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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 1999
-------------------------------------------------
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
Common Stock, par value Outstanding at July 31, 1999
$.05 per share 8,625,477
Total Pages (14) 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 Changes in 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 10
Part II. Other Information 14
2
PART I. FINANCIAL INFORMATION
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
June 30 December 31
Assets: 1999 1998
------------ ------------
Current assets:
Cash $ 13,598,920 $ 20,405,363
Receivables, net 20,197,190 14,624,123
Inventories (Note 4) 17,901,924 20,837,508
Deferred income taxes 1,348,000 1,348,000
Other current assets 833,049 499,549
------------ ------------
Total current assets 53,879,083 57,714,543
Property, plant and equipment 31,578,765 30,654,182
less accumulated depreciation (20,592,522) (19,275,422)
------------ ------------
Net property, plant and equipment 10,986,243 11,378,760
Other assets:
Excess of cost over net assets acquired 10,955,787 8,392,261
Investments in mortgage backed and other securities 6,775,887 1,316,912
Deferred income taxes 553,158 548,047
Notes receivable from sale of assets of
discontinued operations 3,565,390 3,765,390
Other assets 968,243 783,799
------------ ------------
Total other assets 22,818,465 14,806,409
------------ ------------
Total Assets $ 87,683,791 $ 83,899,712
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable $ 9,907,706 $ 9,077,598
Accounts payable 6,357,219 4,589,078
Accrued expenses 4,637,213 3,823,596
Dividends payable 860,944 879,130
Income taxes payable 1,993,193 2,076,658
------------ ------------
Total current liabilities 23,756,275 20,446,060
Stockholders' Equity 63,927,516 63,453,652
------------ ------------
Total Liabilities and Stockholders' Equity $ 87,683,791 $ 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 June 30 Six Months Ended June 30
---------------------------- -----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
Sales $ 29,807,344 $ 16,969,774 $ 56,404,236 $ 34,455,837
Costs and expenses:
Cost of sales 19,906,281 11,619,503 37,467,395 23,861,597
Selling, general and
administrative expenses 7,822,663 2,635,334 13,597,274 5,593,711
------------ ------------ ------------ ------------
Total costs and expenses 27,728,944 14,254,837 51,064,669 29,455,308
------------ ------------ ------------ ------------
Operating income 2,078,400 2,714,937 5,339,567 5,000,529
Other income and (expenses):
Investment income 218,125 328,342 421,760 788,234
Interest expense (168,835) (1,264) (321,178) (2,525)
------------ ------------ ------------ ------------
Other income, net 49,290 327,078 100,582 785,709
Income before income taxes 2,127,690 3,042,015 5,440,149 5,786,238
Income taxes (Note 5) 380,000 600,000 1,220,000 1,150,000
------------ ------------ ------------ ------------
Net income 1,747,690 2,442,015 4,220,149 4,636,238
------------ ------------ ------------ ------------
Other comprehensive income -
Foreign currency translation adjustment (94,154) (12,185) (325,657) 71,075
------------ ------------ ------------ ------------
Comprehensive income $ 1,653,536 $ 2,429,830 $ 3,894,492 $ 4,707,313
============ ============ ============ ============
Basic net income per share $ .20 $ .27 $ .48 $ .50
Diluted net income per share $ .20 $ .27 $ .48 $ .50
Average Basic Shares Outstanding 8,623,804 9,111,450 8,712,894 9,215,611
Average Dilutive Shares Outstanding 8,716,487 9,214,932 8,775,711 9,314,022
See notes to consolidated financial statements.
4
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Additional Stock Option Other
--------------------- Paid-in Retaine Notes Comprehensive
Shares Amount Capital Earnings Receivable Income 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 4,220,149 4,220,149
Issuance of common stock to
Employee Stock Ownership Plan 19,893 995 234,005 235,000
Issuance of common stock under
Employee Stock Option Plan 5,300 265 53,069 53,334
Purchase of stock (203,400) (10,170) (589,075) (1,367,658) (1,966,903)
Shareholder dividends (1,742,059) (1,742,059)
Foreign currency translation
adjustment (325,657) (325,657)
--------- --------- ----------- ----------- ----------- ----------- ------------
BALANCE AT JUNE 30, 1999 8,613,094 $ 430,655 $ 24,948,913 $ 38,972,895 $ (288,225) $ (136,722) $ 63,927,516
========= ========= =========== =========== =========== =========== ============
See notes to consolidated financial statements.
