ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
Communications Systems, Inc. (herein collectively called "CSI", "our" or the "Company") is a Minnesota corporation organized in 1969 which operates directly and through its subsidiaries located in the United States, 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, digital subscriber line filters, structured wiring systems and the manufacture of media and rate conversion products for telecommunications networks. CSI also provides network design, training services, general contracting of infrastructure installations, provisioning of high-speed internet access and maintenance support of network operation centers for K-12 schools.
In 2002, the Company acquired through a newly formed subsidiary, MiLAN Technology Corporation, substantially all the assets of the MiLAN division of Digi International Inc. for approximately $8,100,000 in cash. MiLAN, located in Sunnyvale, California, is a manufacturer of media and rate conversion products, which permit telecommunications networks to move information between copper-wired equipment and fiber-optic cable. In addition, MiLAN is also a supplier of wireless access points, bridges and other networking products. The acquisition was accounted for as a purchase and operations of MiLAN have been included in consolidated operations from March 25, 2002.
Effective March 24, 2004, the Company acquired substantially all the outstanding shares of Image Systems Corporation for a cash purchase price per share of approximately $2.8 million. Image Systems Corporation (Image Systems), located in Minnetonka, Minnesota designs, manufactures and markets high-resolution display solutions and accessories for customers in the medical imaging market or for other customers who have stringent and or unique display requirements. In addition, Image Systems has been a premier developer of video graphics products since 1988. The proforma effects of the Image Systems Corporation acquisition on our consolidated financial statements were not material to the Company's consolidated financial statements. The acquisition and operations of Image Systems are included in the Company's consolidated financial results from the purchase date, March 24, 2004.
Additional information on these acquisitions can be found in subparagraphs (c)(1)(ii), (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 8 of Notes to Consolidated Financial Statements under Item 8, herein.
The Company maintains a website at www.commsystems.com. Our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our periodic reports on Form 8-K (and any amendments to these reports) are available free of charge by linking from our website to the Securities & Exchange Commission website.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company classifies its businesses into five segments: Suttle, which manufactures U.S. standard modular connecting and wiring devices for voice and data communications; Austin Taylor, which manufactures British standard line jacks, patch panels, wiring harness assemblies, metal boxes, distribution cabinets and distribution and central office frames; Transition Networks/ MiLAN Technology, subsidiaries that design and market data transmission, computer network and media conversion products and print servers; and JDL Technologies, (JDL), which provides telecommunications network design, specification and training services to educational institutions; Other which principally consist of Image Systems Corporation, (high-resolution display solutions and accessories for customers in the medical imaging market) and non-allocated corporate general and administrative expenses. Further information regarding operations in the various segments is set forth in Note 10 of the Notes to Consolidated Financial Statements under Item 8, herein.
(c) NARRATIVE DESCRIPTION OF BUSINESS
(1) Information Regarding Business Segments
(i) Suttle
Suttle 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. Suttle also manufactures a line of high performance fiber-optic connectors, interconnect devices and fiber cable assemblies for the telecommunications, computer and electronics markets. Substantially all of Suttle's products are manufactured at its plants in Hector, Minnesota (Suttle Apparatus Minnesota Division), and San Jose, Costa Rica (Suttle Costa Rica, S.A.). Certain products are purchased from offshore contract manufacturers from offshore sources. Segment sales were $40,114,000 in 2004, or 36% of consolidated revenues and $32,900,000 in 2003, or 32% of consolidated revenues.
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 Suttle continues to develop an expanding line of products for data network applications. A significant portion of Suttle's revenues is 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 $0.70 to $25.00 per unit. A majority of Suttle's sales volume, both in units and revenues, is derived from products selling for under $5.00 per unit.
Suttle produces high performance fiber-optic connectors, interconnect devices and fiber cable assemblies that are used in high-speed fiber-optic networks and local area network connections. Suttle'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. Suttle's fiber-optic connector products range in price from $2.50 to $1,500.00.
Suttle is also a manufacturer and seller of DSL (Digital Subscriber Line) filters for home and business applications. Suttle resells DSL filter products procured from offshore sources. These filters permit the user to receive both analog and digital signals simultaneously and allow a single telephone line to support uninterrupted voice, fax and internet capabilities.
Markets and Marketing
Suttle competes in all major areas of the telecommunications connector market utilizing modular four, six and eight conductor jacks. Customers include the major telephone companies (frequently referred to as "RBOCs" such as Verizon Logistics, Bell South, SBC Communications, and Qwest), other telephone companies, electrical contractors, interconnect companies and original equipment manufacturers and retailers. These customers are served directly through the Suttle's sales staff and through distributors such as Sprint North Supply, Verizon Logistics, Graybar Electric Company, Alltel Supply, KGP and Anixter Communications. As a group, sales to the major telephone companies, both directly and through distribution, were approximately $22,388,000 in 2004 and $18,190,000 in 2003, which represented 56% of Suttle's sales in 2004 and 55% in 2003.
Suttle markets business and network systems products, which are 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. Suttle markets its products to independent contractors through a network of manufacturer's representatives, through distributors, and through the Company's sales staff. Sales of products for business and network systems accounted for 11% and 14% of Suttle's sales in 2004 and 2003, respectively. These structured cabling products are also helping Suttle penetrate new markets in the data-networking world with education and hospitality/multiple dwelling unit (MDU) projects. These applications utilize a blended solution of wireline and wireless products.
Fiber-optic products are marketed to original equipment manufacturers (OEMs) in the U.S. and internationally through the Suttle sales staff, manufacturers' representatives and a network of distributors. Sales of fiber-optic products accounted for 2% of Suttle's revenues in 2004 and 2003. Sales of DSL products represented 27% of sales in 2004 and 10% in 2003.
The balance of Suttle's sales in 2004 and 2003 were to original equipment manufacturers, non-major telephone companies and international customers. In the communications industry market, sales to telephone companies are made directly or through distributors. Sales to OEM customers are made through a nationwide network of distributors, some of which are affiliates of major telephone companies, and through the Suttle sales staff.
Competition
Suttle encounters strong competition in all its product lines and competes primarily on the basis of the broad lines of products offered, product performance, quality, price and delivery. In addition, distributors of the apparatus products also market products for one or more of these competitors.
Order Book
Suttle manufactures its products on the basis of estimated customer requirements. Outstanding customer orders at March 1, 2005 were approximately $6,777,000 compared to approximately $2,217,000 at March 1, 2004. Because new orders are filled on a relatively short timetable, Suttle does not believe its order book is a significant indicator of future results.
Manufacturing and Sources of Supply
Suttle's products are manufactured using plastic parts, wire sub-assemblies, fasteners, brackets, electronic circuit boards and other components, most of which are fabricated by Suttle. 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 Tyco Electronics. Suttle has not generally experienced significant problems in obtaining its required supplies, although from time to time spot shortages are experienced and additional order lead times are required from the offshore suppliers.
Research and Development; Patents
Suttle continually monitors industry requirements and creates new products to improve its existing connector product line.
Historically, Suttle has generally not relied on patents to protect its competitive position in the station apparatus market. However, duplication of its designs by foreign apparatus manufacturers has caused Suttle to apply for design patents on a number of products.
The Company's "Suttle" brand name is important to its business. Suttle regularly supports this name by trade advertising and believes it is well known in the marketplace.
(ii) Transition Networks
Transition Networks, Inc. located in Eden Prairie, Minnesota, designs, manufactures and markets media converters, baluns, transceivers, network interface cards, and fiber hubs. Transition Networks sells its product through distributors, resellers, integrators, and OEMs. Sales by Transition Networks were $41,058,000 or 37% of consolidated sales in 2004 compared to $37,856,000 or 37% of the "Company's" consolidated sales in 2003. Transition's international sales accounted for 25% of sales or $10,322,000 in 2004, compared to $9,984,000 in 2003 when international sales accounted for 26% of Transition's total sales. Sales to major distributors in 2004 totaled $26,472,000 compared to $23,789,000 in 2003.
Products
Transition Networks designs, produces, and sells media converter devices that make it possible to transmit telecommunications signals between systems using different types of media (for example, between copper and fiber optic networks). These products are used to support legacy systems as customers' networks grow, integrate fiber optics into a network, and extend the reach of networks. Protocols supported include Gigabit Ethernet, Fast Ethernet, Ethernet, Token Ring, T1/E1, DS3, RS232, RS485, ATM, OC3, OC12, 3270, and 5250. The company uses Application Specific Integrated Circuits (ASIC) for development of some products, but is also uses integrated circuits for the development of new products. Product hardware and software development is done internally. The software that Transition Networks utilizes to manage its products is provided free with the product. Transition Networks product development is focused on hardware, with software developed to support hardware sales.
Manufacturing and Sources of Supply
Transition Networks outsources approximately 15% of its products which are manufactured offshore, principally in the Far East. The balance of its products are produced in the United States. The offshore sources of supply are subject to certain risks, including foreign currency fluctuations and interference from political sources. The Company has alternate sources of supply for its products and to date has not had problems obtaining necessary supplies.
Markets and Marketing
Transition Networks' products are used in a broad array of markets including enterprise networks, service providers' networks, and industrial environments such as in manufacturing processes. Transition Networks has a broad customer base and applications for its products.
The media conversion product line addresses and is utilized in a variety of applications. The chassis based system, the Point System(TM), is used primarily in telecommunication closets for high-density applications and when multiple protocols need to be supported. Stand alone media converters are used typically at a workstation or for lower density applications.
Marketing primarily consists of direct marketing utilizing a telesales force, tradeshows, trade magazine advertising, public relations activities, and direct mail. Transition Networks also provides and participates in advertising and cooperative marketing campaigns with distribution partners.
Research and Development
Transition Networks continues to develop products that address the enterprise, service provider, and industrial markets. This includes developing converters for emerging protocols and existing protocols in new markets. Some of these products include DS3, remote management devices, and single fiber products. Some development efforts are paced by the development of critical components such as integrated circuits and optical transceivers.
Research and development consists primarily of testing, equipment and supplies associated with enhancing existing products and developing new products. Research and development costs are expensed when incurred and were $670,000 in 2004 compared to $607,000 in 2003.
