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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission File Number: 0-10355
COMMUNICATIONS SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Minnesota 41-0957999
- ---------------------------------- --------------------
(State or other jurisdiction Federal Employer
of incorporation or organization) Identification No.)
213 South Main Street
Hector, MN 55342
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (320) 848-6231
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
----------------------------
Common Stock, $.05 par value
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 a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $61,898,000 based upon the closing sale price of
the Company's common stock on the NASDAQ National Market System on March 12,
1999.
As of March 12, 1999 there were outstanding 8,811,194 shares of the Registrant's
common stock.
Documents Incorporated by Reference: The Company's
Proxy Statement for its Annual Meeting of
Shareholders to be held on May 18, 1999 is
incorporated by reference into Part III of
this Form 10-K.
PART I
ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
Communications Systems, Inc. (herein collectively called "CSI" or the "Company")
is a Minnesota corporation organized in 1969 which operates directly and through
its subsidiaries located in the United States (including Puerto Rico), Costa
Rica and the United Kingdom. CSI is principally engaged in the manufacture and
sale of modular connecting and wiring devices for voice and data communications.
Effective December 1, 1998, the Company acquired Transition Networks, Inc.
("TNI"). TNI, located in Eden Prairie, Minnesota is a manufacturer of media and
rate conversion products, which permit telecommunications networks to move
information between copper-wired equipment and fiber-optic cable. The
acquisition was accounted for as a purchase and operations of TNI have been
included in consolidated operations from December 1, 1998.
Effective August 7, 1998, the Company acquired JDL Technologies, Inc. ("JDL").
JDL, located in Edina, Minnesota, provides telecommunications network design,
specification, and training services to educational institutions. JDL also sells
internet access software for use in elementary and secondary schools. The
acquisition was accounted for as a purchase and operations of JDL have been
included in consolidated operations from August 7, 1998.
Effective January 4, 1996, the Company acquired Automatic Tool and Connector
Company, Inc. ("ATC"). ATC, located in Union, New Jersey, manufactures
connecting devices for fiber optic equipment. The acquisition was accounted for
as a purchase and operations of ATC have been included in consolidated
operations from January 4, 1996.
Additional information on these acquisitions can be found in subparagraphs
(c)(1)(iii) and (c)(1)(iv) under Item 1 herein, in "Acquisitions and
Dispositions" under Item 7, Management's Discussion and Analysis and in Note 9
of Notes to Consolidated Financial Statements under Item 8, herein.
On March 12, 1999, the Company signed an agreement to purchase LANart
Corporation, a manufacturer of application specific integrated circuits located
in Needham, Massachusetts, for approximately $6,000,000. The Company expects to
complete this acquisition in April 1999.
Until November, 1996, the Company conducted a value-added design and contract
manufacturing operation through a subsidiary located in Merrifield, Minnesota.
During 1996, the Company's Board of Directors concluded this business was no
longer a strategic fit with the Company's telephone station apparatus business.
Effective November 4, 1996, these operations were sold to Nortech Systems, Inc.
For additional information on this divestiture, see subparagraph (c)(2) under
Item 1 herein and "Acquisitions and Dispositions" under Item 7, Management's
Discussion and Analysis and Note 2 of Notes to Consolidated Financial Statements
under Item 8, herein.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company classifies its businesses into three 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, which
designs and markets data transmission and computer network products; and other
operations. The Company conducts manufacturing in the United States (including
Puerto Rico), the United Kingdom and Costa Rica. Information regarding
operations in the various segments is set forth in Note 11 of the Notes to
Consolidated Financial Statements under Item 8 herein.
2
(c) NARRATIVE DESCRIPTION OF BUSINESS
(1) Suttle
The Company manufactures and markets connectors and wiring devices for voice,
data and video communications under the "Suttle" brand name in the United States
(U.S.) and internationally. Products are manufactured at the Company's plants in
Hector, Minnesota (Suttle Apparatus Minnesota Division), Humacao, Puerto Rico
(Suttle Caribe, Inc.) and San Jose, Costa Rica (Suttle Costa Rica, S.A.). The
Company also manufactures a line of high performance fiber-optic connectors,
interconnect devices and fiber cable assemblies for the telecommunications,
computer and electronics markets at its plant in Elizabeth, New Jersey
(Automatic Tool and Connector Company). Segment sales were $55,540,000 in 1998,
or 78% of consolidated revenues.
(A) Products
Suttle's products are used in on-premise connection of telephones, data
terminals and related equipment. The product line consists primarily of modular
connecting devices and includes numerous types of jacks, connecting blocks and
assemblies, adapters, cords and related equipment, which are offered in a
variety of colors, styles and wiring configurations. Most of the products are
used in voice applications, but the Company continues to develop an expanding
line of products for network systems applications. A significant portion of the
Company's revenues are derived from sales of a line of corrosion resistant
connectors which utilize a water resistant gel to offer superior performance in
harsh environments. Station apparatus products generally range in price from
$.70 to $25.00 per unit. A majority of the sales volume, both in units and
revenues, is derived from products selling for under $5.00.
High performance fiber-optic connectors, interconnect devices and fiber cable
assemblies are used in high speed fiber-optic networks and local area network
connections. The Company's patented Quick Term TM fiber optic connector
significantly reduces installation time and costs associated with making fiber
connections. By eliminating the need for a curing oven, the product reduces
field installation time for this process from 20 minutes to 2 minutes. The
Company's fiber-optic connector products range in price from $2.50 to $1,500.00.
(B) Markets and Marketing
Suttle competes in all major areas of the telecommunications connector market
characterized by modular four, six and eight conductor jacks. Customers include
the "Big 6" telephone companies (the five Regional Bell Operating Companies, or
"RBOCs" and GTE), other telephone companies, electrical contractors,
interconnect companies, original equipment manufacturers and retailers. These
customers are served directly through the Company's sales staff and through
distributors such as Sprint North Supply, Graybar Electric Company, Alltel
Supply, KGP and Anixter Communications.
As a group, sales to the Big 6 telephone companies, both directly and through
distribution, were approximately $33,245,000 in 1998 and $38,027,000 in 1997,
which represented about 60% of Suttle's sales in each year. Sales to GTE Supply,
Alltel Supply and KGP, the principal distributors serving this market, amounted
to 17%, 13% and 13%, respectively, of Suttle's sales in 1998. Sales to GTE
Supply and KGP were 21% and 12%, respectively, of Suttle's sales in 1997.
The Company believes business and network systems products will become an
increasingly important part of its product line. Independent contractors (which
include businesses often referred to as "interconnect companies") are engaged in
the business of engineering, selling, installing and maintaining telephone
equipment for the business community. The Company markets its products to
independent contractors through a network of manufacturer's representatives,
through distribution, and through the Company's sales staff. Sales of products
for business and network systems accounted for 11% and 12% of Suttle's revenues
in 1998 and 1997, respectively.
Approximately 8% of Suttle's 1998 revenues were derived from sales in the retail
market. The Company is a supplier of station apparatus to Radio Shack, other
retailers, office supply distributors and specialized telephone stores. Sales to
the retail market are made through a limited number of manufacturer's
representatives.
3
Fiber-optic products are marketed to original equipment manufacturers (OEMs) in
the U.S. and internationally through the Company's sales staff and a network of
distributors and manufacturer's representatives, including Graybar Electric
Company, Arcade Electronics and Primestock. Sales of fiber-optic products
accounted for 6% and 7% of Suttle's revenues in 1998 and 1997, respectively.
The balance of Suttle's sales in 1998 and 1997 were to original equipment
manufacturers, non-Big 6 telephone companies and international customers. In the
communications industry market, sales to telephone companies are made directly
or through distribution. Sales to OEM customers are made through a nationwide
network of distributors, some of which are affiliates of major telephone
companies, and through the Company's sales staff.
(C) Competition
Suttle encounters strong competition in all its product lines. The Company
competes primarily on the basis of the broad lines of products offered, product
performance, quality, price and delivery.
Suttle's principal competitors for sales to telephone companies and independent
contractors include: Lucent Technologies, Ortronics, Leviton, Hubbell, Northern
Telecom and AMP, Inc. Most of these companies have greater financial resources
than the Company. In addition, distributors of the Company's apparatus products
also market products for one or more of these competitors. Lucent Technologies
markets to telephone companies and independent contractors directly and through
telephone industry distributors that also market the Company's products.
In retail markets, the Company experiences significant competition from
importers of low-priced modular products that market their products directly and
through a number of distributors to various retail outlets.
The Company's principal competitor for sales to the Regional Bell Operating
Companies is Lucent Technologies. To date, foreign manufacturers of apparatus
products have not presented significant competition for sales to this market.
(D) Order Book
Suttle manufactures its products on the basis of estimated customer
requirements. Outstanding customer orders at March 1, 1999, were approximately
$3,551,000 compared to approximately $3,664,000 at March 1, 1998. Because new
orders are filled on a relatively short timetable, the Company does not believe
its order book is a significant indicator of future results.
(E) Manufacturing and Sources of Supply
The Company's station apparatus products are manufactured using plastic parts,
wire sub-assemblies, fasteners, brackets, electronic circuit boards and other
components, most of which are fabricated by the Company. There are multiple
sources of supply for the materials and parts required and the Company is not
dependent upon any single supplier, except that Suttle's corrosion resistant
products utilize a moisture-resistant gel-filled fig available only from Raychem
Corporation. The unavailability of the gel-filled figs from Raychem Corporation
could have a material adverse effect on the Company. The Company has not
generally experienced significant problems in obtaining its required supplies,
although from time to time spot shortages are experienced.
(F) Research and Development; Patents
The Company continually monitors industry requirements and creates new products
to improve its existing station apparatus product line. The Company's
CorroShield line of corrosion resistant products was introduced in 1993, as was
the Flex-Plate line of data products. The Company added additional products to
these product lines in 1994 and 1995. The Company's new SpeedStar line of
high-speed data connectors was introduced in early 1996. In 1997, a proprietary
Category 5 connector was developed which meets the highest current industry
standard.
Historically, the Company has not relied on patents to protect its competitive
position in the station apparatus market. However, duplication of Company
designs by foreign apparatus manufacturers has caused the Company to apply for
design patents on a number of station apparatus products.
4
The Company's "Suttle Apparatus" brand name is important to its business. The
Company regularly supports this name by trade advertising and believes it is
well known in the marketplace.
(ii) Austin Taylor
Austin Taylor Communications, Ltd. manufactures voice and data connectors and
related products at its plant in Bethesda, Wales, U.K. Its product line consists
of British standard line jacks, patch panels, wiring harness assemblies, metal
boxes, distribution cabinets and distribution and central office frames. Sales
by Austin Taylor were $11,730,000, or 16% of consolidated revenues, in 1998.
