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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2002
-------------------------------------------------
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
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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
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 October 31, 2002
- --------------------------------------- --------------------------------
Common Stock, par value $.05 per share 8,155,821
Total Pages (17)
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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 (loss)
and Comprehensive Income (loss) 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 11
Item 3. Quantitative and Qualitative Disclosures
about Market Risk 14
Item 4. Controls and Procedures 15
Part II. Other Information 15
SIGNATURES
CERTIFICATIONS
2
PART I. FINANCIAL INFORMATION
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
September 30 December 31
2002 2001
------------ ------------
Assets:
Current assets:
Cash $ 21,806,653 $ 22,239,883
Trade receivables, net 19,407,501 19,182,828
Inventories 27,621,876 24,931,739
Note Receivable 2,765,390
Deferred income taxes 2,716,405 2,176,405
Other current assets 670,528 556,906
------------ ------------
Total current assets 72,222,963 71,853,151
Property, plant and equipment 34,641,152 32,955,036
less accumulated depreciation (27,057,579) (24,818,363)
------------ ------------
Net property, plant and equipment 7,583,573 8,136,673
Other assets:
Excess of cost over net assets acquired 5,290,725 4,638,068
Deferred income taxes 3,070,027 3,070,027
Other assets 338,036 313,884
------------ ------------
Total other assets 8,698,788 8,021,979
------------ ------------
Total Assets $ 88,505,324 $ 88,011,803
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable $ 7,000,000 $ 9,000,000
Accounts payable 5,352,958 5,567,390
Accrued expenses 5,186,244 3,890,113
Deferred revenue 522,583
Income taxes payable 2,346,672 2,246,299
------------ ------------
Total current liabilities 20,408,457 20,703,802
Stockholders' Equity 68,096,867 67,308,001
------------ ------------
Total Liabilities and Stockholders' Equity $ 88,505,324 $ 88,011,803
============ ============
See notes to consolidated financial statements.
3
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
(unaudited)
Three Months Ended September 30 Nine Months Ended September 30
------------------------------- -------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Sales $ 28,987,379 $ 23,073,751 $ 80,082,308 $ 71,849,561
Costs and expenses:
Cost of sales 19,834,897 17,464,144 59,918,509 52,649,728
Selling, general and
administrative expenses 6,384,016 6,100,458 18,273,034 19,109,437
------------ ------------ ------------ ------------
Total costs and expenses 26,218,913 23,564,602 78,191,543 71,759,165
------------ ------------ ------------ ------------
Operating income (loss) 2,768,466 (490,851) 1,890,765 90,396
Other income and (expenses):
Investment income 30,601 153,268 161,035 622,771
Interest expense (73,791) (128,742) (223,884) (469,530)
------------ ------------ ------------ ------------
Other income, (expense) net (43,190) 24,526 (62,849) 153,241
Income (loss) before income taxes 2,725,276 (466,325) 1,827,916 243,637
Income taxes (benefit) 1,055,000 (270,000) 730,000 (60,000)
------------ ------------ ------------ ------------
Net income (loss) 1,670,276 (196,325) 1,097,916 303,637
------------ ------------ ------------ ------------
Other comprehensive income (loss):
Foreign currency
translation adjustment 60,103 170,311 256,435 (11,636)
------------ ------------ ------------ ------------
Comprehensive income (loss) $ 1,730,379 $ (26,014) $ 1,354,351 $ 292,001
============ ============ ============ ============
Basic net income (loss) per share $ .20 $ (.02) $ .13 $ .04
Diluted net income (loss) per share $ .20 $ (.02) $ .13 $ .04
Average Basic Shares Outstanding 8,261,819 8,365,133 8,275,912 8,396,236
Average Dilutive Shares Outstanding 8,262,130 8,365,581 8,278,178 8,399,272
See notes to consolidated financial statements.
