Business context and reporting period
Filing identity: The supplied metadata names Sunation Energy, Inc., but the filing itself is Communications Systems, Inc. (CSI), a Minnesota-based communications products and IT services company. The summary below reflects the filing text, not the metadata. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2017.
CSI reports four segments: Suttle, Transition Networks, JDL Technologies and Net2Edge. Its businesses serve broadband and voice communications, data networks, IT services and telecommunications carriers.
Financial results and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Sales | $22.1 million | $26.3 million | $42.9 million | $51.0 million |
| Gross profit | $6.0 million | $7.4 million | $12.0 million | $14.1 million |
| Operating loss | $4.1 million | $2.7 million | $5.5 million | $1.4 million |
| Net loss | $4.1 million | $2.5 million | $5.6 million | $5.0 million |
| Loss per diluted share | $0.46 | $0.29 | $0.63 | $0.56 |
- Gross margin was approximately 27.2% in Q2 2017 versus 28.0% a year earlier; first-half gross margin was approximately 27.9% versus 27.7%.
- Operating cash flow was $5.1 million in the first half, compared with $2.5 million used in the first half of 2016. Cash and cash equivalents were $19.1 million at June 30, 2017; cash, cash equivalents and investments totaled approximately $20.6 million.
- Working capital was $41.5 million, down from $44.0 million at December 31, 2016. Current assets were $53.2 million and current liabilities $11.6 million.
- No line-of-credit borrowings were outstanding. The $15 million secured facility had $9.971 million available under the borrowing base and matures August 2021. CSI reported compliance with its $10 million minimum-liquidity covenant.
- First-half capital expenditures were $0.14 million. Cash dividends paid were $0.74 million, or $0.08 per share, versus $2.84 million, or $0.32 per share, in the prior-year period.
- Total assets were $67.6 million and stockholders’ equity was $55.8 million at June 30, 2017. The company reported no outstanding long-term debt.
Material changes versus prior comparable periods
- Second-quarter sales fell 16% year over year, primarily due to lower Suttle sales. First-half sales also declined 16%.
- Suttle revenue fell 24% in Q2 and 25% in the first half amid customer pricing pressure, weaker legacy-product volumes and project delays. First-half excess and obsolete inventory adjustments were $1.11 million, versus $0.24 million in 2016.
- Transition Networks’ Q2 sales declined 7%, but first-half sales were essentially flat. The segment moved from operating losses to operating income of $0.36 million in Q2 and $0.51 million in the first half, reflecting cost reductions and improved first-half margins.
- JDL Technologies’ sales declined 13% in Q2 and 23% in the first half, with lower education and commercial project revenue. A $1.463 million goodwill impairment contributed to its Q2 operating loss; the segment had reported operating income in Q2 2016.
- Net2Edge sales fell 70% in Q2 and 54% in the first half, largely because a large legacy-customer project had been completed in 2016. A $154,000 intangible-asset impairment was recorded.
- First-half operating loss comparisons were affected by a $4.148 million pension liability adjustment gain recorded in 2016; the pension plan had been settled in 2016.
Outlook, risks and unusual items
- Management expected total 2017 restructuring costs of approximately $2.6 million. CSI recorded $1.53 million in the first half, paid $1.005 million and accrued $525,000; substantially all production had been transferred from Costa Rica to Minnesota by the end of Q2.
- Management stated that available funds and projected resources were sufficient for anticipated operating and capital needs. No formal revenue or earnings guidance was provided.
- Unusual Q2 charges included $1.617 million of impairment losses and $1.142 million of restructuring expense. Suttle also recorded approximately $700,000 of Q2 excess and obsolete inventory adjustments.
- Management cited risks including continued Suttle customer concentration, pricing pressure and legacy-product declines; successful transfer of Costa Rica operations; federal spending and project timing affecting Transition Networks; education-sector revenue volatility at JDL; and Net2Edge’s need to grow revenue to cover costs.
- Disclosure controls were deemed ineffective because of material weaknesses in ERP segregation of duties/vendor master-file controls and the precision of goodwill impairment review controls. Remediation was underway; management anticipated completing remediation and validation testing during Q3 2017.
- The filing reported no material pending legal claims known to management and no material subsequent events requiring disclosure. The company was still evaluating the impact of the forthcoming revenue-recognition standard, with the most significant expected impact in JDL.
Important facts for investors to verify
- Confirm the issuer: the filing is for Communications Systems, Inc., not Sunation Energy, Inc.
- Assess whether Suttle can stabilize sales and margins, reduce inventory write-offs and complete the manufacturing transition within the expected cost.
- Review the assumptions behind the JDL goodwill impairment and the disclosed weakness in impairment-testing controls.
- Track remediation and independent validation of the material weaknesses in financial reporting controls.
- Monitor liquidity against the facility’s minimum-liquidity covenant, as well as restructuring cash payments and the reduced dividend.
- Evaluate whether revenue recovery in JDL and Net2Edge, and continued improvement at Transition Networks, can offset weakness in Suttle.