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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2002
--------------------------------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number: 0-10355
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COMMUNICATIONS SYSTEMS, INC.
.................................................................................
(Exact name of registrant as specified in its charter)
MINNESOTA 41-0957999
.................................................................................
(State or other jurisdiction of (Federal Employer
incorporation or organization) Identification No.)
213 South Main Street, Hector, MN 55342
.................................................................................
(Address of principal executive offices) (Zip Code)
(320) 848-6231
.................................................................................
Registrant's telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS Outstanding at July 31, 2002
- -------------------------------------- -----------------------------
Common Stock, par value $.05 per share 8,277,741
Total Pages (15) Exhibit Index at (NO EXHIBITS)
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COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
INDEX
Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income and Comprehensive Income 4
Consolidated Statements of Changes in Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11
Part II. Other Information 15
2
PART I. FINANCIAL INFORMATION
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
June 30 December 31
2002 2001
------------ ------------
Assets:
Current assets:
Cash $ 21,966,994 $ 22,239,883
Trade receivables, net 20,290,863 19,182,828
Inventories 27,205,404 24,931,739
Note Receivable 2,765,390
Deferred income taxes 2,716,405 2,176,405
Other current assets 290,012 556,906
------------ ------------
Total current assets 72,469,678 71,853,151
Property, plant and equipment 34,058,488 32,955,036
less accumulated depreciation (26,251,624) (24,818,363)
------------ ------------
Net property, plant and equipment 7,806,864 8,136,673
Other assets:
Excess of cost over net assets acquired 5,295,585 4,638,068
Deferred income taxes 3,070,027 3,070,027
Other assets 344,804 313,884
------------ ------------
Total other assets 8,710,416 8,021,979
------------ ------------
Total Assets $ 88,986,958 $ 88,011,803
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable $ 7,000,000 $ 9,000,000
Accounts payable 6,430,529 5,567,390
Accrued expenses 3,941,448 3,890,113
Deferred revenue 3,133,149
Income taxes payable 1,374,898 2,246,299
------------ ------------
Total current liabilities 21,880,024 20,703,802
Stockholders' Equity 67,106,934 67,308,001
------------ ------------
Total Liabilities and Stockholders' Equity $ 88,986,958 $ 88,011,803
============ ============
See notes to consolidated financial statements.
3
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF (LOSS) INCOME AND COMPREHENSIVE (LOSS) INCOME
(unaudited)
Three Months Ended June 30 Six Months Ended June 30
------------------------------- -------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Sales $ 27,174,589 $ 25,681,533 $ 51,094,929 $ 48,775,810
Costs and expenses:
Cost of sales 22,539,883 18,733,338 40,083,612 35,185,584
Selling, general and
administrative expenses 6,163,756 6,569,156 11,889,018 13,008,979
------------ ------------ ------------ ------------
Total costs and expenses 28,703,639 25,302,494 51,972,630 48,194,563
------------ ------------ ------------ ------------
Operating income (loss) (1,529,050) 379,039 (877,701) 581,247
Other income and (expenses):
Investment income 54,530 226,365 130,434 469,503
Interest expense (57,696) (160,170) (150,093) (340,788)
------------ ------------ ------------ ------------
Other income, (expense) net (3,166) 66,195 (19,659) 128,715
Income (loss) before income taxes (1,532,216) 445,234 (897,360) 709,962
Income taxes (benefit) (490,000) 130,000 (325,000) 210,000
------------ ------------ ------------ ------------
Net income (loss) (1,042,216) 315,234 (572,360) 499,962
------------ ------------ ------------ ------------
Other comprehensive income (loss):
Unrealized holding gain (loss)
on debt securities (22,838) 5,288
Foreign currency
translation adjustment 263,982 (5,386) 196,332 (185,437)
------------ ------------ ------------ ------------
Other comprehensive income ( loss)
before income taxes 263,982 (28,224) 196,332 (180,149)
Income tax expense (benefit) related
to unrealized loss on debt securities (7,916) 1,798
------------ ------------ ------------ ------------
263,982 (20,308) 196,332 (181,947)
------------ ------------ ------------ ------------
Comprehensive income (loss) $ (778,234) $ 294,926 $ (376,028) $ 318,015
============ ============ ============ ============
Basic net income (loss) per share $ (.13) $ .04 $ (.07) $ .06
Diluted net income (loss) per share $ (.13) $ .04 $ (.07) $ .06
Average Basic Shares Outstanding 8,264,487 8,391,380 8,263,918 8,425,243
Average Dilutive Shares Outstanding 8,267,646 8,400,278 8,270,100 8,445,937
See notes to consolidated financial statements.
