Sunation Energy, Inc. quarterly report, Q3 FY2021

Filing identity and reporting period

This is Communications Systems, Inc. (Nasdaq: JCS), not Sunation Energy, Inc. The filing is a Form 10-Q for the quarter ended September 30, 2021, filed November 15, 2021. The company sold its Electronics & Software businesses on August 2, 2021; those results are presented as discontinued operations. Continuing operations principally comprise Services & Support, with corporate costs reported separately.

Financial results and liquidity

Q3 continuing-operations gross margin was approximately 39.2%, versus 35.0% a year earlier; nine-month margin was approximately 34.9%, versus 29.4%. The Services & Support segment reported Q3 gross margin of 42.8% versus 38.0%, and nine-month margin of 39.5% versus 35.5%. Higher-margin services revenue supported the improvement, while lower education-project revenue weighed on sales and segment results.

Operating cash flow was a use of $2.63 million in the first nine months of 2021, compared with a use of $5.58 million in 2020. Investing activities provided $26.33 million, including $23.63 million of net proceeds from the E&S sale. Financing activities used $1.57 million. Cash and cash equivalents were $35.28 million at September 30; cash, cash equivalents, restricted cash and liquid investments totaled approximately $40.94 million. Total assets were $56.96 million and stockholders’ equity $18.56 million.

Current liabilities were $37.93 million, including a $34.02 million special dividend payable; current assets were $41.47 million and reported working capital was $3.54 million. The special dividend of $3.50 per share was paid October 15, 2021. The company reported no outstanding borrowings and terminated its $5 million Wells Fargo credit facility effective August 13, 2021. Management said available funds were sufficient for anticipated operating and capital expenditure needs.

Material changes and unusual items

• Q3 continuing sales fell 45.5% year over year. Education revenue declined 97% as prior-year school-district projects were substantially completed and the company was not selected as the next project’s primary vendor; it remained a secondary vendor for specified work.
• Q3 Services & Support revenue from services and support rose 80%, while project and product revenue fell 89%. Acquisitions of Ecessa and IVDesk contributed to services growth.
• Nine-month continuing sales were nearly flat, but the operating loss widened. Management cited lower education revenue, acquired-company expenses, higher amortization, and increased corporate legal and financial consulting costs associated with the proposed Pineapple merger.
• Reported net income was materially affected by the $13.46 million gain on the E&S sale, recorded in discontinued operations. Discontinued operations generated $10.84 million of nine-month net income, versus $2.93 million in the comparable 2020 period.
• The company recorded $1.53 million of 2021 restructuring costs, primarily severance related to the E&S sale; $612,000 remained accrued at September 30 and was expected to be paid in 2021 and 2022. A $400,000 investment impairment was also recorded in the first nine months.
• The special dividend totaled approximately $34.0 million. The filing reports it as payable at quarter-end and paid after quarter-end; the resulting liability sharply reduced working capital from $28.32 million at December 31, 2020.

Outlook, transactions and risks

The filing gives no specific financial guidance. The proposed CSI–Pineapple merger and a related $32 million PIPE financing remained subject to shareholder approval and other closing conditions. The proposed financing involved convertible preferred stock and warrants, with potential substantial dilution. CSI shareholders were expected to receive contingent value rights tied to proceeds from future asset dispositions; the amount was not yet determinable.

Up to $7 million of additional proceeds from the Lantronix sale depended on revenue-based earnout targets, with no assurance of payment. Other risks discussed include merger completion and timing, realizing expected value from remaining business and real estate dispositions, higher unallocated overhead after the E&S divestiture, the education customer concentration and vendor position, competition in SD-WAN, integration of acquisitions, COVID-19 effects, and cybersecurity. Management reported disclosure controls were effective and no material changes to internal control over financial reporting during the quarter.

Most important facts for investors to verify

• Confirm the filing belongs to Communications Systems, Inc.; the supplied company metadata names Sunation Energy, Inc.
• Review continuing-operations performance separately from discontinued operations and the E&S sale gain when assessing earnings quality.
• Verify payment and cash impact of the $34.02 million special dividend, and assess liquidity after that payment.
• Check whether the merger and PIPE financing closed, their final terms and dilution, and the ultimate value of shareholder contingent value rights.
• Track whether the Lantronix revenue earnout was achieved and whether remaining business and real estate assets were sold on expected terms.
• Assess whether Services & Support can offset lost education-project revenue and improve continuing-operations profitability and cash generation.