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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 1999
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OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ..................... to ........................
Commission File Number: 0-10355
COMMUNICATIONS SYSTEMS, INC.
................................................................................
(Exact name of registrant as specified in its charter)
MINNESOTA 41-0957999
................................................................................
(State or other jurisdiction of (Federal Employer
incorporation or organization) Identification No.)
213 South Main Street, Hector, MN 55342
...............................................................................
(Address of principal executive offices) (Zip Code)
(320) 848-6231
...............................................................................
Registrant's telephone number, including area code
................................................................................
(Former name, address, and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS Outstanding at April 30, 1999
Common Stock, par value 8,608,294
$.05 per share
Total Pages (11) Exhibit Index at (NO EXHIBITS)
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COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
INDEX
Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income and
Comprehensive Income 4
Consolidated Statements of Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
Part II. Other Information 12
2
PART I. FINANCIAL INFORMATION
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
March 31 December 31
Assets: 1999 1998
------------ ------------
Current assets:
Cash $ 21,832,810 $ 20,405,363
Receivables, net 19,125,141 14,624,123
Inventories - Note 2 17,705,069 20,837,508
Deferred income taxes 1,348,000 1,348,000
Other current assets 477,065 499,549
------------ ------------
Total current assets 60,488,085 57,714,543
Property, plant and equipment 30,994,518 30,654,182
less accumulated depreciation (19,903,318) (19,275,422)
------------ ------------
Net property, plant and equipment 11,091,200 11,378,760
Other assets:
Excess of cost over net assets acquired 7,987,588 8,392,261
Investments in mortgage backed and other securities 1,240,830 1,316,912
Deferred income taxes 548,047 548,047
Notes receivable from sale of assets of
discontinued operations 3,765,390 3,765,390
Other assets 834,053 783,799
------------ ------------
Total other assets 14,375,908 14,806,409
------------ ------------
Total Assets $ 85,955,193 $ 83,899,712
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable $ 9,069,305 $ 9,077,598
Accounts payable 4,568,389 4,589,078
Accrued expenses 3,964,848 3,823,596
Dividends payable 881,114 879,130
Income taxes payable 2,656,803 2,076,658
------------ ------------
Total current liabilities 21,140,459 20,446,060
Stockholders' Equity 64,814,734 63,453,652
------------ ------------
Total Liabilities and Stockholders' Equity $ 85,955,193 $ 83,899,712
============ ============
See notes to consolidated financial statements.
3
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited)
Three Months Ended March 31
---------------------------------
1999 1998
------------ ------------
Sales $ 26,596,892 $ 17,486,063
Costs and expenses:
Cost of sales 17,561,114 12,242,094
Selling, general and
administrative expenses 5,774,611 2,958,377
------------ ------------
Total costs and expenses 23,335,725 15,200,471
------------ ------------
Operating income 3,261,167 2,285,592
Other income and (expenses):
Investment income 203,635 459,892
Interest expense (152,343) (1,261)
------------ ------------
Other income, net 51,292 458,631
Income before income taxes 3,312,459 2,744,223
Income taxes (Note 3) 840,000 550,000
------------ ------------
Net income 2,472,459 2,194,223
------------ ------------
Other comprehensive income -
Foreign currency translation adjustment (231,503) 83,260
------------ ------------
Comprehensive income $ 2,240,956 $ 2,277,483
============ ============
Basic net income per share $ .28 $ .24
Diluted net income per share $ .28 $ .23
Average Basic Shares Outstanding 8,802,972 9,321,576
Average Dilutive Shares Outstanding 8,832,458 9,418,637
See notes to consolidated financial statements.