5
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended June 30
---------------------------------
1999 1998
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,220,149 $ 4,636,238
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 2,448,596 1,355,908
Changes in assets and liabilities net of effects from
acquisition of LANart Corporation:
Decrease (increase) in accounts receivable (3,864,667) 192,239
Decrease (increase) in inventory 4,056,044 (2,030,678)
Decrease (increase) in other current assets (358,705) 1,245,259
Increase in accounts payable 557,046 253,009
Increase (decrease) in accrued expenses (533,887) 933,581
Increase (decrease) in income taxes payable (78,664) 107,093
------------ ------------
Net cash provided by operating activities 6,445,912 6,692,649
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (926,280) (2,131,338)
Maturities of mortgage-backed and other investment securities 166,025 825,167
Purchases of mortgaged-backed and other securities (5,625,000)
Increase in other assets (196,766) (481,478)
Collection of notes receivable 200,000 200,000
Proceeds from maturities of U.S. Treasury securities 5,249,314
Payment for purchase of LANart Corporation, net of cash acquired (3,983,703)
------------ ------------
Net cash (used in) provided by investing activities (10,365,724) 3,661,665
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable (266,813)
Proceeds from issuance of notes payable 1,096,921
Dividends paid (1,760,245) (1,676,818)
Proceeds from issuance of common stock 53,334 626,869
Purchase of stock (1,966,903) (7,597,249)
------------ ------------
Net cash used in financing activities (2,843,706) (8,647,198)
------------ ------------
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (42,925) 31,242
------------ ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (6,806,443) 1,738,358
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 20,405,363 17,942,315
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 13,598,920 $ 19,680,673
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 1,303,136 $ 1,040,711
Interest paid 325,983 2,525
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 changes in stockholders' equity as of June
30, 1999, the statements of income and comprehensive income for the three and
six month periods ended June 30, 1999 and 1998 and the statements of cash flows
for the six-month periods ended June 30, 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 June 30, 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 June 30 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
these acquisitions were effective January 1, 1998 are as follows:
Three Months Ended Six Months Ended
June 30, 1998 June 30, 1998
-------------- ---------------
Revenues $ 24,657,533 $ 48,519,350
Net income 2,292,955 3,978,923
Basic net income per share $ .25 $ .42
Diluted net income per share $ .24 $ .42
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.
Effective April 8, 1999, the Company acquired all the capital stock of LANart
Corporation for $3,984,000 (cash payments net of cash acquired). The transaction
is being accounted for as a purchase. Excess cost over net assets acquired in
the transaction was $3,550,000, which is being amortized on a straight-line
basis over 5 years. The operations of LANart Corporation, which are not material
to the Company's financial statements, are included in consolidated operations
as of the effective date. Subsequent to the acquisition, the Company merged
LANart's operations into Transition Networks, Inc.
7
NOTE 2 - 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. The
Company calculates the dilutive effect of outstanding options using the treasury
stock method.
NOTE 3 - 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 for the six-month periods ended June 30, 1999 and 1998 is as
follows:
Austin Transition
Suttle Taylor Networks Other Consolidated
---------------------------------------------------------------
Six Months Ended June 30, 1999:
Revenues $29,977,460 $5,708,793 $16,729,834 $ 3,988,149 $56,404,236
Cost of sales 19,369,544 4,615,993 10,683,321 2,798,537 37,467,395
---------------------------------------------------------------
Gross profit 10,607,916 1,092,800 6,046,513 1,189,612 18,936,841
Selling, general and
administrative expenses 4,085,366 680,594 6,653,141 2,178,173 13,597,274
---------------------------------------------------------------
Operating income (loss) $ 6,522,550 $ 412,206 $ (606,628) $ (988,561) $ 5,339,567
===============================================================
Depreciation and amortization $ 1,059,262 $ 319,923 $ 751,134 $ 318,277 $ 2,448,596
===============================================================
Assets $49,090,211 $6,849,903 $19,610,095 $12,133,582 $87,683,791
===============================================================
Capital expenditures $ 516,764 $ 258,750 $ 96,638 $ 54,128 $ 926,280
===============================================================
Six Months Ended June 30, 1998:
Revenues $28,195,697 $6,260,140 $34,455,837
Cost of sales 18,852,059 5,009,538 23,861,597
---------------------------------------------------------------
Gross profit 9,343,638 1,250,602 10,594,240
Selling, general and
administrative expenses 4,173,543 682,856 $ 737,312 5,593,711
