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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1999
-------------------------------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-10355
COMMUNICATIONS SYSTEMS, INC.
................................................................................
(Exact name of registrant as specified in its charter)
MINNESOTA 41-0957999
................................................................................
(State or other jurisdiction of (Federal Employer
incorporation or organization) Identification No.)
213 South Main Street, Hector, MN 55342
................................................................................
(Address of principal executive offices) (Zip Code)
(320) 848-6231
................................................................................
Registrant's telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS Outstanding at October 31, 1999
----------------------------------- -------------------------------
Common Stock, par value 8,548,772
$.05 per share
Total Pages (14) Exhibit Index at (NO EXHIBITS)
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COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
INDEX
Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income
and Comprehensive Income 4
Consolidated Statements of Changes
in Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
Part II. Other Information 14
2
<PAGE>
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
September 30 December 31
Assets: 1999 1998
------------ ------------
Current assets:
<S> <C> <C>
Cash $ 15,479,792 $ 20,405,363
Receivables, net 19,989,023 14,624,123
Inventories (Note 4) 19,255,948 20,837,508
Deferred income taxes 1,348,000 1,348,000
Other current assets 880,975 499,549
------------ ------------
Total current assets 56,953,738 57,714,543
Property, plant and equipment 31,913,634 30,654,182
less accumulated depreciation (21,025,691) (19,275,422)
------------ ------------
Net property, plant and equipment 10,887,943 11,378,760
Other assets:
Excess of cost over net assets acquired 10,345,789 8,392,261
Investments in mortgage backed and other securities 6,197,483 1,316,912
Deferred income taxes 548,753 548,047
Notes receivable from sale of assets of
discontinued operations 3,565,390 3,765,390
Other assets 693,623 783,799
------------ ------------
Total other assets 21,351,038 14,806,409
------------ ------------
Total Assets $ 89,192,719 $ 83,899,712
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable $ 9,898,951 $ 9,077,598
Accounts payable 6,801,218 4,589,078
Accrued expenses 4,897,352 3,823,596
Dividends payable 858,424 879,130
Income taxes payable 2,081,752 2,076,658
------------ ------------
Total current liabilities 24,537,697 20,446,060
Stockholders' Equity 64,655,022 63,453,652
------------ ------------
Total Liabilities and Stockholders' Equity $ 89,192,719 $ 83,899,712
============ ============
See notes to consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited)
Three Months Ended Sept. 30 Nine Months Ended Sept. 30
---------------------------- -----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales $ 29,278,686 $ 18,029,530 $ 85,682,922 $ 52,485,367
Costs and expenses:
Cost of sales 19,143,527 12,826,725 56,610,922 36,688,322
Selling, general and
administrative expenses 7,543,603 2,840,180 21,140,877 8,433,891
------------ ------------ ------------ ------------
Total costs and expenses 26,687,130 15,666,905 77,751,799 45,122,213
------------ ------------ ------------ ------------
Operating income 2,591,556 2,362,625 7,931,123 7,363,154
Other income and (expenses):
Investment income 299,309 330,402 721,069 1,118,636
Interest expense (189,368) (1,278) (510,546) (3,803)
------------ ------------ ------------ ------------
Other income, net 109,941 329,124 210,523 1,114,833
Income before income taxes 2,701,497 2,691,749 8,141,646 8,477,987
Income taxes (Note 5) 600,000 740,000 1,820,000 1,890,000
------------ ------------ ------------ ------------
Net income 2,101,497 1,951,749 6,321,646 6,587,987
------------ ------------ ------------ ------------
Other comprehensive income -
Foreign currency translation adjustment 194,768 122,723 (130,889) 193,798
------------ ------------ ------------ ------------
Comprehensive income $ 2,296,265 $ 2,074,472 $ 6,190,757 $ 6,781,785
============ ============ ============ ============
Basic net income per share $ .24 $ .22 $ .73 $ .72
Diluted net income per share $ .24 $ .22 $ .72 $ .72
Average Basic Shares Outstanding 8,603,260 8,942,618 8,675,949 9,123,609
Average Dilutive Shares Outstanding 8,723,100 8,960,993 8,760,734 9,191,146
See notes to consolidated financial statements.
