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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, 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
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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 [ ]
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 July 31, 2004
- -------------------------------------- ----------------------------
Common Stock, par value $.05 per share 8,236,489
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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 4
Comprehensive Income
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 12
Part II. Other Information 17
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
June 30 December 31
Assets: 2004 2003
------------ ------------
Current assets:
Cash $ 20,530,574 $ 14,941,254
Trade receivables, net 22,075,267 22,647,129
Related party receivables 198,110 387,411
Inventories 23,640,847 24,354,041
Deferred income taxes 3,163,869 2,682,869
Other current assets 728,636 1,197,027
------------ ------------
Total current assets 70,337,303 66,209,731
Property, plant and equipment 34,538,604 32,331,619
less accumulated depreciation 27,673,874) (26,499,908)
------------ ------------
Net property, plant and equipment 6,864,730 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 512,146 547,966
------------ ------------
Total other assets 7,018,696 7,054,516
------------ ------------
Total Assets $ 84,220,729 $ 79,095,958
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Accounts payable $ 5,054,375 $ 2,194,560
Accrued compensation and benefits 3,246,812 3,013,533
Other accrued liabilities 1,680,366 1,885,000
Dividends payable 329,460 327,397
Income taxes payable 1,576,959 837,703
------------ ------------
Total current liabilities 11,887,972 8,258,193
Stockholders' Equity 72,332,757 70,837,765
------------ ------------
Total Liabilities and Stockholders' Equity $ 84,220,729 $ 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 June 30 Six Months Ended June 30
---------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Sales $ 27,133,140 $ 24,868,683 $ 52,382,304 $ 51,443,833
Costs and expenses:
Cost of sales 18,062,559 17,454,032 35,374,930 36,623,393
Selling, general and
administrative expenses 7,468,860 6,668,606 14,284,741 12,890,497
------------ ------------ ------------ ------------
Total costs and expenses 25,531,419 24,122,638 49,659,671 49,513,890
------------ ------------ ------------ ------------
Operating income 1,601,721 746,045 2,722,633 1,929,943
Other income and (expenses):
Investment and other income 42,351 270,436 75,856 293,010
Interest expense (34,264) (18,279) (34,264) (51,680)
------------ ------------ ------------ ------------
Other income, net 8,087 252,157 41,592 241,330
Income before income taxes 1,609,808 998,202 2,764,225 2,171,273
Income taxes 620,000 370,000 1,050,000 820,000
------------ ------------ ------------ ------------
Net income 989,808 628,202 1,714,225 1,351,273
------------ ------------ ------------ ------------
Other comprehensive income (loss):
Foreign currency
translation adjustment (12,492) 148,070 38,373 88,556
------------ ------------ ------------ ------------
Comprehensive income $ 977,316 $ 776,272 $ 1,752,598 $ 1,439,829
============ ============ ============ ============
Basic net income per share $ .12 $ .08 $ .21 $ .17
Diluted net income per share $ .12 $ .08 $ .21 $ .17
Average Basic Shares Outstanding 8,232,791 8,161,216 8,221,983 8,160,931
Average Dilutive Shares Outstanding 8,271,982 8,176,809 8,267,207 8,174,406
See notes to consolidated financial statements.
4
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARI
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 income 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 1,714,225 1,714,225
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 18,315 916 137,209 138,125
Purchase of common stock (197) (10) (673) (1,056) (1,739)
Shareholder dividends (658,366) (658,366)
Other comprehensive income 38,373 38,373
--------- --------- ------------ ------------ ------------ ------------
BALANCE AT JUNE 30, 2004 8,236,489 $ 411,824 $ 28,353,896 $ 43,333,287 $ 233,750 $ 72,332,757
========= ========= ============ ============ =========== =============
See notes to consolidated financial statements.