4
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(unaudited)
Cumulative
Common Stock Additional Other
--------------------- Paid-in Retained Comprehensive
Shares Amount Capital Earnings Income (Loss) Total
--------- --------- ----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 2000 8,616,909 $ 430,846 $ 28,877,135 $ 42,309,918 $ (350,971) $ 71,266,928
Net income 712,249 712,249
Issuance of common stock under
Employee Stock Purchase Plan 15,657 783 82,363 83,146
Issuance of common stock to
Employee Stock Ownership Plan 25,000 1,250 219,075 220,325
Purchase of stock (395,252) (19,763) (1,323,044) (1,885,563) (3,228,370)
Shareholder dividends (1,673,467) (1,673,467)
Other comprehensive loss (72,810) (72,810)
--------- --------- ----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 2001 8,262,314 413,116 27,855,529 39,463,137 (423,781) 67,308,001
Net income 1,097,916 1,097,916
Issuance of common stock under
Employee Stock Purchase Plan 36,276 1,814 188,744 190,558
Issuance of common stock to
Employee Stock Ownership Plan 25,000 1,250 187,250 188,500
Issuance of common stock under
Employee Stock Option Plan 1,700 85 11,645 11,730
Purchase of stock (149,346) (7,468) (505,451) (443,354) (956,273)
Other comprehensive income 256,435 256,435
--------- --------- ----------- ----------- ----------- -----------
BALANCE AT SEPTEMBER 30, 2002 8,175,944 $ 408,797 $ 27,737,717 $ 40,117,699 $ (167,346) $ 68,096,867
========= ========= =========== =========== =========== ===========
See notes to consolidated financial statements.
5
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended September 30
---------------------------------
2002 2001
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,097,916 $ 303,637
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 2,143,429 3,808,018
Changes in assets and liabilities net of
effects of the purchase of MiLAN Technology
Corporation:
Trade receivables 2,425,285 4,881,125
Inventories 2,541,480 1,698,856
Other current assets (652,852) (22,639)
Accounts payable (305,651) (220,822)
Accrued expenses and deferred revenue 1,730,523 16,841
Income taxes payable 100,217 (508,268)
------------ ------------
Net cash provided by operating activities 9,080,347 9,956,748
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,255,950) (926,420)
Maturities of mortgage-backed and other
investment securities 5,883,247
Other assets (65,498) (16,033)
Collection of notes receivable 2,765,390 200,000
Payment for purchase of MiLAN Technology Corporation (8,058,932)
------------ ------------
Net cash (used in) provided by investing activities (6,614,990) 5,140,794
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable (2,000,000) (101,438)
Dividends paid (2,554,058)
Proceeds from issuance of stock 11,730 83,146
Repurchase of stock (956,273) (3,160,507)
------------ ------------
Net cash used in financing activities (2,944,543) (5,732,857)
------------ ------------
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH 45,956 38,770
------------ ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (433,230) 9,403,455
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 22,239,883 11,321,374
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 21,806,653 $ 20,724,829
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 711,554 $ 451,872
Interest paid 293,408 454,746
See notes to consolidated financial statements.
6
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - CONSOLIDATED FINANCIAL STATEMENTS
Unless the context otherwise specifies, the use of the terms the "Company" and
"CSI" in the following refers to Communications Systems, Inc. and Subsidiaries.
The balance sheet and statement of changes in stockholders' equity as of
September 30, 2002, the statements of income (loss) and comprehensive income
(loss) for the three and nine-month periods ended September 30, 2002 and 2001
and the statements of cash flows for the nine-month periods ended September 30,
2002 and 2001 have been prepared by the Company without audit. In the opinion of
management, all adjustments (which include only normal recurring adjustments)
necessary to present fairly the financial position, results of operations, and
cash flows at September 30, 2002 and 2001 and for the nine months then ended
have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America 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, 2001 Annual
Report to Shareholders. The results of operations for the periods ended
September 30 are not necessarily indicative of the operating results for the
entire year.