4
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(unaudited)
Cumulative
Common Stock Additional Other
--------------------- Paid-in Retained Comprehensive
Shares Amount Capital Earnings Income (Loss) Total
--------- --------- ----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 2000 8,616,909 $ 430,846 $ 28,877,135 $ 42,309,918 $ (350,971) $ 71,266,928
Net income 712,249 712,249
Issuance of common stock under
Employee Stock Purchase Plan 15,657 783 82,363 83,146
Issuance of common stock to
Employee Stock Ownership Plan 25,000 1,250 219,075 220,325
Purchase of stock (395,252) (19,763) (1,323,044) (1,885,563) (3,228,370)
Shareholder dividends (1,673,467) (1,673,467)
Other comprehensive loss (72,810) (72,810)
--------- --------- ----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 2001 8,262,314 413,116 27,855,529 39,463,137 (423,781) 67,308,001
Net loss (572,360) (572,360)
Issuance of common stock to
Employee Stock Ownership Plan 25,000 1,250 187,250 188,500
Issuance of common stock under
Employee Stock Option Plan 1,700 85 11,645 11,730
Purchase of stock (2,762) (138) (9,333) (15,798) (25,269)
Other comprehensive income 196,332 196,332)
--------- --------- ----------- ----------- ----------- -----------
BALANCE AT JUNE 30, 2002 8,286,252 $ 414,313 $ 28,045,091 $ 38,874,979 $ (227,449) $ 67,106,934
========= ========= =========== =========== =========== ===========
See notes to consolidated financial statements.
5
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended June 30
--------------------------------
2002 2001
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (572,360) $ 499,962
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 1,570,744 2,617,515
Changes in assets and liabilities net of effects of the
purchase of MiLAN Technology Corporation:
Trade receivables 1,524,624 4,600,361
Inventories 2,920,977 (147,924)
Other current assets 266,929 210,409
Accounts payable 791,746 (191,829)
Accrued expenses and deferred revenue 2,909,116 (285,250)
Income taxes payable (1,411,407) (137,162)
------------ ------------
Net cash provided by operating activities 8,000,369 7,166,082
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (935,740) (712,192)
Maturities of mortgage-backed and other investment securities 5,747,354
Other assets (68,766) 18,661
Collection of notes receivable 2,765,390 200,000
Payment for purchase of MiLAN Technology Corporation (8,058,932)
------------ ------------
Net cash provided by (used in) investing activities (6,298,048) 5,253,823
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable (2,000,000) (20,882)
Dividends paid (1,717,643)
Proceeds from issuance of stock 11,730
Purchase of stock (25,269) (2,344,302)
------------ ------------
Net cash used in financing activities (2,013,539) (4,082,827)
------------ ------------
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH 38,329 15,134
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (272,889) 8,352,212
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 22,239,883 11,321,374
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 21,966,994 $ 19,673,586
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 455,641 $ 347,969
Interest paid 211,617 377,716
See notes to consolidated financial statements.
6
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - CONSOLIDATED FINANCIAL STATEMENTS
The balance sheet and statement of changes in stockholders' equity as of June
30, 2002, the statements of (loss) income and comprehensive (loss) income for
the three and six month periods ended June 30, 2002 and 2001 and the statements
of cash flows for the six-month periods ended June 30, 2002 and 2001 have been
prepared by the Company without audit. In the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the financial position, results of operations, and cash flows at
June 30, 2002 and 2001 and for the six months then ended have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested these condensed financial
statements be read in conjunction with the financial statements and notes
thereto included in the Company's December 31, 2001 Annual Report to
Shareholders. The results of operations for the periods ended June 30 are not
necessarily indicative of the operating results for the entire year.
