NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Communications Systems, Inc. (herein collectively referred to as CSI, our, we or the Company) is a Minnesota corporation organized in 1969 that operates directly and through its subsidiaries located in the United States (U.S.) and the United Kingdom (U.K.). CSI is principally engaged through its Transition Networks, Inc. (Transition Networks or Transition) subsidiary and business unit in the manufacture and sale of solutions that provide actionable intelligence, power and connectivity at the edge of networks through Power over Ethernet (PoE) products, software and services as well as traditional products such as media converters, network adapters and other connectivity products. Through its JDL Technologies, Inc. (JDL Technologies or JDL) business unit, the Company provides technology solutions including virtualization, managed services, wired and wireless network design and implementation, and hybrid cloud infrastructure and deployment. Through its Net2Edge Limited (Net2Edge) U.K.-based business unit, the Company designs, develops, and sells edge network access products, TDM (time-division multiplexing) over IP and other circuit emulation solutions, along with specialized cloud-based software solutions, primarily within the telecommunications market.
The Company classifies its businesses into three segments that correspond to these three business units. Non-allocated general and administrative expenses are separately accounted for as Other in the Company’s segment reporting. Intersegment revenues are eliminated upon consolidation.
Financial Statement Presentation
The condensed consolidated balance sheets and condensed consolidated statement of changes in stockholders’ equity as of March 31, 2020 and the related condensed consolidated statements of income and comprehensive income, and the condensed consolidated statements of cash flows for the periods ended March 31, 2020 and 2019 have been prepared by Company management. In the opinion of management, all adjustments (which include only normal recurring adjustments, except where noted) necessary to present fairly the financial position, results of operations, and cash flows at March 31, 2020 and 2019 and for the periods then ended have been made.
Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted. We recommend these condensed consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s December 31, 2019 Annual Report to Shareholders on Form 10-K. The results of operations for the period ended March 31, 2020 are not necessarily indicative of operating results for the entire year.
The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the balance sheet date, and the reported amounts of revenues and expenses during the reporting period. The estimates and assumptions used in the accompanying condensed consolidated financial statements are based upon management’s evaluation of the relevant facts and circumstances as of the time of the financial statements. Actual results could differ from those estimates.
Except to the extent updated or described below, the significant accounting policies set forth in Note 1 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, appropriately represent, in all material respects, the current status of accounting policies, and are incorporated herein by reference.
Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss, net of tax, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Currency
Translation
|
|
|
Unrealized gain
(loss) on securities
|
|
|
Accumulated Other
Comprehensive Loss
|
|
December 31, 2019
|
|
$
|
(709,000
|
)
|
|
$
|
11,000
|
|
|
$
|
(698,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net current period change
|
|
|
(132,000
|
)
|
|
|
(14,000
|
)
|
|
|
(146,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2020
|
|
$
|
(841,000
|
)
|
|
$
|
(3,000
|
)
|
|
$
|
(844,000
|
)
|
NOTE 2 – REVENUE RECOGNITION
Transition Networks
The Company has determined that the revenue recognition for its Transition Networks division occurs upon delivery of the Company’s connectivity infrastructure and data transmission products. To determine when revenue should be recognized, it is important to determine when the transfer of control has occurred. The Company has determined that control transfers for these products upon shipment or delivery to the customer, in accordance with the agreed upon shipping terms. As such, the timing of revenue recognition occurs at a specific point in time.
JDL Technologies, Inc.
The Company has determined that the following performance obligations identified in its JDL Technologies, Inc. division are transferred over time: managed services and professional services (time and materials (T&M) and fixed price). JDL’s managed services performance obligation is a bundled solution consisting of a series of distinct services that are substantially the same and that have the same pattern of transfer to the customer and are therefore recognized evenly over the term of the contract. T&M professional services arrangements are measured over time with an input method based on hours expended towards satisfying the performance obligation. Fixed price professional service arrangements under a relatively longer-term service will also be measured over time with an input method based on hours expended.
The Company has also identified the following performance obligations within its JDL Technologies division that are recognized at a point in time which include resale of third-party hardware and software, installation, arranging for another party to transfer services to the customer, and certain professional services. The resale of third-party hardware and software is recognized at a point in time, when the goods are shipped or delivered to the customer’s location, in accordance with the shipping terms. Installation services are recognized at a point in time when the services are completed. The service the Company provides to arrange for another party to transfer services to the customer is satisfied at a point in time after the Company has transferred control when the service is first available to the customer by the third-party vendor. The Company reports revenue from these third-party services on a net basis in its financial statements. Depending on the nature of the service, certain professional services transfer control at a point in time. The Company evaluates these circumstances on a case by case basis to determine if revenue should be recognized over time or at a point in time.