In February 2002, the Company issued 25,000 shares of the Company's common stock
to the Employee Stock Ownership Plan in payment of its 2001 obligation. In a
noncash transaction, the Company recorded additional stockholders' equity of
$188,500 (reflecting the market value of the stock at the time of the
contribution) and reduced accrued expenses by the same amount.
NOTE 2 - NET INCOME PER SHARE
Basic net income (loss) per common share is based on the weighted average number
of common shares outstanding during each year. Diluted net income (loss) 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 - ACQUISITIONS
Effective March 25, 2002 the Company acquired substantially all of the assets
and assumed certain liabilities of Digi International Inc.'s MiLAN legacy
business. The business has been reincorporated as MiLAN Technology Corporation.
Located in Sunnyvale, California, MiLAN is a growing provider of leading edge
wireless telecommunications products for businesses and residences, managed and
unmanaged LAN switches, media conversion products and print servers. The Company
expects the MiLAN acquisition will be both complementary and supplementary to
its Transition Networks business by increasing the product offerings and
expanding the customer bases of both business units. The pro forma effects of
the MiLAN acquisition on our condensed consolidated financial statements were
not material.
7
The operations of MiLAN are included in the Company's financial results from the
purchase date. In the acquisition, the estimated fair value of the following
assets were acquired and liabilities assumed:
Accounts receivable $ 2,426,713
Inventory 5,121,936
Plant and equipment 234,971
Excess of cost over net assets acquired 910,170
Accrued expenses (566,039)
-----------
Total purchase price $ 8,127,751
===========
The Company believes the excess of cost over net assets acquired in this
transaction has an indefinite useful life and is not subject to amortization.
NOTE 4 - INVENTORIES
Inventories summarized below are priced at the lower of first-in, first-out cost
or market:
September 30 December 31
2002 2001
------------ ------------
Finished Goods $ 15,809,624 $ 15,821,487
Raw Materials 11,812,252 9,110,252
------------ ------------
Total $ 27,621,876 $ 24,931,739
============ ============
NOTE 5 - OTHER ASSETS
Effective January 1, 2002, the company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS 142
provides a new methodology for evaluating goodwill impairment. While we have not
yet completed the necessary calculations, we anticipate that upon adoption the
methodology prescribed by SFAS 142 for evaluating and measuring the impairment
of goodwill will result in a goodwill impairment charge for Suttle Apparatus
which had $1,250,000 of goodwill at September 30, 2002. Once the calculations
are finalized, any charge will be reported as a cumulative effect of change in
accounting principle against first quarter 2002 earnings. We will assess, on at
least an annual basis, whether our goodwill carrying value has incurred
additional impairment. Amortization of intangible assets that the Company
determines to have finite useful lives will continue. Amortization expense for
those assets will be approximately $33,400 annually.
The following table summarizes operating and net (loss) income for the nine
months ended September 30,
2002 and 2001, and pro forma amounts for 2001 excluding amortization expense
recognized in that period related to goodwill.
Nine Months Ended September 30
2002 2001 2001 Pro forma
------------ ------------- --------------
Sales $ 80,082,308 $ 71,849,561 $ 71,849,561
Gross Margin 20,163,799 19,199,833 19,199,833
Operating Income 1,890,765 90,396 1,644,012
Income Before Income Taxes 1,827,916 243,637 1,797,253
Income Taxes (Benefit) 730,000 (60,000) 540,000
Net Income 1,097,916 303,637 1,257,253
Basic Net Income Per Share $ .13 $ .04 $ .15
Diluted Net Income Per Share $ .13 $ .04 $ .15
Average Shares Outstanding:
Average Common Shares Outstanding 8,275,912 8,396,236 8,396,236
Dilutive Effect of Stock Options Outstanding 2,266 3,036 3,036
------------ ------------- -------------
8,278,178 8,399,272 8,399,272
============ ============= =============
8
NOTE 6 - SEGMENT INFORMATION
The Company classifies its businesses into four 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 central office frames; Transition Networks and MiLAN Technology
(substantially all assets of MiLAN purchased March 25, 2002), which designs and
markets data transmission, computer network and media conversion products and
print servers; and JDL Technologies (JDL) which provides telecommunications
network design, specification and training services to educational institutions.
