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JCS > SEC Filings for JCS > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for COMMUNICATIONS SYSTEMS INC


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Communications Systems, Inc. provides physical connectivity infrastructure and services for global deployments of broadband networks through the following business units:

Suttle manufactures and markets copper and fiber connectivity systems, enclosure systems, xDSL filters and splitters, and active technologies for voice, data and video communications under the Suttle brand in the United States and internationally;

Transition Networks manufactures network interface devices (NIDs), media converters, network interface cards (NICs), Ethernet switches, and other connectivity products that offer customers the ability to affordably integrate fiber optics into any data network; and

JDL Technologies provides technology solutions including virtualization, managed services, wired and wireless network design and implementation services, and converged infrastructure configuration and deployment.

For the three months ended September 30, 2012, net income was $1,119,000 or $0.13 per diluted share, on revenue of $28,688,000, compared to net income of $3,730,000 or $0.44 per diluted on revenue of $41,985,000 in the fiscal 2011 third quarter. For the first nine months ended September 30, 2012, net income was $2,146,000 or $0.25 per diluted share, on revenue of $78,493,000 compared to net income of $10,372,000 or $1.22 per diluted share, on revenue of $118,437,000 in the nine months ended September 30, 2011.

As the Company discussed in reporting its 2011 interim and full year results, its strong 2011 financial performance was bolstered by large projects in its Transition Networks and JDL business units, making year-over-year comparisons more challenging. The significant decrease in the revenue and net income for the three and nine-month periods from the 2011 periods is primarily due to a large, one-time 2011 Transition Networks project that generated $32.8 million of revenue in the second and third quarters of 2011. The Company continues to face a difficult 2012 economic environment, primarily related to lower government spending, which is affecting both its Transition Networks and JDL business units.

Excluding the revenues from this one-time project, Transition Networks 2012 third quarter revenues decreased $563,000 or 4% over the 2011 third quarter. Transition Networks is working to increase revenue in its focus markets, including the service provider market and continues to have success with Telcos that provide business Ethernet services. The July 2011 addition of Patapsco has helped to expand its capacity to serve the mobile backhaul space. The Company expects growth in this space and continues to invest in product development to support it. Although Transition Networks does not sell directly to the federal government or to state or local governments, a number of its customers sell directly to the government, work on government projects, or receive government funding. Accordingly, Transition Networks's revenues and profitability are dependant, in part, on the level of federal, state and local government spending on infrastructure projects.


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JDL's 2012 revenues decreased 60% as it completed a large contract for the Broward Country School District in the third quarter of 2011. JDL continues to support this school district, and is marketing its products and services to new school districts and universities. It is also expanding its products and services to small- and medium-sized businesses to implement new technologies such as virtualization and migration to the cloud. As previously announced, JDL has been selected as one of the partners for a project with the Miami-Dade County Public School District ("M-DCPS"), the fourth largest public school district in the United States. As part of the district's "Bringing Wireless to the Classroom" initiative, M-DCPS applied for and has been granted federal funding under the E-Rate program to expand wireless connectivity for students and staff. JDL Technologies has been selected to provide the hardware and wiring for 232 district schools as part of the project. The wireless connectivity project is expected to launch in the fourth quarter of 2012 for completion by year-end 2013, and to contribute up to $23 million in revenue to JDL Technologies. While this project will contribute to CSI's overall profitability, the M-DCPS project is primarily hardware; therefore the Company's margins from this project will be significantly lower than the margins from JDL's historical projects, which have included a significant value-added service component.

Suttle experienced a 16% increase in third quarter revenues, due primarily to an improving housing market, especially for multi-tenant dwelling units as Suttle's strong position within this market enabled it to increase structured wiring products revenues by $1.6 million or 47% over the third quarter of 2011. In addition, through its copper and fiber connectivity products, Suttle has achieved success obtaining new opportunities within its existing customer base as well as gaining new customers in Latin America, Europe and the Middle East. Suttle's Costa Rica facility is growing to support customers globally with production and has added engineering resources to support new product development.

