station
apparatus market. These market segments include the "Big 6" telephone companies
(the five Regional Bell Operating Companies, or "RBOCs" and GTE), other
telephone companies, electrical contractors, interconnect companies, original
equipment manufacturers and retailers. These markets are served directly through
the Company's sales staff and through distributors such as Sprint North Supply,
Graybar Electric Company, Alltel Supply, KGP and Anixter Communications.
As a group, sales to the Big 6 telephone companies, both directly and
through distribution, were approximately $38,027,000 in 1997 and $34,271,000 in
1996, which represented about 65% of Suttle Apparatus' sales in each year. Sales
to GTE Supply and KGP, Inc., the principal distributors serving this market,
amounted to 23% and 13%, respectively, of Suttle Apparatus' sales in 1997. Sales
to Sprint North Supply, another large distributor serving this market were
approximately 10% of Suttle Apparatus' sales in 1996.
Approximately 10% of Suttle Apparatus' 1997 revenues were derived from
sales in the retail market. The Company is a supplier of station apparatus to
Radio Shack, other retailers, office supply distributors and specialized
telephone stores. Sales to the retail market are made through a limited number
of manufacturers' representatives.
The market for business and network systems products is the fastest growing
segment of the station apparatus industry. Independent contractors (which
include businesses often referred to as "interconnect companies") are engaged in
the business of engineering, selling, installing and maintaining telephone
equipment for the business community. The Company markets its products to
independent contractors through a network of manufacturers representatives,
through distribution, and through the Company's sales staff. Sales of products
for business and network systems accounted for 13% of Suttle Apparatus' 1997
revenues.
The balance of Suttle Apparatus' sales in 1997 and 1996 were to original
equipment manufacturers and non-Big 6 telephone companies. In the communications
industry market, sales to telephone companies are made directly or through
distribution. Sales to OEM customers are made through a nationwide network of
distributors, some of which are affiliates of major telephone companies, and
through the Company's sales staff.
3
(C) Competition
Suttle Apparatus encounters strong competition in all its station apparatus
product lines. The Company competes primarily on the basis of the broad lines of
products offered, product performance, quality, price and delivery.
The Company's principal competitors for sales to telephone companies and
independent contractors include: Lucent Technologies, Ortronics, Leviton,
Hubbell, Northern Telecom and AMP, Inc. Most of these companies have greater
financial resources than the Company. In addition, distributors of the Company's
apparatus products also market products for one or more of these competitors.
Lucent Technologies markets to telephone companies and independent contractors
directly and through telephone industry distributors that also market the
Company's products.
In retail markets, the Company experiences significant competition from
importers of low-priced modular products which market their products directly
and through a number of distributors to various retail outlets.
The Company's principal competitor for sales to the Regional Bell Operating
Companies is Lucent Technologies. To date, foreign manufacturers of apparatus
products have not presented significant competition for sales to this market.
(D) Order Book
Suttle Apparatus manufactures its station apparatus on the basis of
estimated customer requirements. Outstanding customer orders at March 1, 1998
were approximately $3,664,000 compared to approximately $4,600,000 at March 1,
1997. Because new orders are filled on a relatively short timetable, the Company
does not believe its order book is a significant indicator of future results.
(E) Manufacturing and Sources of Supply
The Company's station apparatus products are manufactured using plastic
parts, wire sub-assemblies, fasteners, brackets, electronic circuit boards and
other components, most of which are fabricated by the Company. There are
multiple sources of supply for the materials and parts required and the Company
is not dependent upon any single supplier, except that Suttle's corrosion
resistant products utilize a moisture-resistant gel-filled fig available only
from Raychem Corporation. The unavailability of the gel-filled figs from Raychem
Corporation could have a material adverse effect on the Company. The Company has
not generally experienced significant problems in obtaining its required
supplies, although from time to time spot shortages are experienced.
(F) Research and Development; Patents
The Company continually monitors industry requirements and creates new
products to improve its existing station apparatus product line. The Company's
CorroShield line of corrosion resistant products was introduced in 1993, as was
the Flex-Plate line of data products. The Company added additional products to
these product lines in 1994 and 1995. The Company's new SpeedStar line of high
speed data connectors was introduced in early 1996. In 1997, a proprietary
Category 5 connector was developed which meets the highest current industry
standard.
Historically, the Company has not relied on patents to protect its
competitive position in the station apparatus market. However, duplication of
Company designs by foreign apparatus manufacturers has caused the Company to
apply for design patents on a number of station apparatus products.
The Company's "Suttle Apparatus" brand name is important to its business.
The Company regularly supports this name by trade advertising and believes it is
well known in the marketplace.
4
(ii) Austin Taylor Operations
Austin Taylor Communications, Ltd. manufactures voice and data connectors
and related products at its plant in Bethesda, Wales, U.K. Its product line
consists of British standard line jacks, patch panels, wiring harness
assemblies, metal boxes, distribution cabinets and distribution and central
office frames.
Austin Taylor is a vertically integrated manufacturer with metal stamping,
metal bending, forming and painting, plastic injection molding and printed
circuit board assembly capabilities. Austin Taylor's major customers include
Cable and Wireless Communications, Northern Telecom Europe, Lucent Technologies
and British Telecom. Austin Taylor's products are sold directly by its sales
staff and through distributors, including Anixter Communications, NS Supply
Group, RS Components and Telcom Products. Approximately 78% and 76% of Austin
Taylor sales were to United Kingdom customers in 1997 and 1996, respectively.
The Company believes the European telecommunications market will offer
increasing opportunities as the European Economic Community eliminates trade
barriers and standardizes on modular connector products. In addition to
continued manufacturing and marketing of its existing products, Austin Taylor
will be a base to manufacture and/or distribute existing Suttle Apparatus
products or new jointly developed products in the United Kingdom, Europe and
internationally. The Company also markets Austin Taylor products in the U.S.,
Canada, and other markets.
Outstanding customer orders for Austin Taylor products were approximately
$754,000 at March 1, 1998 compared to $1,531,000 at March 1, 1997. Because
Austin Taylor fills new orders on a relatively short time table, the Company
does not believe its order book is a significant indicator of future results.
(iii) Automatic Tool and Connector Company Operations
Effective January 4, 1996, by its acquisition of Automatic Tool and
Connector Company ("ATC"), the Company entered the rapidly growing market for
fiber optic connector products. Located in Elizabeth, New Jersey, ATC
manufactures a line of high performance fiber optic connectors, interconnect
devices and fiber cable assemblies for the telecommunications, computer and
electronics markets. ATC's patented Quick Term TM fiber optic connector
significantly reduces installation time and costs associated with making fiber
connections. By eliminating the need for a curing oven, the product reduces
field installation time for this process from 20 minutes to 2 minutes.
ATC markets its products to original equipment manufacturers (OEMs) in the
U.S. and internationally through the Company's sales staff and a network of
distributors and manufacturers representatives, including Graybar Electric
Company, Arcade Electronics and Primestock. Export sales of ATC products were
$538,000 in 1997 accounting for 13% of ATC's sales.
Outstanding customer orders for ATC's products were approximately $197,000
at March 1, 1998 compared to $80,000 at March 1, 1997. Because ATC fills new
orders on a relatively short time table, the Company does not believe its order
book is a significant indicator of future results.
(2) Discontinued Contract Manufacturing Operations
Prior to November, 1996, the Company, through its subsidiary, Zercom
Corporation, engaged in contract manufacturing of electronic assemblies and
products, including printed circuit board assembly, cable and harness assembly
and electro-mechanical assemblies, for original equipment manufacturers (OEMs).
Zercom also provided product engineering services, including circuit board
design, case and enclosure design and product development consulting from design
concept to finished product and manufactured electronic fishing products for the
sports fishing market.
During the third quarter of 1996, the Company's Board of Directors
concluded that the contract manufacturing business was no longer a strategic fit
with the Company's plans for its domestic and international telecommunications
manufacturing business. After considering various alternatives for the
disposition of Zercom, the Company agreed to sell the assets (except cash and
accounts receivable) of Zercom Corporation to Nortech Systems, Inc. . (Nasdaq
National Market System: NSYS ) effective November 4, 1996.
5
(3) Employment Levels
As of March 1, 1998 the Company employed 950 people. Of this number, 936
were engaged in telephone equipment manufacturing operations (including 224 in
Puerto Rico, 179 in Hector, Minnesota, 37 in Elizabeth, New Jersey, 319 in Costa
Rica and 177 in Wales) and 14 held general and administrative positions. The
Company considers its employee relations to be good.
(4) Factors Affecting Future Performance
From time to time, in reports filed with the Securities and Exchange
Commission, in press releases, and in other communications to shareholders or
the investing public, the Company may comment on anticipated future financial
performance. Such forward looking statements are subject to risks and
uncertainties, including but not limited to buying patterns of Bell Operating
Companies, the impact of new products introduced by competitors, higher than
expected expenses related to sales and new marketing initiatives, changes in tax
laws, particularly in regard to taxation of income of its subsidiary in Puerto
Rico and other risks involving the telecommunications industry generally.
(5) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 1998 were
as follows:
Name Age Position (1)
Curtis A. Sampson 64 Chairman of the Board, President
and Chief Executive Officer [1970]
Jeffrey K. Berg 55 President and General Manager
Suttle Apparatus Corporation [1990]
Paul N. Hanson 51 Vice President - Finance, Treasurer
and Chief Financial Officer [1982]
John C. Hudson 53 Managing Director, Austin Taylor
Communications, Ltd. [1992]
- -----------------------------------
(1) Dates in brackets indicate period during which officers began serving
in such capacity. Executive officers serve at the pleasure of the Board of
Directors and are elected annually for one year terms.