---------------------------------------------------------------
Operating income (loss) $ 5,170,095 $ 567,746 $ (737,312) $ 5,000,529
===============================================================
Depreciation and amortization $ 1,015,051 $ 277,329 $ 63,528 $ 1,355,908
===============================================================
Assets $55,752,796 $9,830,885 $9,310,837 $74,894,518
===============================================================
Capital expenditures $ 1,654,323 $ 452,976 $ 24,039 $ 2,131,338
===============================================================
Information concerning the Company's continuing operations in the various
segments for the three-month periods ended June 30, 1999 and 1998 is as follows:
8
Austin Transition
Suttle Taylor Networks Other Consolidated
---------------------------------------------------------------
Three Months Ended June 30, 1999:
Revenues $14,007,252 $2,901,298 $ 9,964,452 $2,934,342 $29,807,344
Cost of sales 9,123,663 2,364,131 6,340,492 2,077,995 19,906,281
---------------------------------------------------------------
Gross profit 4,883,589 537,167 3,623,960 856,347 9,901,063
Selling, general and
administrative expenses 2,137,522 340,786 4,138,177 1,206,178 7,822,663
---------------------------------------------------------------
Operating income (loss) $ 2,746,067 $ 196,381 $ (514,217) $ (349,831) $ 2,078,400
===============================================================
Depreciation and amortization $ 529,630 $ 158,649 $ 488,891 $ 159,139 $ 1,336,309
===============================================================
Capital expenditures $ 236,671 $ 141,045 $ 36,493 $ 33,850 $ 448,059
===============================================================
Three Months Ended June 30, 1998:
Revenues $14,047,383 $2,922,391 $16,969,774
Cost of sales 9,251,029 2,368,474 11,619,503
---------------------------------------------------------------
Gross profit 4,796,354 553,917 5,350,271
Selling, general and
administrative expenses 1,938,154 359,535 $ 337,645 2,635,334
---------------------------------------------------------------
Operating income (loss) $ 2,858,200 $ 194,382 $ (337,645) $ 2,714,937
===============================================================
Depreciation and amortization $ 507,524 $ 138,808 $ 31,764 $ 678,096
===============================================================
Capital expenditures $ 719,294 $ 403,203 $ 2,966 $ 1,125,463
===============================================================
NOTE 4 - INVENTORIES
Inventories summarized below are priced at the lower of first-in, first-out cost
or market:
June 30 December 31
1999 1998
Finished Goods $ 6,763,423 $ 8,450,447
Raw Materials 11,138,501 12,387,061
------------ ------------
Total $ 17,901,924 $ 20,837,508
============ ============
NOTE 5 - INCOME TAXES
Income taxes are computed based upon the estimated effective rate applicable to
operating results for the full fiscal year. For the periods ended June 30, 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.
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Statements regarding the Company's anticipated performance in future periods are
forward looking and involve risks and uncertainties, including but not limited
to: buying patterns of its Regional Bell Operating Customers, competitor's
products, the success of its recent acquisitions, changes in tax laws,
particularly in regard to taxation of its subsidiary in Puerto Rico, Year 2000
exposures and other risks involving the telecommunications industry generally.
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9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Six Months Ended June 30, 1999 Compared to
Six Months Ended June 30, 1998
Consolidated sales increased 64% to $56,404,000. Consolidated operating income
increased 7% to $5,340,000.
Suttle sales increased 6% to $29,977,000. Sales to customers in the United
States (U.S.) increased 7% to $28,745,000. Sales to the Big 6 telephone
companies (the five Regional Bell Operating Companies (RBOCs) and GTE) increased
16% to $18,785,000. Sales to these customers accounted for 63% of Suttle's
sales. Sales to distributors, original equipment manufacturers (OEMs), and
electrical contractors increased $211,000, or 3%. Sales to retail customers
decreased $670,000 or 29% due to decreased sales to Radio Shack, which is
Suttle's principal retail customer. Suttle's export sales, including sales to
Canada decreased 6% to $1,232,000.
The sales increases were mainly of Suttle's CorroShield and data products.
CorroShield product sales increased 40%, 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 conventional products declined 20% in the 1999 period. The
Company's sales of conventional voice products are also being hurt by price
competition from foreign manufacturers. Sales of data products increased 28%.
Sales of fiber-optic connector products decreased 27%.
Suttle's gross margins increased 14% to $10,608,000. Gross margin percentage
improved to 35.4% in 1999 from 33.1% 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. Selling,
general and administrative expenses declined $89,000 or 2%. 1998 expenses were
higher than normal due to a campaign to increase export sales and sales of data
products. Suttle's operating income increased $1,352,000 or 26%.