5
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended June 30
------------------------
2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,714,225 $ 1,351,273
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 1,157,315 1,246,018
Changes in assets and liabilities net of effects of
the purchase of Image Systems Corporation in 2004:
Trade receivables 1,238,221 (2,626,442)
Inventories 1,460,265 (5,136,616)
Other current assets 400,008 749,928
Accounts payable 2,670,303 (1,585,473)
Accrued expenses 13,499 785,668
Income taxes payable 739,256 (1,438,373)
----------- -----------
Net cash provided by (used in) operating activities 9,393,092 (6,654,017)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (717,480) (390,981)
Other assets 138,556 (134,775)
Payment for purchase of Image Systems Corporation (2,801,683)
----------- -----------
Net cash used in investing activities (3,380,607) (525,756)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable (6,000,000)
Dividends paid (658,366) (652,661)
Proceeds from issuance of stock 138,125
Purchase of stock (1,739) (675)
----------- -----------
Net cash used in financing activities (521,980) (6,653,336)
----------- -----------
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH 98,715 (8,294)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 5,589,220 (13,841,403)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 14,941,254 19,816,328
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $20,530,474 $ 5,974,925
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 310,744 $ 2,251,045
Interest paid 34,083 71,467
Dividends declared not paid 329,460 326,449
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 June 30, 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 six-month periods ended June 30, 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 June 30, 2004 and 2003 and for the six
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 June 30 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.
STOCK BASED 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 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 (loss) and net income per share
would have been as follows:
Three Months Ended June 30
----------------------------------
2004 2003
------------ ------------
Net Income
As reported $ 990,000 $ 628,000
Compensation expense, net of tax $ 109,000 $ 126,000
Pro forma $ 881,000 $ 502,000
Earnings Per Share-Basic
As reported $ . 12 $ .08
Pro forma $ . 11 $ .06
Earnings Per Share-Diluted
As reported $ . 12 $ .08
Pro forma $ . 11 $ .06
7
Six Months Ended June 30
----------------------------------
2004 2003
------------ ------------
Net Income
As reported $ 1,714,000 $ 1,351,000
Compensation expense, net of tax $ 186,000 $ 176,000
Pro forma $ 1,528,000 $ 1,175,000
Earnings Per Share-Basic
As reported $ . 21 $ .17
Pro forma $ . 19 $ .14
Earnings Per Share-Diluted
As reported $ . 21 $ .17
Pro forma $ . 19 $ .14
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 $0.643 or 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 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
8
=============
NOTE 3 - INVENTORIES
Inventories summarized below are priced at the lower of first-in, first-out cost
or market:
June 30 December 31
2004 2003
------------- -------------
Finished Goods $ 13,464,963 $ 14,531,725
Raw Materials 10,175,884 9,822,316
Total $ 23,640,847 $ 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
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 six months ended June 30, 2004
that indicated our remaining goodwill was not recoverable. As of June 30, 2004
the Company had net goodwill of $5,254,000. Intangible assets with finite 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
$23,000 and $34,000 for the six months ended June 30, 2004 and 2003,
respectively.