Messrs. Sampson and Hanson each devote approximately 60% of their working
time to the Company's business with the balance devoted to management
responsibilities at Hector Communications Corporation ("HCC"), a diversified
telecommunications holding company also headquartered in Hector, Minnesota, for
which they are separately compensated by HCC.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND
EXPORT SALES
Financial information about domestic and foreign operations and export
sales may be obtained by reference to Note 10 of the "Notes to Consolidated
Financial Statements" under Item 8 herein.
6
ITEM 2. PROPERTIES
The administrative and manufacturing functions of CSI are conducted at the
following facilities:
- -- In Hector, Minnesota the Company owns a 15,000 square foot building where
its executive and administrative offices are located.
- -- Telephone station apparatus manufacturing is conducted at four locations.
At Hector, Minnesota, the Company owns three plants totaling 68,000 feet of
manufacturing space. Austin Taylor Communications, Ltd. owns a 40,000
square foot facility and leases a 6,000 square foot facility in Bethesda,
Wales. The Company has a long-term lease from the Puerto Rico Industrial
Development Company on three facilities in Humacao, Puerto Rico aggregating
65,000 square feet. The Company also has leased 40,000 square feet of
manufacturing space in San Jose, Costa Rica.
- -- The Company leases a 5,000 square foot facility in Elizabeth, New Jersey
where Automatic Tool and Connector Company manufactures its fiber optic
connector products.
- -- The Company owns a 35,000 square foot plant in Lawrenceville, Illinois.
This facility is for sale, but is currently leased to other tenants,
pending a sale.
CSI believes these facilities will be adequate to accommodate its
administrative and manufacturing needs for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
No material litigation or other claims are presently pending against
the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
7
PART II
ITEM 5. MARKET MATTERS FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
(a) MARKET INFORMATION
The Company's common stock is currently traded in the National Market
System of the National Association of Securities Dealers Automated Quotation
System ("NASDAQ").
The table below presents the price range of high and low trades of the
Company's common stock for each period indicated as reported by NASDAQ:
1997 1996
------------------ ---------------------
High Low High Low
------- -------- -------- --------
First $15.13 $13.50 $16.25 $13.25
Second 15.00 12.50 16.50 12.75
Third 22.63 14.00 15.88 11.25
Fourth 22.75 16.00 16.00 12.50
(b) HOLDERS
At March 1, 1998 there were approximately 785 holders of record of
Communications Systems, Inc. common stock.
(c) DIVIDENDS
The Company has paid regular quarterly dividends since October 1, 1985.
The per share quarterly dividends payable in fiscal 1996 and 1997 were as
follows:
January 1, 1996 - April, 1996 $.07
July 1, 1996 - April, 1997 .08
July 1, 1997 - Present .09
8
ITEM 6. SELECTED FINANCIAL DATA
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
SELECTED FINANCIAL INFORMATION
(in thousands except per share amounts)
Year Ended December 31
-----------------------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
Selected Income Statement Data
Revenues From Continuing Operations $ 75,732 $ 68,705 $ 66,004 $ 57,077 $ 47,896
Costs and Expenses:
Cost of Sales 52,302 47,719 47,297 40,812 33,348
Selling, General and Administrative Expenses 10,947 10,581 8,519 8,180 7,126
------- ------- ------- ------- -------
Total Costs and Expenses 63,249 58,300 55,816 48,992 40,474
Operating Income From Continuing Operations 12,483 10,405 10,189 8,086 7,422
Other Income, Net 1,654 799 899 341 567
Income From Continuing Operations Before Income Taxes 14,137 11,204 11,088 8,427 7,988
Income Tax Expense 3,200 2,250 2,164 1,616 1,308
------- ------- ------- ------- -------
Income From Continuing Operations 10,937 8,954 8,924 6,811 6,680
Income (Loss) From Discontinued Operations, Net of Taxes (721) 160 (7) 55
------- ------- ------- ------- -------
Net Income $ 10,937 $ 8,233 $ 9,084 $ 6,804 $ 6,735
======= ======= ======= ======= =======
Basic Net Income (Loss) Per Common Share:
Continuing Operations $ 1.18 $ .97 $ .98 $ .76 $ .75
Discontinued Operations (.08) .02 .01
------- ------- ------- ------- -------
Basic Net Income Per Share $ 1.18 $ .89 $ 1.00 $ .76 $ .76
======= ======= ======= ======= =======
Diluted Net Income (Loss) Per Common Share
Continuing Operations $ 1.17 $ .96 $ .97 $ .75 $ .74
Discontinued Operations (.08) .02 .01
------- ------- ------- ------- -------
Diluted Net Income Per Share $ 1.17 $ .88 $ .99 $ .75 $ .75
======= ======= ======= ======= =======
Cash Dividends Per Share $ .34 $ .30 $ .26 $ .22 $ .19
======= ======= ======= ======= =======
Average Common and Potential Common
Shares Outstanding 9,325 9,352 9,217 9,093 9,026
======= ======= ======= ======= =======
Selected Balance Sheet Data
Total Assets $ 77,518 $ 67,596 $ 61,945 $ 54,799 $ 46,105
Property, Plant and Equipment, Net 9,675 8,965 8,658 8,132 5,883
Working Capital 48,514 35,906 29,039 22,420 20,283
Net Assets of Discontinued Operations 537 9,255 8,033 5,218
Assets of Businesses Transferred Under
Contractual Arrangements 593 1,001
Stockholders' Equity 69,264 59,015 54,076 45,566 40,365
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
1997 Compared to 1996
Sales increased 10% to $75,732,000. Operating income increased 20% to
$12,483,000. Sales to customers in the United States (U.S.) increased 10% to
$59,674,000. Sales to the Big 6 telephone companies (the five Regional Bell
Operating Companies (RBOCs) and GTE) increased 11% to $38,027,000, accounting
for 64% of U.S. customer sales. Sales to distributors, original equipment
manufacturers (OEMs), and electrical contractors increased 8%. Sales to retail
customers increased 11% due to increased sales to Radio Shack. U.S. export
sales, including sales to Canada decreased 9% to $2,741,000.
The sales increases were generated by a 56% increase in sales of the Company's
CorroShield line of corrosion resistant connectors. CorroShield product sales
totaled $23,610,000 in 1997 compared to $15,123,000 in 1996. During 1997, two
additional RBOCs converted to this product line for the majority of their
residential installations. This product conversion resulted in an 11% decline in
sales of conventional voice connecting products in 1997, a trend the Company
expects to continue. Sales of data products increased 8% to $7,314,000. Sales of
fiber optic connector products decreased 15% to $4,091,000.
Sales by Austin Taylor Communications, Ltd., the Company's United Kingdom (U.K.)
based subsidiary increased 18% to $13,316,000. Growth was due to increased sales
of network termination equipment and street cabinets to U.K. cable television
companies and increased sales of plastic and metal distribution boxes through
the distributor market.
Gross margins on sales increased 12% to $23,430,000. Gross margin as a
percentage of sales was 31%, unchanged from 1996. Gross margin in U.S. plants
was 34% compared to 33% in 1996. Improvement in gross margin was due to lower
purchase costs for certain raw materials and improved manufacturing overhead
efficiencies due to increased production volumes. Margins on Austin Taylor
products were 18% compared to 19% in 1996. The decline in margins was due to
product development costs and increased costs for certain raw materials.
Selling, general and administrative expenses increased $366,000 or 3%. 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 U.S.
apparatus products. These U.S. sales expense increases more than offset lower
sales expenses at Austin Taylor and lower corporate expenses.
Investment income, net of interest expense, increased $855,000 due to increased
levels of funds available for investment and interest on notes receivable from
the sale of discontinued operations.
Income from continuing operations before income taxes increased $2,933,000 or
26%. The Company's effective income tax rate was 22.6% compared to 20.1% in
1996. The increase in the tax rate was due to increased U.S. taxes on the
Company's earnings in Puerto Rico. Income from continuing operations increased
$1,983,000 or 22%.
10
1996 Compared to 1995
Revenues from continuing operations increased 4% to $68,705,000. Operating
income from continuing operations increased 2% to $10,405,000. Sales to
customers in the United States (U.S.) increased 11% to $54,421,000. Sales to the
Big 6 telephone companies increased 9% and accounted for 63% of U.S. apparatus
sales. Sales to distributors, original equipment manufacturers (OEMs), and
electrical contractors increased 29%. The sales increases were generated by
increased sales of the Company's CorroShield line of corrosion resistant
connectors and by sales of the fiber optic connector products acquired in the
January, 1996 purchase of Automatic Tool and Connector Company, Inc. CorroShield
sales increased 3% to $15,123,000 in 1996, accounting for 28% of all U.S.
shipments. Sales of data products increased 9% to $6,746,000 and accounted for
12% of U.S. shipments. Sales to retail customers decreased 8% primarily due to
loss of the Company's sales contract with Coast-to-Coast stores. Sales to
international customers from the Company's U.S. plants, including sales to
Canada, decreased 1% to $3,020,000 as sales of fiber optic products offset lower
station apparatus sales.
Sales by Austin Taylor, the Company's United Kingdom based subsidiary, decreased
$2,490,000, or 18%. The sales decrease was due to the loss to competitors of a
number of sales contracts with British Telecom for line jacks and modular boxes.
Shipments of new products to the U.K. cable television industry were delayed due
to slower than anticipated contract start-ups. Sales of these products did not
reach expected volumes until later in 1996. Sales to U.K. customers accounted
for 76% of Austin Taylor's 1996 sales.