Net2Edge Limited
The Company’s Net2Edge division manufactures and markets Ethernet based edge network access devices. The Company principally sells these products through approved partners and integrators outside the United States. The Company has determined that the performance obligation in the Net2Edge division occurs at a point in time, specifically upon the delivery of its connectivity infrastructure and data transmission products.
Disaggregation of revenue
Revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that best reflects the consideration we expect to receive in exchange for those goods or services. In accordance with ASC 606-10-50-5, the following tables present how we disaggregate our revenues, which is different for each segment.
For Transition Networks, we analyze revenue by
region and product group. During 2020, the Company reclassified its product groups into two new categories as noted below. In
order to conform to the 2020 presentation, the Company has reclassified the 2019 information as follows for the three months ended
March 31, 2020 and 2019:
|
|
|
|
|
|
|
|
|
Transition Networks Sales by Region
|
|
|
|
Three Months Ended March 31
|
|
|
|
2020
|
|
|
2019
|
|
North America
|
|
$
|
7,442,000
|
|
|
$
|
6,910,000
|
|
International
|
|
|
722,000
|
|
|
|
1,980,000
|
|
|
|
$
|
8,164,000
|
|
|
$
|
8,890,000
|
|
|
|
|
|
|
|
|
|
|
Transition Networks Sales by Product Group
|
|
|
|
Three Months Ended March 31
|
|
|
|
2020
|
|
|
2019
|
|
Intelligent edge solutions
|
|
$
|
3,100,000
|
|
|
$
|
2,272,000
|
|
Traditional products
|
|
|
5,064,000
|
|
|
|
6,618,000
|
|
|
|
$
|
8,164,000
|
|
|
$
|
8,890,000
|
|
For JDL, we analyze revenue by customer group, which is as follows for the three months ended March 31, 2020 and 2019:
|
|
JDL Revenue by Customer Group
|
|
|
|
Three Months Ended March 31
|
|
|
|
2020
|
|
|
2019
|
|
Education
|
|
$
|
93,000
|
|
|
$
|
1,473,000
|
|
Healthcare and commercial clients
|
|
|
534,000
|
|
|
|
451,000
|
|
CSI IT operations
|
|
|
200,000
|
|
|
|
284,000
|
|
|
|
$
|
827,000
|
|
|
$
|
2,208,000
|
|
The Company does not currently analyze revenue for Net2Edge on a disaggregated basis. Revenues from Net2Edge were $424,000 and $448,000 for the three months ended March 31, 2020 and 2019, respectively.
NOTE 3 – DISCONTINUED OPERATIONS
On March 11, 2020, the Company sold the remainder of its Suttle business lines, including the SoHo, MediaMAX, and SpeedStar brands and inventory as well as working capital, certain capital equipment, intellectual property, and customer relationships to Oldcastle Infrastructure, Inc. (Oldcastle) for $8,000,000, with a working capital adjustment 90 days after close. Oldcastle, a wholly-owned subsidiary of Ireland based CRH PLC, will operate the majority of the acquired Suttle business through its wholly-owned subsidiary, Primex Technologies, Inc. The Company received proceeds of $8,308,000 and recorded a gain on the sale of $2,161,000 in the first quarter of 2020.
Concurrent with the closing of the transaction, the Company and Oldcastle entered into a Transition Services Agreement (TSA) under which Suttle will continue to manufacture products for Oldcastle for up to six months, to ensure seamless supply and quality assurance to the existing customer base. Concurrently with the closing of the transaction and the TSA, the Company and Oldcastle also entered into a lease agreement under which Oldcastle agreed to lease two buildings in Hector, Minnesota, where Suttle had conducted operations. Base rents under the lease agreement range from $6,970 to $7,180 per month. The parties intend to work with Suttle’s existing suppliers to ensure continued support and delivery of all Suttle products during the transition period. The associated assets and liabilities related to this sale were classified as held for sale at December 31, 2019. The presentation of discontinued operations has been retrospectively applied to all prior periods presented.