In February 2002, the Company issued 25,000 shares of the Company's common stock
to the Employee Stock Ownership Plan in payment of its 2001 obligation. In a
noncash transaction, the Company recorded additional stockholders' equity of
$188,500 (reflecting the market value of the stock at the time of the
contribution) and reduced accrued expenses by the same amount.
NOTE 2 - NET INCOME PER SHARE
Basic net (loss) income per common share is based on the weighted average number
of common shares outstanding during each year. Diluted net (loss) income per
common share takes into effect the dilutive effect of potential common shares
outstanding. The Company's only potential common shares outstanding are stock
options. The Company calculates the dilutive effect of outstanding options using
the treasury stock method.
NOTE 3 - ACQUISITIONS
Effective March 25, 2002 the Company acquired substantially all of the assets
and assumed certain liabilities of Digi International Inc.'s MiLAN legacy
business. The business has been reincorporated as MiLAN Technology Corporation.
Located in Sunnyvale, California, MiLAN is a growing provider of leading edge
wireless telecommunications products for businesses and residences, managed and
unmanaged LAN switches, media conversion products and print servers. The Company
expects the MiLAN acquisition will be both complementary and supplementary to
its Transition Networks business by increasing the product offerings and
expanding the customer bases of both business units.
The operations of MiLAN are included in the Company's financial results from the
purchase date. In the acquisition, the following assets were acquired and
liabilities assumed:
Accounts receivable $ 2,426,713
Inventory 5,121,936
Plant and equipment 234,971
Excess of cost over net assets acquired 910,170
Accrued expenses (566,039)
-----------
Total purchase price $ 8,127,751
===========
The Company believes the excess of cost over net assets acquired in this
transaction has an indefinite useful life and is not subject to amortization.
7
NOTE 4 - INVENTORIES
Inventories summarized below are priced at the lower of first-in, first-out cost
or market:
June 30 December 31
2002 2001
------------ ------------
Finished Goods $ 9,429,563 $ 15,821,487
Raw Materials 17,775,841 9,110,252
------------ ------------
Total $ 27,205,404 $ 24,931,739
============ ============
NOTE 5 - OTHER ASSETS
Effective January 1, 2002, the company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS 142
provides a new methodology for evaluating goodwill impairment. While we have not
yet completed the necessary calculations, we anticipate that upon adoption the
methodology prescribed by SFAS 142 for evaluating and measuring the impairment
of goodwill will result in a goodwill impairment charge for Suttle Apparatus
which had $1,262,000 of goodwill at June 30, 2002. Once the calculations are
finalized, any charge will be reported as a cumulative effect of change in
accounting principle against first quarter 2002 earnings. We will be required by
SFAS No. 142 to assess, on at least an annual basis, whether our goodwill
carrying value has incurred additional impairment. Amortization of intangible
assets that the Company determines to have finite useful lives will continue.
Amortization expense for those assets will be approximately $33,400 annually.
The following table summarizes operating and net (loss) income for the six
months ended June 30, 2002 and 2001, and proforma amounts for 2001 excluding
amortization expense recognized in that period related to goodwill:
Six Months Ended June 30
2002 2001 2001 Pro forma
------------- ------------- -------------
Revenues $ 51,094,929 $ 48,775,810 $ 48,775,810
Gross Margin 11,011,317 13,590,226 13,590,226
Operating (Loss) Income (877,701) 581,247 1,616,991
Income Before Income Taxes (897,360) 709,962 1,745,706
Income Taxes (325,000) 210,000 527,000
Net (Loss) Income (572,360) 499,962 1,218,706
Basic Net (Loss) Income Per Share $ (.07) $ .06 $ .14
Diluted Net (Loss) Income Per Share $ (.07) $ .06 $ .14
8
NOTE 6 - SEGMENT INFORMATION
The Company classifies its businesses into four segments: Suttle, which
manufactures U.S. standard modular connecting and wiring devices for voice and
data communications; Austin Taylor, which manufactures British standard line
jacks, patch panels, wiring harness assemblies, metal boxes, distribution
cabinets and central office frames; Transition Networks and MiLAN Technology
(substantially all assets of MiLAN purchased March 25, 2002), which designs and
markets data transmission, computer network and media conversion products and
print servers; and JDL Technologies (JDL) which provides telecommunications
network design, specification and training services to educational institutions.