Gross margins on sales were $20,986,000 in 1996, up 12% from $18,707,000 in
1995. Gross margin as a percentage of sales was 31% compared to 28% in 1995.
Gross margin in U.S. plants was 33% compared to 29% in 1995. Improvement in
gross margin was due to lower purchase costs for certain raw materials and
changes in product mix, emphasizing sales of higher margin CorroShield and fiber
optic connector products. Austin Taylor's margins declined to 19% from 24% in
1995 due to increased product development costs and unfavorable overhead costs
associated with reduced sales volumes.
Selling, general and administrative expenses increased $2,063,000 or 24%. The
increase was principally due to selling, administration and amortization costs
associated with the Company's new Automatic Tool and Connector Co. subsidiary.
U.S. apparatus selling and administrative expenses, exclusive of the effect of
the Automatic Tool acquisition, increased $561,000 or 11% due to increased
international sales expenses. General corporate expenses increased $220,000 or
23% due to increased reserves in the company group medical program.
Investment income, net of interest expense, decreased $100,000 due to decreased
marketable securities valuations.
Income from continuing operations before income taxes increased $116,000 or 1%.
The Company's effective income tax rate was 20.1% compared to 19.5% in 1995. The
increase in the tax rate was due to increased U.S. taxes on the Company's
earnings in Puerto Rico. Income from continuing operations increased $30,000.
Acquisitions and Dispositions
Effective January 4, 1996, the Company acquired Automatic Tool and Connector
Co., Inc. ("ATC") of Union, New Jersey, in exchange for $3,191,000, consisting
of $1,473,000 of cash and 112,676 shares of the Company's common stock. 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 entry into
the market for fiber optic connectors, which is the fastest growing segment in
the telecommunications connector market. Sales of fiber optic products were
$4,091,000 and $4,789,000 in 1997 and 1996, respectively. The decrease in sales
was due to loss of the business of a major OEM customer who is also a competitor
of Suttle Apparatus and design and production problems with the Company's Quick
Term TM fiber optic connector product. The Company has upgraded this product for
1998 to address these problems. ATC's operating income was $30,000 and $129,000
in 1997 and 1996, respectively.
11
During the third quarter of 1996, the Company's Board of Directors concluded
that the contract manufacturing business was no longer a strategic fit with the
Company's plans for its domestic and international telecommunications
manufacturing business. After considering various alternatives for the
disposition of Zercom, the Company agreed to sell the assets (except cash and
accounts receivable) of Zercom Corporation to Nortech Systems, Inc. for
$1,500,000 of cash and a $4,867,000 five-year note. The transaction was
completed November 4, 1996.
Revenue from discontinued operations was $13,518,000 in 1996. Loss from
operations, net of income tax benefits, was $719,000. The loss was principally
due to write-downs against slow-moving electronic fishing products inventory.
Loss on disposal of the business, after income taxes, was $2,000.
The acquisitions the Company has made over the past several years have served to
expand the Company's product offerings and customer base in both U.S. and
international markets. The Company is 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.
Effects of Inflation
Inflation has not had a significant effect on operations. The Company does not
have long-term production or procurement contracts and has historically been
able to adjust pricing and purchasing decisions to respond to inflationary
pressures.
Year 2000 Issues
The Company's U.S. accounting and management control systems are Year 2000
compliant. Austin Taylor's facilities are not currently Year 2000 compliant, and
will be upgraded in the third quarter of 1998. The Company has also been in
contact with its major customers and suppliers to ensure that Year 2000 issues
do not cause any unforseen electronic data interchange or other problems. Year
2000 issues are not expected to have a material effect on the Company's
operations or financial results.
Liquidity and Capital Resources
At December 31, 1997, the Company had approximately $23,192,000 of cash, cash
equivalents and short-term U.S. Treasury investments compared to $17,799,000 of
cash and cash equivalents at December 31, 1996. The Company had working capital
of approximately $48,514,000 and a current ratio of 6.9 to 1 compared to working
capital of $35,906,000 and a current ratio of 5.2 to 1 at the end of 1996.
Cash flow provided by operations was approximately $7,545,000 in 1997 compared
to $10,572,000 in 1996. The decrease was due to the increased inventory and
accounts receivable levels caused by the Company's increased levels of business.
Investing activities utilized $6,435,000 in cash in 1997. Cash investments in
U.S. Treasury bills and new plant and equipment in 1997 were $5,249,000 and
$2,878,000, respectively. Capital additions were primarily related to
improvements to manufacturing facilities in Minnesota and Costa Rica. The
Company expects to spend $2,500,000 on capital additions in 1998.
Net cash used in financing activities decreased to $891,000. Proceeds from
common stock issuances, principally exercises of key employee stock options,
offset an increase in the Company's common stock dividend. In 1996, the Company
purchased and retired 255,495 common shares under an authorization by the Board
of Directors, at a cost of $3,263,000. The Company did not purchase any Company
stock in 1997. However, the Company does intend to purchase and retire
additional shares in 1998 if warranted by market conditions and the Company's
financial position.
12
The bulk of the Company's U.S. apparatus manufacturing operations are located in
Puerto Rico. Until 1994, substantially all the earnings of the Puerto Rico
operations were sheltered from U.S. income tax due to the possessions tax credit
(Internal Revenue Code Section 936). Under provisions of the Omnibus Budget Act
of 1993, which went into effect beginning in the 1994 tax year, the amount of
the possessions credit is limited to a percentage of the Company's Puerto Rico
payroll and depreciation. U.S. income tax expense on the Company's earnings in
Puerto Rico, after full utilization of the available tax credits, was $791,000,
$352,000 and $272,000 in 1997, 1996 and 1995, respectively.
Under provisions of the Small Business Job Protection Act of 1996, the
possessions tax credit 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 applies 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 $1,987,000.
At December 31, 1997 approximately $35,032,000, $8,782,000 and $1,545,000 of
assets were invested in the Company's subsidiaries in Puerto Rico, the United
Kingdom and Costa Rica, respectively. The Company expects to maintain these
investments to support the continued operation of the subsidiaries. The Company
uses the U.S. dollar as its functional currency in Costa Rica. The United
Kingdom is a politically and economically stable country. Accordingly, the
Company believes its risk of material loss due to adjustments in foreign
currency markets to be small.
At December 31, 1997, the Company had no outstanding obligations for notes
payable or long-term debt. The Company has a $2,000,000 bank line of credit
available for use. 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.
Changes in Accounting Standards
Effective December 15, 1997, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings per Share". The
Statement requires the Company to present its net income per share in basic and
diluted forms and to restate net income per share for prior periods to conform
with the new statement. Basic net income per common share is based on the
weighted average number of common shares outstanding during each year. Diluted
net 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. Adoption of the new standard did not have a
material effect on the Company's net income per share.
The Financial Accounting Standards Board ("FASB") has issued SFAS No.
130, "Reporting Comprehensive Income". This statement establishes standards for
reporting and presenting comprehensive income and its components in the
financial statements. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997. Reclassification of financial statements for earlier periods
provided for comparative purposes is required. Adoption of this standard will
have no material effect on the Company's results of operations or financial
position.
The FASB has also issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information". This statement establishes standards for
the way public enterprises report information about operating segments in annual
financial statements and requires those enterprises to report selected
information about operating segments in interim financial reports to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997. Financial
statement disclosures from prior periods are required to be restated. Adoption
of this standard will have no material effect on the Company's results of
operations or financial position.
13
REPORT OF MANAGEMENT
The management of Communications Systems, Inc. and its subsidiary companies is
responsible for the integrity and objectivity of the financial statements and
other financial information contained in the annual report. The financial
statements and related information were prepared in accordance with generally
accepted accounting principles and include amounts that are based on
management's informed judgments and estimates.
In fulfilling its responsibilities for the integrity of financial information,
management maintains accounting systems and related controls. These controls
provide reasonable assurance, at appropriate costs, that assets are safeguarded
against losses and that financial records are reliable for use in preparing
financial statements. Management recognizes its responsibility for conducting
the Company's affairs according to the highest standards of personal and
corporate conduct.
The Audit Committee of the Board of Directors, comprised solely of outside
directors, meets with the independent auditors and management periodically to
review accounting, auditing, financial reporting and internal control matters.
The independent auditors have free access to this committee, without management
present to discuss the results of their audit work and their opinion on the
adequacy of internal financial controls and the quality of financial reporting.
/s/ Curtis A. Sampson
-------------------------------------
Curtis A. Sampson
President and Chief Executive Officer
/s/ Paul N. Hanson
-------------------------------------
Paul N. Hanson
March 27, 1998 Chief Financial Officer
14
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
Shareholders and Board of Directors
Communications Systems, Inc.