4
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Additional Stock Option Cumulative
--------------------- Paid-in Retaine Notes Translation
Shares Amount Capital Earnings Receivable Adjustment Total
--------- --------- ----------- ----------- ----------- ----------- ------------
BALANCE AT DECEMBER 31, 1997 9,326,652 $ 466,333 $ 24,132,771 $ 44,552,855 $ - $ 111,737 $ 69,263,696
Net income 7,867,425 7,867,425
Issuance of stock to acquire
JDL Technologies, Inc. 158,005 7,900 2,204,170 2,212,070
Issuance of common stock under
Employee Stock Purchase Plan 12,210 610 112,259 112,869
Issuance of stock under
Employee Stock Option Plan 84,834 4,242 938,102 942,344
Tax benefit from non qualified
employee stock options 37,017 37,017
Issuance of notes receivable
for stock options, net (288,225) (288,225)
Purchase of stock (790,400) (39,520) (2,173,405) (11,052,325) (13,265,250)
Shareholder dividends (3,505,492) (3,505,492)
Foreign currency translation
adjustment 77,198 77,198
--------- --------- ----------- ----------- ----------- ----------- ------------
BALANCE AT DECEMBER 31, 1998 8,791,301 439,565 25,250,914 37,862,463 (288,225) 188,935 63,453,652
Net income 2,472,459 2,472,459
Issuance of common stock to
Employee Stock Ownership Plan 19,893 995 234,005 235,000
Purchase of stock (23,400) (1,170) (67,679) (164,911) (233,760)
Shareholder dividends (881,114) (881,114)
Foreign currency translation
adjustment (231,503) (231,503)
--------- --------- ----------- ----------- ----------- ----------- ------------
BALANCE AT MARCH 31, 1999 8,787,794 $ 439,390 $ 25,417,240 $ 39,288,897 $ (288,225) $ (42,568) $ 64,814,734
========= ========= =========== =========== =========== =========== ============
See notes to consolidated financial statements.
5
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended March 31
--------------------------------
1999 1998
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,472,459 $ 2,194,223
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 1,112,287 677,812
Changes in assets and liabilities:
Decrease (increase) in accounts receivable (4,553,860) 1,621,219
Decrease (increase) in inventory 3,076,917 (1,285,723)
Decrease in other current assets 20,315 313,256
Increase in accounts payable 23,607 282,969
Increase in accrued expenses 300,733 936,080
Increase (decrease) in income taxes payable 584,509 (85,423)
------------ ------------
Net cash provided by operating activities 3,036,967 4,654,413
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (478,221) (1,005,875)
Maturities of mortgage-backed and other investment securities 76,082 433,874
Increase in other assets (56,950) (466,727)
Proceeds from maturities of U.S. Treasury securities 5,249,314
------------ ------------
Net cash provided by (used in) investing activities (459,089) 4,210,586
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable (8,293)
Dividends paid (879,130) (839,399)
Proceeds from issuance of common stock 325,787
Purchase of stock (233,760) (2,101,131)
------------ ------------
Net cash used in financing activities (1,121,183) (2,614,743)
------------ ------------
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (29,248) 45,008
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 1,427,447 6,295,264
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 20,405,363 17,942,315
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 21,832,810 $ 24,237,579
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 259,855 $ 633,340
Interest paid 46,427 1,261
See notes to consolidated financial statements.
6
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - CONSOLIDATED FINANCIAL STATEMENTS
The balance sheet and statement of stockholders' equity as of March 31, 1999,
the statements of income and comprehensive income and the statements of cash
flows for the three-month periods ended March 31, 1999 and 1998 have been
prepared by the Company without audit. In the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the financial position, results of operations, and cash flows at
March 31, 1999 and 1998 have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested these condensed financial
statements be read in conjunction with the financial statements and notes
thereto included in the Company's December 31, 1998 Annual Report to
Shareholders. The results of operations for the periods ended March 31 are not
necessarily indicative of the operating results for the entire year.
Effective December 1, 1998, the Company acquired all the capital stock of
Transition Networks, Inc. for $8,507,000 (cash payments net of cash acquired).
The transaction is being accounted for as a purchase, and the operations of
Transition Networks, Inc. are included in consolidated operations as of the
effective date. Excess cost over net assets acquired in the transaction was
$4,047,000, which is being amortized on a straight-line basis over 5 years.
Effective August 7, 1998, in a noncash transaction, the Company acquired JDL
Technologies, Inc. in exchange for 158,005 shares of its common stock. The
acquisition was accounted for as a purchase. The excess of cost over net assets
acquired in the transaction was $2,223,000 which is being amortized on a
straight-line basis over 5 years. The results of operations of JDL Technologies,
Inc. have been included in the Company's operations effective August 7, 1998.