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Additional Stock Option Other
--------------------- Paid-in Retaine Notes Comprehensive
Shares Amount Capital Earnings Receivable Income Total
--------- --------- ----------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
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
Net income 6,321,646 6,321,646
Issuance of common stock under
Employee Stock Purchase Plan 27,431 1,372 266,766 268,138
Issuance of common stock to
Employee Stock Ownership Plan 19,893 995 234,005 235,000
Issuance of common stock under
Employee Stock Option Plan 5,300 265 53,069 53,334
Stock issued as compensation
to employees 8,000 400 124,262 124,662
Purchase of stock (309,536) (15,477) (908,885) (2,328,775) (3,253,137)
Shareholder dividends (2,600,483) (2,600,483)
Foreign currency translation
adjustment (130,889) (130,889)
--------- --------- ----------- ----------- ----------- ----------- ------------
BALANCE AT SEPTEMBER 30, 1999 8,559,372 $ 427,969 $ 25,202,381 $ 39,254,851 $ (288,225) $ 58,046 $ 64,655,022
========= ========= =========== =========== =========== =========== ============
See notes to consolidated financial
statements.
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended September 30
--------------------------------
1999 1998
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 6,321,646 $ 6,587,987
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 3,918,252 2,113,980
Stock-based compensation expense 124,662
Changes in assets and liabilities net of effects from acquisition of
LANart Corporation:
Decrease (increase) in accounts receivable (3,562,131) 803,466
Decrease (increase) in inventory 2,641,030 (1,159,803)
Decrease (increase) in other current assets (263,933) 1,056,843
Increase (decrease) in accounts payable 938,680 (769,412)
Increase (decrease) in accrued expenses (297,139) 143,855
Increase in income taxes payable 2,311 480,000
------------ ------------
Net cash provided by operating activities 9,823,378 9,256,916
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,616,608) (2,619,135)
Maturities of mortgage-backed and other investment securities 744,429 1,044,213
Purchases of investment securities (5,625,000)
Decrease (increase) in other assets 72,652 (536,913)
Collection of notes receivable 200,000 200,000
Proceeds from maturities of U.S. Treasury securities 5,249,314
Payment for purchase of LANart Corporation, net of cash acquired (3,955,898)
Payment for purchase of JDL Technologies, Inc. (32,260)
------------ ------------
Net cash (used in) provided by investing activities (10,180,425) 3,305,219
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable (275,568)
Proceeds from issuance of notes payable 1,096,921
Dividends paid (2,621,189) (2,576,252)
Proceeds from issuance of common stock 504,571 766,988
Purchase of stock (3,253,137) (12,199,670)
------------ ------------
Net cash used in financing activities (4,548,402) (14,008,934)
------------ ------------
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (20,122) 97,342
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (4,925,571) (1,349,457)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 20,405,363 17,942,315
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 15,479,792 $ 16,592,858
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 1,814,143 $ 1,400,130
Interest paid 515,351 3,803
See notes to consolidated financial statements.
</TABLE>
6
<PAGE>
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - CONSOLIDATED FINANCIAL STATEMENTS
The balance sheet and statement of changes in stockholders' equity as of
September 30, 1999, the statements of income and comprehensive income for the
three and nine month periods ended September 30, 1999 and 1998 and the
statements of cash flows for the nine-month periods ended September 30, 1999 and
1998 have been prepared by the Company without audit. In the opinion of
management, all adjustments (which include only normal recurring adjustments)
necessary to present fairly the financial position, results of operations, and
cash flows at September 30, 1999 and 1998 have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested these condensed financial
statements be read in conjunction with the financial statements and notes
thereto included in the Company's December 31, 1998 Annual Report to
Shareholders. The results of operations for the periods ended September 30 are
not necessarily indicative of the operating results for the entire year.
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 cost over net assets acquired in the transaction was
$4,047,000, which is being amortized on a straight-line basis over 5 years.
Effective August 7, 1998 the Company acquired JDL Technologies, Inc. in exchange
for 158,005 shares of its common stock. The acquisition was accounted for as a
purchase. The excess of cost over net assets acquired in the transaction was
$2,223,000, which is being amortized on a straight-line basis over 5 years. The
results of operations of JDL Technologies, Inc. have been included in the
Company's operations effective August 7, 1998.
Unaudited consolidated results of operations on a pro forma basis as though
these acquisitions were effective January 1, 1998 are as follows:
Three Months Ended Nine Months Ended
September 30, 1998 September 30, 1998
Revenues $ 25,549,999 $ 74,069,349
Net income 2,050,776 6,029,699
Basic net income per share $ .23 $ .65
Diluted net income per share $ .23 $ .65
In February 1999 the Company issued 19,893 shares of the Company's common stock
to the Employee Stock Ownership Plan in payment of its 1998 obligation. In a
noncash transaction, the Company recorded additional stockholders' equity of
$235,000 (reflecting the market value of the stock at the time of the
contribution) and reduced accrued expenses by the same amount.