Information concerning the Company's operations in the various segments for the
six-month periods ended June 30, 2002 and 2001 is as follows:
Transition
Suttle Austin Taylor Networks/MiLAN JDL Technologies Corporate Consolidated
---------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2002:
Revenues $ 16,815,072 $ 3,701,551 $ 20,291,979 $ 10,286,327 $ 0 $ 51,094,929
Cost of sales 15,481,098 3,285,097 13,899,790 7,417,627 0 40,083,612
---------------------------------------------------------------------------------------------------
Gross profit 1,333,974 416,454 6,392,189 2,868,700 0 11,011,317
Selling, general and
administrative expenses 3,316,437 465,001 5,486,803 1,777,396 843,381 11,889,018
---------------------------------------------------------------------------------------------------
Operating income (loss) $ (1,982,463) $ (48,547) $ 905,386 $ 1,091,304 $ (843,381) $ (877,701)
===================================================================================================
Depreciation and amortization $ 1,081,505 $ 232,361 $ 148,878 $ 60,000 $ 48,000 $ 1,570,744
===================================================================================================
Capital expenditures $ 422,768 $ 15,186 $ 475,313 $ (1,462) $ 23,935 $ 935,740
===================================================================================================
Assets $ 48,599,053 $ 5,681,714 $ 20,731,950 $ 6,955,750 $7,018,491 $ 88,986,958
===================================================================================================
Six Months Ended June 30, 2001:
Revenues $ 20,837,696 $ 5,797,026 $ 17,374,202 $ 4,766,886 $ 0 $ 48,775,810
Cost of sales 16,881,625 4,945,715 10,700,290 2,657,954 0 35,185,584
---------------------------------------------------------------------------------------------------
Gross profit 3,956,071 851,311 6,673,912 2,108,932 0 13,590,226
Selling, general and
administrative expenses 3,557,103 781,326 5,017,559 1,625,513 2,027,478 13,008,979
Goodwill amortization 143,524 29,169 640,774 222,277 (1,035,744) 0
---------------------------------------------------------------------------------------------------
Operating income (loss) $ 255,444 $ 40,816 $ 1,015,579 $ 261,142 $ (991,734) $ 581,247
===================================================================================================
Depreciation and amortization $ 1,148,273 $ 308,182 $ 819,424 $ 282,277 $ 59,359 $ 2,617,515
===================================================================================================
Capital expenditures $ 397,255 $ 15,186 $ 46,787 $ 68,590 $ 184,374 $ 712,192
===================================================================================================
Assets $ 47,131,700 $ 6,926,429 $ 20,175,355 $ 5,444,187 $9,047,349 $ 88,725,020
===================================================================================================
Information concerning the Company's operations in the various segments for the
three-month periods ended June 30, 2002 and 2001 is as follows:
9
Transition
Suttle Austin Taylor Networks/MiLAN JDL Technologies Corporate Consolidated
---------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2002:
Revenues $ 8,532,050 $ 1,805,156 $ 10,738,896 $ 6,098,487 $ 0 $ 27,174,589
Cost of sales 8,433,701 1,632,030 7,810,947 4,663,205 0 22,539,883
---------------------------------------------------------------------------------------------------
Gross profit 98,349 173,126 2,927,949 1,435,282 0 4,634,706
Selling, general and
administrative expenses 1,768,710 247,354 2,862,185 846,891 438,616 6,163,756
---------------------------------------------------------------------------------------------------
Operating income (loss) $ (1,670,361) $ (74,228) $ 65,764 $ 588,391 $ (438,616) $ (1,529,050)
===================================================================================================
Depreciation and amortization $ 613,100 $ 155,450 $ 82,520 $ 30,000 $ 24,000 $ 905,070
===================================================================================================
Capital expenditures $ 246,503 $ 7,201 $ 394,664 $ (1,462) $ 19,170 $ 666,076
===================================================================================================
Three Months Ended June 30, 2001:
Revenues $ 10,827,616 $ 2,863,177 $ 9,358,479 $ 2,632,261 $ 0 $ 25,681,533