Unaudited consolidated results of operations on a pro forma basis as though the
acquisitions were effective January 1, 1998 are as follows:
Three Months Ended March 31, 1998
---------------------------------
Revenues $ 23,861,817
Net income 1,685,968
Basic net income per share $ .18
Diluted net income per share $ .18
In February, 1999 the Company issued 19,893 shares of the Company's common stock
to the Employee Stock Ownership Plan in payment of its 1998 obligation. In a
noncash transaction, the Company recorded additional stockholders' equity of
$235,000 (reflecting the market value of the stock at the time of the
contribution) and reduced accrued expenses by the same amount.
7
NOTE 2 - INVENTORIES
Inventories summarized below are priced at the lower of first-in, first-out cost
or market:
March 31 December 31
1999 1998
Finished Goods $ 6,484,389 $ 8,450,447
Raw Materials 11,220,680 12,387,061
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Total $ 17,705,069 $ 20,837,508
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NOTE 3 - INCOME TAXES
Income taxes are computed based upon the estimated effective rate applicable to
operating results for the full fiscal year. For the periods ended March 31, 1999
and 1998 income taxes do not bear a normal relationship to income before income
taxes, primarily because income from Puerto Rico operations is taxed at rates
lower than the U.S. rate.
NOTE 4 - NET INCOME PER SHARE
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, which
resulted in a dilutive effect of 29,486 shares and 97,061 shares in 1999 and
1998, respectively. The Company calculates the dilutive effect of outstanding
options using the treasury stock method.
NOTE 5 - SUBSEQUENT EVENT
On March 12, 1999, the Company signed an agreement to purchase LANart
Corporation, a manufacturer of application specific integrated circuits located
in Needham, Massachusetts, for approximately $6,000,000. LANart Corporation had
sales of approximately $10,687,000 and a net loss of $1,151,000 for its most
recent fiscal year ended December 31, 1998. The Company completed this
acquisition in April 1999.
NOTE 6 - SEGMENT INFORMATION
The Company classifies its businesses into three segments: Suttle, which
manufactures U.S. standard modular connecting and wiring devices for voice and
data communications; Austin Taylor, which manufactures British standard line
jacks, patch panels, wiring harness assemblies, metal boxes, distribution
cabinets and distribution and central office frames; Transition Networks, which
designs and markets data transmission and computer network products; and other
operations. Information concerning the Company's continuing operations in the
various segments is as follows:
8
Austin Transition
Suttle Taylor Networks Other Consolidated
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Three Months Ended March 31, 1999:
Revenues $ 15,970,208 $ 2,807,495 $ 6,765,382 $ 1,053,807 $ 26,596,892
Cost of sales 10,245,881 2,251,862 4,342,829 720,542 17,561,114
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Gross profit 5,724,327 555,633 2,422,553 333,265 9,035,778
Selling, general and
administrative expenses 1,947,844 339,808 2,514,964 971,995 5,774,611
-----------------------------------------------------------------------------------
Operating income (loss) $ 3,776,483 $ 215,825 $ (92,411) $ (638,730) $ 3,261,167
===================================================================================
Depreciation and amortization $ 529,632 $ 161,274 $ 262,243 $ 159,138 $ 1,112,287
===================================================================================
Assets $ 55,284,130 $ 6,903,216 $ 11,786,255 $ 11,981,592 $ 85,955,193
===================================================================================
Capital expenditures $ 280,093 $ 117,705 $ 60,145 $ 20,278 $ 478,221
==================================================================================
Three Months Ended March 31, 1998:
Revenues $ 14,148,314 $ 3,337,749 $ 17,486,063
Cost of sales 9,601,030 2,641,064 12,242,094
-----------------------------------------------------------------------------------
Gross profit 4,547,284 696,685 5,243,969
Selling, general and
administrative expenses 2,235,389 323,321 $ 399,667 2,958,377
-----------------------------------------------------------------------------------
Operating income (loss) $ 2,311,895 $ 373,364 $ (399,667) $ 2,285,592
==================================================================================
Depreciation and amortization $ 507,527 $ 138,521 $ 31,764 $ 677,812
==================================================================================
Assets $ 56,258,045 $ 9,900,317 $ 12,192,432 $ 78,350,794
==================================================================================
Capital expenditures $ 935,029 $ 49,773 $ 21,073 $ 1,005,875
==================================================================================
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Three Months Ended March 31, 1999 Compared to
Three Months Ended March 31, 1998
Consolidated sales increased 52% to $26,597,000. Consolidated operating income
increased 43% to $3,261,000.
