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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission File Number: 001-31588
COMMUNICATIONS SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Minnesota 41-0957999
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(State or other jurisdiction (Federal Employer
of incorporation or organization) Identification No.)
213 South Main Street
Hector, MN 55342
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (320) 848-6231
Securities registered pursuant to Section 12(b) of the Act (effective January
27, 2003):
Title of each class Name of each exchange on which registered
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Common Stock, $.05 par value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES [ ] NO [X]
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the Registrant (shareholders other than officers and
directors) was approximately $53,062,000 based upon the closing sale price of
the Company's common stock on the American Stock Exchange ("AMEX") on June 30,
2004.
As of March 15, 2005 there were outstanding 8,535,926 shares of the Registrant's
common stock.
Documents Incorporated by Reference: Portions of the Company's Proxy Statement
for its Annual Meeting of Shareholders to be held on May 24, 2005 are
incorporated by reference into Part III of this Form 10-K.
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PART I
ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
Communications Systems, Inc. (herein collectively called "CSI", "our" or the
"Company") is a Minnesota corporation organized in 1969 which operates directly
and through its subsidiaries located in the United States, Costa Rica and the
United Kingdom. CSI is principally engaged in the manufacture and sale of
modular connecting and wiring devices for voice and data communications, digital
subscriber line filters, structured wiring systems and the manufacture of media
and rate conversion products for telecommunications networks. CSI also provides
network design, training services, general contracting of infrastructure
installations, provisioning of high-speed internet access and maintenance
support of network operation centers for K-12 schools.
In 2002, the Company acquired through a newly formed subsidiary, MiLAN
Technology Corporation, substantially all the assets of the MiLAN division of
Digi International Inc. for approximately $8,100,000 in cash. MiLAN, located in
Sunnyvale, California, is a manufacturer of media and rate conversion products,
which permit telecommunications networks to move information between
copper-wired equipment and fiber-optic cable. In addition, MiLAN is also a
supplier of wireless access points, bridges and other networking products. The
acquisition was accounted for as a purchase and operations of MiLAN have been
included in consolidated operations from March 25, 2002.
Effective March 24, 2004, the Company acquired substantially all the outstanding
shares of Image Systems Corporation for a cash purchase price per share of
approximately $2.8 million. Image Systems Corporation (Image Systems), located
in Minnetonka, Minnesota designs, manufactures and markets high-resolution
display solutions and accessories for customers in the medical imaging market or
for other customers who have stringent and or unique display requirements. In
addition, Image Systems has been a premier developer of video graphics products
since 1988. The proforma effects of the Image Systems Corporation acquisition on
our consolidated financial statements were not material to the Company's
consolidated financial statements. The acquisition and operations of Image
Systems are included in the Company's consolidated financial results from the
purchase date, March 24, 2004.
Additional information on these acquisitions can be found in subparagraphs
(c)(1)(ii), (c)(1)(iii) and (c)(1)(iv) under Item 1 herein, in "Acquisitions and
Dispositions" under Item 7, Management's Discussion and Analysis and in Note 8
of Notes to Consolidated Financial Statements under Item 8, herein.
The Company maintains a website at www.commsystems.com. Our annual reports on
Form 10-K, our quarterly reports on Form 10-Q and our periodic reports on Form
8-K (and any amendments to these reports) are available free of charge by
linking from our website to the Securities & Exchange Commission website.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company classifies its businesses into five 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/ MiLAN
Technology, subsidiaries that design and market 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; Other which principally consist
of Image Systems Corporation, (high-resolution display solutions and accessories
for customers in the medical imaging market) and non-allocated corporate general
and administrative expenses. Further information regarding operations in the
various segments is set forth in Note 10 of the Notes to Consolidated Financial
Statements under Item 8, herein.
2
(c) NARRATIVE DESCRIPTION OF BUSINESS
(1) Information Regarding Business Segments
(i) Suttle
Suttle manufactures and markets connectors and wiring devices for voice, data
and video communications under the "Suttle" brand name in the United States
(U.S.) and internationally. Suttle also manufactures a line of high performance
fiber-optic connectors, interconnect devices and fiber cable assemblies for the
telecommunications, computer and electronics markets. Substantially all of
Suttle's products are manufactured at its plants in Hector, Minnesota (Suttle
Apparatus Minnesota Division), and San Jose, Costa Rica (Suttle Costa Rica,
S.A.). Certain products are purchased from offshore contract manufacturers from
offshore sources. Segment sales were $40,114,000 in 2004, or 36% of consolidated
revenues and $32,900,000 in 2003, or 32% of consolidated revenues.
Products
Suttle's products are used in on-premise connection of telephones, data
terminals and related equipment. The product line consists primarily of modular
connecting devices and includes numerous types of jacks, connecting blocks and
assemblies, adapters, cords and related equipment, which are offered in a
variety of colors, styles and wiring configurations. Most of the products are
used in voice applications, but Suttle continues to develop an expanding line of
products for data network applications. A significant portion of Suttle's
revenues is derived from sales of a line of corrosion-resistant connectors,
which utilize a water-resistant gel to offer superior performance in harsh
environments. Station apparatus products generally range in price from $0.70 to
$25.00 per unit. A majority of Suttle's sales volume, both in units and
revenues, is derived from products selling for under $5.00 per unit.
Suttle produces high performance fiber-optic connectors, interconnect devices
and fiber cable assemblies that are used in high-speed fiber-optic networks and
local area network connections. Suttle's patented Quick Term TM fiber optic
connector significantly reduces installation time and costs associated with
making fiber connections. By eliminating the need for a curing oven, the product
reduces field installation time for this process from 20 minutes to 2 minutes.
Suttle's fiber-optic connector products range in price from $2.50 to $1,500.00.
Suttle is also a manufacturer and seller of DSL (Digital Subscriber Line)
filters for home and business applications. Suttle resells DSL filter products
procured from offshore sources. These filters permit the user to receive both
analog and digital signals simultaneously and allow a single telephone line to
support uninterrupted voice, fax and internet capabilities.
Markets and Marketing
Suttle competes in all major areas of the telecommunications connector market
utilizing modular four, six and eight conductor jacks. Customers include the
major telephone companies (frequently referred to as "RBOCs" such as Verizon
Logistics, Bell South, SBC Communications, and Qwest), other telephone
companies, electrical contractors, interconnect companies and original equipment
manufacturers and retailers. These customers are served directly through the
Suttle's sales staff and through distributors such as Sprint North Supply,
Verizon Logistics, Graybar Electric Company, Alltel Supply, KGP and Anixter
Communications. As a group, sales to the major telephone companies, both
directly and through distribution, were approximately $22,388,000 in 2004 and
$18,190,000 in 2003, which represented 56% of Suttle's sales in 2004 and 55% in
2003.
Suttle markets business and network systems products, which are an increasingly
important part of its product line. Independent contractors (which include
businesses often referred to as "interconnect companies") are engaged in the
business of engineering, selling, installing and maintaining telephone equipment
for the business community. Suttle markets its products to independent
contractors through a network of manufacturer's representatives, through
distributors, and through the Company's sales staff. Sales of products for
business and network systems accounted for 11% and 14% of Suttle's sales in 2004
and 2003, respectively. These structured cabling products are also helping
Suttle penetrate new markets in the data-networking world with education and
hospitality/multiple dwelling unit (MDU) projects. These applications utilize a
blended solution of wireline and wireless products.
3
Fiber-optic products are marketed to original equipment manufacturers (OEMs) in
the U.S. and internationally through the Suttle sales staff, manufacturers'
representatives and a network of distributors. Sales of fiber-optic products
accounted for 2% of Suttle's revenues in 2004 and 2003. Sales of DSL products
represented 27% of sales in 2004 and 10% in 2003.
The balance of Suttle's sales in 2004 and 2003 were to original equipment
manufacturers, non-major telephone companies and international customers. In the
communications industry market, sales to telephone companies are made directly
or through distributors. Sales to OEM customers are made through a nationwide
network of distributors, some of which are affiliates of major telephone
companies, and through the Suttle sales staff.
Competition
Suttle encounters strong competition in all its product lines and competes
primarily on the basis of the broad lines of products offered, product
performance, quality, price and delivery. In addition, distributors of the
apparatus products also market products for one or more of these competitors.
Order Book
Suttle manufactures its products on the basis of estimated customer
requirements. Outstanding customer orders at March 1, 2005 were approximately
$6,777,000 compared to approximately $2,217,000 at March 1, 2004. Because new
orders are filled on a relatively short timetable, Suttle does not believe its
order book is a significant indicator of future results.
Manufacturing and Sources of Supply
Suttle's products are manufactured using plastic parts, wire sub-assemblies,
fasteners, brackets, electronic circuit boards and other components, most of
which are fabricated by Suttle. There are multiple sources of supply for the
materials and parts required and the Company is not dependent upon any single
supplier, except that Suttle's corrosion-resistant products utilize a
moisture-resistant gel-filled fig available only from Tyco Electronics. Suttle
has not generally experienced significant problems in obtaining its required
supplies, although from time to time spot shortages are experienced and
additional order lead times are required from the offshore suppliers.
Research and Development; Patents
Suttle continually monitors industry requirements and creates new products to
improve its existing connector product line.
Historically, Suttle has generally not relied on patents to protect its
competitive position in the station apparatus market. However, duplication of
its designs by foreign apparatus manufacturers has caused Suttle to apply for
design patents on a number of products.
The Company's "Suttle" brand name is important to its business. Suttle regularly
supports this name by trade advertising and believes it is well known in the
marketplace.
(ii) Transition Networks
Transition Networks, Inc. located in Eden Prairie, Minnesota, designs,
manufactures and markets media converters, baluns, transceivers, network
interface cards, and fiber hubs. Transition Networks sells its product through
distributors, resellers, integrators, and OEMs. Sales by Transition Networks
were $41,058,000 or 37% of consolidated sales in 2004 compared to $37,856,000 or
37% of the "Company's" consolidated sales in 2003. Transition's international
sales accounted for 25% of sales or $10,322,000 in 2004, compared to $9,984,000
in 2003 when international sales accounted for 26% of Transition's total sales.
Sales to major distributors in 2004 totaled $26,472,000 compared to $23,789,000
in 2003.
4
Products
Transition Networks designs, produces, and sells media converter devices that
make it possible to transmit telecommunications signals between systems using
different types of media (for example, between copper and fiber optic networks).
These products are used to support legacy systems as customers' networks grow,
integrate fiber optics into a network, and extend the reach of networks.
Protocols supported include Gigabit Ethernet, Fast Ethernet, Ethernet, Token
Ring, T1/E1, DS3, RS232, RS485, ATM, OC3, OC12, 3270, and 5250. The company uses
Application Specific Integrated Circuits (ASIC) for development of some
products, but is also uses integrated circuits for the development of new
products. Product hardware and software development is done internally. The
software that Transition Networks utilizes to manage its products is provided
free with the product. Transition Networks product development is focused on
hardware, with software developed to support hardware sales.
Manufacturing and Sources of Supply
Transition Networks outsources approximately 15% of its products which are
manufactured offshore, principally in the Far East. The balance of its products
are produced in the United States. The offshore sources of supply are subject to
certain risks, including foreign currency fluctuations and interference from
political sources. The Company has alternate sources of supply for its products
and to date has not had problems obtaining necessary supplies.
Markets and Marketing
Transition Networks' products are used in a broad array of markets including
enterprise networks, service providers' networks, and industrial environments
such as in manufacturing processes. Transition Networks has a broad customer
base and applications for its products.
The media conversion product line addresses and is utilized in a variety of
applications. The chassis based system, the Point System(TM), is used primarily
in telecommunication closets for high-density applications and when multiple
protocols need to be supported. Stand alone media converters are used typically
at a workstation or for lower density applications.
Marketing primarily consists of direct marketing utilizing a telesales force,
tradeshows, trade magazine advertising, public relations activities, and direct
mail. Transition Networks also provides and participates in advertising and
cooperative marketing campaigns with distribution partners.
Research and Development
Transition Networks continues to develop products that address the enterprise,
service provider, and industrial markets. This includes developing converters
for emerging protocols and existing protocols in new markets. Some of these
products include DS3, remote management devices, and single fiber products. Some
development efforts are paced by the development of critical components such as
integrated circuits and optical transceivers.
Research and development consists primarily of testing, equipment and supplies
associated with enhancing existing products and developing new products.
Research and development costs are expensed when incurred and were $670,000 in
2004 compared to $607,000 in 2003.
Competition
Transition Networks faces strong competition across its entire product line. A
large number of competitors exist for the highest volume products in the
Ethernet and Fast Ethernet family. Low cost competitors from China and Taiwan
are strongest in the developing Asian markets, but have had limited success in
the North American market. A deeper penetration of these competitors poses a
potential threat to sales and profit margins. Competition also exists from
substitutes such as lower cost fiber switches.
5
Order Book
Outstanding customer orders for Transition Networks products were approximately
$956,000 at March 1, 2005 and $1,047,000 at March 1, 2004. Transition Networks
fills orders on a relatively short-term basis and therefore does not believe its
order book is a significant indicator of future results.
(iii) MiLAN Technology Corporation
MiLAN Technology Corp, located in Sunnyvale, California is a manufacturer of
media converter and rate conversion products, which permit telecommunications
networks to move information between copper-wired equipment and fiber-optic
cable. In addition, MiLAN is also a supplier of wireless access points, bridges
and other networking products. Results of operations of MiLAN have been included
in consolidated operations from March 25, 2002. Sales by MiLAN in 2004 totaled
$11,386,000 and represented 10% of the "Company's" consolidated sales compared
to 2003 sales of $13,146,000 or 13% of consolidated sales.
