Pineapple Energy (PEGY) - 2020 Q4 - Annual Report

Part I Item 1. Business Communications Systems, Inc. (CSI) is strategically shifting towards the residential solar market through a proposed merger with Pineapple Energy, while divesting legacy assets and operating through its Electronics & Software and Services & Support segments Overview and Recent Developments CSI is undergoing a major strategic pivot with a proposed merger with Pineapple Energy, aiming to enter the residential solar market, following the divestiture of its Suttle business and acquisitions to bolster its Services & Support segment - On March 1, 2021, CSI entered a merger agreement with Pineapple Energy LLC, marking a strategic shift into the residential solar energy sector[9] - As part of the merger, CSI plans to dispose of its legacy assets, with proceeds distributed to legacy shareholders as a cash dividend before the merger or via Contingent Value Rights (CVRs) post-merger[12][22] - The company sold its Suttle business in two transactions in 2019 and 2020, with operations now reported as discontinued[23] - CSI acquired Ecessa Corporation on May 14, 2020, for $4.6 million in cash to enhance its SD-WAN offerings[25] - On November 3, 2020, CSI acquired the operating assets of IVDesk for $1.4 million to expand its private cloud services[26] Current Operations and Business Segments CSI's continuing operations are organized into Electronics & Software (E&S) and Services & Support (S&S) segments, focusing on connectivity products and IT managed services, respectively, with varying sales performance in 2020 - The company operates through two primary segments: Electronics & Software (E&S) and Services & Support (S&S)[28][31] Segment Sales Performance (2020 vs. 2019) | Segment | 2020 Sales | 2019 Sales | Change | | :--- | :--- | :--- | :--- | | Electronics & Software (E&S) | $34,496,000 | $47,007,000 | -26.6% | | Services & Support (S&S) | $8,777,000 | $4,741,000 | +85.1% | - The E&S segment manufactures products through contract manufacturers, with 91% of total value in 2020 sourced from TAA compliant countries (Taiwan, U.S., U.K.)[32] - The S&S segment aggressively targets healthcare, education, and commercial business verticals, with a multi-year project for a Florida school district being a significant revenue driver in 2020[46][49] Order Backlog as of March 1 | Segment | 2021 Backlog | 2020 Backlog | | :--- | :--- | :--- | | Electronics & Software | $1,559,000 | $2,813,000 | | Services & Support | $4,333,000 | $1,546,000 | Human Capital and Executive Officers As of March 15, 2021, CSI employed 150 people, primarily in the Electronics & Software segment, with a focus on employee safety during COVID-19 and a new CEO appointed in December 2020 Employee Distribution as of March 15, 2021 | Category | Number of Employees | | :--- | :--- | | Electronics & Software | 92 | | Services & Support | 37 | | Corporate G&A | 21 | | Total | 150 | - The company prioritized employee health and safety in response to COVID-19 by instituting office closures, work-from-home policies, and social distancing for essential on-site staff[59] - Anita Kumar was appointed Chief Executive Officer in December 2020, previously serving as General Manager for Transition Networks, Inc[62] Item 1A. Risk Factors The company faces significant risks related to its proposed merger, intense competition, cybersecurity threats, customer concentration, and ongoing impacts from the COVID-19 pandemic - Significant risks are associated with the planned merger with Pineapple Energy, including obtaining shareholder approval, successfully selling legacy assets, and the ability of the combined company to operate profitably in the residential solar market[64][65] - The company faces intense competition and pricing pressure in its markets, which are characterized by rapid technological change, leading to fluctuating gross margins due to product mix, material costs, and tariffs[64][67][69] - CSI is exposed to cybersecurity risks, including data breaches and system failures, and must comply with data protection regulations like GDPR and CCPA, with non-compliance potentially leading to significant fines and reputational damage[71][73][74] - The business is highly dependent on a small number of customers, with the top ten customers accounting for 74% of net sales in both 2020 and 2019, and two customers representing 19% and 17% of consolidated sales in 2020[79] - The COVID-19 pandemic has caused supply chain and demand disruptions, and is expected to continue to impact logistics and operational costs into 2021[96] Item 2. Properties CSI owns its headquarters in Minnetonka and three buildings in Hector, Minnesota, all currently marketed for sale as part of its strategic shift, while also leasing office space in Florida and the U.K - The company owns a 105,000 sq. ft. building in Minnetonka, MN, which serves as its headquarters and is currently being marketed for sale[103] - Three owned buildings in Hector, MN, totaling 109,000 sq. ft., are also being marketed for sale, with portions leased on a short-term basis related to the Suttle transaction[111] - The company leases office space for its JDL Technologies subsidiary in Florida and its Net2Edge subsidiary in the U.K[111] Item 3. Legal