We have audited the accompanying consolidated balance sheets of Communications
Systems, Inc. and its subsidiaries (the Company) as of December 31, 1997 and
1996 and the related consolidated statements of income, changes in stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 1997. Our audits also include the financial statement schedule listed in the
Index at Item 14. These consolidated financial statements and the financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and the schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 1997
and 1996 and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1997 in conformity with
generally accepted accounting principles. Also, in our opinion, the financial
statement schedule referred to above, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/s/ Deloitte & Touche LLP
- ---------------------------
Deloitte & Touche LLP
February 20, 1998
Minneapolis, Minnesota
15
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
------------------------------
1997 1996
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents $ 17,942,315 $ 17,799,398
Investments in U.S. Treasury securities (Note 3) 5,249,314
Marketable equity securities (Note 3) 802,045 889,782
Trade accounts receivable, less allowance for
doubtful accounts of $796,000 and $306,000 respectively 12,571,511 10,682,546
Inventories (Note 4) 18,438,531 13,861,914
Prepaid expenses 684,221 460,692
Deferred income taxes (Note 9) 1,080,000 792,000
------------ ------------
TOTAL CURRENT ASSETS 56,767,937 44,486,332
PROPERTY, PLANT AND EQUIPMENT,net (Notes 1 and 5) 9,674,861 8,964,590
NET ASSETS OF DISCONTINUED OPERATIONS (Note 2) 536,679
OTHER ASSETS:
Excess of cost over net assets acquired (Note 1) 2,881,544 3,166,422
Investments in mortgage backed and other securities (Notes 1 and 3) 3,356,568 4,487,934
Note receivable from sale of assets of discontinued
contract manufacturing operations (Note 2) 4,557,767 4,866,597
Deferred income taxes (Note 9) 114,047 835,047
Other assets 165,204 252,513
------------ ------------
TOTAL OTHER ASSETS 11,075,130 13,608,513
------------ ------------
TOTAL ASSETS $ 77,517,928 $ 67,596,114
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,770,628 $ 3,164,406
Accrued expenses 3,030,736 2,622,853
Dividends payable 839,399 728,585
Income taxes payable 1,613,469 2,064,792
------------ ------------
TOTAL CURRENT LIABILITIES 8,254,232 8,580,636
LEASE COMMITMENTS (Note 7)
STOCKHOLDERS' EQUITY:
Preferred stock, par value $1.00 per share;
3,000,000 shares authorized; none issued
Common stock, par value $.05 per share; 30,000,000 shares authorozed;
9,326,652 and 9,107,309 shares issued and
outstanding, respectively (Notes 1 and 8) 466,333 455,365
Additional paid-in capital 24,132,771 21,454,353
Retained earnings 44,552,855 36,856,285
Cumulative translation adjustments (Note 1) 111,737 249,475
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 69,263,696 59,015,478
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 77,517,928 $ 67,596,114
============ ============
See notes to consolidated financial
statements.
16
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31
--------------------------------------------------
1997 1996 1995
------------ ------------ ------------
REVENUES FROM CONTINUING OPERATIONS (Note 10): $ 75,731,651 $ 68,704,940 $ 66,004,316
COSTS AND EXPENSES:
Cost of sales 52,301,671 47,718,676 47,297,078
Selling, general and administrative expenses 10,947,163 10,581,557 8,518,644
------------ ------------ ------------
TOTAL COSTS AND EXPENSES 63,248,834 58,300,233 55,815,722
------------ ------------ ------------
OPERATING INCOME FROM ~ CONTINUING OPERATIONS 12,482,817 10,404,707 10,188,594
OTHER INCOME (EXPENSE):
Investment income 1,690,223 808,287 917,037
Interest expense (36,167) (9,139) (17,806)
------------ ------------ ------------
OTHER INCOME, net 1,654,056 799,148 899,231
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS ~ BEFORE INCOME TAXES 14,136,873 11,203,855 11,087,825
INCOME TAX EXPENSE (Note 9) 3,200,000 2,250,000 2,164,000
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS 10,936,873 8,953,855 8,923,825
DISCONTINUED OPERATIONS (Note 2):
Income (loss) from operations of discontinued
contract manufacturing operations,
net of income taxes (719,218) 160,328
Loss on disposal of assets of contract
~ manufactuing operations, net of income taxes (2,106)
------------ ------------ ------------
NET INCOME $ 10,936,873 $ 8,232,531 $ 9,084,153
============ ============ ============
BASIC NET INCOME ~ PER COMMON SHARE (Note 1):
Continuing Operations $ 1.18 $ .97 $ .98
Discontinued Operations - (.08) .02
------------ ------------ ------------
$ 1.18 $ .89 $ 1.00
============ ============ ============
DILUTED NET INCOME ~ PER COMMON SHARE (Note 1):
Continuing Operations $ 1.17 $ .96 $ .97
Discontinued Operations - (.08) .02
------------ ------------ ------------
$ 1.17 $ .88 $ .99
============ ============ ============
AVERAGE SHARES OUTSTANDING:
Weighted average number of common
shares outstanding 9,231,858 9,272,825 9,097,771
Dilutive effect of stock options outstanding after
application of treasury stock method 92,853 78,915 119,450
------------ ------------ ------------
9,324,711 9,351,740 9,217,221
============ ============ ============
See notes to consolidated financial
statements.
17
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Advances to
Additional Employee Cumulative
Common Stock Paid-in Retained Stock Owner- Translation
Shares Amount Capital Earnings ship Plan Adjustment Total
--------- --------- ----------- ----------- ----------- ----------- -----------
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
Issuance of common stock under
Employee Stock Purchase Plan 23,567 1,178 193,957 195,135
Issuance of common stock under
Employee Stock Option Plan 173,311 8,666 1,267,846 1,276,512
Tax benefit from non qualified
employee stock options 243,000 243,000
Shareholder dividends (2,463,672) (2,463,672)
Repayment of advances to Emplo
Stock Ownership Plan 72,000 72,000
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)
Foreign currency translation adjustment 102,007 102,007
--------- --------- ----------- ----------- ----------- ----------- ----------
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
Issuance of common stock to acquire
Automatic Tool and Connector Co. 112,676 5,634 1,712,675 1,718,309
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 non qualified
employee stock options 12,701 12,701
Shareholder dividends (2,868,154) (2,868,154)
Purchase of Communications
Systems, Inc. common stock (255,495) (12,775) (601,381) (2,648,527) (3,262,683)
Foreign currency translation adjustment 479,629 479,629
--------- --------- ----------- ----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 1996 9,107,309 455,365 1,454,353 36,856,285 - 249,475 59,015,478
Net income 10,936,873 10,936,873
Issuance of common stock to
Employee Stock Ownership Plan 20,870 1,044 298,956 300,000
Issuance of common stock under
Employee Stock Purchase Plan 16,622 831 182,843 183,674
Issuance of common stock under
Employee Stock Option Plan 181,851 9,093 2,045,715 2,054,808
Tax benefit from non qualified
employee stock options 150,904 150,904
Shareholder dividends (3,240,303) (3,240,303)
Foreign currency translation adjustment (137,738) (137,738)
--------- --------- ----------- ----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 1997 9,326,652 $ 466,333 $24,132,771 $44,552,855 $ - $ 111,737 $69,263,696
========= ========= =========== =========== =========== =========== ===========
See notes to consolidated financial
statements.
18
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
-----------------------------------------------
1997 1996 1995
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 10,936,873 $ 8,232,531 $ 9,084,153
Discontinued operations 721,324 (160,328)
------------ ------------ ------------
Income from continuing operations 10,936,873 8,953,855 8,923,825
Adjustments to reconcile income from continuing operations to
net cash provided by operating activities:
Depreciation and amortization 2,471,510 2,303,303 1,995,352
Deferred taxes 702,713 (405,880) (22,000)
Loss on liquidation of foreign subsidiary 73,696
Adjustment to marketable securities reserve (40,404) 9,687 (90,046)
Changes in assets and liabilities net of effects from acquisitions and
discontinued operations:
Decrease in marketable securities 128,141 81,001
Decrease (increase) in accounts receivable (1,966,519) (1,483,853) 1,603,613
Decrease (increase) in inventory (4,634,744) 1,565,972 (4,240,940)
Decrease (increase) in prepaid expenses (225,284) (99,921) 97,456
Decrease in accounts payable (328,639) (925,127) (503,139)
Increase (decrease) in accrued expenses 727,787 617,793 (479,097)
Increase (decrease) in income taxes payable (300,273) 36,534 (452,939)
------------ ------------ ------------
Total adjustments (3,392,016) 1,618,508 (2,010,739)
------------ ------------ ------------
Net cash provided by operating activities 7,544,857 10,572,363 6,913,086
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (2,878,073) (1,989,053) (2,496,488)
Maturities (purchases) of mortgage backed and other
investment securities 1,131,366 909,598 (87,181)
Purchase of U.S. Treasury bill investments (5,249,314)
Sales (purchases) of other assets 64,293 218,630 (150,475)
Collections from businesses transferred under
contractual arrangements 564,657
Cash receipts from sale of assets of discontinued operations 308,830 1,500,000
Changes in assets and liabilities of discontinued operations 267,679 1,630,416 (1,062,021)
Payment for purchase of Austin Taylor Communications, Ltd., (79,947) (135,131)
Payment for purchase of Automatic Tool and Connector Co., Inc.,
net of cash acquired (1,273,776)
------------ ------------ ------------
Net cash provided by (used in) investing activities (6,435,166) 860,684 (3,231,508)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable and long-term debt (65,557) (152,508)
Dividends paid (3,129,489) (2,782,407) (2,360,025)
Proceeds from issuance of common stock 2,238,482 640,270 1,934,979
Purchase of Communications Systems, Inc. common stock (3,262,683) (220,332)
Repayments from Employee Stock Ownership Plan 72,000
------------ ------------ ------------
Net cash used in financing activities (891,007) (5,470,377) (725,886)
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (75,767) 133,192 1,774
------------ ------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 142,917 6,095,862 2,957,466
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 17,799,398 11,703,536 8,746,070
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 17,942,315 $ 17,799,398 $ 11,703,536
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 2,797,237 $ 2,137,401 $ 2,664,962
Interest paid 13,723 9,139 17,806
See notes to consolidated financial
statements.