Competition
Transition Networks faces strong competition across its entire product line. A large number of competitors exist for the highest volume products in the Ethernet and Fast Ethernet family. Low cost competitors from China and Taiwan are strongest in the developing Asian markets, but have had limited success in the North American market. A deeper penetration of these competitors poses a potential threat to sales and profit margins. Competition also exists from substitutes such as lower cost fiber switches.
Order Book
Outstanding customer orders for Transition Networks products were approximately $956,000 at March 1, 2005 and $1,047,000 at March 1, 2004. Transition Networks fills orders on a relatively short-term basis and therefore does not believe its order book is a significant indicator of future results.
(iii) MiLAN Technology Corporation
MiLAN Technology Corp, located in Sunnyvale, California is a manufacturer of media converter and rate conversion products, which permit telecommunications networks to move information between copper-wired equipment and fiber-optic cable. In addition, MiLAN is also a supplier of wireless access points, bridges and other networking products. Results of operations of MiLAN have been included in consolidated operations from March 25, 2002. Sales by MiLAN in 2004 totaled $11,386,000 and represented 10% of the "Company's" consolidated sales compared to 2003 sales of $13,146,000 or 13% of consolidated sales.
Products
MiLAN is a supplier of a broad range of networking products of wired and wireless markets. Main product lines include media converters, Ethernet switches and wireless access points and bridges. The Company has been developing and marketing Ethernet based networking products for approximately 12 years. MiLAN continues to develop products that address the enterprise, service provider, and industrial markets and in addition targets specific vertical markets of government and education. Product hardware and software development is performed internally and is expensed when incurred.
Manufacturing and Sources of Supply
MiLAN outsources most of its manufacturing with approximately 85% of its products manufactured offshore, principally in the Far East. These offshore sources of supply are subject to certain risks, including foreign currency fluctuations and interference from political sources. The Company has alternate sources of supply for its products and to date has not had problems obtaining necessary supplies.
Markets and Marketing
MiLAN competes in the wired and wireless networking markets. The wired networking market consists of the media conversion products and the Ethernet switch markets. MiLAN also offers products in the newest and potentially high growth wireless market.
Marketing primarily consists of tradeshows, trade magazine advertising, public relations activities, and direct mail. MiLAN also provides and participates in advertising and cooperative marketing campaigns with distribution partners
Order Book
Outstanding customer orders for MiLAN products were approximately $117,000 as of March 1, 2005 compared to $350,000 as of March 1, 2004. MiLAN does not believe its order book is a significant indicator of future results.
(iv) JDL Technologies, Inc.
JDL Technologies, Inc., located in Edina, Minnesota ("JDL"), provides telecommunications network design, specification, and training services to K-12 educational institutions. JDL focus's on providing services to the top 100 school districts in the United States, including all hardware, software, training, communications and services required to meet the business and educational learning requirements of the individual schools. Sales by JDL for 2004 were $7,969,000 and represented 7% of the "Company's" consolidated sales compared to 2003 sales of $11,868,000 or 12% of consolidated sales. Sales of hardware, software and related equipment totaled $6,324,000 in 2004 or 79% of total JDL sales compared to $5,361,000 in 2003 or 45% of total JDL sales. Training, support and consulting revenue were $1,645,000 and $6,507,000 in 2004 and 2003, respectively.
Order Book
Outstanding customer orders and contracts for JDL products and services were approximately $2,517,000 as of March 1, 2005 and $2,180,000 at March 1, 2004. JDL does not believe its order book is a significant indicator of future results.
(v) Austin Taylor
Austin Taylor Communications, Ltd. manufactures voice and data connectors and related ancillary products at its plant in Bethesda, Wales, U.K. Its product line consists of British standard line jacks, patch panels, data modules, wiring harness assemblies, metal boxes, distribution cabinets and distribution and central office frames. Austin Taylor also manufactures its "AT Net" structured cabling range. Sales by Austin Taylor were $8,029,000, or 7% of the "Company's" consolidated revenues, in 2004 and $6,640,000 or 6% of consolidated revenues in 2003.
Austin Taylor is a vertically integrated manufacturer with metal stamping, metal bending, forming and painting. It also has plastic injection molding and printed circuit board assembly capabilities. Austin Taylor's products are sold direct to customers and through distributors. Approximately 60% of Austin Taylor sales were to United Kingdom customers in 2004 and in 2003.
Outstanding customer orders for Austin Taylor products were approximately $190,000 at March 1, 2005 compared to $450,000 at March 1, 2004. 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.
(2) Employment Levels
As of March 1, 2005 the Company employed 496 people. Of this number, 263 were employed by Suttle (including 122 in Hector, Minnesota and 141 in Costa Rica), 94 by Transition Networks, Inc., 32 by MiLAN Technology., 27 by JDL Technologies, Inc., 14 by Image Systems Corp., 48 by Austin Taylor Communications, Ltd and 18 general and administrative positions. The Company considers its employee relations to be good.
(3) 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 make forward-looking statements concerning possible or anticipated future financial performance, business activities or plans which are typically preceded by the words "believes", "expects", "anticipates", "intends" or similar expressions. For such forward-looking statements, the Company claims the protection of the safe harbor for forward-looking statements contained in federal securities laws. Shareholders and the investing public should understand that such forward looking statements are subject to risks and uncertainties which could cause actual performance, activities or plans to differ significantly from those indicated in the forward-looking statements. Such risks and uncertainties include, but are not limited to: lower sales to RBOCs and other major customers; competitive products and technologies; our ability to successfully reduce operating expenses at certain business units; the general health of the telecom sector, profitability of recent acquisitions; delays in new product introductions; higher than expected expense related to new sales and marketing initiatives; unfavorable resolution of claims and litigation, availability of adequate supplies of raw materials and components; fuel prices; government funding of education technology spending; and other factors discussed from time to time in the Company's filings with the Securities and Exchange Commission.
(4) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 2005 were as follows:
Name Age Position1 - ----------------- --- ----------------------------------------------------
Curtis A. Sampson 71 Chairman of the Board and Chief Executive Officer [1970]
Jeffrey K. Berg 62 President and Chief Operating Officer [2000]2
Paul N. Hanson 58 Vice President - Finance, Treasurer, Secretary and Chief Financial Officer [1982]
David R. Opsahl 55 Exec.Vice President - Corporate Development [2004]3
Daniel G. Easter 48 President and General Manager, Transition Networks, Inc. [2000] 4
Thomas J. Lapping 46 President , JDL Technologies, Inc. [1998]5
David T. McGraw 53 President and General Manager, Suttle Apparatus Corporation [2002]6
Gary D. Nentwig 62 President and General Manager, MiLAN Technology Corporation. [2002] 7 ---------------------------------
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. Berg was appointed Chief Operating Officer of Communications Systems, Inc. in November 2000 and named President of the Company in March 2002. Prior to November 2000, Mr. Berg served as President of the Company's Suttle Apparatus Corporation.
3 Mr. Opsahl was appointed Executive Vice President, Corporate Development in June 2004. Mr. Opsahl was President and Owner of a consulting business from July 2003 to May 2004. Prior to May 2004 Mr. Opsahl was Senior Vice President, Professional Services for ADC Telecommunications Inc."
4 Mr. Easter was appointed President of Transition Networks, Inc. in September 2000. From July 1997 to September 2000, he served as Transition Networks Vice President of Sales and Marketing. Prior to July 1997, he was an executive of Allied Telesyn International Corporation in Seattle, WA.
5 JDL Technologies, Inc. was acquired by the Company in 1998. Mr. Lapping founded JDL Technologies, Inc. in 1989.
6 Mr. McGraw was appointed President of Suttle Apparatus Corporation in September 2002. From May 2001 to August 2002, he served as Chief Operating Officer of JDL Technologies, Inc. Prior to May 2001, he was Vice President- General Manager of Precision Diversified Industries in Plymouth, MN.
7 Mr. Nentwig was appointed President of MiLAN Technology Corporation in March 2002 (CSI acquired substantially all assets of MiLAN from Digi International, March 25, 2002) Mr. Nentwig previously served as MiLAN's General Manager.
Messrs. Sampson and Hanson each devote approximately 50% 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 10 of the "Notes to Consolidated Financial Statements" under Item 8 herein.
ITEM 2.
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 two locations. At Hector, Minnesota, the Company owns three plants totaling 68,000 feet of manufacturing space. The Company leases 40,000 square feet of manufacturing space in San Jose, Costa Rica.
- In 2004, the Company acquired a 30,000 square foot facility in Eden Prairie, Minnesota as part of the Image Systems Corporation acquisition. In addition to the Image Systems operations, the facility serves as distribution center for Transition Networks, Inc.
- Austin Taylor Communications, Ltd. owns a 40,000 square foot facility in Bethesda, Wales, U.K.
- Transition Networks, Inc. leases a 20,000 square foot facility in Eden Prairie, Minnesota where its engineering and administrative operations are conducted.
- JDL Technologies, Inc. leases an 11,000 square foot facility in Edina, Minnesota where its operations are located.
- MiLAN Technology Corporation leases a 24,000 square foot facility in Sunnyvale, California, where its business and distribution operations are conducted.
- The Company owns a 35,000 square foot building in Lawrenceville, Illinois. This facility is currently leased to other tenants.
CSI believes these facilities will be adequate to accommodate its administrative, manufacturing and distribution needs for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
A former officer of one of the Company's subsidiaries has challenged the Company's determination of the retirement benefit payable to be provided to the former officer. The former officer has asserted that, in addition to the retirement benefit the Company has provided, the Company should also provide a supplemental retirement benefit of approximately $100,000 per year to the former officer based on language in his employment contract with the subsidiary and a related letter delivered by the Company when the former officer entered into the employment contract. The Company has denied the former officer's claim for a supplemental retirement benefit. While the former officer has threatened to commence a lawsuit with respect to his claim, as of the date of this report, the Company has not received any formal notice that legal proceedings have been started. If the former officer initiates legal action, the Company will vigorously defend against any claims that may be asserted.
