Business context and reporting period
Filing identity discrepancy: The request identifies Sunation Energy, Inc., but the supplied Form 10-Q is for Communications Systems, Inc. (CSI), a communications equipment and IT-services company. This summary reflects the filing text, for the quarter and nine months ended September 30, 2011.
CSI operates through Suttle, Transition Networks, JDL Technologies and Austin Taylor. The financial statements are unaudited.
Financial performance and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Sales | $42.0 million | $33.3 million | $118.4 million | $89.9 million |
| Operating income | $6.5 million | $6.3 million | $17.9 million | $12.6 million |
| Net income | $3.7 million | $4.0 million | $10.4 million | $7.7 million |
| Diluted earnings per share | $0.44 | $0.48 | $1.22 | $0.92 |
Q3 sales rose 26%, but net income fell about 7%; the effective tax rate was approximately 43% versus 37% a year earlier. For the nine-month period, sales rose 32% and net income rose 34%. Gross margin was approximately 39% in Q3 and 41% year to date; management cited lower margins on a large customer project, product mix and input costs. The nine-month effective tax rate was 42.4%, compared with 38.7% in 2010.
Nine-month operating cash flow was $8.3 million, versus $5.0 million in 2010. Investing used $1.0 million and financing used $3.9 million. Cash and cash equivalents were $20.1 million at September 30; cash plus investments totaled approximately $43.3 million. Current assets were $91.4 million and current liabilities $14.2 million. The mortgage balance was approximately $2.1 million; there were no borrowings on the prior $10 million credit line during the first nine months.
Material changes and unusual items
- Transition Networks’ Q3 sales increased 45%, driven largely by a one-time network upgrade project for a Fortune 500 customer. The project generated $13.4 million in Q3 revenue and $32.8 million in the first nine months and was substantially complete by September 30. Volume discounts reduced the segment’s gross margin percentage.
- CSI acquired UK-based Patapsco Designs Limited on July 27 for stated total consideration of approximately $5.0 million, including deferred and contingent amounts. The purchase-price allocation remained preliminary; recorded goodwill was approximately $2.0 million.
- CSI recorded a $1.27 million goodwill impairment for Suttle in the second quarter, following weaker legacy-product profitability and delays to new-technology projects. Suttle goodwill was fully impaired.
- Q3 segment trends varied: JDL sales and operating income declined; Austin Taylor’s sales rose but its operating loss widened. For the nine months, JDL sales increased 24%.
- The company paid $0.45 per share in dividends during the first nine months, versus $0.43 in the comparable 2010 period.
Outlook, risks and contingencies
The filing gives no formal revenue or earnings guidance. Management said available resources were sufficient for anticipated operating and capital needs. It identified risks including reliance on major customers and large, irregular orders; telecom-sector and economic weakness; government-purchase delays; competitive products; product-launch and delivery execution; input availability and costs; and successful integration of Patapsco. Management reported no known pending legal matters expected to materially affect results.
After quarter-end, CSI entered a new $10 million Wells Fargo revolving credit agreement, expiring October 31, 2013, at LIBOR plus 1.1%. The facility is secured and includes financial covenants, including a minimum current ratio of 1.75 to 1.0, minimum net profit of $3.0 million, minimum tangible net worth of $60.0 million, and a restriction on two consecutive quarterly losses. Management reported disclosure controls were effective and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Confirm the issuer: the supplied filing is for Communications Systems, Inc., not Sunation Energy, Inc.
- Assess the sustainability of revenue and earnings after completion of the large, lower-margin Transition Networks project.
- Review Suttle’s recovery prospects after the impairment, including legacy-market declines and delayed product projects.
- Check the final Patapsco purchase-price allocation, contingent payments and integration performance.
- Monitor cash conversion, receivables, dividend payments and compliance with the new credit facility’s covenants.