Products
MiLAN is a supplier of a broad range of networking products of wired and
wireless markets. Main product lines include media converters, Ethernet switches
and wireless access points and bridges. The Company has been developing and
marketing Ethernet based networking products for approximately 12 years. MiLAN
continues to develop products that address the enterprise, service provider, and
industrial markets and in addition targets specific vertical markets of
government and education. Product hardware and software development is performed
internally and is expensed when incurred.
Manufacturing and Sources of Supply
MiLAN outsources most of its manufacturing with approximately 85% of its
products manufactured offshore, principally in the Far East. These offshore
sources of supply are subject to certain risks, including foreign currency
fluctuations and interference from political sources. The Company has alternate
sources of supply for its products and to date has not had problems obtaining
necessary supplies.
Markets and Marketing
MiLAN competes in the wired and wireless networking markets. The wired
networking market consists of the media conversion products and the Ethernet
switch markets. MiLAN also offers products in the newest and potentially high
growth wireless market.
Marketing primarily consists of tradeshows, trade magazine advertising, public
relations activities, and direct mail. MiLAN also provides and participates in
advertising and cooperative marketing campaigns with distribution partners
Order Book
Outstanding customer orders for MiLAN products were approximately $117,000 as of
March 1, 2005 compared to $350,000 as of March 1, 2004. MiLAN does not believe
its order book is a significant indicator of future results.
(iv) JDL Technologies, Inc.
JDL Technologies, Inc., located in Edina, Minnesota ("JDL"), provides
telecommunications network design, specification, and training services to K-12
educational institutions. JDL focus's on providing services to the top 100
school districts in the United States, including all hardware, software,
training, communications and services required to meet the business and
educational learning requirements of the individual schools. Sales by JDL for
2004 were $7,969,000 and represented 7% of the "Company's" consolidated sales
compared to 2003 sales of $11,868,000 or 12% of consolidated sales. Sales of
hardware, software and related equipment totaled $6,324,000 in 2004 or 79% of
total JDL sales compared to $5,361,000 in 2003 or 45% of total JDL sales.
Training, support and consulting revenue were $1,645,000 and $6,507,000 in 2004
and 2003, respectively.
6
Order Book
Outstanding customer orders and contracts for JDL products and services were
approximately $2,517,000 as of March 1, 2005 and $2,180,000 at March 1, 2004.
JDL does not believe its order book is a significant indicator of future
results.
(v) Austin Taylor
Austin Taylor Communications, Ltd. manufactures voice and data connectors and
related ancillary products at its plant in Bethesda, Wales, U.K. Its product
line consists of British standard line jacks, patch panels, data modules, wiring
harness assemblies, metal boxes, distribution cabinets and distribution and
central office frames. Austin Taylor also manufactures its "AT Net" structured
cabling range. Sales by Austin Taylor were $8,029,000, or 7% of the "Company's"
consolidated revenues, in 2004 and $6,640,000 or 6% of consolidated revenues in
2003.
Austin Taylor is a vertically integrated manufacturer with metal stamping, metal
bending, forming and painting. It also has plastic injection molding and printed
circuit board assembly capabilities. Austin Taylor's products are sold direct to
customers and through distributors. Approximately 60% of Austin Taylor sales
were to United Kingdom customers in 2004 and in 2003.
Outstanding customer orders for Austin Taylor products were approximately
$190,000 at March 1, 2005 compared to $450,000 at March 1, 2004. Because Austin
Taylor fills new orders on a relatively short timetable, the Company does not
believe its order book is a significant indicator of future results.
(2) Employment Levels
As of March 1, 2005 the Company employed 496 people. Of this number, 263 were
employed by Suttle (including 122 in Hector, Minnesota and 141 in Costa Rica),
94 by Transition Networks, Inc., 32 by MiLAN Technology., 27 by JDL
Technologies, Inc., 14 by Image Systems Corp., 48 by Austin Taylor
Communications, Ltd and 18 general and administrative positions. The Company
considers its employee relations to be good.
(3) Factors Affecting Future Performance
From time to time, in reports filed with the Securities and Exchange Commission,
in press releases, and in other communications to shareholders or the investing
public, the Company may make forward-looking statements concerning possible or
anticipated future financial performance, business activities or plans which are
typically preceded by the words "believes", "expects", "anticipates", "intends"
or similar expressions. For such forward-looking statements, the Company claims
the protection of the safe harbor for forward-looking statements contained in
federal securities laws. Shareholders and the investing public should understand
that such forward looking statements are subject to risks and uncertainties
which could cause actual performance, activities or plans to differ
significantly from those indicated in the forward-looking statements. Such risks
and uncertainties include, but are not limited to: lower sales to RBOCs and
other major customers; competitive products and technologies; our ability to
successfully reduce operating expenses at certain business units; the general
health of the telecom sector, profitability of recent acquisitions; delays in
new product introductions; higher than expected expense related to new sales and
marketing initiatives; unfavorable resolution of claims and litigation,
availability of adequate supplies of raw materials and components; fuel prices;
government funding of education technology spending; and other factors discussed
from time to time in the Company's filings with the Securities and Exchange
Commission.
7
(4) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 2005 were as
follows:
Name Age Position1
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Curtis A. Sampson 71 Chairman of the Board and
Chief Executive Officer [1970]
Jeffrey K. Berg 62 President and Chief Operating Officer [2000]2
Paul N. Hanson 58 Vice President - Finance, Treasurer, Secretary
and Chief Financial Officer [1982]
David R. Opsahl 55 Exec.Vice President - Corporate Development [2004]3
Daniel G. Easter 48 President and General Manager,
Transition Networks, Inc. [2000] 4
Thomas J. Lapping 46 President , JDL Technologies, Inc. [1998]5
David T. McGraw 53 President and General Manager,
Suttle Apparatus Corporation [2002]6
Gary D. Nentwig 62 President and General Manager,
MiLAN Technology Corporation. [2002] 7
---------------------------------
1 Dates in brackets indicate period during which officers began serving in
such capacity. Executive officers serve at the pleasure of the Board of
Directors and are elected annually for one-year terms.
2 Mr. Berg was appointed Chief Operating Officer of Communications Systems,
Inc. in November 2000 and named President of the Company in March 2002.
Prior to November 2000, Mr. Berg served as President of the Company's Suttle
Apparatus Corporation.
3 Mr. Opsahl was appointed Executive Vice President, Corporate Development in
June 2004. Mr. Opsahl was President and Owner of a consulting business from
July 2003 to May 2004. Prior to May 2004 Mr. Opsahl was Senior Vice
President, Professional Services for ADC Telecommunications Inc."
4 Mr. Easter was appointed President of Transition Networks, Inc. in September
2000. From July 1997 to September 2000, he served as Transition Networks
Vice President of Sales and Marketing. Prior to July 1997, he was an
executive of Allied Telesyn International Corporation in Seattle, WA.
5 JDL Technologies, Inc. was acquired by the Company in 1998. Mr. Lapping
founded JDL Technologies, Inc. in 1989.
6 Mr. McGraw was appointed President of Suttle Apparatus Corporation in
September 2002. From May 2001 to August 2002, he served as Chief Operating
Officer of JDL Technologies, Inc. Prior to May 2001, he was Vice President-
General Manager of Precision Diversified Industries in Plymouth, MN.
7 Mr. Nentwig was appointed President of MiLAN Technology Corporation in March
2002 (CSI acquired substantially all assets of MiLAN from Digi
International, March 25, 2002) Mr. Nentwig previously served as MiLAN's
General Manager.
8
Messrs. Sampson and Hanson each devote approximately 50% of their working time
to the Company's business with the balance devoted to management
responsibilities at Hector Communications Corporation ("HCC"), a diversified
telecommunications holding company also headquartered in Hector, Minnesota, for
which they are separately compensated by HCC.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT
SALES
Financial information about domestic and foreign operations and export sales may
be obtained by reference to Note 10 of the "Notes to Consolidated Financial
Statements" under Item 8 herein.
ITEM 2. PROPERTIES
The administrative and manufacturing functions of CSI are conducted at the
following facilities:
- In Hector, Minnesota the Company owns a 15,000 square foot building where
its executive and administrative offices are located.
- Suttle's manufacturing is conducted at two locations. At Hector,
Minnesota, the Company owns three plants totaling 68,000 feet of
manufacturing space. The Company leases 40,000 square feet of
manufacturing space in San Jose, Costa Rica.
- In 2004, the Company acquired a 30,000 square foot facility in Eden
Prairie, Minnesota as part of the Image Systems Corporation acquisition.
In addition to the Image Systems operations, the facility serves as
distribution center for Transition Networks, Inc.
- Austin Taylor Communications, Ltd. owns a 40,000 square foot facility in
Bethesda, Wales, U.K.
- Transition Networks, Inc. leases a 20,000 square foot facility in Eden
Prairie, Minnesota where its engineering and administrative operations
are conducted.
- JDL Technologies, Inc. leases an 11,000 square foot facility in Edina,
Minnesota where its operations are located.
- MiLAN Technology Corporation leases a 24,000 square foot facility in
Sunnyvale, California, where its business and distribution operations are
conducted.
- The Company owns a 35,000 square foot building in Lawrenceville,
Illinois. This facility is currently leased to other tenants.
CSI believes these facilities will be adequate to accommodate its
administrative, manufacturing and distribution needs for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
A former officer of one of the Company's subsidiaries has challenged the
Company's determination of the retirement benefit payable to be provided to the
former officer. The former officer has asserted that, in addition to the
retirement benefit the Company has provided, the Company should also provide a
supplemental retirement benefit of approximately $100,000 per year to the former
officer based on language in his employment contract with the subsidiary and a
related letter delivered by the Company when the former officer entered into the
employment contract. The Company has denied the former officer's claim for a
supplemental retirement benefit. While the former officer has threatened to
commence a lawsuit with respect to his claim, as of the date of this report, the
Company has not received any formal notice that legal proceedings have been
started. If the former officer initiates legal action, the Company will
vigorously defend against any claims that may be asserted.
The Company is not aware of any other material litigation or other claims
presently pending against the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
9
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
(a) MARKET INFORMATION
Effective January 27, 2003 the Company began trading its common stock on the
American Stock Exchange ("AMEX") under the trading symbol JCS. Prior to January
27, 2003 the Company's common stock was traded in the National Market System of
the National Association of Securities Dealers Automated Quotation System
("NASDAQ").
The table below presents the price range of high and low trades of the Company's
common stock for each quarterly period indicated as reported by AMEX for 2004
and 2003. These prices indicate inter-dealer prices without retail markup,
markdowns or commissions:
2004 2003
------------------------- ------------------------
High Low High Low
First $8.97 $7.75 $8.50 $6.40
Second 9.24 7.66 8.35 6.95
Third 8.40 7.55 8.38 7.55
Fourth 12.74 8.25 8.04 6.76
(b) HOLDERS
At March 1, 2005 there were approximately 740 holders of record of
Communications Systems, Inc. common stock.
(c) DIVIDENDS
Quarterly dividends of $.04 per share were paid at the beginning of each of the
four fiscal quarters in 2003. In 2004, a $.04 per share quarterly dividend was
paid in the first and second quarters, and increased to dividends of $.05 and
$.06 per share in the third and fourth quarters, respectively. A $.07 per share
quarterly dividend was declared by the Board of Directors in the first quarter
of 2005 payable April 1, 2005.
(d) RECENT SALES OF UNREGISTERED SECURITIES
Not applicable.
(e) REPURCHASES OF ISSUER'S EQUITY SECURITIES
The registrant repurchased 48 shares of its common stock totaling $540 during
the fourth quarter of 2004. At December 31, 2004, the Company was authorized to
purchase in accordance with Rule 10b-18 282,433 shares of its common stock
pursuant to Board authorizations granted in November 2002.
10
ITEM 6. SELECTED FINANCIAL DATA
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
SELECTED FINANCIAL INFORMATION
(in thousands except per share amounts)
Year Ended December 31
----------------------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
Selected Income Statement Data
Sales (2) $110,779 $102,411 $107,300 $ 95,105 $119,720
Costs and Expenses:
Cost of Sales 74,295 72,949 78,748 69,602 82,355
Selling, General and Administrative Expenses 29,120 25,442 24,612 24,691 29,432
-------- -------- -------- -------- --------
Total Costs and Expenses 103,415 98,391 103,360 94,293 111,787
Operating Income (1) (2) 7,364 4,020 3,940 812 7,933
Other income (expense), Net 167 315 (45) 225 339
Income Before Income Taxes (1) (2) 7,531 4,335 3,895 1,037 8,272
Income Tax Expense 2,768 1,618 1,558 325 1,600
-------- -------- -------- -------- --------
Net Income (1) (2) $ 4,763 $ 2,717 $ 2,337 $ 712 $ 6,672
======== ======== ======== ======== ========
Basic Net Income Per Share (1) (2) $ .58 $ .33 $ .28 $ .09 $ .76
======== ======== ======== ======== ========
Diluted Net Income Per Share (1) (2) $ .57 $ .33 $ .28 $ .09 $ .75
======== ======== ======== ======== ========
Cash Dividends Per Share $ .19 $ .16 $ .04 $ .30 $ .40
======== ======== ======== ======== ========
Average Common and Potential Common
Shares Outstanding 8,263 8,186 8,246 8,365 8,865
======== ======== ======== ======== ========
Selected Balance Sheet Data
Total Assets $ 89,481 $ 79,096 $ 88,758 $ 88,012 $ 93,198
Property, Plant and Equipment, Net 7,040 5,832 7,425 8,137 10,106
Stockholders' Equity 77,051 70,838 68,871 67,308 71,267
(1) 2004, 2003 and 2002 amounts benefited from the implementation of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets as
disclosed in Note 9 of the consolidated financial statements, included in
Item 8.