The Company is not aware of any other material litigation or other claims presently pending against the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
(a) MARKET INFORMATION Effective January 27, 2003 the Company began trading its common stock on the American Stock Exchange ("AMEX") under the trading symbol JCS. Prior to January 27, 2003 the Company's common stock was 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 quarterly period indicated as reported by AMEX for 2004 and 2003. These prices indicate inter-dealer prices without retail markup, markdowns or commissions:
2004 2003 ------------------------- ------------------------ High Low High Low
First $8.97 $7.75 $8.50 $6.40 Second 9.24 7.66 8.35 6.95 Third 8.40 7.55 8.38 7.55 Fourth 12.74 8.25 8.04 6.76
(b) HOLDERS
At March 1, 2005 there were approximately 740 holders of record of Communications Systems, Inc. common stock.
(c) DIVIDENDS
Quarterly dividends of $.04 per share were paid at the beginning of each of the four fiscal quarters in 2003. In 2004, a $.04 per share quarterly dividend was paid in the first and second quarters, and increased to dividends of $.05 and $.06 per share in the third and fourth quarters, respectively. A $.07 per share quarterly dividend was declared by the Board of Directors in the first quarter of 2005 payable April 1, 2005.
(d) RECENT SALES OF UNREGISTERED SECURITIES
Not applicable.
(e) REPURCHASES OF ISSUER'S EQUITY SECURITIES
The registrant repurchased 48 shares of its common stock totaling $540 during the fourth quarter of 2004. At December 31, 2004, the Company was authorized to purchase in accordance with Rule 10b-18 282,433 shares of its common stock pursuant to Board authorizations granted in November 2002.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
(1) 2004, 2003 and 2002 amounts benefited from the implementation of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets as disclosed in Note 9 of the consolidated financial statements, included in Item 8. (2) 2004, 2003 and 2002 amounts include results from the acquisition of MiLAN Technology Corporation in March 2002 and 2004 include the results from Image Systems Corporation acquisition in March of 2004.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Communications Systems, Inc. (herein collectively called "CSI", "our" or the "Company") is a Minnesota corporation organized in 1969 which operates directly and through its subsidiaries located in the United States, 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, digital subscriber line filters, structured wiring systems and the manufacture of media and rate conversion products for telecommunications networks. CSI also provides network design, training services, general contracting of infrastructure installations, provisioning of high-speed internet access and maintenance support of network operation centers for K-12 schools.
Critical Accounting Policies
Allowance for Doubtful Accounts: We record a provision for doubtful accounts receivable based on specific identification of doubtful accounts. This involves a degree of judgement based on discussion with our internal sales and marketing groups, our customer base and the examination of the financial stability of our customers. There can be no assurance that our estimates will match actual amounts ultimately written off. During periods of downturn in the market for our products or economic recession, a greater degree of risk exists concerning the ultimate collectability of our accounts receivable due to the impact that these conditions might have on our customer base.
Sales Returns: An allowance is established for possible return of products, rebates and advertising allowances. The amount of the allowance is an estimate, which is based on historical ratios of returns to sales, the historical average length of time between the sale and the return and other factors. Though management considers these allowances adequate and proper, changes in customers' behavior versus historical experience or changes in the Company's return policies are among the factors that would result in materially different amounts for this item.
Inventory Valuation: The Company's inventories are valued at the lower of cost or market. Reserves for overstock and obsolescence are estimated and recorded to reduce the carrying value to estimated net realizable value. The amount of the reserve is determined based on projected sales information, plans for discontinued products and other factors. Though management considers these reserves adequate and proper, changes in sales volumes due to unexpected economic or competitive conditions are among the factors that could materially affect the adequacy of this reserve.
Income Taxes: We account for income taxes in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. In the preparation of the Company's consolidated financial statements, management calculates income taxes. This includes estimating the Company's current tax liability as well as assessing temporary differences resulting from different treatment of items for tax and book accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded on the balance sheet. These assets and liabilities are analyzed regularly and management assesses the likelihood that deferred tax assets will be realized from future taxable income. The valuation allowance for deferred income tax benefits is determined based upon the expectation of whether the benefits are more likely than not to be realized.
Warranty: We provide a standard product warranty program for our product lines and a five year warranty on certain equipment purchased from two vendors and installed at our customer locations. We provide reserves for the estimated cost of product warranties at the time revenue is recognized. We estimate the costs of our warranty obligations based on our warranty policy or applicable contractual warranty, our historical experience of known product failure rates, our vendors' experience and use of materials and service delivery costs incurred in correcting product failures. Management reviews the estimated warranty liability on a quarterly basis to determine its adequacy. Though management considers these balances adequate and proper, changes in the Company's warranty policy or a significant change in product defects versus historical experience are among the factors that could result in materially different amounts for this item.
Goodwill Impairment: Beginning in 2002, goodwill is required to be evaluated annually for impairment, according to SFAS No. 142, Goodwill and Other Intangible Assets. The standard requires a two-step process be performed to analyze whether or not goodwill has been impaired. Step one is to test for potential impairment, and requires that the fair value of the reporting unit be compared to its book value including goodwill. If the fair value is higher than the book value, no impairment is recognized. If the fair value is lower than the book value, a second step must be performed. The second step is to measure the amount of impairment loss, if any, and requires that a hypothetical purchase price allocation be done to determine the implied fair value of goodwill. This fair value is then compared to the carrying value of goodwill. If the implied
fair value is lower than the carrying value, an impairment must be recorded. As of December 31, 2004, 2003 and 2002 the Company had net goodwill of $5,264,000, $5,254,000 and $5,254,000, respectively. Carrying amounts of goodwill by segment as of December 31, 2004 is as follows: Suttle $1,198,000; Transition Networks/MiLAN Technology $3,362,000; JDL Technologies $704,000.
The Company believes that accounting estimates related to goodwill impairment are critical because the underlying assumptions used for the discounted cash flow can change from period to period and could potentially cause a material impact to the income statement. Management's assumptions about inflation rates and other internal and external economic conditions, such as earnings growth rate, require significant judgment based on fluctuating rates and expected revenues.
Revenue Recognition: The Company recognizes revenue when the earnings process is complete, evidenced by persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectibility is reasonably assured. Related to the Suttle, Austin Taylor, and Transition Networks and MiLAN Technology segments, the earning process completion is evidenced through the shipment of goods as the terms these segments are FOB shipping point and the risk of loss is transferred upon shipment and they are have no significant obligations subsequent to that point. Other than the sales returns as discussed above, there are not significant estimates related to revenue recognition for these segments. JDL Technologies, Inc Segment (JDL) records revenue on hardware, software and related equipment sales and installation contracts when the products are installed and accepted by the customer. JDL records revenue on service contracts on a straight-line basis over the contract period, unless evidence suggests that the revenue is earned or obligations are fulfilled in a different pattern. Each contract is individually reviewed to determine when the earnings process is complete.
Foreign Currency Translation: Assets and liabilities of the foreign subsidiary are translated to U.S. dollars at year-end rates, and the statements of operations are translated at average exchange rates during the year. Translation adjustments arising from the translation of the foreign affiliates' net assets into U.S dollars are recorded in other comprehensive income.
Results of operations
2004 Compared to 2003
Consolidated sales in 2004 increased 8% to $110,779,000 compared to $102,411,000 in 2003. The 2004 revenues include $2,224,000 in sales contributed from the Image Systems business unit, which was acquired in March 2004. Image Systems incurred a $265,000 operating loss in 2004. Consolidated operating income in 2004 increased to $7,364,000 compared to operating income of $4,020,000 in 2003. The Company's core business units providing broadband products, Digital Subscriber Line (DSL) products and media conversion and network switching products provided the revenue and earnings growth in 2004 compared to 2003.
Suttle's sales increased 22% to $40,114,000 in 2004 as compared to $32,900,000 in 2003. Sales to customers in the United States (U.S.) in 2004 increased 20% to $38,430,000 from $31,976,000 in 2003. Suttle's sales increases are attributable to increases in capital spending by telecommunications industry companies and in particular the former Regional Bell Operating Company (RBOC) customers. Sales to the RBOC's increased 23% to $22,388,000 in 2004 from $18,190,000 in 2003 which represent 55% of Suttle's U.S. customer sales in 2004 and 2003. Sales to distributors, original equipment manufacturers (OEMs), and electrical contractors increased to $9,554,000 in 2004 compared to $7,441,000 in 2003. Suttle also provided contract manufacturing services to one company, which generated revenues of approximately $2,550,000 in 2004 and $3,400,000 in 2003.
Suttle's gross margins increased 50% to $9,961,000 in 2004 compared to $6,611,000 in 2003. Gross margin as a percentage of sales improved to 24% in 2004 from 20% in 2003. The gross margin percentage increase was due to increased business volumes, cost reductions gained by shifting more manufacturing to the lower cost plant in Costa Rica and from outsourcing the manufacturing of certain products to Asia. Suttle is utilizing offshore manufacturing arrangements in the Pacific Rim to strengthen the competitive position of traditional products and its DSL line filter business. Selling, general and administrative expenses increased to $5,201,000 in 2004 compared to $4,597,000 in 2003 due to increased sales and marketing costs. Suttle's operating income increased to $4,760,000 in 2004 compared to operating income of $2,014,000 in 2003.
Austin Taylor's sales increased in 2004 to $8,029,000 compared to $6,640,000 in 2003 reflecting an increase in sales to several key United Kingdom (U.K.) telecommunications customers. Austin Taylor reported a gross margin of $275,000 in 2004 compared to a negative gross margin of $288,000 in 2003. The increase in gross margin was principally due to higher business volumes and reductions in manufacturing and overhead costs. Austin Taylor is also utilizing offshore manufacturing arrangements in the Pacific Rim to strengthen the competitive position of their product line. Selling, general and administrative expenses decreased $553,000 in 2004 due to lower selling and administrative costs. Severance costs relative to workforce reductions incurred in 2003 were approximately $420,000. No such costs were incurred in 2004. Austin Taylor's operating loss in 2004 was $450,000 in 2004 compared to an operating loss of $1,566,000 in 2003.