Information concerning the Company's operations in the various segments for the
nine-month periods ended September 30, 2002 and 2001 is as follows:
Austin Transition JDL
Suttle Taylor Networks Technologies Corporate Consolidated
-------------------------------------------------------------------------------------------------
Nine Months Ended September 30, 2002:
Sales $ 24,791,892 $ 5,275,311 $ 34,709,446 $15,305,659 $ - $ 80,082,308
Cost of sales 21,756,189 4,761,366 22,703,131 10,697,823 59,918,509
-------------------------------------------------------------------------------------------------
Gross profit 3,035,703 513,945 12,006,315 4,607,836 - 20,163,799
Selling, general and
administrative expenses 4,831,978 792,998 8,790,535 2,683,171 1,174,352 18,273,034
-------------------------------------------------------------------------------------------------
Operating income (loss) $ (1,796,275) $ (279,053) $ 3,215,780 $ 1,924,665 $(1,174,352) $ 1,890,765
=================================================================================================
Depreciation and amortization $ 1,405,215 $ 353,390 $ 222,824 $ 90,000 $ 72,000 $ 2,143,429
=================================================================================================
Capital expenditures $ 347,317 $ 221,983 $ 548,222 $ 25,962 $ 112,466 $ 1,255,950
=================================================================================================
Assets $ 44,649,479 $ 5,498,067 $ 25,226,784 $ 6,164,898 $ 6,966,096 $ 88,505,324
=================================================================================================
Nine Months Ended Sept. 30, 2001:
Revenues $ 30,953,843 $ 7,644,306 $ 26,360,158 $ 6,891,254 $ 71,849,561
Cost of sales 24,998,427 6,968,203 16,532,938 4,150,160 52,649,728
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Gross profit 5,955,416 676,103 9,827,220 2,741,094 19,199,833
Selling, general and
administrative expenses 5,241,545 1,150,222 7,443,915 2,357,796 $ 2,915,959 19,109,437
Goodwill amortization 229,869 43,749 977,914 333,414 (1,584,946) 0
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Operating income (loss) $ 484,002 $ (517,868) $ 1,405,391 $ 49,884 $(1,331,013) $ 90,396
=================================================================================================
Depreciation and amortization $ 1,637,694 $ 429,235 $ 1,228,638 $ 423,414 $ 89,037 $ 3,808,018
=================================================================================================
Capital expenditures $ 556,055 $ - $ 72,190 $ 88,548 $ 209,627 $ 926,420
=================================================================================================
Assets $ 47,814,338 $ 5,906,433 $ 19,164,532 $ 5,921,272 $ 8,216,339 $ 87,022,914
=================================================================================================
9
Information concerning the Company's operations in the various segments for the
three-month periods ended September 30, 2002 and 2001 is as follows:
Austin Transition JDL
Suttle Taylor Networks Technologies Corporate Consolidated
-------------------------------------------------------------------------------------------------
Three Months Ended September 30, 2002:
Revenues $ 7,976,820 $ 1,573,760 $ 14,417,467 $ 5,019,332 $ - $ 28,987,379
Cost of sales 6,275,091 1,476,269 8,803,341 3,280,196 19,834,897
-------------------------------------------------------------------------------------------------
Gross profit 1,701,729 97,491 5,614,126 1,739,136 9,152,482
Selling, general and
administrative expenses 1,515,541 327,997 3,303,732 905,775 330,971 6,384,016
-------------------------------------------------------------------------------------------------
Operating income (loss) $ 186,188 $ (230,506) $ 2,310,394 $ 833,361 $ (330,971) $ 2,768,466
=================================================================================================
Depreciation and amortization $ 323,710 $ 121,029 $ 73,946 $ 30,000 $ 24,000 $ 572,685
=================================================================================================
Capital expenditures $ (75,451) $ 206,797 $ 72,909 $ 27,424 $ 88,531 $ 320,210
=================================================================================================
Three Months Ended Sept. 30, 2001:
Revenues $ 10,116,147 $ 1,847,280 $ 8,985,956 $ 2,124,368 $ 23,073,751
Cost of sales 8,116,802 2,022,488 5,832,648 1,492,206 17,464,144
-------------------------------------------------------------------------------------------------
Gross profit 1,999,345 (175,208) 3,153,308 632,162 5,609,607
Selling, general and
administrative expenses 1,684,442 368,896 2,426,356 732,283 $ 888,481 6,100,458
Goodwill amortization 86,345 14,580 337,140 111,137 (549,202) 0
-------------------------------------------------------------------------------------------------
Operating income (loss) $ 228,558 $ (558,684) $ 389,812 $ (211,258) $ (339,279) $ (490,851)
=================================================================================================
Depreciation and amortization $ 489,421 $ 121,053 $ 409,214 $ 141,137 $ 29,678 $ 1,190,503
=================================================================================================
Capital expenditures $ 162,289 $ - $ 25,403 $ 19,958 $ 25,253 $ 232,903
=================================================================================================
NOTE 7 - INCOME TAXES
Income taxes are computed based upon the estimated effective rate applicable to
operating results for the full fiscal year.
- --------------------------------------------------------------------------------
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.
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10
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
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Nine Months Ended September 30, 2002 Compared to
Nine Months Ended September 30, 2001
Consolidated sales increased 11% to $80,082,000 in 2002. Consolidated operating
income increased from $90,400 to $1,890,000 in 2002. Nine month sales included a
$ 6,373,000 sales contribution from the MiLAN business unit which was acquired
in this year's first quarter.
On March 25, 2002 the Company acquired substantially all the assets of MiLAN
Technology from Digi International (NASDAQ: DGII) in an all cash transaction
valued at approximately $8,100,000. MiLAN is a growing provider of wireless
telecommunications products, LAN switches, media conversion products and print
servers. The Company continues to streamline MiLAN's cost structure and
consolidate certain functions with other operating business units of CSI during
2002.
Suttle sales decreased 20% to $24,792,000 in 2002 compared to $30,954,000 in the
nine-month period in 2001. Sales to the major telephone companies decreased
$3,255,000 or 22% for the nine-month period. Sales to these customers accounted
for 47% of Suttle's sales. Sales to distributors, original equipment
manufacturers (OEMs), and electrical contractors decreased $4,680,000, or 35%.
Sales to retail customers increased $925,000 or 69% in 2002. Suttle's export
sales, including sales to Canada, increased 120% to $1,537,000.
Suttle's sales declines are attributable to the continuing slowdown in capital
spending by telecommunications industry companies and in particular the Regional
Bell Operating Company (RBOC) customers. Suttle has implemented a strategy to
utilize offshore manufacturing for data products as well as implementing a
telesales group to sell voice and data products to the nation's thousands of
telecom and electrical installation companies.
Suttle's gross margins decreased 49% to $3,036,000 in 2002 compared to
$5,955,000 in 2001. Suttle recorded a write down of excess and slow-moving
inventory in the second quarter in the amount of $1,500,000, which resulted in a
9% reduction in gross margin in the second quarter. Gross margin as a percentage
of sales declined to 12% in 2002 from 19% in 2001. The decline in gross margin
was also due to price cutting to meet competition and from the effect of excess
manufacturing overhead costs relative to lower volumes. Suttle's operating
income decreased $2,510,000 in 2002 compared to 2001 before goodwill
amortization. Suttle has implemented cost reduction measures, including 15%
workforce reductions at its plants in Minnesota, Puerto Rico and Costa Rica.
Suttle is also beginning to utilize offshore manufacturing arrangements in the
Pacific Rim to strengthen the competitive position of traditional products and
the DSL line filter business.