Cost of sales 9,115,156 2,389,287 5,674,565 1,554,330 0 18,733,338
---------------------------------------------------------------------------------------------------
Gross profit 1,712,460 473,890 3,683,914 1,077,931 0 6,948,195
Selling, general and
administrative expenses 1,699,800 418,302 2,525,438 793,843 1,131,773 6,569,156
Goodwill amortization 66,905 14,584 320,387 111,139 (513,015) 0
---------------------------------------------------------------------------------------------------
Operating income (loss) $ (54,245) $ 41,004 $ 838,089 $ 172,949 $ (618,758) $ 379,039
===================================================================================================
Depreciation and amortization $ 573,126 $ 156,722 $ 409,886 $ 141,139 $ 29,680 $ 1,280,873
===================================================================================================
Capital expenditures $ 224,523 $ 16,755 $ 31,181 $ 13,246 $ 176,128 $ 285,705
===================================================================================================
NOTE 7 - INCOME TAXES
Income taxes are computed based upon the estimated effective rate applicable to
operating results for the full fiscal year. For the periods ended June 30, 2002
and 2001 income taxes do not bear a normal relationship to income before income
taxes, primarily because income from Puerto Rico operations is taxed at rates
lower than the U.S. rate.
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Statements regarding the Company's anticipated performance in future periods are
forward looking and involve risks and uncertainties, including but not limited
to: buying patterns of its Regional Bell Operating Customers, competitor's
products, the success of its recent acquisitions, changes in tax laws,
particularly in regard to taxation of its subsidiary in Puerto Rico.
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10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Six Months Ended June 30, 2002 Compared to
Six Months Ended June 30, 2001
Consolidated sales increased 5% to $51,095,000. Consolidated operating income
decreased from $581,000 to a loss of $878,000.
Suttle sales decreased 19% to $16,815,000. Sales to the major telephone
companies (Bell South, SBC, Verizon and Qwest) decreased $4,621,000 or 38%.
Sales to these customers accounted for 44% of Suttle's sales. Sales to
distributors, original equipment manufacturers (OEMs), and electrical
contractors decreased $1,406,000, or 21%. Sales to retail customers decreased
$560,000 or 61% due to decreased sales to Radio Shack, which is Suttle's
principal retail customer. Suttle's export sales, including sales to Canada,
increased 194% to $1,272,000.
Suttle's sales declines are attributable to the continuing slowdown in capital
spending by telecommunications industry companies and in particular the Regional
Bell Operating Company (RBOC) customers. DSL (Digital Subscriber Lines) revenues
decreased to $1,113,000 from $3,357,000 in the year earlier period. Revenues
from CorroShield products, which are sold mainly to the major telephone
companies, decreased 3%. Sales of conventional voice products declined 47%.
Sales of voice products are being adverserly impacted by price competition from
foreign manufacturers. Suttle is implementing a strategy to utilize offshore
manufacturing for data products as well as implementing a telesales group to
sell voice and data products to the nation's thousands of telecom and electrical
installation companies. Sales of fiber-optic connector products decreased 10%.
Suttle's gross margins decreased 66% to $1,334,000. Suttle recorded a write down
of excess and slow-moving inventory in the second quarter in the amount of
$1,500,000, which resulted in a 9% reduction in gross margin. Gross margin
percentage declined to 8% in 2002 from 19% in 2001. The decline in gross margin
was also due to price cutting to meet competition and from the effect of excess
manufacturing overhead costs relative to lower volumes. Suttle's operating
income decreased $2,238,000. Suttle has implemented cost reduction measures,
including 15% workforce reductions at its plants in Minnesota, Puerto Rico and
Costa Rica. Suttle is also beginning to utilize offshore manufacturing
arrangements in the Pacific Rim to strengthen the competitive position of
traditional products and the DSL line filter business.