While the Company has reduced its overall general and administrative costs, it continues to invest strategically in its core markets to pursue new opportunities in its global customer base and expand into new markets. The Company's ongoing implementation of its enterprise resource planning (ERP) system is proceeding well. This new system will standardize all of the Company business units on one system, bringing efficiencies to product development, manufacturing, delivering services and back office support.

Despite some near-term economic uncertainty in some areas such as government spending, the Company remains optimistic about its long-term prospects and will continue to invest in areas that will enable it to be successful in its target markets.

Forward-looking statements

In this report and, 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" within the meaning of the Private Securities Litigation Reform Act of 1995 concerning possible or anticipated future financial performance, business activities, plans, pending claims, investigations or litigation which are typically preceded by the words "believes," "expects," "anticipates," "intends" or similar expressions. For these 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 these forward-looking statements are subject to risks and uncertainties that could cause actual performance, activities, anticipated results, outcomes or plans to differ significantly from those indicated in the forward-looking statements. These risks and uncertainties include, but are not limited to:

our ability to manufacture and deliver our products to customers in the time frame these customers have specified;
possible lower future sales to major telephone companies and other major customers;
the introduction of competitive products and technologies;
our ability to successfully control operating expenses in our business units;
the general health of the telecom sector;


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the continuing worldwide financial downturn and sluggish economic conditions in certain market segments;
our ability to successfully and profitability integrate our acquisitions, including our July 2011 acquisition of Patapsco;
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;
the dependence of our Transition Networks business unit on federal government spending;
the timing and availability of the federal and school district components of the funding of our M-DCPS project could affect the timing of JDL's delivery of services and its receipt of revenues under the project;
the fact the Company's margins from JDL's M-DCSD project will be significantly lower than the margins from JDL's historical projects, which have included a significant value-added service component; and
other factors discussed from time to time in the Company's filings with the Securities and Exchange Commission, including risk factors presented under Item 1A of the Company's most recently filed annual report on Form 10-K.

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011

Consolidated sales decreased 32% in 2012 to $28,688,000 compared to $41,985,000 in 2011. Consolidated operating income in 2012 decreased to $1,707,000 compared to $6,484,000 in the third quarter of 2011. Net income in 2012 decreased to $1,119,000 compared to $3,730,000 in the third quarter of 2011.

Suttle

The Company realigned its business operations effective January 1, 2012 and as a result, the Austin Taylor operations are now included within the Suttle business unit. The Company has reclassified Austin Taylor's 2011 operations to conform to this presentation. Suttle sales increased 16% in the third quarter of 2012 to $12,242,000 compared to $10,538,000 in the same period of 2011 due to increases in new multi-dwelling unit construction in the U.S. housing market and revenue from multiple new product contracts. Sales by customer groups in the third quarter of 2012 and 2011 were:

                              Suttle Sales by Customer Group
                                  2012               2011
Major telephone companies   $       9,501,000    $   7,414,000
Distributors                        1,308,000        1,106,000
International                       1,248,000        2,000,000
Other                                 185,000           18,000
                            $      12,242,000    $  10,538,000


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Suttle's sales by product groups in third quarter of 2012 and 2011 were:

                                Suttle Sales by Product Group
                                    2012              2011
Modular connecting products   $      3,485,000    $   3,271,000
Structured cabling products          5,011,000        3,418,000
DSL products                         2,300,000        2,520,000
Other products                       1,446,000        1,329,000
                              $     12,242,000    $  10,538,000

Sales to the major telephone companies increased 28% in 2012 due to an increase in new multi-dwelling unit construction within the U.S. housing market and revenue from multiple new product contracts. Sales to these customers accounted for 78% of Suttle's sales in the third quarter of 2012 compared to 70% of sales in 2011. Sales to distributors increased 18% in 2012 due to stronger demand for structured cabling products to support the increase in multi-dwelling unit construction. This customer segment accounted for 11% and 10% of sales in the third quarters of 2012 and 2011, respectively. International sales decreased 38% and accounted for 10% of Suttle's third quarter 2012 sales, due to a delay in DSL sales to a large customer, discontinuation of Austin Taylor's metal business, and reduction in revenue from Austin Taylor's legacy products.