Effective April 8, 1999, the Company acquired all the capital stock of LANart
Corporation for $3,956,000 (cash payments net of cash acquired). The transaction
is being accounted for as a purchase. Excess cost over net assets acquired in
the transaction was $3,523,000, which is being amortized on a straight-line
basis over 5 years. The operations of LANart Corporation, which are not material
to the Company's financial statements, are included in consolidated operations
as of the effective date. Subsequent to the acquisition, the Company merged
LANart's operations into Transition Networks, Inc.
7
<PAGE>
NOTE 2 - NET INCOME PER SHARE
Basic net income per common share is based on the weighted average number of
common shares outstanding during each period. 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. The Company calculates the dilutive effect of outstanding options using
the treasury stock method.
NOTE 3 - SEGMENT INFORMATION
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 operations in the various
segments for the nine-month periods ended September 30, 1999 and 1998 is as
follows: <TABLE> <CAPTION>
Austin Transition
Suttle Taylor Networks Other Consolidated
----------- ---------- ----------- ----------- -----------
Nine Months Ended September 30, 1999:
<S> <C> <C> <C> <C> <C>
Revenues $44,422,016 $8,716,082 $26,134,463 $ 6,410,361 $85,682,922
Cost of sales 28,846,450 7,071,579 16,418,102 4,274,791 56,610,922
----------- ---------- ----------- ----------- -----------
Gross profit 15,575,566 1,644,503 9,716,361 2,135,570 29,072,000
Selling, general and
administrative expenses 6,146,014 1,012,953 10,401,783 3,580,127 21,140,877
----------- ---------- ----------- ----------- -----------
Operating income (loss) $ 9,429,552 $ 631,550 $ (685,422) $(1,444,557) $ 7,931,123
=========== ========== =========== =========== ===========
Depreciation and amortization $ 1,748,636 $ 480,667 $ 1,211,534 $ 477,415 $ 3,918,252
=========== ========== =========== =========== ===========
Assets $49,087,016 $7,346,459 $20,203,702 $12,555,542 $89,192,719
=========== ========== =========== =========== ===========
Capital expenditures $ 1,041,379 $ 360,839 $ 73,424 $ 140,966 $ 1,616,608
=========== ========== =========== =========== ===========
Nine Months Ended September 30, 1998:
Revenues $42,215,632 $8,923,157 $ 1,346,578 $52,485,367
Cost of sales 28,375,955 7,335,932 976,435 36,688,322
----------- ---------- ----------- ----------- -----------
Gross profit 13,839,677 1,587,225 370,143 15,797,045
Selling, general and
administrative expenses 5,948,875 951,231 1,533,785 8,433,891
----------- ---------- ----------- ----------- -----------
Operating income (loss) $ 7,890,802 $ 635,994 $(1,163,642) $ 7,363,154
=========== ========== =========== =========== ===========
Depreciation and amortization $ 1,522,578 $ 417,951 $ 173,451 $ 2,113,980
=========== ========== =========== =========== ===========
Assets $51,979,244 $9,883,890 $12,324,135 $74,187,269
=========== ========== =========== =========== ===========
Capital expenditures $ 2,018,991 $ 488,516 $ 111,628 $ 2,619,135
=========== ========== =========== =========== ===========
</TABLE>
8
<PAGE>
Information concerning the Company's operations in the various segments for the
three-month periods ended September 30, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
Austin Transition
Suttle Taylor Networks Other Consolidated
----------- ---------- ----------- ----------- -----------
Three Months Ended September 30, 1999:
<S> <C> <C> <C> <C> <C>
Revenues $14,444,556 $3,007,289 $ 9,404,629 $ 2,422,212 $29,278,686
Cost of sales 9,476,906 2,455,586 5,734,781 1,476,254 19,143,527
----------- ---------- ----------- ----------- -----------
Gross profit 4,967,650 551,703 3,669,848 945,958 10,135,159
Selling, general and
administrative expenses 2,060,648 332,359 3,748,642 1,401,954 7,543,603
----------- ---------- ----------- ----------- -----------
Operating income (loss) $ 2,907,002 $ 219,344 $ (78,794) $ (455,996) $ 2,591,556
=========== ========== =========== =========== ===========
Depreciation and amortization $ 689,374 $ 160,744 $ 460,400 $ 159,138 $ 1,469,656
=========== ========== =========== =========== ===========
Capital expenditures $ 524,615 $ 102,089 $ 23,214) $ 86,838 $ 690,328
=========== ========== =========== =========== ===========
Three Months Ended September 30, 1998:
Revenues $14,019,935 $2,663,017 $ 1,346,578 $18,029,530
Cost of sales 9,523,896 2,326,394 976,435 12,826,725
----------- ---------- ----------- ----------- -----------
Gross profit 4,496,039 336,623 370,143 5,202,805
Selling, general and
administrative expenses 1,775,332 268,375 796,473 2,840,180
----------- ---------- ----------- ----------- -----------
Operating income (loss) $ 2,720,707 $ 68,248 $ (426,330) $ 2,362,625
=========== ========== =========== =========== ===========
Depreciation and amortization $ 507,527 $ 140,622 $ 109,923 $ 758,072
=========== ========== =========== =========== ===========
Capital expenditures $ 364,668 $ 35,540 $ 87,589 $ 487,797
=========== ========== =========== =========== ===========
</TABLE>
NOTE 4 - INVENTORIES
Inventories summarized below are priced at the lower of first-in, first-out cost
or market:
September 30 December 31
1999 1998
Finished Goods $ 7,765,105 $ 8,450,447
Raw Materials 11,490,843 12,387,061
------------------- --------------------
Total $ 19,255,948 $ 20,837,508
=================== ====================
NOTE 5 - INCOME TAXES
Income taxes are computed based upon the estimated effective rate applicable to
operating results for the full fiscal year. For the periods ended September 30,
1999 and 1998 income taxes do not bear a normal relationship to income before
income taxes, primarily because income from Puerto Rico operations is taxed at
rates lower than the U.S. rate.
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Statements regarding the Company's anticipated performance in future periods are
forward looking and involve risks and uncertainties. These include but are not
limited to: buying patterns of its Regional Bell Operating Company customers,
competitor's products, the success of its recent acquisitions, changes in tax
laws, particularly in regard to taxation of its subsidiary in Puerto Rico, Year
2000 exposures and other risks involving the telecommunications industry
generally.
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9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Nine Months Ended September 30, 1999 Compared to
Nine Months Ended September 30, 1998
Consolidated sales increased 63% to $85,683,000. Consolidated operating income
increased 8% to $7,931,000.
Suttle sales increased 5% to $44,422,000. Sales to customers in the United
States (U.S.) increased 6% to $42,716,000. Sales to the Big 6 telephone
companies (the five Regional Bell Operating Companies (RBOCs) and GTE) increased
11% to $27,688,000. Sales to these customers accounted for 62% of Suttle's
sales. Sales to distributors, original equipment manufacturers (OEMs), and
electrical contractors increased $916,000, or 8%. Sales to retail customers
decreased $822,000 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 6% to $1,706,000.
The sales gains were due to increased sales of Suttle's CorroShield and data
products. CorroShield product sales increased 29%, reflecting a return to more
normal buying patterns by the RBOCs, which are CorroShield's major customers.
CorroShield products are continuing to displace conventional voice connecting
products. Sales of conventional products declined 15% in the 1999 period. The
Company's sales of conventional voice products are also being hurt by price
competition from foreign manufacturers. Sales of data products increased 28%.
Sales of fiber-optic connector products decreased 33%. The Company relocated
production of its fiber-optic connector products and closed its New Jersey
manufacturing facility in August 1999, which disrupted third quarter sales.
Suttle's gross margins increased 13% to $15,576,000. Gross margin percentage
improved to 35.1% in 1999 from 32.8% in 1998. The improvement in gross margin
was due to product mix. The fastest selling products in 1999 (CorroShield and
data products) tended to be the products with the highest margins. Selling,
general and administrative expenses increased $197,000 or 3%. Suttle's operating
income increased $1,539,000 or 20%.
Austin Taylor's sales decreased 2% to $8,716,000. The decrease was due to
reduced sales of CATV products caused by major reductions of cable television
construction activity in the U.K. Austin Taylor's gross margin increased 4% to
$1,645,000. Gross margin as a percentage of sales was 19% compared to 18% in
1998. Selling, general and administrative expenses increased $62,000 or 6%.
Operating income decreased $4,000.