19
COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 1997, 1996 and 1995
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business: The Company is principally engaged in the manufacture
and sale of modular connecting and wiring devices for voice and data
communications. The Company's product line, which is commonly referred to as
"telephone station apparatus", consists primarily of equipment which connects
telephones, data terminals and related equipment at customer premises to the
telephone network. The Company sells these products to telephone companies,
electrical contractors, interconnect companies, original equipment manufacturers
and retailers. The Company's operations are located in the United States, United
Kingdom, Puerto Rico, and Costa Rica. Discontinued operations represent the
Company's contract manufacturing operations, which were sold in November, 1996.
Principles of consolidation: The consolidated financial statements include the
accounts of the Company and its subsidiaries. All material intercompany
transactions and accounts have been eliminated.
Use of estimates: The presentation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The
Company's estimates consist principally of reserves for doubtful accounts and
inventory obsolescence.
Cash equivalents: For purposes of the consolidated statements of cash flows, the
Company considers all highly liquid investments with a maturity of three months
or less at the time of purchase to be cash equivalents.
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. (ATC) 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) and liabilities of $872,000 were assumed.
Subsequent to the acquisition, the Company leased, with option the to purchase,
the building housing ATC's manufacturing and sales operations from ATC's former
owners. Payments under the lease were $143,700 and $129,600 in 1997 and 1996
respectively, which the Company believes to be the building's fair market
rental. The lease expired December 31, 1997. At the expiration of the lease, the
Company declined to exercise its purchase option on the building and moved to a
different location. As required by the purchase agreement, the Company then made
an additional payment of $100,000 to ATC's former owners. The Company has
accounted for this payment as part of the purchase price.
Accounts receivable from Hector Communications Corporation: The Company provides
services for Hector Communications Corporation ("HCC"), a former subsidiary of
the Company. Several of the Company's officers and directors work in similar
capacities for HCC. Outstanding receivable balances from HCC were $357,000 and
$307,000 at December 31, 1997 and 1996, respectively. Accounts with HCC are
handled on an open account basis.
Property, plant and equipment: Property, plant and equipment is recorded at
cost. Depreciation is computed using principally the straight-line method.
Depreciation included in costs and expenses was $2,086,366, $1,927,081, and
$1,950,563 for 1997, 1996 and 1995, respectively. Maintenance and repairs are
charged to operations and additions or betterments are capitalized. Items of
property sold, retired or otherwise disposed of are removed from the asset and
accumulated depreciation accounts and any gains or losses on disposal are
reflected in operations.
20
Excess of cost over net assets acquired: The excess of cost over net assets of
subsidiaries acquired in purchase transactions is being amortized on the
straight-line method over periods of from 10 to 15 years. Amortization included
in costs and expenses was $385,144, $376,222 and $44,789 in 1997, 1996 and 1995,
respectively.
Line of credit: The Company has a $2,000,000 line of credit from First Bank of
Minneapolis. Interest on borrowings on the credit line are at the bank's average
CD rate plus 1.5%. The Credit line expires June 30, 1998. There were no
outstanding borrowings against the credit line at December 31, 1997 or 1996.
Foreign currency translation: Assets and liabilities denominated in foreign
currencies were translated into U.S. dollars at year-end exchange rates. Revenue
and expense transactions were translated using average exchange rates. In 1997,
the Company recognized a foreign currency translation loss of $73,696 upon
liquidation of its Canadian subsidiary. Gains or losses from other currency
exchange transactions during the periods were not material.
Net income per share: Effective December 15, 1997, the Company adopted the
provisions of Statement of Financial Accounting Standards No. 128, "Earnings per
Share". The Statement requires the Company to present its net income per share
in basic and diluted forms and to restate net income per share for prior periods
to conform with the new statement. Basic net income per common share is based on
the weighted average number of common shares outstanding during each year.
Diluted net 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. Adoption of the new standard did not have a
material effect on the Company's net income per share.
Changes in accounting principles: The Financial Accounting Standards Board
("FASB") has issued SFAS No. 130, "Reporting Comprehensive Income". This
statement establishes standards for reporting and presenting comprehensive
income and its components in the financial statements. SFAS No. 130 is effective
for fiscal years beginning after December 15, 1997. Reclassification of
financial statements for earlier periods provided for comparative purposes is
required. Adoption of this standard will have no material effect on the
Company's results of operations or financial position.
The FASB has also issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information". This statement establishes standards for
the way public enterprises report information about operating segments in annual
financial statements and requires those enterprises to report selected
information about operating segments in interim financial reports to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997. Financial
statement disclosures from prior periods are required to be restated. Adoption
of this standard will have no material effect on the Company's results of
operations or financial position.
Change of presentation: Certain amounts in the 1996 and 1995 financial
statements have been reclassified to conform with the 1997 financial statement
presentation. These reclassifications had no effect on net income or
stockholders' equity as previously reported.
NOTE 2 - DISCONTINUED OPERATIONS
Discontinued operations represent the Company's contract manufacturing
operations. Effective November 4, 1996, the Company sold all the assets of these
operations, except cash and accounts receivable, to Nortech Systems, Inc.
(Nasdaq National Market System: NSYS) for $1,500,000 cash and a note receivable
of $4,866,597. The note bears interest at the prime rate established by First
Bank of Minneapolis and is secured by the assets sold. The balance outstanding
on the note receivable at December 31, 1997 was $4,557,767.
The Company's consolidated financial statements and accompanying notes present
separately the net assets and results of operations of the discontinued
operations. Operating results of the discontinued contract operations were as
follows:
21
Ten Months
Ended Year Ended
October 31 December 31
1996 1995
------------ ------------
Sales $ 13,517,501 $ 19,953,130
Costs and expenses 14,684,080 19,697,551
Interest income, net 35,361 40,749
------------ ------------
Income (loss) before income taxes (1,131,218) 296,328
Income tax expense (benefit) (412,000) 136,000
------------ ------------
Income (loss) from operations (719,218) 160,328
Loss on disposal of value-added design and
electronic assembly operations, net of income
tax expense of $77,000 (2,106)
------------ ------------
Net income (loss) $ (721,324) $ 160,328
============ ============
Net assets of discontinued operations at December 31, 1996 consisted of the
following :
Working capital $ 267,679
Deferred taxes 269,000
-------------
$ 536,679
=============
NOTE 3 - INVESTMENT IN DEBT AND EQUITY SECURITIES
Marketable securities consist primarily of equity securities, are classified as
trading securities, and are carried at market value. Aggregate cost, based on
the weighted average purchase price for each security, and market value was as
follows:
December 31
---------------------------
1997 1996
----------- ----------
Aggregate cost $ 835,156 $ 963,297
Valuation allowance (33,111) (73,515)
----------- ----------
Aggregate market value $ 802,045 $ 889,782
=========== ==========
Investment income (loss) includes $40,404, ($9,687) and $90,046 for changes in
the unrealized holding gains and losses in 1997, 1996 and 1995, respectively.
Investment income also includes gain on sales of marketable securities of
$14,926 in 1997 and $99,800 in 1995.
The Company's Puerto Rico subsidiary owns a portfolio of AAA rated
mortgage-backed securities it is holding to maturity. At December 31, 1997, the
amortized cost basis of the securities was $3,249,000. Market value of the
securities was $3,213,000 resulting in a gross unrealized holding loss of
$36,000, which is not reflected in the consolidated financial statements.
The same subsidiary has invested in twelve month U.S. Treasury bills which
mature in February, 1998. These securities are available-for-sale. Amortized
cost of the securities is $5,249,314, which approximates fair value.
The Company has an investment in convertible bonds issued by Hector
Communications Corporation (Note 1). The bonds mature in 2002 and the Company
considers them available-for-sale. Amortized cost of the bonds was $108,000
which approximates their market value.
22
NOTE 4 - INVENTORIES
Inventories are carried at the lower of cost (first-in, first out method) or
market and consist of :
December 31
----------------------------
1997 1996
------------- -------------
Finished goods $ 5,237,907 $ 3,957,655
Raw and processed materials 13,200,624 9,904,259
------------- -------------
$ 18,438,531 $ 13,861,914
============= =============
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment and the estimated useful lives are as follows:
December 31
Estimated ----------------------------------------
useful life 1997 1996
------------------ -------------------- ------------------
Land $ 291,989 $ 292,619
Buildings 7-30 years 2,965,102 2,905,108
Machinery and equipment 3-15 years 21,351,745 19,119,653
Furniture and fixtures 5-10 years 2,073,739 1,982,324
-------------------- ------------------
26,682,575 24,299,704
Less accumulated depreciation 17,007,714 15,335,114
-------------------- ------------------
$ 9,674,861 $ 8,964,590
==================== ==================
NOTE 6 - EMPLOYEE BENEFIT PLANS
The Company has an Employee Savings Plan (401(k)) and matches a percentage of
employee contributions up to eight percent of compensation. Contributions to the
plan in 1997, 1996 and 1995 were $89,000, $73,000, and $77,000 respectively.
The Company does not provide post retirement benefits to its employees.
NOTE 7 - LEASE COMMITMENTS
The Company leases land, buildings and equipment under operating leases with
original terms from one to ten years. Certain of these leases contain renewal
and purchase options. Rent expense charged to operations was $640,000, $603,000
and $454,000 in 1997, 1996 and 1995 respectively.