Modular connecting products sales increased 7% due to an increase in new multi-dwelling unit construction in the U.S. housing market. Sales of structured cabling products increased 47% due to an increase in new multi-dwelling unit construction market. Sales of DSL products decreased 9% due to the maturation of the U.S. DSL market and the order cycle of major customers.

Suttle's gross margin increased 41% in the third quarter of 2012 to $3,327,000 compared to $2,358,000 in the same period of 2011. Gross margin as a percentage of sales increased to 27% in 2012 from 22% in 2011 due to product mix changes and increased production levels. Selling, general and administrative expenses increased $190,000 or 9% in the third quarter of 2012 compared to the same period in 2011, due to increased spending in the Company's technology development and market expansion initiatives. Suttle's operating income was $1,009,000 in the third quarter of 2012 compared to $231,000 in 2011.

Transition Networks

Transition Networks sales decreased 51% to $13,647,000 in the third quarter of 2012 compared to $27,574,000 in 2011 due primarily to $13,364,000 in revenue from a one-time large network upgrade project with a Fortune 500 company in the third quarter of 2011. Revenues excluding this major project decreased 4% or $563,000 as compared to the third quarter of 2011 due to sales in Latin America and Southeast Asia and a few larger projects that took place in that quarter.

Third quarter sales by region are presented in the following table:

                                          Transition Networks Sales by Region
                                              2012                   2011
North America                          $        10,314,000    $        23,817,000
Europe, Middle East, Africa ("EMEA")             1,381,000              1,065,000
Rest of world                                    1,952,000              2,692,000
                                       $        13,647,000    $        27,574,000


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The following table summarizes Transition Networks' 2012 and 2011 third quarter sales by its major product groups:

Transition Networks Sales by Product Group

                             2012                      2011
Media converters    $            8,884,000    $           22,944,000
Ethernet switches                1,196,000                 1,087,000
Ethernet adapters                1,522,000                 1,924,000
Other products                   2,045,000                 1,619,000
                    $           13,647,000    $           27,574,000

Sales in North America decreased 57% or $13,503,000 due to a one-time large network upgrade project with a Fortune 500 company in the third quarter of 2011 noted above. This was also a major contributor to the reported decrease in revenue from sales of media converters. International sales decreased $424,000, or 11%, due to delayed project activity in the international markets, specifically within Rest of world region.

Gross margin on third quarter Transition Networks' sales decreased 48% to $6,663,000 in 2012 from $12,728,000 in 2011. Gross margin as a percentage of sales increased to 49% in 2012 as compared to 46% in 2011 due to volume discounts given in 2011 for the large network upgrade project with a Fortune 500 company described above. Selling, general and administrative expenses decreased 11% to $5,365,000 in 2012 compared to $6,017,000 in 2011 due to cost reduction measures during the quarter. Operating income decreased to $1,298,000 in 2012 compared to $6,711,000 in 2011.

JDL Technologies, Inc.

JDL Technologies, Inc. sales decreased 28% to $2,798,000 in the third quarter of
2012 compared to $3,872,000 in 2011.

JDL's revenues by customer group were as follows:


                               JDL Revenue by Customer Group
                                  2012                2011
Broward County FL schools   $      1,749,000    $      3,691,000
All other                          1,049,000             181,000
                            $      2,798,000    $      3,872,000

Revenues earned in Broward County, Florida decreased $1,942,000 or 53% in the third quarter of 2012 as compared to the 2011 third quarter. In the first quarter of 2010, the Company received significant funding for federal government contract work. This contract work was of a long-term nature, and the Company completed these contracts during the quarter ended September 30, 2011. All other revenues increased $868,000 due to JDL's concentrated effort in the commercial and education markets including the capturing of a wireless opportunity with the Miami-Dade County Public School District as a result of JDL's E-Rate 15 initiative with the district.