Austin Taylor is a vertically integrated manufacturer with metal stamping, metal
bending, forming and painting, plastic injection molding and printed circuit
board assembly capabilities. Austin Taylor's major customers include Cable and
Wireless Communications, Northern Telecom Europe, Lucent Technologies and
British Telecom. Austin Taylor's products are sold directly by its sales staff
and through distributors, including Anixter Communications, NS Supply Group, RS
Components and Telcom Products. Approximately 61% and 78% of Austin Taylor sales
were to United Kingdom customers in 1998 and 1997, respectively.
The Company believes the European telecommunications market will offer
increasing opportunities as the European Economic Community eliminates trade
barriers and standardizes use of modular connector products. In addition to
continued manufacturing and marketing of its existing products, Austin Taylor
will be a base to manufacture and/or distribute existing Suttle products or new
jointly developed products in the United Kingdom, Europe and internationally.
The Company also markets Austin Taylor products in the U.S., Canada, and other
markets.
Outstanding customer orders for Austin Taylor products were approximately
$539,000 at March 1, 1999 compared to $754,000 at March 1, 1998. Because Austin
Taylor fills new orders on a relatively short timetable, the Company does not
believe its order book is a significant indicator of future results.
(iii) Transition Networks
Effective December 1, 1998, by its acquisition of Transition Networks, Inc. ,
the Company entered the rapidly growing market for media converter products.
Located in Eden Prairie, Minnesota, TNI manufactures a line of media and rate
conversion products that permit telecommunications networks to move information
between copper-wired equipment and fiber-optic cable. The products make it
possible for customers to take advantage of the newer technologies and higher
data transmission speeds supported by fiber without sacrificing their
investments in older, copper based equipment.
TNI markets its products in the U.S. and internationally through its sales staff
and a limited number of distributors. TNI has international sales offices in
London and Prague and distribution partners in South America and the Pacific
Rim. TNI is generally regarded as the market leader in conversion technology.
Its principal competitors include Allied Telsyn International and Digi
International. Sales by TNI for all of 1998 totaled $24,558,000. December sales
included in the Company's consolidated operating results were $2,208,000.
Other
Results of other operations include the Company's corporate operations and JDL
Technologies, Inc., which was acquired effective August 7, 1998. JDL provides
telecommunications network design, specification, and training services to
educational institutions. JDL also sells internet access software for use in
elementary and secondary schools. Sales by JDL for all of 1998 totaled
$5,613,000. Sales included in the Company's operating results were $1,681,000.
(2) Discontinued Contract Manufacturing Operations
Prior to November, 1996, the Company, through its former subsidiary,
Zercom Corporation, engaged in contract manufacturing of electronic assemblies
and products, including printed circuit board assembly, cable and harness
assembly and electro-mechanical assemblies, for original equipment manufacturers
(OEMs). Zercom also provided product-engineering services, including circuit
board design, case and enclosure design and product development consulting from
design concept to finished product and manufactured electronic fishing products
for the sports fishing market.
5
During the third quarter of 1996, the Company's Board of Directors
concluded that the contract manufacturing business was no longer a strategic fit
with the Company's plans for its domestic and international telecommunications
manufacturing business. After considering various alternatives for the
disposition of Zercom, the Company agreed to sell the assets (except cash and
accounts receivable) of Zercom Corporation to Nortech Systems, Inc. (Nasdaq
National Market System: NSYS ) effective November 4, 1996.
(3) Employment Levels
As of March 1, 1999 the Company employed 894 people. Of this number, 617
were employed by Suttle (including 206 in Puerto Rico, 164 in Hector, Minnesota,
20 in Elizabeth, New Jersey and 227 in Costa Rica), 147 by Austin Taylor
Communications, Ltd., 92 by Transition Networks, Inc., 24 by JDL Technologies,
Inc. and 14 held general and administrative positions. The Company considers its
employee relations to be good.
(4) Factors Affecting Future Performance
From time to time, in reports filed with the Securities and Exchange Commission,
in press releases, and in other communications to shareholders or the investing
public, the Company may comment on anticipated future financial performance.
Such forward looking statements are subject to risks and uncertainties,
including but not limited to buying patterns of Bell Operating Companies, the
impact of new products introduced by competitors, higher than expected expenses
related to sales and new marketing initiatives, Year 2000 exposures, changes in
tax laws, particularly in regard to taxation of income of its subsidiary in
Puerto Rico and other risks involving the telecommunications industry generally.
6
(5) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 1999
were as follows:
Name Age Position1
Curtis A. Sampson 65 Chairman of the Board, President
and Chief Executive Officer [1970]
Jeffrey K. Berg 56 President and General Manager
Suttle Apparatus Corporation [1990]
Paul N. Hanson 52 Vice President - Finance, Treasurer
and Chief Financial Officer [1982]
Lee Ludlam 38 Managing Director, Austin Taylor
Communications, Ltd. [1998]2
C.S. Mondelli 48 President, Transition
Networks, Inc. [1998]3
Thomas Lapping 40 President,
JDL Technologies, Inc. [1998]4
- -----------------------------------
1 Dates in brackets indicate period during which officers began
serving in such capacity. Executive officers serve at the pleasure
of the Board of Directors and are elected annually for one-year
terms.
2 Mr. Ludlam was appointed Managing Director of Austin Taylor in
November, 1998. From December, 1995 to November, 1998 he served as
Austin Taylor's Director of Manufacturing. Prior to December, 1995
he served as Austin Taylor's plant manager.
3 Mr. Mondelli was appointed President of Transition Networks, Inc.
in May, 1996. From November, 1995 to May, 1996 he served as
Transition Networks' Vice President of Sales and Marketing. Prior
to November, 1995, he was an executive vice president of Prodea
Software in Minneapolis. Transition Networks, Inc. was acquired by
the Company in December, 1998.
4 JDL Technologies, Inc. was acquired by the Company in 1998.
Messrs. Sampson and Hanson each devote approximately 60% of their
working time to the Company's business with the balance devoted to management
responsibilities at Hector Communications Corporation ("HCC"), a diversified
telecommunications holding company also headquartered in Hector, Minnesota, for
which they are separately compensated by HCC.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND
EXPORT SALES
Financial information about domestic and foreign operations and export
sales may be obtained by reference to Note 11 of the "Notes to Consolidated
Financial Statements" under Item 8 herein.
7
ITEM 2. PROPERTIES
The administrative and manufacturing functions of CSI are conducted at
the following facilities:
-- In Hector, Minnesota the Company owns a 15,000 square foot
building where its executive and administrative offices are
located.
--- Suttle's manufacturing is conducted at four locations. At Hector,
Minnesota, the Company owns three plants totaling 68,000 feet of
manufacturing space. The Company has a long-term lease from the
Puerto Rico Industrial Development Company on three facilities in
Humacao, Puerto Rico aggregating 65,000 square feet. The Company
leases 40,000 square feet of manufacturing space in San Jose,
Costa Rica. The Company also leases a 5,000 square foot facility
in Elizabeth, New Jersey where Automatic Tool and Connector
Company manufactures its fiber optic connector products.
-- Austin Taylor Communications, Ltd. owns a 40,000 square foot
facility and leases a 6,000 square foot facility in Bethesda,
Wales.
--- Transition Networks, Inc. leases a 27,000 square foot facility in
Eden Prairie, Minnesota where its manufacturing and administrative
facilities are located.
--- JDL Technologies, Inc. leases a 4,000 square foot facility in
Edina, Minnesota which houses its business operations.
-- The Company owns a 35,000 square foot plant in Lawrenceville,
Illinois. This facility is for sale, but is currently leased to
other tenants, pending a sale.
CSI believes these facilities will be adequate to accommodate its
administrative and manufacturing needs for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
No material litigation or other claims are presently pending against
the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
8
PART II
ITEM 5. MARKET MATTERS FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
(a) MARKET INFORMATION
The Company's common stock is currently traded in the National Market
System of the National Association of Securities Dealers Automated Quotation
System ("NASDAQ").
The table below presents the price range of high and low trades of the
Company's common stock for each period indicated as reported by NASDAQ:
1998 1997
----------------------- ------------------------
High Low High Low
First $19.25 $15.25 $15.13 $13.50
Second 19.00 16.00 15.00 12.50
Third 16.00 10.88 22.63 14.00
Fourth 13.88 10.50 22.75 16.00
(b) HOLDERS
At March 1, 1999 there were approximately 800 holders of record of
Communications Systems, Inc. common stock.
(c) DIVIDENDS
The Company has paid regular quarterly dividends since October 1, 1985.
The per share quarterly dividends payable in fiscal 1997 and 1998 were as
follows:
January 1, 1997 - April, 1997 $.08
July 1, 1997 - April, 1998 .09
July 1, 1998 - Present .10
9
ITEM 6. SELECTED FINANCIAL DATA
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
SELECTED FINANCIAL INFORMATION
(in thousands except per share amounts)
Year Ended December 31
-----------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
Selected Income Statement Data
Revenues From Continuing Operations $71,159 $75,732 $68,705 $66,004 $57,077
Costs and Expenses:
Cost of Sales 50,188 52,302 47,719 47,297 40,812
Selling, General and Administrative Expenses 12,413 10,947 10,581 8,519 8,180
------- ------- ------- ------- -------
Total Costs and Expenses 62,601 63,249 58,300 55,816 48,992
Operating Income From Continuing Operations 8,558 12,483 10,405 10,189 8,086
Other Income, Net 1,259 1,654 799 899 341
Income From Continuing Operations Before Income Taxes 9,817 14,137 11,204 11,088 8,427
Income Tax Expense 1,950 3,200 2,250 2,164 1,616
------- ------- ------- ------- -------
Income From Continuing Operations 7,867 10,937 8,954 8,924 6,811
Income (Loss) From Discontinued Operations, Net of Taxes (721) 160 (7)
------- ------- ------- ------- -------
Net Income $ 7,867 $10,937 $ 8,233 $ 9,084 $ 6,804
======= ======= ======= ======= =======
Basic Net Income (Loss) Per Common Share:
Continuing Operations $ .87 $ 1.18 $ .97 $ .98 $ .76
Discontinued Operations (.08) .02
------- ------- ------- ------- -------
Basic Net Income Per Share $ .87 $ 1.18 $ .89 $ 1.00 $ .76
======= ======= ======= ======= =======
Diluted Net Income (Loss) Per Common Share
Continuing Operations $ .87 $ 1.17 $ .96 $ .97 $ .75
Discontinued Operations (.08) .02
------- ------- ------- ------- -------
Diluted Net Income Per Share $ .87 $ 1.17 $ .88 $ .99 $ .75
======= ======= ======= ======= =======
Cash Dividends Per Share $ .38 $ .34 $ .30 $ .26 $ .22
======= ======= ======= ======= =======
Average Common and Potential Common
Shares Outstanding 9,084 9,325 9,352 9,217 9,093
======= ======= ======= ======= =======
Selected Balance Sheet Data
Total Assets $83,900 $77,518 $67,596 $61,945 $54,799
Property, Plant and Equipment, Net 11,379 9,675 8,965 8,658 8,132
Working Capital 37,268 48,514 35,906 29,039 22,420
Net Assets of Discontinued Operations 537 9,255 8,033
Assets of Businesses Transferred Under
Contractual Arrangements 593
Stockholders' Equity 63,454 69,264 59,015 54,076 45,566
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
1998 Compared to 1997
---------------------
Consolidated sales decreased 6% to $71,759,000. Consolidated operating income
decreased 31% to $8,558,000.