The assets and liabilities of the discontinued operations that are classified as held for sale are as follows:
|
|
March 31, 2020
|
|
|
December 31, 2019
|
|
|
|
|
|
|
|
|
|
|
Trade accounts receivable
|
|
$
|
—
|
|
|
$
|
2,235,000
|
|
Inventories
|
|
|
—
|
|
|
|
3,009,000
|
|
Other current assets
|
|
|
—
|
|
|
|
93,000
|
|
Total current assets
|
|
$
|
—
|
|
|
$
|
5,337,000
|
|
|
|
|
|
|
|
|
|
|
Property, plant, and equipment
|
|
$
|
—
|
|
|
$
|
883,000
|
|
Total noncurrent assets
|
|
$
|
—
|
|
|
$
|
883,000
|
|
|
|
|
|
|
|
|
|
|
Total assets held for sale
|
|
$
|
—
|
|
|
$
|
6,220,000
|
|
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
—
|
|
|
$
|
1,111,000
|
|
Other accrued liabilities
|
|
|
—
|
|
|
|
82,000
|
|
Total liabilities held for sale
|
|
$
|
—
|
|
|
$
|
1,193,000
|
|
The financial results of the discontinued operations
are as follows:
|
|
|
|
|
|
|
|
|
Three Months Ended March 31
|
|
|
|
2020
|
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
3,025,000
|
|
|
$
|
5,507,000
|
|
Cost of sales
|
|
|
2,050,000
|
|
|
|
3,706,000
|
|
Selling, general and administrative expenses
|
|
|
500,000
|
|
|
|
799,000
|
|
Restructuring expenses
|
|
|
320,000
|
|
|
|
—
|
|
Gain on sale of assets
|
|
|
(2,161,000
|
)
|
|
|
(9,000
|
)
|
Operating income before income taxes
|
|
|
2,316,000
|
|
|
|
1,011,000
|
|
Income tax expense (benefit)
|
|
|
3,000
|
|
|
|
(21,000
|
)
|
Income from discontinued operations
|
|
$
|
2,313,000
|
|
|
$
|
1,032,000
|
|
During the three months ended March 31, 2020, the Company recorded $320,000 in restructuring expense. This consisted of severance and related benefits costs due to the sale of the remainder of Suttle’s business lines and the closure of the plant once the TSA is completed. We expect 2020 restructuring costs to be $1,200,000 including remaining severance and other shut down costs. Any remaining assets will be held for sale at the completion of the TSA. The Company did not make any restructuring charge payments during the first three months of 2020 and had $320,000 in restructuring accruals recorded in accrued compensation and benefits at March 31, 2020 that are expected to be paid during 2020.
NOTE 4 – CASH EQUIVALENTS AND INVESTMENTS
The following tables show the Company’s
cash equivalents and available –for-sale securities’ amortized cost, gross unrealized gains, gross unrealized losses
and fair value by significant investment category recorded as cash and cash equivalents or short- and long-term investments as
of March 31, 2020 and December 31, 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March
31, 2020
|
|
|
|
Amortized
Cost
|
|
|
Gross
Unrealized
Gains
|
|
|
Gross
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
Cash
Equivalents
|
|
|
Short-Term
Investments
|
|
|
Long-Term
Investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money Market funds
|
|
$
|
16,913,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
16,913,000
|
|
|
$
|
16,913,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Subtotal
|
|
|
16,913,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
16,913,000
|
|
|
|
16,913,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Paper
|
|
|
11,316,000
|
|
|
|
1,000
|
|
|
|
(17,000
|
)
|
|
|
11,300,000
|
|
|
|
—
|
|
|
|
11,300,000
|
|
|
|
—
|
|
Convertible Debt
|
|
|
355,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
355,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
355,000
|
|
Subtotal
|
|
|
11,671,000
|
|
|
|
1,000
|
|
|
|
(17,000
|
)
|
|
|
11,655,000
|
|
|
|
—
|
|
|
|
11,300,000
|
|
|
|
355,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
28,584,000
|
|
|
$
|
1,000
|
|
|
$
|
(17,000
|
)
|
|
$
|
28,568,000
|
|
|
$
|
16,913,000
|
|
|
$
|
11,300,000
|
|
|
$
|
355,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2019
|
|
|
|
Amortized
Cost
|
|
|
Gross
Unrealized
Gains
|
|
|
Gross
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
Cash
Equivalents
|
|
|
Short-Term
Investments
|
|
|
Long-Term
Investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money Market funds
|
|
$
|
8,761,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
8,761,000
|
|
|
$
|
8,761,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Subtotal
|
|
|
8,761,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
8,761,000
|
|
|
|
8,761,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Paper
|
|
|
8,695,000
|
|
|
|
—
|
|
|
|
(1,000
|
)
|
|
|
8,694,000
|
|
|
|
—
|
|
|
|
8,694,000
|
|
|
|
—
|
|
Corporate Notes/Bonds
|
|
|
756,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
756,000
|
|
|
|
—
|
|
|
|
756,000
|
|
|
|
—
|
|
Convertible Debt
|
|
|
250,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
250,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
250,000
|
|
Subtotal
|
|
|
9,701,000
|
|
|
|
—
|
|
|
|
(1,000
|
)
|
|
|
9,700,000
|
|
|
|
—
|
|
|
|
9,450,000
|
|
|
|
250,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
18,462,000
|
|
|
$
|
—
|
|
|
$
|
(1,000
|
)
|
|
$
|
18,461,000
|
|
|
$
|
8,761,000
|
|
|
$
|
9,450,000
|
|
|
$
|
250,000
|
|
The Company tests for other than temporary losses on a quarterly basis and has considered the unrealized losses indicated above to be temporary in nature. The Company intends to hold the investments until it can recover the full principal amount and has the ability to do so based on other sources of liquidity. The Company expects such recoveries to occur prior to the contractual maturities. All unrealized losses as of March 31, 2020 were in a continuous loss position of less than twelve months and are not deemed to be other than temporarily impaired as of March 31, 2020.