Transition Networks / MiLAN Technology segment sales increased to $52,443,000 in 2004 compared to $51,002,000 in 2003. Combined segment sales to international customers were $10,553,000 representing 20% of total segment sales in 2004 compared to $11,816,000 or 22% in 2003. Gross margin increased to $21,174,000 in 2004 from $18,584,000 in 2003. Gross margin as a percentage of sales was 40% in 2004 compared to 36% in 2002. The gross margin increase was due to higher business volumes and reductions in material and product component cost reductions from vendors. Selling, general and administrative expenses increased to $16,640,000 in 2004 compared to $14,260,000 in 2003 due to higher sales and marketing expenses including incentives, promotional costs and additional sales staff. Selling, general and administrative expenses as a percentage of sales were 32% in 2004 and 28% in 2003. Operating income was $4,533,000 in 2004 compared to $4,325,000 in 2003.
JDL Technologies, the Company's technology consulting segment for the education market, sales decreased to $7,969,000 in 2004 compared to $11,868,000 in 2003. Computer and network hardware sales represented $4,113,000 or 52% of total JDL revenues in 2004 compared to $5,361,000 or 45% of total revenue in 2003. Consulting, training and support and connectivity services were $3,856,000 or 48% of total 2004 sales compared to $6,507,000 or 55% of total sales in 2003. Gross margin in 2004 was $4,199,000 or 53% compared to $4,554,000 or 38% in 2003. The gross margin as a percentage of sales increased due to higher margin sales of connectivity and consulting services to client school districts. Selling, general and administrative expenses decreased to $3,015,000 in 2004 compared to $3,454,000 in 2003 due primarily to lower administrative and sales staffing expenses. Operating income remained consistent at $1,184,000 in 2004 compared to $1,100,000 in 2003
Consolidated investment and other income decreased $184,000 in 2004 compared to 2003. The Company realized a net gain of approximately $280,000 on disposal of non-operating assets upon termination of all production in Puerto Rico in the second quarter of 2003 which was recorded as other income. Investment income increased by $96,000 in 2004 compared to 2003. Interest expense (and related line of credit fees) decreased by $35,000 in 2004 compared to 2003 due to a decrease in annual average borrowings on a line of credit and a lower effective interest rate. Consolidated income before income taxes increased to $7,531,000 in 2004 compared to $4,335,000 in 2003. The Company's annualized effective income tax rate was approximately 37% in 2004 and 2003. Consolidated net income in 2004 increased to $4,763,000 compared to $2,717,000 in 2003.
2003 Compared to 2002
Consolidated sales in 2003 decreased 5% to $102,411,000 from sales of $107,300,000 in 2002. Consolidated gross margins increased by 3% in 2003 to $29,462,000 compared to $28,552,000 in 2002. Consolidated operating income increased to $4,020,000 in 2003 compared to $3,940,000 in 2002. Consolidated net income increased to $2,717,000 in 2003 or $.33 per diluted share compared to $2,337,000 or $.28 in 2002.
On March 25, 2002 the Company acquired substantially all the assets of the MiLAN division of Digi International (NASDAQ: DGII) in an all cash transaction valued at approximately $8,100,000. MiLAN is a growing provider of wireless telecommunications products, LAN switches, media conversion products and print servers. 2003 MiLAN sales were $13,146,000 compared to $10,503,000 in 2002.
Suttle's sales were $32,900,000 in 2003 as compared to $33,159,000 in 2002. Sales to customers in the United States (U.S.) in 2003 increased 1% to $31,796,000 from $31,383,000 in 2002. Suttle's sales increases are attributable to increases in capital spending by telecommunications industry companies and in particular the former Regional Bell Operating Company (RBOC) customers. Sales to the RBOC's increased 9% to $18,190,000 in 2003 from $16,687,000 in 2002 which represent 55% and 50% of Suttle's U.S. customer sales in 2003 and 2002, respectively. Sales to distributors, original equipment manufacturers (OEMs), and electrical contractors decreased to $7,441,000 in 2003 compared to $9,779,000 in 2002. Suttle's international sales decreased to $1,104,000 in 2003 compared to $1,776,000 in 2002. Suttle also provide contract manufacturing services to one company, which generated revenues of approximately $3,400,000 in 2003 and $1,500,000 in 2002.
Suttle's gross margins increased 28% to $6,611,000 in 2003 compared to $5,148,000 in 2002. Suttle recorded a write down of excess and slow-moving inventory approximating $1,700,000 in 2002. Gross margin as a percentage of sales improved to 20% in 2003 from 16% in 2002. The gross margin percentage increase was due to the effect of the 2002 writedown of excess and slow-moving inventory and to cost and workforce reduction measures implemented in 2003. The Company has downsized operations by closing two of three manufacturing facilities in Puerto Rico in 2002 and its final building in May 2003 to align production capacities and overhead with current business volumes. Suttle is also utilizing offshore manufacturing arrangements in the Pacific Rim to strengthen the competitive position of traditional products and its DSL line filter business. Suttle's operating income increased to $2,014,000 in 2003 compared to an operating loss of $710,000 in 2002.
Austin Taylor's sales decreased in 2003 to $6,640,000 compared to $7,138,000 in 2002 reflecting a decline in sales to several key United Kingdom (U.K.) telecommunications customers. Austin Taylor reported negative gross margin of ($288,000) in 2003 compared to $691,000 in 2002. The decline in gross margin was principally due to increased pricing competition, lower business volumes and excess manufacturing and overhead capacity. Severance costs relative to workforce reductions incurred in 2003 were approximately $420,000. Selling, general and administrative expenses increased $209,000 in 2003 due to higher selling and marketing costs. Austin Taylor's operating loss in 2003 was $1,566,000 in 2003 compared to an operating loss of $377,000 in 2002.
Transition Networks / MiLAN Technology segment sales increased to $51,002,000 in 2003 compared to $49,010,000 in 2002. Sales for this segment include $13,146,000 in 2003 and $10,503,000 in 2002 contribution from MiLAN Technology, the assets of which CSI purchased from Digi International on March 25, 2002. Transition Networks sales were $37,856,000 in 2003 compared to $38,507,000 in 2002. Combined segment sales to international customers were $11,186,000 representing 22% of total segment sales in 2003 compared to $12,518,000 or 26% in 2002. Gross margin increased to $18,584,000 in 2003 from $16,887,000 in 2002. Gross margin as a percentage of sales was 36% in 2003 compared to 34% in 2002. Gross margins in 2002 were adversely affected by the sale of inventory acquired in the MiLAN acquisition, which had lower margins. Selling, general and administrative expenses increased to $14,260,000 in 2003 compared to $12,528,000 in 2002 due to higher selling and marketing expenses. Selling, general and administrative expenses as a percentage of sales were 28% in 2003 and 26% in 2002. Operating income was $4,325,000 in 2003 compared to $4,359,000 in 2002.
JDL Technologies, the Company's technology consulting segment for the education market, sales decreased to $11,868,000 in 2003 compared to $17,992,000 in 2002. Several major projects were delayed due to processing problems of applications for funds from the federal government's E-Rate program. Computer and network hardware sales represented $5,361,000 or 45% of total JDL revenues in 2003 compared to $13,155,000 or 73% of total revenue in 2002. Consulting, training and support were $6,507,000 or 55% of total 2003 sales compared to $4,837,000 or 27% of total sales in 2002. Gross margin in 2003 was $4,554,000 or 38% compared to $5,825,000 or 32% in 2002. Increased sales of higher margin consulting and training services produced a higher gross margin percentage in 2003 compared to 2002. Selling, general and administrative expenses remained consistent at $3,454,000 in 2003 compared to $3,424,000 in 2002. Operating income decreased to $1,100,000 in 2003 compared to $2,401,000 in 2002
Consolidated investment and other income increased $160,000 in 2003 compared to 2002. The Company realized a net gain of approximately $280,000 on disposal of non-operating assets upon termination of all production in Puerto Rico in the second quarter of 2003 which was recorded as other income. Interest expense decreased by $201,000 in 2003 compared to 2002 due to a decrease in annual average borrowings on a line of credit and a lower effective interest rate. Income before income taxes increased by $441,000 to $4,335,000 compared to $3,894,000 in 2002. The Company's annualized effective income tax rate is approximately 37% in 2003 compared to 40% in 2002. The reduction in the effective income tax rate in 2003 is due to the utilization of available tax credits and income exclusions. Net income in 2003 increased $381,000 to $2,717,000 compared to $2,336,000 in 2002.
Acquisitions and Dispositions
Effective March 24, 2004, the Company acquired substantially all the outstanding shares of Image Systems Corporation for a cash purchase price per share of approximately $2.8 million. Image Systems Corporation, located in Minnetonka, Minnesota designs, manufactures and markets high-resolution display solutions and accessories for customers in the medical imaging market or for other customers who have stringent and or unique display requirements. In addition, Image Systems has been a premier developer of video graphics products since 1988. The proforma effects of the Image Systems Corporation acquisition on our consolidated financial statements were not material to the Company's consolidated financial statements. The acquisition and operations of Image Systems are included in the Company's consolidated financial results from the purchase date March 24, 2004.
Effective March 25, 2002, the Company acquired substantially all the assets of the MiLAN division of Digi International, Inc. for approximately $8,100,000 in cash. MiLAN, located in Sunnyvale, California is a manufacturer of media and rate conversion products, which permit telecommunications networks to move information between copper-wired equipment and fiber-optic cable. In addition, MiLAN is also a supplier of wireless access points, bridges and other networking products. The acquisition was accounted for as a purchase and operations of MiLAN have been included in consolidated financial results March 25, 2002.
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. European Currency
The introduction of the Euro has not had a 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 conduct significant 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, 2004, the Company had approximately $25,843,000 of cash and cash equivalents compared to $14,941,000 of cash and cash equivalents at December 31, 2003. The Company had current assets of approximately $76,220,000 and current liabilities of $12,430,000 at December 31, 2004 compared to current assets of $66,210,000 and current liabilities of $8,258,000 at the end of 2003. The increase in working capital was primarily due to improved 2004 operations and cash flow from operations.