Suttle sales decreased 11% to $55,540,000. Sales to customers in the United
States (U.S.) decreased 10% to $53,426,000. Sales to the Big 6 telephone
companies (the five Regional Bell Operating Companies (RBOCs) and GTE) decreased
13% to $33,245,000. Sales to these customers account for 62% of Suttle's U.S.
customer sales. Sales to distributors, original equipment manufacturers (OEMs),
and electrical contractors decreased $155,000, or 1%. Sales to retail customers
decreased $1,476,000 or 26% due to decreased sales to Radio Shack, which is
Suttle's principal retail customer. Suttle's export sales, including sales to
Canada decreased 23% to $2,114,000 due to reduced exports of fiber-optic
connector products and lower sales to Pacific Rim countries.
The sales decreases were across all of Suttle's product lines. CorroShield
product sales fell 6% to $22,247,000 in 1998, the first year it failed to
produce double-digit sales growth since its introduction. The decrease in
CorroShield sales is due to changes in ordering patterns and inventory reduction
programs at the RBOCs, which are CorroShield's major customers. CorroShield
products are continuing to displace conventional voice connecting products,
sales of which declined 12% in 1998. Sales of data products decreased 18% to
$5,972,000. Sales of fiber-optic connector products decreased 18% to $3,336,000.
Suttle's gross margins declined 14% to $18,176,000. Gross margin percentage
declined to 32.7% in 1998 from 33.8% in 1997. The decline in gross margin was
due to costs associated with excess production capacity and provisions for
inventory obsolescence due to slow-moving inventory. Selling, general and
administrative expenses declined $886,000 or 10% due to lower selling and
delivery expenses associated with lower sales volume. Suttle's operating income
decreased $2,037,000 or 16%.
Austin Taylor's sales decreased 12% to $11,730,000. The decrease was due to
reduced sales of CATV products caused by major reductions of cable television
construction activity in the U.K. and below plan sales to Pacific Rim telephone
companies. Austin Taylor's gross margin declined 21% to $1,835,000. Gross margin
as a percentage of sales was 15.7% compared to 17.5% in 1997. The decline in
gross margin was principally due to lower than expected business volume.
Selling, general and administrative expenses increased $21,000. Operating income
decreased $517,000 or 45%.
The Company acquired JDL Technologies, Inc. in August, 1998 and Transition
Networks, Inc. in December, 1998. While the Company expects both acquisitions to
make positive contributions in future periods, neither had a positive impact in
1998. JDL had sales of $1,681,000 in the last five months of 1998, and an
operating loss of $675,000. Government funding delays for new telecommunications
infrastructure in the public schools negatively affected JDL's performance. TNI
had sales of $2,208,000 and an operating loss of $334,000. TNI's performance was
hurt by the lack of manufacturing margins on December sales.
Consolidated investment income, net of interest expense, decreased $395,000 due
to decreased levels of funds available for investment and interest on notes
payable associated with acquisitions. Income from continuing operations before
income taxes decreased $4,319,000 or 31%. The Company's effective income tax
rate was 19.9% compared to 22.6% in 1997. The decrease in the tax rate was due
to decreased earnings in the U.S. and U.K., where the Company pays a higher rate
of tax than it does on earnings in Puerto Rico. Net income decreased $3,069,000
or 28%.
11
1997 Compared to 1996
---------------------
Consolidated sales increased 10% to $75,732,000. Consolidated operating income
increased 20% to $12,483,000.
Suttle sales increased 9% to $62,416,000. Sales to customers in the United
States (U.S.) increased 10% to $59,674,000. Sales to the Big 6 telephone
companies (the five Regional Bell Operating Companies (RBOCs) and GTE) increased
11% to $38,027,000. Sales to these customers accounted for 64% of Suttle's U.S.
customer sales. Sales to distributors, original equipment manufacturers (OEMs),
and electrical contractors increased 8%. Sales to retail customers increased 11%
due to increased sales to Radio Shack. Suttle's export sales, including sales to
Canada decreased 9% to $2,741,000.
Suttle's sales increases were generated by a 56% increase in sales of the
CorroShield line of corrosion resistant connectors. CorroShield product sales
totaled $23,610,000 in 1997 compared to $15,123,000 in 1996. During 1997, two
additional RBOCs converted to this product line for the majority of their
residential installations. This product conversion resulted in an 11% decline in
sales of conventional voice connector products in 1997, a trend the Company
expects to continue. Sales of data products increased 8% to $7,314,000. Sales of
fiber-optic connector products decreased 15% to $4,091,000.
Suttle's gross margins increased 12% to $21,099,000. Gross margin percentage
increased to 33.8% from 32.9% in 1996. The improvement in gross margin was due
to lower purchase costs for certain raw materials and improved manufacturing
overhead efficiencies due to increased production volumes. Selling, general and
administrative expenses increased $829,000 or 10% due to increased sales
expenses associated with efforts to increase sales of data products and develop
export markets for Suttle products. Suttle's operating income increased
$1,392,000 or 13%.
Austin Taylor's sales increased 18% to $13,316,000. Growth was due to increased
sales of network termination equipment and street cabinets to U.K. cable
television companies and increased sales of plastic and metal distribution boxes
through the distributor market. Austin Taylor's gross margin increased 11% to
$2,331,000. Gross margin as a percentage of sales was 17.5% compared to 18.7% in
1996. The decline in gross margin was due to increased product development costs
and increased costs for certain raw materials. Selling, general and
administrative expenses decreased $288,000 or 19% due to reduced sales costs.
Operating income increased $511,000 or 82%.
Consolidated investment income, net of interest expense, increased $855,000 due
to increased levels of funds available for investment and interest on notes
receivable from sales of discontinued operations. Income from continuing
operations before income taxes increased $2,933,000 or 26%. The Company's
effective income tax rate was 22.6% compared to 20.1% in 1996. The increase in
the tax rate was due to increased U.S. taxes on the Company's earnings in Puerto
Rico. Income from continuing operations increased $1,983,000 or 22%.
Acquisitions and Dispositions
-----------------------------
Effective December 1, 1998, the Company acquired Transition Networks, Inc.
("TNI") in exchange for $8,507,000 of cash (net of cash acquired). TNI is a
manufacturer of media and rate conversion products, which permit
telecommunications networks to move information between copper-wired equipment
and fiber-optic cable.
Effective August 7, 1998, the Company acquired JDL Technologies, Inc. ("JDL") in
exchange for 158,005 shares of CSI common stock. JDL provides telecommunications
network design, specification, and training services to educational
institutions. JDL also sells internet access software for use in elementary and
secondary schools.
Effective January 4, 1996, the Company acquired Automatic Tool and Connector
Co., Inc. ("ATC") of Union, New Jersey, in exchange for $3,191,000, consisting
of $1,473,000 of cash and 112,676 shares of the Company's common stock. ATC is a
manufacturer of high performance fiber-optic connectors, interconnect devices
and coaxial cable assemblies for telecommunications, medical electronics,
computer and other markets.
12
During the third quarter of 1996, the Company's Board of Directors concluded
that the contract manufacturing business was no longer a strategic fit with the
Company's plans for its domestic and international telecommunications
manufacturing business. After considering various alternatives for the
disposition of Zercom, the Company agreed to sell the assets (except cash and
accounts receivable) of Zercom Corporation to Nortech Systems, Inc. for
$1,500,000 of cash and a $4,867,000 five-year note. The transaction was
completed November 4, 1996.
Revenue from discontinued operations was $13,518,000 in 1996. Loss from
operations, net of income tax benefits, was $719,000. The loss was principally
due to write-downs against slow-moving electronic fishing products inventory.
Loss on disposal of the business, after income taxes, was $2,000.
The acquisitions the Company has made over the past several years have served to
expand the Company's product offerings and customer base in both U.S. and
international markets. The Company is a growth-oriented manufacturer of
telecommunications connecting and networking devices. The Company is continuing
to search for acquisition candidates with products that will enable the Company
to better serve its target markets.
Effects of Inflation
--------------------
Inflation has not had a significant effect on operations. The Company does not
have long-term production or procurement contracts and has historically been
able to adjust pricing and purchasing decisions to respond to inflationary
pressures.
Year 2000 Issues
----------------
Most older computer software was originally designed to use references to
calendar dates on an abbreviated basis. Under this system, references to the
calendar year are abbreviated to the last two digits of the year, i.e. 1998 is
abbreviated as "98". Software using this system often fails to recognize that
the year 2000, abbreviated as "00", follows 1999. This "Y2K" problem can cause
computing errors in date sensitive processes. In 1998, the Company surveyed its
operations to locate computer systems that could be subject to this error and
initiated a program of corrective action.
The Company's accounting and management control systems at Suttle and Austin
Taylor utilize a company-wide computer network centered in the Company's Hector,
MN corporate office. The hardware and software used in operating the network are
all purchased from third party suppliers. The Company has contracted with these
suppliers and obtained the necessary hardware and software to bring its central
computer system into Y2K compliance on a current basis. However, certain
elements of the data network itself may not be compliant and will be upgraded on
an as needed basis in 1999. Total cost of the Y2K compliance program is
estimated at $150,000, of which approximately $100,000 has been spent to date.
At the present time, neither Suttle nor Austin Taylor produces products
containing embedded controllers or microprocessors. None of the products are
date sensitive or subject to the Y2K problem. The Company does not believe it
has any warranty exposure to customers due to potential Y2K problems.
In 1998, the Company acquired JDL Technologies, Inc. and Transition Networks,
Inc. Potential Y2K problems were explored as part of the Company's due diligence
investigations of these companies. The Company does not believe Y2K problems
will have a material effect on the operations of these companies.
13
The Company has also been in contact with its major customers and suppliers to
estimate the extent to which it may be vulnerable to their respective Y2K
problems. The Company is reliant on third parties for critical functions,
including transportation, supplies, utilities and communications services.
Multiple sources of supply are available for most of these services. The Company
has not received any indication from these parties that they will not be Y2K
compliant. However, if customers and suppliers experience unexpected Y2K
problems, it could affect Company's ability to produce products or make
scheduled deliveries. As a result, although the Company does not believe Year
2000 problems will cause a material disruption of its operations, it will
continue to monitor the situation and modify its business plans and procedures
and take corrective actions as necessary.