The following table summarizes the estimated fair value of our investments, designated as available-for-sale and classified by the contractual maturity date of the securities as of March 31, 2020:
|
|
|
|
|
|
|
|
|
Amortized Cost
|
|
|
Estimated Market Value
|
|
|
|
|
|
|
|
|
|
|
Due within one year
|
|
$
|
11,316,000
|
|
|
$
|
11,300,000
|
|
Due after one year through five years
|
|
|
355,000
|
|
|
|
355,000
|
|
|
|
$
|
11,671,000
|
|
|
$
|
11,655,000
|
|
The Company did not recognize any gross realized gains or losses during either of the three-month periods ending March 31, 2020 and 2019, respectively. If the Company had realized gains or losses, they would be included within investment and other income in the accompanying condensed consolidated statement of income and comprehensive income.
NOTE 5 - STOCK-BASED COMPENSATION
Employee Stock Purchase Plan
Under the Company’s Employee Stock Purchase Plan (ESPP), employees are able to acquire shares of common stock at 85% of the price at the end of each current quarterly plan term. The most recent term ended March 31, 2020. The ESPP is considered compensatory under current Internal Revenue Service rules. At March 31, 2020, after giving effect to the shares issued as of that date, 85,573 shares remain available for future issuance under the ESPP.
2011 Executive Incentive Compensation Plan
On March 28, 2011 the Board adopted and on May 19, 2011 the Company’s shareholders approved the Company’s 2011 Executive Incentive Compensation Plan (2011 Incentive Plan). The 2011 Incentive Plan authorizes incentive awards to officers, key employees and non-employee directors in the form of options (incentive and non-qualified), stock appreciation rights, restricted stock, restricted stock units, performance stock units (deferred stock), performance cash units, and other awards in stock, cash, or a combination of stock and cash. The 2011 Incentive Plan, as amended, allows the issuance of up to 2,500,000 shares of common stock.
At March 31, 2020, 411,664 shares have been issued under the 2011 Incentive Plan, 1,298,156 shares are subject to currently outstanding options, deferred stock awards, and unvested restricted stock units, and 790,180 shares are eligible for grant under future awards.
Stock Option Plan for Directors
Shares of common stock are reserved for issuance to non-employee directors under options granted by the Company prior to 2011 under its Stock Option Plan for Non-Employee Directors (the Director Plan). Under the Director Plan nonqualified stock options to acquire shares of common stock were automatically granted to each non-employee director concurrent with annual meetings of shareholders in 2010 and earlier years, with the exercise price of options granted being the fair market value of the common stock on the date of the respective shareholder meetings. Options granted under the Director Plan expire 10 years from date of grant. No options have been granted under the Director Plan since 2011 when the Company amended the Director Plan to prohibit future option grants. As of March 31, 2020, there were 18,000 shares subject to outstanding options under the Director Plan.
Changes in Stock Options Outstanding
The following table summarizes changes in the number of outstanding stock options under the 2011 Incentive Plan and the Director Plan over the period December 31, 2019 to March 31, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average
|
|
|
|
|
|
|
|
Weighted average
|
|
|
remaining
|
|
|
|
|
|
|
|
exercise price
|
|
|
contractual term
|
|
|
|
|
Options
|
|
|
per share
|
|
|
in years
|
|
Outstanding – December 31, 2019
|
|
|
|
1,130,472
|
|
|
$
|
7.28
|
|
|
|
3.48
|
|
Awarded
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Exercised
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Forfeited
|
|
|
|
(28,369
|
)
|
|
|
10.66
|
|
|
|
|
|
Outstanding – March 31, 2020
|
|
|
|
1,102,103
|
|
|
|
7.20
|
|
|
|
3.31
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2020
|
|
|
|
922,192
|
|
|
$
|
7.93
|
|
|
|
2.94
|
|
Expected to vest March 31, 2020
|
|
|
|
1,102,103
|
|
|
|
7.20
|
|
|
|
3.31
|
|
The aggregate intrinsic value of all options (the amount by which the market price of the stock on the last day of the period exceeded the market price of the stock on the date of grant) outstanding at March 31, 2020 was $400,000. The intrinsic value of all options exercised during the three months ended March 31, 2020 was $0. Net cash proceeds from the exercise of all stock options were $0 in each of the three-month periods ended March 31, 2020 and 2019.