Cash flow provided by operating activities was approximately $14,631,000 in 2004 compared to $4,572,000 provided by operations in 2003. The increase was primarily due to the Company's improved profitability, decreased accounts receivable and inventory levels and an increase in trade and income tax payable levels and accrued liabilities.
Investing activities used $4,621,000 of cash in 2004 compared to cash used in investing activities in 2003 of $1,208,000. The Company purchased substantially all the assets of Image Systems Corporation for approximately $2,800,000 in cash in the first quarter of 2004 financed through internal cash flows. Cash investments in new plant and equipment totaled $1,977,000 in 2004 compared to $715,000 in 2003. The Company expects to invest approximately $1,500,000 on capital additions in 2005.
Net cash provided by financing activities was $1,001,000 in 2004 compared to net cash used in financing activities of $8,269,000 in 2003. Cash dividends paid on common stock totaled $1,399,000 in 2004 and $1,307,000 in 2003. Proceeds from common stock issuances, principally exercises of employee stock options, totaled approximately $2,408,000 in 2004 and $135,000 in 2003. The Company purchased and retired 1,000 and 14,000 shares of its stock in open market transactions during 2004 and 2003 respectively. Board authorizations are outstanding to purchase approximately 282,000 additional shares. The Company may purchase and retire additional shares in 2005 if warranted by market conditions and the Company's financial position. The Company paid down the outstanding balance of its line of credit of $7,000,000 in the first quarter of 2003. There have been no further advances on the line of credit subsequent to that period.
The Company has revoked its Section 936 election effective January 1, 2002 and has included all subsequent Puerto Rico operations in its consolidated federal income tax group. As a result, the Company expects its corporate income tax rate on current and future earnings to continue to more closely match normal U.S. income tax rates. The effective tax rate in 2004 and 2003 was approximately 37% and 40% in 2002. Distributions by Suttle Caribe, Inc. to the parent company of income earned prior to December 31, 2000 are subject to a tollgate tax at rates which, depending on various factors, range from 3.5% to 10%. The cumulative amount of prior earnings on which no tollgate tax has been recognized was approximately $11,054,000 at December 31, 2004. Tollgate taxes of approximately $860,000 have been accrued and will likely be paid on these prior earnings in 2005.
At December 31, 2004 approximately $5,138,000 and $937,000 of assets were invested in the Company's subsidiaries in the United Kingdom and Costa Rica, respectively. The remaining Puerto Rico assets were transferred to the U.S. in the first quarter of 2004. Tollgate taxes have been accrued and will be paid in 2005 on these transfers. The Company expects to maintain assets in the United Kingdom and Costa Rica as needed to support the continued operation of those 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 fluctuations in foreign currency markets to be small.
The Company' had no outstanding obligations under its line of credit at December 31, 2004 and 2003. The Company paid this credit line in full in March 1, 2003. The Company's entire credit line ($10,000,000 at March 1, 2005) 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.
Contractual Obligation Summary
The Company leases land, buildings and equipment under operating leases with original terms from one to five years. Certain of these leases contain renewal and purchase options. Rent expense charged to operations was $1,198,000, $1,271,000 and $1,135,000 in 2004, 2003 and 2002 respectively. Sublease income received was $71,000, $62,000 and $57,000 in 2004, 2003 and 2002 respectively. At December 31, 2004, the Company was obligated under non-cancelable operating leases to make minimum annual future lease payments as follows:
Year Ending December 31: 2005 $ 710,000 2006 704,000 2007 227,000 ----------- $ 1,641,000 ===========
As of December 31, 2004, the Company had no other material commitments (either cancelable or non-cancelable) for capital expenditures, short or long term debt, capital leases or other purchase commitments related to ongoing operations.
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R) (revised 2004), "Share-Based Payment", which amends FASB Statement No. 123 and will be effective for public companies for interim or annual periods beginning after June 15, 2005. The new standard will require us to expense employee stock options and other share-based payments. (As valued and calculated under SFAS No. 123 for pro forma disclosures). The Company has not yet determined how it will value future grants or whether it will elect to adjust prior periods upon adoption of SFAS No. 123 (revised 2004).
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. This statement amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB No. 43, Chapter 4, previously stated that "...under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges..." SFAS No. 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal." In addition, this statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of SFAS 151 shall be applied prospectively and are effective for inventory costs incurred during fiscal years beginning after June 15, 2005, with earlier application permitted for inventory costs incurred during fiscal years beginning after the date this Statement was issued. The adoption of SFAS No. 151 is not expected to have a material impact on our financial position and results of operations.
In December 2004, the FASB staff issued FSP FAS 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004" (the "FSP") to provide guidance on the application of Statement 109 to the provision within the American Jobs Creation Act of 2004 (the "Act") that provides tax relief to U.S. domestic manufacturers. The FSP states that the manufacturers' deduction provided for under the Act should be accounted for as a special deduction in accordance with Statement 109 and not as a tax rate reduction. A special deduction is accounted for by recording the benefit of the deduction in the year in which it can be taken in the company's tax return, and by not adjusting deferred tax assets and liabilities in the period of the Act's enactment (which would have been done if the deduction on qualified production activities were treated as a change in enacted tax rates). The FSP was effective upon issuance. The adoption of the FSP has not and is not expected to have a material impact on our financial position and results of operations.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has no freestanding or embedded derivatives. All contracts that contain provisions meeting the definition of a derivative also meet the requirements of, and have been designated as normal purchases or sales. The Company's policy is to not use freestanding derivatives and to not enter into contracts with terms that cannot be designated as normal purchases or sales.
The vast majority of our transactions are denominated in U.S. dollars; as such, fluctuations in foreign currency exchange rates have historically not been material to the Company. At December 31, 2004 our bank line of credit carried a variable interest rate based on our bank's average certificate of deposit rate plus 1.5%. The Company's investments are money market type of investments that earn interest at prevailing market rates and as such do not have material risk exposure.
Based on the Company's operations, in the opinion of management, no material future losses or exposure exist relative to market risk.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) FINANCIAL STATEMENTS 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 accounting principles generally accepted in the United States of America 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 /s/ Paul N. Hanson - ------------------------------------ ----------------------------------- Curtis A. Sampson Paul N. Hanson Chairman and Chief Executive Officer Chief Financial Officer
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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, 2004 and 2003 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, 2004. Our audits also include the financial statement schedule listed in the Index at Item 15. 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 the standards of the Public Company Accounting Oversight Board (United States). 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, 2004 and 2003 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. 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 22, 2005 Minneapolis, Minnesota
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
ASSETS
December 31 ---------------------------- 2004 2003 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $ 25,842,580 $ 14,941,254 Trade accounts receivable, less allowance for doubtful accounts of $1,427,000 and $1,423,000, respectively 22,077,987 22,647,129 Related party receivables (Note 1) 283,378 387,411 Inventories (Note 2) 23,935,421 24,354,041 Other current assets 966,061 1,197,027 Deferred income taxes (Note 7) 3,114,338 2,682,869 ------------ ------------ TOTAL CURRENT ASSETS 76,219,765 66,209,731
PROPERTY, PLANT AND EQUIPMENT, net (Notes 1 and 3) 7,040,075 5,831,711
OTHER ASSETS: Excess of cost over net assets acquired (Notes 1 and 9) 5,264,095 5,253,793 Investments (Note 1) 19,242 41,846 Deferred income taxes (Note 7) 569,037 1,252,757 Other assets 368,857 506,120 ------------ ------------ TOTAL OTHER ASSETS 6,221,231 7,054,516 ------------ ------------
TOTAL ASSETS $ 89,481,071 $ 79,095,958 ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES: Accounts payable $ 4,631,722 $ 2,194,560 Accrued compensation and benefits 3,472,704 3,013,533 Other accrued liabilities 2,009,822 1,885,000 Dividends payable 508,969 327,397 Income taxes payable 1,806,582 837,703 ------------ ------------ TOTAL CURRENT LIABILITIES 12,429,799 8,258,193
COMMITMENTS AND CONTINGENCIES (Note 5)
STOCKHOLDERS' EQUITY (Notes 1 and 6) 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; 8,502,700 and 8,185,371 shares issued and outstanding, respectively 425,135 409,268 Additional paid-in capital 30,803,482 27,954,636 Retained earnings 45,456,339 42,278,484 Cumulative other comprehensive income (Note 1) 366,316 195,377 ------------ ------------ TOTAL STOCKHOLDERS' EQUITY 77,051,272 70,837,765 ------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 89,481,071 $ 79,095,958 ============ ============
See notes to consolidated financial statements.
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31 ------------------------------------------ 2004 2003 2002 ------------ ------------ ------------ SALES (Note 10): $110,778,938 $102,410,501 $107,299,857
COSTS AND EXPENSES: Cost of sales 74,295,403 72,948,849 78,748,160 Selling, general and administrative expenses 29,119,767 25,441,483 24,611,972 ------------ ------------ ------------ TOTAL COSTS AND EXPENSES 103,415,170 98,390,332 103,360,132 ------------ ------------ ------------
OPERATING INCOME 7,363,768 4,020,169 3,939,725
OTHER INCOME (EXPENSE): Investment and other income 214,338 398,091 238,316 Interest expense (47,373) (82,779) (283,369) ------------ ------------ ------------ OTHER INCOME (EXPENSE), net 166,965 315,312 (45,053) ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 7,530,733 4,335,481 3,894,672
INCOME TAX EXPENSE (Note 7) 2,768,000 1,618,000 1,558,000 ------------ ------------ ------------
NET INCOME 4,762,733 2,717,481 2,336,672 ------------ ------------ ------------
OTHER COMPREHENSIVE INCOME Foreign currency translation adjustment 170,939 264,755 354,403 ------------ ------------ ------------
COMPREHENSIVE INCOME $ 4,933,672 $ 2,982,236 $ 2,691,075 ============ ============ ============
BASIC NET INCOME PER COMMON SHARE (Note 1) $ .58 $ .33 $ .28 ============ ============ ============
DILUTED NET INCOME PER COMMON SHARE (Note 1) $ .57 $ .33 $ .28 ============ ============ ============
AVERAGE BASIC SHARES OUTSTANDING 8,263,041 8,169,078 8,245,352 AVERAGE DILUTED SHARES OUTSTANDING 8,320,614 8,185,679 8,246,481
See notes to consolidated financial statements.
COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 2004, 2003 and 2002
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 currently located in the United States, United Kingdom, and Costa Rica. Until May 2003, the Company also had operations in Puerto Rico.
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 accounting principles generally accepted in the United States of America 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, sales returns, warranty costs, lower of cost or market inventory adjustments, provision for income taxes and deferred taxes, fixed asset impairment review, goodwill and other intangible asset impairment review and depreciable lives of fixed assets.
Financial instruments: The fair value of the Company's financial instruments, which consist of investment securities, accounts receivable, notes receivable, accounts payable and accrued expenses approximate their carrying value due to their short-term nature or the variable interest rate on outstanding indebtedness.
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 related parties: 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 $221,000 and $223,000 at December 31, 2004 and 2003, respectively. Accounts with HCC are paid on a current basis during the year. The Company also has certain receivables from employees and an officer, the majority of which are repaid through biweekly payroll deductions. These receivables totaled $63,000 and $164,000 as of December 31, 2004 and 2003 respectively. These receivables earn interest ranging from 6.5% to 8 % and have maturity dates extending through 2006.
Inventories: Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method. Provision to reduce inventories to the lower of cost or market is made based on a review of excess and obsolete inventories, estimates of future sales, examination of historical consumption rates and the related value of component parts.
Investments: The Company owns marketable securities for which the underlying cost approximates market value at December 31, 2004 and 2003.
Property, plant and equipment: Property, plant and equipment are recorded at cost. Depreciation is computed using the straight-line method. Depreciation included in cost of sales and selling, general and administrative expenses was $2,222,000, $2,394,000 and $2,564,000 for 2004, 2003 and 2002, respectively. Maintenance and repairs are charged to operations and additions or improvements 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 (Goodwill) and other intangible assets: Goodwill represents the amount by which the purchase price and transaction costs of business the Company has acquired exceed the estimated fair value of the net tangible assets and separately identifiable assets of these businesses. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 142 "Goodwill and Other Intangible Assets" on January 1, 2002. Under SFAS No. 142, goodwill and intangible assets with indefinite useful lives are not amortized, but are tested at least annually for impairment. Intangible assets with discrete useful lives (consisting of a royalty agreement) will continue to be amortized over its remaining life of five years. Amortization included in costs and expenses was $46,000, $69,000 and $70,000 in 2004, 2003 and 2002, respectively.
Recoverability of long-lived assets: The Company reviews its long-lived assets periodically to determine potential impairment by comparing the carrying value of the assets with expected net cash flows expected to be provided by operating activities of the business or related products. Should the sum of the expected future net cash flows be less than the carrying value, an impairment loss would be measured by comparing the amount by which the carrying value exceeds the fair value of the asset based on market value that is based on the discounted cash flows expected to be generated by the asset.
Notes payable: The Company has a $10,000,000 line of credit from U.S. Bank. The Company had no outstanding borrowings against the line of credit at December 31, 2004 and 2003. Interest on borrowings on the credit line is at the bank's average CD rate plus 1.5% (2.9% at December 31, 2004). The credit agreement matures June 30, 2005 and is secured by assets of the Company.
Warranty: We provide reserves for the estimated cost of product warranties at the time revenue is recognized. We estimate the costs of our warranty obligations based on our warranty policy or applicable contractual warranty, historical experience of known product failure rates, and use of materials and service delivery costs incurred in correcting product failures. Management reviews the estimated warranty liability on a quarterly basis to determine its adequacy.
The following table presents the changes in the Company's warranty liability for the year ended December 31, 2004 and 2003, which relates to normal product warranties and a five year obligation to provide for potential future liabilities for network equipment sales. 2004 2003 --------- --------- Beginning Balance $ 659,684 $ 662,672 Actual warranty costs paid (124,368) (568,768) Amounts charged to expense 375,034 565,780 --------- --------- Ending balance $ 910,350 $ 659,684 ========= =========
Foreign currency translation: The functional currency of Austin Taylor is the United Kingdom pound. Assets and liabilities denominated in this foreign currency were translated into U.S. dollars at year-end exchange rates. Revenue and expense transactions were translated using average exchange rates. The cumulative foreign currency translation balance is $366,000 and $195,000 at December 31, 2004 and 2003, respectively.
Revenue recognition: The Company recognizes revenue when the earnings process is complete, evidenced by persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectibility is reasonably assured. The Company records a provision for sale returns, sales incentives and warranty costs at the time of the sale based on historical experience and current trends.
JDL Technologies records revenue on hardware, software and related equipment sales and installation contracts when the products are installed and accepted by customer. Revenue under customer service contracts is recognized on a straight-line basis over the contract period, unless evidence suggests that the revenue is earned or obligations are fulfilled in a different pattern.
For all other operating businesses, revenue is recognized for domestic and international sales at the shipping point based on shipping terms of FOB shipping point. Risk of Loss transfers at the point of shipment and the Company has no further obligation after such time. These businesses sell products directly to its customers and through distributors. Payment terms for distributors are consistent with the terms of the Company's direct customers.
Research and development: Research and development consists mostly of outside testing, equipment and supplies associated with enhancing existing products and developing new products. Research and development costs are expensed when incurred and totaled $670,000 in 2004, $607,000 in 2003, and $482,000 in 2002, respectively.
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 adjusts for the 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 57,573 shares, 16,601 shares, and 1,129 shares in 2004, 2003 and 2002, respectively. The Company calculates the dilutive effect of outstanding options using the treasury stock method. The number of shares not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of common stock during the year for 2004, 2003, and 2002 was 344,200, 905,000 and 1,142,000, respectively
Stock-based employee compensation plans: The Company has adopted the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," but applies APB Opinion No. 25, "Accounting for Stock Issued to Employees" for measurement and recognition of stock-based transactions with its employees and accordingly no stock-based employee compensation cost is reflected in the consolidated statements of income and comprehensive income. If the Company had elected to recognize compensation cost for its stock based transactions using the method prescribed by SFAS No. 123, pro forma net income and net income per share would have been as follows:
Year Ended December 31 --------------------------------------- 2004 2003 2002 ----------- ----------- ----------- Net Income As reported $ 4,763,000 $ 2,717,000 $ 2,337,000 Compensation expense, net of tax $ (378,000) $ (558,000) $ (975,000) Pro forma $ 4,385,000 $ 2,159,000 $ 1,362,000
Earnings Per Share-Basic As reported $ . 58 $ .33 $ . 28 Pro forma $ .53 $ .26 $ . 17
Earnings Per Share-Diluted As reported $ . 57 $ .33 $ . 28 Pro forma $ .53 $ .26 $ . 17
Information on the Company's stock-based compensation plans and data used to calculate compensation expense in the table above are described in more detail in Note 6.
Basis of presentation: Certain amounts in the 2003 and 2002 financial statements have been reclassified to conform to the 2004 financial statement presentation. These reclassifications had no effect on net income or stockholders' equity as previously reported.
Recently issued accounting pronouncements: In December 2004, the FASB issued SFAS No. 123(R) (revised 2004), "Share-Based Payment", which amends FASB Statement No. 123 and will be effective for public companies for interim or annual periods beginning after June 15, 2005. The new standard will require the Company to expense employee stock options and other share-based payments. The Company has not yet determined how it will value future grants or whether it will elect to adjust prior periods upon adoption of SFAS No. 123 (revised 2004).
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. This statement amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB No. 43, Chapter 4, previously stated that "...under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges..." SFAS No. 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal." In addition, this statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of SFAS 151 shall be applied prospectively and are effective for inventory costs incurred during fiscal years beginning after June 15, 2005, with earlier application permitted for inventory costs incurred during fiscal years beginning after the date this Statement was issued. Management believes the adoption of SFAS No. 151 will not have a material impact on our financial position and results of operations.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005. Management believes the adoption of SFAS No. 153 will not have a material impact on our financial position and results of operations.
In December 2004, the FASB staff issued FSP FAS 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004" (the "FSP") to provide guidance on the application of Statement 109 to the provision within the American Jobs Creation Act of 2004 (the "Act") that provides tax relief to U.S. domestic manufacturers. The FSP states that the manufacturers' deduction provided for under the Act should be accounted for as a special deduction in accordance with Statement 109 and not as a tax rate reduction. A special deduction is accounted for by recording the benefit of the deduction in the year in which it can be taken in the company's tax return, and by not adjusting deferred tax assets and liabilities in the period of the Act's enactment (which would have been done if the deduction on qualified production activities were treated as a change in enacted tax rates). The FSP was effective upon issuance. Management believes the adoption of the FSP will not have a material impact on our financial position and results of operations.
NOTE 2 - INVENTORIES Inventories consist of: December 31 -------------------------- 2004 2003 ------------ ------------ Finished goods $ 15,613,485 $ 14,531,725 Raw and processed materials 8,321,936 9,822,316 ------------ ------------ $ 23,935,421 $ 24,354,041 ============ ============
NOTE 3 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment and the estimated useful lives are as follows:
December 31 Estimated -------------------------- useful life 2004 2003 ----------- ------------ ------------ Land $ 769,683 $ 290,939 Buildings and improvements 7-30 years 4,639,751 3,472,418 Machinery and equipment 3-15 years 26,392,818 25,127,087 Furniture and fixtures 5-10 years 3,061,659 3,441,175 ------------ ------------ 34,863,911 32,331,619 Less accumulated depreciation (27,823,836) (26,499,908) ------------ ------------ $ 7,040,075 $ 5,831,711 ============ ============
NOTE 4 - EMPLOYEE BENEFIT PLANS
The Company has an Employee Savings Plan (401(k)) and matches a percentage of employee contributions up to six percent of compensation. Contributions to the plan in 2004, 2003 and 2002 were $356,000, $313,000, and $312,000, respectively.