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 six months ended June 30, 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 (66,833) (80,124)
Amounts charged to expense 57,833 90,144
------------- -------------
Ending balance $ 650,684 $ 672,692
============= =============
9
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:
Austin Transition JDL
Suttle Taylor Networks/MiLAN Technologies Other Consolidated
------------ ----------- ------------ ----------- ----------- ------------
Six Months Ended June 30, 2004:
Sales $ 18,727,133 $ 4,572,642 $ 25,195,987 $ 3,018,344 $ 868,198 $ 52,382,304
Cost of sales 14,470,739 4,037,905 14,969,461 1,320,462 576,363 35,374,930
------------ ----------- ------------ ----------- ----------- ------------
Gross profit 4,256,394 534,737 10,226,526 1,697,882 291,835 17,007,374
Selling, general and
administrative expenses 2,487,059 663,706 8,266,280 1,486,592 1,381,104 14,284,741
------------ ----------- ------------ ----------- ----------- ------------
Operating income (loss) $ 1,769,335 $ (128,969) $ 1,960,246 $ 211,290 $(1,089,269) $ 2,722,633
============ =========== ============ =========== =========== ============
Depreciation and amortization $ 705,785 $ 166,302 $ 147,166 $ 60,000 $ 78,062 $ 1,157,315
============ =========== ============ =========== =========== ============
Capital expenditures $ 305,191 $ 27,973 $ 220,971 $ 100,617 $ 62,728 $ 717,480
============ =========== ============ =========== =========== ============
Assets $ 34,810,327 $ 6,118,888 $ 27,202,200 $ 5,670,651 $10,418,663 $ 84,220,729
============ =========== ============ =========== =========== ============
Six Months Ended June 30, 2003:
Sales $ 15,442,285 $ 3,286,946 $ 24,717,251 $ 7,997,351 $ - $ 51,443,833
Cost of sales 12,537,965 3,279,684 15,727,223 5,078,521 - 36,623,393
------------ ----------- ------------ ----------- ----------- ------------
Gross profit 2,904,320 7,262 8,990,028 2,918,830 - 14,820,440
Selling, general and
administrative expenses 2,418,779 687,598 6,992,874 1,854,535 936,711 12,890,497
------------ ----------- ------------ ----------- ----------- ------------
Operating income (loss) $ 485,541 $ (680,336) $ 1,997,154 $ 1,064,295 $ (936,711) $ 1,929,943
============ =========== ============ =========== =========== ============
Depreciation and amortization $ 762,859 $ 154,392 $ 190,407 $ 90,360 $ 48,000 $ 1,246,018
============ =========== ============ =========== =========== ============
Capital expenditures $ 162,377 $ - $ 59,882 $ 145,994 $ 22,728 $ 390,981
============ =========== ============ =========== =========== ============
Assets $ 36,157,535 $ 4,886,904 $ 27,690,812 $ 6,659,483 $ 6,107,708 $ 81,502,442
============ =========== ============ =========== =========== ============
10
Information concerning the Company's operations in the various segments for the
three-month periods ended June 30, 2004 and 2003 is as follows:
Austin Transition JDL
Suttle Taylor Networks/MiLAN Technologies Other Consolidated
------------ ----------- ------------ ----------- ----------- ------------
Three Months Ended June 30, 2004:
Sales $ 9,416,781 $ 1,830,649 $ 12,969,172 $ 2,048,340 $ 868,198 $ 27,133,140
Cost of sales 7,341,812 1,647,851 7,725,452 771,081 576,363 18,062,559
------------ ----------- ------------ ----------- ----------- ------------
Gross profit 2,074,969 182,798 5,243,720 1,277,259 291,835 9,070,581
Selling, general and
administrative expenses 1,195,916 329,961 4,298,601 714,870 929,512 7,468,860
------------ ----------- ------------ ----------- ----------- ------------
Operating income (loss) $ 879,053 $ (147,163) $ 945,119 $ 562,389 $ (637,677) $ 1,601,721
============ =========== ============ =========== =========== ============
Depreciation and amortization $ 354,942 $ 75,291 $ 79,456 $ 30,000 $ 44,185 $ 583,874
============ =========== ============ =========== =========== ============
Capital expenditures $ 182,589 $ 8,593 $ 117,896 $ 89,037 $ 2,728 $ 400,843
============ =========== ============ =========== =========== ============
Three Months Ended June 30, 2003:
Sales $ 7,299,435 $ 1,712,835 $ 12,335,908 $ 3,520,505 $ - $ 24,868,683
Cost of sales 5,859,002 1,619,099 7,923,887 2,052,044 - 17,454,032
------------ ----------- ------------ ----------- ----------- ------------
Gross profit 1,440,433 93,736 4,412,021 1,468,461 - 7,414,651
Selling, general and
administrative expenses 1,218,077 363,231 3,573,289 963,533 550,476 6,668,606
------------ ----------- ------------ ----------- ----------- ------------
Operating income (loss) $ 222,356 $ (269,495) $ 838,732 $ 504,928 $ (550,476) $ 746,045
============ =========== ============ =========== =========== ============
Depreciation and amortization $ 345,289 $ 74,220 $ 111,116 $ 45,180 $ 6,662 $ 582,467
============ =========== ============ =========== =========== ============
Capital expenditures $ (100,830) $ (61,302) $ 40,564 $ 67,121 $ 21,347 $ (33,100)
============ =========== ============ =========== =========== ============
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. The Company's effective income tax rate
was 38% as of June 30, 2004 and 2003 which approximates the estimated annual
effective tax rate.