Austin Taylor's sales decreased 36% to $3,702,000. Austin Taylor's gross margin
declined 51% to $417,000. Gross margin as a percentage of sales in 2002 was 11%
compared to 14% in 2001. The decline in gross margin was principally due to
increased pricing competition and lower business volumes. Selling, general and
administrative expenses decreased by $316,000 due to cost reduction measures
implemented. Operating income decreased $89,000 to a reported loss of $49,000 in
2002.
Transition Networks / MiLAN Technology segment sales increased by 17% to
$20,292,000 in the first six months of 2002 compared to $17,374,000 in the same
period in 2001. Sales for this segment include a $2,920,000 contribution from
MiLAN Technology, which CSI purchased substantially all the assets from Digi
International on March 25, 2002. MiLAN sales since acquisition were $2,930,000.
Transition Networks sales were $17,362,000 in 2002 compared to $17,374,000 in
the 2001 six month period. The demand for media conversion and related products
has remained strong in the first half of 2002 and is expected to remain a growth
market for some time. Gross margin decreased to $6,392,000 in 2002 from
$6,674,000 in 2001. Gross margin as a percentage of sales was 27% in 2002
compared to 38% in 2001. Gross margins were adversely affected by the sale of
11
the MiLAN acquired inventory, which had lower margins. Transition Network's
gross margin for the first six months was 38% compared to 38% in 2001. Selling,
general and administrative expenses increased to $5,486,000 in 2002 compared to
$5,018,000 in 2001. The increase was due to planned integration expenses related
to the MiLAN acquisition. Transition Networks selling, general and
administrative expenses in 2002 of $5,032,000 were comparable to the 2001 amount
of $5,018,000. Operating income decreased to $905,000 compared to $1,656,000
(before goodwill amortization) in 2001.
On March 25, 2002 the Company acquired substantially all the assets of MiLAN
Technology from Digi International (NASDAQ: DGII) in an all cash transaction
valued at approximately $8,100,000. MiLAN is a growing provider of wireless
telecommunications products, LAN switches, media conversion products and print
servers. The Company plans to streamline MiLAN's cost structure and consolidate
certain functions with other operating business units of CSI during 2002.
Sales by JDL Technologies, Inc. increased $5,519,000 or 115%. The increase was
due to sales of hardware purchases and services to plan, design, implement and
manage network data systems for several large school districts. Gross margin in
2002 increased to $2,869,000 compared to $2.109,000 in 2001. Gross margin as a
percentage of sales decreased to 28% from 44% in the 2001 period. Higher sales
of lower margin hardware were the principal factor in a lower gross margin
percentage in 2002. Selling, general and administrative expenses decreased
$286,000, or 15%, due to tighter cost control efforts. JDL's operating income
was $1,091,000 in 2002 compared to operating income of $483,000 (before goodwill
amortization) in the 2001 period.
Consolidated investment income decreased $339,000 due to lower earnings on
invested funds and collection of the balance of a note receivable and accrued
interest in the first quarter related to the sale of assets of discontinued
operations. Interest expense decreased by $191,000 in 2002 compared to 2001 due
to a decrease in borrowings on the line of credit and a lower interest rate.
Income before income taxes decreased by $1,607,000 to a loss of $897,000. The
Company's effective income tax rate was (36)% compared to 26% in the first half
of 2001 resulting in a refundable amount of $325,000 in 2002. The decrease in
the tax rate was due to losses from operations and also from the lower amount of
non-deductible goodwill amortization previously experienced. Net income
decreased $1,072,000.
Three Months Ended June 30, 2002 Compared to
Three Months Ended June 30, 2001
Consolidated sales increased 6% to $27,175,000. Consolidated operating income
decreased to a loss of $1,529,000.
Suttle sales decreased 21% to $8,532,000. Sales to the major telephone companies
decreased $3,658,000 to $3,494,000. Sales to these customers accounted for 41%
of Suttle's sales. Sales to distributors, original equipment manufacturers
(OEMs), and electrical contractors increased $476,000, or 18%. Sales to retail
customers decreased $312,000 or 64% due to decreased sales to Radio Shack, which
is Suttle's principal retail customer. Suttle's export sales increased 22% to
$262,000.