Austin Taylor's sales decreased 9% to $5,709,000. 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 13% to $1,093,000. Gross margin
as a percentage of sales was 19% compared to 20% in 1998. The decline in gross
margin was principally due to lower business volume. Selling, general and
administrative expenses decreased $2,000. Operating income decreased $156,000 or
27%.
The Company acquired Transition Networks, Inc. in December 1998. In April 1999,
the Company acquired LANart Corporation, which has been merged into Transition
Networks. The combined entities had sales of $16,730,000 and an operating loss
of $607,000 in the 1999 period. Expenses associated with closing LANart's sales
and marketing operations in Europe and transferring inventory and manufacturing
processes from Massachusetts to Minnesota were a significant cause of the
operating loss.
10
The Company acquired JDL Technologies, Inc. in August 1998. JDL had sales of
$3,988,000 in the 1999 period, an increase of 8% (on a pro forma basis) from
sales in the first six months of 1998. JDL had an operating loss of $136,000 in
1999 compared to a pro forma loss of $211,000 in 1998. Government funding delays
for new telecommunications infrastructure in the public schools negatively
affected JDL's performance in the first part of 1999. JDL earned a significant
portion of its revenues in the 1999 period from contracts to provide network
services and equipment to the U.S. Virgin Islands Department of Education and to
the Gary, Indiana public schools. CSI's corporate operating expenses were
$853,000 compared to $737,000 in the 1998 period.
Consolidated investment income, net of interest expense, decreased $685,000 due
to decreased levels of funds available for investment and interest expense on
notes payable associated with acquisitions. Income before income taxes decreased
$346,000 or 6%. The Company's effective income tax rate was 22.4% compared to
19.9% 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 decreased $416,000 or 9%.
Three Months Ended June 30, 1999 Compared to
Three Months Ended June 30, 1998
Consolidated sales increased 76% to $29,807,000. Consolidated operating income
decreased 23% to $2,078,000.
Suttle sales decreased $40,000 to $14,007,000. Sales to customers in the United
States (U.S.) decreased $16,000 to $13,361,000. Sales to the Big 6 telephone
companies (the five Regional Bell Operating Companies (RBOCs) and GTE) increased
5% to $8,776,000. Sales to these customers accounted for 63% of Suttle's sales.
Sales to distributors, original equipment manufacturers (OEMs), and electrical
contractors decreased $215,000, or 6%. Sales to retail customers decreased
$119,000 or 13% due to decreased sales to Radio Shack, which is Suttle's
principal retail customer. Suttle's export sales decreased 4% to $670,000.
Suttle's CorroShield and data product lines had solid sales increases in the
1999 three month period. Sales of data products increased 35%, reflecting
increased customer demand for high-speed data connections to internet service
providers. CorroShield product sales increased 47%, reflecting a return to more
normal buying patterns by the RBOCs, which are CorroShield's major customers.
CorroShield product sales are displacing sales of conventional voice connecting
products with RBOC customers. Sales of conventional voice products declined 36%
in the 1999 period. The Company's sales of conventional voice products are also
being hurt by price competition from foreign manufacturers. Sales of fiber-optic
connector products decreased 27%.
Suttle's gross margins increased 2% to $4,884,000. Gross margin percentage
improved to 34.9% in 1999 from 34.1% 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. Selling,
general and administrative expenses increased $199,000 or 10%. Suttle's
operating income decreased $112,000 or 4%.
11
Austin Taylor's sales decreased 1% to $2,901,000. The decrease was due to
reduced sales of CATV products caused by major reductions of cable television
construction activity in the U.K. Austin Taylor's gross margin declined 3% to
$537,000. Gross margin as a percentage of sales was 18.5% compared to 18.9% in
1998. The decline in gross margin was principally due to higher prices for
certain purchased parts. Selling, general and administrative expenses decreased
$19,000 or 5%. Operating income increased $2,000 or 1%.
The Company acquired Transition Networks, Inc. in December 1998. In April 1999,
the Company acquired LANart Corporation, which has been merged into Transition
Networks. The combined entities had sales of $9,964,000 and an operating loss of
$514,000 in the 1999 period. Expenses associated with closing LANart's sales and
marketing operations in Europe and transferring inventory and manufacturing
processes from Massachusetts to Minnesota were a significant cause of the
operating loss.
JDL Technologies, Inc had sales of $2,934,000 in the 1999 period, an increase of
$910,000 (on a pro forma basis) from sales in the second quarter of 1998. JDL
had operating income of $107,000 in 1999 compared to a pro forma loss of $37,000
in 1998. JDL earned a significant portion of its revenues in the 1999 period
from contracts to provide network services and equipment to the U.S. Virgin
Islands Department of Education and to the Gary, Indiana public schools. CSI's
corporate operating expenses in the second quarter were $457,000 compared to
$338,000 in the 1998 period.