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 45,224 shares and 13,475 shares for the periods
ended June 30, 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 1,094,784 at June 30, 2004 and 1,300,741 at
June 30, 2003.
11
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- -------------------------------------------------------------------------------
Six Months Ended June 30, 2004 Compared to
Six Months Ended June 30, 2003
------------------------------
Consolidated sales in 2004 increased 2% to $52,382,000 compared to $51,443,000
in 2003. The 2004 six-month revenues include $868,000 in sales contributed from
the Image Systems business unit, which was acquired in March 2004. Consolidated
operating income in 2004 increased to $2,723,000 compared to $1,923,000 in the
first six months of 2003. The Company's core business units providing broadband
products, Digital Subscriber Line (DSL) products and media conversion and
network switching products continue to show growth in the first six months of
2004.
Suttle sales increased 18% in the first six months of 2004 to $18,727,000
compared to $15,442,000 in the same period of 2003 due to increased volumes with
the major telephone companies. Sales to the major telephone companies (the
Regional Bell Operating Companies ("RBOCs" which are Verizon Logistics, Bell
South, SBC Communications and Qwest) increased 23% to $10,140,000 in 2004
compared to $8,224,000 in 2003. Sales to these customers accounted for 54% and
53% of Suttle's U.S. customer sales in 2004 and 2003 respectively. Sales to
distributors, original equipment manufacturers (OEMs), and electrical
contractors decreased 9% to $3,402,000 in 2004 compared to $3,744,000 in 2003.
Contract manufacturing sales totaled $1,674,000 in the first six months of 2004
compared to $1,780,000 in 2003.
Suttle's gross margins increased to $4,256,000 in the first six months of 2004
compared to $2,904,000 in the same period in 2003. Gross margin percentage was
23% in 2004 compared to 19% in 2003. The gross margin percentage increase was
due to cost reduction measures implemented in 2004 and 2003 and higher business
volumes. The Company has continued to outsource more manufacturing in Asia and
shifted manufacturing to the lower cost plant in Costa Rica. These actions
contributed to a positive impact on gross margin and operating results. Selling,
general and administrative expenses increased $68,000 in the first six months of
2004 compared to the same period in 2003. Suttle's operating income was
$1,769,000 in the first six months of 2004 compared to $486,000 in the same
period of 2003.
Austin Taylor's sales increased to $4,573,000 in the first six months of 2004
compared to $3,287,000 in the same period of 2003. Gross margin increased to
$535,000 in the first six months of 2004 compared to $7,200 in 2003. The
increase in gross margin was principally due to higher business volumes,
headcount reductions and outsourcing certain manufacturing to Asia. Selling,
general and administrative expenses decreased by $24,000 in the first six months
of 2004 compared to the same period in 2003. Operating loss decreased to
$129,000 in 2004 compared to an operating loss of $680,000 in the same period of
2003.