European Currency
-----------------
In January 1999, the European Monetary Union (EMU) entered into a three-year
transition phase during which a common currency called the Euro was introduced
in participating countries. Initially, this new currency is being used for
financial transactions. It will eventually replace the national currencies of
participating nations, which will be withdrawn by July 2002.
The Company does not believe introduction of the Euro will have any material
effect on its business at this time. The United Kingdom, where Austin Taylor is
located, is not among the countries converting to the Euro. The Company does not
do significant amounts of business in other participating European nations, nor
does it hold assets valued in other European currencies. The Company will
continue to monitor the European currency situation and take action as required.
Liquidity and Capital Resources
-------------------------------
At December 31, 1998, the Company had approximately $20,405,000 of cash and cash
equivalents compared to $23,192,000 of cash and cash equivalents and short-term
U.S. Treasury investments at December 31, 1997. The Company had working capital
of approximately $37,268,000 and a current ratio of 2.8 to 1 compared to working
capital of $48,514,000 and a current ratio of 6.9 to 1 at the end of 1997. The
reduction in working capital was primarily due to use of short-term debt by the
Company in making acquisitions.
Cash flow provided by operations was approximately $14,012,000 in 1998 compared
to $7,545,000 in 1997. The increase was due to cash flows from decreased
inventory and accounts receivable levels caused by the Company's decreased
levels of business.
Investing activities utilized $4,586,000 of cash in 1998. Cash investments in
new subsidiaries in 1998 were $8,539,000. The Company expects to spend an
additional $6,000,000 in April, 1999 to acquire LANart Corporation. Cash
investments in new plant and equipment totaled $3,352,000 in 1998. Capital
expenditures to support the Company's Suttle and Austin Taylor operations were
$2,269,000 and $936,000, respectively. These investments were financed by use of
operating cash flows, maturities of mortgage-backed securities and redemption of
U.S. Treasury investments. The Company expects to spend $3,500,000 on capital
additions in 1999.
Net cash used in financing activities increased to $7,027,000. The Company
purchased and retired 790,400 shares of its stock in open market transactions
during 1998. Board authorizations are outstanding to purchase an additional
209,600 shares. Dividends paid on common stock increased to $3,466,000. Proceeds
from common stock issuances, principally exercises of key employee stock
options, totaled $804,000 in 1998. The Company may purchase and retire
additional shares in 1999 if warranted by market conditions and the Company's
financial position.
The bulk of Suttle's operations are located in Puerto Rico. Until 1994,
substantially all the earnings of these operations were sheltered from U.S.
income tax due to the possessions tax credit (Internal Revenue Code Section
936). Under provisions of the Omnibus Budget Act of 1993, which went into effect
beginning in the 1994 tax year, the amount of the possessions credit is limited
to a percentage of the Company's Puerto Rico payroll and depreciation. U.S.
income tax expense on the Company's earnings in Puerto Rico, after full
utilization of the available tax credits, was $556,000, $791,000 and $352,000 in
1998, 1997 and 1996, respectively.
14
Under provisions of the Small Business Job Protection Act of 1996, the
possessions tax credit was repealed for years after 1995. However, companies
like CSI which currently qualify for the credit, may continue to claim the
credit until 2005, subject to certain limitations. As of July 1, 1996, the
credit no longer applies to investment income earned in Puerto Rico. The credit
will continue to apply to business income earned in Puerto Rico through 2001.
For the years 2002 to 2005, the amount of Puerto Rico business income eligible
for the credit will be limited to an inflation-adjusted amount based on Puerto
Rico business income earned from 1990 to 1994. The possessions tax credit has a
materially favorable effect on the Company's income tax expense. Had the Company
incurred income tax expense on Puerto Rico operations at the full U.S. rate,
income tax expense would have increased by $1,947,000, $1,987,000 and $1,908,000
in 1998, 1997 and 1996, respectively.
At December 31, 1998 approximately $34,693,000, $6,907,000 and $1,880,000 of
assets were invested in the Company's subsidiaries in Puerto Rico, the United
Kingdom and Costa Rica, respectively. The Company expects to maintain these
investments to support the continued operation of the subsidiaries. The Company
uses the U.S. dollar as its functional currency in Costa Rica. The United
Kingdom is a politically and economically stable country. Accordingly, the
Company believes its risk of material loss due to adjustments in foreign
currency markets to be small.
At December 31, 1998, the Company's outstanding obligations for notes payable
totaled $9,078,000, consisting principally of borrowings against its line of
credit used to purchase Transition Networks, Inc. The Company expects to repay
or refinance this credit line in 1999. The unused portion of the Company's
credit line ($1,097,000 at December 31, 1998) is available for use. In the
opinion of management, based on the Company's current financial and operating
position and projected future expenditures, sufficient funds are available to
meet the Company's anticipated operating and capital expenditure needs.
New Accounting Standards
------------------------
Effective January 1, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income". This
statement establishes standards for reporting and presenting comprehensive
income and its components in the financial statements. The Company has adjusted
the presentation of its financial statements for earlier periods to comply with
the standard. Adoption of the standard resulted in the addition of the foreign
currency translation adjustment to the Company's results of operations.
Effective January 1, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information". This statement revises the standards for
the way public enterprises report financial and descriptive information about
operating segments in financial statements. Adoption of this standard had no
material effect on the Company's results of operations or financial position,
but did affect the disclosure of segment information contained elsewhere in this
report (Note 11).
In June, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which is effective January 1, 2000. SFAS 133
requires companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
the values of those derivatives would be accounted for depending on the use of
the derivative and whether it qualifies for hedge accounting. The Company has
not yet determined the impact of this pronouncement on its financial statements.
15
REPORT OF MANAGEMENT
--------------------
The management of Communications Systems, Inc. and its subsidiary companies is
responsible for the integrity and objectivity of the financial statements and
other financial information contained in the annual report. The financial
statements and related information were prepared in accordance with generally
accepted accounting principles and include amounts that are based on
management's informed judgments and estimates.
In fulfilling its responsibilities for the integrity of financial information,
management maintains accounting systems and related controls. These controls
provide reasonable assurance, at appropriate costs, that assets are safeguarded
against losses and that financial records are reliable for use in preparing
financial statements. Management recognizes its responsibility for conducting
the Company's affairs according to the highest standards of personal and
corporate conduct.
The Audit Committee of the Board of Directors, comprised solely of outside
directors, meets with the independent auditors and management periodically to
review accounting, auditing, financial reporting and internal control matters.
The independent auditors have free access to this committee, without management
present, to discuss the results of their audit work and their opinion on the
adequacy of internal financial controls and the quality of financial reporting.
/s/ Curtis A. Sampson
- -------------------------------------
Curtis A. Sampson
President and Chief Executive Officer
/s/ Paul N. Hanson
- -------------------------------------
Paul N. Hanson
Chief Financial Officer
March 29, 1999
16
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
Shareholders and Board of Directors
Communications Systems, Inc.
We have audited the accompanying consolidated balance sheets of Communications
Systems, Inc. and subsidiaries (the Company) as of December 31, 1998 and 1997
and the related consolidated statements of income and comprehensive income,
changes in stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1998. Our audits also include the financial
statement schedule listed in the Index at Item 14. These consolidated financial
statements and the financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and the schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 1998
and 1997 and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998 in conformity with
generally accepted accounting principles. Also, in our opinion, the financial
statement schedule referred to above, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/s/ Deloitte & Touche LLP
- --------------------------------------------
Deloitte & Touche LLP
March 2, 1999 (March 12, 1999 as to Note 11)
Minneapolis, Minnesota
17
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
-------------------------------
1998 1997
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents $ 20,405,363 $ 17,942,315
Investments in U.S. Treasury securities 5,249,314
Trade accounts receivable, less allowance for
doubtful accounts of $884,000 and $796,000, respectively 14,624,123 12,571,511
Inventories (Note 3) 20,837,508 18,438,531
Other current assets 499,549 1,486,266
Deferred income taxes (Note 8) 1,348,000 1,080,000
------------ ------------
TOTAL CURRENT ASSETS 57,714,543 56,767,937
PROPERTY, PLANT AND EQUIPMENT,net (Notes 1 and 4) 11,378,760 9,674,861
OTHER ASSETS:
Excess of cost over net assets acquired (Note 1) 8,392,261 2,881,544
Investments in mortgage-backed and other securities (Note 1) 1,316,912 3,356,568
Note receivable from sale of assets of discontinued 3,765,390 4,557,767
contract manufacturing operations (Note 2)
Deferred income taxes (Note 8) 548,047 114,047
Other assets 783,799 165,204
------------ ------------
TOTAL OTHER ASSETS 14,806,409 11,075,130
------------ ------------
TOTAL ASSETS $ 83,899,712 $ 77,517,928
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable (Note 1) $ 9,077,598
Accounts payable 4,589,078 $ 2,770,628
Accrued expenses 3,823,596 3,030,736
Dividends payable 879,130 839,399
Income taxes payable 2,076,658 1,613,469
------------ ------------
TOTAL CURRENT LIABILITIES 20,446,060 8,254,232
COMMITMENTS AND CONTINGENCIES (Note 6)
STOCKHOLDERS' EQUITY:
Preferred stock, par value $1.00 per share;
3,000,000 shares authorized; none issued
Common stock, par value $.05 per share; 30,000,000 shares authorized;
8,791,301 and 9,326,652 shares issued and outstanding,
respectively (Notes 1 and 7) 439,565 466,333
Additional paid-in capital 25,250,914 24,132,771
Retained earnings 37,862,463 44,552,855
Stock option notes receivable (Note 7) (288,225)
Cumulative translation adjustment (Note 1) 188,935 111,737
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 63,453,652 69,263,696
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 83,899,712 $ 77,517,928
============ ============
See notes to consolidated financial statements.