Proceedings The company is subject to ordinary course claims and lawsuits, which management believes will not have a material adverse effect on its operations or liquidity - The company is involved in claims and lawsuits in the ordinary course of business, but management believes these will not have a material adverse effect[105] Part II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on the Nasdaq Capital Market under 'JCS', with details provided on equity compensation plans and a limited stock repurchase activity in Q4 2020 - The company's common stock is traded on the Nasdaq Capital Market under the symbol JCS[108] Equity Compensation Plan Information as of Dec 31, 2020 | Plan Category | Shares to be Issued Upon Exercise | Weighted-Average Exercise Price | Shares Available for Future Issuance | | :--- | :--- | :--- | :--- | | Approved by Security Holders | | | | | 1990 Employee Stock Purchase Plan | 5,647 | $3.88 | 68,843 | | 2011 Executive Incentive Compensation Plan | 1,445,885 | $6.03 | 623,083 | - During the three months ended December 31, 2020, the company repurchased 148 shares at an average price of $4.58, with approximately $341,242 remaining available for repurchases under the announced program as of December 2020[115] Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations In 2020, consolidated sales decreased 16% to $42.6 million, resulting in a net loss from continuing operations of $1.8 million, driven by a sales drop in the Electronics & Software segment partially offset by growth in Services & Support due to acquisitions, with future liquidity tied to planned asset divestitures and the Pineapple merger Results of Operations Consolidated sales fell 16% in 2020 to $42.6 million, primarily due to a 27% drop in the Electronics & Software segment, partially offset by an 85% increase in the Services & Support segment driven by acquisitions, leading to a net loss from continuing operations Consolidated Financial Performance (2020 vs. 2019) | Metric | 2020 | 2019 | | :--- | :--- | :--- | | Consolidated Sales | $42,576,000 | $50,906,000 | | Net (Loss) Income from Continuing Operations | ($1,796,000) | $251,000 | | Diluted EPS from Continuing Operations | ($0.19) | $0.03 | Electronics & Software Sales Breakdown (2020 vs. 2019) | Category | 2020 Sales | 2019 Sales | | :--- | :--- | :--- | | By Region | | | | North America | $29,721,000 | $39,771,000 | | International | $4,775,000 | $7,236,000 | | By Product | | | | Intelligent Edge Solutions | $12,162,000 | $18,442,000 | | Traditional Products | $22,334,000 | $28,565,000 | Services & Support Revenue Breakdown (2020 vs. 2019) | Category | 2020 Revenue | 2019 Revenue | | :--- | :--- | :--- | | By Customer Group | | | | Education | $4,483,000 | $1,926,000 | | Healthcare | $887,000 | $705,000 | | Financial & Other | $2,708,000 | $1,268,000 | | By Revenue Type | | | | Project & Product | $5,120,000 | $2,242,000 | | Services & Support | $3,657,000 | $2,499,000 | - The acquisitions of Ecessa and IVDesk in 2020 contributed $1,260,000 and $401,000 in revenue, respectively, to the Services & Support segment[144] Liquidity and Capital Resources As of December 31, 2020, CSI maintained a strong liquidity position with $21.5 million in cash and investments, despite a reversal to cash used in operating activities, with future liquidity significantly influenced by planned asset dispositions and the Pineapple merger Liquidity Position as of December 31 | Metric | 2020 | 2019 | | :--- | :--- | :--- | | Cash, Cash Equivalents & Liquid Investments | $21,457,000 | $24,057,000 | | Working Capital | $28,320,000 | $38,052,000 | - Cash used in operating activities was $4,684,000 in 2020, compared to cash provided by operating activities of $10,231,000 in 2019[157] - The company has a $5.0 million line of credit facility, with no outstanding borrowings at year-end 2020, though a $550,000 letter of credit related to the IVDesk acquisition was outstanding and subsequently paid in March 2021[161][162][163] - Future liquidity plans are tied to the Pineapple merger, including distributing proceeds from asset sales to legacy shareholders and a potential private placement to fund the combined company's growth[165][167] Item 7A. Quantitative and Qualitative Disclosures About Market Risk The company reports no material exposure to market risk, with minimal foreign currency risk due to predominantly U.S. dollar transactions and low-risk investment instruments - The company does not use freestanding derivatives and believes its exposure to market risk is not material[174] - Foreign currency risk is considered small, as the vast majority of transactions are in U.S. dollars, with sales from its U.K. subsidiary representing less than 5% of consolidated net sales in 2020 and 2019[175][177] Item 8. Financial Statements and Supplementary Data This section presents the company's audited consolidated financial statements for 2020 and 2019, including the independent auditor's report highlighting critical audit matters related to intangible asset valuation and impairment testing Report of Independent Registered Public Accounting Firm The independent auditor issued an unqualified opinion on the consolidated financial statements, identifying critical audit matters related to the valuation