Transition Networks / MiLAN Technology segment sales increased by 2% to
$25,196,000 in the first six months of 2004 compared to $24,717,000 in the same
period in 2003. The demand for media conversion, network switching and related
products has remained strong in the first half of 2004 and is expected to remain
a growth market for some time. Gross margin increased to $10,227,000 in the
first six months of 2004 from $8,990,000 in 2003. Gross margin as a percentage
of sales was 40% in 2004 compared to 36% in 2003. Improved gross margin was a
result of cost reductions from vendors and higher business volumes experienced
in the first six months of 2004. Selling, general and administrative expenses
increased to $8,266,000 in the first six months of 2004 compared to $6,993,000
in 2003. The increase was due to higher marketing costs and an expansion of the
domestic sales force. Operating income for this segment decreased slightly to
$1,960,000 from $1,997,000 in the first six months of 2004 compared to the same
period in 2003.
12
Sales by JDL Technologies, Inc. were $3,018,000 in the first six months of 2004
compared to $7,997,000 in the same period 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 six months 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. Gross margin in the first six months of 2004 decreased to
$1,698,000 compared to $2,918,000 in the same period of 2003. Gross margin as a
percentage of sales increased to 56% from 36% in the 2004 period due to higher
margin sales of design and maintenance services to client school districts.
Selling, general and administrative expenses decreased $377,000 in the first six
months of 2004 compared to the same period of 2003. This was attributable to
cost and headcount reductions within JDL. JDL's operating income was $211,000 in
the first six months of 2004 compared to operating income of $1,064,000 in the
same period in 2003.
Consolidated investment and other income decreased $200,000 in the first six
months of 2004 compared to 2003. In 2003 the Company realized a net gain on
disposal of assets relative to the closing of the final building in Puerto Rico
in the second quarter of approximately $280,000 which was recorded as other
income. Interest expense decreased by $17,000 in the first six months of 2004
compared to the same period in 2003 due to a decrease in borrowings on the line
of credit and a lower interest rate. Income before income taxes increased by
$593,000 to $2,764,000. The Company's effective income tax rate was 38% in 2004
and 2003. Net income through the first six months of 2004 increased $363,000 to
$1,714,000 compared to $1,351,000 in the same period in 2003.
Three Months Ended June 30, 2004 Compared to
Three Months Ended June 30, 2003
--------------------------------
Consolidated sales increased 9% to $27,133,000 in the three-month period ended
June 30, 2004 compared to $24,869,000 in the same period in 2003. Consolidated
operating income increased $856,000 to $1,602,000 in the three months ended June
30, 2004 compared to $746,000 in the same period in 2003.
Suttle sales increased 29% to $9,417,000 in 2004 compared to $7,299,000 in 2003
due to increased volumes with the major telephone companies (RBOC's). Suttle's
gross margins increased to $2,075,000 in 2004 compared to $1,440,000 in 2003.
Improved margins were a result of cost reductions from vendors and higher sales
volumes. Selling, general and administrative expenses decreased $22,000 in the
second quarter of 2004 compared to the same period in 2003. Suttle had operating
income of $879,000 in the three-month period in 2004 compared to operating
income of $222,000 in the same period in 2003.
13
Austin Taylor's sales increased 7% to $1,831,000 in the 2004 three-month period
compared to $1,713,000 in 2003 due to increased volumes with several major
customers. Austin Taylor's gross margin improved to $183,000 in 2004 compared to
$94,000 in 2003. Selling, general and administrative expenses decreased $33,000
in the second quarter of 2004 compared to the same period in 2003. Operating
loss decreased $122,000 to an operating loss of $147,000 in the second quarter
of 2004 compared to an operating loss of $269,000 in 2003.
Transition Networks / MiLAN Technology segment sales increased by 5% to
$12,969,000 in the second quarter of 2004 compared to $12,336,000 in the same
period in 2003. Gross margin increased to $5,244,000 in 2004 from $4,412,000 in
2003. Gross margin as a percentage of sales was 40% in 2004 compared to 36% in
2003. Gross margin improvements can be attributed to lower material costs from
vendors and higher sales volumes. Selling, general and administrative expenses
increased to $4,299,000 in 2004 compared to $3,573,000 in 2003. Operating income
increased to $945,000 in the second quarter of 2004 compared to $839,000 in the
same period of 2003.