Austin Taylor's sales decreased 31% to $5,275,000 in 2002 compared to $7,644,000
in 2001. Austin Taylor's gross margin declined 24% to $514,000 in 2002. Gross
margin as a percentage of sales in 2002 was 10% compared to 9% in 2001. The
decline in gross margin was principally due to increased pricing competition and
lower business volumes. Selling, general and administrative expenses decreased
by $357,000 due to cost reduction measures implemented. The operating loss
decreased $239,000 to a reported loss of $279,000 in 2002 compared to the
operating loss through nine months in 2001 of $474,000 before goodwill
amortization.
11
Transition Networks / MiLAN Technology segment sales increased by 32% to
$34,709,000 in the first nine months of 2002 compared to $26,360,000 in the same
period in 2001. Sales for this segment include a $6,373,000 contribution from
MiLAN Technology, which CSI purchased substantially all the assets from Digi
International on March 25, 2002. Transition Networks sales were $28,336,000 in
2002 compared to $26,360,000 in the 2001 nine month period. The demand for media
conversion and related products has remained strong in 2002 and is expected to
remain strong throughout 2002. Gross margin increased to $12,006,000 in 2002
from $9,827,000 in 2001. Gross margin as a percentage of sales was 35% in 2002
compared to 37% in 2001. Gross margins were adversely affected by the sale of
the MiLAN acquired inventory, which had lower margins. Selling, general and
administrative expenses increased to $8,791,000 in 2002 compared to $7,444,000
in 2001. The increase was due to planned integration expenses related to the
MiLAN acquisition. Selling, general and administrative expenses as a percentage
of sales were 25% in 2002 and 28% in 2001. Operating income increased to
$3,216,000 compared to $2,383,000 before goodwill amortization in 2001.
Sales by JDL Technologies, Inc. increased to $15,306,000 in 2002 from $6,891,000
in 2001. The increase was due to sales of hardware purchases and services to
plan, design, implement and manage network data systems for several large school
districts. Gross margin in 2002 increased to $4,608,000 compared to $2,741,000
in 2001. Gross margin as a percentage of sales decreased to 30% from 40% in the
2001 period. Higher sales of lower margin hardware were the principal factor in
a lower gross margin percentage in 2002. Selling, general and administrative
expenses increased $325,000, or 14% in 2002. JDL's operating income was
$1,925,000 in 2002 compared to operating income of $383,000 before goodwill
amortization in the 2001 period.
Consolidated investment income decreased $462,000 due to lower earnings on
invested funds and collection of the balance of a note receivable and accrued
interest in the first quarter related to the sale of assets of discontinued
operations. Interest expense decreased by $246,000 in 2002 compared to 2001 due
to a decrease in borrowings on the line of credit and lower interest rates.
Income before income taxes increased by $1,584,000 to $1,828,000 in 2002. The
Company's effective income tax rate is 40% in 2002 compared to 24% in 2001. This
is due to higher U.S. income, which is taxed at a higher rate, and lower income
in Puerto Rico, which was taxed at a lower rate. Also, the Company received
higher dividends from Puerto Rico in 2002 which are subject to a toll gate tax
of 1.75%. Net income increased $794,000 to $1,098,000 in 2002. 2001 pro forma
net income for the nine months ended September 30, 2001 excluding goodwill
amortization would have been $1,257,000.
Three Months Ended September 30, 2002 Compared to
Three Months Ended September 30, 2001
Consolidated sales increased 26% to $28,987,000 in 2002. Consolidated operating
income increased to $2,768,000 from a loss of $491,000 in the 2001 period. Third
quarter sales included a $ 3,444,000 sales contribution from the MiLAN business
unit which was acquired in this year's first quarter.
Suttle sales decreased 21% to $7,977,000 in the 2002 period compared to
$10,116,000 in 2001. Sales to the major telephone companies increased $1,366,000
to $4,060,000 in 2002. Sales to these customers accounted for 51% of Suttle's
sales. Sales to distributors, original equipment manufacturers (OEMs), and
electrical contractors decreased $3,274,000 in 2002. Suttle's export sales
remained constant at $264,000 in 2002.