The Company acquired Transition Networks, Inc. in December 1998. In April 1999,
the Company acquired LANart Corporation, which has been merged into Transition
Networks. The combined entities had sales of $26,134,000 and an operating loss
of $685,000 in the 1999 period. The strong sales performance was due to
increased international sales and the introduction of new products. Transition
Networks believes it currently has a 22% share of the market for media
conversion products. Expenses associated with closing LANart's sales and
marketing operations in Europe and transferring inventory and manufacturing
processes from Massachusetts to Minnesota were a significant cause of the
operating loss.
10
<PAGE>
The Company acquired JDL Technologies, Inc. in August 1998. JDL had sales of
$6,410,000 in the 1999 period, an increase of 63% (on a pro forma basis) from
sales in the first nine months of 1998. JDL had an operating loss of $151,000 in
1999 compared to a pro forma loss of $592,000 in 1998. Government funding delays
for new telecommunications infrastructure in the public schools negatively
affected JDL's performance in the first part of 1999. JDL earned a significant
portion of its revenues in the 1999 period from contracts to provide network
services and equipment to the U.S. Virgin Islands Department of Education and to
the Gary, Indiana public schools. CSI's corporate operating expenses were
$1,293,000 compared to $1,069,000 in the 1998 period.
Consolidated investment income, net of interest expense, decreased $904,000 due
to decreased levels of funds available for investment and interest expense on
notes payable associated with acquisitions. Income before income taxes decreased
$336,000 or 4%. The Company's effective income tax rate was 22.4% compared to
22.2% in 1998. Net income decreased $266,000 or 4%.
Three Months Ended September 30, 1999 Compared to
Three Months Ended September 30, 1998
Consolidated sales increased 62% to $29,279,000. Consolidated operating income
increased 10% to $2,592,000.
Suttle sales increased 3% to $14,445,000. Sales to customers in the United
States (U.S.) increased 3% to $13,971,000. Sales to the Big 6 telephone
companies (the five Regional Bell Operating Companies (RBOCs) and GTE) increased
2% to $8,903,000. Sales to these customers accounted for 62% of Suttle's sales.
Sales to distributors, original equipment manufacturers (OEMs), and electrical
contractors increased $705,000, or 19%. Sales to retail customers decreased
$153,000 or 19% due to decreased sales to Radio Shack, which is Suttle's
principal retail customer. Suttle's export sales decreased 5% to $473,000.
Suttle's CorroShield and data product lines had solid sales increases in the
1999 three-month period. Sales of data products increased 27%, reflecting
increased customer demand for high-speed data connections to internet service
providers. CorroShield product sales increased 9%, reflecting a return to more
normal buying patterns by the RBOCs, which are CorroShield's major customers.
CorroShield product sales are displacing sales of conventional voice connecting
products with RBOC customers. Sales of conventional voice products declined 3%
in the 1999 period. The Company's sales of conventional voice products are also
being hurt by price competition from foreign manufacturers. Sales of fiber-optic
connector products decreased 41%. The Company relocated production of its
fiber-optic connector products and closed its New Jersey manufacturing facility
in August 1999, which disrupted third quarter sales.
Suttle's gross margins increased 10% to $4,968,000. Gross margin percentage
improved to 34.4% in 1999 from 32.1% in 1998. The improvement in gross margin
was due to product mix. The fastest selling products in 1999 (CorroShield and
data products) tended to be the products with the highest margins. Suttle's
selling, general and administrative expenses increased $285,000 or 16%.
Suttle's operating income increased $186,000 or 7%.
Austin Taylor's sales increased 13% to $3,007,000. The improvement was due to
increased export sales to telephone companies in Europe and the Far East. Austin
Taylor's gross margin increased 64% to $552,000. Gross margin as a percentage of
sales was 18.3% compared to 12.6% in 1998. Gross margin percentage was
abnormally low in the 1998 period do to lower than sales volume. Selling,
general and administrative expenses increased $64,000 or 24%. Operating income
increased $151,000 or 221%.
11
<PAGE>
The Company acquired Transition Networks, Inc. in December 1998. In April 1999,
the Company acquired LANart Corporation, which has been merged into Transition
Networks. The combined entities had sales of $9,405,000 and an operating loss of
$79,000 in the 1999 period. Expenses associated with closing LANart's sales and
marketing operations in Europe and transferring inventory and manufacturing
processes from Massachusetts to Minnesota were a significant cause of the
operating loss.
JDL Technologies, Inc. had sales of $2,422,000 in the 1999 period, an increase
of $2,200,000 (on a pro forma basis) from sales in the third quarter of 1998.