(2) 2004, 2003 and 2002 amounts include results from the acquisition of MiLAN
Technology Corporation in March 2002 and 2004 include the results from Image
Systems Corporation acquisition in March of 2004.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Communications Systems, Inc. (herein collectively called "CSI", "our" or the
"Company") is a Minnesota corporation organized in 1969 which operates directly
and through its subsidiaries located in the United States, Costa Rica and the
United Kingdom. CSI is principally engaged in the manufacture and sale of
modular connecting and wiring devices for voice and data communications, digital
subscriber line filters, structured wiring systems and the manufacture of media
and rate conversion products for telecommunications networks. CSI also provides
network design, training services, general contracting of infrastructure
installations, provisioning of high-speed internet access and maintenance
support of network operation centers for K-12 schools.
Critical Accounting Policies
Allowance for Doubtful Accounts: We record a provision for doubtful accounts
receivable based on specific identification of doubtful accounts. This involves
a degree of judgement based on discussion with our internal sales and marketing
groups, our customer base and the examination of the financial stability of our
customers. There can be no assurance that our estimates will match actual
amounts ultimately written off. During periods of downturn in the market for our
products or economic recession, a greater degree of risk exists concerning the
ultimate collectability of our accounts receivable due to the impact that these
conditions might have on our customer base.
Sales Returns: An allowance is established for possible return of products,
rebates and advertising allowances. The amount of the allowance is an estimate,
which is based on historical ratios of returns to sales, the historical average
length of time between the sale and the return and other factors. Though
management considers these allowances adequate and proper, changes in customers'
behavior versus historical experience or changes in the Company's return
policies are among the factors that would result in materially different amounts
for this item.
Inventory Valuation: The Company's inventories are valued at the lower of cost
or market. Reserves for overstock and obsolescence are estimated and recorded to
reduce the carrying value to estimated net realizable value. The amount of the
reserve is determined based on projected sales information, plans for
discontinued products and other factors. Though management considers these
reserves adequate and proper, changes in sales volumes due to unexpected
economic or competitive conditions are among the factors that could materially
affect the adequacy of this reserve.
Income Taxes: We account for income taxes in accordance with the provisions of
Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for
Income Taxes. In the preparation of the Company's consolidated financial
statements, management calculates income taxes. This includes estimating the
Company's current tax liability as well as assessing temporary differences
resulting from different treatment of items for tax and book accounting
purposes. These differences result in deferred tax assets and liabilities, which
are recorded on the balance sheet. These assets and liabilities are analyzed
regularly and management assesses the likelihood that deferred tax assets will
be realized from future taxable income. The valuation allowance for deferred
income tax benefits is determined based upon the expectation of whether the
benefits are more likely than not to be realized.
Warranty: We provide a standard product warranty program for our product lines
and a five year warranty on certain equipment purchased from two vendors and
installed at our customer locations. We provide reserves for the estimated cost
of product warranties at the time revenue is recognized. We estimate the costs
of our warranty obligations based on our warranty policy or applicable
contractual warranty, our historical experience of known product failure rates,
our vendors' experience and use of materials and service delivery costs incurred
in correcting product failures. Management reviews the estimated warranty
liability on a quarterly basis to determine its adequacy. Though management
considers these balances adequate and proper, changes in the Company's warranty
policy or a significant change in product defects versus historical experience
are among the factors that could result in materially different amounts for this
item.
Goodwill Impairment: Beginning in 2002, goodwill is required to be evaluated
annually for impairment, according to SFAS No. 142, Goodwill and Other
Intangible Assets. The standard requires a two-step process be performed to
analyze whether or not goodwill has been impaired. Step one is to test for
potential impairment, and requires that the fair value of the reporting unit be
compared to its book value including goodwill. If the fair value is higher than
the book value, no impairment is recognized. If the fair value is lower than the
book value, a second step must be performed. The second step is to measure the
amount of impairment loss, if any, and requires that a hypothetical purchase
price allocation be done to determine the implied fair value of goodwill. This
fair value is then compared to the carrying value of goodwill. If the implied
12
fair value is lower than the carrying value, an impairment must be recorded. As
of December 31, 2004, 2003 and 2002 the Company had net goodwill of $5,264,000,
$5,254,000 and $5,254,000, respectively. Carrying amounts of goodwill by segment
as of December 31, 2004 is as follows: Suttle $1,198,000; Transition
Networks/MiLAN Technology $3,362,000; JDL Technologies $704,000.
The Company believes that accounting estimates related to goodwill impairment
are critical because the underlying assumptions used for the discounted cash
flow can change from period to period and could potentially cause a material
impact to the income statement. Management's assumptions about inflation rates
and other internal and external economic conditions, such as earnings growth
rate, require significant judgment based on fluctuating rates and expected
revenues.
Revenue Recognition: The Company recognizes revenue when the earnings process is
complete, evidenced by persuasive evidence of an arrangement, delivery has
occurred or services have been rendered, the price is fixed or determinable, and
collectibility is reasonably assured. Related to the Suttle, Austin Taylor, and
Transition Networks and MiLAN Technology segments, the earning process
completion is evidenced through the shipment of goods as the terms these
segments are FOB shipping point and the risk of loss is transferred upon
shipment and they are have no significant obligations subsequent to that point.
Other than the sales returns as discussed above, there are not significant
estimates related to revenue recognition for these segments. JDL Technologies,
Inc Segment (JDL) records revenue on hardware, software and related equipment
sales and installation contracts when the products are installed and accepted by
the customer. JDL records revenue on service contracts on a straight-line basis
over the contract period, unless evidence suggests that the revenue is earned or
obligations are fulfilled in a different pattern. Each contract is individually
reviewed to determine when the earnings process is complete.
Foreign Currency Translation: Assets and liabilities of the foreign subsidiary
are translated to U.S. dollars at year-end rates, and the statements of
operations are translated at average exchange rates during the year. Translation
adjustments arising from the translation of the foreign affiliates' net assets
into U.S dollars are recorded in other comprehensive income.
Results of operations
2004 Compared to 2003
Consolidated sales in 2004 increased 8% to $110,779,000 compared to $102,411,000
in 2003. The 2004 revenues include $2,224,000 in sales contributed from the
Image Systems business unit, which was acquired in March 2004. Image Systems
incurred a $265,000 operating loss in 2004. Consolidated operating income in
2004 increased to $7,364,000 compared to operating income of $4,020,000 in 2003.
The Company's core business units providing broadband products, Digital
Subscriber Line (DSL) products and media conversion and network switching
products provided the revenue and earnings growth in 2004 compared to 2003.
Suttle's sales increased 22% to $40,114,000 in 2004 as compared to $32,900,000
in 2003. Sales to customers in the United States (U.S.) in 2004 increased 20% to
$38,430,000 from $31,976,000 in 2003. Suttle's sales increases are attributable
to increases in capital spending by telecommunications industry companies and in
particular the former Regional Bell Operating Company (RBOC) customers. Sales to
the RBOC's increased 23% to $22,388,000 in 2004 from $18,190,000 in 2003 which
represent 55% of Suttle's U.S. customer sales in 2004 and 2003. Sales to
distributors, original equipment manufacturers (OEMs), and electrical
contractors increased to $9,554,000 in 2004 compared to $7,441,000 in 2003.
Suttle also provided contract manufacturing services to one company, which
generated revenues of approximately $2,550,000 in 2004 and $3,400,000 in 2003.
Suttle's gross margins increased 50% to $9,961,000 in 2004 compared to
$6,611,000 in 2003. Gross margin as a percentage of sales improved to 24% in
2004 from 20% in 2003. The gross margin percentage increase was due to increased
business volumes, cost reductions gained by shifting more manufacturing to the
lower cost plant in Costa Rica and from outsourcing the manufacturing of certain
products to Asia. Suttle is utilizing offshore manufacturing arrangements in the
Pacific Rim to strengthen the competitive position of traditional products and
its DSL line filter business. Selling, general and administrative expenses
increased to $5,201,000 in 2004 compared to $4,597,000 in 2003 due to increased
sales and marketing costs. Suttle's operating income increased to $4,760,000 in
2004 compared to operating income of $2,014,000 in 2003.
13
Austin Taylor's sales increased in 2004 to $8,029,000 compared to $6,640,000 in
2003 reflecting an increase in sales to several key United Kingdom (U.K.)
telecommunications customers. Austin Taylor reported a gross margin of $275,000
in 2004 compared to a negative gross margin of $288,000 in 2003. The increase in
gross margin was principally due to higher business volumes and reductions in
manufacturing and overhead costs. Austin Taylor is also utilizing offshore
manufacturing arrangements in the Pacific Rim to strengthen the competitive
position of their product line. Selling, general and administrative expenses
decreased $553,000 in 2004 due to lower selling and administrative costs.
Severance costs relative to workforce reductions incurred in 2003 were
approximately $420,000. No such costs were incurred in 2004. Austin Taylor's
operating loss in 2004 was $450,000 in 2004 compared to an operating loss of
$1,566,000 in 2003.
Transition Networks / MiLAN Technology segment sales increased to $52,443,000 in
2004 compared to $51,002,000 in 2003. Combined segment sales to international
customers were $10,553,000 representing 20% of total segment sales in 2004
compared to $11,816,000 or 22% in 2003. Gross margin increased to $21,174,000 in
2004 from $18,584,000 in 2003. Gross margin as a percentage of sales was 40% in
2004 compared to 36% in 2002. The gross margin increase was due to higher
business volumes and reductions in material and product component cost
reductions from vendors. Selling, general and administrative expenses increased
to $16,640,000 in 2004 compared to $14,260,000 in 2003 due to higher sales and
marketing expenses including incentives, promotional costs and additional sales
staff. Selling, general and administrative expenses as a percentage of sales
were 32% in 2004 and 28% in 2003. Operating income was $4,533,000 in 2004
compared to $4,325,000 in 2003.
JDL Technologies, the Company's technology consulting segment for the education
market, sales decreased to $7,969,000 in 2004 compared to $11,868,000 in 2003.
Computer and network hardware sales represented $4,113,000 or 52% of total JDL
revenues in 2004 compared to $5,361,000 or 45% of total revenue in 2003.
Consulting, training and support and connectivity services were $3,856,000 or
48% of total 2004 sales compared to $6,507,000 or 55% of total sales in 2003.
Gross margin in 2004 was $4,199,000 or 53% compared to $4,554,000 or 38% in
2003. The gross margin as a percentage of sales increased due to higher margin
sales of connectivity and consulting services to client school districts.
Selling, general and administrative expenses decreased to $3,015,000 in 2004
compared to $3,454,000 in 2003 due primarily to lower administrative and sales
staffing expenses. Operating income remained consistent at $1,184,000 in 2004
compared to $1,100,000 in 2003
Consolidated investment and other income decreased $184,000 in 2004 compared to
2003. The Company realized a net gain of approximately $280,000 on disposal of
non-operating assets upon termination of all production in Puerto Rico in the
second quarter of 2003 which was recorded as other income. Investment income
increased by $96,000 in 2004 compared to 2003. Interest expense (and related
line of credit fees) decreased by $35,000 in 2004 compared to 2003 due to a
decrease in annual average borrowings on a line of credit and a lower effective
interest rate. Consolidated income before income taxes increased to $7,531,000
in 2004 compared to $4,335,000 in 2003. The Company's annualized effective
income tax rate was approximately 37% in 2004 and 2003. Consolidated net income
in 2004 increased to $4,763,000 compared to $2,717,000 in 2003.
2003 Compared to 2002
Consolidated sales in 2003 decreased 5% to $102,411,000 from sales of
$107,300,000 in 2002. Consolidated gross margins increased by 3% in 2003 to
$29,462,000 compared to $28,552,000 in 2002. Consolidated operating income
increased to $4,020,000 in 2003 compared to $3,940,000 in 2002. Consolidated net
income increased to $2,717,000 in 2003 or $.33 per diluted share compared to
$2,337,000 or $.28 in 2002.
On March 25, 2002 the Company acquired substantially all the assets of the MiLAN
division of 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. 2003 MiLAN sales were $13,146,000 compared to $10,503,000 in 2002.
14
Suttle's sales were $32,900,000 in 2003 as compared to $33,159,000 in 2002.
Sales to customers in the United States (U.S.) in 2003 increased 1% to
$31,796,000 from $31,383,000 in 2002. Suttle's sales increases are attributable
to increases in capital spending by telecommunications industry companies and in
particular the former Regional Bell Operating Company (RBOC) customers. Sales to
the RBOC's increased 9% to $18,190,000 in 2003 from $16,687,000 in 2002 which
represent 55% and 50% of Suttle's U.S. customer sales in 2003 and 2002,
respectively. Sales to distributors, original equipment manufacturers (OEMs),
and electrical contractors decreased to $7,441,000 in 2003 compared to
$9,779,000 in 2002. Suttle's international sales decreased to $1,104,000 in 2003
compared to $1,776,000 in 2002. Suttle also provide contract manufacturing
services to one company, which generated revenues of approximately $3,400,000 in
2003 and $1,500,000 in 2002.