18
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31
--------------------------------------------------
1998 1997 1996
------------ ------------ ------------
REVENUES FROM CONTINUING OPERATIONS (Note 10): $ 71,158,743 $ 75,731,651 $ 68,704,940
COSTS AND EXPENSES:
Cost of sales 50,188,186 52,301,671 47,718,676
Selling, general and administrative expenses 12,412,361 10,947,163 10,581,557
------------ ------------ ------------
TOTAL COSTS AND EXPENSES 62,600,547 63,248,834 58,300,233
------------ ------------ ------------
OPERATING INCOME FROM 8,558,196 12,482,817 10,404,707
CONTINUING OPERATIONS
OTHER INCOME (EXPENSE):
Investment income 1,306,466 1,690,223 808,287
Interest expense (47,237) (36,167) (9,139)
------------ ------------ ------------
OTHER INCOME, net 1,259,229 1,654,056 799,148
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS 9,817,425 14,136,873 11,203,855
BEFORE INCOME TAXES
INCOME TAX EXPENSE (Note 8) 1,950,000 3,200,000 2,250,000
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS 7,867,425 10,936,873 8,953,855
DISCONTINUED OPERATIONS (Note 2):
Loss from operations, net of income taxes (719,218)
Loss on disposal, net of income taxes (2,106)
------------ ------------ ------------
NET INCOME 7,867,425 10,936,873 8,232,531
------------ ------------ ------------
OTHER COMPREHENSIVE INCOME (Note 1) -
Foreign currency translation adjustment 77,198 (137,738) 479,629
------------ ------------ ------------
COMPREHENSIVE INCOME $ 7,944,623 $ 10,799,135 $ 8,712,160
============ ============ ============
BASIC NET INCOME
PER COMMON SHARE (Note 1):
Continuing Operations $ .87 $ 1.18 $ .97
Discontinued Operations - - (.08)
------------ ------------ ------------
$ .87 $ 1.18 $ .89
============ ============ ============
DILUTED NET INCOME
PER COMMON SHARE (Note 1):
Continuing Operations $ .87 $ 1.17 $ .96
Discontinued Operations - - (.08)
------------ ------------ ------------
$ .87 $ 1.17 $ .88
============ ============ ============
AVERAGE BASIC SHARES OUTSTANDING 9,040,000 9,232,000 9,273,000
AVERAGE DILUTED SHARES OUTSTANDING 9,084,000 9,325,000 9,352,000
See notes to consolidated financial statements.
19
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Additional Stock Option Cumulative
-------------------- Paid-in Retained Note Translation
Shares Amount Capital Earnings Receivable Adjustment Total
--------- --------- ------------ ------------ ----------- ----------- ------------
BALANCE AT DECEMBER 31, 1995 9,183,401 $ 459,170 $ 19,706,125 $ 34,140,435 $ - $ (230,154) $ 54,075,576
Net income 8,232,531 8,232,531
Issuance of stock to acquire
Automatic Tool and Connector Co. 112,676 5,634 1,712,675 1,718,309
Issuance of stock under
Employee Stock Purchase Plan 14,346 717 157,806 158,523
Issuance of stock under
Employee Stock Option Plan 52,381 2,619 466,427 469,046
Tax benefit from non qualified
employee stock options 12,701 12,701
Shareholder dividends (2,868,154) (2,868,154)
Purchase of stock (255,495) (12,775) (601,381) (2,648,527) (3,262,683)
Foreign currency translation
adjustment 479,629 479,629
--------- --------- ------------ ------------ ----------- ----------- ------------
BALANCE AT DECEMBER 31, 1996 9,107,309 455,365 21,454,353 36,856,285 - 249,475 59,015,478
Net income 10,936,873 10,936,873
Issuance of stock to
Employee Stock Ownership Plan 20,870 1,044 298,956 300,000
Issuance of stock under
Employee Stock Purchase Plan 16,622 831 182,843 183,674
Issuance of stock under
Employee Stock Option Plan 181,851 9,093 2,045,715 2,054,808
Tax benefit from non qualified
employee stock options 150,904 150,904
Shareholder dividends (3,240,303) (3,240,303)
Foreign currency translation
adjustment (137,738) (137,738)
--------- --------- ------------ ------------ ----------- ----------- ------------
BALANCE AT DECEMBER 31, 1997 9,326,652 466,333 24,132,771 44,552,855 - 111,737 69,263,696
Net income 7,867,425 7,867,425
Issuance of stock to acquire
JDL Technologies, Inc. 158,005 7,900 2,204,170 2,212,070
Issuance of common stock under
Employee Stock Purchase Plan 12,210 610 112,259 112,869
Issuance of stock under
Employee Stock Option Plan 84,834 4,242 938,102 942,344
Tax benefit from non qualified
employee stock options 37,017 37,017
Issuance of notes receivable
for stock options, net (288,225) (288,225)
Purchase of stock (790,400) (39,520) (2,173,405) (11,052,325) (13,265,250)
Shareholder dividends (3,505,492) (3,505,492)
Foreign currency translation
adjustment 77,198 77,198
--------- --------- ------------ ------------ ----------- ----------- ------------
BALANCE AT DECEMBER 31, 1998 8,791,301 $ 439,565 $ 25,250,914 $ 37,862,463 $ (288,225) $ 188,935 $ 63,453,652
========= ========= ============ ============ =========== =========== ============
See notes to consolidated financial statements.
20
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
-------------------------------------------------
1998 1997 1996
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,867,425 $ 10,936,873 $ 8,232,531
Discontinued operations 721,324
------------ ------------ ------------
Income from continuing operations 7,867,425 10,936,873 8,953,855
Adjustments to reconcile income from continuing operations
to net cash provided by operating activities:
Depreciation and amortization 3,085,533 2,471,510 2,303,303
Deferred taxes (702,323) 702,713 (405,880)
Loss on liquidation of foreign subsidiary 73,696
Changes in assets and liabilities net of effects from acquisitions and
discontinued operations:
Decrease (increase) in accounts receivable 2,651,591 (1,966,519) (1,483,853)
Decrease (increase) in inventory 1,073,699 (4,634,744) 1,565,972
Decrease (increase) in other current assets 1,045,802 (137,547) (90,234)
Decrease in accounts payable (1,114,838) (328,639) (925,127)
Increase (decrease) in accrued expenses (353,930) 727,787 617,793
Increase (decrease) in income taxes payable 459,438 (300,273) 36,534
------------ ------------ ------------
Total adjustments 6,144,972 (3,392,016) 1,618,508
------------ ------------ ------------
Net cash provided by operating activities 14,012,397 7,544,857 10,572,363
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (3,351,927) (2,878,073) (1,989,053)
Maturities of mortgage-backed and other
investment securities 2,039,656 1,131,366 909,598
Sales (purchase) of U.S. Treasury bill investments 5,249,314 (5,249,314)
Increase (decrease) in other assets (617,433) 64,293 218,630
Cash receipts from sale of assets of discontinued operations 492,377 308,830 1,500,000
Changes in assets and liabilities of discontinued operations 267,679 1,630,416
Payment for purchase of subsidiaries (8,397,852) (79,947) (1,408,907)
------------ ------------ ------------
Net cash (used in) provided by investing activities (4,585,865) (6,435,166) 860,684
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable and long-term debt (65,557)
Increase in notes payable 8,900,364
Dividends paid (3,465,761) (3,129,489) (2,782,407)
Proceeds from issuance of stock 804,005 2,238,482 640,270
Purchase of stock (13,265,250) (3,262,683)
------------ ------------ ------------
Net cash used in financing activities (7,026,642) (891,007) (5,470,377)
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH 63,158 (75,767) 133,192
------------ ------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,463,048 142,917 6,095,862
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 17,942,315 17,799,398 11,703,536
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 20,405,363 $ 17,942,315 $ 17,799,398
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 2,152,133 $ 2,797,237 $ 2,137,401
Interest paid 10,727 13,723 9,139
See notes to consolidated financial statements.
21
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 1998, 1997 and 1996
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business: The Company is principally engaged in the manufacture
and sale of modular connecting and wiring devices for voice and data
communications. The Company sells these products to telephone companies,
electrical contractors, interconnect companies, original equipment manufacturers
and retailers. The Company also owns subsidiaries which manufacture media and
rate conversion products (products that permit telecommunications networks to
move information between copper wired equipment and fiber-optic cable) and offer
internet network design, specification and training services to educational
institutions. The Company's operations are located in the United States, United
Kingdom, Puerto Rico, and Costa Rica. Discontinued operations represent the
Company's contract manufacturing operations, which were sold in November, 1996.
Principles of consolidation: The consolidated financial statements include the
accounts of the Company and its subsidiaries. All material intercompany
transactions and accounts have been eliminated.
Use of estimates: The presentation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The
Company's estimates consist principally of reserves for doubtful accounts and
inventory obsolescence.
Financial instruments: The fair value of the Company's financial instruments,
which consist of marketable securities, accounts receivable, mortgage-backed
securities, accounts payable and notes payable, approximate their carrying value
due to their short-term nature.
Cash equivalents: For purposes of the consolidated statements of cash flows, the
Company considers all highly liquid investments with a maturity of three months
or less at the time of purchase to be cash equivalents.
Accounts receivable from Hector Communications Corporation: The Company provides
services for Hector Communications Corporation ("HCC"), a former subsidiary of
the Company. Several of the Company's officers and directors work in similar
capacities for HCC. Outstanding receivable balances from HCC were $645,000 and
$357,000 at December 31, 1998 and 1997, respectively. Accounts with HCC are
handled on an open account basis.
Property, plant and equipment: Property, plant and equipment is recorded at
cost. Depreciation is computed using principally the straight-line method.
Depreciation included in costs and expenses was $2,444,192, $2,086,366, and
$1,927,081 for 1998, 1997 and 1996, respectively. Maintenance and repairs are
charged to operations and additions or betterments are capitalized. Items of
property sold, retired or otherwise disposed of are removed from the asset and
accumulated depreciation accounts and any gains or losses on disposal are
reflected in operations.
Excess of cost over net assets acquired: The excess of cost over net assets of
subsidiaries acquired in purchase transactions is being amortized on the
straight-line method over periods of from 5 to 15 years. Amortization included
in costs and expenses was $641,341, $385,144 and $376,222 in 1998, 1997 and
1996, respectively.
Investment in debt securities: The Company's Puerto Rico subsidiary owns a
portfolio of AAA rated mortgage-backed securities it is holding to maturity. At
December 31, 1998, the amortized cost basis of the securities was $1,317,000.
Market value of the securities was $1,330,000 resulting in a gross unrealized
holding gain of $13,000, which is not reflected in the consolidated financial
statements.
22
Notes payable: The Company has a $10,000,000 line of credit from U.S. Bank.
Outstanding borrowings against the line of credit at December 31, 1998 were
$8,903,000. The Company utilized those funds in the acquisition of Transition
Networks, Inc. Interest on borrowings on the credit line is at the bank's
average CD rate plus 1.5% (7.03% at December 31, 1998). The credit line matures
June 30, 2000. There were no outstanding borrowings against the credit line at
December 31, 1997.
Foreign currency translation: Assets and liabilities denominated in foreign
currencies were translated into U.S. dollars at year-end exchange rates. Revenue
and expense transactions were translated using average exchange rates.
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 44,261 shares, 92,853
shares , and 78,915 shares in 1998, 1997 and 1996, respectively. The Company
calculates the dilutive effect of outstanding options using the treasury stock
method.
New accounting principles: Effective January 1, 1998, the Company adopted the
provisions of Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income". This statement establishes standards for reporting and
presenting comprehensive income and its components in the financial statements.
The Company has adjusted the presentation of its financial statements for
earlier periods to comply with the standard. Adoption of the standard resulted
in the addition of the foreign currency translation adjustment to the Company's
results of operations.