At December 31, 1997, the Company was obligated under noncancellable operating
leases to make minimum annual future lease payments as follows:
Year Ending December 31:
1998 $ 287,000
1999 304,000
2000 266,000
2001 266,000
2002 266,000
After 2002 354,000
--------------
$ 1,743,000
==============
23
NOTE 8 - COMMON STOCK AND STOCK OPTIONS
Common shares are reserved in connection with the Company's 1992 stock plan
under which 900,000 shares of common stock may be issued pursuant to stock
options, stock appreciation rights, restricted stock or deferred stock granted
to officers and key employees. Exercise prices of stock options under the plan
cannot be less than fair market value of the stock on the date of grant. Rules
and conditions governing awards of stock options, stock appreciation rights and
restricted or deferred stock are determined by the Compensation Committee of the
Board of Directors, subject to certain limitations incorporated into the plan.
At December 31, 1997, 169,483 shares remained available to be issued under the
plan. Options granted to key employees in 1995, 1996 and 1997 are subject to
vesting. One third of the options issued vest immediately, the remaining two
thirds vest equally over the next two years. All employee options expire five
years from date of grant.
Common shares are also reserved for issuance in connection with a nonqualified
stock option plan under which up to 200,000 shares may be issued to nonemployee
directors. The plan provides for the automatic grant of nonqualified options for
2,000 shares of common stock annually to each nonemployee director concurrent
with the annual stockholders' meeting. Exercise price will be the fair market
value of the stock at the date of grant. Options issued under this plan expire
ten years from date of grant. At December 31, 1997, 84,000 shares are available
to be issued under the plan.
A summary of changes in outstanding employee and director stock options during
the three years ended December 31, 1997 is as follows:
Weighted
average
Number of exercise price
shares per share
Outstanding at December 31, 1994 457,700 $ 8.62
Granted 153,700 14.29
Exercised (173,311) 7.37
Canceled (2,667) 14.00
-------------
Outstanding at December 31, 1995 457,700 11.09
Granted 167,000 14.75
Exercised (52,381) 8.95
Canceled (8,352) 13.95
-------------
Outstanding at December 31, 1996 541,689 12.38
Granted 197,700 13.82
Exercised (181,851) 11.30
Canceled (32,266) 14.04
-------------
Outstanding at December 31, 1997 525,272 $ 13.19
At December 31, 1997, 384,039 stock options are currently exercisable. The
following table summarizes the status of Communications Systems, Inc. stock
options outstanding at December 31, 1997:
Weighted Average
Remaining
Range of Exercise Prices Shares Option Life Exercise Price
- ------------------------ ---------- --------------- ----------------
$ 5.31 to $ 9.99 71,100 1.7 years $ 8.12
$10.00 to $14.99 397,172 3.5 years 13.74
$15.00 to $15.95 57,000 5.3 years 15.70
24
EMPLOYEE STOCK PURCHASE PLAN
The Company maintains an Employee Stock Purchase Plan for which 200,000 common
shares have been reserved. Under the terms of the plan, participating employees
may acquire shares of common stock through payroll deductions up to the lower of
10% of compensation or $25,000. The price at which shares can be purchased is
85% of the lower of fair market value for such shares on one of two specified
dates in each plan year. A participant is limited in any plan year to acquiring
the number of shares which their payroll deductions for the year would purchase
based on the market price on the first day of the plan year. Shares issued to
employees under the plan were 16,622, 14,346 and 23,567 for the plan years ended
August 31, 1997, 1996 and 1995, respectively. At December 31, 1997 employees had
subscribed to purchase an additional 14,140 shares in the current plan year
ending August 31, 1998.
PRO FORMA FINANCIAL INFORMATION
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. 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 and net income per share would have been
as follows:
Year Ended December 31
-----------------------------------------
1997 1996 1995
------------ ------------ ------------
Net Income $ 10,254,975 $ 7,740,304 $ 8,774,114
Basic Net Income Per Share $ 1.11 $ .83 $ .96
Diluted Net Income Per Share $ 1.10 $ .83 $ .95
The fair value of the Company's stock options and Employee Stock Purchase Plan
transactions used to compute pro forma net income and net income per share
disclosures is the estimated present value at grant date using the Black-Scholes
option-pricing model with the following assumptions for 1997: expected
volatility of 25%, a risk free interest rate of 6.2%, an expected holding period
of four years for key employee options and seven years for director options, and
a 2.6% dividend yield. Assumptions used to compute 1996 and 1995 fair values
were an expected volatility of 27%, a risk free interest rate of 6.8%, an
expected holding period of four years for key employee options and seven years
for director options, and a 1.8% dividend yield. Pro forma stock-based
compensation cost was $682,000, $492,000 and $310,000 in 1997, 1996 and 1995,
respectively. The fair value of all options issued in 1997, 1996 and 1995 was
$690,000, $714,000 and $650,000, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN
During 1985, the Board of Directors adopted a leveraged employee stock ownership
plan (ESOP) and authorized the Company to advance the ESOP or guarantee debt of
up to $2,000,000 to enable the plan to purchase the Company's common stock in
the open market. Advances to the plan bear interest at 85% of prime and are
repaid through Company contributions to the plan. There were no outstanding
advances to the ESOP at December 31, 1997.
At December 31, 1997, the ESOP held 296,162 shares of the Company's common
stock, all of which has been allocated to the accounts of eligible employees.
Contributions to the plan are determined by the Board of Directors and can be
made in cash or shares of the Company's stock. A cash contribution of $72,000
was made for the year ended December 31, 1995. The Company accrued a 1996 ESOP
contribution of $300,000, for which the Company issued 20,870 shares of common
stock to the ESOP in February, 1997. The Company's 1997 ESOP contribution was
$350,000 of cash.
All eligible employees of the Company participate in the ESOP after completing
one year of service. Contributions are allocated to each participant based on
compensation and vest 30% after three years of service and incrementally
thereafter, with full vesting after seven years.
25
PURCHASES OF COMMUNICATIONS SYSTEMS, INC. COMMON STOCK
In August, 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. In 1996, the Company purchased and retired
255,495 common shares under this authorization, at a cost of $3,263,000.
AUSTIN TAYLOR COMMUNICATIONS, LTD.
In connection with refinancing debt associated with the purchase of Austin
Taylor Communications, Ltd., the Company issued an option to the Welsh
Development Agency (WDA) to purchase 20,142 shares of CSI common stock at $7.35
share. The option was exercised by the WDA in January, 1995. Subsequent to the
exercise of the stock option, the Company purchased and retired the stock from
the WDA.
Effective February 1, 1992, the Company granted the Managing Director of Austin
Taylor an option to acquire up to 5% of Austin Taylor's outstanding common stock
at a price of one British pound per share (approximately $1.65 U.S. per share at
December 31, 1997). The price per share was management's best estimate of the
fair market value of Austin Taylor common stock at the date of grant. If the
option is exercised, the shares are transferable only to the Company, and the
transfer price is management's best estimate of the fair market value of a
publicly traded company in Austin Taylor's industry (eighteen times Austin
Taylor's average pretax earnings for the preceding three years.) At December 31,
1997, there were 1,005,030 shares of Austin Taylor common stock issued and
outstanding. The average pretax earnings of Austin Taylor over the last three
years was $1.19 per share.
NOTE 9 - INCOME TAXES
Income tax expense from continuing operations consists of the following:
Year Ended December 31
--------------------------------------------------------
1997 1996 1995
----------------- ------------------ -----------------
Currently payable income taxes:
Federal $ 898,000 $ 1,444,000 $ 966,000
State 168,000 294,000 105,000
Puerto Rico 826,000 646,000 589,000
Canada 40,000 10,000 40,000
United Kingdom 414,000 247,000 450,000
----------------- ------------------ -----------------
2,346,000 2,641,000 1,943,000
Tax effect of disqualified employee incentive
stock options 151,000 13,000 243,000
Deferred income taxes (benefit) 703,000 (404,000) (22,000)
----------------- ------------------- ------------------
$ 3,200,000 $ 2,250,000 $ 2,164,000
================= ================== =================
A subsidiary, Suttle Caribe, Inc., operates in Puerto Rico, and is qualified
under Internal Revenue Service Code section 936 for credit against U.S. income
taxes. Under provisions of the Omnibus Budget Reconciliation Act of 1993,
Congress set limits on the section 936 credit which went into effect for the
1994 tax year. As a result of the tax credit limitation, the Company incurred
$791,000, $352,000 and $272,000 of U.S. federal income tax expense on earnings
in Puerto Rico for 1997, 1996 and 1995, respectively.
26
Earnings of Suttle Caribe, Inc. are 90% exempt from Puerto Rico income taxes
through 2003, subject to satisfaction of the employment and investment
requirements of the tax exemption grant received by the Company. Distributions
by Suttle Caribe, Inc. to the parent company are subject to a tollgate tax at
rates which, depending on various factors, range from 3.5% to 10%. The Company
has provided for and prepaid toll gate taxes at a 1.75% rate on its Puerto Rico
earnings for each year since 1993. The Company has recognized tollgate tax
expense at the 3.5% rate on earnings from years prior to 1993 only to the extent
distributions were received from Suttle Caribe, Inc. The cumulative amount of
undistributed prior earnings on which no tollgate tax has been recognized was
approximately $8,078,000 at December 31, 1997. In 1997, the Puerto Rico Treasury
Department audited the Company's Puerto Rico tax returns for the years 1993,
1994 and 1995. Settlement of issues raised by the audit did not require a
material adjustment to the Company's consolidated financial statements.
In 1997, the Company liquidated its Suttle Apparatus Canada, Ltd. subsidiary and
repatriated its retained earnings to the U.S. This repatriation dividend was
subject to a Canadian withholding tax of $40,000. This subsidiary was subject to
Canadian rather than U.S. income taxes. Canadian pretax income was $21,000 and
$80,000 for 1996 and 1995, respectively.