Suttle's gross margins increased 28% to $6,611,000 in 2003 compared to
$5,148,000 in 2002. Suttle recorded a write down of excess and slow-moving
inventory approximating $1,700,000 in 2002. Gross margin as a percentage of
sales improved to 20% in 2003 from 16% in 2002. The gross margin percentage
increase was due to the effect of the 2002 writedown of excess and slow-moving
inventory and to cost and workforce reduction measures implemented in 2003. The
Company has downsized operations by closing two of three manufacturing
facilities in Puerto Rico in 2002 and its final building in May 2003 to align
production capacities and overhead with current business volumes. Suttle is also
utilizing offshore manufacturing arrangements in the Pacific Rim to strengthen
the competitive position of traditional products and its DSL line filter
business. Suttle's operating income increased to $2,014,000 in 2003 compared to
an operating loss of $710,000 in 2002.
Austin Taylor's sales decreased in 2003 to $6,640,000 compared to $7,138,000 in
2002 reflecting a decline in sales to several key United Kingdom (U.K.)
telecommunications customers. Austin Taylor reported negative gross margin of
($288,000) in 2003 compared to $691,000 in 2002. The decline in gross margin was
principally due to increased pricing competition, lower business volumes and
excess manufacturing and overhead capacity. Severance costs relative to
workforce reductions incurred in 2003 were approximately $420,000. Selling,
general and administrative expenses increased $209,000 in 2003 due to higher
selling and marketing costs. Austin Taylor's operating loss in 2003 was
$1,566,000 in 2003 compared to an operating loss of $377,000 in 2002.
Transition Networks / MiLAN Technology segment sales increased to $51,002,000 in
2003 compared to $49,010,000 in 2002. Sales for this segment include $13,146,000
in 2003 and $10,503,000 in 2002 contribution from MiLAN Technology, the assets
of which CSI purchased from Digi International on March 25, 2002. Transition
Networks sales were $37,856,000 in 2003 compared to $38,507,000 in 2002.
Combined segment sales to international customers were $11,186,000 representing
22% of total segment sales in 2003 compared to $12,518,000 or 26% in 2002. Gross
margin increased to $18,584,000 in 2003 from $16,887,000 in 2002. Gross margin
as a percentage of sales was 36% in 2003 compared to 34% in 2002. Gross margins
in 2002 were adversely affected by the sale of inventory acquired in the MiLAN
acquisition, which had lower margins. Selling, general and administrative
expenses increased to $14,260,000 in 2003 compared to $12,528,000 in 2002 due to
higher selling and marketing expenses. Selling, general and administrative
expenses as a percentage of sales were 28% in 2003 and 26% in 2002. Operating
income was $4,325,000 in 2003 compared to $4,359,000 in 2002.
JDL Technologies, the Company's technology consulting segment for the education
market, sales decreased to $11,868,000 in 2003 compared to $17,992,000 in 2002.
Several major projects were delayed due to processing problems of applications
for funds from the federal government's E-Rate program. Computer and network
hardware sales represented $5,361,000 or 45% of total JDL revenues in 2003
compared to $13,155,000 or 73% of total revenue in 2002. Consulting, training
and support were $6,507,000 or 55% of total 2003 sales compared to $4,837,000 or
27% of total sales in 2002. Gross margin in 2003 was $4,554,000 or 38% compared
to $5,825,000 or 32% in 2002. Increased sales of higher margin consulting and
training services produced a higher gross margin percentage in 2003 compared to
2002. Selling, general and administrative expenses remained consistent at
$3,454,000 in 2003 compared to $3,424,000 in 2002. Operating income decreased to
$1,100,000 in 2003 compared to $2,401,000 in 2002
15
Consolidated investment and other income increased $160,000 in 2003 compared to
2002. The Company realized a net gain of approximately $280,000 on disposal of
non-operating assets upon termination of all production in Puerto Rico in the
second quarter of 2003 which was recorded as other income. Interest expense
decreased by $201,000 in 2003 compared to 2002 due to a decrease in annual
average borrowings on a line of credit and a lower effective interest rate.
Income before income taxes increased by $441,000 to $4,335,000 compared to
$3,894,000 in 2002. The Company's annualized effective income tax rate is
approximately 37% in 2003 compared to 40% in 2002. The reduction in the
effective income tax rate in 2003 is due to the utilization of available tax
credits and income exclusions. Net income in 2003 increased $381,000 to
$2,717,000 compared to $2,336,000 in 2002.
Acquisitions and Dispositions
Effective March 24, 2004, the Company acquired substantially all the outstanding
shares of Image Systems Corporation for a cash purchase price per share of
approximately $2.8 million. Image Systems Corporation, located in Minnetonka,
Minnesota designs, manufactures and markets high-resolution display solutions
and accessories for customers in the medical imaging market or for other
customers who have stringent and or unique display requirements. In addition,
Image Systems has been a premier developer of video graphics products since
1988. The proforma effects of the Image Systems Corporation acquisition on our
consolidated financial statements were not material to the Company's
consolidated financial statements. The acquisition and operations of Image
Systems are included in the Company's consolidated financial results from the
purchase date March 24, 2004.
Effective March 25, 2002, the Company acquired substantially all the assets of
the MiLAN division of Digi International, Inc. for approximately $8,100,000 in
cash. MiLAN, located in Sunnyvale, California is a manufacturer of media and
rate conversion products, which permit telecommunications networks to move
information between copper-wired equipment and fiber-optic cable. In addition,
MiLAN is also a supplier of wireless access points, bridges and other networking
products. The acquisition was accounted for as a purchase and operations of
MiLAN have been included in consolidated financial results March 25, 2002.
The acquisitions the Company has made over the past several years have served to
expand the Company's product offerings and customer base in both U.S. and
international markets. The Company is a growth-oriented manufacturer of
telecommunications connecting and networking devices. The Company is continuing
to search for acquisition candidates with products that will enable the Company
to better serve its target markets.
Effects of Inflation
Inflation has not had a significant effect on operations. The Company does not
have long-term production or procurement contracts and has historically been
able to adjust pricing and purchasing decisions to respond to inflationary
pressures.
European Currency
The introduction of the Euro has not had a material effect on its business at
this time. The United Kingdom, where Austin Taylor is located, is not among the
countries converting to the Euro. The Company does not conduct significant
business in other participating European nations, nor does it hold assets valued
in other European currencies. The Company will continue to monitor the European
currency situation and take action as required.
Liquidity and Capital Resources
At December 31, 2004, the Company had approximately $25,843,000 of cash and cash
equivalents compared to $14,941,000 of cash and cash equivalents at December 31,
2003. The Company had current assets of approximately $76,220,000 and current
liabilities of $12,430,000 at December 31, 2004 compared to current assets of
$66,210,000 and current liabilities of $8,258,000 at the end of 2003. The
increase in working capital was primarily due to improved 2004 operations and
cash flow from operations.
Cash flow provided by operating activities was approximately $14,631,000 in 2004
compared to $4,572,000 provided by operations in 2003. The increase was
primarily due to the Company's improved profitability, decreased accounts
receivable and inventory levels and an increase in trade and income tax payable
levels and accrued liabilities.
16
Investing activities used $4,621,000 of cash in 2004 compared to cash used in
investing activities in 2003 of $1,208,000. The Company purchased substantially
all the assets of Image Systems Corporation for approximately $2,800,000 in cash
in the first quarter of 2004 financed through internal cash flows. Cash
investments in new plant and equipment totaled $1,977,000 in 2004 compared to
$715,000 in 2003. The Company expects to invest approximately $1,500,000 on
capital additions in 2005.
Net cash provided by financing activities was $1,001,000 in 2004 compared to net
cash used in financing activities of $8,269,000 in 2003. Cash dividends paid on
common stock totaled $1,399,000 in 2004 and $1,307,000 in 2003. Proceeds from
common stock issuances, principally exercises of employee stock options, totaled
approximately $2,408,000 in 2004 and $135,000 in 2003. The Company purchased and
retired 1,000 and 14,000 shares of its stock in open market transactions during
2004 and 2003 respectively. Board authorizations are outstanding to purchase
approximately 282,000 additional shares. The Company may purchase and retire
additional shares in 2005 if warranted by market conditions and the Company's
financial position. The Company paid down the outstanding balance of its line of
credit of $7,000,000 in the first quarter of 2003. There have been no further
advances on the line of credit subsequent to that period.
The Company has revoked its Section 936 election effective January 1, 2002 and
has included all subsequent Puerto Rico operations in its consolidated federal
income tax group. As a result, the Company expects its corporate income tax rate
on current and future earnings to continue to more closely match normal U.S.
income tax rates. The effective tax rate in 2004 and 2003 was approximately 37%
and 40% in 2002. Distributions by Suttle Caribe, Inc. to the parent company of
income earned prior to December 31, 2000 are subject to a tollgate tax at rates
which, depending on various factors, range from 3.5% to 10%. The cumulative
amount of prior earnings on which no tollgate tax has been recognized was
approximately $11,054,000 at December 31, 2004. Tollgate taxes of approximately
$860,000 have been accrued and will likely be paid on these prior earnings in
2005.
At December 31, 2004 approximately $5,138,000 and $937,000 of assets were
invested in the Company's subsidiaries in the United Kingdom and Costa Rica,
respectively. The remaining Puerto Rico assets were transferred to the U.S. in
the first quarter of 2004. Tollgate taxes have been accrued and will be paid in
2005 on these transfers. The Company expects to maintain assets in the United
Kingdom and Costa Rica as needed to support the continued operation of those
subsidiaries. The Company uses the U.S. dollar as its functional currency in
Costa Rica. The United Kingdom is a politically and economically stable country.
Accordingly, the Company believes its risk of material loss due to fluctuations
in foreign currency markets to be small.
The Company' had no outstanding obligations under its line of credit at December
31, 2004 and 2003. The Company paid this credit line in full in March 1, 2003.
The Company's entire credit line ($10,000,000 at March 1, 2005) is available for
use. In the opinion of management, based on the Company's current financial and
operating position and projected future expenditures, sufficient funds are
available to meet the Company's anticipated operating and capital expenditure
needs.
Contractual Obligation Summary
The Company leases land, buildings and equipment under operating leases with
original terms from one to five years. Certain of these leases contain renewal
and purchase options. Rent expense charged to operations was $1,198,000,
$1,271,000 and $1,135,000 in 2004, 2003 and 2002 respectively. Sublease income
received was $71,000, $62,000 and $57,000 in 2004, 2003 and 2002 respectively.
At December 31, 2004, the Company was obligated under non-cancelable operating
leases to make minimum annual future lease payments as follows:
Year Ending December 31:
2005 $ 710,000
2006 704,000
2007 227,000
-----------
$ 1,641,000
===========
As of December 31, 2004, the Company had no other material commitments (either
cancelable or non-cancelable) for capital expenditures, short or long term debt,
capital leases or other purchase commitments related to ongoing operations.
17
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R) (revised 2004), "Share-Based
Payment", which amends FASB Statement No. 123 and will be effective for public
companies for interim or annual periods beginning after June 15, 2005. The new
standard will require us to expense employee stock options and other share-based
payments. (As valued and calculated under SFAS No. 123 for pro forma
disclosures). The Company has not yet determined how it will value future grants
or whether it will elect to adjust prior periods upon adoption of SFAS No. 123
(revised 2004).
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of
ARB No. 43, Chapter 4. This statement amends the guidance in ARB No. 43, Chapter
4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage).
Paragraph 5 of ARB No. 43, Chapter 4, previously stated that "...under some
circumstances, items such as idle facility expense, excessive spoilage, double
freight, and rehandling costs may be so abnormal as to require treatment as
current period charges..." SFAS No. 151 requires that those items be recognized
as current-period charges regardless of whether they meet the criterion of "so
abnormal." In addition, this statement requires that allocation of fixed
production overheads to the costs of conversion be based on the normal capacity
of the production facilities. The provisions of SFAS 151 shall be applied
prospectively and are effective for inventory costs incurred during fiscal years
beginning after June 15, 2005, with earlier application permitted for inventory
costs incurred during fiscal years beginning after the date this Statement was
issued. The adoption of SFAS No. 151 is not expected to have a material impact
on our financial position and results of operations.
In December 2004, the FASB staff issued FSP FAS 109-1, "Application of FASB
Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on
Qualified Production Activities Provided by the American Jobs Creation Act of
2004" (the "FSP") to provide guidance on the application of Statement 109 to the
provision within the American Jobs Creation Act of 2004 (the "Act") that
provides tax relief to U.S. domestic manufacturers. The FSP states that the
manufacturers' deduction provided for under the Act should be accounted for as a
special deduction in accordance with Statement 109 and not as a tax rate
reduction. A special deduction is accounted for by recording the benefit of the
deduction in the year in which it can be taken in the company's tax return, and
by not adjusting deferred tax assets and liabilities in the period of the Act's
enactment (which would have been done if the deduction on qualified production
activities were treated as a change in enacted tax rates). The FSP was effective
upon issuance. The adoption of the FSP has not and is not expected to have a
material impact on our financial position and results of operations.
18
ITEM 7A. 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.
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 December 31, 2004 our bank line of credit carried a
variable interest rate based on our bank's average certificate of deposit rate
plus 1.5%. 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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) FINANCIAL STATEMENTS
REPORT OF MANAGEMENT
The management of Communications Systems, Inc. and its subsidiary companies is
responsible for the integrity and objectivity of the financial statements and
other financial information contained in the annual report. The financial
statements and related information were prepared in accordance with accounting
principles generally accepted in the United States of America and include
amounts that are based on management's informed judgments and estimates.
In fulfilling its responsibilities for the integrity of financial information,
management maintains accounting systems and related controls. These controls
provide reasonable assurance, at appropriate costs, that assets are safeguarded
against losses and that financial records are reliable for use in preparing
financial statements. Management recognizes its responsibility for conducting
the Company's affairs according to the highest standards of personal and
corporate conduct.