Suttle sales increased 13% to $15,970,000. Sales to customers in the United
States (U.S.) increased 14% to $15,384,000. Sales to the Big 6 telephone
companies (the five Regional Bell Operating Companies (RBOCs) and GTE) increased
27% to $10,009,000. Sales to these customers accounted for 65% of Suttle's U.S.
customer sales. Sales to distributors, original equipment manufacturers (OEMs),
and electrical contractors increased $426,000, or 12%. Sales to retail customers
decreased $550,000 or 39% due to decreased sales to Radio Shack, which is
Suttle's principal retail customer. Suttle's export sales, including sales to
Canada decreased 9% to $586,000.
The sales increases were mainly of Suttle's CorroShield and data products.
CorroShield product sales increased 33%, reflecting a return to more normal
buying patterns by the RBOCs, which are CorroShield's major customers.
CorroShield products are continuing to displace conventional voice connecting
products, sales of which declined 3% in the 1999 quarter. Sales of data products
increased 22%. Sales of fiber-optic connector products decreased 26%.
9
Suttle's gross margins increased 26% to $5,724,000. Gross margin percentage
improved to 35.8% in 1999 from 32.1% in 1998. The improvement in gross margin
was due to product mix. The fastest selling products in 1999 (CorroShield and
data products) tended to be the products with the highest margins. Margins also
benefited from Suttle's inventory overstock at the end of 1998. No extra
production costs were incurred to meet the increase in sales. Selling, general
and administrative expenses declined $288,000 or 13%. 1998 expenses were higher
than normal due to a campaign to increase export sales and sales of data
products. Suttle's operating income increased $1,465,000 or 63%.
Austin Taylor's sales decreased 16% to $2,807,000. The decrease was due to
reduced sales of CATV products caused by major reductions of cable television
construction activity in the U.K. and below plan sales to Pacific Rim telephone
companies. Austin Taylor's gross margin declined 20% to $556,000. Gross margin
as a percentage of sales was 19.8% compared to 20.9% in 1998. The decline in
gross margin was principally due to lower business volume. Selling, general and
administrative expenses increased $16,000. Operating income decreased $158,000
or 42%.
The Company acquired JDL Technologies, Inc. in August, 1998 and Transition
Networks, Inc. in December, 1998. While the Company expects both acquisitions to
make positive contributions in future periods, neither had a positive impact in
the 1999 period. JDL had sales of $1,054,000 in the period and an operating loss
of $242,000. Government funding delays for new telecommunications infrastructure
in the public schools negatively affected JDL's performance. TNI had sales of
$6,765,000 and an operating loss of $92,000. Transition Network's performance
was hurt by the lack of manufacturing margins on sales inventory in stock at the
time it was acquired by the Company. CSI's corporate operating expenses were
$396,000 compared to $399,000 in the 1998 period.
Consolidated investment income, net of interest expense, decreased $407,000 due
to decreased levels of funds available for investment and interest on notes
payable associated with acquisitions. Income from continuing operations before
income taxes increased $568,000 or 21%. The Company's effective income tax rate
was 25.4% compared to 20.0% in 1998. The increase in the tax rate was because
the Company did not generate sufficient tax credits in Puerto Rico to shelter
all of its Puerto Rico earnings. Net income increased $278,000 or 13%.
Liquidity and Capital Resources
At March 31, 1999, the Company had approximately $21,833,000 of cash and cash
equivalents compared to $20,405,000 of cash and cash equivalents at December 31,
1998. The Company had working capital of approximately $39,348,000 and a current
ratio of 2.9 to 1 compared to working capital of $37,268,000 and a current ratio
of 2.8 to 1 at the end of 1998.
