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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 2004
-------------------------------------------------
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: 001-31588
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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES [ ] NO [X]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS Outstanding at April 30, 2004
- -------------------------------------- -----------------------------
Common Stock, par value $.05 per share 8,229,209
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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
Item 3. Quantitative and Qualitative Disclosures about Market Risk 14
Item 4. Controls and Procedures 15
Part II. Other Information 15
SIGNATURES
CERTIFICATIONS
2
PART I. FINANCIAL INFORMATION
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
March 31 December 31
Assets: 2004 2003
------------ ------------
Current assets:
Cash $ 19,035,064 $ 14,941,254
Trade receivables, net 21,644,633 22,647,129
Related party receivables 467,445 387,411
Inventories 23,607,400 24,354,041
Deferred income taxes 3,163,869 2,682,869
Other current assets 1,093,947 1,197,027
------------ ------------
Total current assets 69,012,358 66,209,731
Property, plant and equipment 34,173,100 32,331,619
less accumulated depreciation (27,127,852) (26,499,908)
------------ ------------
Net property, plant and equipment 7,045,248 5,831,711
Other assets:
Excess of cost over net assets acquired 5,253,793 5,253,793
Deferred income taxes 1,252,757 1,252,757
Other assets 575,383 547,966
------------ ------------
Total other assets 7,081,933 7,054,516
------------ ------------
Total Assets $ 83,139,539 $ 79,095,958
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Accounts payable $ 5,229,276 $ 2,194,560
Accrued compensation and benefits 2,742,302 3,013,533
Other accrued liabilities 1,905,381 1,885,000
Dividends payable 327,415 327,397
Income taxes payable 1,333,209 837,703
------------ ------------
Total current liabilities 11,537,583 8,258,193
Stockholders' Equity 71,601,956 70,837,765
------------ ------------
Total Liabilities and Stockholders' Equity $ 83,139,539 $ 79,095,958
============ ============
See notes to consolidated financial statements.
3
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited)
Three Months Ended March 31
-----------------------------------
2004 2003
------------ ------------
Sales $ 25,249,164 $ 26,575,150
Costs and expenses:
Cost of sales 17,312,371 19,169,361
Selling, general and
administrative expenses 6,815,881 6,221,891
------------ ------------
Total costs and expenses 24,128,252 25,391,252
------------ ------------
Operating income 1,120,912 1,183,898
Other income and (expense):
Investment income 33,505 22,574
Interest expense (33,401)
------------ ------------
Other income (expense), net 33,505 (10,827)
Income before income taxes 1,154,417 1,173,071
Income taxes 430,000 450,000
------------ ------------
Net income 724,417 723,071
------------ ------------
Other comprehensive income (loss):
Foreign currency translation adjustment 50,865 (59,513)
------------ ------------
Comprehensive income $ 775,282 $ 663,558
============ ============
Basic net income per share $ .09 $ .09
Diluted net income per share $ .09 $ .09
Average Basic Shares Outstanding 8,219,410 8,160,931
Average Dilutive Shares Outstanding 8,272,003 8,171,868
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, 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 724,417 724,417
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 7,455 373 53,316 53,689
Purchase of common stock (197) (10) (673) (1,056) (1,739)
Shareholder dividends (327,415) (327,415)
Other comprehensive gain 50,865 50,865
--------- --------- ----------- ----------- ----------- -----------
BALANCE AT MARCH 31, 2004 8,225,629 $ 411,281 $ 28,270,003 $ 42,674,430 $ 246,242 $ 71,601,956
========= ========= =========== =========== =========== ===========
See notes to consolidated financial
statements.
5
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended March 31
---------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 724,417 $ 723,071
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 573,441 663,551
Changes in assets and liabilities net of
effects of the purchase of Image
Systems Corporation:
Trade receivables 1,664,564 (2,457,451)
Inventories 1,506,729 (4,896,469)
Other current assets 131,790 217,783
Accounts payable 1,841,939 1,327,906
Accrued expenses (124,195) 491,736
Income taxes payable 495,506 (717,173)
------------ ------------
Net cash provided by (used in) operating
activities 6,814,191 (4,647,046)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (316,637) (424,081)
Other assets (169,283) (182,151)
Purchase of Image Systems Corporation (1,803,357)
------------ ------------
Net cash used in investing activities (2,289,277) (606,232)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable (7,000,000)
Dividends paid (327,397) (325,714)
Proceeds from issuance of common stock 53,689
Purchase of common stock (1,739) (675)
------------ ------------
Net cash (used in) financing activities (275,447) (7,326,389)
------------ ------------
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (155,657) (12,621)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 4,093,810 (12,592,288)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 14,941,254 19,816,328
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 19,035,064 $ 7,224,040
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes (refunded) paid $ (65,506) $ 1,159,892
Interest paid 53,188
Dividends declared not paid 327,415 326,947
See notes to consolidated financial statements.