Consolidated investment income, net of interest expense, decreased $278,000 due
to decreased levels of funds available for investment and interest expense on
notes payable associated with acquisitions. Income before income taxes decreased
$914,000 or 30%. The Company's effective income tax rate was 17.8% compared to
19.7% in 1998. Net income decreased $694,000 or 28%.
Liquidity and Capital Resources
At June 30, 1999, the Company had approximately $13,599,000 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 $30,123,000 and a current
ratio of 2.3 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 $6,446,000 in the first six
months of 1999 compared to $6,693,000 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. Depreciation and amortization
charges, which are noncash expenses, increased $1,093,000 due to amortization of
excess costs associated with the Company's acquisitions.
Investing activities utilized $10,366,000 of cash in the 1999 period. Cash
investments in new plant and equipment totaled $926,000, which was financed by
internal cash flows. The Company expects to spend $3,500,000 on capital
additions in 1999. The Company paid $3,984,000 (net of cash acquired) to
purchase LANart Corporation. The Company financed that acquisition using a
combination of internal funds and short-term borrowing from U.S. Bank.
Subsequent to the acquisition, the Company invested an additional $1,457,000 of
cash in LANart to pay acquired liabilities and provide working capital.
Short-term notes payable outstanding increased to $9,908,000 at June 30, 1999.
The Company expects to repay or refinance this debt in 1999. The Company also
invested $5,625,000 of cash held by its subsidiary in Puerto Rico in
intermediate term bank notes.
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Net cash used in financing activities was $2,844,000. The Company paid
$1,967,000 to purchase and retire 203,400 shares of its stock in open market
transactions during the 1999 period. Dividends paid on common stock increased to
$1,760,000. Proceeds from borrowings, net of repayments, were $830,000.
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 old 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 upgrade its
computer systems. The Company believes these systems are currently Y2K
compliant. Cost of 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, none of the Company's subsidiaries 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.
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. The Company's worst probable
Y2K related problem is the failure of third parties to provide necessary raw
material, manufacturing supplies, utilities or communications services. Failure
to receive needed materials or services could disrupt manufacturing systems and
delay shipments to customers. The Company expects to utilize multiple sources of
supply to meet any problems that arise. The Company does not expect production
to be materially affected by Y2K related production problems.
At the present time, the Company expects to handle 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.
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PART II. OTHER INFORMATION
Items 1 - 3. Not Applicable
Item 4. Submission of Matters to a Vote of Securities Holders The Annual Meeting
of the Shareholders of the Registrant was held on May 18, 1999 in Minneapolis,
MN. The total number of shares outstanding and entitled to vote at the meeting
was 8,811,144 of which 8,181,525 were present either in person or by proxy.
Shareholders re-elected board members Edwin C. Freeman, Luella Gross Goldberg
and Edward E. Strickland to three-year terms expiring at the 2002 Annual Meeting
of Shareholders. The vote for these board members was as follows:
In Favor Abstaining
Edwin C. Freeman 8,149,950 31,575
Luella Gross Goldberg 8,147,845 33,680
Edward E. Strickland 8,149,625 31,900
John C. Ortman has retired and did not seek re-election to the board of
directors.
Board members continuing in office are Paul J. Anderson, Wayne E. Sampson and
Frederick M. Green (whose terms expire at the 2000 Annual Meeting of
Shareholders) and Curtis A. Sampson, Joseph W. Parris and Gerald D. Pint (whose
terms expire at the 2001 Annual Meeting of Shareholders).
Shareholders also approved amendments to increase the number of shares
authorized to be issued under the Company's 1992 Stock Plan by 500,000 shares to
1,900,000 shares; and to amend the Company's 1990 Stock Option Plan for
Nonemployee Directors to increase the stock options automatically granted each
year to non-employee directors from 2,000 to 3,000 shares. The vote on these
amendments was as follows:
In Favor Opposed Abstaining Not Voting
1992 Stock Plan Amendment 5,885,184 1,240,610 168,889 886,842
Nonemployee Director Stock Options 7,585,335 411,293 184,897
Items 5 - 6. Not Applicable
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Communications Systems, Inc.
By /s/ Paul N. Hanson
------------------------------
Paul N. Hanson
Vice President and
Chief Financial Officer
Date: August 13, 1999
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