Changes in Deferred Stock Outstanding
The following table summarizes the changes in the number of deferred stock shares under the 2011 Incentive Plan over the period December 31, 2019 to March 31, 2020:
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
|
Grant Date
|
|
|
|
Shares
|
|
|
Fair Value
|
|
Outstanding – December 31, 2019
|
|
|
321,227
|
|
|
$
|
3.37
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
Vested
|
|
|
(46,584
|
)
|
|
|
2.64
|
|
Forfeited
|
|
|
(60,590
|
)
|
|
|
4.40
|
|
Outstanding – March 31, 2020
|
|
|
214,053
|
|
|
|
3.24
|
|
Compensation Expense
Share-based compensation expense recognized for the three months ended March 31, 2020 was $79,000 before income taxes and $63,000 after income taxes. Share-based compensation expense recognized for the three months ended March 31, 2019 was $70,000 before income taxes and $55,000 after income taxes. Unrecognized compensation expense for the Company’s plans was $235,000 at March 31, 2020 and is expected to be recognized over a weighted-average period of 1.8 years. Share-based compensation expense is recorded as a part of selling, general and administrative expenses.
NOTE 6 - INVENTORIES
Inventories summarized below are priced at the lower of first-in, first-out cost or net realizable value:
|
|
|
|
|
|
|
|
|
March
31
|
|
|
December
31
|
|
|
|
2020
|
|
|
2019
|
|
Finished goods
|
|
$
|
6,776,000
|
|
|
$
|
6,728,000
|
|
Raw and processed materials
|
|
|
1,314,000
|
|
|
|
1,803,000
|
|
|
|
$
|
8,090,000
|
|
|
$
|
8,531,000
|
|
NOTE 7 – CONTINGENCIES
In the ordinary course of business, the Company is exposed to legal actions and claims and incurs costs to defend against these actions and claims. Company management is not aware of any outstanding or pending legal actions or claims that could materially affect the Company’s financial position or results of operations.
NOTE 8 – DEBT
Line of Credit
The Company has a $15,000,000 line of credit from Wells Fargo Bank, N.A. The Company had no outstanding borrowings against the line of credit at March 31, 2020 or December 31, 2019. Due to the revolving nature of loans under our credit facility, additional borrowings and periodic repayments and re-borrowings may be made until the maturity date. The total amount available for borrowings under our credit facility at March 31, 2020 was $3,875,000, based on the borrowing base calculation. Interest on borrowings on the credit line is at LIBOR plus 2.0% (3.0% at March 31, 2020). The credit agreement expires August 12, 2021 and is secured by assets of the Company. Our credit agreement contains financial covenants including a minimum liquidity balance of $10,000,000. Liquidity is calculated as the sum of unrestricted cash, marketable securities and the availability on the line of credit. The Company was in compliance with its financial covenants at March 31, 2020.
NOTE 9 – INCOME TAXES
In the preparation of the Company’s consolidated financial statements, management calculates income taxes based upon the estimated effective rate applicable to operating results for the full fiscal year. This includes estimating the current tax liability as well as assessing differences resulting from different treatment of items for tax and book accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded on the balance sheet. Management analyzes these assets and liabilities regularly and assesses the likelihood that deferred tax assets will be recovered from future taxable income.
At March 31, 2020 there was $131,000 of net uncertain tax benefit positions that would reduce the effective income tax rate if recognized. The Company records interest and penalties related to income taxes as income tax expense in the condensed consolidated statements of income (loss) and comprehensive income (loss).
The Company is subject to U.S. federal income tax as well as income tax of multiple state and foreign jurisdictions. The tax years 2016-2019 remain open to examination by the Internal Revenue Service and the years 2015-2019 remain open to examination by various state tax departments. The tax years from 2016-2018 remain open in Costa Rica.