Effective January 1, 2004, the Company implemented a "Performance Unit Incentive Plan". The plan provides long term competitive compensation to enable the Company to attract and retain qualified executive talent and to reward employees for achieving goals and improving company performance. The plan provides grants of "performance units" made at the beginning of four year performance periods and paid at the end of the period if return on asset goals are met. Awards are made every other year and are given in the form of cash at the end of the cycle with annual vesting. Payment in the case of retirement, disability or death will be on a pro rata basis. Every other year a new four-year cycle begins to create a potential pay out every other year. In 2004, the Company recorded contribution expense of approximately $450,000, for unpaid contributions.
NOTE 5 - COMMITMENTS AND CONTINGENCIES
The Company leases land, buildings and equipment under operating leases with original terms from 1 to 5 years. Certain of these leases contain renewal and purchase options. Rent expense charged to operations was $1,198,000 $1,271,000 and $1,135,000 in 2004, 2003 and 2002 respectively. Sublease income received was $71,000, $62,000 and $57,000 in 2004, 2003 and 2002 respectively. At December 31, 2004, the Company was obligated under noncancellable operating leases to make minimum annual future lease payments as follows:
Year Ending December 31: 2005 $ 710,000 2006 704,000 2007 227,000 ------------ $ 1,641,000 ============
As of December 31, 2004, the Company had no other material commitments (either cancelable or non-cancelable) for capital expenditures or other purchase commitments related to ongoing operations. The Company' had no outstanding obligations under its line of credit at December 31, 2004 and 2003. The Company's entire credit line ($10,000,000 at March 1, 2005) is available for use.
A former officer of one of the Company's subsidiaries has challenged the Company's determination of the retirement benefit payable to be provided to the former officer. The former officer has asserted that, in addition to the retirement benefit the Company has provided, the Company should also provide a supplemental retirement benefit of approximately $100,000 per year to the former officer based on language in his employment contract with the subsidiary and a related letter delivered by the Company when the former officer entered into the employment contract. The Company has denied the former officer's claim for a supplemental retirement benefit. While the former officer has threatened to commence a lawsuit with respect to his claim, as of the date of this report, the Company has not received any formal notice that legal proceedings have been started. If the former officer initiates legal action, the Company will vigorously defend against any claims that may be asserted.
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 other outstanding or pending legal actions that would materially affect the Company's financial position or results of operations.
NOTE 6 - COMMON STOCK AND STOCK OPTIONS
Common shares are reserved in connection with the Company's 1992 stock plan under which 2,500,000 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, 2004, 121,779 shares remained available to be issued under the plan. Options expire five years from date of grant with one-third of the options vesting after six months and the remaining two-thirds vesting equally over the next two years.
Shares of common stock 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 3,000 shares of common stock annually to each nonemployee director concurrent with the annual stockholders' meeting. Exercise price is the fair market value of the stock at the date of grant. Options granted under this plan vest when issued and expire 10 years from date of grant. At December 31, 2004, 34,500 shares are available to be issued under the plan.
Changes in outstanding employee and director stock options during the three years ended December 31, 2004 were as follows: Weighted average Number of exercise price shares per share Outstanding at December 31, 2001 1,077,811 $ 13.01 Granted 248,500 8.42 Exercised (1,700) 6.27 Canceled (158,457) 13.20 ------------ Outstanding at December 31, 2002 1,166,234 12.02 Granted 270,250 7.21 Exercised (1,700) 7.05 Canceled (275,828) 13.50 ------------ Outstanding at December 31, 2003 1,158,956 10.54 Granted 312,750 9.31 Exercised (263,170) 8.51 Canceled (185,511) 10.03 ------------ Outstanding at December 31, 2004 1,023,025 10.72 ============
At December 31, 2004, 774,264 stock options are currently exercisable at a weighted average price of $9.93. The following table summarizes the status of Communications Systems, Inc. stock options outstanding at December 31, 2004:
Weighted Average Weighted Remaining Average Range of Exercise Prices Shares Option Life Exercise Price - ------------------------ --------- ----------- ------------- $ 7.14 to $ 9.99 660,725 3.4 years $ 8.12 $10.00 to $12.00 68,100 1.0 years 11.37 $12.01 to $14.99 68,500 4.3 years 13.51 $15.00 to $18.56 225,700 .6 years 17.02
On October 29, 1999 the Board of Directors adopted a shareholders' rights plan. Under this plan, the Board of Directors declared a distribution of one right per share of common stock. Each right entitles the holder to purchase 1/100th of a share of a new series of Junior Participating Preferred Stock of the Company at an initial exercise price of $65. The rights expire on October 26, 2009. The rights will become exercisable only following the acquisition by a person or group, without the prior consent of the Board of Directors, of 15% or more of the Company's voting stock, or following the announcement of a tender offer or exchange offer to acquire an interest of 15% or more. If the rights become exercisable, each rightholder will be entitled to purchase, at the exercise price, common stock with a market value equal to twice the exercise price. Should the Company be acquired, each right would entitle the holder to purchase, at the exercise price, common stock of the acquiring company with a market value equal to twice the exercise price. Any rights owned by the acquiring person or group would become void.
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 -------------------------------------- 2004 2003 2002 ------- ------- ------- Expected volatility 37% 33% 33% Risk free interest rate 2.9% 2.6% 4.6% Expected holding period - employees 4 years 4 years 4 years Expected holding period - directors 7 years 7 years 7 years Dividend yield 2.0% 2.2% 1.9%
Information regarding the effect on net income and earnings per common share had the Company applied the fair value expense recognition provisions of SFAS No. 123 is included in Note 1.
EMPLOYEE STOCK PURCHASE PLAN
The Company maintains an Employee Stock Purchase Plan for which 300,000 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 22,193, 23,172 and 36,276 for the plan years ended August 31, 2004, 2003 and 2002, respectively. At December 31, 2004 employees had subscribed to purchase an additional 22,604 shares in the current plan year ending August 31, 2004.
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, 2004, the ESOP held 332,500 shares of the Company's common stock, all of which have 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's 2004 ESOP contribution was $426,564 for which the Company issued 35,000 shares of common stock to the ESOP in March 2005. The 2003 ESOP contribution was $264,374 for which the Company issued 33,000 shares in February 2004. The 2002 ESOP contribution was $255,040 for which the Company issued 32,000 shares in February 2003.
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 2004, the Company purchased and retired 1,034 shares at a cost of $8,500. In 2003, the Company purchased and retired 14,217 shares at a cost of $98,000. In 2002, the Company purchased and retired 182,574 shares at a cost of $1,193,000. At December 31, 2004, 282,433 additional shares could be repurchased under outstanding Board authorizations.
NOTE 7 - INCOME TAXES
Income tax expense from continuing operations consists of the following:
Year Ended December 31 ---------------------------------------- 2004 2003 2002 ----------- ----------- ----------- Currently payable income taxes (benefit): Federal $ 1,884,000 $ (890,000) $ 2,000,000 State 260,000 106,000 260,000 Puerto Rico 133,000 161,000 Foreign 45,000 53,000 42,000 ----------- ----------- ----------- 2,189,000 (598,000) 2,463,000
Deferred income taxes (benefit) 579,000 2,216,000 (905,000) ----------- ----------- ----------- $ 2,768,000 $ 1,618,000 $ 1,558,000 =========== =========== ===========
The bulk of Suttle's operations were located in Puerto Rico until December 2001. In 2002, the Company determined that these operations were no longer cost effective and ultimately terminated its Puerto Rico operations completely in May of 2003. The Company's earnings in Puerto Rico were sheltered from U.S. income tax by the possessions tax credit (Internal Revenue Code Section 936). The amount of the possessions tax credit was limited to a percentage of the Company's Puerto Rico payroll and depreciation. The possessions tax credit has had a materially favorable effect on the Company's income tax expense in years prior to 2002.
The Company has revoked its Section 936 election effective January 1, 2002 and has included all subsequent Puerto Rico operations in its consolidated federal income tax group. As a result, the Company expects its corporate income tax rate on current and future earnings to continue to more closely match normal U.S. income tax rates. The effective tax rate in 2004 and 2003 was approximately 37% and 40% in 2002.
Distributions by Suttle Caribe, Inc. to the parent company of income earned prior to December 31, 2000 are subject to a tollgate tax at rates which, depending on various factors, range from 3.5% to 10%. The cumulative amount of prior earnings on which no tollgate tax has been recognized was approximately $11,054,000 at December 31, 2004. Tollgate taxes of approximately $860,000 have been accrued and will likely be paid on these prior earnings in 2005.
Austin Taylor Communications, Ltd. operates in the U.K. and is subject to U.K. rather than U.S. income taxes. U.K. pretax loss was $438,000, $1,566,000, and $349,000 in 2004, 2003 and 2002, respectively. No benefit was recorded for these losses due to the uncertainty of generating taxable income in the future. 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 $3,122,000 at December 31, 2004. It is the Company's intention to reinvest the remaining undistributed earnings of its 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 ----------------------------------- 2004 2003 2002 ------- ------- ------- Tax at U.S. statutory rate 35.0% 35.0% 35.0% Surtax exemption (1.0) (1.0) (1.0) U.S. taxes not provided on Puerto Rico operations (1.3) State income taxes, net of federal benefit 2.3 1.6 4.4 Other .5 1.7 2.9 ------- ------- ------- Effective tax rate 36.8% 37.3% 40.0% ======= ======= ======
Deferred tax assets and liabilities as of December 31 related to the following:
2004 2003 ----------- ----------- Current assets: Bad debts $ 421,323 $ 414,756 Inventory 1,345,097 1,376,968 Accrued expenses 1,347,918 891,145 ----------- ----------- $ 3,114,338 $ 2,682,869 =========== =========== Long term assets and (liabilities): Depreciation $ (507,929) $ (361,117) Net operating loss carryforward 799,746 799,897 Excess of cost over net assets 278,632 375,495 Other (1,412) (2,550) Alternative minimum tax credits 441,032 Foreign net operating loss carryforward 1,039,542 890,765 Less: valuation reserve for foreign net operating loss carryforward (1,039,542) (890,765) ----------- ----------- $ 569,037 $ 1,252,757 =========== ===========
As part of the LANart acquisition, the Company purchased net operating loss carryforwards in the amount of $3,416,000. As part of the Image Systems Corporation acquisition, the Company purchased net operating loss carryforwards in the amount of $374,000. At December 31, 2004, the Company has $2,352,000 available net operating loss carryforwards for income tax purposes, of which the majority expire in 2014.