Effective January 1, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information". This statement revises the standards for
the way public enterprises report financial and descriptive information about
operating segments in financial statements. Adoption of this standard had no
material effect on the Company's results of operations or financial position,
but did affect the disclosure of segment information contained elsewhere in this
report (Note 11).
In June, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which is effective January 1, 2000. SFAS 133
requires companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
the values of those derivatives would be accounted for depending on the use of
the derivative and whether it qualifies for hedge accounting. The Company has
not yet determined the impact of this pronouncement on its financial statements.
Basis of presentation: Certain amounts in the 1997 and 1996 financial statements
have been reclassified to conform to the 1998 financial statement presentation.
These reclassifications had no effect on net income or stockholders' equity as
previously reported.
23
NOTE 2 - DISCONTINUED OPERATIONS
Discontinued operations represent the Company's contract manufacturing
operations, which were sold November 4, 1996 for $1,500,000 cash and a note
receivable of $4,866,597. The note bears interest at the prime rate and is
secured by the assets sold.
The Company's consolidated financial statements and accompanying notes present
separately the net assets and results of operations of the discontinued
operations. Operating results of the discontinued contract operations were as
follows:
Ten Months Ended
October 31, 1996
----------------
Sales $ 13,571,501
Costs and expenses 14,684,080
Interest income, net 35,361
-------------
Loss before income taxes (1,131,218)
Income tax benefit (412,000)
-------------
Loss from operations (719,218)
Loss on disposal, net of income
tax expense of $77,000 (2,106)
-------------
Net loss $ (721,324)
=============
NOTE 3 - INVENTORIES
Inventories are carried at the lower of cost (first-in, first out method) or
market and consist of :
December 31
1998 1997
-----------------------------------
Finished goods $ 8,450,447 $ 5,237,907
Raw and processed materials 12,387,061 13,200,624
-------------- --------------
$ 20,837,508 $ 18,438,531
============== ==============
NOTE 4 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment and the estimated useful lives are as follows:
December 31
Estimated ----------------------------------------
useful life 1998 1997
------------------ -------------------- ------------------
Land $ 309,939 $ 291,989
Buildings 7-30 years 3,091,289 2,965,102
Machinery and equipment 3-15 years 24,550,064 21,351,745
Furniture and fixtures 5-10 years 2,702,890 2,073,739
-------------------- ------------------
30,654,182 26,682,575
Less accumulated depreciation 19,275,422 17,007,714
-------------------- ------------------
$ 11,378,760 $ 9,674,861
==================== ==================
NOTE 5 - EMPLOYEE BENEFIT PLANS
The Company has an Employee Savings Plan (401(k)) and matches a percentage of
employee contributions up to eight percent of compensation. Contributions to the
plan in 1998, 1997 and 1996 were $93,000, $89,000, and $73,000 respectively.
The Company does not provide post retirement benefits to its employees.
24
NOTE 6 - COMMITMENTS AND CONTINGENCIES
The Company leases land, buildings and equipment under operating leases with
original terms from one to ten years. Certain of these leases contain renewal
and purchase options. Rent expense charged to operations was $590,000, $640,000
and $603,000 in 1998, 1997 and 1996 respectively. At December 31, 1998, the
Company was obligated under noncancellable operating leases to make minimum
annual future lease payments as follows:
Year Ending December 31:
1999 $ 559,000
2000 495,000
2001 450,000
2002 373,000
2003 266,000
After 2003 89,000
--------------
$ 2,232,000
==============
In the ordinary course of business, the Company is exposed to legal actions and
incurs costs to pursue and defend legal claims. Company management is not aware
of any outstanding or pending legal actions that would materially affect the
Company's financial position or results of operations.
NOTE 7 - COMMON STOCK AND STOCK OPTIONS
Common shares are reserved in connection with the Company's 1992 stock plan
under which 1,400,000 shares of common stock may be issued pursuant to stock
options, stock appreciation rights, restricted stock or deferred stock granted
to officers and key employees. Exercise prices of stock options under the plan
cannot be less than fair market value of the stock on the date of grant. Rules
and conditions governing awards of stock options, stock appreciation rights and
restricted or deferred stock are determined by the Compensation Committee of the
Board of Directors, subject to certain limitations incorporated into the plan.
At December 31, 1998, 468,733 shares remained available to be issued under the
plan. Options expire five years from date of grant with one third of the options
vesting immediately, the remaining two thirds vesting equally over the next two
years
Common shares are also reserved for issuance in connection with a nonqualified
stock option plan under which up to 200,000 shares may be issued to nonemployee
directors. The plan provides for the automatic grant of nonqualified options for
2,000 shares of common stock annually to each nonemployee director concurrent
with the annual stockholders' meeting. Exercise price will be the fair market
value of the stock at the date of grant. Options granted under this plan vest
when issued and expire ten years from date of grant. At December 31, 1998,
68,000 shares are available to be issued under the plan.
Changes in outstanding employee and director stock options during the three
years ended December 31, 1998 were as follows:
Weighted
average
exercise
Number of price
shares per share
----------------- ----------
Outstanding at December 31, 1995 435,422 $ 11.09
Granted 167,000 14.75
Exercised (52,381) 8.95
Canceled (8,352) 13.95
-----------------
Outstanding at December 31, 1996 541,689 12.38
Granted 197,700 13.82
Exercised (181,851) 11.30
Canceled (32,266) 14.04
-----------------
Outstanding at December 31, 1997 525,272 13.19
Granted 224,550 17.46
Exercised (84,834) 11.11
Canceled (5,800) 15.07
-----------------
Outstanding at December 31, 1998 659,188 $ 14.89
25
At December 31, 1998, 475,188 stock options are currently exercisable. The
following table summarizes the status of Communications Systems, Inc. stock
options outstanding at December 31, 1998:
Weighted Average Weighted
Remaining Average
Range of Exercise Prices Shares Option Life Exercise Price
- ------------------------ ----------- -------------- ---------------
$ 5.31 to $ 9.99 26,000 3.4 years $ 7.23
$10.00 to $14.99 356,138 2.5 years 13.72
$15.00 to $18.91 277,050 4.6 years 17.12
EMPLOYEE STOCK PURCHASE PLAN
The Company maintains an Employee Stock Purchase Plan for which 200,000 common
shares have been reserved. Under the terms of the plan, employees may acquire
shares of common stock, subject to limitations, through payroll deductions at
85% of the lower of fair market value for such shares on one of two specified
dates in each plan year. Shares issued to employees under the plan were 12,210,
16,622 and 14,346 for the plan years ended August 31, 1998, 1997 and 1996,
respectively. At December 31, 1998 employees had subscribed to purchase an
additional 21,785 shares in the current plan year ending August 31, 1999.
PRO FORMA FINANCIAL INFORMATION
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. If the Company had elected to recognize
compensation cost for its stock based transactions using the method prescribed
by SFAS No. 123, pro forma net income and net income per share would have been
as follows:
Year Ended December 31
--------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- ------------------
Net Income $ 7,061,627 $ 10,254,975 $ 7,740,304
Basic Net Income Per Share $ .78 $ 1.11 $ .83
Diluted Net Income Per Share $ .78 $ 1.10 $ .83
The fair value of the Company's stock options and Employee Stock Purchase Plan
transactions used to compute pro forma net income and net income per share
disclosures is the estimated present value at grant date using the Black-Scholes
option-pricing model. The following table displays the assumptions used in the
model.
Year Ended December 31
--------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- ------------------
Expected volatility 26% 25% 27%
Risk free interest rate 5.7% 6.2% 6.8%
Expected holding period - employees 4 years 4 years 4 years
Expected holding period - directors 7 years 7 years 7 years
Dividend yield 2.4% 2.6% 1.8%
Pro forma stock-based compensation cost was $806,000, $682,000 and $492,000 in
1998, 1997 and 1996, respectively. The fair value of all options issued in 1998,
1997 and 1996 was $971,000, $690,000 and $714,000, respectively.
In 1998, the Company provided financing to employees and directors who exercised
stock options during the year. The notes bear interest at 6% and mature February
28, 2000. The notes have been reflected as a reduction of stockholders' equity
in the financial statements.
26
EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)
All eligible employees of the Company participate in the ESOP after completing
one year of service. Contributions are allocated to each participant based on
compensation and vest 30% after three years of service and incrementally
thereafter, with full vesting after seven years. At December 31, 1998, the ESOP
held 284,480 shares of the Company's common stock, all of which has been
allocated to the accounts of eligible employees. Contributions to the plan are
determined by the Board of Directors and can be made in cash or shares of the
Company's stock. The Company accrued a 1996 ESOP contribution of $300,000, for
which the Company issued 20,870 shares of common stock to the ESOP in February,
1997. The Company's 1997 ESOP contribution was $350,000 of cash. The Company's
1998 ESOP contribution was $235,000 for which the Company issued 19,893 shares
of common stock to the ESOP in February, 1999.
PURCHASES OF COMMUNICATIONS SYSTEMS, INC. COMMON STOCK
The Company's Board of Directors has authorized the purchase and retirement,
from time to time, of shares of the Company's stock on the open market, or in
private transactions consistent with overall market and financial conditions. In
1996, the Company purchased and retired 255,495 shares at a cost of $3,263,000.
In 1998, the Company purchased and retired 790,400 shares at a cost of
$13,265,000. At December 31, 1998, 209,600 shares could be repurchased under
existing Board authorizations.
NOTE 8 - INCOME TAXES
Income tax expense from continuing operations consists of the following:
Year Ended December 31
--------------------------------------------------------
1998 1997 1996
----------------- ------------------ -----------------
Currently payable income taxes:
Federal $ 1,607,000 $ 898,000 $ 1,444,000
State 110,000 168,000 294,000
Puerto Rico 767,000 826,000 646,000
Foreign 131,000 454,000 257,000
----------------- ------------------ -----------------
2,615,000 2,346,000 2,641,000
Tax effect of disqualified employee incentive
stock options 37,000 151,000 13,000
Deferred income taxes (benefit) (702,000) 703,000 (404,000)
------------------ ------------------ ------------------
$ 1,950,000 $ 3,200,000 $ 2,250,000
================= ================== ==================
A subsidiary, Suttle Caribe, Inc., operates in Puerto Rico, and is qualified
under Internal Revenue Service Code section 936 for credit against U.S. income
taxes. Under provisions of the Omnibus Budget Reconciliation Act of 1993,
Congress set limits on the section 936 credit that went into effect for the 1994
tax year. As a result of the tax credit limitation, the Company incurred
$556,000, $791,000 and $352,000 of U.S. federal income tax expense on earnings
in Puerto Rico for 1998, 1997 and 1996, respectively.
Earnings of Suttle Caribe, Inc. are 90% exempt from Puerto Rico income taxes
through 2003, subject to satisfaction of the employment and investment
requirements of the tax exemption grant received by the Company. Distributions
by Suttle Caribe, Inc. to the parent company 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. The cumulative amount of
undistributed prior earnings on which no tollgate tax has been recognized was
approximately $10,004,000 at December 31, 1998.