The Company’s effective income tax rate was 0.5% for the first three months of 2020. The effective tax rate differs from the federal tax rate of 21% due to state income taxes, foreign tax rate differences, foreign losses not deductible for U.S. income tax purposes, the effect of uncertain income tax positions, stock compensation windfalls and changes in valuation allowances related to deferred tax assets. The foreign operating losses may ultimately be deductible in the countries in which they occurred; however, the Company has not recorded a deferred tax asset for these losses due to uncertainty regarding the eventual realization of the benefit. The effect of the foreign operations was an overall rate decrease of approximately (10.1%) for the three months ended March 31, 2020. There were no additional uncertain tax positions identified in the first quarter of 2020. The Company’s effective income tax rate for the three months ended March 31, 2019 was 0.5%, and differed from the federal tax rate due to state income taxes, foreign tax rate differences, foreign losses not deductible for U.S. income tax purposes, changes in the reserve for uncertain income tax positions, provisions for interest charges for uncertain income tax positions, stock compensation shortfalls and changes in valuation allowances related to deferred tax assets.
NOTE 10 – SEGMENT INFORMATION
The Company classifies its remaining businesses into three segments as follows:
|
●
|
Transition Networks designs, develops and sells Intelligent Edge solutions that provide connectivity and power through PoE products and actionable intelligence to end devices in an IoT ecosystem through embedded and cloud-based management software. Transition Networks continues to generate revenue from its traditional products consisting of, media converters, NICs, and Ethernet switches that offer the ability to affordably integrate the benefits of fiber optics into any data network;
|
|
●
|
JDL Technologies provides technology solutions that address prevalent IT challenges, including virtualization and cloud solutions, managed services, wired and wireless network design and implementation, and converged infrastructure configuration and deployment; and
|
|
●
|
Net2Edge designs, develops, and sells edge network access products, TDM over IP and other circuit emulation solutions, along with specialized cloud-based software solutions, primarily within the telecommunications market.
|
Management has chosen to organize the Company and disclose reportable segments based on our products and services. Intersegment revenues are eliminated upon consolidation. Other includes non-allocated corporate overhead costs. As a result of our treatment of Suttle as discontinued operations, Other includes amounts previously allocated to Suttle that do not meet the criteria to be included in income from discontinued operations.
Information concerning the Company’s continuing operations in the various segments for the three month periods ended March 31, 2020 and 2019 are as follows:
|
|
Transition
|
|
|
JDL
|
|
|
|
|
|
|
|
|
Intersegment
|
|
|
|
|
|
|
Networks
|
|
|
Technologies
|
|
|
Net2Edge
|
|
|
Other
|
|
|
Eliminations
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
8,164,000
|
|
|
$
|
827,000
|
|
|
$
|
424,000
|
|
|
$
|
—
|
|
|
$
|
(252,000
|
)
|
|
$
|
9,163,000
|
|
Cost of sales
|
|
|
4,604,000
|
|
|
|
620,000
|
|
|
|
214,000
|
|
|
|
—
|
|
|
|
(12,000
|
)
|
|
|
5,426,000
|
|
Gross profit
|
|
|
3,560,000
|
|
|
|
207,000
|
|
|
|
210,000
|
|
|
|
—
|
|
|
|
(240,000
|
)
|
|
|
3,737,000
|
|
Selling,
general and administrative expenses
|
|
|
3,344,000
|
|
|
|
328,000
|
|
|
|
593,000
|
|
|
|
936,000
|
|
|
|
(240,000
|
)
|
|
|
4,961,000
|
|
Operating income (loss)
|
|
|
216,000
|
|
|
|
(121,000
|
)
|
|
|
(383,000
|
)
|
|
|
(936,000
|
)
|
|
|
—
|
|
|
|
(1,224,000
|
)
|
Other income
|
|
|
—
|
|
|
|
—
|
|
|
|
14,000
|
|
|
|
397,000
|
|
|
|
—
|
|
|
|
411,000
|
|
Income (loss) before income tax
|
|
$
|
216,000
|
|
|
$
|
(121,000
|
)
|
|
$
|
(369,000
|
)
|
|
$
|
(539,000
|
)
|
|
$
|
—
|
|
|
$
|
(813,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
$
|
54,000
|
|
|
$
|
13,000
|
|
|
$
|