The Audit Committee of the Board of Directors, comprised solely of outside
directors, meets with the independent auditors and management periodically to
review accounting, auditing, financial reporting and internal control matters.
The independent auditors have free access to this committee, without management
present, to discuss the results of their audit work and their opinion on the
adequacy of internal financial controls and the quality of financial reporting.
/s/ Curtis A. Sampson /s/ Paul N. Hanson
- ------------------------------------ -----------------------------------
Curtis A. Sampson Paul N. Hanson
Chairman and Chief Executive Officer Chief Financial Officer
19
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and Board of Directors
Communications Systems, Inc.
We have audited the accompanying consolidated balance sheets of Communications
Systems, Inc. and subsidiaries (the Company) as of December 31, 2004 and 2003
and the related consolidated statements of income and comprehensive income,
changes in stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 2004. Our audits also include the financial
statement schedule listed in the Index at Item 15. These consolidated financial
statements and the financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and the schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 2004
and 2003 and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2004 in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, the financial statement schedule referred to above, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
/s/ Deloitte & Touche LLP
- ---------------------------
Deloitte & Touche LLP
March 22, 2005
Minneapolis, Minnesota
20
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
----------------------------
2004 2003
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents $ 25,842,580 $ 14,941,254
Trade accounts receivable, less allowance
for doubtful accounts of $1,427,000 and
$1,423,000, respectively 22,077,987 22,647,129
Related party receivables (Note 1) 283,378 387,411
Inventories (Note 2) 23,935,421 24,354,041
Other current assets 966,061 1,197,027
Deferred income taxes (Note 7) 3,114,338 2,682,869
------------ ------------
TOTAL CURRENT ASSETS 76,219,765 66,209,731
PROPERTY, PLANT AND EQUIPMENT, net (Notes 1 and 3) 7,040,075 5,831,711
OTHER ASSETS:
Excess of cost over net assets
acquired (Notes 1 and 9) 5,264,095 5,253,793
Investments (Note 1) 19,242 41,846
Deferred income taxes (Note 7) 569,037 1,252,757
Other assets 368,857 506,120
------------ ------------
TOTAL OTHER ASSETS 6,221,231 7,054,516
------------ ------------
TOTAL ASSETS $ 89,481,071 $ 79,095,958
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 4,631,722 $ 2,194,560
Accrued compensation and benefits 3,472,704 3,013,533
Other accrued liabilities 2,009,822 1,885,000
Dividends payable 508,969 327,397
Income taxes payable 1,806,582 837,703
------------ ------------
TOTAL CURRENT LIABILITIES 12,429,799 8,258,193
COMMITMENTS AND CONTINGENCIES (Note 5)
STOCKHOLDERS' EQUITY (Notes 1 and 6)
Preferred stock, par value $1.00 per share;
3,000,000 shares authorized; none issued
Common stock, par value $.05 per share;
30,000,000 shares authorized; 8,502,700 and
8,185,371 shares issued and outstanding,
respectively 425,135 409,268
Additional paid-in capital 30,803,482 27,954,636
Retained earnings 45,456,339 42,278,484
Cumulative other comprehensive income (Note 1) 366,316 195,377
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 77,051,272 70,837,765
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 89,481,071 $ 79,095,958
============ ============
See notes to consolidated financial statements.
21
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31
------------------------------------------
2004 2003 2002
------------ ------------ ------------
SALES (Note 10): $110,778,938 $102,410,501 $107,299,857
COSTS AND EXPENSES:
Cost of sales 74,295,403 72,948,849 78,748,160
Selling, general and
administrative expenses 29,119,767 25,441,483 24,611,972
------------ ------------ ------------
TOTAL COSTS AND EXPENSES 103,415,170 98,390,332 103,360,132
------------ ------------ ------------
OPERATING INCOME 7,363,768 4,020,169 3,939,725
OTHER INCOME (EXPENSE):
Investment and other income 214,338 398,091 238,316
Interest expense (47,373) (82,779) (283,369)
------------ ------------ ------------
OTHER INCOME (EXPENSE), net 166,965 315,312 (45,053)
------------ ------------ ------------
INCOME BEFORE INCOME TAXES 7,530,733 4,335,481 3,894,672
INCOME TAX EXPENSE (Note 7) 2,768,000 1,618,000 1,558,000
------------ ------------ ------------
NET INCOME 4,762,733 2,717,481 2,336,672
------------ ------------ ------------
OTHER COMPREHENSIVE INCOME
Foreign currency translation
adjustment 170,939 264,755 354,403
------------ ------------ ------------
COMPREHENSIVE INCOME $ 4,933,672 $ 2,982,236 $ 2,691,075
============ ============ ============
BASIC NET INCOME
PER COMMON SHARE (Note 1) $ .58 $ .33 $ .28
============ ============ ============
DILUTED NET INCOME
PER COMMON SHARE (Note 1) $ .57 $ .33 $ .28
============ ============ ============
AVERAGE BASIC SHARES OUTSTANDING 8,263,041 8,169,078 8,245,352
AVERAGE DILUTED SHARES OUTSTANDING 8,320,614 8,185,679 8,246,481
See notes to consolidated financial statements.
22
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Cumulative
Common Stock Additional Other
------------------------ Paid-in Retained Comprehensive
Shares Amount Capital Earnings Income (Loss) Total
--------- --------- ----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 2001 8,262,314 $ 413,116 $27,855,529 $39,463,137 $ (423,781) $67,308,001
Net income 2,336,672 2,336,672
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 common stock (182,574) (9,130) (630,005) (553,737) (1,192,872)
Shareholder dividends (325,714) (325,714)
Other comprehensive gain 354,403 354,403
--------- --------- ----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 2002 8,142,716 $ 407,135 $27,613,163 $40,920,358 $ (69,378) $68,871,278
Net income 2,717,481 2,717,481
Issuance of common stock under
Employee Stock Purchase Plan 23,172 1,159 122,503 123,662
Issuance of common stock to
Employee Stock Ownership Plan 32,000 1,600 253,440 255,040
Issuance of common stock under
Employee Stock Option Plan 1,700 85 11,645 11,730
Purchase of Common stock (14,217) (711) (46,115) (51,122) (97,948)
Shareholder dividends (1,308,233) (1,308,233)
Other comprehensive gain 264,755 264,755
--------- --------- ----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 2003 8,185,371 $ 409,268 $27,954,636 $42,278,484 $ 195,377 $70,837,765
Net income 4,762,733 4,762,733
Issuance of common stock under
Employee Stock Purchase Plan 22,193 1,110 160,489 161,599
Issuance of common stock to
Employee Stock Ownership Plan 33,000 1,650 262,724 264,374
Issuance of common stock under
Employee Stock Option Plan 263,170 13,159 2,233,212 2,246,371
Tax benefit from non-qualified
employee stock options 195,976 195,976
Purchase of Common stock (1,034) (52) (3,555) (4,873) (8,480)
Shareholder dividends (1,580,005) (1,580,005)
Other comprehensive gain 170,939 170,939
--------- --------- ----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 2004 8,502,700 $ 425,135 $30,803,482 $45,456,339 $ 366,316 $77,051,272
========= ========= =========== =========== =========== ===========
See notes to consolidated financial statements.
23
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
--------------------------------------------------
2004 2003 2002
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,762,733 $ 2,717,481 $ 2,336,672
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 2,271,569 2,463,478 2,633,671
Deferred taxes 733,251 2,215,920 (905,114)
(Gain) Loss on sale of assets (11,748)
Tax benefit from non-qualified stock options 195,976
Changes in assets and liabilities net of effects
from acquisitions:
Trade and related party receivables 1,377,475 (3,168,871) 2,333,236
Inventories 1,280,612 4,945,452 1,075,464
Other current assets 266,694 192,973 (824,839)
Accounts payable 2,206,175 (3,177,738) (389,124)
Accrued expenses 578,909 363,125 621,730
Income taxes payable 968,879 (1,979,552) 570,087
------------ ------------ ------------
Net cash provided by operating activities 14,630,525 4,572,268 7,451,783
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,976,748) (714,591) (1,740,220)
Maturities of debt securities 21,809
Other assets 104,057 (493,145) 157,015
Collection of notes receivable 2,765,390
Proceeds from the sale of fixed assets 53,396
Payment for purchase of Image Systems Corporation (2,801,683)
Payment for purchase of MiLAN Technology Corporation (8,127,751)
------------ ------------ ------------
Net cash used in investing activities (4,620,978) (1,207,736) (6,923,757)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable (7,000,000) (2,000,000)
Cash dividends paid (1,398,434) (1,306,550)
Proceeds from issuance of common stock 2,407,970 135,392 202,288
Purchase of common stock (8,480) (97,948) (1,192,872)
------------ ------------ ------------
Net cash provided by (used in) financing activities 1,001,056 (8,269,106) (2,990,584)
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (109,277) 29,500 39,003
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 10,901,326 (4,875,074) (2,423,555)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 14,941,254 19,816,328 22,239,883
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 25,842,580 $ 14,941,254 $ 19,816,328
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 1,841,526 $ 1,116,627 $ 973,932
Interest paid 47,373 102,566 356,357
Dividends declared not paid 508,969 327,397 325,714
See notes to consolidated financial statements.
24
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business: The Company is principally engaged in the manufacture
and sale of modular connecting and wiring devices for voice and data
communications. The Company sells these products to telephone companies,
electrical contractors, interconnect companies, original equipment manufacturers
and retailers. The Company also owns subsidiaries which manufacture media and
rate conversion products (products that permit telecommunications networks to
move information between copper wired equipment and fiber-optic cable) and offer
internet network design, specification and training services to educational
institutions. The Company's operations are currently located in the United
States, United Kingdom, and Costa Rica. Until May 2003, the Company also had
operations in Puerto Rico.
Principles of consolidation: The consolidated financial statements include the
accounts of the Company and its subsidiaries. All material intercompany
transactions and accounts have been eliminated.
Use of estimates: The presentation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. The Company's estimates consist principally of reserves
for doubtful accounts, sales returns, warranty costs, lower of cost or market
inventory adjustments, provision for income taxes and deferred taxes, fixed
asset impairment review, goodwill and other intangible asset impairment review
and depreciable lives of fixed assets.
Financial instruments: The fair value of the Company's financial instruments,
which consist of investment securities, accounts receivable, notes receivable,
accounts payable and accrued expenses approximate their carrying value due to
their short-term nature or the variable interest rate on outstanding
indebtedness.
Cash equivalents: For purposes of the consolidated statements of cash flows, the
Company considers all highly liquid investments with a maturity of three months
or less at the time of purchase to be cash equivalents.
Accounts receivable from related parties: The Company provides services for
Hector Communications Corporation ("HCC"), a former subsidiary of the Company.
Several of the Company's officers and directors work in similar capacities for
HCC. Outstanding receivable balances from HCC were $221,000 and $223,000 at
December 31, 2004 and 2003, respectively. Accounts with HCC are paid on a
current basis during the year. The Company also has certain receivables from
employees and an officer, the majority of which are repaid through biweekly
payroll deductions. These receivables totaled $63,000 and $164,000 as of
December 31, 2004 and 2003 respectively. These receivables earn interest ranging
from 6.5% to 8 % and have maturity dates extending through 2006.
Inventories: Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out method. Provision to reduce inventories to
the lower of cost or market is made based on a review of excess and obsolete
inventories, estimates of future sales, examination of historical consumption
rates and the related value of component parts.
Investments: The Company owns marketable securities for which the underlying
cost approximates market value at December 31, 2004 and 2003.
Property, plant and equipment: Property, plant and equipment are recorded at
cost. Depreciation is computed using the straight-line method. Depreciation
included in cost of sales and selling, general and administrative expenses was
$2,222,000, $2,394,000 and $2,564,000 for 2004, 2003 and 2002, respectively.
Maintenance and repairs are charged to operations and additions or improvements
are capitalized. Items of property sold, retired or otherwise disposed of are
removed from the asset and accumulated depreciation accounts and any gains or
losses on disposal are reflected in operations.
25
Excess of cost over net assets acquired (Goodwill) and other intangible assets:
Goodwill represents the amount by which the purchase price and transaction costs
of business the Company has acquired exceed the estimated fair value of the net
tangible assets and separately identifiable assets of these businesses. The
Company adopted Statement of Financial Accounting Standards (SFAS) No. 142
"Goodwill and Other Intangible Assets" on January 1, 2002. Under SFAS No. 142,
goodwill and intangible assets with indefinite useful lives are not amortized,
but are tested at least annually for impairment. Intangible assets with discrete
useful lives (consisting of a royalty agreement) will continue to be amortized
over its remaining life of five years. Amortization included in costs and
expenses was $46,000, $69,000 and $70,000 in 2004, 2003 and 2002, respectively.
Recoverability of long-lived assets: The Company reviews its long-lived assets
periodically to determine potential impairment by comparing the carrying value
of the assets with expected net cash flows expected to be provided by operating
activities of the business or related products. Should the sum of the expected
future net cash flows be less than the carrying value, an impairment loss would
be measured by comparing the amount by which the carrying value exceeds the fair
value of the asset based on market value that is based on the discounted cash
flows expected to be generated by the asset.
Notes payable: The Company has a $10,000,000 line of credit from U.S. Bank. The
Company had no outstanding borrowings against the line of credit at December 31,
2004 and 2003. Interest on borrowings on the credit line is at the bank's
average CD rate plus 1.5% (2.9% at December 31, 2004). The credit agreement
matures June 30, 2005 and is secured by assets of the Company.