12
Suttle's gross margins decreased 15% to $1,702,000 in 2002. The decline in gross
margin was due primarily to price cutting to meet competition and excess factory
overhead costs relative to lower volumes. Gross margin as a percentage of sales
increased in 2002 to 21% compared to 20% in 2001. Suttle had operating income of
$186,000 in the three-month period in 2002 compared to operating income of
$315,000 in the same period in 2001 before goodwill amortization.
Austin Taylor's sales decreased 15% to $1,574,000 in the 2002 period compared to
$1,847,000 in 2001. Austin Taylor's gross margin increased by $273,000 compared
to the 2001 period. Gross margin as a percentage of sales was 6% in 2002
compared to a negative 9% in 2001. Selling, general and administrative expenses
decreased $41,000 in 2002 due to increased cost control efforts. The operating
loss decreased to $231,000 compared to the operating loss of $544,000 (before
goodwill amortization) in the 2001 third quarter.
Transition Networks / MiLAN Technology segment sales increased by 60% to
$14,417,000 in the third quarter of 2002 compared to $8,986,000 in the same
period in 2001. Sales for this segment include sales from MiLAN Technology,
which CSI purchased substantially all the assets from Digi International on
March 25, 2002. MiLAN sales in the third quarter were $3,444,000. Transition
Networks third quarter sales were $10,973,000 in 2002 compared to $8,986,000 in
the 2001 three-month period. Segment gross margin increased to $5,614,000 in
2002 from $3,153,000 in 2001. Gross margin as a percentage of sales was 39% in
2002 compared to 35% in 2001. Selling, general and administrative expenses
increased to $3,304,000 in 2002 compared to $2,426,000 in 2001. The increase was
due to planned integration expenses related to the MiLAN acquisition and higher
selling and marketing costs. Operating income increased to $2,310,000 compared
to $727,000 before goodwill amortization in 2001.
Sales by JDL Technologies, Inc. increased by $2,895,000 to $5,019,000 in 2002.
JDL's gross margin increased $1,107,000 to $1,739,000 in 2002 due to increased
sales of hardware and services. Gross margin as a percentage of sales increased
to 35% from 30% in the 2001 period. Selling, general and administrative expenses
increased $173,000, or 24% in 2002. JDL's operating income was $833,000 compared
to $100,000 before goodwill amortization in the 2001 period.
Consolidated investment income decreased $123,000 due to lower earnings on
invested funds and collection of the balance of a note receivable and accrued
interest in the first quarter related to the sale of assets of discontinued
operations. Interest expense decreased by $55,000 in 2002 compared to 2001 due
to a decrease in borrowings on the line of credit and lower interest rates.
Income before income taxes increased to $2,725,000 compare to a loss of $466,000
in the 2001 third quarter. The Company's effective income tax rate was 39% in
2002. 2001 pro forma net income for the three months ended September 30, 2001
excluding goodwill amortization would have been $36,000.
Liquidity and Capital Resources
At September 30, 2002, the Company had approximately $21,807,000 of cash and
cash equivalents compared to $22,240,000 of cash and cash equivalents at
December 31, 2001. The Company had working capital of approximately $51,815,000
and a current ratio of 3.5 to 1 compared to working capital of $51,149,000 and a
current ratio of 3.5 to 1 at the end of 2001.
13
The Company had operating cash flows of $9,080,000 in the first nine months of
2002 compared to cash flows of $9,957,000 in the same period in 2001. The
decrease in cash flows from operations is due primarily to a reduction in
depreciation and amortization as, upon adoption of SFAS 142, the Company stopped
amortizing goodwill effective January 1, 2002. The Company has adjusted the
business plans of all operations in order to conserve cash and reduce excess
inventory and accounts receivable levels.