DSL revenues decreased to $586,000 from $991,000 in the year earlier period.
Additional broadband products are to be released this year. Sales of Suttle's
voice products (CorroShield and conventional products) declined $2,550,000 or
29%. Sales of voice products are being adverserly impacted by price competition
from foreign manufacturers. Sales of fiber-optic connector products decreased
12%.
12
Suttle's gross margins decreased 94% to $98,000. Suttle recorded a write down of
excess and slowmoving inventory in the second quarter in the amount of
$1,500,000, which resulted in an 18% reduction in gross margin. Beyond this the
decline in gross margin was due primarily to price cutting to meet competition
and excess factory overhead costs relative to lower volumes. Suttle reported an
operating loss of $1,670,000 in the three-month period in 2002 compared to
operating loss of $54,000 in the same period in 2001.
Austin Taylor's sales decreased 37% to $1,805,000 in the 2002 period. Austin
Taylor's gross margin declined 63% to $173,000. Gross margin as a percentage of
sales was 9% in 2002 compared to 17% in 2001. Selling, general and
administrative expenses decreased $171,000 due to increased cost control
efforts. Operating income decreased $103,000 to an operating loss of $74,000.
Transition Networks / MiLAN Technology segment sales increased by 15% to
$10,739,000 in the second quarter of 2002 compared to $9,358,000 in the same
period in 2001. Sales for this segment include sales from MiLAN Technology,
which CSI purchased substantially all the assets from Digi International on
March 25, 2002. MiLAN sales since acquisition were $2,930,000. Transition
Networks second quarter sales were $8,689,000 in 2002 compared to $9,358,000 in
the 2001 three-month period. Gross margin decreased to $2,928,000 in 2002 from
$3,684,000 in 2001. Gross margin as a percentage of sales was 27.3% in 2002
compared to 39% in 2001. Gross margins were adversely affected by the sale of
the MiLAN acquired inventory, which had lower margins. Transition Network's
gross margin for second quarter was 38% compared to 39% in 2001. Selling,
general and administrative expenses increased to $2,862,000 in 2002 compared to
$2,525,000 in 2001. The increase was due to planned integration expenses related
to the MiLAN acquisition. Transition Network's selling, general and
administrative expenses in 2002 of $2,505,000 were comparable to the 2001 amount
of $2,525,000. Operating income decreased to $66,000 compared to $1,158,000
(before goodwill amortization) in 2001.
Sales by JDL Technologies, Inc. increased $3,466,000 or 132%. JDL's gross margin
only increased $357,000 to $1,435,000 due to increased sales of hardware and
services. Gross margin as a percentage of sales decreased to 24% from 41% in the
2001 period due to increased sales of lower margin hardware and equipment.
Selling, general and administrative expenses increased $53,000, or 7%. JDL's
operating income was $588,000 compared to $284,000 (before goodwill
amortization) in the 2001 period.
Consolidated investment income decreased $172,000 due to lower earnings on
invested funds and collection of the balance of a note receivable and accrued
interest in the first quarter related to the sale of assets of discontinued
operations. Interest expense decreased by $102,000 in 2002 compared to 2001 due
to a decrease in borrowings on the line of credit and lower interest rates.
Income before income taxes decreased by $1,977,000 to a loss of $1,532,000. The
Company's effective income tax rate was (32)% compared to 29% in the first half
of 2001 resulting in a refundable amount of $490,000 in 2002. The decrease in
the tax rate was due to losses from operations and also from the lower amount of
non-deductible goodwill amortization previously experienced. Net income
decreased $1,357,000.
Liquidity and Capital Resources
At June 30, 2002, the Company had approximately $21,967,000 of cash and cash
equivalents compared to $22,240,000 of cash and cash equivalents at December 31,
2001. The Company had working capital of approximately $50,590,000 and a current
ratio of 3.3 to 1 compared to working capital of $51,149,000 and a current ratio
of 3.4 to 1 at the end of 2001.