Warranty: We provide reserves for the estimated cost of product warranties at
the time revenue is recognized. We estimate the costs of our warranty
obligations based on our warranty policy or applicable contractual warranty,
historical experience of known product failure rates, and use of materials and
service delivery costs incurred in correcting product failures. Management
reviews the estimated warranty liability on a quarterly basis to determine its
adequacy.
The following table presents the changes in the Company's warranty liability for
the year ended December 31, 2004 and 2003, which relates to normal product
warranties and a five year obligation to provide for potential future
liabilities for network equipment sales.
2004 2003
--------- ---------
Beginning Balance $ 659,684 $ 662,672
Actual warranty costs paid (124,368) (568,768)
Amounts charged to expense 375,034 565,780
--------- ---------
Ending balance $ 910,350 $ 659,684
========= =========
Foreign currency translation: The functional currency of Austin Taylor is the
United Kingdom pound. Assets and liabilities denominated in this foreign
currency were translated into U.S. dollars at year-end exchange rates. Revenue
and expense transactions were translated using average exchange rates. The
cumulative foreign currency translation balance is $366,000 and $195,000 at
December 31, 2004 and 2003, respectively.
Revenue recognition: The Company recognizes revenue when the earnings process is
complete, evidenced by persuasive evidence of an arrangement, delivery has
occurred or services have been rendered, the price is fixed or determinable, and
collectibility is reasonably assured. The Company records a provision for sale
returns, sales incentives and warranty costs at the time of the sale based on
historical experience and current trends.
JDL Technologies records revenue on hardware, software and related equipment
sales and installation contracts when the products are installed and accepted by
customer. Revenue under customer service contracts is recognized on a
straight-line basis over the contract period, unless evidence suggests that the
revenue is earned or obligations are fulfilled in a different pattern.
For all other operating businesses, revenue is recognized for domestic and
international sales at the shipping point based on shipping terms of FOB
shipping point. Risk of Loss transfers at the point of shipment and the Company
has no further obligation after such time. These businesses sell products
directly to its customers and through distributors. Payment terms for
distributors are consistent with the terms of the Company's direct customers.
26
Research and development: Research and development consists mostly of outside
testing, equipment and supplies associated with enhancing existing products and
developing new products. Research and development costs are expensed when
incurred and totaled $670,000 in 2004, $607,000 in 2003, and $482,000 in 2002,
respectively.
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 adjusts for the 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 57,573 shares, 16,601
shares, and 1,129 shares in 2004, 2003 and 2002, respectively. The Company
calculates the dilutive effect of outstanding options using the treasury stock
method. The number of shares not included in the computation of diluted earnings
per share because the options' exercise price was greater than the average
market price of common stock during the year for 2004, 2003, and 2002 was
344,200, 905,000 and 1,142,000, respectively
Stock-based employee compensation plans: The Company has adopted the disclosure
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," but
applies APB Opinion No. 25, "Accounting for Stock Issued to Employees" for
measurement and recognition of stock-based transactions with its employees and
accordingly no stock-based employee compensation cost is reflected in the
consolidated statements of income and comprehensive income. If the Company had
elected to recognize compensation cost for its stock based transactions using
the method prescribed by SFAS No. 123, pro forma net income and net income per
share would have been as follows:
Year Ended December 31
---------------------------------------
2004 2003 2002
----------- ----------- -----------
Net Income
As reported $ 4,763,000 $ 2,717,000 $ 2,337,000
Compensation expense, net of tax $ (378,000) $ (558,000) $ (975,000)
Pro forma $ 4,385,000 $ 2,159,000 $ 1,362,000
Earnings Per Share-Basic
As reported $ . 58 $ .33 $ . 28
Pro forma $ .53 $ .26 $ . 17
Earnings Per Share-Diluted
As reported $ . 57 $ .33 $ . 28
Pro forma $ .53 $ .26 $ . 17
Information on the Company's stock-based compensation plans and data used to
calculate compensation expense in the table above are described in more detail
in Note 6.
Basis of presentation: Certain amounts in the 2003 and 2002 financial statements
have been reclassified to conform to the 2004 financial statement presentation.
These reclassifications had no effect on net income or stockholders' equity as
previously reported.
Recently issued accounting pronouncements: In December 2004, the FASB issued
SFAS No. 123(R) (revised 2004), "Share-Based Payment", which amends FASB
Statement No. 123 and will be effective for public companies for interim or
annual periods beginning after June 15, 2005. The new standard will require the
Company to expense employee stock options and other share-based payments. The
Company has not yet determined how it will value future grants or whether it
will elect to adjust prior periods upon adoption of SFAS No. 123 (revised 2004).
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of
ARB No. 43, Chapter 4. This statement amends the guidance in ARB No. 43, Chapter
4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage).
Paragraph 5 of ARB No. 43, Chapter 4, previously stated that "...under some
circumstances, items such as idle facility expense, excessive spoilage, double
freight, and rehandling costs may be so abnormal as to require treatment as
current period charges..." SFAS No. 151 requires that those items be recognized
as current-period charges regardless of whether they meet the criterion of "so
abnormal." In addition, this statement requires that allocation of fixed
production overheads to the costs of conversion be based on the normal capacity
of the production facilities. The provisions of SFAS 151 shall be applied
prospectively and are effective for inventory costs incurred during fiscal years
beginning after June 15, 2005, with earlier application permitted for inventory
costs incurred during fiscal years beginning after the date this Statement was
issued. Management believes the adoption of SFAS No. 151 will not have a
material impact on our financial position and results of operations.
27
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets,
an amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29,
Accounting for Nonmonetary Transactions, is based on the principle that
exchanges of nonmonetary assets should be measured based on the fair value of
assets exchanged. The guidance in that Opinion, however, included certain
exceptions to that principle. This Statement amends Opinion 29 to eliminate the
exception for nonmonetary exchanges of similar productive assets that do not
have commercial substance. A nonmonetary exchange has commercial substance if
the future cash flows of the entity are expected to change significantly as a
result of the exchange. SFAS No. 153 is effective for nonmonetary exchanges
occurring in fiscal periods beginning after June 15, 2005. Management believes
the adoption of SFAS No. 153 will not have a material impact on our financial
position and results of operations.
In December 2004, the FASB staff issued FSP FAS 109-1, "Application of FASB
Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on
Qualified Production Activities Provided by the American Jobs Creation Act of
2004" (the "FSP") to provide guidance on the application of Statement 109 to the
provision within the American Jobs Creation Act of 2004 (the "Act") that
provides tax relief to U.S. domestic manufacturers. The FSP states that the
manufacturers' deduction provided for under the Act should be accounted for as a
special deduction in accordance with Statement 109 and not as a tax rate
reduction. A special deduction is accounted for by recording the benefit of the
deduction in the year in which it can be taken in the company's tax return, and
by not adjusting deferred tax assets and liabilities in the period of the Act's
enactment (which would have been done if the deduction on qualified production
activities were treated as a change in enacted tax rates). The FSP was effective
upon issuance. Management believes the adoption of the FSP will not have a
material impact on our financial position and results of operations.
NOTE 2 - INVENTORIES Inventories consist of:
December 31
--------------------------
2004 2003
------------ ------------
Finished goods $ 15,613,485 $ 14,531,725
Raw and processed materials 8,321,936 9,822,316
------------ ------------
$ 23,935,421 $ 24,354,041
============ ============
NOTE 3 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment and the estimated useful lives are as follows:
December 31
Estimated --------------------------
useful life 2004 2003
----------- ------------ ------------
Land $ 769,683 $ 290,939
Buildings and improvements 7-30 years 4,639,751 3,472,418
Machinery and equipment 3-15 years 26,392,818 25,127,087
Furniture and fixtures 5-10 years 3,061,659 3,441,175
------------ ------------
34,863,911 32,331,619
Less accumulated depreciation (27,823,836) (26,499,908)
------------ ------------
$ 7,040,075 $ 5,831,711
============ ============
NOTE 4 - EMPLOYEE BENEFIT PLANS
The Company has an Employee Savings Plan (401(k)) and matches a percentage of
employee contributions up to six percent of compensation. Contributions to the
plan in 2004, 2003 and 2002 were $356,000, $313,000, and $312,000, respectively.
Effective January 1, 2004, the Company implemented a "Performance Unit Incentive
Plan". The plan provides long term competitive compensation to enable the
Company to attract and retain qualified executive talent and to reward employees
for achieving goals and improving company performance. The plan provides grants
of "performance units" made at the beginning of four year performance periods
and paid at the end of the period if return on asset goals are met. Awards are
made every other year and are given in the form of cash at the end of the cycle
with annual vesting. Payment in the case of retirement, disability or death will
be on a pro rata basis. Every other year a new four-year cycle begins to create
a potential pay out every other year. In 2004, the Company recorded contribution
expense of approximately $450,000, for unpaid contributions.
28
NOTE 5 - COMMITMENTS AND CONTINGENCIES
The Company leases land, buildings and equipment under operating leases with
original terms from 1 to 5 years. Certain of these leases contain renewal and
purchase options. Rent expense charged to operations was $1,198,000 $1,271,000
and $1,135,000 in 2004, 2003 and 2002 respectively. Sublease income received was
$71,000, $62,000 and $57,000 in 2004, 2003 and 2002 respectively. At December
31, 2004, the Company was obligated under noncancellable operating leases to
make minimum annual future lease payments as follows:
Year Ending December 31:
2005 $ 710,000
2006 704,000
2007 227,000
------------
$ 1,641,000
============
As of December 31, 2004, the Company had no other material commitments (either
cancelable or non-cancelable) for capital expenditures or other purchase
commitments related to ongoing operations. The Company' had no outstanding
obligations under its line of credit at December 31, 2004 and 2003. The
Company's entire credit line ($10,000,000 at March 1, 2005) is available for
use.
A former officer of one of the Company's subsidiaries has challenged the
Company's determination of the retirement benefit payable to be provided to the
former officer. The former officer has asserted that, in addition to the
retirement benefit the Company has provided, the Company should also provide a
supplemental retirement benefit of approximately $100,000 per year to the former
officer based on language in his employment contract with the subsidiary and a
related letter delivered by the Company when the former officer entered into the
employment contract. The Company has denied the former officer's claim for a
supplemental retirement benefit. While the former officer has threatened to
commence a lawsuit with respect to his claim, as of the date of this report, the
Company has not received any formal notice that legal proceedings have been
started. If the former officer initiates legal action, the Company will
vigorously defend against any claims that may be asserted.
In the ordinary course of business, the Company is exposed to legal actions and
incurs costs to pursue and defend legal claims. Company management is not aware
of any other outstanding or pending legal actions that would materially affect
the Company's financial position or results of operations.
NOTE 6 - COMMON STOCK AND STOCK OPTIONS
Common shares are reserved in connection with the Company's 1992 stock plan
under which 2,500,000 shares of common stock may be issued pursuant to stock
options, stock appreciation rights, restricted stock or deferred stock granted
to officers and key employees. Exercise prices of stock options under the plan
cannot be less than fair market value of the stock on the date of grant. Rules
and conditions governing awards of stock options, stock appreciation rights and
restricted or deferred stock are determined by the Compensation Committee of the
Board of Directors, subject to certain limitations incorporated into the plan.
At December 31, 2004, 121,779 shares remained available to be issued under the
plan. Options expire five years from date of grant with one-third of the options
vesting after six months and the remaining two-thirds vesting equally over the
next two years.
Shares of common stock are also reserved for issuance in connection with a
nonqualified stock option plan under which up to 200,000 shares may be issued to
nonemployee directors. The plan provides for the automatic grant of nonqualified
options for 3,000 shares of common stock annually to each nonemployee director
concurrent with the annual stockholders' meeting. Exercise price is the fair
market value of the stock at the date of grant. Options granted under this plan
vest when issued and expire 10 years from date of grant. At December 31, 2004,
34,500 shares are available to be issued under the plan.
29
Changes in outstanding employee and director stock options during the three
years ended December 31, 2004 were as follows:
Weighted
average
Number of exercise price
shares per share
Outstanding at December 31, 2001 1,077,811 $ 13.01
Granted 248,500 8.42
Exercised (1,700) 6.27
Canceled (158,457) 13.20
------------
Outstanding at December 31, 2002 1,166,234 12.02
Granted 270,250 7.21
Exercised (1,700) 7.05
Canceled (275,828) 13.50
------------
Outstanding at December 31, 2003 1,158,956 10.54
Granted 312,750 9.31
Exercised (263,170) 8.51
Canceled (185,511) 10.03
------------
Outstanding at December 31, 2004 1,023,025 10.72
============
At December 31, 2004, 774,264 stock options are currently exercisable at a
weighted average price of $9.93. The following table summarizes the status of
Communications Systems, Inc. stock options outstanding at December 31, 2004:
Weighted Average Weighted
Remaining Average
Range of Exercise Prices Shares Option Life Exercise Price
- ------------------------ --------- ----------- -------------
$ 7.14 to $ 9.99 660,725 3.4 years $ 8.12
$10.00 to $12.00 68,100 1.0 years 11.37
$12.01 to $14.99 68,500 4.3 years 13.51
$15.00 to $18.56 225,700 .6 years 17.02
On October 29, 1999 the Board of Directors adopted a shareholders' rights plan.
Under this plan, the Board of Directors declared a distribution of one right per
share of common stock. Each right entitles the holder to purchase 1/100th of a
share of a new series of Junior Participating Preferred Stock of the Company at
an initial exercise price of $65. The rights expire on October 26, 2009. The
rights will become exercisable only following the acquisition by a person or
group, without the prior consent of the Board of Directors, of 15% or more of
the Company's voting stock, or following the announcement of a tender offer or
exchange offer to acquire an interest of 15% or more. If the rights become
exercisable, each rightholder will be entitled to purchase, at the exercise
price, common stock with a market value equal to twice the exercise price.
