Sunation Energy, Inc. quarterly report, Q2 FY2018

Full document

Communications Systems, Inc. — Q2 2018 Form 10-Q

Filing identity: The supplied filing is for Communications Systems, Inc. (CSI), not Sunation Energy, Inc. It covers the quarter and six months ended June 30, 2018; financial statements are unaudited.

Business context

CSI operates four business units: Suttle and Transition Networks (connectivity and data-transmission products), JDL Technologies (IT services and solutions), and Net2Edge (telecommunications network-access products). The 2018 results reflect adoption of ASC 606; 2017 comparatives use the previous revenue standard.

Financial performance and liquidity

  • Q2 revenue: $15.0 million, down 32% from $22.1 million. Gross profit was $4.0 million, a 26.5% gross margin versus $6.0 million and 27.2% a year earlier. Operating loss was $2.7 million; net loss was $2.6 million, or $0.29 per diluted share, compared with a $4.1 million loss and $0.46 per share in Q2 2017.
  • First-half revenue: $31.8 million, down 26% from $42.9 million. Gross profit was $9.2 million, a 28.8% margin versus $12.0 million and 27.9%. Operating loss was $4.7 million; net loss was $4.5 million, or $0.50 per diluted share, compared with a $5.6 million loss and $0.63 per share.
  • Cash flow: Operating activities used $2.5 million in the first half, versus $5.1 million provided in 2017. Investing activities used $1.1 million; financing activities used $0.7 million, mainly dividends. Cash and cash equivalents declined $4.4 million to $8.1 million.
  • Liquidity and debt: Cash, cash equivalents and investments totaled approximately $14.2 million at June 30. Working capital was $32.4 million, down from $36.5 million at year-end 2017. There were no borrowings on the $15 million secured credit line; availability under its borrowing-base calculation was $7.6 million. The facility matures August 2021 and requires at least $10 million of covenant liquidity; CSI reported compliance.
  • Capital returns: Dividends declared were $0.04 per share for Q2 and $0.08 per share for the first half, unchanged from the comparable 2017 periods. First-half cash dividends paid were $0.8 million.

Material changes and segment performance

  • Q2 and first-half losses were lower than in 2017, but comparisons include prior-year charges: $1.6 million of impairment and $1.1 million of restructuring in Q2 2017; first-half 2017 restructuring totaled $1.5 million. No restructuring or impairment charge was recorded in the 2018 periods shown.
  • Suttle: Q2 sales fell 32% to $5.9 million; first-half sales fell 26% to $12.8 million. Management cited reduced spending by major telecom providers, declining legacy products, and purchasing shifts. Q2 gross margin fell to 7.8% from 9.5%; first-half margin improved to 14.3% from 10.8%, attributed to pricing changes and discontinuing lower-margin products. Major service providers represented 77% of Q2 Suttle sales.
  • Transition Networks: Q2 sales declined 18% to $7.8 million; first-half sales declined 8% to $17.0 million. Slower activity at a major service-provider customer and project timing weighed on results. Q2 operating income was $19,000, versus $361,000; first-half operating income was $231,000, versus $507,000.
  • JDL Technologies: Q2 sales dropped 77% to $0.9 million; first-half sales fell 76% to $1.6 million. Education revenue plunged amid delayed federal funding approvals, while two large commercial contracts had expired. JDL reported operating losses of $0.4 million in Q2 and $0.9 million in the first half.
  • Net2Edge: Sales increased to $0.7 million in Q2 and $0.8 million in the first half, but the unit remained loss-making: operating losses were $0.6 million and $1.4 million, respectively. Management cited product-expediting costs and increased engineering and product-development spending.

Outlook, risks and unusual items

  • CSI provided no quantified earnings or revenue guidance. Management said current financial and operating resources, together with projected funds, should be sufficient for anticipated operating and capital needs. Results through June are not necessarily indicative of full-year results.
  • Key disclosed risks include Suttle’s dependence on a small number of telecom providers and pricing pressure; Transition Networks’ need to offset traditional-product declines with new products; JDL’s exposure to delayed education funding and customer concentration; and Net2Edge’s ability to scale new products profitably.
  • On August 2, 2018, CSI agreed to sell its Minnetonka headquarters for $10 million. The proposed sale is subject to buyer due diligence, regulatory approval and other conditions; closing was expected in Q2 or Q3 2019. CSI said it expected to find replacement space in the Twin Cities area.
  • Management concluded disclosure controls and procedures were not effective. The filing identifies a material weakness in review controls over goodwill and long-lived-asset impairment analyses, related to insufficiently precise review of assumptions. Management said it was designing stronger review controls; it reported no resulting financial-statement misstatement.
  • ASC 606 adoption had no significant opening retained-earnings adjustment. Compared with the former standard, reported first-half 2018 revenue and gross profit were each $291,000 lower, with no effect on operating loss because SG&A was also lower by the same amount.
  • Management reported no pending legal matter expected to materially affect financial position or results. The filing notes potential warranty-estimate variability and open tax examination years; no additional uncertain tax positions were identified in the first half.

Important facts for investors to verify

  • Confirm the filing is for Communications Systems, Inc., not Sunation Energy, Inc.
  • Assess whether the sharp JDL education-revenue decline is temporary and whether delayed funding or lost contracts affect subsequent periods.
  • Monitor Suttle’s customer concentration, sales recovery and gross margins, as well as Transition Networks’ major-customer exposure.
  • Track operating cash use, inventory growth, borrowing-base availability and compliance with the $10 million liquidity covenant.
  • Verify progress on the headquarters sale, its closing conditions, expected timing and relocation costs.
  • Review remediation of the disclosed material weakness and any subsequent auditor or management updates.