Business context and reporting period
The supplied filing is Communications Systems, Inc.’s unaudited Form 10-Q for the three months ended March 31, 2018. It is not a filing for Sunation Energy, Inc.; the company identity in the request metadata does not match the filing.
Communications Systems operates four business units: Suttle and Transition Networks (connectivity products), JDL Technologies (IT and managed services), and U.K.-based Net2Edge (network access products).
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Sales | $16.77 million | $20.80 million |
| Gross profit | $5.18 million | $5.97 million |
| Gross margin | 30.9% | 28.7% |
| Operating loss | $1.97 million | $1.46 million |
| Net loss | $1.86 million | $1.52 million |
| Diluted loss per share | $0.21 | $0.17 |
| Operating cash flow | $0.24 million | $1.69 million |
Sales fell 19% year over year. Gross margin improved, but the operating loss widened as lower sales and higher SG&A more than offset the absence of the prior-year restructuring charge. Q1 2017 included $388,000 of restructuring expense associated with the Costa Rica facility closure.
At March 31, 2018, cash and cash equivalents were $11.59 million and investments were $6.02 million, for approximately $17.61 million combined. Working capital was $35.23 million, down from $36.51 million at December 31, 2017. The company had no borrowings under its credit line; borrowing availability was $8.69 million, subject to the borrowing base. The $15 million facility matures August 12, 2021 and requires minimum liquidity of $10 million; the company reported compliance. No material debt balance is reported.
Cash declined $0.86 million during the quarter. Investing activities used $0.72 million, including net investment purchases, and financing activities used $0.39 million, primarily for dividends. The quarterly dividend declared was $0.04 per share. Total assets were $57.74 million and stockholders’ equity was $47.49 million at quarter-end.
Material changes and segment results
- Suttle: Sales declined 21% to $6.97 million, with management citing pricing pressure, lower legacy-product volumes, and a shift in purchasing toward installers. Gross margin improved to 19.7% from 12.1%; the segment’s operating loss narrowed to $0.88 million from $1.54 million.
- Transition Networks: Sales rose 2% to $9.15 million. Ethernet switches and adapters grew 35%, while media converter sales declined 5%. Operating income was $0.21 million versus $0.15 million.
- JDL Technologies: Sales fell 75% to $0.71 million. Education revenue dropped amid delayed federal funding approvals, and commercial revenue declined following expiration of two large contracts. The segment recorded an operating loss of $0.50 million versus operating income of $0.39 million.
- Net2Edge: Sales fell 54% to $0.17 million because of delays in new product releases. Higher engineering and R&D spending contributed to an operating loss of $0.80 million, compared with $0.45 million.
The company adopted ASC 606 on January 1, 2018 using the modified retrospective method. It reported no significant opening retained-earnings adjustment. For Q1, reported revenue and gross profit were each $125,000 lower than they would have been under the prior revenue guidance; operating loss was unchanged. Comparability with Q1 2017 is therefore affected by the accounting change.
Outlook, risks, contingencies and unusual items
No numerical earnings or revenue guidance is provided. Management stated that current resources and projected future expenditures should be sufficient to meet anticipated operating and capital expenditure needs.
Risks highlighted include Suttle’s dependence on a small number of communications service providers and legacy-product declines; Transition Networks’ need to develop products that offset traditional-product declines; JDL’s exposure to education funding timing and customer concentration; and Net2Edge’s ability to launch and sell new products at sufficient scale. Management also cited risks from cost-effective operation of the business units and changing government expenditures.
Management reported no known pending legal matters expected to materially affect financial position or results. The filing describes warranty obligations, including a five-year obligation for potential network-equipment liabilities; the warranty reserve was $657,000 at March 31, 2018. Investments had $7,000 of gross unrealized losses, which management considered temporary.
Disclosure controls and procedures were deemed ineffective. The filing also reports a material weakness in review controls over goodwill and long-lived-asset impairment analyses: the review was not sufficiently precise to identify improper assumptions. The company said it was designing new review controls. Goodwill had been written off in 2017; management reported no resulting financial-statement misstatement from the impairment-control deficiency.
Important facts for investors to verify
- Confirm the issuer: this filing is for Communications Systems, Inc., not Sunation Energy, Inc.
- Review the causes and expected duration of JDL’s education-funding delays and Net2Edge’s product-launch delays.
- Assess whether Suttle can offset continuing declines and customer concentration with new products and installer-channel sales.
- Monitor operating cash generation, liquidity-covenant compliance, and the borrowing base supporting the reported credit availability.
- Track remediation of the disclosed impairment-review material weakness and any further changes to disclosure controls.
- Consider the effect of ASC 606 when comparing reported 2018 results with prior periods.