27
Austin Taylor Communications, Ltd. operates in the U.K. and is subject to U.K.
rather than U.S. income taxes. U.K. pretax income was $915,000, $1,343,000, and
$791,000 in 1998, 1997 and 1996, respectively. Suttle Costa Rica, S.A. operates
in Costa Rica and is currently exempt from Costa Rica income taxes. Accumulated
earnings in Costa Rica on which no U.S. income tax has been accrued was
$1,368,000 at December 31, 1998. It is the Company's intention to reinvest the
remaining undistributed earnings of its Puerto Rico, U.K. and Costa Rica
subsidiaries to support the continued operation of those subsidiaries.
The provision for income taxes varied from the federal statutory tax rate as
follows:
Year Ended December 31
--------------------------------------------------------
1998 1997 1996
----------------- ------------------ -----------------
Tax at U.S. statutory rate 35.0% 35.0% 35.0%
Surtax exemption (1.0) (.7) (1.0)
U.S. taxes not provided on Puerto Rico operations (19.8) (14.1) (17.0)
State income taxes, net of federal benefit .7 .8 1.7
Other 5.0 1.6 1.4
----------------- ------------------ -----------------
Effective tax rate 19.9% 22.6% 20.1%
================= ================== =================
Deferred tax assets and liabilities as of December 31 related to the following:
1998 1997
---------------- -----------------
Current assets:
Bad debts $ 264,000 $ 240,000
Inventory 617,000 445,000
Accrued expenses 470,000 383,000
Other (3,000) 12,000
---------------- ----------------
$ 1,348,000 $ 1,080,000
================ ================
Long term assets and (liabilities):
Depreciation $ (382,953) $ (324,953)
Loss reserves on notes receivable 132,000 132,000
Other 16,000
Alternative minimum tax credits 783,000 307,000
---------------- -----------------
$ 548,047 $ 114,047
================ =================
NOTE 9 - ACQUISITIONS
Effective December 1, 1998, the Company acquired all the capital stock of
Transition Networks, Inc. for $8,507,000 (cash payments net of cash acquired).
The transaction is being accounted for as a purchase, and the operations of
Transition Networks, Inc. are included in consolidated operations as of the
effective date. Excess of cost over net assets acquired in the transaction was
$4,047,000, which is being amortized on a straight-line basis over 5 years. In
the acquisition, the following assets were acquired and liabilities assumed:
Property, plant and equipment $ 708,804
Excess of cost over net assets acquired 4,046,565
Accounts receivable 3,262,689
Inventory 3,198,942
Cash 550,049
Accounts payable (1,973,236)
Accrued expenses (643,263)
Other assets and liabilities (93,786)
----------------
Total purchase price 9,056,764
Less cash acquired (550,049)
Payment for purchase of Transition Networks, Inc.,
net of cash acquired $ 8,506,715
================
28
Effective August 7, 1998, the Company purchased all the capital stock of JDL
Technologies, Inc. for $2,244,000, consisting of 158,005 shares of the Company's
common stock and $32,000 of acquisition costs. The acquisition was accounted for
as purchase. Excess of cost over net assets acquired in the transaction was
$2,223,000, which is being amortized on a straight-line basis over five years.
The results of operations of JDL are included in consolidated operations as of
the acquisition date. In the acquisition, the following assets were acquired and
liabilities assumed:
Property, plant and equipment $ 77,799
Excess of cost over net assets acquired 2,222,772
Accounts receivable 1,430,953
Inventory 264,608
Accounts payable (949,999)
Accrued expenses (800,803)
Other assets and liabilities (1,000)
----------------
Payment for purchase of JDL Technologies, Inc. $ 32,260
================
Unaudited consolidated results of operations on a pro forma basis as though the
acquisitions were effective January 1, 1997 are as follows:
Year Ended December 31
---------------------------------
1998 1997
-------------- ----------------
Revenues from continuing operations $ 97,440,835 $ 98,917,302
Net income 6,473,170 9,482,716
Basic net income per share $ .71 $ 1.01
Diluted net income per share $ .71 $ 1.01
Effective January 4, 1996, the Company purchased all the capital stock of
Automatic Tool and Connector Co., Inc. (ATC) for $3,191,000, consisting of
$1,473,000 of cash and 112,676 shares of the Company's common stock. The fair
value of assets acquired in the transaction was $4,063,000 (including excess of
cost over net assets acquired of $2,864,000) and liabilities of $872,000 were
assumed.
NOTE 10- INFORMATION CONCERNING INDUSTRY SEGMENTS AND MAJOR CUSTOMERS
The Company classifies its businesses into three 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, which
designs and markets data transmission and computer network products; and other
operations. Information concerning the Company's continuing operations in the
various segments is as follows:
29
Austin Transition
Suttle Taylor Networks Other Consolidated
Year Ended December 31, 1998:
Revenues $ 55,539,979 $ 11,729,725 $ 2,208,295 $ 1,680,744 $ 71,158,743
Cost of sales 37,363,994 9,894,546 1,701,222 1,228,424 50,188,186
-------------- ------------- ------------ ----------- ------------
Gross profit 18,175,985 1,835,179 507,073 452,320 20,970,557
Selling, general and
administrative expenses 7,861,420 1,213,987 841,360 2,495,594 12,412,361
-------------- ------------- ------------ ----------- ------------
Operating income (loss) $ 10,314,565 $ 621,192 $ (334,287) $(2,043,274) $ 8,558,196
============== ============= ============ =========== ============
Depreciation and amortization $ 1,957,261 $ 692,453 $ 96,756 $ 339,063 $ 3,085,533
============== ============= ============ =========== ============
Assets $ 53,130,454 $ 7,091,218 $ 11,731,323 $11,946,717 $ 83,899,712
============== ============= ============ =========== ============
Capital expenditures $ 2,269,177 $ 935,603 $ 15,294 $ 131,853 $ 3,351,927
============== ============= ============ =========== ============
Year Ended December 31, 1997:
Revenues $ 62,415,513 $ 13,316,138 $ 75,731,651
Cost of sales 41,316,252 10,985,419 52,301,671
-------------- ------------- ------------
Gross profit 21,099,261 2,330,719 23,429,980
Selling, general and
administrative expenses 8,747,540 1,192,648 $ 1,006,975 10,947,163
-------------- ------------- ----------- ------------
Operating income (loss) $ 12,351,721 $ 1,138,071 $(1,006,975) $ 12,482,817
============== ============= =========== ============
Depreciation and amortization $ 1,744,554 $ 599,982 $ 126,974 $ 2,471,510
============== ============= =========== ============
Assets $ 54,740,837 $ 9,150,276 $13,626,815 $ 77,517,928
============== ============= =========== ============
Capital expenditures $ 2,553,360 $ 265,340 $ 59,373 $ 2,878,073
============== ============= =========== ============
Year Ended December 31, 1996:
Revenues $ 57,441,328 $ 11,263,612 $ 68,704,940
Cost of sales 38,562,815 9,155,861 47,718,676
-------------- ------------- ------------
Gross profit 18,878,513 2,107,751 20,986,264
Selling, general and
administrative expenses 7,918,487 1,481,030 $ 1,182,040 10,581,557
-------------- ------------- ----------- ------------
Operating income (loss) $ 10,960,026 $ 626,721 $(1,182,040) $ 10,404,707
============== ============= =========== ============
Depreciation and amortization $ 1,606,481 $ 549,512 $ 147,310 $ 2,303,303
============== ============= =========== ============
Assets $ 43,469,695 $ 8,147,019 $15,979,400 $ 67,596,114
============== ============= =========== ============
Capital expenditures $ 1,576,697 $ 368,592 $ 43,764 $ 1,989,053
============== ============= =========== ============
Suttle products are sold principally to United States (U.S.) customers. Suttle
operates manufacturing facilities in the U.S. (including Puerto Rico) and Costa
Rica. Austin Taylor operates in the United Kingdom (U.K.). Transition Networks
manufactures its products in the United States and makes sales in both the U.S.
and U.K. markets. Export sales were less than 10% of consolidated revenues in
each of the last three years. At December 31, 1998, foreign earnings in excess
of amounts received in the United States were approximately $4,697,000.
30
In 1998, sales to three U.S. customers amounted to 13.6%, 10.4% and 10.3% of
consolidated revenues, respectively. In 1997, sales to two U.S. customers
amounted to 17.6% and 10.0% of consolidated revenues, respectively. No customer
accounted for more than ten percent of the Company's consolidated revenues in
1996.
The Company's station apparatus products are manufactured using plastic parts,
wire sub-assemblies, fasteners, brackets, electronic circuit boards and other
components, most of which are fabricated by the Company. There are multiple
sources of supply for the materials and parts required and the Company is not
dependent upon any single supplier, except that the Company's corrosion
resistant products utilize a moisture-resistant gel-filled fig available only
from Raychem Corporation. The unavailability of the gel-filled figs from Raychem
Corporation could have a material adverse effect on the Company. The Company has
not generally experienced significant problems in obtaining its required
supplies, although from time to time spot shortages are experienced.
NOTE 11 - SUBSEQUENT EVENT
On March 12, 1999, the Company signed an agreement to purchase LANart
Corporation, a manufacturer of application specific integrated circuits located
in Needham, Massachusetts, for approximately $6,000,000. LANart Corporation had
sales of approximately $10,687,000 and a net loss of $1,151,000 for its most
recent fiscal year ended December 31, 1998. The Company expects to complete this
acquisition in April 1999.