JDL gross margin decreased 48% to $770,000 in the third quarter of 2012 compared to $1,469,000 in the same period in 2011. Gross margin as a percentage of sales decreased to 28% in 2012 from 38% in 2011 due to purchasing discounts and rebates the Company was able to take advantage of during the prior year quarter and customer mix. Selling, general and administrative expenses increased 8% in 2012 to $564,000 compared to $522,000 in 2011 due to increased sales, marketing and G&A expenses as JDL has increased its headcount to further expand into the commercial market. JDL reported operating income of $205,000 in the third quarter of 2012 compared to $947,000 in the same period of 2011.


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Other

The Company's income before income taxes decreased to $1,663,000 in 2012 compared to $6,575,000 in 2011. The Company's effective income tax rate was 33% in 2012 and 43% in 2011. This effective rate differs from the standard rate of 35% due to state income taxes, provisions for interest charges, the release of valuation allowance placed on foreign net operating losses, and the effect of operations conducted in lower foreign tax rate jurisdictions.

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

Consolidated sales decreased 34% in 2012 to $78,493,000 compared to $118,437,000 in 2011. Consolidated operating income in 2012 decreased to $3,195,000 compared to $17,878,000 in the first nine months of 2011. Net income in 2012 decreased to $2,146,000 compared to $10,372,000 in the first nine months of 2011.

Suttle

The Company realigned its business operations effective January 1, 2012 and as a
result, the Austin Taylor operations are now included within the Suttle business
unit. The Company has reclassified Austin Taylor's 2011 operations to conform to
this presentation. Suttle sales increased 10% in the first nine months of 2012
to $33,167,000 compared to $30,275,000 in the same period of 2011. Sales by
customer groups in the first nine months of 2012 and 2011 were:


                                                          Suttle Sales by Customer Group
                                                              2012               2011
Major telephone companies                               $      24,686,000    $  20,049,000
Distributors                                                    4,127,000        3,334,000
International                                                   3,943,000        6,596,000
Other                                                             411,000          296,000
                                                        $      33,167,000    $  30,275,000

Suttle's sales by product groups in first nine
months of 2012 and 2011 were:

                                                          Suttle Sales by Product Group
                                                              2012               2011
Modular connecting products                             $       9,962,000    $   9,533,000
Structured cabling products                                    13,254,000        8,795,000
DSL products                                                    5,912,000        7,836,000
Other products                                                  4,039,000        4,111,000
                                                        $      33,167,000    $  30,275,000


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Sales to the major telephone companies increased 23% in 2012 due to an increase in new multi-dwelling unit construction in the U.S. housing market and contribution from new product contracts. Sales to these customers accounted for 74% of Suttle's sales in the first nine months of 2012 compared to 66% of sales in the same period in 2011. Sales to distributors increased 24% in 2012 primarily due to increase in activity in the U.S. housing market. This customer segment accounted for 12% and 11% of sales in the first nine months of 2012 and 2011, respectively. International sales decreased 40% and accounted for 12% of Suttle's first nine months 2012 sales due to a delay in DSL sales to a large customer, discontinuation of Austin Taylor's metal business, and reduction in revenue from Austin Taylor's legacy products.

Modular connecting products sales have increased 5% due to an increase in new multi-dwelling unit construction in the U.S. housing market. Sales of structured cabling products increased 51% due to increased construction activity in the multi-dwelling unit space in specific regions in the U.S. Sales of DSL products decreased 25% due to the maturation of the U.S. DSL market and order cycles of major customers.

Suttle's gross margin increased 22% in the first nine months of 2012 to $8,725,000 compared to $7,123,000 in the same period of 2011. Gross margin as a percentage of sales increased to 26% in 2012 from 24% in 2011 due to product mix changes and increased production levels. Selling, general and administrative expenses increased $721,000 or 12% in the first nine months of 2012 compared to the same period in 2011, due to an increase in spending in the technology development and market expansion initiative. Suttle's operating income was $1,833,000 in the first nine months of 2012 compared to an operating loss of $320,000 in 2011 due to a goodwill impairment charge of $1,272,000 in the third quarter of 2011.