Austin Taylor Communications, Ltd. operates in the U.K. and is subject to U.K.
rather than U.S. income taxes. U.K. pretax income was $1,343,000, $791,000, and
$1,450,000 in 1997, 1996 and 1995, respectively. Suttle Costa Rica, S.A.
operates in Costa Rica and is currently exempt from Costa Rica income taxes. It
is the Company's intention to reinvest the remaining undistributed earnings of
its Puerto Rico, U.K. and Costa Rica subsidiaries to support the continued
operation of those subsidiaries.
The provision for income taxes varied from the federal statutory tax rate as
follows:
Year Ended December 31
------------------------------------------------------
1997 1996 1995
----------------- ------------------ ---------------
Tax at U.S. statutory rate 35.0% 35.0% 35.0%
Surtax exemption (.7) (1.0) (1.0)
U.S. taxes not provided on Puerto Rico operations (14.1) (17.0) (18.3)
State income taxes, net of federal benefit .8 1.7 1.0
Other 1.6 1.4 2.8
----------------- ------------------ ---------------
Effective tax rate 22.6% 20.1% 19.5%
================= ================== ===============
Deferred tax assets and liabilities as of December 31 related to the following:
1997 1996
----------------- ------------------
Current assets:
Marketable securities $ 12,000 $ 26,000
Bad debts 240,000 73,000
Inventory 445,000 365,000
Accrued expenses 383,000 328,000
----------------- ------------------
$ 1,080,000 $ 792,000
================= ==================
Long term assets and (liabilities):
Depreciation $ (324,953) $ (232,953)
Loss reserves on notes receivable 132,000 130,000
Alternative minimum tax credits 307,000 938,000
----------------- ------------------
$ 114,047 $ 835,047
================= ==================
27
NOTE 10 - INFORMATION CONCERNING INDUSTRY SEGMENTS AND MAJOR CUSTOMERS
The Company's continuing operations are in one business segment - manufacture of
telephone station apparatus products. The Company operates in the United States,
including Puerto Rico (U.S.), United Kingdom (U.K.), and Costa Rica. Information
concerning the Company's continuing operations in the various geographic areas
is as follows:
Telephone Station Apparatus
-----------------------------------------------
U.S. U.K. Other Corporate Eliminations Consolidated
-----------------------------------------------------------------------------------------------
Year Ended December 31, 1997:
Revenues:
Sales to unaffiliated customers $ 62,415,513 $ 13,316,138 $ 75,731,651
Transfers between geographic
areas $ 1,642,623 $ (1,642,623)
-----------------------------------------------------------------------------------------------
Total $ 62,415,513 $ 13,316,138 $ 1,642,623 $ (1,642,623) $ 75,731,651
===============================================================================================
Operating Income $ 12,195,834 $ 1,138,071 $ 155,887 $ (1,006,975) $ 12,482,817
===============================================================================================
Identifiable Assets $ 53,195,928 $ 9,150,276 $ 1,544,909 $ 13,626,815 $ 77,517,928
===============================================================================================
Depreciation and Amortization $ 1,487,420 $ 599,982 $ 257,134 $ 126,974 $ 2,471,510
===============================================================================================
Capital Expenditures $ 2,028,550 $ 265,340 $ 524,810 $ 59,373 $ 2,878,073
===============================================================================================
Year Ended December 31, 1996:
Revenues:
Sales to unaffiliated customers $ 56,473,963 $ 11,263,612 $ 967,365 $ 68,704,940
Transfers between geographic
areas 719,583 1,357,653 $ (2,077,236)
-----------------------------------------------------------------------------------------------
Total $ 57,193,546 $ 11,263,612 $ 2,325,018 $ (2,077,236) $ 68,704,940
===============================================================================================
Operating Income $ 10,841,084 $ 626,721 $ 118,942 $ (1,182,040) $ 10,404,707
===============================================================================================
Identifiable Assets $ 41,386,485 $ 8,147,019 $ 2,083,210 $ 15,979,400 $ 67,596,114
===============================================================================================
Depreciation and Amortization $ 1,419,544 $ 549,512 $ 186,937 $ 147,310 $ 2,303,303
===============================================================================================
Capital Expenditures $ 1,091,214 $ 368,592 $ 485,483 $ 43,764 $ 1,989,053
===============================================================================================
Year Ended December 31, 1995:
Revenues:
Sales to unaffiliated customers $ 51,313,001 $ 13,753,235 $ 938,080 $ 66,004,316
Transfers between geographic
areas 697,155 1,636,312 $ (2,333,467)
-----------------------------------------------------------------------------------------------
Total $ 52,010,156 $ 13,753,235 $ 2,574,392 $ (2,333,467) $ 66,004,316
===============================================================================================
Operating Income $ 9,610,251 $ 1,370,675 $ 169,345 $ (961,677) $ 10,188,594
===============================================================================================
Identifiable Assets $ 36,508,774 $ 8,139,074 $ 1,679,581 $ 15,617,179 $ 61,944,608
===============================================================================================
Depreciation and Amortization $ 1,132,236 $ 566,814 $ 139,247 $ 157,055 $ 1,995,352
===============================================================================================
Capital Expenditures $ 1,205,477 $ 926,905 $ 101,361 $ 262,745 $ 2,496,488
===============================================================================================
28
Export sales were less than 10% of consolidated revenues in each of the last
three years. At December 31, 1997, foreign earnings in excess of amounts
received in the United States were approximately $5,962,000.
In 1997, sales to two U.S. customers amounted to 17.6% and 10.0% of consolidated
revenues, respectively. No customer accounted for more than ten percent of the
Company's consolidated revenues in 1996. In 1995, sales to two U.S. customers
amounted to 12.1% and 10.7% of consolidated revenues, respectively.
The Company's station apparatus products are manufactured using plastic parts,
wire sub-assemblies, fasteners, brackets, electronic circuit boards and other
components, most of which are fabricated by the Company. There are multiple
sources of supply for the materials and parts required and the Company is not
dependent upon any single supplier, except that the Company's corrosion
resistant products utilize a moisture-resistant gel-filled fig available only
from Raychem Corporation. The unavailability of the gel-filled figs from Raychem
Corporation could have a material adverse effect on the Company. The Company has
not generally experienced significant problems in obtaining its required
supplies, although from time to time spot shortages are experienced.
29
(b) SUPPLEMENTAL FINANCIAL INFORMATION
Unaudited Quarterly Operating Results
(in thousands except per share amounts)
Quarter Ended
------------------------------------------------------
March 31 June 30 Sept 30 Dec 31
- ----------------------------------------------------------------------------------------------------------------
1997
Revenues $ 16,816 $ 20,181 $ 19,790 $ 18,945
Gross Margins 4,991 6,347 6,775 5,317
Operating income 2,368 3,359 4,033 2,723
Net Income 2,169 2,883 3,154 2,731
Basic Net Income per Share $ .24 $ .31 $ .34 $ .29
Diluted Net Income per Share $ .24 $ .31 $ .33 $ .29
1996
Revenues from Continuing Operations $ 15,794 $ 16,434 $ 18,391 $ 18,086
Gross Margins 4,631 4,621 5,862 5,872
Operating income from Continuing Operations 2,313 1,925 2,992 3,175
Income from Continuing Operations 2,003 1,668 2,433 2,850
Income (Loss) from Discontinued Operations 42 (369) (421) 27
Net Income 2,045 1,299 2,012 2,877
Basic Net Income (Loss) Per Share:
Continuing Operations $ .21 $ .18 $ .27 $ .31
Discontinued Operations .01 (.04) (.05)
----------- ----------- ------------ -------------
Net Income Per Share $ .22 $ .14 .22 $ .31
=========== =========== ============ =============
Diluted Net Income (Loss) Per Share:
Continuing Operations $ .21 $ .18 $ .26 $ .31
Discontinued Operations .01 (.04) (.05)
----------- ----------- ------------ -------------
Net Income Per Share $ .22 .14 $ .21 $ .31
=========== =========== ============ =============
Net Income Per Share for the periods presented above has been restated in
accordance with SFAS No. 128.
30
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by paragraphs [a], [c], [d], [e], and [f] of Item 401
under Regulation S-K, to the extent applicable, will be set forth under the
caption "Election of Directors" in the Company's definitive proxy material for
its May 19, 1998 Annual Meeting of Shareholders to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated by reference herein. The information called for by paragraph [b] of
Item 401 is set forth under Item 1[c] herein. The information called for by Item
405 under Regulation S-K, to the extent applicable, will be set forth under the
caption "Certain Transactions" in the Company's above referenced definitive
proxy material.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 402 under Regulation S-K to the extent
applicable, will be set forth under the caption "Executive Compensation" in the
Company's definitive proxy materials for its May 19, 1998 Annual Meeting to be
filed within 120 days from the end of the Registrant's fiscal year, which
information is expressly incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 403 under Regulation S-K will be set forth
under the captions "Security Ownership of Certain Beneficial Owners and
Management" and "Election of Directors" in the Company's definitive proxy
materials for its May 19, 1998 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 404 under Regulation S-K will be set forth
under the caption "Certain Transactions" in the Company's definitive proxy
materials for its May 19, 1998 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
31
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Consolidated Financial Statements
The following Consolidated Financial Statements of Communications Systems,
Inc. and subsidiaries appear at pages 15 to 29 herein:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Income for the years ended December 31, 1997,
1996 and 1995
Consolidated Statements of Changes in Stockholders' Equity for the years
ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the years ended December 31,
1997, 1996 and 1995
Notes to Consolidated Financial Statements
(a) (2) Consolidated Financial Statement Schedule Page Herein
----------------------------------------- -----------
The following financial statement schedule is being filed as part of this
Form 10-K Report:
Independent Auditors' Report 15
Schedule II - Valuation and Qualifying Accounts and Reserves 35
All other schedules are omitted as the required information is inapplicable
or the information is presented in the consolidated financial statements or
related notes.