Sales by JDL Technologies, Inc. decreased to $2,048,000 in the second quarter of
2004 compared to $3,521,000 in the same period in 2003. Delays for the year 6
government technology funding (Federal E-Rate program) adversely affected JDL's
sales in the second quarter of 2004. JDL's gross margin decreased to $1,277,000
in 2004 from $1,468,000 in 2003. Selling, general and administrative expenses
decreased $249,000 in the second quarter of 2004 to $715,000 compared to
$964,000 in the same period of 2003 due to cost and headcount reductions. JDL's
operating income was $562,000 in the second quarter of 2004 compared to $505,000
in the 2003 second quarter.
Investment and other income in the second quarter of 2004 decreased by $244,000
in 2004 compared to 2003. The Company realized a net gain on disposal of assets
relative to the closing of the final building in Puerto Rico in the second
quarter of 2003 of approximately $280,000 which was recorded as other income.
Income before income taxes increased by $612,000 to $1,610,000 in the second
quarter of 2004 compared to $998,000 in the same period in 2003. The Company's
effective income tax rate was 38% in 2004 compared to 37% in 2003. Net income
for the second quarter of 2004 was $990,000 compared to net income of $628,000
in the second quarter of 2003.
Liquidity and Capital Resources
-------------------------------
At June 30, 2004, the Company had $20,530,000 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 $58,449,000 and a current ratio of
5.9 to 1 compared to working capital of $57,952,000 and a current ratio of 8.0
to 1 at the end of 2003.
Net cash provided by operating activities was $9,393,000 in the first six months
of 2004 compared to net cash used in operating activities of $6,654,000 in the
same period in 2003. The increase was due primarily to reducing inventories and
accounts receivable and also increases in accounts payable and income taxes
payable.
14
Net cash used in investing activities was $3,381,000 in the first six months in
2004 compared to $526,000 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 $0.643 or
approximately $2.8 million in total consideration net of cash acquired. In the
first six months of 2004, cash investments in new plant and equipment totaled
$717,000 compared to $391,000 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 $522,000 in 2004 compared to net cash
used in financing activities in 2003 of $6,653,000. 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 June 30, 2004 Board authorizations are
outstanding to purchase an additional 283,270 shares. Cash dividends paid in the
first six months of 2004 was $658,000 compared to $653,000 in the same period in
2003. There were no additional borrowings on the line of credit during the first
six months 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 June 30, 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 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 have no
variable interest entities, the adoption of this new standard did not have a
material effect on our consolidated financial position or results of operations.
15
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 June 30, 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.
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 20,
2004 in Eden Prairie, Minnesota. The total number of shares outstanding and
entitled to vote at the meeting was 8,222,646 of which 7,960,058 were present
either in person or by proxy. Shareholders re-elected board members Gerald D.
Pint and Curtis A. Sampson to three-year terms expiring at the 2007 Annual
Meeting of Shareholders. The vote for these board members was as follows:
In Favor Abstaining
Gerald D. Pint 7,593,795 366,263
Curtis A. Sampson 7,593,176 366,882
Board members continuing in office are Edwin C. Freeman, Luella Gross Goldberg
and Randall D. Sampson (whose terms expire at the 2005 Annual Meeting of
Shareholders) and Paul A. Anderson, Frederick M. Green and Wayne E. Sampson
(whose terms expire at the 2006 Annual Meeting of Shareholders).
16
Item 5. Not Applicable
Item 6. Exhibits and Reports on Form 8-K.
(a) The following exhibits are included herein:
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 May 5, 2004, the Company filed a Current Report on Form 8-K with the
Securities and Exchange Commission, reporting under Items 7 and 12 its first
quarter 2004 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: August 12, 2004 Chairman and
Chief Executive Officer
/s/ Paul N. Hanson
----------------------------
Date: August 12, 2004 Paul N. Hanson
Vice President and
Chief Financial Officer