Transition Networks

Transition Networks sales decreased 47% to $40,615,000 in the first nine months of 2012 compared to $76,508,000 in 2011 due to $32,751,000 in revenue from a one-time large network upgrade project with a Fortune 500 company in the first nine months of 2011. Revenues excluding this major project decreased 7% or $3,142,000 as compared to the first nine months of 2011 due to a continued slowdown in Federal Government spending.

First nine months sales by region are presented in the following table:

                                          Transition Networks Sales by Region
                                              2012                   2011
North America                          $        30,256,000    $        65,547,000
Europe, Middle East, Africa ("EMEA")             4,437,000              4,394,000
Rest of world                                    5,922,000              6,567,000
                                       $        40,615,000    $        76,508,000

The following table summarizes Transition Networks' 2012 and 2011 first nine months sales by its major product groups:

Transition Networks Sales by Product Group

                             2012                      2011
Media converters    $           26,852,000    $           62,370,000
Ethernet switches                3,643,000                 3,362,000
Ethernet adapters                3,064,000                 4,824,000
Other products                   7,056,000                 5,952,000
                    $           40,615,000    $           76,508,000


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Sales in North America decreased 54% or $35,291,000 due to revenue from a one-time large network upgrade project with a Fortune 500 company that was completed during the third quarter of 2011 as noted above. This also caused the decrease in revenue from sales of media converters. Other vertical markets, especially the Federal Government market in the United States, continued to record lower revenue due to the slow-down in government purchases resulting in project delays. International sales decreased $602,000, or 5% due to lower project activity in the international markets, specifically within Rest of world region.

Gross margin on the first nine months of Transition Networks' sales decreased to $21,274,000 in 2012 from $36,243,000 in 2011. Gross margin as a percentage of sales increased to 52% in 2012, compared to 47% in the 2011 period, due to volume discounts offered in the prior year on an upgrade project with the Fortune 500 Company described above. Selling, general and administrative expenses decreased 4% to $16,557,000 in 2012 compared to $17,246,000 in 2011 due to cost reduction measures taken in the second and third quarters. Operating income decreased to $4,717,000 in 2012 compared to $18,996,000 in 2011.

JDL Technologies, Inc.

JDL Technologies, Inc. sales decreased 60% in the first nine months of 2012 to
$4,711,000 compared to $11,654,000 in 2011.

JDL's revenues by customer group were as follows:


                               JDL Revenue by Customer Group
                                 2012                2011
Broward County FL schools   $     2,931,000    $      11,262,000
All other                         1,780,000              392,000
                            $     4,711,000    $      11,654,000

Revenues earned in Broward County FL decreased $8,331,000 or 74% in 2012. In the first quarter of 2010, the Company received significant funding for federal government contract work. This contract work was of a long-term nature, and the Company completed these contracts during the quarter ended September 30, 2011. All other revenues increased $1,388,000 due to JDL's concentrated effort to expand its market focus.

JDL gross margin decreased 73% to $1,365,000 in the first nine months of 2012 compared to $4,974,000 in the same period in 2011. Gross margin as a percentage of sales decreased to 29% in 2012 from 43% in 2011 due to purchasing discounts and rebates the Company was able to take advantage of during the first nine months of the prior year. Selling, general and administrative expenses increased 10% in 2012 to $1,679,000 compared to $1,523,000 in 2011 due to an increase in the sales and marketing headcount as JDL expands into the commercial markets. JDL reported an operating loss of $313,000 in the first nine months of 2012 compared to operating income of $3,451,000 in the same period of 2011.

Other

Income before income taxes decreased to $3,202,000 in 2012 compared to $18,000,000 in 2011. The Company's effective income tax rate was 33% in 2012 as compared to 42% in 2011. This effective rate was lower than the standard rate of 35% due to state income taxes, provisions for interest charges, the release of valuation allowance placed on foreign net operating losses, and the effect of operations conducted in lower foreign tax rate jurisdictions.

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