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The Company had operating cash flows of $8,000,000 in the first six months of
2002 compared to cash flows of $7,166,000 in the same period in 2001. The
Company has adjusted the business plans of all operations in order to conserve
cash and reduce excess inventory and accounts receivable levels.
Investing activities used $6,298,000 of cash in the 2002 period. The Company
acquired substantially all of the assets of MiLAN Technology on March 25, 2002
for approximately $8,058,000 in cash. Also in the first quarter of 2002, the
Company received the balance of $2,765,000 of the note receivable related to the
sale of assets of a previously discontinued business unit. Cash investments in
new plant and equipment totaled $936,000, which was financed by internal cash
flows. The Company expects to spend $1,500,000 on capital additions in 2002.
Net cash used in financing activities was $2,014,000 for the first six months of
2002. The Company reduced its notes payable by $2,000,000 in the second quarter
of 2002. Notes payable were $7,000,000 at June 30, 2002 compared to $9,000,000
at December 31, 2001. The Company purchased and retired 2,762 shares of its
stock in open market transactions during the 2002 period. At June 30, 2002 Board
authorizations are outstanding to purchase an additional 225,671 shares.
In the opinion of management, based on the Company's current financial and
operating position and projected future expenditures, sufficient funds are
available to meet the Company's anticipated operating and capital expenditure
needs.
Critical Accounting Policies
Our critical accounting policies, including the assumptions and judgements
underlying them, are discussed in our 2001 Form 10-K in Note 1 Summary of
Significant Accounting Policies included in our Consolidated Financial
Statements. These policies have been consistently applied in all material
respects and disclose such matters as revenue recognition, investment valuation,
asset impairment recognition and foreign currency translation. On an ongoing
basis, we evaluate our estimates, including those related to reserves for
inventory valuation, uncollectable receivables and sales returns. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the result of which form the
basis for making judgements about the carrying value of assets and liabilities
that are not readily apparent from other sources. Results may differ from these
estimates due to actual outcomes being different from those on which we based
our assumptions. Management on an ongoing basis reviews these estimates and
judgements.
Market Risk Disclosures
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 June 30, 2002 our bank line of credit carried a
variable interest rate based on the London Interbank Offered Rate (Libor) plus
2%. The Company's investments are money market type of investments that earn
interest at prevailing market rates and as such do not have material risk
exposure.
Based on the Company's operations, in the opinion of management, no material
future losses or exposure exist relative to market risk.
14
PART II. OTHER INFORMATION
Items 1 - 3. Not Applicable
Item 4. Submission of Matters to a Vote of Securities Holders
- --------------------------------------------------------------
The Annual Meeting of the Shareholders of the Registrant was held on May 16,2002
in Minneapolis, MN. The total number of shares outstanding and entitled to vote
at the meeting was 8,261,493 of which 7,703,144 were present either in person or
by proxy. Shareholders re-elected board members Edwin C. Freeman, Luella Gross
Goldberg and Randall D. Sampson to three-year terms expiring at the 2005 Annual
Meeting of Shareholders. The vote for these board members was as follows:
In Favor Abstaining
----------- -----------
Edwin C. Freeman 7,611,491 91,653
Luella Gross Goldberg 7,611,290 91,854
Randall D. Sampson 7,599,534 103,609
Board members continuing in office are Paul J. Anderson, Wayne E. Sampson and
Frederick M. Green (whose terms expire at the 2003 Annual Meeting of
Shareholders) and Curtis A. Sampson and Gerald D. Pint (whose terms expire at
the 2004 Annual Meeting of Shareholders).
Shareholders also approved an amendment to increase the number of shares
authorized to be issued under the Company's 1990 Employee Stock Purchase Plan to
increase the total number of shares authorized to be issued under such plan by
100,000 shares to 400,000 shares. The vote to approve the amendment was
7,350,149 in favor, 102,915 against and 250,077 abstaining.
Items 5 - 6. Not Applicable
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Communications Systems, Inc.
By /s/ Paul N. Hanson
-------------------------
Paul N. Hanson
Vice President and
Chief Financial Officer
Date: August 14, 2002
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