6
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - CONSOLIDATED FINANCIAL STATEMENTS
The consolidated balance sheet as of March 31, 2004 and the related consolidated
statements of income and comprehensive income, consolidated statements of
changes in stockholders' equity and the consolidated statements of cash flows
for the three-month periods ended March 31, 2004 and 2003 have been prepared by
Communications Systems, Inc. and Subsidiaries (the Company or we) without audit.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position,
results of operations, and cash flows at March 31, 2004 and 2003 and for the
three months then ended have been made.
Certain information and footnote disclosures normally included in consolidated
financial statements prepared in accordance with generally accepted accounting
principles in the United States of America have been condensed or omitted. It is
suggested these condensed consolidated financial statements be read in
conjunction with the financial statements and notes thereto included in the
Company's December 31, 2003 Annual Report to Shareholders and form 10-K. The
results of operations for the periods ended March 31 are not necessarily
indicative of the operating results for the entire year.
In February 2004 the Company issued 33,000 shares of the Company's common stock
to the Employee Stock Ownership Plan in payment of its 2003 obligation. In a
noncash transaction, the Company recorded additional stockholders' equity of
$262,724 (reflecting the market value of the stock at the time of the
contribution) and reduced accrued expenses by the same amount.
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 net 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:
Quarter Ended March 31
---------------------------
2004 2003
------------ ------------
Net Income
As reported $ 724,400 $ 723,000
Compensation expense, net of tax $ 70,400 $ 50,300
Pro forma $ 654,000 $ 672,700
Earnings Per Share-Basic
As reported $ . 09 $ .09
Pro forma $ . 08 $ .08
Earnings Per Share-Diluted
As reported $ . 09 $ .09
Pro forma $ . 08 $ .08
7
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
NOTE 2 - ACQUISITIONS
Effective March 24, 2004, the Company acquired substantially all the outstanding
shares of Image Systems Corporation (Pinksheets: IMSG) for a cash purchase price
per share of $.643 or approximately $2,800,000 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 financial results from the purchase date March 24, 2004. In the
acquisition, the estimated fair value of the following assets were acquired and
liabilities assumed:
Property, plant and equipment $ 1,434,000
Accounts receivable 576,297
Inventory 716,999
Cash 103,625
Other assets 508,770
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
============
The allocation of purchase price is preliminary and is subject to adjustment as
additional information becomes available.
NOTE 3 - INVENTORIES
Inventories summarized below are priced at the lower of first-in, first-out cost
or market:
March 31 December 31
2004 2003
------------ ------------
Finished goods $ 15,506,180 $ 14,531,725
Raw and processed materials 8,101,220 9,822,316
------------ ------------
Total $ 23,607,400 $ 24,354,041
============ ============
NOTE 4 - 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. We reassess the value of our
business units and related goodwill balances at the beginning of the first
8
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
quarter of each fiscal year and at other times if events have occurred or
circumstances exist that indicate the carrying amount of goodwill may not be
recoverable. Accordingly, we have determined that there was no impairment as of
January 1, 2004 and no events occurred during the quarter ended March 31, 2004
that indicated our remaining goodwill was not recoverable. As of March 31, 2004
the Company had net goodwill of $5,254,000. Intangible assets with definite
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 $11,000 for the quarter ended March 31, 2004.