JDL had an operating loss of $16,000 in 1999 compared to a pro forma loss of
$381,000 in 1998. JDL earned a significant portion of its revenues in the 1999
period from contracts to provide network services and equipment to the U.S.
Virgin Islands Department of Education and to the Gary, Indiana public schools.
CSI's corporate operating expenses in the third quarter were $440,000 compared
to $332,000 in the 1998 period.
Consolidated investment income, net of interest expense, decreased $219,000 due
to decreased levels of funds available for investment and interest expense on
notes payable associated with acquisitions. Income before income taxes increased
$10,000. The Company's effective income tax rate was 22.2% compared to 27.5% in
1998. The Company's tax rate was higher in the 1998 quarterly period due to
higher tollgate tax expenses on dividends from the Company's Puerto Rico
subsidiary. Net income increased $150,000 or 8%.
Liquidity and Capital Resources
At September 30, 1999, the Company had approximately $15,480,000 of cash and
cash equivalents compared to $20,405,000 of cash and cash equivalents at
December 31, 1998. The Company had working capital of approximately $32,416,000
and a current ratio of 2.3 to 1 compared to working capital of $37,268,000 and a
current ratio of 2.8 to 1 at the end of 1998.
Cash flow provided by operations was approximately $9,823,000 in the first nine
months of 1999 compared to $9,257,000 in the same period in 1998. Cash flow
benefited in the 1999 period from decreased inventory levels, as the Company was
able to satisfy some of the increased customer demand out of existing stocks.
Depreciation and amortization charges, which are noncash expenses, increased
$1,804,000 due to amortization of excess costs associated with the Company's
acquisitions.
Investing activities utilized $10,180,000 of cash in the 1999 period. Cash
investments in new plant and equipment totaled $1,617,000, which was financed by
internal cash flows. The Company expects to spend $2,500,000 on capital
additions in 1999. The Company paid $3,956,000 (net of cash acquired) to
purchase LANart Corporation. The Company financed that acquisition using a
combination of internal funds and short-term borrowing from U.S. Bank.
Subsequent to the acquisition, the Company invested an additional $1,457,000 of
cash in LANart to pay acquired liabilities and provide working capital.
Short-term notes payable outstanding increased to $9,899,000 at September 30,
1999. The Company expects to repay or refinance this debt in 1999. The Company
also invested $5,625,000 of cash held by its subsidiary in Puerto Rico in
intermediate term bank notes.
Net cash used in financing activities was $4,548,000. The Company paid
$3,253,000 to purchase and retire 309,500 shares of its stock in open market
transactions during the 1999 period. Board authorizations to purchase 148,700
additonal shares were outstanding at September 30, 1999. Dividends paid on
common stock increased to $2,621,000. Proceeds from borrowings, net of
repayments, were $821,000.
12
<PAGE>
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.
Year 2000 Issues
Most old 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. 1999 is
abbreviated as "99". 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 upgrade its
computer systems. The Company believes these systems are currently Y2K
compliant. Cost of hardware and software purchased as part of the Y2K compliance
program was approximately $150,000. The Company did not separately track
internal costs of Y2K compliance.
In 1998, the Company acquired JDL Technologies, Inc. and Transition Networks,
Inc. These operations are not presently part of the Company's central computer
network. Both operations utilize personal computer based computing networks that
were materially Y2K compliant prior to their acquisition by the Company.
At the present time, none of the Company's subsidiaries manufacture products
containing embedded controllers or microprocessors that 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.
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 raw materials and supplies, transportation, utilities and
communications services. Multiple sources of supply are available for most of
these products and services. The Company has not received any indication from
these parties that they will not be Y2K compliant. The Company's worst probable
Y2K related problem is the failure of third parties to provide necessary raw
material, manufacturing supplies, utilities or communications services. Failure
to receive needed materials or services could disrupt manufacturing systems and
delay shipments to customers. The Company expects to utilize multiple sources of
supply to meet any problems that arise. The Company does not expect production
to be materially affected by Y2K related production problems.
At the present time, the Company expects to handle Y2K problems that occur as
part of the ordinary course of business. No special contingency plans have been
developed. The Company will continue to monitor its Y2K situation and will
respond appropriately if any problem arises.
PART II. OTHER INFORMATION
Items 1 - 6. Not Applicable
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Communications Systems, Inc.
By /s/ Paul N. Hanson
----------------------------
Paul N. Hanson
Vice President and
Chief Financial Officer
Date: November 15, 1999
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