(a) (3) Exhibits
The exhibits which accompany or are incorporated by reference in this
report, including all exhibits required to be filed with this report, are
described on the Exhibit Index, which begins on page 37 of the sequential
numbering system used in this report.
(b) REPORTS ON FORM 8-K FILED DURING THE THREE MONTHS ENDED DECEMBER 31, 1997
Not Applicable.
32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COMMUNICATIONS SYSTEMS, INC.
/s/Curtis A. Sampson
Dated: March 27, 1998 ---------------------------------------
Curtis A. Sampson, Chairman of the
Board of Directors, President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated:
Each person whose signature appears below constitutes and appoints
CURTIS A. SAMPSON and PAUL N. HANSON as his true and lawful attorneys-in-fact
and agents, each acting alone, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this Annual Report on Form 10-K and
to file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, each acting alone, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all said attorneys-in-fact
and agents, each acting alone, or his substitute or substitutes, may lawfully do
or cause to be done by virtue thereof.
Signature Title Date
/s/Curtis A. Sampson Chairman of the Board of March 27, 1998
- ----------------------------- Directors, President, and Director
Curtis A. Sampson (Principal Executive Officer)
/s/Paul N. Hanson Vice President, Treasurer and March 27, 1998
- ----------------------------- Chief Financial Officer
Paul N. Hanson (Principal Financial Officer and
Principal Accounting Officer)
/s/Paul J. Anderson Director March 27, 1998
- -----------------------------
Paul J. Anderson
/s/Edwin C. Freeman Director March 27, 1998
- -----------------------------
Edwin C. Freeman
Director March 27, 1998
- -----------------------------
Luella Gross Goldberg
/s/Frederick M. Green Director March 27, 1998
- -----------------------------
Frederick M. Green
/s/John C. Ortman Director March 27, 1998
- -----------------------------
John C. Ortman
Director March 27, 1998
- -----------------------------
Joseph W, Parris
Director March 27, 1998
- -----------------------------
Gerald D. Pint
/s/Wayne E. Sampson Director March 27, 1998
- -----------------------------
Wayne E. Sampson
Director March 27, 1998
- -----------------------------
Edward E. Strickland
33
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
COMMUNICATIONS SYSTEMS, INC.
FOR
YEAR ENDED DECEMBER 31, 1997
--------------------------------
FINANCIAL STATEMENT SCHEDULE
================================================================================
34
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Schedule II - Valuation and Qualifying Accounts and Reserves
Balance at Additions Additions Deductions Balance
Beginning of Charged to Cost Charged to from at End
Description Period and Expenses Other Accounts Reserves of Period
Allowance for doubtful accounts:
Year ended:
December 31, 1997 $ 306,000 $ 50,000 $ 441,000 (A) $ 1,000 (B) $ 796,000
December 31, 1996 $ 288,000 $ 91,000 $ - $ 73,000 (B) $ 306,000
December 31, 1995 $ 275,000 $ 60,000 $ - $ 47,000 (B) $ 288,000
Inventory valuation reserves:
Year ended:
December 31, 1997 $ 1,370,000 $ - $ - $ 213,000 $ 1,157,000
December 31, 1996 $ 1,262,000 $ 108,000 $ - $ - $ 1,370,000
December 31, 1995 $ 1,262,000 $ - $ - $ - $ 1,262,000
Reserve for assets transferred under contractual arrangements and notes
receivable:
Year Ended:
December 31, 1997 $ 358,000 $ - $ 13,000 (C) $ - $ 371,000
December 31, 1996 $ 335,000 $ - $ 23,000 (C) $ - $ 358,000
December 31, 1995 $ 377,000 $ - $ 43,000 (C) $ 85,000 $ 335,000
- -----------------------------------------
(A) Reclassification of allowance for doubtful accounts related to net assets of
discontinued operations. (B) Accounts determined to be uncollectible and charged
off against reserve.
(C) Interest on notes receivable credited to valuation reserve.
35
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
COMMUNICATIONS SYSTEMS, INC.
FOR
YEAR ENDED DECEMBER 31, 1997
----------------------
EXHIBITS
================================================================================
36
COMMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Exhibit Index To
Form 10-K for the Year Ended December 31, 1997
Regulation S-K Location in Consecutive Numbering
Exhibit Table System as Filed With the Securities
Reference Title of Document and Exchange Commission
3.1 Articles of Incorporation, Filed as Exhibit 3.1 to the Form
as amended 10-K Report of the Company for its
year ended December 31, 1989 (the
"1989 Form 10-K") and incorporated
herein by reference.
3.2 Bylaws, as amended Filed as Exhibit 3.2 to the 1989
Form 10-K and incorporated herein
by reference.
10.1 1987 Stock Plan Filed as Exhibit 10.1 to the Form
10-K Report of the Company for its
year ended December 31, 1993 (the
"1993 Form 10-K") and incorporated
herein by reference.
10.2 Employee Savings Plan Filed as Exhibit 10.2 to the 1993
Form 10-K and incorporated herein
by reference.
10.3 Employee Stock Ownership Filed as Exhibit 10.3 to the 1993
Plan Form 10-K and incorporated herein
by reference.
10.4 Employee Stock Purchase Filed as Exhibit 10.4 to the 1993
Plan Form 10-K and incorporated herein
by reference.
10.5 Stock Option Plan for Filed as Exhibit 10.5 to the 1993
Nonemployee Directors Form 10-K and incorporated herein
by reference.
10.6 1992 Stock Plan Filed as Exhibit 10.6 to the 1993
Form 10-K and incorporated herein
by reference.
10.7 Flexible Benefit Plan Filed as Exhibit 10.7 to the 1993
Form 10-K and incorporated herein
by reference.
10.8 Supplemental Executive Filed as Exhibit 10.8 to the 1993
Retirement Plan Form 10-K and incorporated herein
by reference.
11 Calculation of Earnings Filed herewith at page 38
Per Share
21 Subsidiaries of the Filed herewith at page 39
Registrant
23 Independent Auditors' Filed herewith at page 40.
Consent
24 Power of Attorney Included in signatures at page 33.
The exhibits referred to in this Exhibit Index will be supplied to a shareholder
at a charge of $.25 per page upon written request directed to CSI's Assistant
Secretary at the executive offices of the Company.
37
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CALCULATION OF EARNINGS PER SHARE
EXHIBIT 11
Twelve Months Ended December 31
----------------------------------------------------
Basic: 1997 1996 1995
- ------- ------------- ------------- -------------
Income from Continuing Operations $ 10,936,873 $ 8,953,855 $ 8,923,825
Income (loss) from Discontinued Operations (721,324) 160,328
------------- ------------- -------------
Net Income $ 10,936,873 $ 8,232,531 $ 9,084,153
============= ============= =============
Common shares:
Weighted average number of common
shares outstanding 9,231,858 9,272,825 9,097,771
============= ============= =============
Basic net income per common share:
Continuing Operations $ 1.18 $ .97 $ .98
Discontinued Operations (.08) .02
------------- ------------- -------------
$ 1.18 $ .89 $ 1.00
============= ============= =============
Diluted:
- -------------
Income from Continuing Operations $ 10,936,873 $ 8,953,855 $ 8,923,825
Income (loss) from Discontinued Operations (721,324) 160,328
------------- ------------- -------------
Adjusted net income $ 10,936,873 $ 8,232,531 $ 9,084,153
============= ============= =============
Common and potentially dilutive shares:
Weighted average number of common
shares outstanding 9,231,858 9,272,825 9,097,771
Dilutive effect of stock options outstanding
after application of treasury stock method 92,853 78,915 119,450
------------- ------------- -------------
9,324,711 9,351,740 9,217,221
============= ============= =============
Diluted net income per common share:
Continuing Operations $ 1.17 $ .96 $ .97
Discontinued Operations (.08) .02
------------- ------------- -------------
$ 1.17 $ .88 $ .99
============= ============= =============
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SUBSIDIARIES OF COMMUNICATIONS SYSTEMS, INC.
EXHIBIT 21
Subsidiaries Jurisdiction of Incorporation
Suttle Apparatus Corporation Illinois
Suttle Costa Rica, S.A. Costa Rica
Tel Products, Inc. Minnesota
Suttle Caribe, Inc. Minnesota
Austin Taylor Communications, Ltd. United Kingdom
Automatic Tool & Connector Company, Inc. New Jersey
All such subsidiaries are 100%-owned directly by Communications Systems, Inc.
The financial statements of all such subsidiaries are included in the
consolidated financial statements of Communications Systems, Inc.
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EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
33-28486, 33-39862, 33-39864, 33-60930, 33-83662, 33-99564, and 33-99566 of
Communications Systems, Inc. of our report dated February 20, 1998 on the
consolidated financial statements and schedule of Communications Systems, Inc.
appearing in this Annual Report on Form 10-K of Communications Systems, Inc. for
the year ended December 31, 1997.
/s/ Deloitte & Touche LLP
- -------------------------
Deloitte & Touche LLP
March 26, 1998
Minneapolis, Minnesota
40