NOTE 5 - 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 three months ended March 31, 2004 and 2003, the majority of which relates to
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 (28,870) (77,726)
Amounts charged to expense 26,499 430,229
------------ ------------
Ending balance $ 657,313 $ 1,015,175
============ ============
NOTE 6 - SEGMENT INFORMATION
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. Information concerning the Company's continuing
operations in the various segments is as follows:
9
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Austin Transition JDL
Suttle Taylor Networks/MiLAN Technolgies Other Consolidated
--------------------------------------------------------------------------------------
Three Months Ended March 31, 2004
Sales $ 9,310,352 $ 2,741,993 $ 12,226,815 $ 970,004 $ - $ 25,249,164
Cost of sales 7,128,927 2,390,054 7,244,009 549,381 17,312,371
--------------------------------------------------------------------------------------
Gross profit 2,181,425 351,939 4,982,806 420,623 7,936,793
Selling, general and
administrative expenses 1,291,143 333,745 3,967,679 771,722 451,592 6,815,881
--------------------------------------------------------------------------------------
Operating income (loss) $ 890,282 $ 18,194 $ 1,015,127 $ (351,099) $ (451,592) $ 1,120,912
======================================================================================
Depreciation and amortization $ 350,843 $ 91,011 $ 67,710 $ 30,000 $ 33,877 $ 573,441
======================================================================================
Assets $ 34,678,834 $ 6,131,888 $ 26,560,033 $ 4,837,794 $ 10,930,990 $ 83,139,539
======================================================================================
Capital expenditures $ 122,602 $ 19,380 $ 103,075 $ 11,580 $ 60,000 $ 316,637
======================================================================================
Three Months Ended March 31, 2003
Sales $ 8,142,850 $ 1,574,111 $ 12,381,343 $ 4,476,846 $ - $ 26,575,150
Cost of sales 6,678,963 1,660,585 7,803,336 3,026,477 19,169,361
--------------------------------------------------------------------------------------
Gross profit 1,463,887 (86,474) 4,578,007 1,450,369 7,405,789
Selling, general and
administrative expenses 1,200,702 324,367 3,419,585 891,002 386,235 6,221,891
--------------------------------------------------------------------------------------
Operating income (loss) $ 263,185 $ (410,841) $ 1,158,422 $ 559,367 $ (386,235) $ 1,183,898
======================================================================================
Depreciation and amortization $ 417,570 $ 80,172 $ 79,291 $ 45,180 $ 41,338 $ 663,551
======================================================================================
Assets $ 38,988,611 $ 5,085,054 $ 25,312,068 $ 7,388,535 $ 6,557,859 $ 83,332,127
======================================================================================
Capital expenditures $ 263,207 $ 61,302 $ 19,318 $ 78,873 $ 1,381 $ 424,081
======================================================================================
NOTE 7 - INCOME TAXES
In the preparation of the Company's consolidated financial statements,
management calculates income taxes based upon the estimated effective rate
applicable to operating results for the full fiscal year. This includes
estimating the 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 recovered from future taxable income.
NOTE 8 - NET INCOME PER SHARE
Basic net income per common share is based on the weighted average number of
common shares outstanding during each year. Diluted net income per common share
takes into effect the dilutive effect of potential common shares outstanding.
The Company's only potential common shares outstanding are stock options, which
resulted in a dilutive effect of 52,593 shares and 10,937 shares for the periods
ended March 31, 2004 and 2003, respectively. The Company calculates the dilutive
effect of outstanding options using the treasury stock method. The total number
of non-dilutive stock options was 1,089,962 at March 31, 2004 and 1,399,447 at
March 31, 2003.
10
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
- ----------------------------------------------------------
Three Months Ended March 31, 2004 Compared to
Three Months Ended March 31, 2003
---------------------------------------------
Consolidated sales in 2004 decreased 5% to $25,249,000 compared to $26,575,000
in 2003. Consolidated operating income in 2004 decreased slightly to $1,121,000
compared to $1,184,000 in the first quarter of 2003. The sales decrease was
attributable primarily to the Company's JDL Technologies business segment
(network design and training services for educational institutions) compared to
the previous year. Their delays for the year 6 government technology funding
(Federal E-Rate program) adversely affected CSI's revenue and profit for the
first quarter of 2004.
Suttle sales increased 14% in the first quarter of 2004 to $9,310,000 compared
to $8,143,000 in the same period of 2003. Sales to the major telephone companies
(the Regional Bell Operating Companies ("RBOCs") increased 7% to $4,599,000 in
2004 compared to $4,320,000 in 2003. Sales to these customers accounted for 49%
and 53% of Suttle's U.S. customer sales in 2004 and 2003 respectively. Contract
manufacturing sales totaled $1,158,000 in the first quarter of 2004 compared to
$1,164,000 in 2003. Suttle's gross margins increased in the first quarter of
2004 to $2,181,000 compared to $1,464,000 in the same period of 2003. Gross
margin percentage increased to 23% in 2004 from 18% in 2003. The gross margin
percentage increase was due to cost reduction measures implemented in 2003 and
higher business volumes in 2004. The Company has continued to outsource more
manufacturing in Asia, shifted manufacturing to the lower cost plant in Costa
Rica and effective May 31, 2003 closed the final building in Puerto Rico with 25
employees. These actions all contributed to improved gross margin and operating
income. Selling, general and administrative expenses increased $90,000 or 8% in
the first quarter of 2004 compared to the same period in 2003. Suttle's
operating income was $890,000 in the first quarter of 2004 compared to operating
income of $263,000 in 2003.