of acquired intangible assets and goodwill, and the impairment testing of long-lived assets and goodwill - The auditor issued an unqualified opinion, confirming the financial statements conform with U.S. GAAP[183] - A key Critical Audit Matter was the valuation of intangible assets (totaling $2,980,000) and goodwill (totaling $2,086,000) from the Ecessa and IVDesk acquisitions, which involved significant management estimates for future revenues, discount rates, and royalty rates[188][189] - Other CAMs included the impairment testing of long-lived assets and goodwill, which required subjective judgments regarding future cash flow forecasts and the assessment of qualitative factors[191][196][197] Consolidated Financial Statements The consolidated financial statements show a decrease in total assets and liabilities from 2019 to 2020, primarily due to the reclassification and sale of Suttle assets, resulting in a net loss of $172,000 in 2020 compared to a net income of $6.5 million in 2019 Consolidated Balance Sheet Highlights (As of Dec 31) | Account | 2020 | 2019 | | :--- | :--- | :--- | | Total Current Assets | $35,758,253 | $49,401,810 | | Total Assets | $55,556,325 | $59,150,712 | | Total Current Liabilities | $7,437,651 | $11,350,044 | | Total Liabilities | $8,061,598 | $11,758,430 | | Total Stockholders' Equity | $47,494,727 | $47,392,282 | Consolidated Income Statement Highlights (Year Ended Dec 31) | Account | 2020 | 2019 | | :--- | :--- | :--- | | Sales | $42,575,546 | $50,906,179 | | Gross Profit | $17,206,428 | $22,185,812 | | Operating (Loss) Income from Continuing Ops | ($2,697,350) | $9,214 | | Net (Loss) Income from Continuing Ops | ($1,795,674) | $250,619 | | Net Income from Discontinued Ops | $1,624,016 | $6,218,430 | | Net (Loss) Income | ($171,658) | $6,469,049 | Consolidated Cash Flow Highlights (Year Ended Dec 31) | Activity | 2020 | 2019 | | :--- | :--- | :--- | | Net Cash (Used in) Provided by Operating Activities | ($4,683,529) | $10,231,136 | | Net Cash Provided by (Used in) Investing Activities | $3,930,231 | ($5,221,975) | | Net Cash Used in Financing Activities | ($799,868) | ($1,450,114) | Notes to Consolidated Financial Statements The notes provide detailed explanations of accounting policies and financial results, including the sale of the Suttle business, the acquisitions of Ecessa and IVDesk, significant net operating loss carryforwards with a valuation allowance, and high customer concentration - The sale of the remainder of the Suttle business to Oldcastle Infrastructure, Inc. was completed on March 11, 2020, for $8.0 million, resulting in a gain on sale of $2.2 million in 2020, with Suttle's results presented as discontinued operations[249] - The acquisition of Ecessa Corporation for $4.6 million resulted in $1.34 million of goodwill and $2.26 million of identifiable intangible assets, primarily internally developed software and customer relationships[253][254] - The acquisition of IVDesk for $1.4 million resulted in a preliminary allocation of $745,000 to goodwill and $720,000 to intangible assets[255][257] - At December 31, 2020, the company had a federal net operating loss (NOL) carryforward of approximately $10.9 million and a federal capital loss carryforward of $1.9 million, with a valuation allowance of $8.7 million recorded against deferred tax assets[289][290] - In 2020, two E&S customers accounted for 18.7% and 17.3% of consolidated sales, and one S&S customer accounted for 10.3% of consolidated sales, indicating significant customer concentration[296] Item 9A. Controls and Procedures Management concluded that the company's disclosure controls and procedures, as well as internal control over financial reporting, were effective as of December 31, 2020, with no independent auditor attestation report included - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2020[314] - Based on an evaluation using the COSO framework, management concluded that the company's internal control over financial reporting was effective as of December 31, 2020[315] Part III Items 10-14. Directors, Executive Compensation, Security Ownership, and Accountant Fees Information required by Items 10 through 14, covering directors, executive compensation, security ownership, and accountant fees, is incorporated by reference from the Company's 2021 Proxy Materials - Information required by Items 10, 11, 12, 13, and 14 will be set forth in the Company's definitive proxy material for its 2021 Annual Meeting of Shareholders and is incorporated herein by reference[321][325][326][327][329] Part IV Item 15. Exhibits and Financial Statement Schedules This section lists the consolidated financial statements and key exhibits filed with the Form 10-K, including the Pineapple Energy merger agreement and Sarbanes-Oxley certifications, with financial statement schedules omitted as inapplicable - The consolidated financial statements are listed and can be found within the report from pages 31 to 58[332] - Key exhibits filed with the report include the Merger Agreement with Pineapple Energy, the Asset Purchase Agreement for the Suttle business, and the Credit Agreement with Wells Fargo Bank[333] - Certifications by the CEO and CFO pursuant to Sarbanes-Oxley Sections 302 and 906 are filed as exhibits[341]