Should the Company be acquired, each right would entitle the holder to purchase,
at the exercise price, common stock of the acquiring company with a market value
equal to twice the exercise price. Any rights owned by the acquiring person or
group would become void.
The fair value of the Company's stock options and Employee Stock Purchase Plan
transactions used to compute pro forma net income and net income per share
disclosures is the estimated present value at grant date using the Black-Scholes
option-pricing model. The following table displays the assumptions used in the
model.
Year Ended December 31
--------------------------------------
2004 2003 2002
------- ------- -------
Expected volatility 37% 33% 33%
Risk free interest rate 2.9% 2.6% 4.6%
Expected holding period - employees 4 years 4 years 4 years
Expected holding period - directors 7 years 7 years 7 years
Dividend yield 2.0% 2.2% 1.9%
Information regarding the effect on net income and earnings per common share had
the Company applied the fair value expense recognition provisions of SFAS No.
123 is included in Note 1.
30
EMPLOYEE STOCK PURCHASE PLAN
The Company maintains an Employee Stock Purchase Plan for which 300,000 common
shares have been reserved. Under the terms of the plan, employees may acquire
shares of common stock, subject to limitations, through payroll deductions at
85% of the lower of fair market value for such shares on one of two specified
dates in each plan year. Shares issued to employees under the plan were 22,193,
23,172 and 36,276 for the plan years ended August 31, 2004, 2003 and 2002,
respectively. At December 31, 2004 employees had subscribed to purchase an
additional 22,604 shares in the current plan year ending August 31, 2004.
EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)
All eligible employees of the Company participate in the ESOP after completing
one year of service. Contributions are allocated to each participant based on
compensation and vest 30% after three years of service and incrementally
thereafter, with full vesting after seven years. At December 31, 2004, the ESOP
held 332,500 shares of the Company's common stock, all of which have been
allocated to the accounts of eligible employees. Contributions to the plan are
determined by the Board of Directors and can be made in cash or shares of the
Company's stock. The Company's 2004 ESOP contribution was $426,564 for which the
Company issued 35,000 shares of common stock to the ESOP in March 2005. The 2003
ESOP contribution was $264,374 for which the Company issued 33,000 shares in
February 2004. The 2002 ESOP contribution was $255,040 for which the Company
issued 32,000 shares in February 2003.
PURCHASES OF COMMUNICATIONS SYSTEMS, INC. COMMON STOCK
The Company's Board of Directors has authorized the purchase and retirement,
from time to time, of shares of the Company's stock on the open market, or in
private transactions consistent with overall market and financial conditions. In
2004, the Company purchased and retired 1,034 shares at a cost of $8,500. In
2003, the Company purchased and retired 14,217 shares at a cost of $98,000. In
2002, the Company purchased and retired 182,574 shares at a cost of $1,193,000.
At December 31, 2004, 282,433 additional shares could be repurchased under
outstanding Board authorizations.
NOTE 7 - INCOME TAXES
Income tax expense from continuing operations consists of the following:
Year Ended December 31
----------------------------------------
2004 2003 2002
----------- ----------- -----------
Currently payable income taxes (benefit):
Federal $ 1,884,000 $ (890,000) $ 2,000,000
State 260,000 106,000 260,000
Puerto Rico 133,000 161,000
Foreign 45,000 53,000 42,000
----------- ----------- -----------
2,189,000 (598,000) 2,463,000
Deferred income taxes (benefit) 579,000 2,216,000 (905,000)
----------- ----------- -----------
$ 2,768,000 $ 1,618,000 $ 1,558,000
=========== =========== ===========
The bulk of Suttle's operations were located in Puerto Rico until December 2001.
In 2002, the Company determined that these operations were no longer cost
effective and ultimately terminated its Puerto Rico operations completely in May
of 2003. The Company's earnings in Puerto Rico were sheltered from U.S. income
tax by the possessions tax credit (Internal Revenue Code Section 936). The
amount of the possessions tax credit was limited to a percentage of the
Company's Puerto Rico payroll and depreciation. The possessions tax credit has
had a materially favorable effect on the Company's income tax expense in years
prior to 2002.
The Company has revoked its Section 936 election effective January 1, 2002 and
has included all subsequent Puerto Rico operations in its consolidated federal
income tax group. As a result, the Company expects its corporate income tax rate
on current and future earnings to continue to more closely match normal U.S.
income tax rates. The effective tax rate in 2004 and 2003 was approximately 37%
and 40% in 2002.
31
Distributions by Suttle Caribe, Inc. to the parent company of income earned
prior to December 31, 2000 are subject to a tollgate tax at rates which,
depending on various factors, range from 3.5% to 10%. The cumulative amount of
prior earnings on which no tollgate tax has been recognized was approximately
$11,054,000 at December 31, 2004. Tollgate taxes of approximately $860,000 have
been accrued and will likely be paid on these prior earnings in 2005.
Austin Taylor Communications, Ltd. operates in the U.K. and is subject to U.K.
rather than U.S. income taxes. U.K. pretax loss was $438,000, $1,566,000, and
$349,000 in 2004, 2003 and 2002, respectively. No benefit was recorded for these
losses due to the uncertainty of generating taxable income in the future. Suttle
Costa Rica, S.A. operates in Costa Rica and is currently exempt from Costa Rica
income taxes. Accumulated earnings in Costa Rica on which no U.S. income tax has
been accrued was $3,122,000 at December 31, 2004. It is the Company's intention
to reinvest the remaining undistributed earnings of its Costa Rica subsidiaries
to support the continued operation of those subsidiaries.
The provision for income taxes varied from the federal statutory tax rate as
follows:
Year Ended December 31
-----------------------------------
2004 2003 2002
------- ------- -------
Tax at U.S. statutory rate 35.0% 35.0% 35.0%
Surtax exemption (1.0) (1.0) (1.0)
U.S. taxes not provided on
Puerto Rico operations (1.3)
State income taxes, net of
federal benefit 2.3 1.6 4.4
Other .5 1.7 2.9
------- ------- -------
Effective tax rate 36.8% 37.3% 40.0%
======= ======= ======
Deferred tax assets and liabilities as of December 31 related to the following:
2004 2003
----------- -----------
Current assets:
Bad debts $ 421,323 $ 414,756
Inventory 1,345,097 1,376,968
Accrued expenses 1,347,918 891,145
----------- -----------
$ 3,114,338 $ 2,682,869
=========== ===========
Long term assets and (liabilities):
Depreciation $ (507,929) $ (361,117)
Net operating loss carryforward 799,746 799,897
Excess of cost over net assets 278,632 375,495
Other (1,412) (2,550)
Alternative minimum tax credits 441,032
Foreign net operating loss carryforward 1,039,542 890,765
Less: valuation reserve for foreign net
operating loss carryforward (1,039,542) (890,765)
----------- -----------
$ 569,037 $ 1,252,757
=========== ===========
As part of the LANart acquisition, the Company purchased net operating loss
carryforwards in the amount of $3,416,000. As part of the Image Systems
Corporation acquisition, the Company purchased net operating loss carryforwards
in the amount of $374,000. At December 31, 2004, the Company has $2,352,000
available net operating loss carryforwards for income tax purposes, of which the
majority expire in 2014.
NOTE 8 - ACQUISITIONS
Effective March 24, 2004, the Company acquired substantially all the outstanding
shares of Image Systems Corporation for a cash purchase price per share of
approximately $2.8 million in total consideration. Image Systems Corporation
(Image Systems), located in Minnetonka, Minnesota designs, manufactures and
markets high-resolution display solutions and accessories for customers in the
medical imaging market or for other customers who have stringent and or unique
display requirements. In addition, Image Systems has been a premier developer of
video graphics products since 1988. The proforma effects of the Image Systems
Corporation acquisition on our consolidated financial statements were not
material to the Company's consolidated financial statements. The acquisition and
operations of Image Systems are included in the Company's consolidated financial
results from the purchase date March 24, 2004. The sum of amounts assigned to
assets acquired and liabilities assumed exceeded the cost of the acquired
entity. To account for this excess, the amounts assigned to individual property,
plant and equipment were reduced on a pro-rata basis. In the acquisition, the
estimated fair value of the following assets were acquired and liabilities
assumed:
32
Property, plant and equipment $ 1,434,000
Accounts receivable 576,297
Inventory 716,999
Cash 103,625
Other assets 27,770
Deferred tax asset 481,000
Accounts payable (180,162)
Accrued expenses (254,221)
-----------
Total purchase price 2,905,308
Less cash acquired (103,625)
-----------
Payment for purchase of Image Systems Corp.,
net of cash acquired $ 2,801,683
===========
Effective March 25, 2002, the Company acquired substantially all the assets of
MiLAN Technology Corporation for approximately $8,100,000 in cash. MiLAN,
located in Sunnyvale, California is a manufacturer of media and rate conversion
products, which permit telecommunications networks to move information between
copper-wired equipment and fiber-optic cable. In addition, MiLAN is also a
supplier of wireless access points, bridges and other networking products. The
acquisition was accounted for as a purchase and operations of MiLAN have been
included in consolidated operations from March 25, 2002.
The fair value of net assets acquired in the transaction were allocated as
follows:
Equipment and fixtures $ 5,120
Identifiable intangible asset (royalty agreement) 201,341
Excess of cost over net assets acquired 635,046
Accounts receivable 2,426,713
Inventory 5,121,936
Accrued expenses (262,405)
-----------
Total purchase price $ 8,127,751
===========
NOTE 9 - GOODWILL
On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets." Under this statement goodwill as well as other intangibles
determined to have an infinite life will no longer be amortized; however, these
assets will be reviewed for impairment on a periodic basis. Statement No. 142
also includes provisions for the reclassification of certain existing recognized
intangibles as goodwill, reclassification of certain intangibles out of
previously reported goodwill and the identification of reporting units for
purposes of assessing potential future impairments of goodwill. Management
assessed the fair value of the business units to determine whether goodwill
carried on the financial statements was impaired and the extent of such
impairment, if any, using the discounted cash flows method. Based upon these
assessments, management determined that the current goodwill balances were not
impaired. Management will continue to reassess the value of our business units
and related goodwill balances at the beginning of each year or at other times if
events have occurred or circumstances exist that indicate the carrying amount of
goodwill may not be recoverable. As of December 31, 2004, 2003 and 2002 the
Company had net goodwill of $5,264,000, $5,254,000 and $5,254,000, respectively.
Carrying amounts of goodwill by segment as of December 31, 2004 is as follows:
Suttle $1,198,000; Transition Networks/MiLAN Technology $3,362,000; JDL
Technologies $704,000.
NOTE 10- INFORMATION CONCERNING INDUSTRY SEGMENTS AND MAJOR CUSTOMERS
The Company classifies its businesses into five 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 and
MiLAN Technology, 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; Other includes Image Systems Corporation,
(substantially all assets purchased March 24, 2004) which designs, manufactures
and markets high-resolution display solutions and accessories for customers in
the medical imaging market and non-allocated corporate general and
administrative expenses.
33
Suttle products are sold principally to United States (U.S.) customers. Suttle
operates manufacturing facilities in the U.S. and Costa Rica. Net long-lived
assets held in Costa Rica was approximately $796,000 at December 31, 2004.
Austin Taylor operates in the United Kingdom (U.K.). Net long-lived assets held
in the U.K. were approximately $751,000 as of December 31, 2004. Transition
Networks manufactures its products in the United States and makes sales in both
the U.S. and U.K. markets. JDL Technologies operates in the U.S. and makes sales
in the U.S. and Latin America. Consolidated sales to U.S. customers were
approximately 83%, 83% and 80% of total consolidated sales in 2004, 2003 and
2002 respectively. At December 31, 2004, foreign earnings in excess of amounts
received in the United States were approximately $4,268,000. In addition, the
cumulative amount of prior earnings of Suttle Caribe, Inc. on which no Puerto
Rico tollgate tax has been recognized was approximately $11,054,000 at December
31, 2004. Tollgate taxes of approximately $860,000 will be paid on these
undistributed earnings in 2005.
In 2004, 2003 and 2002, no customer accounted for more than 10% of consolidated
sales.