Austin Taylor's sales increased 74% to $2,742,000 in 2004 compared to $1,574,000
for the three months ended March 31, 2003. Austin Taylor's gross margin
increased by $438,000 in 2004 compared to the same period in 2003. Gross margin
as a percentage of sales increased to 13% in 2004 compared to a negative 5% in
2003. Selling, general and administrative expenses increased to $334,000 in 2004
compared to $324,000 in 2003. The Company has implemented a 30% reduction in the
Austin Taylor workforce in 2003 which has improved gross margin and has aligned
overhead costs and production with existing volumes. Operating income increased
by $429,000 in 2004 compared to the first quarter of 2003.
11
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
JDL Technologies, Inc. reported 2004 first quarter sales of $970,000 compared to
$4,477,000 in 2003. Delays for the year 6 government technology funding (Federal
E-Rate program) adversely affected JDL's sales and operating income in the first
quarter of 2004. JDL completed several large educational institutional projects
in the first quarter of 2003 consisting of hardware and software sales as well
as design and network management services. JDL gross margins decreased by
$1,030,000 in the first quarter of 2004 compared to the same period in 2003.
Gross margin as a percentage of sales in 2004 increased to 43% in 2004 from 32%
in 2003 due to a higher percentage of higher margin consulting and training
sales in 2004 compared to 2003. Hardware and software sales were $167,000 in
2004 compared to $2,324,000 in 2003. Sales of consulting, connectivity and
training services decreased in 2004 to $803,000 from $2,144,000 in 2003.
Selling, general and administrative expenses decreased by 13% in 2004 to
$772,000 compared to $891,000 in 2003. JDL reported an operating loss of
$351,000 in the first quarter of 2004 compared to operating income of $559,000
in the first quarter of 2003.
Transition Networks / MiLAN Technology segment sales decreased by 1% to
$12,227,000 in the first quarter of 2004 compared to $12,381,000 in the same
period in 2003. The demand for media conversion and related products has
remained strong in the first quarter of 2004 and is expected to remain a growth
market for some time. Gross margin increased to $4,982,000 in 2004 from
$4,578,000 in 2003 due to product mix. Gross margin as a percentage of sales
increased to 41% in 2004 compared to 37% in 2003. Selling, general and
administrative expenses increased to $3,968,000 in 2004 compared to $3,420,000
in 2003 due to increased sales and marketing costs. Operating income decreased
slightly to $1,015,000 in 2004 compared to $1,158,000 in 2003.
Consolidated investment income was $34,000 in 2004 compared to $23,000 in 2003
due to increased cash and investment balances. Interest expense decreased by
$33,000 in 2004 compared to 2003. The Company paid in full the balance of the
line of credit of $7,000,000 in March of 2003 and has had no subsequent
borrowings since that time. Income before income taxes decreased slightly to
$1,154,000 in 2004 compared to $1,173,000 in 2003. The Company's effective
income tax rate was 37% in 2004 compared to 38% in the first quarter of 2003.
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 Company has provided
for and prepaid tollgate taxes at a 1.75% rate on its Puerto Rico earnings for
each year since 1993. The Company has recognized tollgate tax expense at the
3.5% rate on earnings from years prior to 1993 only to the extent distributions
were received from Suttle Caribe, Inc. Net income was $724,000 in 2004 compared
to $723,000 in 2003.
Liquidity and Capital Resources
-------------------------------
At March 31, 2004, the Company had approximately $19,035,000 of cash and cash
equivalents compared to $14,941,000 of cash and cash equivalents at December 31,
2003. The Company had working capital of approximately $57,475,000 and a current
ratio of 6.0 to 1 compared to working capital of $57,952,000 and a current ratio
of 8.0 to 1 at December 31, 2003.
Net cash provided by operating activities was approximately $6,814,000 in the
first three months of 2004 compared to net cash used in operating activities of
$4,647,000 in the same period in 2003. The increase was due primarily to a
reduction of accounts receivable and inventory levels and an increase in trade
and income tax payables.