Cash flow provided by operations was approximately $3,037,000 in the first three
months of 1999 compared to $4,654,000 in the same period in 1998. The decrease
was due to the need to finance increased accounts receivable levels caused by
the Company's increased sales volume. Cash flow benefited in the 1999 period
from decreased inventory levels, as the Company was able to satisfy some of the
increased customer demand out of existing stocks.
10
Investing activities utilized $459,000 of cash in the 1999 period. Cash
investments in new plant and equipment totaled $478,000, which was financed by
internal cash flows. The Company expects to spend $3,500,000 on capital
additions in 1999. The Company spent an additional $6,000,000 in April, 1999 to
acquire LANart Corporation. The Company financed that acquisition using a
combination of internal funds and short-term borrowing from U.S. Bank.
Short-term notes payable outstanding, which were $9,069,000 at March 31, 1999,
increased to $10,166,000 after the LANart acquisition was completed. . The
Company expects to repay or refinance this debt in 1999.
Net cash used in financing activities was $1,121,000. The Company purchased and
retired 23,400 shares of its stock in open market transactions during the 1999
period. At March 31, 1999 Board authorizations are outstanding to purchase an
additional 186,200 shares. The Company purchased an additional 180,000 shares
under this authorization in April 1999. Dividends paid on common stock increased
to $879,000.
In the opinion of management, based on the Company's current financial and
operating position and projected future expenditures, sufficient funds are
available to meet the Company's anticipated operating and capital expenditure
needs.
Year 2000 Issues
Most older computer software was originally designed to use references to
calendar dates on an abbreviated basis. Under this system, references to the
calendar year are abbreviated to the last two digits of the year, i.e. 1999 is
abbreviated as "99". Software using this system often fails to recognize that
the year 2000, abbreviated as "00", follows 1999. This "Y2K" problem can cause
computing errors in date sensitive processes. In 1998, the Company surveyed its
operations to locate computer systems that could be subject to this error and
initiated a program of corrective action.
The Company's accounting and management control systems at Suttle and Austin
Taylor utilize a company-wide computer network centered in the Company's Hector,
MN corporate office. The hardware and software used in operating the network are
all purchased from third party suppliers. The Company has contracted with these
suppliers and obtained the necessary hardware and software to bring its central
computer system and data network into Y2K compliance on a current basis. Cost
hardware and software purchased as part of the Y2K compliance program was
$150,000. The Company did not separately track internal costs of Y2K compliance.
In 1998, the Company acquired JDL Technologies, Inc. and Transition Networks,
Inc. These operations are not presently part of the Company's central computer
network. Both operations utilize personal computer based computing networks that
were materially Y2K compliant prior to their acquisition by the Company.
At the present time, Suttle, Austin Taylor and Transition Networks do not
manufacture products containing embedded controllers or microprocessors that are
date sensitive or subject to the Y2K problem. The Company does not believe it
has any warranty exposure to customers due to potential Y2K problems.
11
The Company has also been in contact with its major customers and suppliers to
estimate the extent to which it may be vulnerable to their respective Y2K
problems. The Company is reliant on third parties for critical functions,
including raw materials and supplies, transportation, utilities and
communications services. Multiple sources of supply are available for most of
these products and services. The Company has not received any indication from
these parties that they will not be Y2K compliant. If the Company does
experience any Y2K related problems with third parties it is likely to be in the
nature of short-term spot shortages of raw materials or manufacturing supplies
which would not materially affect the Company's operations.
At the present time, the Company expects to handle any Y2K problems that occur
as part of the ordinary course of business. No special contingency plans have
been developed. The Company will continue to monitor its Y2K situation and will
respond appropriately if any problem arises.
PART II. OTHER INFORMATION
Items 1 - 6. Not Applicable
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Communications Systems, Inc.
By /s/ Paul N. Hanson
-----------------------------
Paul N. Hanson
Vice President and
Chief Financial Officer
Date: May 14, 1999
12