(b) SUPPLEMENTAL FINANCIAL INFORMATION
Unaudited Quarterly Operating Results
(in thousands except per share amounts)
Quarter Ended
--------------------------------------------------------
March 31 June 30 Sept 30 Dec 31
- ------------------------------------------------------------------------------------------------------------------
1998
Revenues $ 17,486 $ 16,970 $ 18,030 $ 18,673
Gross Margins 5,244 5,350 5,203 5,174
Operating income 2,286 2,715 2,363 1,195
Net Income 2,194 2,442 1,952 1,279
Basic Net Income per Share $ .24 $ .27 $ .22 $ .15
Diluted Net Income per Share $ .23 $ .27 $ .22 $ .15
1997
Revenues $ 16,816 $ 20,181 $ 19,790 $ 18,945
Gross Margins 4,991 6,347 6,775 5,317
Operating income 2,368 3,359 4,033 2,723
Net Income 2,169 2,883 3,154 2,731
Basic Net Income per Share $ .24 $ .31 $ .34 $ .29
Diluted Net Income per Share $ .24 $ .31 $ .33 $ .29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
31
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by paragraphs [a], [c], [d], [e], and [f] of Item 401
under Regulation S-K, to the extent applicable, will be set forth under the
caption "Election of Directors" in the Company's definitive proxy material for
its May 18, 1999 Annual Meeting of Shareholders to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated by reference herein. The information called for by paragraph [b] of
Item 401 is set forth under Item 1[c] herein. The information called for by Item
405 under Regulation S-K, to the extent applicable, will be set forth under the
caption "Certain Transactions" in the Company's above referenced definitive
proxy material.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 402 under Regulation S-K to the extent
applicable, will be set forth under the caption "Executive Compensation" in the
Company's definitive proxy materials for its May 18, 1999 Annual Meeting to be
filed within 120 days from the end of the Registrant's fiscal year, which
information is expressly incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 403 under Regulation S-K will be set forth
under the captions "Security Ownership of Certain Beneficial Owners and
Management" and "Election of Directors" in the Company's definitive proxy
materials for its May 18, 1999 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 404 under Regulation S-K will be set forth
under the caption "Certain Transactions" in the Company's definitive proxy
materials for its May 18, 1999 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
32
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Consolidated Financial Statements
The following Consolidated Financial Statements of Communications Systems,
Inc. and subsidiaries appear at pages 17 to 31 herein:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Income and Comprehensive Income for the
years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Changes in Stockholders' Equity for the
years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ende
December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
(a) (2) Consolidated Financial Statement Schedule Page Herein
----------------------------------------- -----------
The following financial statement schedule is being filed
as part of this Form 10-K Report:
Independent Auditors' Report 17
Schedule II - Valuation and Qualifying Accounts and Reserves 36
All other schedules are omitted as the required information is
inapplicable or the information is presented in the consolidated financial
statements or related notes.
(a) (3) Exhibits
The exhibits which accompany or are incorporated by reference in this
report, including all exhibits required to be filed with this report, are
described on the Exhibit Index, which begins on page 37 of the sequential
numbering system used in this report.
(b) REPORTS ON FORM 8-K FILED DURING THE THREE MONTHS ENDED DECEMBER 31, 1998
The Company filed a Form 8-K on December 10, 1998 related to the
acquisition of Transition Networks, Inc.
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COMMUNICATIONS SYSTEMS, INC.
Dated: March 29, 1999 /s/Curtis A. Sampson
-----------------------------------------
Curtis A. Sampson, Chairman of the
Board of Directors, President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated:
Each person whose signature appears below constitutes and appoints
CURTIS A. SAMPSON and PAUL N. HANSON as his true and lawful attorneys-in-fact
and agents, each acting alone, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this Annual Report on Form 10-K and
to file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, each acting alone, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all said attorneys-in-fact
and agents, each acting alone, or his substitute or substitutes, may lawfully do
or cause to be done by virtue thereof.
Signature Title Date
/s/Curtis A.Sampson Chairman of the Board of Directors, March 29, 1999
- ------------------------- President, and Director (Principal
Curtis A. Sampson Executive Officer)
/s/Paul N.Hanson Vice President, Treasurer and March 29, 1999
- -------------------------- Chief Financial Officer (Principal
Paul N. Hanson Financial Officer and Principal
Accounting Officer)
/s/ Paul J. Anderson
- -------------------------- Director March 29, 1999
Paul J. Anderson
/s/Edwin C. Freemna
- -------------------------- Director March 29, 1999
Edwin C. Freeman
/s/Luella G. Goldberg
- -------------------------- Director March 29, 1999
Luella Gross Goldberg
- -------------------------- Director March 29, 1999
Frederick M. Green
- -------------------------- Director March 29, 1999
John C. Ortman
/s/Joseph W. Parris
- -------------------------- Director March 29, 1999
Joseph W. Parris
/s/Gerald D. Pint
- -------------------------- Director March 29, 1999
Gerald D. Pint
/s/Wayne E. Sampson
- -------------------------- Director March 29, 1999
Wayne E. Sampson
/s/Edward E. Strickland
- -------------------------- Director March 29, 1999
Edward E. Strickland
34
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
COMMUNICATIONS SYSTEMS, INC.
FOR
YEAR ENDED DECEMBER 31, 1998
FINANCIAL STATEMENT SCHEDULE
35
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Schedule II - Valuation and Qualifying Accounts and Reserves
Balance at Additions Additions Deductions Balance
Beginning of Charged to Cost Charged to from at End
Description Period and Expenses Other Accounts Reserves of Period
- -------------------------------- ------------ -------------- -------------- -------------- -------------
Allowance for doubtful accounts:
Year ended:
December 31, 1998 $ 796,000 $ 94,000 $ - $ 6,000 (B) $ 884,000
December 31, 1997 $ 306,000 $ 50,000 $ 441,000 (A) $ 1,000 (B) $ 796,000
December 31, 1996 $ 288,000 $ 91,000 $ - $ 73,000 (B) $ 306,000
Inventory valuation reserves:
Year ended:
December 31, 1998 $ 1,157,000 $ 1,000,000 $ - $ - $ 2,157,000
December 31, 1997 $ 1,370,000 $ - $ - $ 213,000 $ 1,157,000
December 31, 1996 $ 1,262,000 $ 108,000 $ - $ - $ 1,370,000
Reserve for assets transferred under contractual arrangements and notes
receivable:
Year Ended:
December 31, 1998 $ 371,000 $ - $ - $ - $ 371,000
December 31, 1997 $ 358,000 $ - $ 13,000 (C) $ - $ 371,000
December 31, 1996 $ 335,000 $ - $ 23,000 (C) $ - $ 358,000
- -----------------------------------------
(A) Reclassification of allowance for doubtful accounts related to net assets of
discontinued operations.
(B) Accounts determined to be uncollectible and charged off against reserve. (C)
Interest on notes receivable credited to valuation reserve.
36
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
COMMUNICATIONS SYSTEMS, INC.
FOR
YEAR ENDED DECEMBER 31, 1998
EXHIBITS
37
COMMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Exhibit Index To
Form 10-K for the Year Ended December 31, 1998
Regulation S-K Location in Consecutive Numbering
Exhibit Table System as Filed With the
Reference Title of Document Securities and Exchange Commission
3.1 Articles of Incorporation, as Filed as Exhibit 3.1 to the Form
amended 10-K of the Company for its year
ended December 31, 1989 (the "1989
Form 10-K") and incorporated
herein by reference.
3.2 Bylaws, as amended Filed as Exhibit 3.2 to the 1989
Form 10-K and incorporated herein
by reference.
10.1 1987 Stock Plan Filed as Exhibit 10.1 to the Form
10-K Report of the Company for its
year ended December 31, 1993 (the
"1993 Form 10-K") and incorporated
herein by reference.
10.2 Employee Savings Plan Filed as Exhibit 10.2 to the 1993
Form 10-K and incorporated herein
by reference.
10.3 Employee Stock Ownership Plan
Filed as Exhibit 10.3 to the 1993
Form 10-K and incorporated herein
by reference.
10.4 Employee Stock Purchase Plan Filed
as Exhibit 10.4 to the 1993 Form
10-K and incorporated herein by
reference.
10.5 Stock Option Plan for Filed as Exhibit 10.5 to the 1993
Nonemployee Directors Form 10-K and incorporated herein
by reference.
10.6 1992 Stock Plan Filed as Exhibit 10.6 to the 1993
Form 10-K and incorporated herein
by reference.
10.7 Flexible Benefit Plan Filed as Exhibit 10.7 to the 1993
Form 10-K and incorporated herein
by reference.
10.8 Supplemental Executive Filed as Exhibit 10.8 to the 1993
Retirement Plan Form 10-K and incorporated herein
by reference.
11 Calculation of Earnings Filed herewith at page 39.
Per Share
21 Subsidiaries of the Registrant Filed herewith at page 40.
23 Independent Auditors' Consent Filed herewith at page 41.
24 Power of Attorney Included in signatures at page 34.
The exhibits referred to in this Exhibit Index will be supplied to a shareholder
at a charge of $.25 per page upon written request directed to CSI's Assistant
Secretary at the executive offices of the Company.
38
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CALCULATION OF EARNINGS PER SHARE
EXHIBIT 11
Twelve Months Ended December 31
-----------------------------------------------------
Basic: 1998 1997 1996
- ------- ------------- ------------- -------------
Income from Continuing Operations $ 7,867,425 $ 10,936,873 $ 8,953,855
Loss from Discontinued Operations (721,324)
------------- ------------- -------------
Net Income $ 7,867,425 $ 10,936,873 $ 8,232,531
============= ============= =============
Common shares:
Weighted average number of common 9,039,891 9,231,858 9,272,825
shares outstanding
============= ============= =============
Basic net income per common share:
Continuing Operations $ .87 $ 1.18 $ .97
Discontinued Operations (.08)
------------- ------------- -------------
$ .87 $ 1.18 $ .89
============= ============= =============
Diluted:
- -------------
Income from Continuing Operations $ 7,867,425 $ 10,936,873 $ 8,953,855
Loss from Discontinued Operations (721,324)
------------- ------------- -------------
Net Income $ 7,867,425 $ 10,936,873 $ 8,232,531
============= ============= =============
Common and potentially dilutive shares:
Weighted average number of common 9,039,891 9,231,858 9,272,825
shares outstanding
Dilutive effect of stock options outstanding
after application of treasury stock method 44,261 92,853 78,915
------------- ------------- -------------
9,084,152 9,324,711 9,351,740
============= ============= =============
Diluted net income per common share:
Continuing Operations $ .87 $ 1.17 $ .96
Discontinued Operations (.08)
------------- ------------- -------------
$ .87 $ 1.17 $ .88
============= ============= =============
39
SUBSIDIARIES OF COMMUNICATIONS SYSTEMS, INC.
EXHIBIT 21
Subsidiaries Jurisdiction of Incorporation
Suttle Apparatus Corporation Illinois
Suttle Costa Rica, S.A. Costa Rica
Tel Products, Inc. Minnesota
Suttle Caribe, Inc. Minnesota
Austin Taylor Communications, Ltd. United Kingdom
Automatic Tool & Connector Company, Inc. New Jersey
JDL Technologies, Inc. Minnesota
Transition Networks, Inc. Minnesota
All such subsidiaries are 100%-owned directly by Communications Systems, Inc.
The financial statements of all such subsidiaries are included in the
consolidated financial statements of Communications Systems, Inc.
40
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
33-28486, 33-39862, 33-39864, 33-60930, 33-83662, 33-99564, and 33-99566 of
Communications Systems, Inc. of our report dated March 2, 1999 (March 12, 1999
as to Note 11) on the consolidated financial statements and schedule of
Communications Systems, Inc. and subsidiaries appearing in this Annual Report on
Form 10-K of Communications Systems, Inc. for the year ended December 31, 1998.
/s/ Deloitte & Touche LLP
- -------------------------
Deloitte & Touche LLP
March 29, 1999
Minneapolis, Minnesota
41