12
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Net cash used in investing activities was $2,289,000 in the first three months
in 2004 compared to $606,000 in the same period in 2003. In March 2004, the
Company acquired substantially all the outstanding shares of Image Systems
Corporation (Pinksheets: IMSG) for a cash purchase price per share of $.643 or
approximately $2,800,000 in total consideration net of cash acquired. In 2004
cash investments in new plant and equipment totaled $317,000 compared to
$424,000 in 2003. Plant and equipment purchases in both years were financed by
internal cash flows. The Company expects to spend $1,200,000 on capital
additions in 2004.
Net cash used in financing activities was $275,000 in 2004 compared to net cash
used in financing activities in 2003 of $7,326,000. In March 2003, the Company
paid in full the balance of the line of credit, which was $7,000,000. The
Company purchased and retired 197 shares of its stock in open market
transactions during the 2004 period. At March 31, 2004 Board authorizations are
outstanding to purchase an additional 283,270 shares. Cash dividends paid in the
first quarter of 2004 was $327,000. There were no additional borrowings on the
line of credit during the first quarter of 2004.
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 2003 Form 10-K in Note 1 Summary of
Significant Accounting Policies included in our Consolidated Financial
Statements. There were no significant changes to our critical accounting
policies during the three months ended March 31, 2004. These policies have been
consistently applied in all material respects and disclose such matters as
allowance for doubtful accounts, sales returns, inventory valuation, warranty
expense, income taxes, revenue recognition, asset and goodwill impairment
recognition and foreign currency translation. On an ongoing basis, we evaluate
our estimates based 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.
Recently Issued Accounting Pronouncements
-----------------------------------------
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity", which provides
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. The Statement
is effective for financial instruments entered into or modified after May 31,
2003 and for pre-existing instruments as of the beginning of the first interim
period beginning after June 15, 2003. The adoption of this standard did not have
a material effect on our consolidated financial position or results of
operations.
13
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (VIE), an Interpretation of ARB No. 51 , which
requires all VIEs to be consolidated by the primary beneficiary. The primary
beneficiary is the entity that holds the majority of the beneficial interests in
the VIE. In addition, the interpretation expands disclosure requirements for
both VIEs that are consolidated as well as VIEs from which the entity is the
holder of a significant amount of the beneficial interests, but not the
majority. In October 2003, the FASB agreed to defer the effective date so that a
public company would not need to apply the provisions of the interpretation to
VIE interests acquired before February 1, 2003, until the end of the first
interim or annual period ending after December 15, 2003. Because we believe we
have no variable interest entities, we do not expect that the adoption of this
new standard will have a material effect on our consolidated financial position
or results of operations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
The Company has no freestanding or embedded derivatives. All contracts that
contain provisions meeting the definition of a derivative also meet the
requirements of, and have been designated as normal purchases or sales. The
Company's policy is to not use freestanding derivatives and to not enter into
contracts with terms that cannot be designated as normal purchases or sales.
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 March 31, 2004 our bank line of credit carried a
variable interest rate based on the London Interbank Offered Rate (Libor) plus
2%. The Company's investments are money market type of investments that earn
interest at prevailing market rates and as such do not have material risk
exposure.
Based on the Company's operations, in the opinion of management, no material
future losses or exposure exist relative to market risk.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The Company's Chief Executive Officer, Curtis A. Sampson, and Chief Financial
Officer, Paul N. Hanson, have evaluated the Company's disclosure controls and
procedures as of the end of the period covered by this report. Based upon that
review, they have concluded that these controls and procedures are effective in
ensuring that material information related to the Company is made known to them
by others within the Company.
(b) Changes in Internal Control over Financial Reporting
There have been no significant changes in internal control over financial
reporting that occurred during the fiscal quarter covered by this report that
have materially affected, or are reasonably likely to materially affect, the
registrant's internal control over financial reporting.
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COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
Items 1 - 4. Not Applicable
Item 5. Exhibits and Reports on Form 8-K.
(a) The following exhibits are filed herewith:
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the
Exchange Act).
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the
Exchange Act).
32. Certifications pursuant Section 906 of the Sarbanes-Oxley Act
of 2002 (18 U.S.C.ss.1350).
(b) Reports on Form 8-K.
On March 10, 2004, the Company filed a current report on Form 8-K with
the Securities and Exchange Commission, reporting under Items 7 and 12 its
fourth quarter 2003 earnings release to shareholders.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Communications Systems, Inc.
By /s/ Curtis A. Sampson
----------------------------
Curtis A. Sampson
Date: May 12, 2004 Chairman and
Chief Executive Officer
/s/ Paul N. Hanson
----------------------------
Date: May 12, 2004 Paul N. Hanson
Vice President and
Chief Financial Officer
15