17,000
|
|
|
$
|
127,000
|
|
|
$
|
—
|
|
|
$
|
211,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
$
|
41,000
|
|
|
$
|
—
|
|
|
$
|
2,000
|
|
|
$
|
14,000
|
|
|
$
|
—
|
|
|
$
|
57,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
$
|
13,087,000
|
|
|
$
|
1,394,000
|
|
|
$
|
2,578,000
|
|
|
$
|
39,807,000
|
|
|
$
|
(27,000
|
)
|
|
$
|
56,839,000
|
|
|
|
Transition
|
|
|
JDL
|
|
|
|
|
|
|
|
|
Intersegment
|
|
|
|
|
|
|
Networks
|
|
|
Technologies
|
|
|
Net2Edge
|
|
|
Other
|
|
|
Eliminations
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
8,890,000
|
|
|
$
|
2,208,000
|
|
|
$
|
448,000
|
|
|
$
|
—
|
|
|
$
|
(330,000
|
)
|
|
$
|
11,216,000
|
|
Cost of sales
|
|
|
5,136,000
|
|
|
|
1,341,000
|
|
|
|
227,000
|
|
|
|
—
|
|
|
|
(114,000
|
)
|
|
|
6,590,000
|
|
Gross profit
|
|
|
3,754,000
|
|
|
|
867,000
|
|
|
|
221,000
|
|
|
|
—
|
|
|
|
(216,000
|
)
|
|
|
4,626,000
|
|
Selling,
general and administrative expenses
|
|
|
3,695,000
|
|
|
|
376,000
|
|
|
|
748,000
|
|
|
|
844,000
|
|
|
|
(216,000
|
)
|
|
|
5,447,000
|
|
Operating (loss) income
|
|
|
59,000
|
|
|
|
491,000
|
|
|
|
(527,000
|
)
|
|
|
(844,000
|
)
|
|
|
—
|
|
|
|
(821,000
|
)
|
Other income (expense)
|
|
|
—
|
|
|
|
(10,000
|
)
|
|
|
(1,000
|
)
|
|
|
36,000
|
|
|
|
—
|
|
|
|
25,000
|
|
Income (loss) before income tax
|
|
$
|
59,000
|
|
|
$
|
481,000
|
|
|
$
|
(528,000
|
)
|
|
$
|
(808,000
|
)
|
|
$
|
—
|
|
|
$
|
(796,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
$
|
79,000
|
|
|
$
|
28,000
|
|
|
$
|
20,000
|
|
|
$
|
152,000
|
|
|
$
|
—
|
|
|
$
|
279,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
$
|
—
|
|
|
$
|
36,000
|
|
|
$
|
7,000
|
|
|
$
|
167,000
|
|
|
$
|
—
|
|
|
$
|
210,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
$
|
17,668,000
|
|
|
$
|
3,814,000
|
|
|
$
|
2,863,000
|
|
|
$
|
27,873,000
|
|
|
$
|
(27,000
|
)
|
|
$
|
52,191,000
|
|
NOTE 11 – NET INCOME (LOSS) PER SHARE
Basic net income (loss) per common share is based on the weighted average number of common shares outstanding during each period and year. Diluted net income per common share takes into effect the dilutive effect of potential common shares outstanding. The Company’s only potential common shares outstanding are stock options and shares associated with the long-term incentive compensation plans, which resulted in a dilutive effect of 179,709 and 0 for the three months ended March 31, 2020 and 2019, respectively. The Company calculates the dilutive effect of outstanding options using the treasury stock method. Options totaling 632,114 and 1,311,090 were excluded from the calculation of diluted earnings per share for the three months ended March 31, 2020 and 2019, respectively because the exercise price was greater than the average market price of common stock during the period and deferred stock awards totaling 117,688 and 216,929 shares would not have been included for the three months ended March 31, 2020 and 2019, respectively, because of unmet performance conditions.
NOTE 12 – FAIR VALUE MEASUREMENTS
The accounting guidance establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
Level 1 – Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in active markets that the Company has the ability to access at the measurement date.
Level 2 – Observable inputs such as quoted prices for similar instruments and quoted prices in markets that are not active, and inputs that are directly observable or can be corroborated by observable market data. The types of assets and liabilities included in Level 2 are typically either comparable to actively traded securities or contracts, such as treasury securities with pricing interpolated from recent trades of similar securities, or priced with models using highly observable inputs, such as commodity options priced using observable forward prices and volatilities.
Level 3 – Significant inputs to pricing that have little or no observability as of the reporting date. The types of assets and liabilities included in Level 3 are those with inputs requiring significant management judgment or estimation, such as the complex and subjective models and forecasts used to determine the fair value of financial instruments.
Financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2020 and December 31, 2019, are summarized below:
|
|
March 31, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money Market Funds
|
|
$
|
16,913,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
16,913,000
|
|
Subtotal
|
|
|
16,913,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
16,913,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Paper
|
|
|
—
|
|
|
|
11,300,000
|
|
|
|
—
|
|
|
|
11,300,000
|
|
Subtotal
|
|
|
—
|
|
|
|
11,300,000
|
|
|
|
—
|
|
|
|
11,300,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible debt
|
|
|
—
|
|
|
|
—
|
|
|
|
355,000
|
|
|
|
355,000
|
|
Subtotal
|
|
|
—
|
|
|
|
—
|
|
|
|
355,000
|
|
|
|
355,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
16,913,000
|
|
|
$
|
11,300,000
|
|
|
$
|
355,000
|
|
|
$
|
28,568,000
|
|
|
|
December 31, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money Market Funds
|
|
$
|
8,761,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
8,761,000
|
|
Subtotal
|
|
|
8,761,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
8,761,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Paper
|
|
|
—
|
|
|
|
8,694,000
|
|
|
|
—
|
|
|
|
8,694,000
|
|
Corporate Notes/Bonds
|
|
|
—
|
|
|
|
756,000
|
|
|
|
—
|
|
|
|
756,000
|
|
Subtotal
|
|
|
—
|
|
|
|
9,450,000
|
|
|
|
—
|
|
|
|
9,450,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible debt
|
|
|
—
|
|
|
|
—
|
|
|
|
250,000
|
|
|
|
250,000
|
|
Subtotal
|
|
|
—
|
|
|
|
—
|
|
|
|
250,000
|
|
|
|
250,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
8,761,000
|
|
|
$
|
9,450,000
|
|
|
$
|
250,000
|
|
|
$
|
18,461,000
|
|
We record transfers between levels of the fair value hierarchy, if necessary, at the end of the reporting period. There were no transfers between levels during the three months ended March 31, 2020.
NOTE 13 – GENERAL COMMITMENTS
On August 2, 2018, the Company entered into a purchase agreement with Launch Properties, LLC for the sale of the Company’s building located at 10900 Red Circle Drive, Minnetonka, MN for $10,000,000. The building currently includes the Company’s corporate administrative offices, as well as some operations for Transition Networks and JDL Technologies. The closing of the transaction is subject to several closing conditions, including the buyer’s ability to complete due diligence within 180 days and the buyer’s ability to obtain regulatory approval for its intended use of the property. The original due diligence period lapsed on January 29, 2019, and through two amendments to the original agreement, the due diligence period has been extended to June 30, 2020, and the buyer has met certain required obligations under these amendments. One of the conditions of the agreement and amendments included non-refundable deposits into an escrow account. As of March 31, 2020, the balance within this escrow account was $225,000 and is included within restricted cash within the condensed consolidated balance sheet. If the sale proceeds, the Company currently expects the transaction to close in early 2021.
NOTE 14 – RECENT ACCOUNTING PRONOUNCEMENTS
In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes, which, as part of its Simplification Initiative to reduce the cost and complexity in accounting for income taxes, removes certain exceptions related to the approach for intra-period tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. ASU 2019-12 also amends other aspects of the guidance to help simplify and promote consistent application of GAAP. The guidance is effective for interim and annual periods beginning after December 15, 2020, with early adoption permitted. The Company adopted this standard during the first quarter of 2020 with an immaterial impact to our consolidated financial statements.
In June 2016, FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. The amendments in this update replace the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses. This ASU is intended to provide financial statement users with more decision-useful information about the expected credit losses and is effective for annual periods and interim periods for those annual periods beginning after December 15, 2022, which for us is the first quarter ending March 31, 2023. Entities may early adopt beginning after December 15, 2018. We are currently evaluating the impact of the adoption of ASU 2016-13 on our consolidated financial statements.
NOTE 15 – SUBSEQUENT EVENTS
The Company has evaluated subsequent events through the date of this filing. In April 2020, the Company made an $899,000 investment in Quortus Ltd., a UK-based company that provides virtual core network software for Private LTE solutions for critical and secure communications. The Company believes this investment is important for its Transition Networks and Net2Edge business segments as they have begun exploring partnering with Quortus to integrate their Private LTE core in existing and new products for the Company’s federal business, network extensions, and private networks for enterprises.
On May 14, 2020, the Company completed the acquisition
of Ecessa Corporation (Ecessa) in a reverse triangular merger for $4.0 million with working capital adjustments
90 days after closing. At the closing, Ecessa became a wholly owned subsidiary of CSI. Based in Plymouth, Minnesota, Ecessa designs
and distributes software-defined wide area networking (SD-WAN) solutions for businesses through the deployment of field installations
of Ecessa Edge®, PowerLink®, and WANworX® controllers.