Filing identity and reporting period
The supplied filing is Communications Systems, Inc. (NASDAQ: JCS), not Sunation Energy, Inc. It is a Form 10-K for the fiscal year ended December 31, 2013, filed March 14, 2014; the filing does not report a standalone “2013 Q4” period. Quarterly figures below are unaudited.
Communications Systems operated three businesses: Suttle (telecommunications connectivity products), Transition Networks (network connectivity and data transmission products), and JDL Technologies (IT services and infrastructure projects).
Financial performance
| Metric | 2013 | 2012 |
|---|---|---|
| Revenue | $131.3 million | $104.2 million |
| Gross profit / margin | $44.9 million / 34.2% | $41.5 million / 39.8% |
| Operating income | $1.2 million | $3.4 million |
| Net income (loss) | $(0.96) million | $2.24 million |
| Diluted earnings (loss) per share | $(0.11) | $0.26 |
| Operating cash flow | $0.77 million | $0.20 million |
- Revenue rose 26%, but the company swung to a net loss. The $5.85 million goodwill impairment at Transition Networks and $1.15 million of restructuring expense weighed on results. The impairment was largely nondeductible for tax purposes, contributing to a 186.8% effective tax rate.
- Year-end cash and cash equivalents were $20.1 million; investments were $9.7 million. Working capital was $70.6 million, approximately unchanged from 2012. Total assets were $103.5 million and stockholders’ equity was $88.6 million.
- Debt consisted primarily of a $1.12 million mortgage balance; there were no borrowings on the $10 million revolving credit line. The mortgage carries 6.83% interest and matures in March 2016. The credit agreement expires October 31, 2014, and management intended to renew it.
- Capital expenditures were $2.70 million. Cash dividends paid were $4.10 million; dividends declared were $0.64 per share for the year.
Fourth-quarter results
For the quarter ended December 31, 2013, revenue was $27.3 million versus $25.8 million in the comparable 2012 quarter. Gross profit was $10.0 million versus $10.1 million; operating loss was $0.09 million versus operating income of $0.20 million; and net loss was $0.80 million versus net income of $0.09 million. Quarterly amounts are unaudited.
Material changes and segment performance
- Suttle: Revenue increased 21% to $54.3 million. Gross margin improved to 29% from 27%, and operating income increased to $5.46 million from $2.60 million, helped by higher volumes and product mix. Telecommunications customers generated 80% of Suttle sales.
- Transition Networks: Revenue fell 19% to $43.9 million, with North American sales down 22%, partly due to lower federal-government spending and project delays. Gross margin declined to 51% from 52%. The unit reported a $3.71 million operating loss, including the $5.85 million goodwill impairment; 2012 operating income was $5.89 million.
- JDL Technologies: Revenue surged to $33.1 million from $5.4 million, chiefly from large school-district projects funded through government programs. Operating income was $4.04 million versus a $0.66 million loss. Gross margin fell to 20% from 28% as 2013 sales included a larger hardware component. Management said the current phase of major school projects was substantially completed and expected continued revenue volatility.
Outlook, risks and unusual items
- Management expected JDL’s annual revenue volatility to continue and was pursuing commercial managed services, cloud, virtualization and network-service work to reduce reliance on school and government funding. JDL’s March 1, 2014 backlog and contracts were about $1.5 million, versus $24.5 million a year earlier; the remaining work was primarily scheduled to finish by June 2014.
- Transition Networks planned to develop products for growth markets, particularly telecommunications carriers, and expand sales outside North America. The company closed its China engineering facility as part of efforts to streamline processes and reduce costs; closure was expected in the first half of 2014.
- A September 2013 restructuring and revitalization plan shifted more operational and financial responsibility to business units, reduced corporate overhead, and targeted cost reductions and investment in growth. Curtis Sampson became interim CEO and a new CFO was appointed. Restructuring expense was $1.15 million; $0.49 million remained accrued at year-end.
- Key risks include intense competition and pricing pressure, rapid technological change, customer and supplier concentration, reliance on government-funded projects, order and quarterly revenue volatility, inventory obsolescence, international operations, and successful completion of the ERP rollout. One customer represented 17.5% of consolidated sales and another 18.7% in 2013; the top ten customers accounted for 83% of sales.
- Management said available funds and the credit line were sufficient for anticipated operating and capital needs. Legal claims arising in the ordinary course were not expected to have a material adverse effect. Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting; management also reported effective disclosure controls and internal controls.
Important facts for investors to verify
- Confirm the issuer identity: this is a Communications Systems, Inc. filing, not a Sunation Energy filing.
- Assess whether JDL can replace unusually large, government-funded school projects with recurring commercial revenue, given the steep decline in backlog.
- Review the assumptions behind the Transition Networks goodwill impairment and whether its sales and operating performance improved after 2013.
- Monitor customer concentration, particularly the customers representing 17.5% and 18.7% of 2013 consolidated sales, and the effect of project timing on receivables and cash generation.
- Verify renewal of the revolving credit agreement, continued covenant compliance, and the capacity to fund dividends and operations. The filing reports operating cash flow of $773,000 in its cash-flow statement but approximately $803,000 in the MD&A; reconcile this discrepancy.