Information concerning the Company's operations in the various segments for the
twelve-month periods ended December 31, 2004, 2003 and 2002 is as follows:
Austin Transition JDL
Suttle Taylor Networks/MiLAN Technologies Other Consolidated
------------ ----------- -------------- ------------ ------------ -------------
Year Ended December 31, 2004:
Sales $ 40,113,856 $ 8,028,637 $ 52,443,162 $ 7,969,266 $ 2,224,017 $ 110,778,938
Cost of sales 30,152,990 7,754,063 31,269,300 3,770,390 1,348,660 74,295,403
------------ ----------- -------------- ------------ ------------ -------------
Gross profit 9,960,866 274,574 21,173,862 4,198,876 875,357 36,483,535
Selling, general and
administrative expenses 5,200,954 724,669 16,640,427 3,014,603 3,539,114 29,119,767
------------ ----------- -------------- ------------ ------------ -------------
Operating income (loss) $ 4,759,912 $ (450,095) $ 4,533,435 $ 1,184,273 $ (2,663,757) $ 7,363,768
============ =========== ============== ============ ============ =============
Depreciation and amortization $ 1,329,184 $ 306,243 $ 314,822 $ 162,577 $ 158,743 $ 2,271,569
============ =========== ============== ============ ============ =============
Assets $ 37,816,232 $ 5,138,412 $ 27,763,013 $ 4,959,613 $ 13,803,801 $ 89,481,071
============ =========== ============== ============ ============ =============
Capital expenditures $ 565,264 $ 72,134 $ 562,335 $ 730,953 $ 46,062 $ 1,976,748
============ =========== ============== ============ ============ =============
Year Ended December 31, 2003:
Sales $ 32,900,406 $ 6,639,806 $ 51,002,074 $ 11,868,215 $ - $ 102,410,501
Cost of sales 26,289,518 6,927,830 32,417,775 7,313,726 72,948,849
------------ ----------- -------------- ------------ ------------ -------------
Gross profit (loss) 6,610,888 (288,024) 18,584,299 4,554,489 29,461,652
Selling, general and
administrative expenses 4,597,156 1,278,106 14,259,542 3,454,170 1,852,509 25,441,483
------------ ----------- -------------- ------------ ------------ -------------
Operating income (loss) $ 2,013,732 $(1,566,130) $ 4,324,757 $ 1,100,319 $ (1,852,509) $ 4,020,169
============ =========== ============== ============ ============ =============
Depreciation and amortization $ 1,485,244 $ 325,187 $ 290,625 $ 207,790 $ 154,632 $ 2,463,478
============ =========== ============== ============ ============ =============
Assets $ 33,807,848 $ 5,340,985 $ 29,085,325 $ 6,866,954 $ 3,994,846 $ 79,095,958
============ =========== ============== ============ ============ =============
Capital expenditures $ 352,500 $ 143,403 $ 144,925 $ 52,462 $ 21,301 $ 714,591
============ =========== ============== ============ ============ =============
Year Ended December 31, 2002:
Sales $ 33,158,835 $ 7,138,507 $ 49,010,021 $ 17,992,494 $ - $ 107,299,857
Cost of sales 28,010,474 6,447,388 32,122,860 12,167,438 78,748,160
------------ ----------- -------------- ------------ ------------ -------------
Gross profit 5,148,361 691,119 16,887,161 5,825,056 28,551,697
Selling, general and
administrative expenses 5,857,979 1,068,505 12,528,377 3,424,067 1,733,044 24,611,972
------------ ----------- -------------- ------------ ------------ -------------
Operating income (loss) $ (709,618) $ (377,386) $ 4,358,784 $ 2,400,989 $ (1,733,044) $ 3,939,725
============ =========== ============== ============ ============ =============
Depreciation and amortization $ 1,676,270 $ 418,669 $ 317,539 $ 127,131 $ 94,062 $ 2,633,671
============ =========== ============== ============ ============ =============
Assets $ 47,661,213 $ 5,262,680 $ 24,806,207 $ 4,258,465 $ 6,769,927 $ 88,758,492
============ =========== ============== ============ ============ =============
Capital expenditures $ 559,418 $ 251,922 $ 555,655 $ 281,747 $ 91,478 $ 1,740,220
============ =========== ============== ============ ============ =============
34
(b) SUPPLEMENTAL FINANCIAL INFORMATION
Unaudited Quarterly Operating Results
(in thousands except per share amounts)
Quarter Ended
March 31 June 30 Sept 30 Dec 31
- -------------------------------------------------------------------------------
2004
Sales $ 25,249 $ 27,134 $ 29,261 $ 29,135
Gross Margins 7,936 9,071 9,977 9,499
Operating income 1,115 1,603 2,504 2,141
Net Income 723 990 1,538 1,511
Basic Net Income per Share $ .09 $ .12 $ .19 $ .18
Diluted Net Income per Share $ .09 $ .12 $ .19 $ .17
2003
Sales $ 26,575 $ 24,869 $ 24,666 $ 26,300
Gross Margins 7,406 7,415 6,551 8,090
Operating income 1,184 746 562 1,528
Net Income 723 628 447 919
Basic Net Income per Share $ .09 $ .08 $ .05 $ .11
Diluted Net Income per Share $ .09 $ .08 $ .05 $ .11
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company, under the supervision and with the participation of management,
including the Chief Executive Officer ("CEO") and Chief Financial Officer
("CFO"), evaluated the effectiveness of the design and operation of the
Company's disclosure controls and procedures (as defined in Rule 13a - 15(e)
under the Securities Exchange Act of 1934) as of the end of the period covered
by this report. Based on that evaluation, the CEO and CFO concluded that, as of
the end of the period covered by this report, the Company's disclosure controls
and procedures are operating effectively and are adequately designed to ensure
that information required to be disclosed in the reports filed or submitted
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified in the applicable rules and forms and is accumulated
and communicated to management, including the CEO and CFO, as appropriate to
allow timely decisions regarding required disclosure. During the period covered
by this Report there was no change in the Company's internal control over
financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by paragraphs [a], [c], [d], [e], and [f] of Item 401
under Regulation S-K, to the extent applicable, will be set forth under the
caption "Election of Directors" in the Company's definitive proxy material for
its May 24, 2005 Annual Meeting of Shareholders to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated by reference herein. The information called for by paragraph [b] of
Item 401 is set forth under Item 1[c] herein. The information called for by Item
405 under Regulation S-K, to the extent applicable, will be set forth under the
caption "Certain Transactions" in the Company's above referenced definitive
proxy material.
35
Code of Ethics
The Company has adopted a code of Ethics applicable to all officers of the
Company as well as certain other key accounting personnel. A copy of the Code of
Ethics can be obtained free of charge upon written request directed to the
Company's Assistant Secretary at the executive offices of the Company.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 402 under Regulation S-K to the extent
applicable, will be set forth under the caption "Executive Compensation" in the
Company's definitive proxy materials for its May 24, 2005 Annual Meeting to be
filed within 120 days from the end of the Registrant's fiscal year, which
information is expressly incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 403 under Regulation S-K will be set forth
under the captions "Security Ownership of Certain Beneficial Owners and
Management" and "Election of Directors" in the Company's definitive proxy
materials for its May 24, 2005 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
Securities Authorized For Issuance Under Equity Compensations Plans
(a) (b) (c)
Number of shares of
Number of shares of common stock remaining
common stock to be available for future
issued upon exercise Weighted-average issuance under equity
of outstanding exercise price of compensation plans
options, warrants and outstanding options, excluding shares in
Plan Category (1) rights warrants and rights column (a))
- --------------- ------------------ ------------------ ---------------------
Equity compensation plans approved
by security holders:
1992 Stock Plan 1,023,025 $ 10.72 156,279
1990 Employee Stock Purchase Plan 22,604 $ 6.84 56,274
Equity compensation plans not approved by security holders:
None
(1) The Company does not have individual compensation arrangements involving
the granting of options, warrants and rights.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 404 under Regulation S-K will be set forth
under the caption "Certain Transactions" in the Company's definitive proxy
materials for its May 24, 2005 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information called for by Item 14 Of Form 10K and 9(e) of Schedule 14A will
be set forth under the caption " Principal Accountant Fees and Services in the
Company's definitive proxy materials for its May 24, 2005 Annual Meeting to be
filed within 120 days from the end of the Registrant's fiscal year, which
information is expressly incorporated herein by reference.
36
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8K
(a) (1) Consolidated Financial Statements
The following Consolidated Financial Statements of Communications Systems, Inc.
and subsidiaries appear at pages 19 to 34 herein:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Income and Comprehensive Income for the years
ended December 31, 2004, 2003 and 2002
Consolidated Statements of Changes in Stockholders' Equity for the
years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
(a) (2) Consolidated Financial Statement Schedule
The following financial statement schedule is being filed as part of this Form
10-K Report:
Consent of Independent Registered Public Accounting Firm
Schedule II - Valuation and Qualifying Accounts and Reserves
All other schedules are omitted as the required information is inapplicable or
the information is presented in the consolidated financial statements or related
notes.
(a) (3) Exhibits
The exhibits which accompany or are incorporated by reference in this report,
including all exhibits required to be filed with this report pursuant to Item
601 of Regulation S-K including each management or compensatory plan or
arrangement are described on the Exhibit Index, which begins on page 41 of the
sequential numbering system used in this report.
(b) REPORTS ON FORM 8-K FILED DURING THE THREE MONTHS ENDED DECEMBER 31, 2004
Form 8-K filed relative to the Company's 2004 third quarter earnings release
issued in November 2004.
37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COMMUNICATIONS SYSTEMS, INC.
Dated: March 29, 2005 /s/ Curtis A.Sampson
-----------------------------------
Curtis A. Sampson, Chairman of the
Board of Directors and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated:
Each person whose signature appears below constitutes and appoints
CURTIS A. SAMPSON and PAUL N. HANSON as his true and lawful attorneys-in-fact
and agents, each acting alone, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this Annual Report on Form 10-K and
to file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, each acting alone, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all said attorneys-in-fact
and agents, each acting alone, or his substitute or substitutes, may lawfully do
or cause to be done by virtue thereof.
Signature Title Date
- ----------------------- ---------------------------------- --------------
/s/Curtis A.Sampson Chairman of the Board of Directors, March 29, 2005
- ----------------------- and Director (Principal Executive
Curtis A. Sampson Officer)
/s/Paul N. Hanson Vice President, Treasurer and March 29, 2005
- ----------------------- Chief Financial Officer (Principal
Paul N. Hanson Financial Officer and Principal
Accounting Officer)
/s/Randall D. Sampson Director March 29, 2005
- -----------------------
Randall D. Sampson
/s/Edwin C. Freeman Director March 29, 2005
- ----------------------
Edwin C. Freeman
/s/Luella G. Goldberg Director March 29, 2005
- -----------------------
Luella Gross Goldberg
/s/Frederick M. Green Director March 29, 2005
- -----------------------
Frederick M. Green
/s/Gerald D. Pint Director March 29, 2005
- -----------------------
Gerald D. Pint
/s/Paul J. Anderson Director March 29, 2005
- -----------------------
Paul J. Anderson
/s/Wayne E. Sampson Director March 29, 2005
- -----------------------
Wayne E. Sampson
38
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
COMMUNICATIONS SYSTEMS, INC.
FOR
YEAR ENDED DECEMBER 31, 2004
----------------------------
FINANCIAL STATEMENT SCHEDULE
- --------------------------------------------------------------------------------
39
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Schedule II - Valuation and Qualifying Accounts and Reserves
Balance at Additions Deductions Other Balance
Beginning of Charged to Cost from Changes at End
Description Period and Expenses Reserves Add (Deduct) of Period
Allowance for doubtful accounts:
Year ended:
December 31, 2004 $ 1,423,000 $ 329,000 $ (349,000) (A) $ 24,000 (B) $ 1,427,000
December 31, 2003 $ 1,294,000 $ 129,000 (A) $ 1,423,000
December 31, 2002 $ 1,064,000 $ 88,000 $ (91,000) (A) $ 233,000 (B) $ 1,294,000
Reserve for assets transferred under contractual arrangements and notes receivable:
Year Ended:
December 31, 2004 $ - $ - $ - $ -
December 31, 2003 $ 434,000 $ - $ (434,000) $ -
December 31, 2002 $ 434,000 $ - $ - $ 434,000
- ----------------------------------
(A) Accounts determined to be uncollectible and charged off against reserve.
(B) Result of acquisitions
40
COMMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Exhibit Index To
Form 10-K for the Year Ended December 31, 2004
Regulation S-K Location in Consecutive Numbering
Exhibit Table System as Filed With the
Reference Title of Document Securities and Exchange Commission
- ------------- ----------------- ----------------------------------
3.1 Articles of Incorporation, as Filed as Exhibit 3.1 to the Form
amended 10-K of the Company for its year
ended December 31, 1989 (the "1989
Form 10-K") and incorporated
herein by reference.
3.2 Bylaws, as amended Filed as Exhibit 3.2 to the 1989
Form 10-K and incorporated herein
by reference.
10.1 1987 Stock Plan Filed as Exhibit 10.1 to the Form
10-K Report of the Company for its
year ended December 31, 1993 (the
"1993 Form 10-K") and incorporated
herein by reference.
10.2 Employee Savings Plan Filed as Exhibit 10.2 to the 1993
Form 10-K and incorporated herein
by reference.
10.3 Employee Stock Ownership Filed as Exhibit 10.3 to the 1993
Plan Form 10-K and incorporated herein
by reference.
10.4 Employee Stock Purchase Plan Filed as Exhibit 10.4 to the 1993
Form 10-K and incorporated herein
by reference.
10.5 Stock Option Plan for Filed as Exhibit 10.5 to the 1993
Nonemployee Directors Form 10-K and incorporated herein
by reference.
10.6 1992 Stock Plan Filed as Exhibit 10.6 to the 1993
Form 10-K and incorporated herein
by reference.
10.7 Flexible Benefit Plan Filed as Exhibit 10.7 to the 1993
Form 10-K and incorporated herein
by reference.
10.8 Supplemental Executive Filed as Exhibit 10.8 to the 1993
Retirement Plan Form 10-K and incorporated herein
by reference.
10.9 Form of Rights Agreement, Filed as Exhibit 1 to the
dated as of October 26, 1999 Company's Form 8-A on November 8,
between the Company and 1999 and incorporated herein by
Wells Fargo Bank Minnesota, reference.
National Association
21 Subsidiaries of the Registrant Filed herewith.
23 Independent Auditors' Consent Filed herewith.
24 Power of Attorney Included in signatures at page 38.
31.1 Certification of Chief
Executive Officer Filed herewith.
31.2 Certification of Chief
Financial Officer Filed herewith.
32 Certification under U.S.C.
ss. 1350 Filed herewith.
The exhibits referred to in this Exhibit Index will be supplied to a shareholder
at a charge of $.25 per page upon written request directed to CSI's Assistant
Secretary at the executive offices of the Company.
41