Investing activities used $6,615,000 of cash in the 2002 nine-month period. The
Company acquired substantially all of the assets of MiLAN Technology on March
25, 2002 for approximately $8,058,000 in cash. Also in the first quarter of
2002, the Company received the balance of $2,765,000 of the note receivable
related to the sale of assets of a previously discontinued business unit. Cash
investments in new plant and equipment totaled $1,256,000, which was financed by
internal cash flows. The Company expects to spend an additional $250,000 on
capital additions in 2002.
Net cash used in financing activities was $2,945,000 for the first nine months
of 2002. The Company reduced its notes payable by $2,000,000 in the second
quarter of 2002. Notes payable were $7,000,000 at September 30, 2002 compared to
$9,000,000 at December 31, 2001. The Company purchased and retired 149,346
shares of its stock in open market transactions during the 2002 period. At
September 30, 2002 Board authorizations are outstanding to purchase an
additional 79,087 shares.
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.
Critical Accounting Policies
Our critical accounting policies, including the assumptions and judgements
underlying them, are discussed in our 2001 Form 10-K in Note 1 Summary of
Significant Accounting Policies included in our Consolidated Financial
Statements. These policies have been consistently applied in all material
respects and disclose such matters as revenue recognition, investment valuation,
asset impairment recognition and foreign currency translation. On an ongoing
basis, we evaluate our estimates, including those related to reserves for
inventory writedowns, uncollectable receivables and sales returns. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the result of which form the
basis for making judgements about the carrying value of assets and liabilities
that are not readily apparent from other sources. Results may differ from these
estimates due to actual outcomes being different from those on which we based
our assumptions. Management on an ongoing basis reviews these estimates and
judgements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
- --------------------------------------------------------------------
The Company has no freestanding or embedded derivatives. All contracts that
contain provisions meeting the definition of a derivative also meet the
requirements of, and have been designated as normal purchases or sales. The
Company's policy is to not use freestanding derivatives and to not enter into
contracts with terms that cannot be designated as normal purchases or sales.
14
The vast majority of our transactions are denominated in U.S. dollars; as such,
fluctuations in foreign currency exchange rates have historically not been
material to the Company. At September 30, 2002 our bank line of credit carried a
variable interest rate based on the London Interbank Offered Rate (Libor) plus
2%. The Company's investments are money market type of investments that earn
interest at prevailing market rates and as such do not have material risk
exposure.
Based on the Company's operations, in the opinion of management, no material
future losses or exposure exist relative to market risk.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
The Company's Chief Executive Officer, Curtis A. Sampson, and Chief Financial
Officer, Paul N. Hanson have reviewed the Company's disclosure controls and
procedures within 90 days prior to the filing of this report. Based upon this
review, these officers believe that the Company's disclosure controls and
procedures are effective in ensuring that material information related to the
Company is made known to them by others within the Company.
(b) Changes in Internal Controls.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation.
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/ Curtis A. Sampson
----------------------------
Curtis A. Sampson
Date: November 14, 2002 Chairman and
Chief Executive Officer
/s/ Paul N. Hanson
----------------------------
Date: November 14, 2002 Paul N. Hanson
Vice President and
Chief Financial Officer
15
CERTIFICATIONS
I, Curtis A. Sampson certify that:
1. I have reviewed this quarterly report on Form 10-Q of Communications Systems,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
By /s/ Curtis A. Sampson
----------------------------
Curtis A. Sampson
Date: November 14, 2002 Chairman and
Chief Executive Officer
I, Paul N. Hanson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Communications Systems,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
16
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
By /s/ Paul N. Hanson
----------------------------
Paul N. Hanson
Date: November 14, 2002 Vice President and
Chief Financial Officer
CERTIFICATION
The undersigned certify pursuant to 18 U.S.C.ss.1350, that:
(1) The accompanying Quarterly Report on Form 10-Q for the period ended
September 30, 2002 , fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the accompanying Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
By /s/ Curtis A. Sampson
----------------------------
Curtis A. Sampson
Date: November 14, 2002 Chairman and
Chief Executive Officer
By /s/ Paul N. Hanson
----------------------------
Paul N. Hanson
Date: November 14, 2002 Vice President and
Chief Financial Officer
17