NOTE 8 - ACQUISITIONS
Effective March 24, 2004, the Company acquired substantially all the outstanding shares of Image Systems Corporation for a cash purchase price per share of approximately $2.8 million in total consideration. Image Systems Corporation (Image Systems), located in Minnetonka, Minnesota designs, manufactures and markets high-resolution display solutions and accessories for customers in the medical imaging market or for other customers who have stringent and or unique display requirements. In addition, Image Systems has been a premier developer of video graphics products since 1988. The proforma effects of the Image Systems Corporation acquisition on our consolidated financial statements were not material to the Company's consolidated financial statements. The acquisition and operations of Image Systems are included in the Company's consolidated financial results from the purchase date March 24, 2004. The sum of amounts assigned to assets acquired and liabilities assumed exceeded the cost of the acquired entity. To account for this excess, the amounts assigned to individual property, plant and equipment were reduced on a pro-rata basis. In the acquisition, the estimated fair value of the following assets were acquired and liabilities assumed:
Property, plant and equipment $ 1,434,000 Accounts receivable 576,297 Inventory 716,999 Cash 103,625 Other assets 27,770 Deferred tax asset 481,000 Accounts payable (180,162) Accrued expenses (254,221) ----------- Total purchase price 2,905,308 Less cash acquired (103,625) ----------- Payment for purchase of Image Systems Corp., net of cash acquired $ 2,801,683 ===========
Effective March 25, 2002, the Company acquired substantially all the assets of MiLAN Technology Corporation for approximately $8,100,000 in cash. MiLAN, located in Sunnyvale, California is a manufacturer of media and rate conversion products, which permit telecommunications networks to move information between copper-wired equipment and fiber-optic cable. In addition, MiLAN is also a supplier of wireless access points, bridges and other networking products. The acquisition was accounted for as a purchase and operations of MiLAN have been included in consolidated operations from March 25, 2002.
The fair value of net assets acquired in the transaction were allocated as follows:
Equipment and fixtures $ 5,120 Identifiable intangible asset (royalty agreement) 201,341 Excess of cost over net assets acquired 635,046 Accounts receivable 2,426,713 Inventory 5,121,936 Accrued expenses (262,405) ----------- Total purchase price $ 8,127,751 ===========
NOTE 9 - GOODWILL
On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under this statement goodwill as well as other intangibles determined to have an infinite life will no longer be amortized; however, these assets will be reviewed for impairment on a periodic basis. Statement No. 142 also includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. Management assessed the fair value of the business units to determine whether goodwill carried on the financial statements was impaired and the extent of such impairment, if any, using the discounted cash flows method. Based upon these assessments, management determined that the current goodwill balances were not impaired. Management will continue to reassess the value of our business units and related goodwill balances at the beginning of each year or at other times if events have occurred or circumstances exist that indicate the carrying amount of goodwill may not be recoverable. As of December 31, 2004, 2003 and 2002 the Company had net goodwill of $5,264,000, $5,254,000 and $5,254,000, respectively. Carrying amounts of goodwill by segment as of December 31, 2004 is as follows: Suttle $1,198,000; Transition Networks/MiLAN Technology $3,362,000; JDL Technologies $704,000.
NOTE 10- INFORMATION CONCERNING INDUSTRY SEGMENTS AND MAJOR CUSTOMERS
The Company classifies its businesses into five segments: Suttle, which manufactures U.S. standard modular connecting and wiring devices for voice and data communications; Austin Taylor, which manufactures British standard line jacks, patch panels, wiring harness assemblies, metal boxes, distribution cabinets and distribution and central office frames; Transition Networks and MiLAN Technology, which designs and markets data transmission, computer network and media conversion products and print servers; and JDL Technologies, (JDL), which provides telecommunications network design, specification and training services to educational institutions; Other includes Image Systems Corporation, (substantially all assets purchased March 24, 2004) which designs, manufactures and markets high-resolution display solutions and accessories for customers in the medical imaging market and non-allocated corporate general and administrative expenses.
Suttle products are sold principally to United States (U.S.) customers. Suttle operates manufacturing facilities in the U.S. and Costa Rica. Net long-lived assets held in Costa Rica was approximately $796,000 at December 31, 2004. Austin Taylor operates in the United Kingdom (U.K.). Net long-lived assets held in the U.K. were approximately $751,000 as of December 31, 2004. Transition Networks manufactures its products in the United States and makes sales in both the U.S. and U.K. markets. JDL Technologies operates in the U.S. and makes sales in the U.S. and Latin America. Consolidated sales to U.S. customers were approximately 83%, 83% and 80% of total consolidated sales in 2004, 2003 and 2002 respectively. At December 31, 2004, foreign earnings in excess of amounts received in the United States were approximately $4,268,000. In addition, the cumulative amount of prior earnings of Suttle Caribe, Inc. on which no Puerto Rico tollgate tax has been recognized was approximately $11,054,000 at December 31, 2004. Tollgate taxes of approximately $860,000 will be paid on these undistributed earnings in 2005.
In 2004, 2003 and 2002, no customer accounted for more than 10% of consolidated sales.
Information concerning the Company's operations in the various segments for the twelve-month periods ended December 31, 2004, 2003 and 2002 is as follows:
(b) SUPPLEMENTAL FINANCIAL INFORMATION
Unaudited Quarterly Operating Results (in thousands except per share amounts)
Quarter Ended March 31 June 30 Sept 30 Dec 31 - -------------------------------------------------------------------------------
Sales $ 25,249 $ 27,134 $ 29,261 $ 29,135 Gross Margins 7,936 9,071 9,977 9,499 Operating income 1,115 1,603 2,504 2,141 Net Income 723 990 1,538 1,511
Basic Net Income per Share $ .09 $ .12 $ .19 $ .18 Diluted Net Income per Share $ .09 $ .12 $ .19 $ .17
Sales $ 26,575 $ 24,869 $ 24,666 $ 26,300 Gross Margins 7,406 7,415 6,551 8,090 Operating income 1,184 746 562 1,528 Net Income 723 628 447 919
Basic Net Income per Share $ .09 $ .08 $ .05 $ .11 Diluted Net Income per Share $ .09 $ .08 $ .05 $ .11
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
The Company, under the supervision and with the participation of management, including the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a - 15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on that evaluation, the CEO and CFO concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures are operating effectively and are adequately designed to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the applicable rules and forms and is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. During the period covered by this Report there was no change in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable. PART III
ITEM 10.
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 24, 2005 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.
Code of Ethics
The Company has adopted a code of Ethics applicable to all officers of the Company as well as certain other key accounting personnel. A copy of the Code of Ethics can be obtained free of charge upon written request directed to the Company's Assistant Secretary at the executive offices of the Company.
ITEM 11.
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 24, 2005 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.
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 24, 2005 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.
Securities Authorized For Issuance Under Equity Compensations Plans
ITEM 13.
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 24, 2005 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 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information called for by Item 14 Of Form 10K and 9(e) of Schedule 14A will be set forth under the caption " Principal Accountant Fees and Services in the Company's definitive proxy materials for its May 24, 2005 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.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8K
(a) (1) Consolidated Financial Statements
The following Consolidated Financial Statements of Communications Systems, Inc. and subsidiaries appear at pages 19 to 34 herein:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Income and Comprehensive Income for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
(a) (2) Consolidated Financial Statement Schedule
The following financial statement schedule is being filed as part of this Form 10-K Report:
Consent of Independent Registered Public Accounting Firm
Schedule II - Valuation and Qualifying Accounts and Reserves
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 pursuant to Item 601 of Regulation S-K including each management or compensatory plan or arrangement are described on the Exhibit Index, which begins on page 41 of the sequential numbering system used in this report.
(b) REPORTS ON FORM 8-K FILED DURING THE THREE MONTHS ENDED DECEMBER 31, 2004
Form 8-K filed relative to the Company's 2004 third quarter earnings release issued in November 2004.
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, 2005 /s/ Curtis A.Sampson ----------------------------------- Curtis A. Sampson, Chairman of the Board of Directors 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, 2005 - ----------------------- and Director (Principal Executive Curtis A. Sampson Officer)
/s/Paul N. Hanson Vice President, Treasurer and March 29, 2005 - ----------------------- Chief Financial Officer (Principal Paul N. Hanson Financial Officer and Principal Accounting Officer)
/s/Randall D. Sampson Director March 29, 2005 - ----------------------- Randall D. Sampson
/s/Edwin C. Freeman Director March 29, 2005 - ---------------------- Edwin C. Freeman
/s/Luella G. Goldberg Director March 29, 2005 - ----------------------- Luella Gross Goldberg
/s/Frederick M. Green Director March 29, 2005 - ----------------------- Frederick M. Green
/s/Gerald D. Pint Director March 29, 2005 - ----------------------- Gerald D. Pint
/s/Paul J. Anderson Director March 29, 2005 - ----------------------- Paul J. Anderson
/s/Wayne E. Sampson Director March 29, 2005 - ----------------------- Wayne E. Sampson
- --------------------------------------------------------------------------------
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, 2004
----------------------------
FINANCIAL STATEMENT SCHEDULE
- --------------------------------------------------------------------------------
COMMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES Exhibit Index To Form 10-K for the Year Ended December 31, 2004
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 Filed as Exhibit 10.3 to the 1993 Plan 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.
10.9 Form of Rights Agreement, Filed as Exhibit 1 to the dated as of October 26, 1999 Company's Form 8-A on November 8, between the Company and 1999 and incorporated herein by Wells Fargo Bank Minnesota, reference. National Association
21 Subsidiaries of the Registrant Filed herewith. 23 Independent Auditors' Consent Filed herewith. 24 Power of Attorney Included in signatures at page 38. 31.1 Certification of Chief Executive Officer Filed herewith. 31.2 Certification of Chief Financial Officer Filed herewith. 32 Certification under U.S.C. ss. 1350 Filed herewith.
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.